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Lecture Financial markets and institutions: Chapter 5 - Anthony Saunders, Marcia Millon Cornett

Chapter 5 - Money markets. In this chapter, we reviewed money markets, which are markets that trade debt securities with original maturities of one year or less. The need for money markets arises because cash receipts do not always coincide with cash expenditures for individuals, corporations, and government units. Because holding cash involves an opportunity cost, holders of excess cash invest these funds in money market securities. | Chapter Five Money Markets 5- Money Markets Liquid funds flow between short-term borrowers and lenders through money markets Money markets involve debt instruments with original maturities of one year or less Money market debt issued by high-quality (i.e., low default risk) economic units that require short-term funds purchased by economic units that have excess short-term funds Money market instruments have active secondary markets 5- Money Market Yields Some money market instruments are bought and sold on a discount basis (e.g., Treasury bills and commercial paper) Discount yields (idy) use a 360-day year Pf = the face value of the security P0 = the discount price of the security h = the number of days until maturity 5- Money Market Yields Compare discount securities to U.S. Treasury bonds with bond equivalent yields (ibey) Convert bond equivalent yields into effective annual returns (EAR) 5- Money Market Yields Money market securities that pay interest only at maturity use single-payment yields (ispy) (e.g., jumbo CDs and fed funds) since ispy uses a 360 day year, compare to bonds by converting to a 365 day year to convert a single-payment yield to an effective annual return 5- Money Market Instruments Treasury bills (T-bills) Federal funds (fed funds) Repurchase agreements (repos or RP) Commercial paper (CP) Negotiable certificates of deposit (CD) Banker acceptances (BA) 5- Treasury Bills (T-Bills) T-Bills are short-term debt obligations issued by the U.S. government The Federal Reserve buys and sells T-bills to implement monetary policy T-bills are virtually default risk free, are highly liquid, and have little interest rate risk 5- T-Bill Auctions 13- and 26-week T-bills are auctioned weekly Bids are submitted by government securities dealers, financial and nonfinancial corporations, and individuals Bids can be competitive or noncompetitive competitive bids specify the bid price and the desired quantity of T-bills noncompetitive . | Chapter Five Money Markets 5- Money Markets Liquid funds flow between short-term borrowers and lenders through money markets Money markets involve debt instruments with original maturities of one year or less Money market debt issued by high-quality (i.e., low default risk) economic units that require short-term funds purchased by economic units that have excess short-term funds Money market instruments have active secondary markets 5- Money Market Yields Some money market instruments are bought and sold on a discount basis (e.g., Treasury bills and commercial paper) Discount yields (idy) use a 360-day year Pf = the face value of the security P0 = the discount price of the security h = the number of days until maturity 5- Money Market Yields Compare discount securities to U.S. Treasury bonds with bond equivalent yields (ibey) Convert bond equivalent yields into effective annual returns (EAR) 5- Money Market Yields Money market securities that pay interest only at .