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Chapter 6
Money Markets
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
2
Chapter Outline
Money market securities
Institutional use of money markets
Valuation of money market securities
Risk of money market securities
Interaction among money market yields
Globalization of money markets
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Money Market Securities
Money market securities:
Have maturities within one year
Are issued by corporations and governments to
obtain short-term funds
Are commonly purchased by corporations and
government agencies that have funds available for a
short-term period
Provide liquidity to investors
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Money Market Securities (cont’d)
Treasury bills:
Are issued by the U.S. Treasury
Are sold weekly through an auction
Have a par value of $1,000
Are attractive to investors because they are backed by
the federal government and are free of default risk
Are liquid
Can be sold in the secondary market through
government security dealers
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Money Market Securities (cont’d)
Treasury bills (cont’d)
Investors in Treasury bills
Depository institutions because T-bills can be easily
liquidated
Other financial institutions in case cash outflows exceed
cash inflows
Individuals with substantial savings for liquidity purposes
Corporations to have easy access to funding for
unanticipated(dung truoc, huong truoc) expenses
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Money Market Securities (cont’d)
Treasury bills (cont’d)
Pricing Treasury bills
The price is dependent on the investor’s required rate of
return:
Treasury bills do not pay interest
To price a T-bill with a maturity less than one year, the
annualized return can be reduced by the fraction of the
year in which funds would be invested
n
m
kP )1/(Par +=
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Computing the Price of a
Treasury Bill
A one-year Treasury bill has a par value of
$10,000. Investors require a return of 8 percent
on the T-bill. What is the price investors would
be willing to pay for this T-bill?
259,9$
)08.1/(000,10$
)1/(Par
=
=
+=
n
m
kP
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Money Market Securities (cont’d)
Treasury bills (cont’d)
Treasury bill auction
Investors submit bids on T-bill applications for the maturity of
their choice
Applications can be obtained from a Federal Reserve district
or branch bank
Financial institutions can submit their bids using the Treasury
Automated Auction Processing System (TAAPS-Link)
Institutions must set up an account with the Treasury
Payments to the Treasury are withdrawn electronically from the
account
Payments received from the Treasury are deposited into the
account
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Money Market Securities (cont’d)
Treasury bills (cont’d)
Treasury bill auction (cont’d)
Weekly auctions include 13-week and 26-week T-bills
4-week T-bills are offered when the Treasury anticipates a
short-term cash deficiency
Cash management bills are also occasionally offered
Investors can submit competitive or noncompetitive bids
The bids of noncompetitive bidders are accepted
The highest competitive bids are accepted
Any bids below the cutoff are not accepted
Since 1998, the lowest competitive bid is the price applied to
all competitive and noncompetitive bids
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Money Market Securities (cont’d)
Treasury bills (cont’d)
Estimating the yield
T-bills are sold at a discount from par value
The yield is influenced by the difference between the
selling price and the purchase price
If a newly-issued T-bill is purchased and held until
maturity, the yield is based on the difference between par
value and the purchase price
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Chapter 6
Money Markets
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2 006 by South-Western, a division. ©2 006 by South-Western, a division of Thomson Learning. All rights reserved.
2
Chapter Outline
Money market securities
Institutional use of money markets
Valuation
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