2. International Monetary System
It involves the management of three
processes
(I) the adjustment of balance of payments
positions, including the establishment and
alteration of exchange rates;
(2) the financing of payments imbalances
among countries by the use of credit or
reserves; and
(3) the provision of international money
(reserves).
3. International Money Market Instruments
Treasury Bills
Commercial papers
Banker’s acceptance
Certificate of deposits
Repurchase agreements
4. 5-4
Treasury Bills - short-term obligations issued by the U.S.
government
Commercial Paper - short-term unsecured promissory
notes issued by a company to raise short-term cash
Banker Acceptances - time draft payable to seller of
goods, with payment guaranteed by a bank
Negotiable Certificates of Deposit - negotiable bank-
issued time deposit with specified interest rate and maturity
Repurchase Agreements - agreement involving the sale
of securities between parties with a promise to repurchase
the security at a specific date and price
Treasury Bills - short-term obligations issued by the U.S.
government
Commercial Paper - short-term unsecured promissory
notes issued by a company to raise short-term cash
Banker Acceptances - time draft payable to seller of
goods, with payment guaranteed by a bank
Negotiable Certificates of Deposit - negotiable bank-
issued time deposit with specified interest rate and maturity
Repurchase Agreements - agreement involving the sale
of securities between parties with a promise to repurchase
the security at a specific date and price
5. 5-5
Instrument
Treasury bills
Repurchase agreement
Commercial Paper
Negotiable CDs
Banker’s acceptances
Principal Issuer
U.S. Treasury
FRS; Comm banks;
Brokers and dealers;
Other FIs
Comm banks
Other FIs; Corps
Commercial banks
Commercial banks
Principal Investor
FRS; Comm banks;
Brokers and dealers;
Other FIs; Corp’s
FRS, Comm banks
Brokers and dealers
Other FIs, Corp’s
Brokers and dealers
Corporations
Brokers and dealers;
Corps; Other FIs
Comm banks; Corp’s;
Brokers and dealers
6. Methods of calculating yields5-6
• Treasury Bills - discount yield, 360 day basis. Also as bond
equivalent basis using 365 day basis
• Repurchase Agreements - bond equivalent basis, 360 day basis
• Commercial Paper - discount yield, 360 day basis
• Negotiable Certificates of Deposit - discount yield, 360 day
basis
• Banker Acceptances - discount yield, 360 day basis
• Treasury Bills - discount yield, 360 day basis. Also as bond
equivalent basis using 365 day basis
• Repurchase Agreements - bond equivalent basis, 360 day basis
• Commercial Paper - discount yield, 360 day basis
• Negotiable Certificates of Deposit - discount yield, 360 day
basis
• Banker Acceptances - discount yield, 360 day basis
7. Treasury Bill Basics5-7
Issued by the U.S. Treasury to cover
government budget deficits and to refinance
maturing debt
Standard Original Maturities of 13 weeks, 26
weeks, or 52 weeks
Denominations are $1,000 but typical round
lot is $5 million
Virtually default risk free
Issued by the U.S. Treasury to cover
government budget deficits and to refinance
maturing debt
Standard Original Maturities of 13 weeks, 26
weeks, or 52 weeks
Denominations are $1,000 but typical round
lot is $5 million
Virtually default risk free
8. The Auction Process for T-bills
5-8
Amount of new 13-week and 26-week T-bills offered
announced weekly
Bids submitted by government securities dealers,
financial and nonfinancial corporations and
individuals
Individual competitive bidders limited to 35% total
issue size, can submit more than one bid, allocations
made beginning with highest bidder
Noncompetitive bidders indicate quantity desired and
agree to pay a weighted-average of the rate on winning
competitive bids; get preferential allocation
Amount of new 13-week and 26-week T-bills offered
announced weekly
Bids submitted by government securities dealers,
financial and nonfinancial corporations and
individuals
Individual competitive bidders limited to 35% total
issue size, can submit more than one bid, allocations
made beginning with highest bidder
Noncompetitive bidders indicate quantity desired and
agree to pay a weighted-average of the rate on winning
competitive bids; get preferential allocation
9. The Secondary Market for T-bills5-9
The largest of any U.S. money market security
Approximately 30 financial institutions “make” a
market in T-bills by buying and selling securities
for their own accounts and by trading for their
customers, including depository institutions,
insurance companies, pensions funds, etc.
T-bills are the FOMC’s instrument of choice for its
open market operations
The largest of any U.S. money market security
Approximately 30 financial institutions “make” a
market in T-bills by buying and selling securities
for their own accounts and by trading for their
customers, including depository institutions,
insurance companies, pensions funds, etc.
T-bills are the FOMC’s instrument of choice for its
open market operations
10. T-bill Rates and Yields
5-10
No interest paid on T-bills (coupon rate is
zero), issued at a discount from their par (or
face) value
T-bill rates are quoted in Wall Street Journal
Discount Yield
the price dealers are willing to pay T-bill holders to
purchase their T-bills for them
Asked
the discount yield based on the current purchase price set
by dealers that is available to investors
Spread
the percentage difference in the ask and bid yield; part of
transaction cost; the profit for dealers
No interest paid on T-bills (coupon rate is
zero), issued at a discount from their par (or
face) value
T-bill rates are quoted in Wall Street Journal
Discount Yield
the price dealers are willing to pay T-bill holders to
purchase their T-bills for them
Asked
the discount yield based on the current purchase price set
by dealers that is available to investors
Spread
the percentage difference in the ask and bid yield; part of
transaction cost; the profit for dealers
11. Repurchase Agreements (RPs or Repos)5-11
An agreement involving the sale of securities
by one party to another with a promise to
repurchase the securities at a specified price
on a specified date
Essentially a collateralized fed funds loan with
collateral in the form of securities (e.g. T-bills
and Fannie Mae securities)
Reverse repurchase agreement
involves the purchase of securities between parties with
the promise to sell them back at a given date in the
future
An agreement involving the sale of securities
by one party to another with a promise to
repurchase the securities at a specified price
on a specified date
Essentially a collateralized fed funds loan with
collateral in the form of securities (e.g. T-bills
and Fannie Mae securities)
Reverse repurchase agreement
involves the purchase of securities between parties with
the promise to sell them back at a given date in the
future
12. Trading Process for Repurchase
Agreements
5-12
Arranged either directly between two parties or
with the help of brokers and dealers
The repo buyer arranges to purchase T-bills from
the repo seller with an agreement that the seller
will repurchase the T-bills within a stated period
of time
Arranged either directly between two parties or
with the help of brokers and dealers
The repo buyer arranges to purchase T-bills from
the repo seller with an agreement that the seller
will repurchase the T-bills within a stated period
of time
13. Commercial Paper5-13
An unsecured short-term promissory note issued
by a corporation to raise short-term cash, often to
finance working capital requirements
The largest (in terms of dollar value) of the money
market instruments
Generally sold in denominations of $100,000,
$250,000, $500,000 and $1 million with
maturities of 1-270 days (if maturity is greater than
270 days, SEC requires registration)
Generally held until maturity so there is not an
active secondary market
An unsecured short-term promissory note issued
by a corporation to raise short-term cash, often to
finance working capital requirements
The largest (in terms of dollar value) of the money
market instruments
Generally sold in denominations of $100,000,
$250,000, $500,000 and $1 million with
maturities of 1-270 days (if maturity is greater than
270 days, SEC requires registration)
Generally held until maturity so there is not an
active secondary market
14. Trading Process for Commercial
Paper
5-14
CPs are sold either directly to investors (25%) or
indirectly through brokers and dealers such as
investment banks or major bank subsidiaries
Selling through brokers more expensive for issuer
due to underwriting costs
CPs are sold either directly to investors (25%) or
indirectly through brokers and dealers such as
investment banks or major bank subsidiaries
Selling through brokers more expensive for issuer
due to underwriting costs
15. Negotiable Certificates of Deposits5-15
A bank-issued time deposit that specifies an
interest rate and maturity date and is negotiable
in the secondary market
Bearer Instrument
whoever holds the CD when it matures receives the
principal and interest
Denominations range from $100,000 to $10
million; $1 million being the most common
Often purchased by money market mutual funds
with pools of funds from individual investors
A bank-issued time deposit that specifies an
interest rate and maturity date and is negotiable
in the secondary market
Bearer Instrument
whoever holds the CD when it matures receives the
principal and interest
Denominations range from $100,000 to $10
million; $1 million being the most common
Often purchased by money market mutual funds
with pools of funds from individual investors
16. Trading Process for NCDs5-16
Banks issuing NCDs post daily rates for the
more popular maturities and subject to
funding needs, tries to sell to investors who
are likely to hold them as investments rather
than sell them to the secondary market
In some cases, the bank and investor
negotiate the size, rate and maturity
Secondary market consists of a linked
network of approximately 15 brokers and
allows investors to buy existing CD’s rather
than new issues
Banks issuing NCDs post daily rates for the
more popular maturities and subject to
funding needs, tries to sell to investors who
are likely to hold them as investments rather
than sell them to the secondary market
In some cases, the bank and investor
negotiate the size, rate and maturity
Secondary market consists of a linked
network of approximately 15 brokers and
allows investors to buy existing CD’s rather
than new issues
17. Banker’s Acceptances5-17
A time draft payable to a seller of goods with
payment guaranteed by a bank
Arise from international trade transactions and are
used to finance trade in goods that have yet to be
shipped from a foreign exporter (seller) to a
domestic importer (buyer)
Foreign exporters prefer that banks act as
guarantors for payment before sending goods to
importer
A time draft payable to a seller of goods with
payment guaranteed by a bank
Arise from international trade transactions and are
used to finance trade in goods that have yet to be
shipped from a foreign exporter (seller) to a
domestic importer (buyer)
Foreign exporters prefer that banks act as
guarantors for payment before sending goods to
importer
18. International Aspects of Money Markets5-18
While U.S. money markets are the largest, the
international market is growing
U.S. securities bought/sold by foreign investors
foreign money market securities
Euro money market instruments
Eurodollar deposits, Eurodollar CDs, Euro notes, Euro CP
London Interbank Offered Rate (LIBOR)
the rate paid on Eurodollars
While U.S. money markets are the largest, the
international market is growing
U.S. securities bought/sold by foreign investors
foreign money market securities
Euro money market instruments
Eurodollar deposits, Eurodollar CDs, Euro notes, Euro CP
London Interbank Offered Rate (LIBOR)
the rate paid on Eurodollars
