Deck 10: Introduction to the Money Market and the Roles Played by Governments and Security Dealers

Question 1

According to your text, the windfall profits tax levied by Congress is an example of political risk.

Answer 1

True

Question 2

The market for prime-rate bank loans is a direct competitor with the commercial paper market.

Answer 2

True

Question 3

The risk that an investor will be forced to place earnings from a loan or a security into a lower-yielding investment because interest rates have subsequently fallen is known as:

A) Market risk
B) Reinvestment risk
C) Default risk
D) Inflation risk
E) Currency risk
F) Political risk

Answer 3

Reinvestment risk

Question 4

According to the textbook, money markets of the future will become more:

A) Dominated by banks
B) Security trading oriented
C) Centered around interbank deposit trading
D) Focused on size rather quality
E) None of the above

Question 5

The heart of the international money market is the:

A) Eurocurrency market
B) Commercial paper market
C) Federal funds market
D) Bankers acceptance market
E) None of the above

Question 6

As the U.S. Treasury has shifted its borrowing vehicles more heavily toward longer-term debt issues, the total marketable debt of the US government T-bills has declined from more than one third of the financing to just over

A) 10%
B) 15%
C) 20%
D) 25%
E) None of the above

Question 7

What exactly do you mean by the term money market?

Question 8

Please explain why there is a critical need within the economy and financial system to have money market instruments available to anyone who can afford them?

Question 9

What are the principal goals usually pursued by money market investors?

Question 10

The money market is characterized by very large financial institutions. Who are the principal borrowers and lenders in this market?

Question 11

Define the following:
a. Money or Market risk
b. Default risk
c. Inflation risk
d. Currency risk
e. Political risk
Which of these risks listed above are minimized by purchasing money market instruments? Does investing in the money market avoid all of the foregoing risks?

Question 12

What is the difference between actual maturity and original maturity of a financial asset? Why is this difference important in the money market?

Question 13

How do money markets around the world differ from one another?

Question 14

What are federal funds and how do they differ from clearinghouse funds?

Question 15

Which of these two types of funds - federal funds versus clearinghouse funds - are more important in the money market and why is this so?

Question 16

Please explain why Treasury bills are so popular with investors (savers) all over the world?

Question 17

Why have governments found the Treasury bill such an effective instrument for raising new funds?

Question 18

Please explain how a Treasury bill auction works in the United States. Can you find some advantages stemming from this type of sale?

Question 19

How does the method for determining Treasury bill yields differ from the primary method used to calculate yields on most bonds? Why is this difference important?

Question 20

What is the "normal" or "typical" shape of the yield curve for T-bills? What other shapes have been observed and why do you think these occur?

Question 21

Who are the principal buyers of Treasury bills today? Please make a list of the key factors that you believe motivate these investors to buy bills.

Question 22

Explain why security dealers are essential to promote the smooth functioning of the securities markets and especially the money market.

Question 23

What is a demand loan? How does it help security dealers obtain the financing they need?

Question 24

What is a repurchase agreement or RP? Explain what an RP's role is in financing the operations of security dealers.

Question 25

In what different ways do security dealers generate income and possibly make a profit?

Question 26

To what types of risk is each form or source of dealer income subject? How might a dealer handle these different forms of risk exposure?

Question 27

What causes the positions in securities that dealers hold to change over time?

Question 28

How much interest would be earned (on a simple interest basis) from a three-day money market loan for $1 million at an interest rate of 12 percent (annual rate)? Suppose the loan were extended on the third day for an additional day at the going market rate of 11 percent. How much total interest income would the money-market lender receive?

Question 29

Check the most recent issue of The Wall Street Journal you can find. Calculate the yield spreads in basis points between U.S. Treasury bills of varying maturity, the Federal funds rate and commercial paper, CD and bankers' acceptance rates. How do your calculated yield spreads compare with those shown in Exhibit 10-5? Can you explain the observed differences in yield spreads using your knowledge of the factors explaining movements in interest rates discussed in Chapters 5 through 9.
Refer to the interest rates released by the Federal Reserve on page 113.

Question 30

Suppose the yield spread between the three-month U.S. Treasury bill rate and the three-month bank CD rate were 35 basis points. An investor has $250,000 to invest in either of these instruments for three months. How much does the investor surrender in total interest income for three months if he or she invests in Treasury bills instead of CDs? Does the investor receive any offsetting benefits by buying the bills and not the CDs?

Question 31

From the following sets of figures: (1) calculate the bank discount rate on each T-bill; and (2) convert that rate to the appropriate investment (or coupon-equivalent) yield.

Question 32

Calculate the holding-period yield for the following situations:

Question 33

A dealer in government securities currently holds $875 million in 10-year Treasury bonds and $1,410 million in 6-month Treasury bills. Current yields on the T-bonds average 7.15 percent while 6-month T-bill yields average 3.38 percent. The dealer is currently borrowing $2,300 million through one-week repurchase agreements at an interest rate of 3.20 percent. What is the dealer's expected (annualized) carry income? Suppose that 10-year T-bond rates suddenly rise to 7.30 percent, T-bill rates climb to
5.40 percent and interest rates on comparable maturity RPs increase to 5.55 percent. What will happen to the dealer's expected (annualized) carry income and why? Should this dealer have moved to a long position or a short position before the interest rate change just described? Should the dealer alter his or her borrowing plans in any way? Please explain your answer.

Question 34

A government securities dealer is currently borrowing $25 million from a money-center bank using repurchase agreements based on Treasury bills. If today's RP rate is 6.25 percent, how much in interest will the dealer owe for a 24 hour loan?

Question 35

Suppose that a dealer borrows cash through a $40 million RP from a manufacturing corporation for one day. If the dealer will have to pay $3,500 in interest on this loan, what is the current RP loan rate?

Question 36

An automobile company, NISSAN, has a temporary cash surplus and lends its funds overnight through a repurchase agreement to a government securities dealer, earning $55,600 in interest income when the RP loan rate stood at 5.70%. What was the size of the loan that NISSAN granted to the securities dealer?

Question 37

Ninety-one day Treasury bills carry an investment yield (IR) of 6.25%. What is their purchase price?
What is their discount rate?