Money Markets
Based on slides for
Financial Markets and Institutions
by Mishkin and Eakins
Money Markets Defined:
Money Markets defined
1. Are usually sold in large denominations (USD1mn and above)
2. They have low default risk
3. They mature in one year or less from their issue date
The term “money market” is a misnomer. Money (currency) is not
actually traded in the money markets. Securities in money markets are
short term with high liquidity; therefore, they are close to being money
Why Do We Need Money Markets?
In theory; the banking industry should handle the needs for short-term loans
and accept short-term deposits
Banks also have an information advantage on the credit-worthiness of participants
Banks do mediate between savers and borrowers;
however, they are heavily regulated
This creates a distinct cost advantage for money markets over banks
Reserve requirements create additional expense for banks that money
markets do not have
3-month T-bill rates and
Interest Rate Ceilings
Regulations on the level of interest banks could offer depositors lead to
a significant growth in money markets
When interest rates rose, depositors moved their money from banks to
money markets to earn a higher interest rate
Even today, the
cost structure of
banks limits their
competitiveness to
situations where
their informational
advantages
outweighs their
regulatory costs
The Purpose of Money Markets
Investors in Money Market
Provides a place for warehousing surplus funds for short periods of
time
Borrowers from money market
provide low-cost source of temporary funds
Corporations and U.S. government use these markets because
the timing of cash inflows and outflows are not well synchronized
Money markets provide a way to solve these cash-timing problems
Who Participates in the Money Markets?
Money Market Instruments
Treasury Bills
Federal Funds
Repurchase Agreements
Negotiable Certificates of Deposit
Commercial Paper
Eurodollars
Money Market Instruments:
Treasury Bills
Discounted instruments with maturities up to to 12- months
i.e. Investor pays less for the security than it will be worth when it
matures; the increase in price provides a return
Common in short-term securities as they often mature before the
issuer can mail out interest checks
Treasury Bill Auctions (US)
T-bills are auctioned to the dealers every Thursday in the U.S.
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
Treasury may accept both competitive and noncompetitive bids
Noncompetitive bidders indicate quantity desired and agree to pay the
auction rate on winning competitive bids; get preferential allocation
The price everyone pays is the highest yield to any accepted bid
Money Market Instruments:
Treasury Bill Auctions Example
The Treasury auctioned 2.5 billion (USD or LKR) par value 91-day T-
bills, the following bids were received:
Bidder Bid Amount (USD or LKR) Bid Price (USD or LKR)
A 500 million 0.9940
B 750 million 0.9901
C 1.5 billion 0.9925
D 1 billion 0.9936
E 600 million 0.9939
1. Assuming the US auction process, if the Treasury also received $750
million in noncompetitive bids. Who will receive T-bills, what quantity,
and at what price?
2. Assuming TBill auction in Sri Lanka how would your answer to the above
change (i.e. who will receive T-bills, what quantity, and at what price)?
1. Calculate the weighted average price and published yield by the CBSL
Treasury
Bill
Primary
Market in
Sri Lanka
Source: www.cbsl.gov.lk
Authorized Primary Dealers by CBSL
1. Acuity Securities Limited
As at 13/07/2015
2. Bank of Ceylon (Primary Dealer Unit)
3. Capital Alliance Ltd.
4. Commercial Bank of Ceylon PLC (Primary Dealer Unit )
5. Entrust Securities PLC.
6. First Capital Treasuries Ltd.
7. The Hongkong and Shanghai Banking Corporation Ltd
8. NatWealth Securities Ltd.
9. NSB Fund Management Co. Ltd.
10. Pan Asia Banking Corporation PLC
11. Perpetual Treasuries Ltd
12. People's Bank (Primary Dealer Unit)
13. Sampath Bank PLC (Primary Dealer Unit)
14. Seylan Bank PLC (Primary Dealer Unit)
15. Wealth Trust Securities Ltd
16. Union Bank of Colombo PLC
Treasury Bill
Primary
Market in Sri
Lanka
Example of ISIN number:
LKA 182 17 F 30 5
T Bill Market in Sri Lanka
Treasury securities are sold through primary auction conducted
by the Central Bank on behalf of the Treasury.
T-Bill auction is held weekly and T-bond auction is held 3 or 4
times a month.
Primary dealers are allowed to submit their bids through the
electronic network system by 11:00 AM on auction day
Minimum amount of bid: Rs. 5,000,000
Must be in multiples of Rs. 1,000,000 beyond the minimum bid
Bids are accepted in the descending order, i.e., from the
highest to the lowest price so as to maximize proceeds to the
government
Bids are accepted up to an amount determined by the CBSL
The CBSL publishes the weighted average yield of all bids
accepted at the auction
Main Features of Treasury Bills (Source: www.cbsl.lk)
Issuer Democratic Socialist Republic of Sri Lanka
Tenor 91, 182 and 364 Days
Currency Sri Lanka Rupees (LKR)
Issuance Method Auction basis
Auction system Through competitive bidding price
Bidding at Auctions By Primary Dealers
Eligible Investors Sri Lankan Citizens (No restriction on purchase of bills)
12.5% of the total conventional Treasury Bills outstanding is
available for foreign investors
Interest Payment Bills are issued on a discount basis with payment of interest
up - front
Minimum Amount of a Rupees five million (Rs. 5,000,000/=) and in multiples of
Bid at Auction Rupees one million (Rs. 1,000,000/=)
Method of Sale in the Offered weekly via competitive auctions to primary dealers
Primary Market on multiple price bases.
Interest Rate Market determined
Redemption Face value of the bill will be paid at maturity
Taxation 10% withholding tax on interest income collected at the
primary issue. No stamp duty.
Secondary Market Through Primary Dealers or Licensed Commercial Banks
Trading
Pricing Treasury Bills
US uses a 360 day convention
28 day, 91 day, 182 day securities are auctioned
Price = Face Value / (1 + rate*days to maturity /360)
Sri Lanka uses a 364 day convention
91 day, 182 day, 364 day securities are auctioned
In general Auction is held Wednesday and securities are
issued and cash settlement takes place on Friday
Maturities will fall on Friday
Price = Face Value / (1 + rate*days to maturity /364)
Sri Lanka plans Treasuries auctions
with non-competitive bids
Nov 30, 2016 11:24 AM GMT+0530 | 0 Comment(s)
ECONOMYNEXT - Sri Lanka is planning to revamp its Treasuries auctions with room for non-competitive bids,
with new rules, which are now being vetted by international experts, a top official said. Central Bank Governor
Indrajith Coomaraswamy said the new rules will also be presented to market participants and other
stakeholders including the government to comment …
… Non-competitive bids
Rules for a new auction process has also been devised with the participation only of bureaucrats up to now.
"The central bank's public debt department, had consulted all the officials who worked in the public debt area in
developing a new set of auction rules," Coomaraswamy said.
"The outcome of the process has been shared with experts from the World Bank, the IMF who are looking at it.
We want to get validation of this system before we go live with it. We hope to do so in the first quarter of
2017.“ Coomaraswamy said there were plans to consult market participants and other stake holders including
the government.
"It is apparent that the level of market development is not sufficient to sustain a pure auction system so we are
looking at a hybrid system of competitive and non-competitive bidding," he said. "Once the system has been
validated by international experts we will then consult all the stakeholders and go live with it.“ Allowing non-
competitive bids is does not necessarily have anything to do with the level of market development, analysts
say.
In some markets non-competitive bids are used to allow smaller investors to participate directly in auctions.
Even in the US, where single price auctions are used, arguably the most advanced and liquid Treasuries market,
non-competitive bids are used. In the US, competitive bidding by a single investor is limited to 35 percent of the
total offering.
In Sri Lanka non-competitive bids had been suggested as a way to stop the Employees Provident Fund (EPF),
from being pressured to bid low, a long-term problem associated with so-called 'captive funds' where ordinary
people's wealth is expropriated by the state.
Central Bank officials said investors who submit non-competitive bids will be allocated at the 'weighted average'
yield, seemingly indicating that the new auctions also involve multiple price auctions. (Colombo/Nov30/2016)
Money Market Instruments:
Fed Funds
Short-term funds transferred (loaned or borrowed) between financial
institutions, usually for a period of one day
Used by banks to meet short-term needs to meet reserve
requirements
Federal Funds rate
the interest rate for borrowing
fed funds
a focus or target rate in the
conduct of monetary policy
Federal Funds Yields
single-payment loans
Fed fund transactions take the
form of short-term (mostly
overnight) unsecured loans
Money Market Instruments: Repurchase
Agreements
These work similar to the market for fed funds, but nonbanks
can participate
A firm sells Treasury securities, but agrees to buy them back at
a certain date (usually short term) for a certain price
This set-up makes a repo agreements essentially a short-term
collateralized loan
This is one market that may be used to conduct its monetary
policy, whereby the Fed / Central Banks purchases/sells
Treasury securities in the repo market
Money Market Instruments: Negotiable
Certificates of Deposit
A bank-issued security that documents a deposit and specifies
the interest rate and the maturity date
Denominations range from $100,000 to $10 million
Negotiable in the secondary market
Bearer Instrument
Money Market Instruments: Commercial
Paper
Unsecured promissory notes, issued by corporations, that mature
in no more than 365 days in Sri Lanka (270 days in US)
Similar to Treasury Bills, CPs are discount instruments where
Face value will be paid upfront
Value of CP = Face Value / (1 + rate*no of days / 365)
No active secondary market,
however, may be endorsed
and transferred to a third
party
10% withholding tax on
interest income is payable at
the time of issue
Money Market Instruments: Eurodollars
Eurodollars represent Dollar denominated deposits held in foreign
banks
The market is essential since many foreign contracts call for payment
in USD due to the stability of the dollar, relative to other currencies
Birth of the Euro Dollar
The Eurodollar market is one of the most important financial markets, but
oddly enough, it was fathered by the Soviet Union
In the 1950s, the USSR had accumulated large dollar deposits, but all were
in US banks. They feared the US might seize them, but still wanted dollars
So, the USSR transferred the dollars to European banks, creating the
Eurodollar market
Money Market Instruments: Eurodollars
The Eurodollar market has continued to grow rapidly because
depositors receive a higher rate of return on a dollar deposit in the
Eurodollar market than in the domestic market
Multinational banks are not subject to the same regulations restricting U.S.
banks and because they are willing to accept narrower spreads between the
interest paid on deposits and the interest earned on loans
Euro money market instruments
Eurodollar deposits, Eurodollar CDs, Euro notes, Euro CP
Euro Dollar Rates
London interbank bid rate (LIBID)
The rate paid by banks buying funds
London interbank offer rate (LIBOR)
The rate offered for sale of the funds
Time deposits with fixed maturities
Largest short term security in the world
Comparing Money Market Securities : A
comparison of rates
Comparing Money Market Securities: Money
Market Securities and Their Depth
