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Candan Konat Banking and Finance 16030111063
Chapter 5 Money Markets Questions and Answers
1) What are the three characteristics common to money market securities?
First, money market instruments are generally sold in large denominations (often in units of $1 million to $10 million). Most money market participants want or need to borrow large amounts of cash so that transactions costs are low relative to the interest paid. The size of these initial transactions prohibits most individual investors from investing directly in money market securities. Rather, individuals generally only invest in money market securities indirectly with the help of financial institutions such as money market mutual funds.
Second, money market securities have low default risk; the risk of late or nonpayment of principal and/or interest is generally small. Since cash lent in the money markets must be available for a quick return to the lender, money market instruments can generally be issued only by high quality borrowers with little risk of default.
Finally, money market securities must have an original maturity of one year or less. Recall from Chapter 3 that the longer the maturity of a debt security, the greater is its interest rate risk and the higher its required rate of return (the higher its liquidity risk premium). Given that adverse price movements resulting from interest rate changes are smaller for short term securities, the short term maturity of money market instruments helps lower the risk that interest rate changes will significantly affect the security's market value and price.
2) Describe the T-bill auction process.
Treasury Bills: Treasury bills are the investment securities issued for a short period of time, say less than one year or one year. These are the bonds issued by the government to meet the obligation of payment for their receipts and payments.
The auction process of treasury bills is as follows: Firstly, there is an announcement made regarding the security amount granted, auction date, release date, maturity date. Secondly, the interested bidders can bid the auction prices. Thirdly, the government provides the treasury bills to the selected bidders, and the selected bidders are supposed to pay for the purchase of the treasury bills. The treasury bills can be issued at their face value or at a discounted rate.
4) What are money market securities?
Money market securities are often considered a good place to invest funds that are needed in a shorter time period—usually one year or less. Money market instruments include bankers' acceptances, certificates of deposit and commercial paper. Bankers' acceptances are typically used to finance international transactions in goods and services, while certificates of deposit (CDs) are large-denomination, negotiable time deposits issued by commercial banks and thrift institutions. Commercial paper takes the form of short-term, unsecured promissory notes issued by both financial and non-financial corporations. Some combination of these products makes up a money market fund. All money market funds are required to have a dollar-weighted average portfolio maturity that cannot exceed 90 days. While money market securities are highly liquid (you can usually receive your money in a few days, compared to months or years with a CD), the interest you earn on your money tends to be quite low and may not keep pace with inflation.
