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What are the money markets? Who uses them?
Money markets deal in loans & financial assets by which Govt, FIs & companies raise S/T debt finance for working capital or invest surplus funds from overnight - up to a year
How do firms obtain debt funding? What types are traded?
- The securities are ranked by type of issuer, their creditworthiness & general risk associated with investment
- Trade credit (non-marketable part of MM markets) – by suppliers of good & services
- Intercompany loans
Short-term debt financing instruments
- Trade credit
- Bank overdraft
- S/T bank loans
- Direct financing via money markets
Two Types of Short term Money Markets in NZ
- Official S/T money markets - trades in govt. securities
- Non-Govt S/T money market
Official S/T money markets - Treasury bills (T-bills)
- For funding govt expenditure.
- T-bills issued directly in money markets as discount (zerocoupon) instrument as interest included with nominal value (par value) repaid at maturity
- T-bill interest rate regarded as benchmark interest rate
- T- bills first issued in 1969
- Originally sold on tap by NZRB
- Since 1984, sold weekly by tender by NZDMO.
- “On-tap” - govt quoted interest rate - you ordered what you wante
- N = par (principal) of T-bill
- i = yield divided by 100
- n = number of full days from settlement date to maturity
2. Non-Govt short/term money market
- Deals with flows of money in private sector.
- Banks, merchant & investment banks, & brokers channel surplus funds to companies & individuals requiring funding.
- Important function of money market- smoothing out cash flows for banks & corporates
- Securities in S/T debt markets - mostly discount ones. – Issued at discount to face value
Key S/T Debt Instruments- Bills of Exchange
Negotiable instrument maturing within a given time period (usually 1-6 months), sold at a discount to face value which market believes to be the obligation (debt) of a good creditworthy name
Four parties involved (potentially) in Bank-accepted bill issue
Four parties involved (potentially) in Bank-accepted bill issue - (a) Drawer
- Issuer of the bill = company (draws up the bill)
- Wants to borrow the funds= company S/T financing
- Secondary liability for repayment of the bill to holder (after the acceptor)
Four parties involved (potentially) in Bank-accepted bill issue - (b) Acceptor
- Undertakes to repay the face value to the holder of the bill at maturity Acceptor usually a bank or sometimes investment bank
- Gives the bill a high credit status ⇒ easier to sell & at lower yield
- In case of bank, it quickly is repaid funds by drawer
Four parties involved (potentially) in Bank-accepted bill issue - (c) Payee
- The party to whom the bill is specified to be paid
- Usually the drawer, but drawer could select other party as payee e.g. subsidiary of company
Four parties involved (potentially) in Bank-accepted bill issue - (d) Discounter
- The party that purchases the bill in primary money market (supplies the funds-investor)
- Discounts the face value & buys the bill
- The lender of the money
- May also be the acceptor of the bill
Four parties involved (potentially) in Bank-accepted bill issue - (e) Endorser
- (e) Endorser
- Any previous holder of bill but has sold it.
- Has a contingent liability
- Once the bill has been drawn up by issuer & accepted by a bank, it can be sold in the market place to the discounter who provides the funds
Advantage of Bill Finance
- Lower cost than other S/T borrowing forms (i.e. overdraft, loans= indirect finance)
- Lower as direct finance avoids the cost of intermediation
- Borrowing cost (yield) determined at issue date (not affected by subsequent changes in interest rates)
- Term of loan may be extended by ‘roll-over’ at maturity- at new prevailing interest rate
Discount Securities—Calculating Price
Yield not expressed as decimal (i.e. 8.75%)
Discount Securities—Calculating Price Example 1: A large company issues a 90-day bill with face value $100,000 yielding 8.75% p.a. What initial amount will the company raise with this issue?
Example 2: A company needs ongoing S/T funds of 1.5M & a bank agrees to arrange a bank bill facility & issue 90-day bills at current market yields of 7% + 325 basis points for issuing fees. How much will company first raise by issuing directly a bank bill?
Discount Securities—Rediscounting Example 3: A discounter initially buys a 180 day bill with face value $100,000. The bill now has 90 days to maturity & current 90-day bill yields are 7.80% p.a. Calculate the rediscount price(selling price)
Discount Securities—Calculating Face Value
- A company may need to raise a specific amount of funds from a bill issue.
Discount Securities—Calculating Face Value Example 4: A large company needs to raise $500,000 from issue of 60-day bill roll-over facility, at a yield of 8.50%.At what face value will the bill need to be drawn?
Discount Securities — "Yield" definition
Yield is the rate of interest on the amount outlaid to purchase the bill (or other discount instrument)
Discount Securities—Calculating Yield
- If the bill is Sold before maturity, then face value becomes selling price
Discount Securities—Calculating Yield Example 5: A 180 day bill with a face value of $100,000 & sold at $96,000 with 180 days to maturity is yielding:
Discount Securities—Calculating Yield Example 5 continued - 180 day bill with a face value of $100,000 & sold at $96,000 was discounted at 8.449%. After 6 days, the discounter decides to sell for $96,600, what is yield for original discounter?
Discount Securities—Calculating Yield - Example 5 - continued - 180 day bill with a face value of $100,000 & sold at $96,000 was discounted at 8.449%. After 6 days, the discounter decides to sell for $96,600, what is yield for new purchaser who holds it to maturity
Factors influencing bill rates
- On any, day the AUS & NZ money markets will set bill rates.
- Note bank-accepted bills at slightly higher yield than T-bills - About 20 basis points above T-bills
- Expectation of interest rate movements over term of the bill
- The demand & supply of bills in the market.
- The maturity of bills offered.
- The names of the parties of the bill & their status.
Promissory Nortes (P-Notes)
- Discount securities issued by corporations without an acceptor or endorsement
- Issued directly by high credit-rated company (S&P BBB & higher) with face value payable at maturity, but discounted upon issue at current market yield
- Calculation—use discount securities formula
- Issue Programs- overseas usually by CP dealers
For Underwritten P-note Issues
- Guarantees the full issue of notes is sold
- Underwriter usually a commercial bank, investment bank or merchant bank-takes fee about 0.02%
- can incorporate a roll-over facility, effectively extending borrower’s line of credit beyond short-term life of CP-note issue
Negotiable Certificates of Deposit (CDs)
- Short-term discount security issued by banks
- Maturities range up to 180 days (does vary with country)
- Bearer form
- Issue them to manage their liabilities & liquidity
- Usually issued to international institutional investors in wholesale money markets
Investment Bank Cash Advance Facility
- Made to large corporations
- Generally for a term of a number of years but also available short-term Priced at a margin above a reference rate
- Reference rate fixed for short-term loans (up to 180 days) but may be periodically revised for longer-term loan
- Company sells its accounts receivable to a factoring company Converts a future cash flow (receivables) into a current cash flow
- Recourse arrangement: factor has a claim against vendor if a receivable is not paid
- Non-recourse arrangement: factor has no claim against vendor company