Q1 MONEY MARKET INSTRUMENTS

• FEDERAL FUNDS:
•
– Federal funds, or fed funds, are unsecured loans of reserve balances at Federal Reserve Banks that depository
institutions make to one another. The rate at which these transactions occur is called the fed funds rate.
– The most common duration or term for fed funds transaction is overnight, though longer-term deals are
arranged.
– The Federal Open Market Committee (FOMC) sets a target level for the fed funds rate, which is its primary tool
for implementing monetary policy.
–
–
• CERTIFICATES OF DEPOSITS (CDS):
•
– A CD is a time deposit with a bank entitling the bearer to receive interest. A CD bears a maturity date, a
specified fixed interest rate and can be issued in any denomination.
– CDs are generally issued by commercial banks and are insured by the FDIC (Federal Deposit Insurance
Corporation ). The term of a CD generally ranges from three months to five years.
 Q1 MONEY MARKET INSTRUMENTS
• EURO DOLLAR:
•
– Eurodollars are U.S.-dollar denominated deposits at banks outside of the United States.
– This market evolved in Europe (specifically London), hence the name, but Eurodollars can be held
anywhere outside the United State.


• REPURCHASE AGREEMENT (REPO):

•
– Those who deal in government securities use repos as a form of overnight borrowing. A dealer or
other holder of government securities (usually T-bills) sells the securities to a lender and agrees
to repurchase them at an agreed future date at an agreed price.
– They are usually very short-term, from overnight to 30 days or more. This short-term maturity and
government backing means repos provide lenders with extremely low risk.


• TREASURY BILLS:
•
– Treasury Bills (T-bills) are the most marketable money market security. Their popularity is mainly
due to their simplicity. Essentially, T-bills are a way for government to raise money from the
public.
– T-bills are short-term securities that mature in one year or less from their issue date. They are issued
with three-month, six-month and one-year maturities.
– T-bills are purchased for a price that is less than their par (face) value; when they mature, the
government pays the holder the full par value

•
 Q1 MONEY MARKET INSTRUMENTS
–
• COMMERCIAL PAPER :
•
– Commercial paper is an unsecured, short-term loan issued by a corporation, typically for
financing accounts receivable and inventories. It is usually issued at a discount,
reflecting current market interest rates.
– Maturities on commercial paper are usually no longer than nine months, with maturities
of between one and two months being the average.

• BANKERS ACCEPTANCES:


– A bankers’ acceptance (BA) is a short-term credit investment created by a non-financial firm and guaranteed by
a bank to make payment . Acceptances are traded at discounts from face value in the secondary market.
– For corporations, a BA acts as a negotiable time draft for financing imports, exports or other transactions in
goods. This is especially useful when the creditworthiness of a foreign trade partner is unknown.
–
• DISCOUNT WINDOW:
– This are Credit facilities in which financial institutions go to borrow funds from
the Federal Reserve. These loans, which are priced at the discount rate, are often
structured as secured loans to alleviate pressure in reserve markets.
– It helps to reduce liquidity problems for banks and assists in assuring the basic stability
of financial markets.
 Q2 INTEREST RATE VARIATION
As @ 30/11/2009

YIELD/RATE (%) 52-WEEK CHANGE IN

PCT. PTS
Interest Rate Last Wk Ago High Low 52-Wk 3-Yr
Federal-funds rate target 0-0.25 0.00 1.00 0.00 -1.00 -5.25
Prime rate* 3.25 3.25 4.00 3.25 -0.75 -5.00
Libor, 3-month 0.26 0.26 2.19 0.25 -1.93 -5.10
Money market, annual yield 0.97 1.02 2.40 0.97 -1.43 -2.51
Five-year CD, annual yield 2.59 2.64 3.79 2.59 -1.20 -2.24
30-year mortgage, fixed 5.14 5.09 5.83 5.02 -0.55 -0.57
15-year mortgage, fixed 4.61 4.59 5.56 4.51 -0.95 -0.90
Jumbo mortgages, $417,000-plus 6.02 6.16 7.21 6.02 -1.01 -0.05
Five-year adj mortage (ARM) 4.22 4.36 5.96 4.11 -1.74 -1.38
New-car loan, 48-month 6.79 6.79 7.50 6.57 0.04 -0.14
Home-equity loan, $30,000 5.30 5.29 5.87 5.14 0.13 -1.65
* Base rate posted by 70% of the nation's largest banks.
 Q2. US MONEY MARKET INTEREST RATE VARIATION

U.S. - Prime Rate Charged : Federal Funds Rate Euro-US Dollar Deposits in
By Banks London 3 month (BID)
01/2009 0.19
01/2009 3.25 02/2009 0.20 01/2009 1.52
02/2009 3.25 02/2009 1.67
03/2009 0.17
03/2009 3.25 03/2009 1.62
04/2009 0.17
04/2009 3.25 04/2009 1.42
05/2009 0.17
05/2009 3.25 05/2009 1.27
06/2009 0.24
06/2009 3.25 06/2009 1.06
07/2009 3.25 07/2009 0.15
07/2009 0.76
08/2009 3.25 08/2009 0.16
08/2009 0.56
09/2009 3.25 09/2009 0.12
09/2009 0.56
10/2009 3.25 10/2009 0.11
10/2009 0.46
11/2009 3.25 11/2009 0.11
11/2009 0.46
 Q2 INTEREST RATE VARIATION IN THE US MONEY MARKET
as @30/11/2009

• U.S. - Prime Rate Charged By Banks

– Low 11/2009 = 3.25
– Average 01/2009 - 11/2009 = 3.25
– High 11/2009 = 3.25
–
• Federal Funds Rate
– Low 11/2009= 0.11
– Average 01/2009 - 11/2009= 0.16
– High 06/2009 = 0.24
–
• Euro-US Dollar Deposits in London 3 month (BID)
– Low 11/2009= 0.46
– Average 01/2009 - 11/2009 =1.03
– High 02/2009=1.67
Q3 CHANGING NATURE OF THE WORLD YIELD CURVE
 11/9/2009

Q3 CHANGING NATURE OF THE WORLD YIELD CURVE

12/8/09 12/7/09 11/9/09 9/8/09 12/8/08

Now 1day 1mo 3mos 1yr

3 mo 0.03 0.04 0.07 0.14 0.03

1 yr 0.29 0.32 0.34 0.41 0.53

2 yr 0.73 0.78 0.87 0.93 0.97

3 yr 1.21 1.26 1.40 1.49 1.27

5 yr 2.12 2.19 2.31 2.38 1.76

7 yr 2.90 2.96 3.05 3.13 2.04

10 yr 3.40 3.44 3.52 3.47 2.77

15 yr 4.13 4.15 4.24 4.17 3.50

20 yr 4.28 4.29 4.34 4.24 3.45

25 yr 4.35 4.36 4.39 4.35 3.45

30 yr 4.30 4.31 4.36 4.27 3.50

Q4a. Calculate the interest rate on 1,2,3,4,5,10 and 20 year treasury securities and
plot the yield curve

• r*=2%
•
• MRP=0.2% increase up to 1.0% from year 5 onwards
•
• r1= 2%+7%+0.2%=9.2%
•
• r2=2%+6+0.4%=8.4% *IP2(7+5)/2=6
•
• r3=2%+5+0.6=7.6% *IP3(7+5+3)/3=5
•
•
•

•
 Q4a. Calculate the interest rate on 1,2,3,4,5,10 and 20 year treasury securities and
plot the yield curve

•
• r4=2%+4.5%+0.8%=7.3% *IP4(7+5+3+3)/4=4.5%


• r5=2%+4.2+1.0=7.2% *IP5(7+5+3+3+3)/5=4.2%
•
• r10=2%+3.6%+1.0%=6.6% *IP10(7+5+8(3))/10=3.6%


• r20=2%+3.3%+1.0%=6.3% *IP20(7+5+18(3))/20=3.3%
Q4a. Calculate the interest rate on 1,2,3,4,5,10 and 20 year treasury
securities and plot the yield curve
Q4b.
Q4 C YIELD CURVE OF A RISKY COMPANY
Q5. YIELD CURVE
Q 6 a. What was the average expected inflation rate over the 5
year period 2005-2009? (use the arithmetic average).

• SOLUTION:
•
• IP5 = (13 + 9 + 7 + 6 + 6)/5 = 41 / 5 = 8.2%
Q6 b. Assuming a real risk-free rate of 2% and a maturity risk premium which starts at 0.1
percent and increases by 0.1 percent each year, estimate the interest rate in January 2005
on bonds that mature in 1, 2, 5, 10 and 20 years and draw a yield curve based on these data.

 SOLUTION:
r* = 2%
MRP = 0.1% increase every year
r1, r2,r5,r10,r20 = ?
r = r* + IP + MRP + LP + DRP


 r1=2% + 13% = 15%

 r2=2% + 11% + 0.1% = 13.1% IP2=(13+9)/2=11%


 r5=2% + 8.2% +4(0.1%) = 10.6% IP5=8.2%


 r10=2% + 7.1% + 9(0.1%) = 10% IP10= (13+9+7+6(6))/10=7.1%


 r20=2% + 6.55% + 19(0.1) = 10.45% IP20= (13+9+7+6(16))/20=6.55 %
Q 6b yield Curve
Q6 c. Describe the general economic conditions that could be expected to produce
an upward sloping yield curve.

• If in the future we expect that the inflation will be higher

than the current one, then we will obtain an upward
sloping yield curve.