Management Notes

Reference Notes for Management

Which of the following is not a money market instrument?

Which of the following is not a money market instrument?

A. Commercial paper.
B. Participatory certificates.
C. Warrants.
D. Treasury Bills.

The Correct Answer is Option C. Warrants.

In financial terms, a warrant gives its holder the right, but not the obligation, to purchase or sell an underlying asset at a specified price and time. Companies or financial institutions often issue warrants as a way to raise capital or increase the marketability of other securities.

It is sometimes possible to trade warrants in the money markets, but they are not considered money market instruments because they are not short-term, highly liquid securities used for borrowing and lending. Investing in money market instruments is a low-risk way to park funds and earn short-term income since they typically have a maturation of one year or less.

Compared to exchange-traded notes, warrants have a longer maturity and are often used as a tool for speculating on the price movement of an underlying asset. Generally, warrants do not qualify as highly liquid instruments. They have maturities ranging from a few months to several years, depending on the terms of their issuance.

The longer maturity and lower liquidity of warrants, even though they can be used as investment instruments, do not make them money market instruments.

Money Market Instruments

Money market instruments are investments that offer banks, businesses, and governments the opportunity to meet both large and short-term capital needs at a low cost. Lenders are able to provide easy liquidity to borrowers as well as meet their short-term needs. Money market instruments include several types. Here are a few of the major money market instruments:

  • Treasury Bills

Short-term securities issued by government are called Treasury bills (T-bills). Money market debt securities issued by the government with a one-year or less maturity. Money market debt securities are also considered high liquid marketable securities. The transaction cost is low and the price risk is negotiable.

T-bills do not have fixed interest rates. They are sold at a discount to their par value. In short, investors receive a return on their investment. Treasury bills can be purchased on the secondary market directly from the Treasury department or from a government securities dealer.

Why do u.s. treasury bills have lower interest rates than large-denomination negotiable bank cds?

Ans: U.S. Treasury bills have lower default risk and more liquidity than negotiable CDs.

 

If the fed buys treasury bills, this will shift the

A) shift the money supply curve to the right.
B) shift the money supply curve to the left.
C) shift the money demand curve to the right.
D) shift the money demand curve to the left.

 

A sale of treasury bills by the federal reserve _____ interest rates and _____ the money supply.

a) raises and reduces
b) lowers and increases
c) raises and increases
d) lowers and reduces

 

Buying a treasury bill (t-bill) is best for investors who are looking for

A) a place to invest between $100-$500.
B) a secure, low risk investment.
C) Insecure low risk Investment

 

The primary difference between u.s. treasury bills and u.s. treasury bonds is that the bills:

a) do not have default risk.
b) have more price volatility.
c) have a shorter maturity at time of issue.
d) offer a higher return.

  • Certificate of Deposit

Certificates of deposit are evidence of a deposit in a commercial bank or savings and loan institution for a certain period of time and at a certain rate of interest. To fund their business activities, banks and thrifts issue these bonds. Certificates of deposit can have maturities as short as a few days to as long as many years. Maximum maturities are not set. However, in the USA, Federal Reserve regulations stipulate that CDs cannot have a maturity shorter than seven days. It is possible for a Certificate of Deposit to be negotiated or not negotiated.

The initial depositor will have to wait until the maturity date of the certificate of deposit to get back their funds when it is non-negotiable. An early withdrawal penalty is imposed if the depositor withdraws funds before maturity. A negotiable CD, on the other hand, allows the initial depositor or any subsequent owner of the certificate of deposit to sell it on the open market before the maturity date.

 

  •  Commercial Paper

To raise money from the money market, a company issues a short-term, unsecured negotiable promissory note known as commercial paper. Commercial paper is an effective way of raising funds for well-established and creditworthy companies. Both financial and nonfinancial companies with strong credit ratings can issue commercial paper as an alternative to bank borrowing.

The main purpose of commercial paper is to raise short-term funds for seasonal and working capital needs. Bridge financing can also be done with commercial paper. The term bridge financing refers to the process of using short-term financing to fund fixed assets for a short period of time. It can take from a few days up to 270 days for a commercial paper to mature.

The majority of US companies prefer commercial paper with a maturity of up to 90 days. In the US, if a commercial paper’s maturity exceeds 270 days, it must be registered with Securities and Exchange Commission (SEC). Corporate investors tend to favor commercial paper. Due to the fact that the investor of commercial papers plans to hold them until maturity, commercial papers do not trade on the secondary market.

 

  • Repurchase Agreements

Repurchase agreements (repos) are short-term borrowing arrangements where securities are sold with an agreement to buy them back at a higher price at a later date. Treasury bills are sometimes sold as collateral by dealers in government securities and repurchased at a later date at a agreed price by lenders. An individual or company sells a security to another with the promise to buy it back from the buyer later. It is also known as a Sell-Buy transaction.

At a predetermined time and amount, the buyer buys a security from the seller, which includes the interest rate at which the buyer was agreed to buy the security. Repo rate refers to the price at which buyers purchase securities. When the seller needs short-term funds they can simply sell the securities, and get the funds they need. Investing in repos can yield decent returns for the buyer.

 

  • Banker’s Acceptance

Banker’s acceptances are drafts that are accepted by a bank and used for financing imports and exports. The buyer obtains a written promise from its bank authorizing the seller to draw a draft on the bank as a means of payment to the seller in order to guarantee the payment to the seller. An acceptance of a written promise becomes a contract between both the bank and buyer and is called a banker’s acceptance.

In the money market, it can be discounted or sold. Banker’s acceptances generally have higher yields than Treasury bills of the same maturity and lower yields than Certificates of Deposits and Commercial Papers.

 

  • Eurodollars

Eurodollars are dollar denominated bank deposits held at foreign banks or foreign branches of US banks. As an example, if a US company has a dollar denominated account in a Japanese bank, its account is called a time Eurodollar account. From the Japanese bank, the depositor receives a Eurodollar time deposit certificate. US dollars are used to pay interest on the deposit account.

Most Eurodollars have a fixed maturity date and time deposits. Maturities range from six months to one year. A Eurodollar time deposit is another variation of a Eurodollar CD. Eurodollars CDs can be sold in the secondary market for the cash value before the maturity date, as opposed to Eurodollars time deposits. Although riskier, Eurodollar CDs offer investors a high return.

 

  • Money Market Accounts

Money market accounts are types of savings accounts. The issuers of these accounts frequently pay interest, but some of them allow limited withdrawals and checks against the account. When withdrawals exceed those limits, the account is converted to a checking account.

A money market account is credited with interest on a monthly basis, calculated daily by banks. A money market account typically has a higher interest rate than a standard savings account.

 

Which of the following is not a characteristic of a money market instrument?

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