Tài chính doanh nghiệp - Money market instruments: Commercial paper, federal agency securities, bankers’ acceptances, and eurocurrency deposits

Money and Capital Markets12C h a p t e rEighth EditionFinancial Institutions and Instruments in a Global MarketplacePeter S. RoseMcGraw Hill / IrwinSlides by Yee-Tien (Ted) FuMoney Market Instruments: Commercial Paper, Federal Agency Securities, Bankers’ Acceptances, and Eurocurrency Deposits Learning Objectives To discover the important roles that large corporations, government agencies and banks play in the money market.To explore the nature and characteristics of commercial paper.To learn how federal agencies aid various economic sectors in finding low-cost credit. Learning Objectives To see the trend toward the internationalization of the money market, and examine how bankers’ acceptances and Eurodeposits are employed in aiding both domestic and international trade.To understand how the transfers of money from one spending unit to another across international boundaries can impact a nation’s economy.Commercial PaperCommercial paper consists of short-term, unsecured promissory notes issued by well-known and financially strong companies.Commercial paper is traded mainly in the primary market. Opportunities for resale in the secondary market are more limited.Commercial paper is rated prime, desirable, or satisfactory, depending on the credit standing of the issuing company.Types of Commercial PaperThere are two major types of commercial paper.Direct paper is issued mainly by large finance companies and bank holding companies directly to the investor.Dealer paper, or industrial paper, is issued by security dealers on behalf of their corporate customers (mainly nonfinancial companies and smaller financial companies).Structure of the Commercial Paper MarketInvestors in commercial paperMoney market fundsBanksInsurance companiesPension fundsIndustrial companiesOther investorsDemand SideSupply SideIssuers of commercial paperFinance companiesBank holding companiesNonfinancial firmsDirect or finance paperPaper dealer housesDealer or industrial paperMaturities & Rate of ReturnMaturities of U.S. commercial paper range from three days (“weekend paper”) to nine months. Most commercial paper is issued at a discount from par, and yields to the investor are calculated by the bank discount method, just like Treasury bills.DR = Par value – Purchase price  360 . Par value Days to maturityGrowth of Commercial PaperThe volume of commercial paper has grown rapidly due to its relatively low cost and high quality, as well as the expanding use of credit enhancements.1960 $ 4.5 billion1970 33.41980 124.41990 562.72000 1,615.32001 1,438.8YearOutstanding Volumeof Paper in the U.S.Effect of weaker economy & terrorismMarket Yields on Commercial PaperData Source: Board of Governors of the Federal Reserve System%Commercial PaperAdvantagesRelatively low interest ratesFlexible interest rates - choice of dealer or direct paperLarge amounts may be borrowed convenientlyThe ability to issue paper gives considerable leverage when negotiating with banksCommercial PaperDisadvantagesRisk of alienating banks whose loans may be needed when an emergency developsMay be difficult to raise funds in the paper market at timesCommercial paper must generally remain outstanding until maturity - does not permit early retirement without penaltyContinuing Innovation in the Paper MarketInnovations and extensions of the paper market include:Master note – the investing firm agrees to take some paper each day up to an agreed-upon maximum amountMedium-term notes – 9-month to 10-year notesAsset-backed commercial paper – loans or credit receivables are pooled and paper is then issued as a claim against that pool Federal Agency SecuritiesCertain sectors of the economy, such as agriculture, housing, small businesses, and college students, appear to have an unusually difficult time raising funds in the money and capital markets.Beginning in 1916, the U.S. federal government created special agencies to make direct loans or guarantee private loans to these “disadvantaged” borrowers.Types of Federal Credit AgenciesGovernment-sponsored agencies are federally chartered but privately owned. Their borrowing and lending activities are not reflected in the federal government’s budget.Examples:Federal Farm Credit Banks (FFCB)Federal Home Loan Mortgage Corp (Freddie Mac)Student Loan Marketing Association (Sallie Mae)Financing Assistance Corporation (FAC)Types of Federal Credit AgenciesFederal agencies are legally a part of the government structure, and their borrowing and lending activities are included in the federal budget.Examples:Export-Import Bank (EXIM)Farmers Home Administration (FMHA)Government National Mortgage Association (Ginnie Mae)Federal Deposit Insurance Corporation (FDIC)The Roles of Federal Credit AgenciesPerforming the Roles of a Financial IntermediaryFederal & government-sponsored credit agenciesBorrowing funds from the open market and from other government agenciesGranting loans to disadvantaged sectorsGuaranteeing loans made by other lendersBuying loans from the secondary marketFederal Agency SecuritiesThe agency market has soared in recent years, with the volume of outstanding securities climbing from about $2 billion during the 1950s to almost $2 trillion today.Agency securities are generally short to medium term in maturity (running out to about 10 years).The Marketing of Agency IssuesThe most active buyers of agency securities include banks, state and local governments, government trust funds, and the Federal Reserve System.The Federal Reserve is authorized to conduct open market operations in agency IOUs.Major securities dealers who handle U.S. government securities also generally trade in agency issues.Bankers’ AcceptancesA bankers’ acceptance is a time draft drawn on and endorsed by an importer’s bank.Acceptances are used in international trade because most exporters are uncertain of the credit standing of their importers.The issuing bank unconditionally guarantees to pay the face value of the acceptance when it matures, thus shielding exporters and investors in international markets from default risk.Bankers’ AcceptancesAcceptances carry maturities ranging from 30 to 270 days, with 90 days being the most common.They are traded among financial institutions, industrial corporations, and securities dealers as a high-quality investment and source of ready cash.How Acceptances AriseImporter applies for line of creditImporter’s bank issues letter of credit in favor of exporterLetter of credit authorizes the drawing of a time draftImporter’s bank accepts time draft from exporter’s bankImporter’s bank pays exporter’s bank discounted value of bankers’ acceptance, and then holds or sells itBankers’ acceptance is redeemed at maturityThe Growth and Decline of Acceptance FinancingThe volume of US$ acceptances outstanding grew rapidly, from less than $400 million in 1950, to slightly more than $7 billion in 1970, and almost $80 billion in 1984.Then the volume declined sharply to $10 billion in 2000, as several leading export nations entered a recession, as economic problems developed in Asia, and as businesses turn to other payment and financing methods.Acceptance RatesAcceptances do not carry a fixed rate of interest, but are sold at a discount in the open market like Treasury bills.The yield on acceptances is usually only slightly higher than the yield on Treasury bills, and close to the negotiable CD rates offered by major banks, because of the high credit quality of the banks that issue the acceptances and CDs.Acceptance RatesData Source: Board of Governors of the Federal Reserve System%Investors in AcceptancesInvestors in acceptances include banks, industrial corporations, money market mutual funds, local governments, federal agencies, and insurance companies.To many investors, acceptances are a close substitute for Treasury bills, negotiable CDs, or commercial paper in terms of quality, although the acceptance market is far smaller in terms of the volume of trading.Eurocurrency DepositsThe Eurocurrency market has arisen because of the tremendous need worldwide for funds denominated in dollars, Euros, pounds, and other relatively stable currencies.The Eurocurrency market represents the largest of all money markets worldwide, with total funds probably in excess of $4 trillion.Eurocurrency DepositsEurodollars are deposits of U.S. dollars in banks located outside the U.S. The large majority of Eurodollar deposits are held in Europe, although Europe’s share of the total is declining.Eurocurrency DepositsEurodollars and other Eurocurrency deposits are continually on the move in the form of loans.They are employed to finance the import and export of goods, to supplement government tax revenues, to provide working capital for the foreign operations of multinational corporations, and to provide liquid reserves for the largest banks.Eurocurrency DepositsWhen a dollar deposit is moved to a bank located outside the U.S., that bank then holds claim to the original dollar deposit in the U.S.When a Eurodollar loan is made, the borrower receives a claim against dollars deposited in U.S. banks.Funds are merely passed from one U.S. bank to another. The total amount of dollar deposits and U.S. bank reserves remains unchanged.Eurocurrency Maturities and RisksMost Eurocurrency deposits are short-term deposits ranging from overnight to one year, although a small percentage are long-term time deposits.Eurocurrency deposits are known to be volatile and highly sensitive to fluctuations in interest rates and currency prices. They also carry political risk and default risk.The Supply of Eurocurrency DepositsEurocurrency deposits come from foreign investmenttourismbalance of payments (trade) settlementsinterbank fundsgovernment fundslarge corporations’ cash balancescentral banks supplying or absorbing funds from the banking systemEurodollars in U.S. Domestic Bank OperationsSince the late 1960s, U.S. banks have drawn heavily on Eurodollar deposits as a means of adjusting their domestic reserve positions.Eurodollars usually carry higher reported interest rates than many other sources of bank reserves. However, there are fewer legal restrictions on the borrowing of Eurodollars.U.S. banks also aid their customers in acquiring Eurocurrency deposits and loans.Interest Rates on Eurodollar DepositsData Source: Board of Governors of the Federal Reserve System%Benefits and Costs of the Eurocurrency MarketsBenefitsMakes possible an efficient mobilization of funds around the globe.Encourages international cooperation among nations.Creates a cash-management source to aid the financial operations of corporations and governments around the globe.Benefits and Costs of the Eurocurrency MarketsCostsThe capacity to mobilize massive amounts of funds may contribute to instability in currency values.Monetary and fiscal policies designed to cure domestic economic problems may not achieve their desired impact.Money and Capital Markets in CyberspaceMore information about the various money market instruments can be found at: ReviewCommercial PaperWhat Is Commercial Paper?Types of Commercial PaperStructure of the Commercial Paper MarketMaturities & Rate of Return on Commercial PaperGrowth of Commercial PaperMarket Yields on Commercial PaperAdvantages & DisadvantagesContinuing Innovation in the Paper MarketChapter ReviewFederal Agency SecuritiesTypes of Federal Credit AgenciesThe Roles of Federal Credit AgenciesGrowth of the Agency MarketTerms on Agency SecuritiesThe Marketing of Agency IssuesChapter ReviewBankers’ AcceptancesWhy Acceptances Are Used in International TradeHow Acceptances AriseThe Growth and Decline of Acceptance FinancingAcceptance RatesInvestors in AcceptancesChapter ReviewEurocurrency DepositsWhat is a Eurodollar?The Creation of Eurocurrency DepositsEurocurrency Maturities and RisksThe Supply of Eurocurrency DepositsEurodollars in U.S. Domestic Bank OperationsBenefits and Costs of the Eurocurrency Markets