Financial Instruments - Financial Instruments Money Market...

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Financial Instruments Money Market vs. Capital Market Maturity of 1 year or less vs. maturity of more than 1 year at time of issue Money Market Instruments T-bills Currently 1-month, 3-month and 6-months CDs Notes that banks write on themselves. Under $100,000 are generally non-negotiable Over $100,000 are often available for trading OTC Commercial Paper Alternative to borrowing from a bank Majority is issued by financial companies – GMAC is the biggest Non-financial companies will issue on an irregular basis. Typically backed by a line of credit at a major bank, but lines of credit are not legally binding. The usual maturity is < 45 days. It is eligible as collateral at the Fed’s discount window if the maturity is < 90 days. Don’t need to register with the SEC if maturity is < 9 mo. Little secondary market due to heterogeneity Usually sold in units of $100,000. LOC paper = Letter of credit commercial paper. Bank will pay-off the paper if the company can’t. Direct paper: Sold by issuing firm to investors without an intermediary. Dealer-placed Paper: Uses an underwriter Banker’s Acceptances Usually used with transfer of goods from one country to another. Example: Importer in U.S. and Exporter in Japan. Exporter wants to send goods to U.S. and receive payment in 90 days. Exporter may not know credit-worthiness of importer Importer intends to sell the goods within 90 days to raise the money needed to pay the exporter. Legal remedies in case of default are difficult internationally. Importer obtains commercial letter of credit from his bank in the U.S. – The U.S. bank guarantees payment in 90 days. – Importer pays bank a fee to write the letter and intends to place the money in the bank after he sells the goods in 90 days. 1
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Letter of credit is sent to exporter’s bank in Japan Exporter ships goods and endorses the shipping documents. He presents the documents to his bank in Japan. Japanese bank sends the documents to U.S. bank which “accepts” them. We now have a B.A. U.S. bank pays Japanese bank the PV of the purchase price. Japanese bank pays the exporter. U.S. bank holds the acceptance and is paid by the importer in 90 days Or U.S. bank sells the acceptance on the open market The sale is on a discount basis.
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