Topic 3. The Money Markets.pptx

# Topic 3. The Money Markets.pptx - BX2031 The money markets...

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The money markets BX2031  Personal portfolio Management

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Overview of Sessions 1 - Money market securities 2 - The valuation of money market securities 3 - Risks attached to money market securities 4 - Estimating the yield curve 5 - Theories of term structure & A model of interest rates Required reading: Chapter 5 Brailsford et al. (2015) 5 th ed. Self study questions: 5.7; 5.8; 5.15; 5.17; 5.18
Money market securities BX2031  Personal portfolio Management

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Money market securities The money market allows financial institutions, corporations and individuals to meet their short-term investing and borrowing requirements. Money market securities are short-term in nature (less than 12 months). Securities traded in the money market include: commercial bills promissory notes Treasury notes.
Money market securities A money market security is a security in which the issuer promises to repay to the investor the amount borrowed (principal / face value) plus interest over a specified time. Trading cash is equivalent to borrowing or lending. For example, a trader that needs cash for some purpose will be buying cash, which is equivalent to borrowing money. A trader who is selling cash is lending money.

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Money market securities Interest rates on money market instruments are quoted on a nominal annual basis. Example: A 3.02%, 7-day money market investment of \$25m will pay interest of: nominal rate per annum= 3.02% interest rate for 7-days = 0.0302 x (7/365) = 0.00579 or ~ 0.579% interest amount = 25m x 7/365 x 3.02% = \$14,479.45 Therefore, after 7-days, the \$25m investment returns: final payment = principal + interest = \$25m + \$14,479.45 = \$25,014,479.45
It is also possible to invest in an overnight security in the money market. Example: A \$30m overnight investment will pay interest based on the 11am cash rate of 3.00% p.a: nominal rate per annum = 3.00% interest rate for 1-day = 0.03 x (1/365) = 0.000082% or ~ 0.0082% interest amount = 30m x 1/365 x 3.00% = \$2,465.75 Therefore, after one day, the \$30m investment returns: final payment = principal + interest = \$30m + \$2,465.75 = \$30,002,465.75 Money market securities

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The valuation of money market securities BX2031  Personal portfolio Management
Simple interest formula: Rearranging gives the general valuation formula: where PV = present value (or price) FV = face value (or principal) d = number of days to maturity y = yield (nominal % per annum) Formally: The valuation of money market  securities

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Example The quoted yield for a 90-day dealer's bill is 3.38% per annum. This represents a yield of 0.8334% (3.38% p.a. * (90/365)) over the 90-day period. For a \$100,000 face value, the price is: The valuation of money market  securities
Example (cont) The yield assumes the bill is held for the next 90-days until maturity. That is, the security is purchased now for \$99,173.46 and sold in 90-days time for \$100 000. The discrete holding period return is: ((100 000-\$99,173.46) / \$99 173.46) = 0.833424657534247% for 90-days.

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