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Chapter 2 - Asset Classes and Financial Instruments

Chapter 2 - Asset Classes and Financial Instruments -...

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Chapter 2: Asset Classes and Financial Instruments 2.1 The Money Market Money market is a subsector of the fixed income market, consists of short term debt securities that are highly marketable Treasury Bills- most marketable of all money market instruments o T-Bills are highly liquid, not much price risk, income is exempt from state and local taxes o Asked price- price you would have to pay to buy a T-Bill from a securities dealer o Bid price- slightly lower price you would receive if you wanted to sell a bill to a dealer o Bid-asked price- difference in prices which is the dealers source of profit o Bank discount method- bills discount from its maturity or face value is “annualized” based on a 360 day year and then reported as a percentage of face value. 2 flaws: Assumes year only has 360 days Compute yield as a fraction of par value rather than of the price the investor paid to acquire the bill o Bond equivalent yield- annualizing return using a 365 days year Certificate of Deposit (CD)- time deposit with bank o Bank pays interest and principle at the end of the fixed term o Insured up to $250,000 by FDIC Commercial Paper- short term unsecured debt notes issued by large well known companies o Backed by a bank line of credit o Usually issued with maturities of less than 1-2 months
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o There has been increase in asset backed commercial paper issued by financial firms Bankers’ Acceptances- starts as an order to a bank by a bank’s customer to pay a sum of money at a future date, typically within 6 months o Bank accepts, is responsible for payments. Acceptance can be traded Eurodollars- dollar dominated deposits at foreign banks or foreign branches of American banks. o Escape regulation of Fed o Advantage of Eurodollar CDs over Eurodollar time deposits is that the holder can sell the asset to realize its cash value before maturity o Eurodollar CDs are less liquid and riskier than domestic CDs, thus offering higher reward Repos and Reserves- form of short term, usually overnight borrowing o Dealer sells government securities to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price. o Increase in price is overnight interest o Term repo- same as repo but term of implicit loan can be 30 days or more o Repos considered safe since loans are backed by government securities o Reverse repo- mirror image of a repo; dealer finds investor holding government securities and buys them agreeing to sell them at a specific higher price on a future date.
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