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430Chap005 - Money Markets Money markets involve debt...

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5-1 Money Markets Money Markets Money markets involve debt instruments with original maturities of one year or less Money market debt issued by high-quality (i.e., low default risk) economic units that require short-term funds purchased by those that have excess short-term funds little or no chance of loss of principal low rates of return Most money market instruments have active secondary markets to provide liquidity Money markets involve debt instruments with original maturities of one year or less Money market debt issued by high-quality (i.e., low default risk) economic units that require short-term funds purchased by those that have excess short-term funds little or no chance of loss of principal low rates of return Most money market instruments have active secondary markets to provide liquidity
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5-2 Money Market Yields Money Market Yields Money market securities use special rate quoting conventions: Discount yields (i dy ): Interest rate is quoted on an annual basis assuming a 360 day year as a percent of redemption price or face value Single payment yields (i spy ): Interest rate is quoted on an annual basis assuming a 360 day year as a percent of purchase price Both may be converted to a bond equivalent yield (i bey ) for comparison with bonds Money market securities use special rate quoting conventions: Discount yields (i dy ): Interest rate is quoted on an annual basis assuming a 360 day year as a percent of redemption price or face value Single payment yields (i spy ): Interest rate is quoted on an annual basis assuming a 360 day year as a percent of purchase price Both may be converted to a bond equivalent yield (i bey ) for comparison with bonds
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5-3 Money Market Yields Money Market Yields Treasury bills and commercial paper rates are quoted as discount yields Discount yields ( i dy ) use a 360-day year P f = the face value of the security P 0 = the discount price of the security h = the number of days until maturity Treasury bills and commercial paper rates are quoted as discount yields Discount yields ( i dy ) use a 360-day year P f = the face value of the security P 0 = the discount price of the security h = the number of days until maturity h P P P i f f dy 360 ) ( 0 × - =
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5-4 Money Market Yields Money Market Yields Compare discount securities to bonds with bond equivalent yields ( i bey ) Convert bond equivalent yields into effective annual returns ( EAR ) Compare discount securities to bonds with bond equivalent yields ( i bey ) Convert bond equivalent yields into effective annual returns ( EAR ) h P P P i f bey 365 ) ( 0 0 × - = 1 / 365 1 / 365 - + = h bey h i EAR
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5-5 Money Market Yields Money Market Yields Negotiable (or jumbo) CDs and fed funds are money market securities that pay interest only at maturity. These use single-payment yields ( i spy ) Negotiable (or jumbo) CDs and fed funds are money market securities that pay interest only at maturity. These use single-payment yields ( i spy ) h P P P i f spy 360 ) ( 0 0 × - =
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