Shortage these loans which are usually overnight

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shortage. These loans, which are usually overnight transactions, are arranged at a rate of interest called the federal funds rate. Although the fed funds market arose primarily as a way for banks to transfer balances to meet reserve requirements, today the market has evolved to the point that many large banks use federal funds in a straightforward way as one component of their total sources of funding. Therefore, the fed funds rate is simply the rate of interest on very short-term loans among financial institutions. Brokers’ Calls
Individuals who buy stocks on margin borrow part of the funds to pay for the stocks from their broker. The broker in turn may borrow the funds from a bank, agreeing to repay the bank immediately (on call) if the bank requests it. The rate paid on such loans is usually about 1% higher than the rate on short-term T-bills. The LIBOR Market The London Interbank Offered Rate (LIBOR) is the rate at which large banks in London are willing to lend money among themselves. This rate, which is quoted on dollar-denominated loans, has become the premier short-term interest rate quoted in the European money market, and it serves as a reference rate for a wide range of transactions. For example, a corporation might borrow at a floating rate equal to LIBOR plus 2%. Yields on Money Market Instruments Although most money market securities are of low risk, they are not risk-free. For example, as we noted earlier, the commercial paper market was rocked by the Penn Central bankruptcy, which precipitated a default on $82 million of commercial paper. Money market investors became more sensitive to creditworthiness after this episode, and the yield spread between low- and high-quality paper widened. The securities of the money market do promise yields greater than those on default-free T-bills, at least in part because of greater relative riskiness. In addition, many investors require more liquidity; thus they will accept lower yields on securities such as T- bills that can be quickly and cheaply sold for cash. III. OVERVIEW OF THE TYPES AND FEATURES OF FIXED INCOME SECURITIES 4 I. BONDS Type of Issuer One important characteristic of a bond is the nature of its issuer. Although foreign governments and firms raise capital in U.S. financial markets, the three largest issuers of debt are domestic corporations, municipal governments, and the federal government and its agencies. Each class of issuer, however, features additional and significant differences. Domestic corporations, for example, include regulated utilities as well as unregulated manufacturers. Furthermore, each firm may sell different kinds of bonds: Some debt may be publicly placed, whereas other bonds may be sold directly to one or only a few buyers (referred to as a private placement ); some debt is collateralized by specific assets of the company, whereas other debt may be unsecured. Municipal debt is also varied: “General obligation’’ bonds (GOs) are backed by the full faith, credit, and taxing power of the 4 Internet material (authors: Frank Fabozzi,

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