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Calculate the bond equivalent yield for a 180-day T-bill that is purchased at a 6% "ask"
rate. If the bill has a face value of $10,000, calculate its price.
First, calculate the price of the T-bill,
YD = (F - P) * 100% * (360/D) = (100 - P) * 100% * (360/180) = 6%,
F
100
where YD is the discount yield (6%).
P = F - (F * YD * D/360) = 100 - (100 * 0.06 * 180/360) = 97 per 100 of face value
Second, calculate the bond equivalent yield,
YBE = (F - P) * 100% * (365/D) = (100 - 97) * 100% * (365/180) = 6.27%
2. What are the characteristics of money market instruments? Why must a financial claim
possess these characteristics to function as a money market instrument?
The three fundamental characteristics of money market instruments are: (a) low default risk, (b)
short-term to maturity, and (c) high marketability. These characteristics give money market
instruments their characteristic of being low risk.
3. What types of firms issue commercial paper? What are the characteristics critical to being
able to issue commercial paper?
Large high-rated businesses issue commercial paper as an inexpensive source of short-term
borrowing. Commercial paper is an alternative to prime rate borrowing from a commercial
bank and, typically, the rates are lower than rates charged by banks.
Most investors, an in attempt to protect their principal, only want paper rated high by rating
agencies. Rating agencies will quickly write down or remove their ratings for commercial paper
if the financial conditions of a company decrease. The number companies issuing commercial
paper in the economic boom of the late 1990's, shrunk considerably by 2001 as rating agencies
pulled their commercial paper ratings.
4. Suppose Fargood Corporation engages in a repurchase agreement with The National Bank
of Nebraska. In the agreement, Fargood sells $9,987,950 worth of Treasury securities to
the bank and agrees to repurchase the securities in 30 days for $10,000,000.
a. Is this transaction a loan, and if so, who is the borrower and who is the lender?
Defend your answer.
In this case, the transaction is a reverse repurchase agreement (reverse repo) for the
bank. It agrees to purchase securities under agreement to resell. The bank is buying
(investment of funds) the Treasuries owned by Fargood (liquidity provided; funds gained for
period of reverse repo). Technically, it is not a loan, but a purchase (by the bank) with
agreement to resell, but the effect is the same as a loan to a customer.
b. Is the loan collateralized? What is the Collateral? Who holds the collateral during
the term of the agreement?
The bank or offsite depository would hold the securities during the contract period. It
technically a purchase/sale, but is a type of short-term collateralized loan.
c. What interest rate (or yield) is earned by the lender?
The annualized yield to the bank (cost to Fargood) would be
YREPO = (PREPO - P0) * 100% * (360/D) = ($10,000,000 - $9,987,950) * 100% * (360/30)
P0
$9,987,950
= 1.45%
3.
help insure that investors in money market securities will be paid on a timely basis. One type of
commitment is a backup line of credit to issuers of money market securities, which is typically
dependent on the financial condition of the issuer and can be withdrawn if that condition
deteriorates. Another type of commitment is a credit enhancementgenerally in the form of a
letter of creditthat guarantees that the bank will redeem a security upon maturity if the issuer
does not. Backup lines of credit and letters of credit are widely used by commercial paper
issuers and by issuers of municipal securities.
6. How and why do bankers acceptances frequently arise in
international trade transactions?
Solution: Often when people trade across borders, they trust the guarantee
of an international bank more than they trust an importers
agreement to pay them in the future. Thus, exporters often ask
importers to obtain a letter of credit from a well-known bank that
will agree to pay the importers obligation. When the exporter
complies with all terms of the transaction, the bank accepts the
obligation to make payment to complete the transaction if the
importer does not. Because the banks credit is good, the bankers
acceptance can be sold easily in the money markets and when it
comes due; the bank will pay, if necessary, if the importer does not.
7. The annualized yield is 3% for 91-day commercial paper and 3.5% for 182-days
commercial paper. What is the expected 91-day commercial paper rate 91 days from
now?
Assumingthedifferenceisjustduetohigherfutureinterestrates,aninvestorshouldbeabletoearnthe
samereturnover182daysusingeither182daypaperora91daypaperrolloverstrategy.
Assumethatthe182daypaperhasa$100,000facevalue.Thecurrentpriceis:
$100,000 P
365
3.5%
P
182
P$98,284.73
Now,investthesameamountin91daypaper.
F 98,284.73 365
3.0%
98,284.73
91
F$99,019.87.Thatis,suchaninvestmentshouldpayoff$99,019.87after91days.
Now,invest$99,019.87in91daypaperagain.Itisexpectedtogiveafinalvalueof$100,000(justlike
the182daypaper).
100,000 99,019.87 365