Lesson 2.7: Money Markets and Bank Accounts

Money market instruments are A)short-term debt. B)long-term debt. C)intermediate debt. D)long-term equity.

A)short-term debt. Explanation Money market instruments are high-quality debt securities with maturities that do not exceed one year.

One of the more popular money market instruments is the negotiable CD. To be considered a negotiable CD, a CD must have a face value of at least A)$100,000. B)$500,000. C)$1 million. D)$25,000.

A)$100,000. Explanation Negotiable CDs, sometimes referred to as jumbo CDs, have a minimum denomination of $100,000. They are unsecured, interest-bearing obligations of banks.

All the following securities are issued at a discount except A)CDs. B)Treasury bills. C)commercial paper. D)zero-coupon bonds.

A)CDs. CDs are interest-bearing debt instruments issued by banks at their face value. All of the others are issued at a discount. In truth, only about 85% of commercial paper is, but that's good enough for NASAA.

A money market mutual fund would be least likely to invest in which of the following assets? A)Newly issued ​U.S. Treasury notes B)Jumbo CDs C)Repurchase agreements D)Newly issued ​U.S. Treasury bills

A)Newly issued ​U.S. Treasury notes Explanation A money market mutual fund typically invests in money market instruments—those with a maturity date not exceeding 397 days. Treasury notes are issued with maturity dates of 2-10 years.

Which of the following should be considered a liquid asset for emergency fund purposes? A)Savings account B)Life insurance cash values C)Stock mutual funds D)A personal residence

A)Savings account Explanation A savings account can be accessed immediately if funds are needed right now. The redemption period for mutual funds is seven days. That is quick but not same day as the savings account is. Another factor is that there could be a redemption or back-end load to cash in the fund shares, while there is no fee to draw on a savings account. Life insurance cash values can take 30 days or longer, and selling a house is not the way to meet an emergency.

A European corporation seeking a short-term loan would probably be most concerned about an increase to A)the SOFR. B)the U.S. Treasury bill rate. C)the eurobond rate. D)the Fed funds rate.

A)the SOFR. Explanation For more than 40 years, the London Interbank Offered Rate—commonly known as LIBOR—was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages, and corporate debt. Over the last decade, LIBOR has been burdened by scandals and crises. Effective January 2022, LIBOR is no longer being used to issue new short-term loans in the U.S. It was replaced by the Secured Overnight Financing Rate (SOFR) which many experts consider a more accurate and more secure pricing benchmark. As is always the case with NASAA, we do not know when the exam questions will be updated. One thing we can promise you is that any question relating to this topic will not have both LIBOR and SOFR as choices, so you should choose whichever one appears.

A bank is advertising a no-cost DDA. Your client asks you to describe what that is. You would respond that DDA stands for A)direct deposit account. B)demand deposit account. C)deferred deposit account. D)digital deposit account.

B) demand deposit account. Explanation In the banking industry, the most common definition of a DDA is demand deposit account, better known as a checking account.

Which of the following are not considered money market instruments? American depositary receipts Commercial paper Corporate bonds Jumbo (negotiable) certificates of deposit A)I and II B)I and III C)II and IV D)III and IV

B)I and III Explanation A money market instrument is a high-quality, short-term debt security with maturity of one year or less. American depositary receipts (ADRs) are equity, and corporate bonds are long-term debt instruments.

Which of the following are characteristics of negotiable jumbo CDs? Issued in amounts of $100,000 to $1 million or more Typically pay interest on a monthly basis Always mature in one to two years with a prepayment penalty for early withdrawal Trade in the secondary market A)II and IV B)I and IV C)II and III D)I and III

B)I and IV Explanation Negotiable jumbo CDs are issued for $100,000 to $1 million or more and trade in the secondary market. Most jumbo CDs are issued with maturities of one year or less. Being negotiable, there is no prepayment penalty. These CDs generally pay interest on a semiannual basis, not monthly.

Which of the following are characteristics of commercial paper? Backed by money market deposits Negotiated maturities and yields Issued by insurance companies Not registered with the SEC A)I and III B)II and IV C)III and IV D)I and II

B)II and IV Explanation Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Most commercial paper is sold to institutions, and the borrower and lender negotiate the terms. Those terms include the interest rate (the yield because they're discounted) and whether these are overnight, 30-day, or longer maturities. Because commercial paper is issued with maturities of no more than 270 days, it is exempt from registration under the Securities Act of 1933.

Which of the following is unlikely to be issued at a discount? A)Treasury bill B)Jumbo CD C)Zero-coupon bond D)Commercial paper

B)Jumbo CD Explanation Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. Unlike those issued at a discount, they are interest bearing.

Money market investments consistently fulfill all these roles within a client's portfolio except A)serve as an alternative to bonds and equities in a multi-asset class portfolio to lower the overall volatility. B)outperform the stock market. C)serve as a short-term home for cash balances. D)earn higher returns than cash.

B)outperform the stock market. Explanation Money market investments can fulfill a number of roles within a client's portfolio, including short-term allocation for cash balances; serving as an alternative to bonds and equities in a multi-asset class portfolio to lower the overall volatility of the portfolio; and serving as part of the asset allocation strategy to get higher returns than they would receive on cash.

The minimum face amount of a negotiable CD is A)$25,000. B)$10,000. C)$100,000. D)$50,000.

C)$100,000. Explanation Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are usually traded in blocks of $1 million or more.

The value of which of the following would be least likely to be impacted by changes in interest rates? A)A U.S. Treasury bond issued 25 years ago with a 30-year maturity B)A laddered bond portfolio C)A bank CD maturing in 5 years D)A convertible preferred stock

C)A bank CD maturing in 5 years Explanation This question is dealing with interest rate (or money-rate) risk. That risk refers to the inverse relationship between the price of fixed-income investments and interest rates. That is, when interest rates go up, the price of fixed-income securities falls (and vice versa). However, this risk only affects investments that are marketable (those with a fluctuating market price). Bank CDs are nonnegotiable (we're not referring to the negotiable jumbo CDs with a maturity of one year or less) and, as a result, will not fluctuate in price, regardless of changes to interest rates. In this case, interest rate risk is eliminated. That is one of the reasons why the exam's first choice for capital preservation is insured bank CDs. Will a laddered bond portfolio reduce interest rate risk? Yes, but it will not eliminate it. Is a convertible preferred (or bond) less subject to changes in interest rates than one without the conversion feature? Yes, but the risk is still there. Does a 30-year T-bond with 5 years remaining to maturity have a short duration and, therefore, a reduced interest rate risk? Yes, but the price of the bond will still be affected by changes in the market interest rates.

An individual purchases a $10,000 CD with a 5-year maturity from her local bank branch. In doing so, she is eliminating A)opportunity cost. B)inflation risk. C)interest rate risk. D)purchasing power risk.

C)interest rate risk. Explanation Interest rate risk is the uncertainty that changes to market interest rates will cause the price of an investment to fluctuate in value. Because this type of bank CD is nonnegotiable (it doesn't trade), changes to interest rates do not impact the principal value of the investment—she can always redeem the CD for $10,000 (although there could be a penalty for early withdrawal). As a fixed-income investment, though, it does suffer from purchasing power risk, also known as inflation risk, and the investor has the opportunity cost of settling for a lower rate of return than could potentially be obtained with equities.

A client plans to purchase a home within the next three months and will require $100,000 for the down payment. The client has the money in her DDA and asks you for your recommendation as to the best place to put the money. Your recommendation would probably be for the client to A)move the money into a 1-year CD. B)use the money to buy IPOs until the home is purchased. C)keep the money where it is. D)purchase a GNMA for the monthly income.

C)keep the money where it is. Explanation DDA stands for demand deposit account, usually a checking account at a bank. Because this client cannot afford any risk to principal, and the bank account is covered by FDIC insurance, this is the most attractive option. The 1-year CD would offer more income, but there would likely be a penalty for early withdrawal. Even though the GNMA is directly backed by the U.S. government, it is subject to market fluctuation, a risk this client cannot take.

Which of the following are characteristics of commercial paper? It represents a loan by the holder to the issuer. It is a certificate of ownership in the corporation. It is commonly issued to raise working capital for a corporation. It is junior in preference to convertible preferred stock. A)II and IV B)II and III C)I and IV D)I and III

D)I and III Explanation Commercial paper instruments are debt securities; they represent loans to the issuing corporation by the holder. They are commonly issued to raise working capital and, as debt obligation, are senior in preference to preferred stock in claims against an issuer.

What rate of interest would a bank in England charge another British bank for a short-term loan? A)Discount rate B)Fed funds rate C)Prime rate D)SOFR

D)SOFR Explanation For more than 40 years, the London Interbank Offered Rate—commonly known as LIBOR—was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages, and corporate debt. Over the last decade, LIBOR has been burdened by scandals and crises. Effective January 2022, LIBOR is no longer being used to issue new short-term loans in the U.S. It was replaced by the Secured Overnight Financing Rate (SOFR) which many experts consider a more accurate and more secure pricing benchmark. As is always the case with NASAA, we do not know when the exam questions will be updated. One thing we can promise you is that any question relating to this topic will not have both LIBOR and SOFR as choices, so you should choose whichever one appears.

When comparing a time deposit account and a demand deposit account, you would expect A)lower penalties for withdrawing funds from a time deposit account. B)easier access to the funds in a time deposit account. C)FDIC insurance on the time deposit account but not on the demand deposit account. D)a higher rate of interest paid on the time deposit account.

D)a higher rate of interest paid on the time deposit account. Explanation The best example of a time deposit account is a CD. Money is deposited for a fixed length of time, generally at a fixed interest rate. Demand deposit accounts are checking accounts. Because the bank expects to have longer use of time deposit funds, interest rates are generally higher. DDAs offer the instant access of check-writing (or online payments). Typically CDs, have penalties for early withdrawal; there is no such charge on a checking account. Both are covered by FDIC up to the applicable limit.

If a group of money managers was having a discussion and the term SOFR was mentioned, the topic would most likely be A)current economic conditions in Liberia. B)contract negotiations with the employee's union. C)long-term borrowing rates. D)short-term borrowing rates.

D)short-term borrowing rates. Explanation For more than 40 years, the London Interbank Offered Rate—commonly known as LIBOR—was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages, and corporate debt. Over the last decade, LIBOR has been burdened by scandals and crises. Effective January 2022, LIBOR is no longer being used to issue new short-term loans in the U.S. It was replaced by the Secured Overnight Financing Rate (SOFR) which many experts consider a more accurate and more secure pricing benchmark. As is always the case with NASAA, we do not know when the exam questions will be updated. One thing we can promise you is that any question relating to this topic will not have both LIBOR and SOFR as choices, so you should choose whichever one appears.

All of the following are true of negotiable, jumbo certificates of deposit except A)they are readily marketable. B)they are usually issued in denominations of $100,000 to $1 million or more. C)they usually have maturities of one year or less. D)they are secured obligations of the issuing bank.

D)they are secured obligations of the issuing bank. Explanation Negotiable CDs are general obligations of the issuing bank; they are not secured by any specific asset. They do qualify for FDIC insurance (up to $250,000), but that is not the same as stating that the bank has pledged specific assets as collateral for the loan.