*Ch.2 mma QUIZ
Which statement is TRUE regarding a Step-Down Certificate of Deposit?
At a predetermined time, the interest rate is decreased to a rate that is at, or below, the market. This question boils down to the fact that you don't get something for nothing. With a step-down CD, you start with a higher-than-market "teaser" rate. This is used as an incentive to the client to buy the CD. Then, at a predetermined date, the rate steps down to a lower rate, and this rate is usually a bit lower than the market rate at that time, so that, on average, the investor will still earn the market rate over the life of the CD.
Brokered CDs?
Brokered CDs are sold by brokerage firms that are representing issuing banks. FDIC insurance of $250,000 maximum covers bank deposits - but only if the deposit is titled in the customer's name. If the CD is titled in the brokerage firm's name, then the insurance coverage would not apply! There is no penalty for early withdrawal of funds on brokered CDs - however the amount of interest earned will be pro-rated over the shorter life of the deposit. If interest rates rise after issuance, the value of the CD in the secondary market will fall (though not by much, since this is a short maturity).
Which money market instrument trades "and interest"?
Certificates of Deposit Negotiable Certificates of Deposit are issued at par and mature at par plus accrued interest. Though most CDs are held to maturity, if they are traded before this date, the instrument trades at par plus any accrued interest due. Commercial Paper, Treasury Bills, and Banker's Acceptances are all original issue discount obligations. The increase in the value of the security is the interest earned if the security is traded prior to maturity.
Which statement is TRUE about commercial paper?
Commercial paper is quoted on a yield basis. AND The most common maturity is 30 days. AND Commercial paper is an exempt security under the Securities Act of 1933. Commercial paper is a short term corporate IOU with a maximum maturity of 270 days (if it was longer, it would have to be registered with the SEC). Commercial paper is quoted on a yield basis (as is all money market debt).
Which of the following money market instruments trades at par plus accrued interest?
Jumbo Certificates of Deposit Negotiable certificates of deposit (over $100,000 face amount) are issued at par and mature at par plus accrued interest. If they are traded prior to maturity, they trade with the amount of accrued interest due. Banker's Acceptances, Commercial Paper, and Federal Funds are all original issue discount obligations.
The Federal Reserve would enter into a transaction involving which of the following with a primary U.S. Government securities dealer?
Overnight repurchase agreement There *IS interest rate risk Overnight repurchase agreements are common for transactions between banks and the Federal Reserve. In such an agreement, the Fed buys U.S. Government securities from the dealer for 1 day; agreeing to sell them back to the dealer the next day. The difference in buying and selling price represents one day's worth of interest. By using repurchase agreements, each day the Fed can deposit "cash" into the primary dealers (most of whom are the large commercial banks). This eases credit availability. Due to the fact that the agreement is fully collateralized and the short duration, there is virtually no liquidity risk. However, such agreements do have interest rate risk because the underling securities used as collateral can be longer-term Treasuries. If, during the 1-day period of the agreement, interest rates rise, then on the next day the collateral is returned to the seller, and its decline in value can be more than the 1 day of interest earned!
Which of the following ratings is applicable to commercial paper?
P-1 Commercial paper is rated on a P-1,2,3, and NP ("Not Prime") scale by Moody's or an A-1,2,3 scale by Standard & Poor's. MIG ratings are assigned by Moody's to short-term municipal notes. "ABC" ratings are used by both Moody's and Standard and Poor's for long-term corporates and municipals.
Which of the following securities cannot be margined?
Structured products Because money market instruments are "safe," they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds and listed stocks are the marginable securities. As a general rule, structured products cannot be margined because they are not readily transferable.
Trades of which of the following instruments will settle in Fed Funds?
Treasury Notes Securities that are eligible to be traded by the Federal Reserve are those backed by the guarantee of the U.S. Government as well as certain agency obligations. Both Treasury Bills and Treasury Notes are eligible securities. Trades in eligible securities settle through the Federal Reserve system, and therefore settle in "Fed Funds." Municipal bond trades and trades in corporate securities are not eligible for trading and settling through the Federal Reserve system; these securities settle in "clearing house" funds.
The purchase price of each of the following can be negotiated EXCEPT:
U.S. Savings Bonds U.S. Savings Bonds are not negotiable. All of the other securities listed trade and thus, are all "negotiable."
Eurodollars are:
U.S. dollar deposits held in foreign branches of U.S. banks or foreign banks. Eurodollars are U.S. dollar deposits held in foreign branches of U.S. banks or foreign banks. Eurodollar deposits are used to finance international trade.
All of the following statements are true regarding overnight repurchase agreements EXCEPT:
interest rate risk Overnight repurchase agreements are overnight sales of government securities, with an agreement to buy back the securities the next day at a pre-set price. The difference in prices is the interest earned for the 1 day loan. These are extremely safe and liquid. There is virtually no credit risk since the loan is backed by U.S. Government securities. This is the same as stating that there is no risk to "principal." Interest rate risk is present, however. Repurchase agreements are typically backed by long term government securities. The "seller" has an agreement to "buy back" the securities at a pre-agreed price on the next day. Therefore, if interest rates rise sharply that day, the dealer receives back securities that are now worth substantially less. Thus, the interest rate risk resides in the underlying long term government securities; not in the repurchase agreement itself. Overnight repurchase agreements are typically effected between government securities dealers. A dealer who needs cash will "sell" some of its inventory overnight to another dealer, with an agreement to buy the position back the next day. The difference between the sale price and the repurchase price is the interest earned. There is virtually no liquidity risk, since the loan is of the shortest term and is secured by pledged government securities. The interest rate on such agreements generally parallels and is somewhat lower (since the loans are secured) than the Fed funds rate, since overnight loans using government securities are most similar to overnight loans of reserves (Fed Funds) from bank to bank. Since government securities are pledged as collateral, the dealer gives up custody of the securities overnight. Repos do have interest rate risk, relating to the underlying securities. If interest rates rise, the underlying securities can decline in value. Since the maturity of the underlying securities can be of any length, long maturity values may decline more than the accrued interest to be earned on the agreement. When the borrower of the funds buys back the securities the next day at the pre-agreed price, it buys back securities at more than they are worth! If the borrower of the funds defaults, the lender can sell the collateral - but it will still be worth less than the original loan amount!
On customer account statements, long-term negotiable certificates of deposit must be shown at:
market value All securities positions on customer account statements must be shown at market value - not face value. The amount of accrued interest earned on a debt instrument as of the statement date is not disclosed.
Commercial paper is a(n):
money market instrument that is considered unfunded debt Commercial paper is a short term money market instrument. Short term debts are said to be "unfunded" debts. Long term debts are said to be "funded" (as in a "long term funding").
clearing house funds
monies payable upon regular way settlement of a securities transaction at a designated clearing house such as the Depository Trust and Clearing Corporation. Regular way trades of equities, corporate, and municipal bonds settle in clearing house funds, 2 business days after trade date.
All of the following statements are true about repurchase agreements initiated by the Federal Reserve EXCEPT:
the Fed is selling securities to dealers which it promises to buy back at a later date In a Fed-dealer repurchase agreement (a "repo"), the Federal Reserve buys (not sells) government securities from the primary dealers (mainly large commercial banks) with an agreement to sell them back the next day (at a slightly higher price). This gives the bank cash that it can lend out, easing credit and lowering interest rates. The New York Fed conducts "open market operations" with the primary dealers every day - using "repos" to loosen credit and "reverse repos" (where the Fed sells Treasury securities to the dealers, draining them of cash) to tighten credit.
The Federal Funds rate has been declining over the past few days. This is an indication that:
the Federal Reserve Open Market trading desk has been performing system wide repurchase agreements The Federal Funds rate is the interest rate charged between Federal Reserve member banks on overnight loans. The Federal Reserve can influence this rate through open market operations. If the Fed enters into repurchase agreements with member banks, it injects cash into the banks, which tends to drive the Fed Funds rate down. Conversely, if the Fed enters into reverse repurchase agreements with member banks, it drains the member banks of reserves, tending to drive up the Fed Funds rate. The results of the weekly Treasury auction would not have a direct influence on the Fed Funds rate; nor would member banks borrowing reserves directly from the Federal Reserve discount window.
The money that a bank has in excess of its reserves is called:
federal funds Any funds that a federal reserve member bank has in excess of its required reserves are called "Federal Funds." These are the funds that the bank has available for lending.
The "Effective" Federal Funds Rate is composed of rates offered by:
selected commercial banks across the United States Federal Funds are overnight loans of reserves from commercial bank to commercial bank. The "effective" rate is an average rate for selected banks across the United States. Thrifts cannot loan Federal Funds, nor can all primary dealers, since many of these firms are broker-dealers, not commercial banks.
In a repurchase agreement, the initiating government securities dealer:
sells securities to another dealer and agrees to buy back the securities at a later date In a repurchase agreement, the initiating government securities dealer "sells" securities to another dealer to obtain cash, with an agreement to buy them back at a later date.
Federal Funds
An overnight, unsecured loan between bank members of the Federal Reserve System, this is the shortest term money market instrument. The loan is made from a Federal Reserve member bank that has excess reserves to a member bank that is deficient in reserves. Monies payable the same day at a member bank of the Federal Reserve System. Trades of U.S. Government and Agency securities settle next business day in Federal funds. (compare Clearing house funds)
Which debt instrument is used to finance imports and exports?
Banker's Acceptances Banker's Acceptances are a money market instrument used to finance imports and exports with "Third World" countries.
Trades of all of the following securities will settle in Fed Funds EXCEPT:
Municipal Bonds Securities that are eligible to be traded by the Federal Reserve are those backed by the guarantee of the U.S. Government as well as certain agency obligations. Both Treasury Bills and Treasury Notes are eligible securities. Trades in eligible securities settle through the Federal Reserve system, and therefore settle in "Fed Funds." Municipal bond trades and trades in corporate securities are not eligible for trading and settling through the Federal Reserve system; these securities settle in "clearing house" funds.
Which of the following are risks that should be disclosed to customers when recommending the purchase of a CD sold through a brokerage firm?
The secondary market is limited, so that sale prior to maturity can incur higher than normal transaction costs. There is no penalty for early withdrawal of funds on brokered CDs - however the amount of interest earned will be pro-rated over the shorter life of the deposit. If interest rates rise after issuance, the value of the CD in the secondary market will fall (though not by much, since this is a short maturity). Most of these instruments are held to maturity, so the secondary market is very limited. Finally, brokered CDs qualify for FDIC insurance as long as the CD is titled in the customer's name.
Reverse Repurchase Agreement
This is where the Federal Reserve sells U.S. Government and other eligible securities to bank dealers, with an agreement to buy back the securities, usually the next day. For 1 day, the bank dealers are drained of cash, which reduces the banks' funds that they can lend. This action tightens credit, and raises interest rates - notably the Fed funds rate.
Repurchase agreement (Repo)
Where a U.S. Government securities dealer sells securities either to the Federal Reserve or another dealer, promising to buy back the securities at a later date. The difference between the sale price and purchase price is the "interest" on the transaction. "Repos" are a source of short-term financing for dealers needing cash. When the Fed initiates a repo with a member bank dealer, it is injecting cash into the banks, expanding credit availability. Here, the government securities dealer sells securities to the fed to get liquid. As a result, interest rates are likely to drop. The duration of a repo can range from overnight to weeks.
Money market discount instruments are quoted on a:
yield basis Money market instruments are original issue discount obligations quoted on a yield basis that are priced at a discount to par (with the exception of negotiable certificate of deposit that are priced at par plus accrued interest). The discount from par is the interest earned.
