FN 310 - Chapters 6

How can investors using the primary T-bill market be assured that their bid will be accepted? Why do large corporations typically make competitive bids rather than noncompetitive bids for T-bills?

Noncompetitive bids in the Treasury auction ensure acceptance by the Treasury. Because noncompetitive bidders are limited to purchasing Treasury bills with a maximum par value of one million per auction, large corporations desiring a larger investment typically submit competitive bids.

Which issues commercial paper? What types of financial institutions issue commercial paper? Why do some firms create a department that can directly place commercial paper? What criteria affect the decisions to create such a department

Only well known, credit worthy firms issue commercial paper. An in-house department can reduce expenses for a firm that frequently deals in commercial paper. The frequency of the firm's issuing commercial paper is the main criteria.

Explain how the yield on a foreign money market security would be affected if the foreign currency denominating that security declined to a greater degree?

The foreign money market yield would be reduced if the foreign currency denominating the security depreciates to a greater degree, since the U.S. investors would have to pay a higher exchange rate for the currency than the exchange rate at which the currency is converted back to dollars.

You have the choice of investing in top-rated commercial paper or commercial paper that has a lower risk rating. How do you think the risk and return performances if the two investments would differ?

The investment with the tip-rated commercial paper is safer when it comes to credit risk, yet there is risk to some degree, however the investment with the lower rating has a higher credit risk and hence the investors potential return is higher as well to compensate for such a high risk of default.

Describe the activity in the secondary T-bill market. How can this activity benefit investors in T-bills? Why might a financial institution sometimes consider T-bills as a potential source of funds?

The secondary market for T-bills is very active. Therefore, it makes investors more interested in investing in T-bills knowing there is a high liquidity level. Financial institutions consider T-bills as a potential source of funds because of its liquidity due to short maturity and strong secondary market, and also the fact that they are backed by the federal government makes it risk-free and secure.

The maximum maturity of commercial paper is 270 days. Why would a firm issue commercial paper instead of longer term securities, even if it needs funds for a long period of time?

A firm will issue commercial paper even though it needs funds for a longer time period because it is cheaper than issuing a long term loan and is riskier. "The longer it takes them to pay back the less likely they will pay you back," that applies in the business world and hence the longer the maturity the higher the rates to compensate the lender that risk of default and therefore, commercial papers have lower rates because they have shorter maturity.

Why do agencies assign credit ratings to commercial paper ?

Because commercial paper must be very highly rated for investors to consider investing in. Investors need to know the default (credit) risk in order to know what rates (yields) to expect in return.

Explain how each of the following would use banker's acceptances: (a) exporting firms, (b) importing firm, (c) commercial banks, and (d) investors.

For all each of the following the bank is the third party involved in the transaction and by issuing banker's acceptance the bank would guarantee each of these four parties their payment in case of default by whomever they are trading with.

How can small investors participate in investments in negotiable certificates of deposits (NCDs)?

Individual investors can purchase money market funds which have pooled individual investors funds to purchase an NCD (similar to mutual funds) .

Explain how investors' preferences for commercial paper change during a recession. How should this reaction affect the difference between commercial paper rates and T-bill rates during a recessionary periods?

Investors will require higher rated commercial paper due to increased risk in the market, and they would charge a higher interest rates as well to compensate to that increase in the default risk. T-bill rates do not typically that much during a recession because they are risk-free.

Based on what you know about repurchase agreements, would you expect them to have a lower or higher annualized yield than commercial paper?

Repos would have lower annualized yield. Because they are backed up by securities (usually t-bills) that are used in the repo agreement so in cases of default the investor gets to keep those securities.

Explain how the Treasury uses the primary market to obtain adequate funding.

The treasury issues T-Bill to the public and uses the proceeds to finance the budget deficit.

How do you think the shape of the yield curve for commercial paper and other money market instruments compares to the yield curve for Treasury securities? Explain your logic.

The yield for the commercial paper and other money market instrument would be way higher than that of any Treasury securities. The higher yield is to pay off (compensate) for the risk and the degree of shortage of liquidity (especially during recessions) found in money market securities but are not found in the Treasury securities because it is backed by the federal government.