Money market

The Problem The local Kiwanis Club needs 20,000 in interest annually in order to adequately fund its benevolence programs. It currently has 120,000 invested — one-third of it in a mutual fund earning 5 percent interest and the rest in a money-market fund earning 10 percent interest. This division of the funds is mandated by its endowment agreement. How much more money does the Kiwanis Club need, and how much does it have to have in each fund in order to earn that 20,000 annual interest ... 

Cash Reserves. This includes funds that are readily available in checking accounts, money market accounts, certificates of deposit of one year or less, U.S. Government Series EE and HH bonds, and U.S. Treasury bills. 

Set up three bank accounts. The first account should be a money market account with check-writing privileges, the next a regular checking account, and the third another money market account. 

Deposit all income into a money market account. 

Write two checks. Deposit an amount to cover your monthly fixed expenses into the checking account. Deposit 1/12 of the annual total of your variable expenses into the other money market account. 

Allow savings to build up in the money market account until you have a balance at least equal to three months , and preferably equal to six months , net take home pay. This is your emergency fund. Save it to cover times when your income is interrupted by illness, disability, or unemployment. When your emergency fund is in place, consider investment alternatives for your savings. 

Money Market Accounts Certificates of Deposit U.S. Government Securities Stocks and stock mutual funds Bonds and bond mutual funds Partnership interests Business interests Deferred compensation Real estate investments Net equity from sale of residence Net equity from sale of vacation home Other retirement savings... 

A mutual fund is an investment company that pools the money of many investors and invests it on their behalf. Based on a fund s stated objective, the money is invested in stocks, bonds, money market securities, or a combination of these. At the end of 2004, there were about 8,000 mutual funds with 267 million accounts worth in excess of 8.1 trillion. All investments have an element of risk. Mutual funds are no different. And, with so many choices, great care should be exercised to find a fund that is right for you. 

If the penalty structure is to your liking, make sure that the money market account is FDIC insured. 

In order to open a money market account, you should follow several steps. 

In order to open a money market account, you should follow several steps. First, you should decide what features are important to you. Then you should shop around for the best terms and yields available. After you ve found the best terms, be sure to find out what the minimum account balance is and ask what the penalties are if your account drops below the limit. If the penalty structure is to your liking, make sure that the money market account is FDIC insured. Finally, once the account is opened and you are earning interest, you should consider using that interest to pay off outstanding credit card debt. 

For risk-free investments, such as U.S. Treasury bills, the required return (as a percent of the capital invested) is determined by supply and demand in the money markets. If the going risk-free interest rate is 5 percent per year, for example, an investor who puts up 100 expects to get at least 105 back next year. From another point of view, 100 promised for delivery next year is worth only 95.23 today, because the investor could take that 95.23, invest it in a risk-free security, and have the 100 a year hence. Not having access to the 95.23 today essentially deprives the investor of the opportunity to invest at the going interest rate. 

In this section, we describe the relationship between the price of a zero-coupon bond and spot and forward rates. We assume a risk-free zero-coupon bond of nominal value 1, priced at time t and maturing at time T. We also assume a money market bank account of initial value P t, T) invested at time t. The money market account is denoted M. The price of the bond at time t is denoted P t, T) and if today is time 0 (so that t > 0), then the bmid price today is unknown and a random factor (similar to a future interest rate). The bond price can be related to the spot rate or forward rate that is in force at time t. 

The continuously compounded constant spot rate is r as before. An investor has a choice of purchasing the zero-coupon bond at price P(t, T), which will return the sum of 1 at time T, or of investing this same amount of cash in the money market account, and this sum would have grown to 1 at time T. We know that the value of the money market accoxmt is given by Me If M must have a... 

If the same amount of cash that could be used to buy the bond at t, invested in the money market account, does not return 1 then arbitrage opportunities will result. If the price of the bond exceeded the discoxmt function then... 

Before we come to that, however, we wish to describe the spot rate and the money market account processes. In Equation (4.4), under the particular condition of the maturity point T as it tends towards t (that is t), the forward rate tends to approach the value of the short rate (spot rate), so we have... 

The money market account is also described as a Wiener process. We denote by M(t, t)=M (f) the value of the money market account at time t, which has an initial value of 1 at time 0 so that M(0,0) = 1. This account earns interest at the spot rate r(f) which means that at time t the value of the account is given by... 

The expression for the value of the money market account can be used to determine the expression for the zero-coupon bond price, which we denote as P(t, T). The money market account earns interest at the spot rate rit), while the bond price is the present value of 1 discounted at this rate. Therefore, the inverse of Equation (4.8) is required, which is... 

The no-arbitrage condition is set by defining the price of a zero-coupon bond that matures at time T in terms of an accumulation factor B(t) which is the value of a money market account that is invested at time 0 and reinvested at time t at an interest rate of r(t). This accumulation factor is defined as Equation (4.31) ... 

The traditional approach to yield curve fitting involves the calculation of a set of discount factors from market interest rates. From this, a spot yield curve can be estimated. The market data can be money market interest rates, futures and swap rates and bond yields. In general, though this approach tends to produce ragged spot rates and a forward rate curve with pronounced jagged knot points, due to the scarcity of data along the maturity structure. A refinement of this technique is to use polynomial approximation to the yield curve. 

The fitted spot curve can differ considerably if yields on short-term repo are included. The effect is shown in Figure 5.7, which is reproduced from Anderson and Sleath (1999). Note that this is a short-term spot curve only the maturity extends out to only 2 years. Two curves have been estimated the cubic spline-based yield curve using the repo rate and without the repo rate. The curve that uses repo data generates a curve that is much closer to the money market yield curve than the one that does not. The only impact is at the very short end. After about 1 year, both approaches generate very similar curves. 

In Chapter 11 of the author s book The Bond and Money Markets, we show some approaches used to measure inflation expectations, with reference to the United Kingdom index-linked gilts. To recap, these measures include ... 

Choudhry, M., 2001. The Bond and Money Markets. Butterworth-Heinemann. 

A bond is a debt capital market instrument issued by a borrower, who is then required to repay to the lender/investor the amount borrowed plus interest, over a specified period of time. Bonds are also known as fixed income instruments, or fixed interest instruments in the sterling markets. Usually bonds are considered to be those debt securities with terms to maturity of over one year. Debt issued with a maturity of less than one year is considered to be money market debt. There are many different types of bonds that can be issued. The most common bond is the conventional (or plain vanilla or bullet) bond. This is a bond paying periodic interest pay-... 

One common way to distinguish between different sectors of the debt markets is by the maturity of the instruments. The money market is... 

For a complete treatment of the money markets, see Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry, The Global Money Markets (Hoboken, NJ John Wiley Sons, Inc., 2002). 

Short-term institutional investors include banks and building societies, money market fund managers, central banks and the treasury desks of some types of corporates. Such bodies are driven by short-term investment views, often subject to close guidelines, and will be driven by the total return available on their investments. Banks will have an addi-... 

Floating-rate notes (FRNs) are Eurobonds that have their coupon levels reset periodically, with reference to a money market rate. For dollar-denominated assets, this is LIBOR (the London Inter-bank Offer Rate) as determined by a group of 16 reference banks. The mechanism is run by the British Bankers Association (BBA). The BBA also supervises LIBOR fixings in a number of other currencies. For euros, the most common reference rate is EURIBOR, as determined by a reference group of around 50 banks chosen by European Banking Federation. In both cases, most issues are priced off of the three-month rate, although one-month and six-month rates are also used. 

In debt capital markets the yield on a domestic government T-bill is usually considered to represent the risk-free interest rate, since it is a shortterm instrument guaranteed by the government. This makes the T-bill rate, in theory at least, the most secure investment in the market. It is common to see the 3-month T-bill rate used in corporate finance analysis and option pricing analysis, which often refer to a risk-free money market rate. 

This is in addition to the normal daily money market operations, which keep the BoE closely connected to the gilt repo market. The BoE s dealers also carry ont orders on behalf of its cnstomers, primarily other central banks. 

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