ECMC48 Money Market.docx

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University of Toronto Scarborough
Financial Accounting
Jack Parkinson

The Money Market – the most important securities and features 1. Treasury Bills a) Short-term debt instruments (i.e. usually mature in 91-365 days) b) Issued (sold) by the Federal Government (& others) c) Primary Market: Canadian Government sells new issues by auction (every two weeks) d) Secondary market: for Canada’s large/liquid e) Sold at a discount to its face value f) A higher price translates into a lower yield g) Yield fluctuations correlated to interest rate conditions/developments in the overnight market h) A useful indicator of monetary policy stance 2. Commercial Paper a) Unsecured promissory note with a fixed maturity of 1 to 270 days (i.e. up to 9 months) b) Issued (sold) by large banks and corporations to obtain funds to meet current ST expenses (such as payroll, inventories, receivables, to make loans) c) Only backed by the issuing firm’s promise to pay the face value on the maturity. Since it is not backed by collateral its price (& hence yield) will depend on the credit worthiness (rating) of the issuing firm. d) Sold at a discount to its face value (a higher price translates into a lower yield) e) Usually has higher interest rate than bonds (lower than banks’ rates) f) Can be asset backed – Can be issued by banks or others g) Primary Market: Issuer can sell directly to investors OR to a dealer (who sells them in the market – Indirect finance). h) Secondary Market: where commercial paper notes can be resold 3. Certificates of Deposit a) A certificate of deposit (CD) is a term (time) deposit issued (sold) by a deposit taking institution (i.e. a bank) b) The money deposited in a CD is locked-in for the duration of the specific term (i.e. until the maturity date anywhere between 1 to 60 months into the future). c) Usually these accounts grant the holder higher interest rates than accounts that are more liquid (demand deps) d) Once the term ends the holder is paid the principle plus any accrued interest (the rate could be fixed or variable) e) Could make interest payments over time OR accumulate interest in the locked-in account f) Negotiable & bearer CDs (bearer deposit notes) can be resold (usual terms are 30 to 365 days) g) Non-negotiable CDs (term notes) cannot be resold or redeemed prior to maturity (usually gives a higher rate) 4. Canadian Payments Association a) CPA is the Canadian Payments Association b) The (non-profit) CPA operates the national system for the clearing & settlement of payments c) Facilitates the flow of funds & mitigates risk d) Handles settling cheques, bill payments, debits - Runs electronic wire transfers (LVTS) i. The Large Value Transfer System (LVTS) 1. An electronic wire transfer system created & run by the CPA - Assists in the operations of the clearing system (the LVTS is not an instrument) 2. Attempting to reduce Systemic risk: The risk that a disruption (at a firm, in a market segment, to a settlement system, etc) causes widespread difficulties at other firms, in other market segments, or in the financial system as a whole. a) In this definition, systemic risk is based on a shock or disruption originating either within or outside the financial system that triggers disruptions to other market participants and mechanisms. Such a risk thereby substantially impairs credit allocation, payments, or the pricing or financial assets. b) Interest rates, recession and wars all represent sources of systematic risk because they affect the entire market and cannot be avoided through diversification. Systematic risk can be mitigated only by being hedged. c) Whereas this type of risk affects a broad range of securities, unsystematic risk affects a very specific group of securities or an individual security. d) Even a well-diversified portfolio of assets cannot escape all risk. e) There is systemic financial risk when contingency plans that are developed individually are collectively incompatible. e) Membership: All Cdn banks (63) & the BOC must be members, other financial institutions (such as trust companies, credit unions, life insurance companies & securities dealers) are eligible to be members 5. Bank of Canada Advances a) “Lender of last resort” loan (from the BOC) b) Accessible only t
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