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Midterm

midterm study notes


Department
Rotman Commerce
Course Code
RSM230H1
Professor
Laurence Booth
Study Guide
Midterm

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Money Market < 1 year term to maturity
The overnight rate is important as it affects all short term interest rates
Almost all money market securities are discount notes
Most are marketable and highly liquid which means they can be converted to money
(cash) at full value very quickly: (ie they have high moneyness)
Examples of MM securities: Treasury Bills, Corporate Promissory Notes:
Bankers acceptance & Commercial Paper
US: 360 days or a 30/360 day count basis
Canada: 365 days or an actual/actual (normally 365) day count basis
Bank of Canada data shows US rates on a Canadian yield basis; This is called the
money market yield convention
A basis point is 1/100 of a percentage point so the Canadian yield is
6% plus 11.39 basis points or 6.1139%
(Calculate price)
(calculate effective yield)
Types of Issuer:
Treasury bills (T-bills)
- short term securities issued by the treasury of a government.
- most liquid securities in the money market multiples of $1,000
- NO DEFAULT RISK
The most liquid securities in the market actively traded OTC
Issued at auction held through sealed bids from registered securities distributors
or dealers
Canada Treasury Bills are issued by the Department of Finance through an
auction process conducted by the Bank of Canada which is the governments
fiscal agent.
Competitive bids - each authorized dealer can submit up to 7 bids for a
minimum of $100,000 in multiples of $1,000
Dealers who bid the highest price (lowest yield) win Treasury Bills at the
auction
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Non-Competitive bids are accepted in full or pro-rated up to dealer and
customer limits at the average price.
Treasury bills yields are influenced by inflation (positively) ?
CDS(Canadian Depository for Securities): Since Nov 1995, T-bills are issued
in global certificate form for the full amount registered in the name of CDS; All
payments go through CDS; Transfers are made as book entries on CDS computer
system.
Issued by Banks
- Certificates of Deposits (CDs) and Bearer Deposit Notes (BDNs)
- Large-denomination deposits of $100,000 or more issued by
Chartered banks, for a specified term
Bankers acceptances (BAs)
Nothing to do with trade as in the US market
Simply a bank guaranteed CP
Bank charges a stamping or guarantee fee of 0.50-1.0% for guaranteeing the
note
Issued By Corporations - Commercial paper (CP)
Short-term, unsecured debt issued by the largest corporations.
DEFAULT RISK
-Risk is reflected in higher interest rates
Variable terms to maturity
Large size ie $100,000+ minimum denomination
- Wholesale market, largely institutional investors
You can buy CP direct from the issuing corporation or through an investment
dealer
Not very liquid
Traditionally CP could not be sold to uninformed retail investors; the minimum
investment was at least $50,000-$97,000, depending on the province.
In 2005 this limit was removed and instead CP could be sold to anyone as long as
it had the highest credit rating (ie R-1 high)
Securitizations - ie Asset Backed Securities paper (ABCP) Variable
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Put some assets into a trust or special investment vehicle (SIV)
- the assets are collateral
SIV issues commercial paper (CP) to finance the purchase of the assets
Risk is reduced in several ways:
SIV is over-collateralised,110% asset coverage of the CP
Underlying assets are generally low risk loans, & they are pooled to reduce
risk through diversification
Often SIV gets a bank guarantee or deficiency agreement so someone else
promises to absorb some losses if they occur
Stress tests…Use historic default rates of the assets to judge the level of risk
US SUB PRIME CRISIS: - US housing prices increased dramatically 2002-2006 and with
them mortgage financing; As US house prices moderated and then fell in 2007 (year over
year down 15% in August 2008) defaults increased and the value of these securities
collapsed
Risk Assessment:
Securities legislation protects investors and ensures that:
all information is known about an issuer
Prices are not manipulated
Criminals can not sell securities (registration requirement)
People in the business are well trained (CSC)
Dominion Bond Rating Service (DBRS) is the major Canadian rating agency.
Rates money market instruments and long term bonds
Estimate the probability of default and what is likely to be received in default;
Gives each security (not the issuing company) a credit rating
As part of its rating on money market instruments it requires a back up line of
credit from a major bank
A line of credit just means that in an emergency the CP issuer could borrow from
the bank to pay off the CP
A line is necessary to assure CP holders that they will get repaid when there is a
flight to quality
R-2 is regarded as investment grade for CP
Reality is that most institutional investors require R-1 Ratings!
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