Commercial Paper
4th Ed
Chapter 5:
Money Markets
True/False
1. Everything else equal, an effective annual rate will be greater than the bond equivalent yield on the same security.
Answer: True
Level: Easy
2. Money markets exist to help reduce the opportunity cost of holding cash balances.
Answer: True
Level: Easy
3. The majority of money market securities are low denomination, low risk investments designed to appeal to individual investors with excess cash.
Answer: False
Level: Easy
4. Commercial paper is a short term obligation of the U.S. government issued to cover government budget deficits and to refinance maturing government debt.
Answer: False
Level: Easy
5. Commercial paper, Treasury bills and banker’s acceptance rates are all quoted as discount …show more content…
yields.
Answer: True
Level: Medium
6. Euro commercial paper is a short term obligation of the European Central Bank.
Answer: False
Level: Easy
Ch 5 - 1
4th Ed
7. The U.S. Treasury switched from a discriminating price auction to a single price auction because the latter lowered the average price paid by investors.
Answer: False
Level: Easy
8. In the T-Bill secondary market the ask yield will normally be less than the bid yield.
Answer: True
Level: Medium
9. The largest secondary money market in the U.S. is the secondary market for T-Bills.
Answer: True
Level: Easy
10. Fed funds are short term unsecured loans while repos are short term secured loans.
Answer: True
Level: Medium
11. 360/ h times the difference between the face value and the current value divided by the face value gives you the discount yield on an instrument.
Answer: True
Level: Difficult
12. The bond equivalent yield times 365/360 is equal to the single payment yield.
Answer: False
Level: Medium
Multiple Choice
13. For the purposes for which they are used, money market securities should have which of the following characteristics?
I. Low trading costs
II. Little price risk
III. High rate of return
Ch 5 - 2
4th Ed
IV. Life greater than one year
A) I and III
B) II and IV
C) III and IV
D) I and II
E) I, II and III
Answer: D
Level: Easy
14. Money market securities exhibit which of the following?
I. Large denomination
II. Maturity greater than one year
III. Low default risk
IV. Contractually determined cash flows
A) I, II and III
B) I, III and IV
C) II, III and IV
D) II and IV
E) I, II, III and IV
Answer: B
Level: Medium
15. A repo is in essence a collateralized
A) Banker’s acceptance
B) Certificate of deposit
C) Fed funds loan
D) Commercial paper loan
E) Eurodollar deposit
Answer: C
Level: Medium
16. A short term unsecured promissory note issued by a company is
A) Commercial paper
B) T-Bills
C) Repurchase agreement
D) Negotiable CD
E) Banker's acceptance
Answer: A
Level: Easy
Ch 5 - 3
4th Ed
17. A time draft payable to a seller of goods, with payment guaranteed by a bank is a
A) Commercial paper security
B) T-Bill
C) Repurchase agreement
D) Negotiable CD
E) Banker's acceptance
Answer: E
Level: Easy
18. In the T-Bill auction process the competitive bidder is guaranteed a _____ and a noncompetitive bidder is guaranteed a _____.
A) Minimum price; maximum price
B) Maximum price; minimum price
C) Maximum price; given quantity
D) Minimum price; maximum quantity
E) None of the above
Answer: C
Level: Medium
19. A dealer is quoting a $10,000 face 180 day T-Bill quoted at 2.75 bid, 2.65 ask. You could buy this bill at ________ or sell it at ________.
A) $9,869.23; $9864.36
B) $9864.36; $9,869.23
C) $9,867.50; $9862.50
D) $9,862.50; $9,867.50
E) None of the above
Answer: C
Response: Buy at 10,000[1-(0.0265180/360)] ; Sell at 10,000 [1-(0.0275180/360)]
Level: Medium
20. Rates on federal funds and repurchase agreements are stated
A) On a bond equivalent basis with a 360 day year
B) On a bond equivalent basis with a 365 day year
C) As a discount yield with a 360 day year
D) As an EAR
E) As a discount yield with a 365 day year
Answer: A
Ch 5 - 4
4th Ed
Level: Medium
21. The discount yield on a T-Bill differs from the T-bill’s bond equivalent yield (BEY) because
I. The discount yield is the return per dollar of face value and the BEY is a return per dollar originally invested.
II. A 360 day year is used on the discount yield and the BEY uses 365 days
III. The discount yield is calculated without compounding, the BEY is calculated with compounding A) I only
B) II only
C) I and II only
D) II and III only
E) I, II and III
Answer: C
Level: Difficult
22. The following formula is used to calculate the _________ of a money market investment.
PF P0 360
P0 h A)
B)
C)
D)
E)
EAR
APR
single payment yield discount yield
BEY
Answer: C
Level: Medium
23. The rate of return on a repo is
A) Determined by the rate of return on the underlying collateral
B) Strongly affected by the current Fed funds rate at the time of the repo
C) Determined at the time of the repo
D) A and C
E) B and C
Answer: E
Level: Medium
24. Which one of the following statements about commercial paper is NOT true?
Commercial paper issued in the U.S.
A) Is an unsecured short term promissory note
Ch 5 - 5
4th Ed
B)
C)
D)
E)
Has a maximum maturity of 270 days
Is virtually always rated by at least one ratings agency
Has no secondary market
Carries an interest rate above the prime rate
Answer: E
Level: Medium
25. A negotiable CD
A) Is a bank issued transactions deposit
B) Is a registered instrument
C) Is a bank issued time deposit
D) Has denominations ranging from $50,000 to $10 million
E) Pays discount interest
Answer: C
Level: Medium
26. A 180 day $3 million CD has a 4.25% annual rate quote. If you buy the CD, how much will you collect in 180 days?
A) $3,047,439
B) $3,045.678
C) $3,062,877
D) $3,063,750
E) $3,127,500
Answer: D
Response: $3 mill [1 + (0.0425180/360)
Level: Medium
27. A banker's acceptance is
A) A time draft drawn on the exporter's bank
B) A method to help importers evaluate the creditworthiness of exporters
C) A liability of the importer and the importer's bank
D) An add on instrument
E) For greater than 1 year maturity
Answer: C
Level: Medium
28.
The most liquid of the money market securities are
A) Commercial paper
Ch 5 - 6
4th Ed
B)
C)
D)
E)
Banker's acceptances
T-Bills
Fed funds
Repurchase agreements
Answer: C
Level: Easy
29. In dollars outstanding in 2007 the largest money market security was
A) Commercial paper
B) Banker's acceptances
C) T-Bills
D) Fed funds & repos
Answer: D
Level: Medium
30. You buy a $10,000 par Treasury bill at $9,575 and sell it 60 days later for $9,675. What was your EAR?
A) 4.44%
B) 6.29%
C) 6.35%
D) 6.52%
E) 6.67%
Answer: D
Level: Medium
31. LIBOR is generally _____ the Fed funds rate because foreign bank deposits are generally
_____ than domestic bank deposits
A) Greater than; less risky
B) Less than; more risky
C) The same as; equally risk
D) Greater than; more risky
E) Less than; less risky
Answer: D
Level: Medium
32. A U.S. exporter sells $150,000 of furniture to a Latin American importer. The exporter requires the importer to obtain a letter of credit. When the bank accepts the draft the exporter
Ch 5 - 7
4th Ed
discounts the 120 day note at a 5.25% discount. What is the exporter’s true effective annual financing cost?
A) 5.52%
B) 5.42%
C) 5.34%
D) …show more content…
5.29%
E) 5.25%
Answer: A
Response: 150,000*[1-(0.0525*120/360)] = 147,375; (150,000/147,375)365/120-1 = 5.52%
Level: Difficult
33. A Chinese exporter sells $200,000 of toys to a French importer. The Chinese exporter requires the French importer to obtain a letter of credit. When the bank accepts the draft the exporter discounts the 90 day note at a 4% discount. What is the exporter’s true effective annual financing cost?
A) 4.00%
B) 4.04%
C) 4.10%
D) 4.16%
E) 4.22%
Answer: D
Response: 200,000*[1-(0.04*90/360)] = 198,000; (200,000/198,000)365/90-1 = 4.16%
Level: Difficult
34. If a $10,000 par T-Bill has a 3.75% discount quote and a 90 day maturity, what is the price of the T-Bill to the nearest dollar?
A) $9,625
B) $9,906
C) $9,908
D) $9,627
E) None of the above
Answer: B
Response: 10,000*[1-(0.0375*90/360)] = 9,906
Level: Medium
35. A 90 day T-Bill is selling for $9,900. The par is $10,000. The effective annual return on the
T-Bill is (watch your rounding)
A) 4.00%
B) 4.16%
C) 4.10%
Ch 5 - 8
4th Ed
D) 4.04%
E) 4.21%
Answer: B
Response: (10,000 / 9900)(365 / 90) - 1
Level: Medium
36. Suppose that $10 million face value commercial paper with a 270 day maturity is selling for
$9.55 million. What is the BEY on the paper?
A) 4.71%
B) 6.42%
C) 6.37%
D) 6.28%
E) 4.50%
Answer: C
Response: ((10 mill / 9.55 mill) – 1)* (365 / 270)
Level: Medium
37. A $2 million jumbo CD is paying a quoted 3.55% interest rate on 180 day maturity CDs.
How much money will you have at maturity if you invest in the CD?
A) $2,000,000
B) $2,035,014
C) $2,035,500
D) $2,071,000
E) $2,088,400
Answer: C
Response: 2,000,000 *[1 + (0.0355*180/360)]
Level: Medium
38. From 1990 to 2007 which one of the following money market securities actually declined in terms of dollar amount outstanding?
A) Commercial paper
B) Treasury bills
C) Federal funds and repos
D) Negotiable CDs
E) Banker’s Acceptances
Answer: E
Level: Medium
Ch 5 - 9
4th Ed
39. A 50 day maturity money market security has a bond equivalent yield of 3.60%. The security’s EAR is
A) 3.69%
B) 3.61%
C) 3.55%
D) 3.87%
E) 3.66%
Answer: E
Response: EAR = (1+ (0.0360 / (365/50)))365/50 – 1 = 3.66%
Level: Difficult
40. In a Treasury auction, preferential bidding status is granted to
A) Competitive bidders
B) Noncompetitive bidders
C) Short sale committed bidders
D) Commercial bank bidders
E) No group of bidders
Answer: B
Level: Easy
41. If your firm enters into an overnight reverse repurchase agreement your firm is
A) Borrowing fed funds temporarily
B) Selling a security now while agreeing to buy it back tomorrow
C) Giving an unsecured loan to the counterparty
D) Procuring a banker’s acceptance
E) None of the above
Answer: E
Level: Medium
42. Eurodollar CDs would include
A) CDs denominated in Euros
B) Dollar investments by European entities in the U.S.
C) Dollars deposited in Caribbean banks
D) Dollars deposited in Europe
E) Both C & D
Answer: E
Level: Medium
Ch 5 - 10
4th Ed
Short Answer
43.
Why do most money market securities have large denominations?
Answer: The market has developed for institutional investors because institutional investors have large enough quantities of money to make it costly for them to not invest their excess funds. For most individual investors the dollars lost by not keeping fully invested in interest bearing assets is very minimal.
Level: Easy
44. Given the functions of the money markets, why is it necessary for money market securities to have a maturity of one year or less and low default risk?
Answer: Because these markets are designed to provide safe investments with little or no chance of principle loss. If you could lose principle you would be very unlikely to invest funds that are shortly needed. Low default risk implies that the promised cash flows will in all likelihood be paid in full and on time. The short maturity ensures that the value of these securities will be relatively insensitive to interest rate changes, and also there is not much time for the issuer's condition to change; this also limits the risk.
Level: Medium
45. What is the difference between a discriminating auction and a single price auction? How is the final price determined in a single price auction? Why did the Treasury switch to a
single price auction?
Answer: In a discriminating price auction, different bidders pay a different price for the same securities. In a single price auction, all successful bidders pay the same price, regardless of the specific price they bid. The final price is set as the lowest price of the competitive bids accepted.
The Treasury switched to single price auctions because they found that in single price auctions there tended to be more winning bidders and that bidders bid more aggressively (made higher bids), resulting in overall higher bid prices and revenues for the government.
Level: Difficult
46. A government securities dealer needs to make a 7% pre-tax annual return on $10 million of capital employed to make it worthwhile to make a market in T-Bills. If the bid discount on
$10,000 face value, ninety day T-Bills is 3.50%, and the dealer can expect to do 5200 round trip deals today what must the ask discount be? Hint: A round trip is a buy and a sell transaction.
Answer: Bid Price = 10,000 [1 - .035(90/360)] = $9,913
$10 million (0.07/365) = (Required Ask Price - $9,913) 5200 deals
Required Ask = $9,912.87
Ch 5 - 11
4th Ed
Ask Discount = (($10,000 - $9,912.87)/$10,000) (360/90) = 3.485%
Level: Difficult
47. How does a repo differ from a Fed Funds transaction? How do their rates compare?
Answer: A repo is basically a collateralized loan whereas Fed Funds are uncollateralized. The repo rate will typically be slightly below the equivalent maturity Fed funds rate because the repos are collateralized. Repos are likely to be for longer maturity than Fed funds although both may involve transfers of deposits held at the Fed. Fed Funds loans can be arranged more quickly because no change of title of securities is involved.
Level: Medium
48. As a corporate treasurer who is unsure how soon funds will be needed, which type of money market investment might you prefer? Explain the tradeoffs. Would your answer differ if you had a definite time period during which you would not need the money? Explain.
Answer: If liquidity is a primary concern then T-Bills may be the best choice because they are by far the most liquid. They also typically offer the lowest rate of return because of the government backing and high liquidity. Fed Fund loans may be a slightly higher rate alternative, but are very short term. If you knew for certain (or with high probability) that the funds will not be needed then term repos, commercial paper or banker's acceptances may offer better rates of return.
Level: Medium
49. A corporate treasurer is looking to invest about $4 million for 60 days. Commercial paper rates are a 3.65% discount and CD rates are 3.66%. Comparing the bond equivalent yields over a 365 day year, which is the best alternative? What is the opportunity cost of leaving the funds idle? (Watch your rounding)
Answer: Find the BEY on each
CP: Price = $4 mill * [1 – 0.0365*(60/360)] = $3,975,667
[($4 mill / $3,975,667) – 1] * (365 / 60) = 3.7233% BEY
CD: $4 mill [1 + 0.0366*(60/360)] = $4,024,400
[($4,024,400/$4 mill) – 1] * (365/60) = 3.7108% BEY
The best deal is the CP and the opportunity cost is 3.7233%
Level: Difficult
50. How does a banker's acceptance help create more international trade?
Answer: Importer's do not wish to pay until they receive the goods and exporters do not wish to ship until they receive payment. The creation of a BA allows the exporter to ship prior to receipt of payment, while substituting the credit worthiness of a large international bank for the unknown creditworthiness of the importer.
Ch 5 - 12
4th Ed
Level: Easy
51. Who are the major participants in money markets?
Answer:
U.S. Treasury
Commercial Banks
Federal Reserve
Brokers and dealers
Corporations
Other financial institutions
Level: Easy
52. One hundred eighty day commercial paper can be bought at a 3.75% discount. What are the bond equivalent yield and the effective annual rate on the commercial paper? Why do these rates differ? Answer: Commercial paper price/100 of par = 100*(1 – (0.04*1800/360)) = 98.13
Effective annual rateCP= (100 / 98.13)365/180 – 1 = 3.91%
Bond equivalent yield = [(100 – 98.13) / 98.13] * 365/180 = 3.875%
The discount quote is an annual quote calculated as (Par – Price) / Par, assuming that there are
360 days in a year. The bond equivalent yield is an annual rate calculated as (Par – Price) /
Price, which is the normal way to express a percentage return ($ return per $ invested), assuming that there are 365 days in the year. The effective annual return or EAR is the same as the bond equivalent yield, except that the EAR annualizes the rate of return assuming the proceeds from each 180 day period are reinvested during the next 180 day period and so on.
Level: Medium
53. You are a corporate treasurer for Esso Oil. The quoted rate on dollar denominated euro commercial paper has just blipped down recently. Your firm can issue $10 million of 180 day euro commercial paper in the London markets at 3.45%. You can also invest the proceeds in the
U.S. in comparable maturity negotiable dollar denominated CDs which are quoting 3.95%.
Ignoring any transactions costs, how much money, if any, can Esso make by borrowing in the euro markets and investing in the U.S.? Is this a good deal or not? Should you expect it to last?
Explain.
Answer: Initial proceeds from issuing euro commercial paper (CP) = $10 million * [1(0.0345*180/360)] = $9,827,500; Invest the proceeds of $9,827,500 in 180 day CDs and will wind up with $9,827,500 * [1+(0.0395*180/360)] = $10,021,593
Repay the $10,000,000 owed on the CP and Esso will clear $21,593.
If the CDs are not very risky then this represents an arbitrage opportunity for Esso, because they are not using their own money the rate of return is infinite. Since this is an arbitrage strategy we would not expect this big a difference in the rates to persist. (Exxon constructed a similar arbitrage several years ago using euro commercial paper and T-bills.)
Level: Difficult
Ch 5 - 13
Chapter 5:
Money Markets
True/False
1. Everything else equal, an effective annual rate will be greater than the bond equivalent yield on the same security.
Answer: True
Level: Easy
2. Money markets exist to help reduce the opportunity cost of holding cash balances.
Answer: True
Level: Easy
3. The majority of money market securities are low denomination, low risk investments designed to appeal to individual investors with excess cash.
Answer: False
Level: Easy
4. Commercial paper is a short term obligation of the U.S. government issued to cover government budget deficits and to refinance maturing government debt.
Answer: False
Level: Easy
5. Commercial paper, Treasury bills and banker’s acceptance rates are all quoted as discount …show more content…
yields.
Answer: True
Level: Medium
6. Euro commercial paper is a short term obligation of the European Central Bank.
Answer: False
Level: Easy
Ch 5 - 1
4th Ed
7. The U.S. Treasury switched from a discriminating price auction to a single price auction because the latter lowered the average price paid by investors.
Answer: False
Level: Easy
8. In the T-Bill secondary market the ask yield will normally be less than the bid yield.
Answer: True
Level: Medium
9. The largest secondary money market in the U.S. is the secondary market for T-Bills.
Answer: True
Level: Easy
10. Fed funds are short term unsecured loans while repos are short term secured loans.
Answer: True
Level: Medium
11. 360/ h times the difference between the face value and the current value divided by the face value gives you the discount yield on an instrument.
Answer: True
Level: Difficult
12. The bond equivalent yield times 365/360 is equal to the single payment yield.
Answer: False
Level: Medium
Multiple Choice
13. For the purposes for which they are used, money market securities should have which of the following characteristics?
I. Low trading costs
II. Little price risk
III. High rate of return
Ch 5 - 2
4th Ed
IV. Life greater than one year
A) I and III
B) II and IV
C) III and IV
D) I and II
E) I, II and III
Answer: D
Level: Easy
14. Money market securities exhibit which of the following?
I. Large denomination
II. Maturity greater than one year
III. Low default risk
IV. Contractually determined cash flows
A) I, II and III
B) I, III and IV
C) II, III and IV
D) II and IV
E) I, II, III and IV
Answer: B
Level: Medium
15. A repo is in essence a collateralized
A) Banker’s acceptance
B) Certificate of deposit
C) Fed funds loan
D) Commercial paper loan
E) Eurodollar deposit
Answer: C
Level: Medium
16. A short term unsecured promissory note issued by a company is
A) Commercial paper
B) T-Bills
C) Repurchase agreement
D) Negotiable CD
E) Banker's acceptance
Answer: A
Level: Easy
Ch 5 - 3
4th Ed
17. A time draft payable to a seller of goods, with payment guaranteed by a bank is a
A) Commercial paper security
B) T-Bill
C) Repurchase agreement
D) Negotiable CD
E) Banker's acceptance
Answer: E
Level: Easy
18. In the T-Bill auction process the competitive bidder is guaranteed a _____ and a noncompetitive bidder is guaranteed a _____.
A) Minimum price; maximum price
B) Maximum price; minimum price
C) Maximum price; given quantity
D) Minimum price; maximum quantity
E) None of the above
Answer: C
Level: Medium
19. A dealer is quoting a $10,000 face 180 day T-Bill quoted at 2.75 bid, 2.65 ask. You could buy this bill at ________ or sell it at ________.
A) $9,869.23; $9864.36
B) $9864.36; $9,869.23
C) $9,867.50; $9862.50
D) $9,862.50; $9,867.50
E) None of the above
Answer: C
Response: Buy at 10,000[1-(0.0265180/360)] ; Sell at 10,000 [1-(0.0275180/360)]
Level: Medium
20. Rates on federal funds and repurchase agreements are stated
A) On a bond equivalent basis with a 360 day year
B) On a bond equivalent basis with a 365 day year
C) As a discount yield with a 360 day year
D) As an EAR
E) As a discount yield with a 365 day year
Answer: A
Ch 5 - 4
4th Ed
Level: Medium
21. The discount yield on a T-Bill differs from the T-bill’s bond equivalent yield (BEY) because
I. The discount yield is the return per dollar of face value and the BEY is a return per dollar originally invested.
II. A 360 day year is used on the discount yield and the BEY uses 365 days
III. The discount yield is calculated without compounding, the BEY is calculated with compounding A) I only
B) II only
C) I and II only
D) II and III only
E) I, II and III
Answer: C
Level: Difficult
22. The following formula is used to calculate the _________ of a money market investment.
PF P0 360
P0 h A)
B)
C)
D)
E)
EAR
APR
single payment yield discount yield
BEY
Answer: C
Level: Medium
23. The rate of return on a repo is
A) Determined by the rate of return on the underlying collateral
B) Strongly affected by the current Fed funds rate at the time of the repo
C) Determined at the time of the repo
D) A and C
E) B and C
Answer: E
Level: Medium
24. Which one of the following statements about commercial paper is NOT true?
Commercial paper issued in the U.S.
A) Is an unsecured short term promissory note
Ch 5 - 5
4th Ed
B)
C)
D)
E)
Has a maximum maturity of 270 days
Is virtually always rated by at least one ratings agency
Has no secondary market
Carries an interest rate above the prime rate
Answer: E
Level: Medium
25. A negotiable CD
A) Is a bank issued transactions deposit
B) Is a registered instrument
C) Is a bank issued time deposit
D) Has denominations ranging from $50,000 to $10 million
E) Pays discount interest
Answer: C
Level: Medium
26. A 180 day $3 million CD has a 4.25% annual rate quote. If you buy the CD, how much will you collect in 180 days?
A) $3,047,439
B) $3,045.678
C) $3,062,877
D) $3,063,750
E) $3,127,500
Answer: D
Response: $3 mill [1 + (0.0425180/360)
Level: Medium
27. A banker's acceptance is
A) A time draft drawn on the exporter's bank
B) A method to help importers evaluate the creditworthiness of exporters
C) A liability of the importer and the importer's bank
D) An add on instrument
E) For greater than 1 year maturity
Answer: C
Level: Medium
28.
The most liquid of the money market securities are
A) Commercial paper
Ch 5 - 6
4th Ed
B)
C)
D)
E)
Banker's acceptances
T-Bills
Fed funds
Repurchase agreements
Answer: C
Level: Easy
29. In dollars outstanding in 2007 the largest money market security was
A) Commercial paper
B) Banker's acceptances
C) T-Bills
D) Fed funds & repos
Answer: D
Level: Medium
30. You buy a $10,000 par Treasury bill at $9,575 and sell it 60 days later for $9,675. What was your EAR?
A) 4.44%
B) 6.29%
C) 6.35%
D) 6.52%
E) 6.67%
Answer: D
Level: Medium
31. LIBOR is generally _____ the Fed funds rate because foreign bank deposits are generally
_____ than domestic bank deposits
A) Greater than; less risky
B) Less than; more risky
C) The same as; equally risk
D) Greater than; more risky
E) Less than; less risky
Answer: D
Level: Medium
32. A U.S. exporter sells $150,000 of furniture to a Latin American importer. The exporter requires the importer to obtain a letter of credit. When the bank accepts the draft the exporter
Ch 5 - 7
4th Ed
discounts the 120 day note at a 5.25% discount. What is the exporter’s true effective annual financing cost?
A) 5.52%
B) 5.42%
C) 5.34%
D) …show more content…
5.29%
E) 5.25%
Answer: A
Response: 150,000*[1-(0.0525*120/360)] = 147,375; (150,000/147,375)365/120-1 = 5.52%
Level: Difficult
33. A Chinese exporter sells $200,000 of toys to a French importer. The Chinese exporter requires the French importer to obtain a letter of credit. When the bank accepts the draft the exporter discounts the 90 day note at a 4% discount. What is the exporter’s true effective annual financing cost?
A) 4.00%
B) 4.04%
C) 4.10%
D) 4.16%
E) 4.22%
Answer: D
Response: 200,000*[1-(0.04*90/360)] = 198,000; (200,000/198,000)365/90-1 = 4.16%
Level: Difficult
34. If a $10,000 par T-Bill has a 3.75% discount quote and a 90 day maturity, what is the price of the T-Bill to the nearest dollar?
A) $9,625
B) $9,906
C) $9,908
D) $9,627
E) None of the above
Answer: B
Response: 10,000*[1-(0.0375*90/360)] = 9,906
Level: Medium
35. A 90 day T-Bill is selling for $9,900. The par is $10,000. The effective annual return on the
T-Bill is (watch your rounding)
A) 4.00%
B) 4.16%
C) 4.10%
Ch 5 - 8
4th Ed
D) 4.04%
E) 4.21%
Answer: B
Response: (10,000 / 9900)(365 / 90) - 1
Level: Medium
36. Suppose that $10 million face value commercial paper with a 270 day maturity is selling for
$9.55 million. What is the BEY on the paper?
A) 4.71%
B) 6.42%
C) 6.37%
D) 6.28%
E) 4.50%
Answer: C
Response: ((10 mill / 9.55 mill) – 1)* (365 / 270)
Level: Medium
37. A $2 million jumbo CD is paying a quoted 3.55% interest rate on 180 day maturity CDs.
How much money will you have at maturity if you invest in the CD?
A) $2,000,000
B) $2,035,014
C) $2,035,500
D) $2,071,000
E) $2,088,400
Answer: C
Response: 2,000,000 *[1 + (0.0355*180/360)]
Level: Medium
38. From 1990 to 2007 which one of the following money market securities actually declined in terms of dollar amount outstanding?
A) Commercial paper
B) Treasury bills
C) Federal funds and repos
D) Negotiable CDs
E) Banker’s Acceptances
Answer: E
Level: Medium
Ch 5 - 9
4th Ed
39. A 50 day maturity money market security has a bond equivalent yield of 3.60%. The security’s EAR is
A) 3.69%
B) 3.61%
C) 3.55%
D) 3.87%
E) 3.66%
Answer: E
Response: EAR = (1+ (0.0360 / (365/50)))365/50 – 1 = 3.66%
Level: Difficult
40. In a Treasury auction, preferential bidding status is granted to
A) Competitive bidders
B) Noncompetitive bidders
C) Short sale committed bidders
D) Commercial bank bidders
E) No group of bidders
Answer: B
Level: Easy
41. If your firm enters into an overnight reverse repurchase agreement your firm is
A) Borrowing fed funds temporarily
B) Selling a security now while agreeing to buy it back tomorrow
C) Giving an unsecured loan to the counterparty
D) Procuring a banker’s acceptance
E) None of the above
Answer: E
Level: Medium
42. Eurodollar CDs would include
A) CDs denominated in Euros
B) Dollar investments by European entities in the U.S.
C) Dollars deposited in Caribbean banks
D) Dollars deposited in Europe
E) Both C & D
Answer: E
Level: Medium
Ch 5 - 10
4th Ed
Short Answer
43.
Why do most money market securities have large denominations?
Answer: The market has developed for institutional investors because institutional investors have large enough quantities of money to make it costly for them to not invest their excess funds. For most individual investors the dollars lost by not keeping fully invested in interest bearing assets is very minimal.
Level: Easy
44. Given the functions of the money markets, why is it necessary for money market securities to have a maturity of one year or less and low default risk?
Answer: Because these markets are designed to provide safe investments with little or no chance of principle loss. If you could lose principle you would be very unlikely to invest funds that are shortly needed. Low default risk implies that the promised cash flows will in all likelihood be paid in full and on time. The short maturity ensures that the value of these securities will be relatively insensitive to interest rate changes, and also there is not much time for the issuer's condition to change; this also limits the risk.
Level: Medium
45. What is the difference between a discriminating auction and a single price auction? How is the final price determined in a single price auction? Why did the Treasury switch to a
single price auction?
Answer: In a discriminating price auction, different bidders pay a different price for the same securities. In a single price auction, all successful bidders pay the same price, regardless of the specific price they bid. The final price is set as the lowest price of the competitive bids accepted.
The Treasury switched to single price auctions because they found that in single price auctions there tended to be more winning bidders and that bidders bid more aggressively (made higher bids), resulting in overall higher bid prices and revenues for the government.
Level: Difficult
46. A government securities dealer needs to make a 7% pre-tax annual return on $10 million of capital employed to make it worthwhile to make a market in T-Bills. If the bid discount on
$10,000 face value, ninety day T-Bills is 3.50%, and the dealer can expect to do 5200 round trip deals today what must the ask discount be? Hint: A round trip is a buy and a sell transaction.
Answer: Bid Price = 10,000 [1 - .035(90/360)] = $9,913
$10 million (0.07/365) = (Required Ask Price - $9,913) 5200 deals
Required Ask = $9,912.87
Ch 5 - 11
4th Ed
Ask Discount = (($10,000 - $9,912.87)/$10,000) (360/90) = 3.485%
Level: Difficult
47. How does a repo differ from a Fed Funds transaction? How do their rates compare?
Answer: A repo is basically a collateralized loan whereas Fed Funds are uncollateralized. The repo rate will typically be slightly below the equivalent maturity Fed funds rate because the repos are collateralized. Repos are likely to be for longer maturity than Fed funds although both may involve transfers of deposits held at the Fed. Fed Funds loans can be arranged more quickly because no change of title of securities is involved.
Level: Medium
48. As a corporate treasurer who is unsure how soon funds will be needed, which type of money market investment might you prefer? Explain the tradeoffs. Would your answer differ if you had a definite time period during which you would not need the money? Explain.
Answer: If liquidity is a primary concern then T-Bills may be the best choice because they are by far the most liquid. They also typically offer the lowest rate of return because of the government backing and high liquidity. Fed Fund loans may be a slightly higher rate alternative, but are very short term. If you knew for certain (or with high probability) that the funds will not be needed then term repos, commercial paper or banker's acceptances may offer better rates of return.
Level: Medium
49. A corporate treasurer is looking to invest about $4 million for 60 days. Commercial paper rates are a 3.65% discount and CD rates are 3.66%. Comparing the bond equivalent yields over a 365 day year, which is the best alternative? What is the opportunity cost of leaving the funds idle? (Watch your rounding)
Answer: Find the BEY on each
CP: Price = $4 mill * [1 – 0.0365*(60/360)] = $3,975,667
[($4 mill / $3,975,667) – 1] * (365 / 60) = 3.7233% BEY
CD: $4 mill [1 + 0.0366*(60/360)] = $4,024,400
[($4,024,400/$4 mill) – 1] * (365/60) = 3.7108% BEY
The best deal is the CP and the opportunity cost is 3.7233%
Level: Difficult
50. How does a banker's acceptance help create more international trade?
Answer: Importer's do not wish to pay until they receive the goods and exporters do not wish to ship until they receive payment. The creation of a BA allows the exporter to ship prior to receipt of payment, while substituting the credit worthiness of a large international bank for the unknown creditworthiness of the importer.
Ch 5 - 12
4th Ed
Level: Easy
51. Who are the major participants in money markets?
Answer:
U.S. Treasury
Commercial Banks
Federal Reserve
Brokers and dealers
Corporations
Other financial institutions
Level: Easy
52. One hundred eighty day commercial paper can be bought at a 3.75% discount. What are the bond equivalent yield and the effective annual rate on the commercial paper? Why do these rates differ? Answer: Commercial paper price/100 of par = 100*(1 – (0.04*1800/360)) = 98.13
Effective annual rateCP= (100 / 98.13)365/180 – 1 = 3.91%
Bond equivalent yield = [(100 – 98.13) / 98.13] * 365/180 = 3.875%
The discount quote is an annual quote calculated as (Par – Price) / Par, assuming that there are
360 days in a year. The bond equivalent yield is an annual rate calculated as (Par – Price) /
Price, which is the normal way to express a percentage return ($ return per $ invested), assuming that there are 365 days in the year. The effective annual return or EAR is the same as the bond equivalent yield, except that the EAR annualizes the rate of return assuming the proceeds from each 180 day period are reinvested during the next 180 day period and so on.
Level: Medium
53. You are a corporate treasurer for Esso Oil. The quoted rate on dollar denominated euro commercial paper has just blipped down recently. Your firm can issue $10 million of 180 day euro commercial paper in the London markets at 3.45%. You can also invest the proceeds in the
U.S. in comparable maturity negotiable dollar denominated CDs which are quoting 3.95%.
Ignoring any transactions costs, how much money, if any, can Esso make by borrowing in the euro markets and investing in the U.S.? Is this a good deal or not? Should you expect it to last?
Explain.
Answer: Initial proceeds from issuing euro commercial paper (CP) = $10 million * [1(0.0345*180/360)] = $9,827,500; Invest the proceeds of $9,827,500 in 180 day CDs and will wind up with $9,827,500 * [1+(0.0395*180/360)] = $10,021,593
Repay the $10,000,000 owed on the CP and Esso will clear $21,593.
If the CDs are not very risky then this represents an arbitrage opportunity for Esso, because they are not using their own money the rate of return is infinite. Since this is an arbitrage strategy we would not expect this big a difference in the rates to persist. (Exxon constructed a similar arbitrage several years ago using euro commercial paper and T-bills.)
Level: Difficult
Ch 5 - 13