MODULE 62.

1: MONEY MARKET AND CAPITAL MARKET INSTRUMENTS

LO 62.a: Compare various money market and capital market ins

Quantity: Banks and depository institutions invest a significant portion of their asset po
Tenure: Investment securities can be short term or long term, and can range from Trea
Role / Benfits: Income stabilization, hedging the risk of loans, adding diversification and liqu
Money Market Instruments: Securities with a maturity of one year or less and are typically characterized b
Capital Market Instruments: Securities with a maturity of greater than one year and are characterized by h

Money Mark

Treasury bills (T-bills): Treasury notes (T-notes) a

Short-term securities maturing within one year Coupon-be
Issued by the U.S. federal government Issued by the U.S
Considered one of the safest investment vehicles Considered one of the
Due to short maturities and low risk, their yield is also very low T-notes at issuance hav
Zero-coupon securities and are issued at a discount and mature at par T-bonds have maturiti
Advantages: safety, liquidity, and use as collateral Advantages: safety, liqu
Their returns are ab

Certificates of Deposit (CDs): International Eur

Issued by depository institutions (i.e., banks) for fixed terms Uninsured time deposits with a
Attractive to issuing institutions as they are a source of funds Issued by large banks but the m
Investors prefer them for relatively low risk and low initial investment (as Advantages: low-risk investments, o
low as $500) while offering a higher yield than T-bills deposits issue
Consumer-oriented CDs are typically issued in smaller denominations of Disadvantages: volatility in in
$500 to $100,000
Business oriented CDs are issued with denominations over $100,000

Commercial paper (CP): Short-term mun

Issued by large corporations for short-term maturities (90 days or less) 2 common types of short-term
Issued at a discount and mature at par value anticipation notes (TANs) and r
Disadvantages: Unsecured, taxable income Repayment by an issuer of TANs i
Attractive to both small financial firms and money market funds, and to rev
large international firms and financial firms (mainly in Europe and Japan) Repayment of RANs is supported
generating municipal project
Advantages: e
Due to reduction in quality, attrac

Capital Mark

Treasury notes and bonds: Municipal no

Coupon-bearing securities Issued by states and local governme
Issued by the U.S. federal government Advantages: e
 Considered one of the safest investment vehicles Diasdvanta
T-notes at issuance have maturities up to 10 years Can be purchased through compe
T-bonds have maturities greater than 10 years 2 categories: (1) general obligatio
Advantages: safety, liquidity, and use as collateral GO bonds are backed by the issu
Their returns are above the return of T-bills general revenu
Disadvantages: price risk from higher price volatility, liquidity risk for some Revenue bonds are issued to financ
notes and bonds with less liquid secondary trading and bridges, and repayment of the
these projec

More Recently Develop

Structured notes: Securiti

Existed since the 1990s Created from a pool of underlyin
Created by security dealers from pools of federal agency securities with Higher yields than go
yields that can be reset based on changes in a reference rate Strong liquidity and guarantees f
Securities have a cap rate & floor rate insti
Coupons can be adjustable when rates change or could have a step-up Reason fo
provision for additional coupon yield Pass-throu
Advantages: Higher Yield Collateralized mortg
Disadvantages: Complex & potential for making large losses Real estate mortga
Mortgage-bac

Pass-through securities: Collateralized mortg

Created from pools of mortgages Developed in the ear
Issuing entity transfers from its balance sheet to a trustee and issues Pass-through securities that are als
securities backed by these mortgages Tranche represents a different lev
Principal and interest payments on the mortgages are “passed through” to can be created either from securiti
investors sec

Mortgage-backed bonds (MBBs):

Created from a pool of underlying mortgages
Mortgages remain on the issuer’s balance sheet
Trustee ensures adequate tracking of loans, and periodically verifies that
loan values exceed bond values
 ket and capital market instruments and discuss their advantages and disadvantages

t portion of their asset portfolios in investment securities, which are between one-third and one-fifth of the asset portfolio
m, and can range from Treasury bills and commercial paper to notes, bonds, and asset-backed securities.
ng diversification and liquidity, providing tax benefits by reducing tax exposure, and making the balance sheet appear stronger.
e typically characterized by low risk and low yield.
and are characterized by higher risk and higher yield

Money Market Investments

Treasury notes (T-notes) and Treasury bonds (T-bonds): Federal agency securities:
Coupon-bearing securities Issued by agencies that are owned/sponsored by the U.S. federal govt
Issued by the U.S. federal government Fannie Mae; Freddie Mac
Considered one of the safest investment vehicles Do not directly have a government guarantee but it would rescue thes
T-notes at issuance have maturities up to 10 years agencies if they were in distress
T-bonds have maturities greater than 10 years Advantages: safety, relatively higher liquidity
Advantages: safety, liquidity, and use as collateral Their returns are above the return of securities issued by Govt.
Their returns are above the return of T-bills Interest income on these securities is typically fully taxable

International Eurocurrency deposits: Bankers’ acceptances:

ured time deposits with a fixed maturity of 30, 60, or 90 days Short-term investments primarily used in trade credit/trade finance trx
ed by large banks but the market is concentrated in London Financial firm, mostly a bank, guarantees the payment of a customer fo
ges: low-risk investments, offer a yield advantage relative to time an export/import transaction
deposits issued by local banks Bank receives a fee for the guarantee and becomes the primary obligo
sadvantages: volatility in interest rates and taxable income Issued at a discount and maturing at par value
They have an active market for secondary trading
Offer higher yields than T-bills but lower than Eurocurrency deposits
Disadvantages: Lack of availability for certain maturities, taxable incom

Short-term municipal obligations:

mmon types of short-term municipal obligations include tax-
ipation notes (TANs) and revenue-anticipation notes (RANs)
ment by an issuer of TANs is supported by anticipated future tax
revenue
ment of RANs is supported by future revenues from revenue-
nerating municipal projects, including toll roads or bridges
Advantages: exemted from tax
reduction in quality, attractiveness has declined in recent years

Capital Market Investments

Municipal notes and bonds: Corporate notes and bonds:

states and local governments, including cities and municipalities Corporate notes have maturities up to five years
Advantages: exemted from tax Corporate bonds have maturities greater than five years
 Diasdvantages: Less liquid Several varieties of these debt securities, including debentures or thos
purchased through competitive bids or from investment dealers secured by mortgages
ories: (1) general obligation (GO) bonds and (2) revenue bonds Insurance companies and pension funds find these securities attractive
onds are backed by the issuing government and are paid from because of their higher yields than government-issued debt instrumen
general revenues, including taxes Disadvantages: higher yields imply higher risk, with yields widening
relative to government debt securities during economic downturns
bonds are issued to finance revenue projects, including toll roads
ges, and repayment of the bonds is financed from revenue from
these projects including tolls

More Recently Developed Investment Instruments

Securitized assets: Stripped securities:

ed from a pool of underlying loans of uniform quality and type Hybrid investments: offer either principal or interest payments on a bon
Higher yields than government security yields Dealers “strip” the individual cash flows of a bond into separate
liquidity and guarantees from government agencies or private investments, creating principal-only (PO) and interest-only (IO) securitie
institutions Each IO or PO is issued at a discount and matures at par, and are therefo
Reason for 2007 crisis zero coupon securities
Pass-through securities Advantages: hedge against changes in interest rates
Collateralized mortgage obligations (CMOs) Most common debt obligations to strip are U.S. Treasury notes and bon
Real estate mortgage conduits (REMICs) and mortgage-backed securities
Mortgage-backed bonds (MBBs) IOs are less sensitive to changes in interest rates than regular bonds,
whereas POs are more sensitive

Collateralized mortgage obligations (CMOs): Real estate mortgage conduits (REMICs):

Developed in the early 1980s by Freddie Mac Another form of securitized investments
ough securities that are also divided in segments called tranches Segment cash flows from mortgage loans or mortgage-backed securitie
e represents a different level of risk with different coupon levels into multiple maturity classes, primarily to reduce cash flow uncertaint
reated either from securitizing mortgage loans or pass-through Primary risks: prepayment risk or default
securities
e asset portfolio

heet appear stronger.

ecurities:
nsored by the U.S. federal govt.
die Mac
antee but it would rescue these
e in distress
ely higher liquidity
f securities issued by Govt.
s is typically fully taxable

ances:
n trade credit/trade finance trx.
the payment of a customer for
ransaction
d becomes the primary obligor
turing at par value
or secondary trading
er than Eurocurrency deposits
rtain maturities, taxable income

nd bonds:
ties up to five years
greater than five years
, including debentures or those
tgages
find these securities attractive
nment-issued debt instruments
her risk, with yields widening
during economic downturns

ities:
or interest payments on a bond
ows of a bond into separate
and interest-only (IO) securities
matures at par, and are therefore
curities
anges in interest rates
e U.S. Treasury notes and bonds
d securities
rest rates than regular bonds,
re sensitive

nduits (REMICs):
ed investments
s or mortgage-backed securities
to reduce cash flow uncertainty
nt risk or default