The Money Markets Assoc. Prof

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BUS 362 Financial Institutions and
Markets
Week 6: Financial Markets:The Money Markets
Assoc. Prof. Hülya Hazar
Faculty of Economics and Administrative Sciences, Department of
Business Administration
[email protected]
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Financial Institutions and Markets
1. The Efficient Market Hypothesis
2. The Money Markets Defined
3. The Purpose of Money Markets
4. Money Market Instruments
5. Who Participates in Money Markets?
6. Comparing Money Market Securities
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Financial Institutions and Markets
The efficient markets hypothesis:
• The efficient market hypothesis views the expectations as
equal to optimal forecasts using all available information.
• Assuming the market is in equilibrium, expected returns
equal required returns.
• A security’s price fully reflects all available information in an
efficient market.
• In an efficient market, all abnormal profit opportunities will be
eliminated.
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Financial Institutions and Markets
Favorable evidence on efficient market hypothesis:
• Investment analysts and mutual funds don't beat
the market.
• Stock prices reflect publicly available information
• Stock prices and exchange rates close to random walk
(future behavior is independent of past history)
• Technical analysis does not outperform market
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Financial Institutions and Markets
Unfavorable evidence on efficient market hypothesis:
• Small-firm effect: small firms have abnormally high returns
• January effect: high returns in January
• Market overreaction: stock prices may overreact to news announcements
and that the pricing errors are corrected only slowly
• Excessive volatility: the stock market displays excessive volatility
(fluctuations in stock prices are greater than is warranted by fluctuations in their
fundamental value)
• Mean reversion: stocks with low returns today tend to have high returns in
the future
• New information is not always immediately incorporated into
stock prices
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Financial Institutions and Markets
The money market:
• Money (currency) is not actually traded in the money
markets.
• The securities in the money market are short term with high
liquidity; therefore, they are close to being money.
• Securities have characteristics:
• Usually sold in large denominations ($1,000,000 or more)
• Low default risk
• Mature in one year or less from their issue date, although
most mature in less than 120 days
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Financial Institutions and Markets
The purpose of money markets:
• Investors in money market: Provides a place for
warehousing surplus funds for short periods of time
• Borrowers from money market provide low-cost source of
temporary funds
• Corporations and government use these markets because
the timing of cash inflows and outflows are not well
synchronized.
• Money markets provide a way to solve these cash-timing
problems.
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Financial Institutions and Markets
Money market instruments:
• Treasury Bills
• State Funds
• Repurchase Agreements
• Negotiable Certificates of Deposit
• Commercial Paper
• Banker’s Acceptance
• Eurodollars
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Financial Institutions and Markets
Money market instruments:
• Treasury Bills: Treasury bills have 28-day maturities through 12-
month maturities.
• State Funds: Short-term funds transferred (loaned or borrowed)
between financial institutions, usually for a period of one day. Used by
banks to meet short-term needs to meet reserve requirements.
• Negotiable Certificates of Deposit: A bank-issued security that
documents a deposit and specifies the interest rate and the maturity
date. Denominations range from $100,000 to $10 million.
• Commercial Paper: Unsecured promissory notes, issued by
corporations that mature in no more than 270 days.
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Financial Institutions and Markets
Money market instruments:
• Repurchase Agreements (repos): A form of short-term borrowing
for dealers in government securities. The dealer sells the government
securities to investors, usually on an overnight basis, and buys them
back the following day.
• Banker’s Acceptances: An order to pay a specified amount to the
bearer on a given date if specified conditions have been met, usually
delivery of promised goods. These are often used when buyers / sellers
of expensive goods live in different countries.
• Eurodollars: Eurodollars represent Dollar denominated deposits held
in foreign banks. The market is essential since many foreign contracts
call for payment is U.S. dollars due to the stability of the dollar, relative to
other currencies.
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Financial Institutions and Markets
Who participates in money markets?
• Treasury
• Commercial banks
• Businesses
• Individuals (through banks)
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Financial Institutions and Markets
Comparing money market securities:
• Issuers range from the government to banks to large
corporations
• Mature in as little as 1 day to as long as 1 year
• The secondary market liquidity varies substantially
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Subjects Covered
1. The Efficient Market Hypothesis
2. The Money Markets Defined
3. The Purpose of Money Markets
4. Money Market Instruments
5. Who Participates in Money Markets?
6. Comparing Money Market Securities
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References
Readings:
Chapters 6 and 11
Reference Book:
Mishkin, Frederic S. Financial Markets and Institutions. Eighth Edition.
UK: Pearson, 2016.
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Financial Institutions and Markets
See you next week…
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