Fundamental of Finance Assignment, Money Market Essay
Introduction Definition Money market is the Centre of dealings, mainly short term character, in money assets - Fundamental of Finance Assignment, Money Market Essay introduction. It meets the short term requirements of borrowers and provides liquidity or cash to the lenders. It is the place where short term surplus investible funds at the disposal of financial and other institutions and individual are bid by borrowers, again comprising Institutions, individuals and also the government itself. Money market refers to the market for short term assets that are close substitutes of money, usually with maturities of less than a year.
A well-functioning money market provides a relatively safe and steady income-yielding avenue. It also allows the investor institution to optimize the yield on temporary surplus fund. What is it? The money market is a subsection of the fixed income market. We generally think of the term fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short-term debt securities (debt that matures in less than one year).
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Money markets investments are also called cash investments because of their short maturities. Money market securities are essentially IOUs issued by governments, financial institutions and large corporations. These instruments are very liquid and considered extraordinarily safe. Because they are extremely conservative, money market securities offer significantly lower returns than most others securities. One of the main differences between the money market and the stock market is that most money market securities trade in very high denominations. This limits access for the individual investor.
Furthermore, the money market is a dealer market, which means that firm buys and sells securities in their own accounts, at their own risk. Compare this to the stock market where a broker receives commission to act as an agent, while the investors take the risk of holding the stock. Another characteristic of a dealer market is the lack of a central trading floor or exchange. Deals are transacted over the phone or through electronic systems. The easiest way for us to gain access to the money market is with a money market mutual fund, or sometimes through a money market bank account.
These accounts and fund pool together the assets of thousands of investors in order to buy the money market securities on their behalf. However some money market instruments like Treasury bills maybe purchase directly. Falling that, they can be acquired through other large financial institutions with direct access to these markets. There are several different instruments in money market, offering different returns and different risks. In the following sections, we will take a look at the major money market instruments. Body Money Market Instruments
From what we have learn in AAMS2013 FUNDAMENTALS OF FINANCE, the money market have a few of instruments, there are some that we are going to discuss in this assignment. The instruments includes:- * Call deposit * Term deposit * Bills of exchange * Floating rate note * Treasury bills * Certificate of Deposit (CD) * Commercial paper Call Deposit Definition of call deposit The term Call Deposit, in deposit terminology, is mention about a special type of interest exact investment account that can make a person to withdraws their money from the account without a penalty or inform to the bank.
In many cases the money can be withdrawn from a Call Deposit account without earlier notification to the bank. Example of Call deposit For an example, a person who has a Call Deposit account, besides earning a favourable rate of interest, also has considerably more access to their money than people with their money invested in other types of accounts. As a result, a Call Deposit account has considerable advantages over other types of interest influence accounts when liquid asset is required.
With a Call Deposit account, the holder can withdraw their money anytime and don’t need to inform the bank earlier in development of their purpose to take out their funds. Call Deposit accounts usually have a minimum balance which must be maintained to take advantage of the benefits. Advantages of Call Deposit Attractive interest Rates paid on maturity of the funds. Call Deposit has a higher interest that earn by the holder than other type of account. It is more attractive compare with other. The Deposit can be withdrawn at anytime
Call deposit can let the account holder to withdraw their money anytime, and without notice the bank. Cheque books and ATM cards are provided Normally, the bank will provided the cheque books or the ATM card or either both of It at the same time to the account holder. By the cheque book, holder more easier to access what they want, for example, withdraw with ATM card by the ATM machine which is 24-hours operating. Term Deposit Term deposit can be defined as a deposit that held at a financial organization that has a fixed term.
When a term deposit is purchased, the lender (the customer) know that the money can only be withdrawn after the term has ended or by giving a prearrange number of day notice. Besides that, term deposit also can be explained as an extremely safe investment and it is very attractive to conventional, low-risk investors. People will normally get a greater rate with a term deposit compared with a demand deposit by having the money tied up. Term deposit also is an investment where the interest rate is guaranteed not to change for the qualified term, so people will know exactly what their investment worth.
Example of Term Deposit: For an example, a Term Deposit will frequently use by individuals or personals, businesses and financial institutions all around the world as a means of storing their liquid funds for a fixed period of time for future use. On the other hand, term deposits are relatively safe investments when provided by protected financial institutions such as banks, savings and loan establishments and credit unions that are according to the regulated within the country in which they operate. Advantages of Term Deposit Term deposit accounts are a good way of increasing the amount of your savings.
The interest rates plus the actuality you can choose how long you want to lock up your money are definitely worth binding it up for a required period. The few advantages of these types of accounts are: -High interest rate on your money all over the fixed term -Guaranteed returns -They are a very safe investment -You are able to control how long your money is locked away Disadvantages of Term Deposit While there is a lot of advantages of holding a term deposit account, there are also some disadvantages of what we call is downside of the term deposit.
The few disadvantages of Term Deposit are: -Can’t access it during the investment period People need to be very sure that they can afford to lock up their savings Bill of exchange Definition of bill of exchange A bill of exchange is under the negotiable instrument, it is a document that guaranteeing the payment of a specific amount of money on demand or at a set of time. It is a document considered by a contract, which assure the payment of money. A bill of exchange is also known as ‘’draft’’ that written order by the drawer to the drawee to pay money to the payee. Cheque is a common type of bill of exchange, it is a primarily use in international trade.
It is written orders by one person to his bank to pay to a specific sum on a specific date. A bill of exchange must involve three parties such as the drawer, the drawee and the payee. Due to the start of paper currency, bill of exchange is not used as often today. Advantages of bill of exchange Bill of exchange has been used for hundreds of years and the durability is due to the advantages provided in a trading transaction. It provides us with some advantages such as:- * A bill of exchange simplifies the concession of trade credit to a buyer. * It can provide easy access to the legal systems in the event of non-payment. It provides a legal acknowledgement that a debt exists.
* It can be the formal documentary evidence that the demand for payment or acceptance has been made. Floating rate note Definition of floating rate note Floating rate note is a kind of bond that has a variable coupon or interest rate. The adjustments to the interest rate are usually made every six months and are tied to a certain money-market index. Floating rate note carry little interest rate risk, has duration close to zero and its price shows very low sensitivity to changes in market rates. So it is different from fixed rate bonds, whose prices decline when market rates rise.
Example: Simple margin – this is a measure of the effective spread of a floating rate note that is note traded at par. If it trades at par, the simple margin will equal the quoted spread. To calculate the simple margin, we must first compute the sum of the quoted spread of the FRM and the capital gain or loss an investor will earn if the FRN is held to maturity. Second, we adjust the above for the fact that we buy the FRN at a discount or premium to the nominal value: A more complex measure of the effective spread is a discount margin, which takes into account the ‘’time value of money’’ of the FRN cash flows.
The formula for the calculation of the discount margin is more complex and its calculation generally requires a financial calculator or a computer. Treasury bills Definition of treasury bills Treasury bill also known as T-bill is one types of the treasury security and backed by the government. It is a short-term investment commonly issued with maturity dates of 28 days (or 4 weeks, about a month), 91 days (or 13 weeks, about 3 months), 182 days (or 26 weeks, about 6 months), and 364 days (or 52 weeks, about 1 year). However, they are sold at a discount of the face value (or par value) to create a positive yield to maturity.
Calculation Treasury bills are quoted for purchase and sale in the secondary market on an annualized discount percentage, or basis. General calculation for the discount yield for Treasury bills is face value minus purchase price divide by the face value, times 360 divide by days till maturity, times 100%. The formula is shown below: Advantages & Disadvantages of Treasury Bills These Treasury bills can provide you with some advantages, like safety and consistent returns, but, at the same time, you could probably get better returns from other investments. Advantages: Safety
One of the most attractive features of the Treasury bill is the safety that it provides. You get the assurance that comes with putting money into a government investment when you invest in Treasury bills. This means that the Treasury bill is backed up by the credit of the government. You have a relatively safe form of investment to put your money into, which can earn competitive returns. Advantages: Convenience The process of buying Treasury bills is very simple. Depending on what type of bill you want to purchase, you may be able to simply get on the Treasury website and make an order.
In some cases, you have to work with a broker and bid on what you want. Advantages: Tax Saving You get the benefit of saving money on state and local taxes if you invest in T-bills. The profits you earn from investing are exempt from these types of taxes. Disadvantages: Low Returns In the investment world, you have to give up some return when you get security. When you invest in treasuries, you typically get a very low return on your investment. You might be able to beat the returns with CDs and high-yield savings accounts.
You can definitely do better by putting your money into stocks or corporate bonds, in many cases. In some cases, you might not even keep up with inflation. Certificate of Deposit (CD) Definitions and meanings A certificate of deposit (CD) is a time deposit, a financial product commonly offered to consumers by banks. CDs bear a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the Federal Deposit Insurance Corporation (FDIC) for banks and by the National Credit Union Administration (NCUA) for credit unions.
CDs are similar to savings accounts, the different is the CDs have a specific, fixed term (often monthly, three months, six months, or one to five years), and, usually have a fixed interest rate. CD is intended to be held until maturity, the money may be withdrawn together with the accrued interest at which time. CDs have a higher yield than treasury bills because of the slightly higher default risk for bank. CDs for more than $100,000 are called “large CDs” or “jumbo CDs”; CDs of less than $100,000 are called “small CDs”. Almost all large CDs, as well as some small CDs, are negotiable. General guidelines for interest rates A larger principal should receive a higher interest rate, but may not. * A longer term will usually receive a higher interest rate as higher risk, except in the case of an inverted yield curve (for example: preceding a recession) * Smaller institutions tend to offer higher interest rates than larger. * Business CD accounts generally receive lower interest rates than personal CD accounts. * Banks and credit unions that are not insured by the FDIC or NCUA generally offer higher interest rates. Example For example, let’s say that you purchase a $20,000 CD with an interest rate of 5% compounded annually and a term of one year.
At year’s end, the CD will have grown to $21,000 ($20,000 x 1. 05). Advantages and Disadvantages Advantages: Terms One of the advantages of CDs is that you can choose the term you want. Terms vary from three months to five years. The longer the term, the higher the rate of interest you will receive. Advantages: Grace Period Another advantage of owning a CD is the grace period. After the CD matures, you have a seven-day grace period during which you can decide what you want to do with your money. Advantages: Fixed Rate and Safety CDs are safe investments because the interest rate is fixed and does not change during the entire term.
CDs generally pay a higher rate of interest than savings accounts. Furthermore, there is limited risk or no risk depending on what kind of CD you purchase. Disadvantages: Penalty As of 2009, one of the disadvantages of CDs is that you cannot take your money out before the maturity date. Otherwise, you have to pay a penalty usually by forfeiting some interest. Disadvantages: Automatic Rollover Another disadvantage is that if you do not take some action when your CD matures, it will roll over automatically at prevailing interest rates, which may not be the highest rates available. Commercial paper
Commercial paper is the most worldwide form of security in the money market, and also it issued at a discount but with a yield higher than Treasury bills. Commercial paper is an unsecured debt or as unsecured promissory notes that made by a corporation or bank to support its short-term credit needs for example, accounts receivable and inventory. Normally the main purchasers are other corporations, insurance companies, commercial banks, and mutual funds. Maturities of commercial paper usually range from 1-270 days or not longer than 90days, with maturities between 1 and 2 months is being the average.
Commercial paper is a safety investment because it can easily be predicted over a few months. Besides, commercial paper usually made by companies with high quality debt ratings thus the investment is almost always in low risk. Apart from that, issuers of commercial paper can be separated into financial and nonfinancial companies even almost issuers are financial. There are several types of finance companies that are captive finance companies, bank-related finance companies and independent finance companies.
Captive finance companies are auxiliary of manufacturers, with the objective of providing financing for the manufacturer. The maximum selling of commercial paper such as General Motors Acceptance Corporation (GMAC). Bank is holding companies usually use finance company to satisfy to customer with weaker credit. After that, independent finance companies are not attached with other company or bank. Lastly, a goodwill corporation able borrow from banks the initial interest, they may be able to borrow at low rate by selling commercial paper until the money is expected to be received, for example tax receipts.
We can also use the commercial paper to purchase of mortgage-backed securities (MBSs), to get profit from the MBS securities with paying the lower return of commercial paper. In order to compute or evaluate the investment yield of commercial paper so should compare it to the rates of return of various investments. The first step should be computed the interest rate for the period and the second is complex the rate by the number of periods in a year. Formula for Calculating the Investment Yield or Bond Equivalent Yield (BEY)| | Interest Rate Per Term| | Number of Terms per Year| BEY = | Face Value – Price Paid ————– Price Paid| x| Actual Number of Days in Year ——————- Term Length in Days| Recommendation As we going further on the research of money market, we found out that money market is playing an important role in economic and finance industry. It acted as the Center of Dealing in money assets to provide short term loans and liquidity asset to the borrowers. Therefore, a short term surplus investible funds are available for the institution of financial and government. We think that Money market most useful during inflation period. During the inflation period, we should invest wisely.
We cannot let the money keep saving in saving deposit or saving account. This is because the money value will decrease during the inflation period. We should use our money to invest in money market by buying stock. It could provide us the highest return but, definitely the most risky normally this will lead us to loss money when the inflation rate is surging up. Therefore we should put money in a time deposit since it has a higher interest rate than regular bank deposit.
Otherwise, we can also plan to buy Treasury bills as your investment. This is because it has higher interest rate (coupon rate) espite its risk is lower. For example when we are paying interest, we are facing value of these bonds to increases with inflation. For example, if you buy one bond for rm1000, and inflation goes up by 30% over the ten years or longer than ten years it takes for the bond mature therefore you expected return in bonds is higher, so you will gain rm1300 when you hand it back in. This is a form of inflation protecting our savings and the risk of percentage is facing by ourselves is reducing. Besides, what are the impact to economic and industry, if the money market had been affected?
If the money market been affected most of the people will facing temporary financial problem because unable to apply either short term funds or loan is not able to pay back the loan and the cause of economic is dropping therefore industry can’t expand their temporary capital working from current liabilities. Consumers borrow short term loans or buy treasury bills as their investment in order to satisfy their needs and maintain their quality life. Some of the businessman borrow short term loan to buy more inventory for that month in order to enhance their sales.
Thus, based on my opinion if the money market is affected it really cause local people and the whole economic is going changes economic is critical grow slowly, it may also cause unemployment rate going up. Conclusion As my conclusion, I would like to thanks TAR College that provide us this task to learn more about our subject Fundamentals of Finance. I feel great that I had a good tutor or lecturer Mr. PUA TONG SENG that always give us more information and help in this assignment. Besides that, we’re sincerely thankful to him for his full passion and patient from our thousands kind of questions.
Furthermore, I also would like to thank my group member TAN KOK PIN, LOKE WENG LOONG, CHAN CHONG HONG, and YONG JIAN for giving so much help in this group discussion. We learnt a lot of things that about basic knowledge and gain more experience in this subject. In addition, we also know how to inspire and motivating each other and communicating with each other nicely to finish this assignment in the time that given to pass it up. The most important is teamwork because it can help us finish this discussion in a group.
Based on the research, we understand that the money market specializes in debt securities that mature in less than one year. Money market securities are very liquid, and are considered very safe. As a result, they offer a lower return than other securities. The easiest way for individual to gain access to money market is through a money market mutual fund. T-bill is short term government securities that mature in one year or less from their issue date. T-bills are considered to be one of the safest investments. Besides, a certificate deposit (CD) is a time deposit with a bank.
Annual percentage yield (APY) takes into account compound interest, annual percentage rate does not. CDs are safe, but the returns aren’t great, and your money is tied up for the length of the CD. Commercial Paper is an unsecured, short-term loan issued by a corporation. Return is higher than T-bills because of the higher default risk. Lastly, we really do appreciate the power of internet because it enables us to gather more information from worldwide about finance. I would like to mention again that finance is indeed a necessary subject for us to run a business better.