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Chapter 22
THE MARKETS FOR
BANK OBLIGATIONS
Types of Banks Operating
in the United States
Money Center Banks
Regional Banks
Japanese Banks
Yankee Banks
Large-Denomination
Negotiable CDs
Bank-issued security with specified
interest rate and maturity date.
Nonnegotiable CDs must be held until
maturity to obtain the funds, otherwise an
early withdrawal penalty is imposed.
Negotiable CDs can be sold in the
secondary market prior to maturity.
Maturity cannot be less than 7 days.
CD Issuers
Types of CDs based on issuing institution
domestic CDs
Eurodollar CDs
Yankee CDs
thrift CDs
Primary Issuers
money center banks
large regional banks
Types of CDs
Term CDs
maturity of more than
one year
yields are quoted on
an interest-bearing
basis
semiannual interest
payments
Floating-Rate CDs
interest rate changes
according to a
predetermined formula
coupon may be reset
daily, weekly, monthly,
quarterly, or
semiannually
maturity ranges from
18 months to 5 years
Yields on CDs
Yields on CDs depend on:
credit rating of the issuing bank
maturity of the CD
supply and demand for CDs
Risks of CDs
CD yields are higher than yields on
Treasury securities of the same maturity
due to two risk factors:
Credit Risk
Prime CDs
Non-prime CDs
Liquidity Risk
Federal Funds
Borrowing and lending of excess reserve
balances among depository institutions
Characteristics:
one-day maturity
unsecured
Repurchase Agreements
Sale of security and agreement by bank to
repurchase it later.
Agreement with nonbank customer.
Rate charged is the repo rate.
Alternative to borrowing in the federal
funds market.
Federal Funds Rate
The rate paid by depository institutions
for loans in the federal funds market.
Fed funds rate is determined by the
supply and demand for federal funds.
Fed funds rate is targeted by Fed’s
monetary policy.
Federal Funds versus Repo
Rate
Fed funds rate and repo rate are tied
together because both are a means for a
bank to borrow.
Fed funds rate is higher because fed
funds are borrowed on an unsecured
basis.
In repo, the lender has security as
collateral.
Market for Federal Funds
Typical maturity of fed funds is overnight
but can be longer term transactions.
maturity of one week to six months
Trading of fed funds
directly between buyer and seller
use of a broker
Bankers Acceptances
An order to pay a specified amount on a
specified date in the future.
Facilitates commercial trade transactions.
Sold on a discounted basis prior to
maturity.
Creation of Bankers
Acceptances
Importing of goods into the U.S.
Exporting of goods from the U.S. to
foreign entities
Storing and shipping of goods between
two foreign countries where neither the
importer nor the exporter is a U.S. firm
Storing and shipping of goods between
tow entities in the U.S.
Accepting Banks
Created by all four groups of banks
money center banks
regional banks
Japanese banks
Yankee banks
Eligible BAs can serve as collateral for
discount window loans of the Fed.
BA rate is determined in open market.
Dealers in Bankers
Acceptances
Banks may sell bankers acceptances
directly to investors
directly to dealers
Risks in Bankers
Acceptances
Credit Risk
risk that neither borrower nor accepting bank
will be able to pay the principal at maturity
Yield includes premium for:
credit risk
liquidity risk