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 CDsNon-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 entitiesStoring 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