Short term securities

Bank management

A Typical Trade Transaction

Importer Exporter

Bank I

Bank X

1. Importer orders goods

2. Exporter agrees to fill order

3. Importer arranges L/C with bank I

4. Bank I sends L/C to bank X

6.. Exporter ships goods

5. Bank X advises exporter of L/C

7. Exporter presents shipping documents to bank X

8. Bank X presents shipping documents to bank I

9. Bank I accepts documents and promises to pay within 60 days

Public investor

10. Bank X sells acceptance documents

11. Payment

12. Payment

13. Investor presents documents and gets paid

Repurchase agreements (repos)

• A firm can sell Treasury securities in a repurchase agree ment whereby the firm agrees to buy back the securities at a specified future date and specified price. Most repos have a very short term, the most common being for 3 to 14 days. There is a market, however, for one- to three-month repos.

Fed Funds• Federal funds are short-term funds transferred (loaned or borrwed) between

financial institutions, usually for period of one day.• The Federal Reserve has set minimum reserve requirements that all banks

must maintain. • To meet these reserve requirements, banks must keep a certain percentage of

their total deposits with the Federal Reserve. • The main purpose for fed funds is to provide banks with an immediate infusion

of reserves should they be short. • Banks can borrow directly from the Federal Reserve, but the fed actively

discourages banks from regularly borrowing from it. • The reason that banks like to lend in the fed funds market is that money held

at the Federal Reserve‘ in excess of what is required does not earn any interest. So even though the interest rate on funds is low, it beats the alternative. One indication of the popularity of fed fund is that on a typical day a quarter of a trillion dollars in fed funds will change hands.

Treasury bills (T.B)

• Sort term securities issued by central banks, soled with a discount and have a maturity period less than one year.

• The interest rate in these securities is considered as risk free rate.

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