Question

(a) Suppose an active investment manager purchased a $50 million parcel of 90-day bills at 6.25% and sold those 10 days later at 6.35%.
Calculate the investment return.
(b) Calculate the annualized discount rate % and investment rate % on a Treasury bill that you purchase for $9,900 that will mature in 91 days for $10,000.
(c) Explain the characteristics that define the money market. Why do businesses and corporations use the money markets?

Answer 1

a]

Price of T bill = face value / (1 + (interest rate * (days to maturity / 360)))

Purchase price = $50,000,000 / (1 + (6.25% * (90 / 360)))

Purchase price = $49,230,769.23

Sale price = $50,000,000 / (1 + (6.35% * (80 / 360)))

Sale price = $49,304,262.08

Investment return = (sale price - purchase price) / purchase price

Investment return = ($49,304,262.08 - $49,230,769.23) / $49,230,769.23

Investment return = 0.1493%

b]

Price of T bill = face value / (1 + (interest rate * (days to maturity / 360)))

$9,900 = $10,000 / (1 + (interest rate * (91 / 360)))

interest rate = (($10,000 / $9,900) - 1) * (360 / 91)

interest rate = 3.9960%

Annualized rate = 3.9960%

Investment rate = (face value - price) / price

Investment rate = ($10,000 - $9,900) / $9,900

Investment rate = 1.0101%

c]

Money market is the market for short-term funds. It is characterized by securities with maturity less than 1 year. Government money market instruments are usually called T-Bills, G-Secs, etc. whereas corporate money market instruments are usually called CDs, CPs etc. The money market is also characterized by low risk and lower returns compared to the capital market.

Businesses and corporations use the money market because :

• Helps them get the best interest rate possible
• Huge amounts can be raised, which a single bank may be unable to lend
• Costs of raising short term funds is lower than a bank loan