270 days for the securities to be exempt from the provisions of the Securities Acts

If commercial paper were issued with a longer maturity than 270 days (which does not happen), registration with the SEC and sale with a prospectus would be required, making it very costly for issuers to sell such securities. Commercial paper is not eligible for Fed trading.

Used to finance imports and exports.

BAs are bearer securities.

Most are held to maturity but can be traded (very illiquid).

Maturity is 9 months or less.

Only the highest quality BAs are eligible for Fed trading, known as "prime BA's."

These are "jumbo CDs" with a minimum face amount of $100,000.

Short-term are non-callabale. Long-term are callable.

The issuer promises to pay par plus accrued interest at maturity (usually less than 1 year with most being 1-3 months).

Unlike conventional bank CDs, which can only be redeemed with the issuing bank these are negotiable; can be traded.

Negotiable CDs are not eligible securities for Fed trading.

Repurchase Agreement

REPOS

In order to improve liquidity (get cash), a dealer will "sell" some of his goverment securities to another dealer with an agreement to buy them back at a later date at a price to give a fixed yield. In effect, a security is created, collateralized by underlying U.S. Governments and any other eligible security

Repos by the FED loosen credit

Reverse Repo tightens credit

'matched sale'

The Fed buys the "paper" from the dealer backed by eligible securities. The bank then gets cash which can be lent out.

The Fed enters into "reverse repurchase agreements," selling the "paper" to government dealers. The dealers are temporarily drained of cash, tightening the money supply. This is also called a "matched sale," since the sale is matched to a later buy-back of the security.

Tracks the Federal Funds Rate - overnight bank to bank loan rate.

Since repurchase agreements are secured, whereas loans of Federal Funds are unsecured, the interest rate on repurchase agreements is lower than for loans of "Fed Funds."

Even though the agreement covers a time period of 1 day, the underlying collateral consists of longer maturity government securities. If, during the 1 day period of the agreement, interest rates rise, then on the next day, the collateral is returned to the seller at the pre-agreed price. 

This collateral may be substanially devalued due to a rise in interest rates.

Federal Funds:  Reserves held on deposit by Federal Reserve System member banks.

A bank with excess reserves can lend them to a bank that is deficient, at the Federal Funds Rate.

These loans are overnight and the interest rate is quite volatile, changing as the demand for reserves changes. 

The "effective" Federal Funds Rate gives an indication of the daily demand for reserves and is a daily average of many banks' rates.

Eurodollars:  Deposits denominated in dollars held in a bank branch outside of the US.

Large deposits made by corps. Fixed term 1 to 5 days.

Loaned similar to Fed Funds but longer periods. 

LIBOR:  London Interbank Offered Rate.  Is the average offered rate for Eurodollar loans of 5 major banks centered in London.

Long Term Certificates of Deposit

Called Brokered CDs

• Not redeemable prior to maturity so they are subject to market risk.
• Pre-maturity sale price of a long term CD may be less than the original purchase price if market interest rates rise.
• Limited secondary market
• Callable CDs are subject to reinvestment risk if interest rates fall (thats when they're called)
• Step-up or step-down CDs might not reflect the current market interest rate.
• FDIC only insures if the instrument is titled in the customer's name.

• CDs are priced at market value on customer account statements

• No prepayment penalty because it's not possible.

Securities based on, or derived from, a basket of securities, an index, or other securities, commodities, or currencies. There are many types of structured products, but generally they consist of a "bond" portion, which pays interest based on the performance of a well known index such as the S & P 500 Index. In addition, they have a derivative component (an embedded option) that allows the holder to sell the security back to the issuer (at par) at maturity.

Market Index Linked CD

Structured Product variation of CD

Ties the return to an equity index (usually S&P 500 index)

• Market Risk:  3-5% penalty for early withdrawl.  Because the issuer had to buy a put option.
• Liquidity Risk:  Can only be redeemed at pre-set quarterly dates.
• Credit Risk:  Backed by the issuing bank (if bank goes bankrupt)
• Cap on Return:  Some have a cap on the amount that can be earned.
• Tax Issues:  Returns are treated as interest up to the maximum rate of 35% (divs are only 15%).
• Minimum life up to 3 years.

'Reasonable Basis' Suitability

'Customer Specific' Suitability

FINRA requires issuing firms to tell the customer about the product's potential rewards and risks.

Relative to other similiar SPs

Firm can only offer to customers that are suitable.

Eliminates Liquity Risk

Return is linked to a market index

Has a set maturity date

Backed by the credit of the issuing bank

Listed on exchanges and trade.

Does NOT make periodic interest payments

Taxed as capital gain at preferential rate (15% max)

CREDIT RISK due to bank backing

"Derivative" that is a debt instrument with a long term nominal maturity, but the interest rate on the security is reset, usually weekly, via a Dutch auction.

Issuer:  Sell debt at short term rates, does not have to repay the debt, so it gets long term funding for cheap.

Purchaser:  Weekly choice to renew at the interest rate set by the auction or to sell to someone at the auction.

Thus the purchaser never gets repaid by the issuer.

ATR

Dutch Auction

Clearing Rate

25,000 minimum

Each bid and order size is ranked to highest minimum bid.

The amount of bonds for sale are auctioned form lowest interest rate bid on up, until whole amount is filled.

Clearing Rate:  All winning bids are filled at the highest interest rate that completed the sale.

Thus, the clearing rate is the lowest rate at which there are purchasers willing to buy all of the auction rate securities offered for sale in auction. Any interest rate bids that are higher than the clearing rate will not be filled. 

25,000 minimum to make them attractive

Reasons for failure:

There are more sellers then buyers (bidders) - so there is an excess supply available without willing buyers.

The interest rate set forth in the bids are too high.

Most auctions establish a maximum interest rate bid.  This is the rate the holders will recieve for the next week they are forced to hold the bonds.