CHAPTER 6

1. CHAPTER 6 Financial Markets, Instruments, and Market Makers

2. The Principal Money Market Instruments: Amount Outstanding, End of Year (in Billions of Dollars) Type of Instrument 1960 1970 1980 1990 1998 2001c Treasury bills $37 $76 $200 $482 $ 691 $ 620 Negotiable CDs 0 45 260 NAa NAa NAa Commercial paperb 5 35 99 558 1,173 1,471 Bankers’ acceptances 1 4 32 52 14 7 Repurchase agreements 1 22 102 324 878 1,241 and fed funds Eurodollars 1 20 68 NAa 151 214 aNot available. bIncludes commercial paper issued by financial and nonfinancial firms. cAs of June 30, 2001. SOURCE: Federal Reserve Flow of Funds Accounts, Z1, 2nd Quarter 2001 (September 18, 2001).

3. The Money Market Instrument Typical Maturities Principal Borrowers Secondary Market Treasury bills 3 to 12 months U.S. government Very active Negotiable CDs 1 to 6 months Depository institutions Modest activity Commercial paper 1 to 270 days Financial and business firms Moderately active Bankers’ acceptances 90 days Financial and business firms Limited Repurchase agreements 1 day, and 2 days Banks, securities dealers, None, but very to 3 months typical; other owners of securities, active primary 6 months less typical nonfinancial firms, market for short governments maturities Fed funds Chiefly 1 business day Depository institutions Active brokers’ market Eurodollars Overnight, 1 week, Banks None 1 to 6 months, and longer

4. Goods Now IMPORTER EXPORTER Cash Later Goods Now IMPORTER EXPORTER Cash Later Accepted Time Draft Now BANK Cash Now Accepted Now Cash Later INVESTOR Bankers’ Acceptances Documents Now Transaction occurs with a bankers’ acceptance; less risk to the exporter SOURCE: Adapted from Ann-Marie Meulendyke, U.S. Monetary Policy and Financial Markets (New York: Federal Reserve Bank of New York, 1989): 80

5. The Principal Capital Market Instruments: Amount Outstanding, End of Year (in Billions of Dollars) Type of Instrument 1960 1970 1980 1990 1998 2001** Corporate stock $451 $906 $1,920 $3,530 $15,438 $15,863.6 Mortgages 142 297 965 3,804 5,782 7,250.4 Corporate and foreign bonds75 167 319 1,704 3,894 5,435.1 U.S. government securities 178 156 394 2,776 3,724 3,234.4 U.S. government agency 10 51 170 426 1,328 4,620.4 securities* Municipal securities 71 144 NA NA1,464 1,629.3 *Excludes federally sponsored mortgage pools. **As of June 30, 2001. SOURCE: Federal Reserve Flow of Funds Accounts, Z1 (September 18, 2001); Federal Reserve Bulletin, various issues; Banking and Monetary Statistics 1941-1970.

6. The Capital Market Instrument Typical Maturities Principal Borrowers Secondary Market Corporate Stock — Corporations Very active for large corporations Mortgages 15 to 30 years Home owners and other investors Moderately active Corporate bonds 2 to 30 years Corporations Active U.S. government securities Notes 2 to 10 years U.S. government Very active Bonds 30 years (currently) U.S. government Very active U.S. government agency securities Up to 30 years U.S. government agency Some activity Municipals 2 to 30 years State and local governments Active

7. Market Makers Assist in raising funds to finance deficits by marketing a borrower’s new securities in the primary market MARKET MAKERS Advise potential buyers and sellers of securities on the course of action likely to minimize costs and maximize returns Stand ready to buy or sell outstanding securities in the secondary market

8. APEI wants to issue bonds to finance investment Merrill Lynch agrees (for a fee) to design a bond offering and to market (sell) the bonds Primary Market Activity SSUs and financial intermediaries buy APEI bonds that will mature in 20 years One year later SSUs (or financial intermediaries) decide to sell some of their APEI bonds Salomon Smith Barney makes a market in APEI bonds by buying bonds from SSUs Secondary Market Activity Salomon sells “used” APEI bonds to another SSU The Marketing and Subsequent Trading of a Corporate Bond