Answers to End-of-Chapter Questions

Answers to End-of-Chapter Questions 

1. The money markets can be characterized as having securities that trade in one year or less, are of 

large denomination, and are very liquid. 

2. Money market securities have an original maturity of less than one year, so the bond would not be 

considered a money market security. 

3. Banks have higher costs than the money market owing to the need to maintain reserve requirements. 

The lower cost structure of the money markets, coupled with the economies of scale resulting from 

high volume and large-denomination securities, allows for higher interest rates. 

4. Term securities have a specific maturity date. Demand securities can be redeemed at any time. A six 

month certificate of deposit is a term security. A checking account is a demand security. 

5. Following the Great Depression, regulators were primarily concerned with stopping banks from 

failing. By removing interest-rate competition, bank risk was substantially reduced. The problem with 

these regulations was that when market interest rates rose above the established interest-rate ceiling, 

investors withdrew their funds from banks. 

6. The U.S. government sells large numbers of securities in the money markets to support government 

spending. Over the past several decades, the government has spent more each year than it has 

received in tax revenues. It makes up the difference by borrowing. Part of what it borrows comes 

from the money markets. 

7. Businesses both invest and borrow in the money markets. They borrow to meet short-term cash flow 

needs, often by issuing commercial paper. They invest in all types of money market securities as an 

alternative to holding idle cash balances. 

8. Merrill Lynch initially felt that it could better service it’s regular customers by making it easier to buy 

and sell securities from an account held at the brokerage house. The brokerage could offer a market 

interest rate on these funds by investing them in the money markets. 

9. Life insurance companies can invest for the long term because the timing for their liabilities is known 

with reasonable accuracy. Property and casualty insurance companies cannot predict the natural 

disasters that cause large payouts on policies. 

10. Treasury bills are usually viewed as the most liquid and least risky of securities because they are 

backed by the strength of the U.S. government and trade in extremely large volumes.

11. In competitive bidding for securities, buyers submit bids. A noncompetitive bidder accepts the 

average of the rate paid by the competitive bidders. 

12. Federal funds are sold by banks to other banks. They are used to invest excess reserves and to raise 

reserves if a bank is short. 

13. The Federal Reserve cannot directly set the federal funds rate of interest. It can influence the interest 

rate by adding funds to or withdrawing reserves from the economy. 

14. Large businesses with very good credit standings sell commercial paper to raise short-term funds. 

The most common use of these funds it to extend short-term loans to customers for the purchase of 

the firm’s products. 

15. Banker’s acceptances substitute the creditworthiness of a bank for that of a business. When a 

company sells a product to a company it is unfamiliar with, it often prefers to have the promise of a 

bank that payment will be made. 

• Quantitative Problems 

1. What would be your annualized yield on the purchase of a 182-day Treasury-Bill for $4,925 that pays 

$5,000 at maturity? 

Solution: 

$5,000 − $4,925 365 

i = × = 3.05% 

$4,925 182 

2. What is the annualized yield on a Treasury bill that you purchase for $9,940 and will mature in 

91 days for $10,000? 

Solution: 2.42% 

3. If you want to earn an annualized yield of 3.5%, what is the most you can pay for a 91-day Treasury- 

Bill $5,000 at maturity? 

Solution: 

$5,000 − P 365 

× = 3.50% 

P 91 

P = $4,956.74 

4. What is the annualized yield on a Treasury bill that you purchase for $9,900 that will mature in 91 

days for $10,000? 

Solution: 4.05% 

5. The price of 182-day commercial paper is $7,840. If the annualized yield is 4.04%, what will the 

paper pay at maturity? 

Solution: 

$F − $7,840 365 

× = 4.04% 

$7,840 182 

P = $7997.93

6. How much would you pay for a Treasury bill that matures in one year and pays $10,000 if you 

require a 1.8% return? 

Solution: $9,823.18 

7. The price of $8,000 face value commercial paper is $7,930. if the annualized yield is 4%, when will 

the paper mature? 

Solution: 

$8,000 − $7,930 365 

× = 4.00% 

$7,930 X 

X = 80 days 

8. How much would you pay for a Treasury bill that matures in one year and pays $10,000 if you 

require a 3% return? 

Solution: $9,708.74 

9. The annualized yield on a particular money market instrument is 3.75%. The face value is $200,000 

and it matures in 51 days. What is it’s price? What would be the price if it had 71 days to maturity? 

Solution: 

$200,000 − P 365 

× = 3.75% 

P 51 

P = $198,958 

$200,000 − P 365 

× = 3.75% 

P 71 

P = $198,552 

10. The annualized yield is 3% for 91-day commercial paper and 3.5% for 182-days commercial paper. 

What is the expected 91-day commercial paper rate 91 days from now? 

Assuming the difference is just due to higher future interest rates, an investor should be able to earn 

the same return over 182 days using either 182-day paper or a 91-day paper rollover strategy. 

Assume that the 182-day paper has a $100,000 face value. The current price is: 

$100,000 − P 365 

× = 3.5% 

P 182 

P = $98,284.73 

Now, invest the same amount in 91-day paper. 

F − 98,284.73 365 

× = 3.0% 

98,284.73 91 

F = $99,019.87. That is, such an investment should payoff $99,019.87 after 91 days. 

Now, invest $99,019.87 in 91-day paper again. It is expected to give a final value of $100,000 (just 

like the 182-day paper). 

100,000 − 99,019.87 365 

× = 3.97%. The 91-day rate in 91-days is expected to be 3.97%. 

99,019.87 91

11. Assume that 45% of a Treasury Bill auction was sold for $998 per $1,000 per value, 35% was sold 

for $997, and the last 20% was sold for $996. What would be the weighted average price paid by a 

noncompetitive bid? 

Solution: $998 × 0.45 + $997 × 0.35 + $996 × 0.20 = $997.25 

Noncompetitive bidders pay $997.25 per $1,000 of Treasury Bills purchased. 

12. In a Treasury auction of $2.5 billion par value 91-day T-bills, the following bids were submitted: 

Bidder Bid Amount Price 

1 $500 million $0.9940 

2 $750 million $0.9901 

3 $1.5 billion $0.9925 

4 $1 billion $0.9936 

5 $600 million $0.9939 

(a) If only these competitive bids are received, who will receive T-bills, what quantity, and at what 

price? 

(b) If the Treasury also received $750 million in noncompetitive bids, who will receive T-bills, what 

quantity, and at what price? 

Solution: (a) If only the competitive bids are received, the following bids, quantities, and prices 

will be awarded: 

Bidder Bid Amount Price Amount Paid 

1 $500 million $0.9940 $497.00 million 


4 $1 billion $0.9936 $993.60 million 


(b) If $750 million in noncompetitive bids are also received, the following bids, quantities, 

and prices will be awarded: 

Competitive Bids 

Bidder Bid Amount Price Amount Paid 




Noncompetitive Bids 

$750 million $0.9938 * $745.35 million 

* $0.9938 = (500 × 0.9940 + 600 × 0.9939 + 

650 × 0.9936)/1,750

Answers to End-of-Chapter Questions

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