Global Financial Instruments I
Summary
TLDRThis lecture provides an in-depth exploration of various global financial instruments, focusing on short-term and long-term investments. It covers key money market instruments like Treasury bills, certificates of deposit (CDs), commercial paper, and bankers' acceptances. The speaker explains how these instruments function, including their maturity terms, risks, and how they're used by companies like Hershey and IBM for short-term financing. The lecture also touches on Eurodollar deposits, describing how companies deposit U.S. dollars in foreign banks before converting them into their home currency. Overall, the lecture highlights key concepts of short-term global financial markets.
Takeaways
- 📊 Investments and instruments are used interchangeably in the lecture, referring to financial tools for investors.
- 💵 Money market instruments, which mature in one year or less, are discussed as short-term investments.
- 📝 Treasury bills are the shortest borrowing instruments used by the US government, with maturities from 90 to 365 days and are sold at a discount from face value.
- 💰 Treasury bills are considered risk-free as they are backed by the US government's taxing authority.
- 🏦 Certificates of Deposit (CDs) are available for both retail and commercial markets, offering fixed returns over a set period.
- 🏷 Commercial paper allows companies like Hershey to borrow short-term without registering with the SEC, providing a secured loan option for companies.
- 💼 Bankers' acceptances were once a popular tool for financing short-term loans globally but have declined in use due to technological advances.
- 🌍 Bankers' acceptances are still considered global financial instruments as they are often bundled and sold to hedge funds.
- 💸 Eurodollars refer to US dollars held in foreign banks, used by international companies like Volkswagen and Electrolux before converting to home currency.
- 🏛 Hedge funds play a role in the global financial market by investing in portfolios of bankers' acceptances and other instruments.
Q & A
What are money market instruments?
-Money market instruments are financial investments with a maturity of one year or less, used for short-term borrowing and lending. The market for these instruments is called the money market.
What are Treasury bills and how do they work?
-Treasury bills are short-term borrowing instruments used by the US Treasury, with maturities ranging from 90 to 365 days. They are sold at a discount, and when they mature, investors receive the full face value, with the difference being the interest earned.
Why are Treasury bills considered a riskless investment?
-Treasury bills are considered riskless because they are backed by the full taxing authority of the US federal government, making it highly unlikely for the government to go bankrupt within the short period before maturity.
What is a certificate of deposit (CD), and how does it differ from retail to commercial CDs?
-A certificate of deposit (CD) is a fixed-term deposit in a bank that pays interest. Retail CDs are available to individuals, while commercial CDs are for large corporations, typically with face values of $100,000 or more.
What is commercial paper and why do companies use it?
-Commercial paper is a short-term loan issued by companies, with a maturity of 185 days or less. It allows companies to avoid the costly and lengthy process of registering securities with the SEC, making it a cost-effective way to raise short-term funds.
What are the advantages of using commercial paper for companies like Hershey?
-Commercial paper offers lower interest rates since it is often secured by assets. It also avoids SEC registration, saving the company time and money. Additionally, the interest on commercial paper is tax-free for investors.
What are bankers' acceptances, and how do they work?
-Bankers' acceptances are short-term loans used to finance transactions between companies. A bank pays the seller a discounted value of the invoice and later collects the full amount from the buyer, earning interest on the difference.
Why have bankers' acceptances become less popular over time?
-Bankers' acceptances have become less popular due to the advent of the internet and other technological advancements, which have made other financing options more efficient.
What are Eurodollars, and how are they created?
-Eurodollars are US dollar-denominated deposits held in foreign banks or foreign branches of US banks. They are created when companies like Volkswagen deposit their US revenues in dollar-denominated accounts in their home countries before converting them into their local currency.
Why are Eurodollar deposits considered global financial instruments?
-Eurodollar deposits are considered global financial instruments because they allow companies operating internationally to manage their foreign currency revenues in US dollars before converting them into their home currencies, providing flexibility in international finance.
Outlines
💼 Introduction to Financial Instruments and Money Market Investments
The lecture begins with an introduction to financial instruments, which are interchangeable with investments. It outlines the structure of the lecture, starting with short-term investments, followed by longer-term ones. A money market instrument is defined as one with a maturity of a year or less. The first investment type discussed is Treasury bills, which are zero-coupon instruments issued by the U.S. government to finance its budget deficit. These bills have maturities ranging from 90 to 365 days and are sold at a discount, with the interest being the difference between the purchase price and the face value. Treasury bills are considered risk-free due to the U.S. government’s backing.
🏦 Certificates of Deposit (CDs) and Commercial Paper
This section explains Certificates of Deposit (CDs), both retail and commercial. Retail CDs are available at commercial banks and are deposits made for a fixed period, offering interest. Commercial CDs, typically purchased by large corporations, work similarly but have higher face values, generally $100,000 or more. Next, the discussion shifts to commercial paper, a short-term loan issued by corporations like Hershey. This unsecured debt avoids SEC registration due to its maturity of 185 days or less, saving costs for corporations. Companies like IBM purchase commercial paper to make their excess cash productive, and the interest earned is tax-free.
💡 Bankers Acceptances: Traditional Global Financial Instrument
Bankers acceptances, a traditional short-term financing method, are introduced through an example of a wholesale lumber transaction. The forest products company sells lumber on credit and, using the buyer's bank, converts its receivables into cash by discounting the invoice. The bank then collects the full payment after 30 days. Bankers acceptances were once popular globally for financing, even for international trade, and they involved banks handling short-term loans. While less common today due to technological advances, they are still recognized as a global financial instrument due to their role in hedge fund portfolios.
🌍 Eurodollars: U.S. Dollar Deposits Held Internationally
This paragraph delves into the concept of Eurodollars, which are U.S. dollar-denominated deposits held outside the U.S., often by foreign companies like Volkswagen. These companies, after generating revenue in U.S. dollars, may temporarily deposit these dollars in foreign banks, such as in Frankfurt, before converting them to their home currency. Eurodollar deposits are not limited to Europe but refer to any such deposits held outside the U.S., showcasing their global nature in corporate finance.
Mindmap
Keywords
💡Money Market Instrument
💡Treasury Bill
💡Certificate of Deposit (CD)
💡Commercial Paper
💡Bankers Acceptance
💡Letter of Credit
💡Eurodollars
💡Budget Deficit
💡Zero-coupon Instrument
💡Securities and Exchange Commission (SEC)
Highlights
The lecture discusses a variety of global financial instruments used for investments.
Short-term investments, also known as money market instruments, have a maturity of one year or less.
The US Treasury Bill is the simplest investment in the money market with maturities ranging from 90 to 365 days.
Treasury bills are zero-coupon instruments, sold at a discount, and considered riskless since they're backed by the US government.
Certificates of Deposit (CDs) are short-term, fixed-period investments made through commercial banks, offering interest over time.
The commercial CD market is similar to retail CDs but typically involves larger corporations and investments with face values of $100,000 or more.
Commercial paper is a short-term loan used by companies like Hershey to raise funds, maturing in 185 days or less.
Commercial paper doesn't require registration with the SEC, saving companies time and money.
Commercial paper is often secured by assets like machinery or real estate, lowering the risk for lenders.
Investing companies like IBM earn tax-free interest when purchasing commercial paper from other companies.
Bankers’ acceptances were a popular global financial instrument for financing short-term loans for small companies.
Bankers’ acceptances could be bundled and sold to hedge funds, which would collect from the various companies involved.
Letters of credit are a form of bankers' acceptance used for international trade, especially before the advent of modern banking technologies.
Eurodollars are US dollar-denominated deposits in foreign banks, such as when Volkswagen deposits US dollars in Frankfurt before converting them to euros.
Many companies, such as large international corporations, use Eurodollar deposits to manage US dollar revenue before converting to their home currency.
Transcripts
welcome to my lecture on global
financial instruments I'm going to
discuss here variety of different
financial investments that are available
for investors across the globe will call
these investments instruments and
investments and instruments are used
interchangeably in this screencast
generally speaking my lecture is divided
in a way where the boss short term
investments will be discussed first then
longer term and then the longest oh okay
any instrument that has a maturity of
one year or less is called a money
market instrument and the market
consisting of these instruments is
called the money market the first and
simplest investment in the money market
is the Treasury bill the US federal
government frequently spends more money
than it takes in as revenue the
difference between what it spends and
what it takes in as revenue is called
the budget deficit and the budget
deficit is financed by having the
federal government borrow money the
federal government borrows money by
selling three different types of
instruments Treasury bills Treasury
notes and Treasury bonds Treasury bills
are the shortest Tom
borrowing instrument used by the US
Treasury Treasury bills have maturities
ranging from 90 days to 365 days they
were face value of $10,000 and their
zero-coupon instruments meaning
there is no stated interest rate on
Treasury bills when investors buy
Treasury bills they buy them and a
discount from face value for example you
might be able to purchase a Treasury
bill that matures in 90 days for $9,500
in 90 days when that Treasury bill
matures you'll receive $10,000 from the
government the difference between ninety
five hundred and ten thousand dollars
five hundred dollars is your interest on
the Treasury bill Treasury bills are
considered to be a riskless investment
why because they're backed by the full
taxing authority of the US federal
government and it's highly unlikely that
the federal government will go bankrupt
within the next year the second
instrument in the money market is
actually quite familiar to most students
the certificate of deposit you or I can
walk into a retail commercial bank and
deposit our money for a fixed period of
time it could be six months one year
five years ten years whatever and the
bank will pay us interest on our deposit
that's the retail certificate of deposit
likewise even large corporations buy
certificates of deposit that's called
the commercial CD market typically in
the commercial CD market CDs have face
values of $100,000 or more but in all
other respects the commercial CD market
works exactly like the retail CD market
closely related to the CD market is the
market for commercial paper suppose you
have a company like Hershey corporation
that makes and sells candy once in a
while
her.she corporation may find that it
needs to borrow money short-term in that
case they can sell a short-term
commercial paper this commercial paper
is a short-term loan made by Hershey
corporation it has a maturity of 185
days or less because when any company
sells a security that that has a
maturity of more than 185 days that
company has to register that security
with the Securities and Exchange
Commission the whole registration
process with the Securities and Exchange
Commission can be fairly lengthy and
expensive so commercial paper avoids
having to register that security with
the SEC thereby saving a company like
Hershey corporation a ton of money
secondly commercial paper is usually
secured there are some assets that back
that loan Hershey corporation may offer
some machinery or real estate or some
other equipment as security when it
sells commercial paper because
commercial paper is secured
it carries a relatively lower interest
rate
lenders are less worried about not
having they're not getting their money
back if the loan is secured finally if a
company like IBM buys Hershey's
commercial paper IBM does it because
it's got some extra cash available on
hand they don't want that cash to be
sitting in their bank account not
earning any money might as well take
that money and put it in a short-term
investment of a high quality company
that owns them interest so when IBM buys
commercial paper issued by Hershey the
interest that it
recieves on that investment is tax-free
IBM doesn't have to pay any tax on that
interest okay so these are some of the
advantages of commercial people in the
market for commercial paper is pretty
large okay and lot of companies are
active in it including insurance
companies who invest in short term
commercial paper that brings me to
bankers acceptances up until about 20
years ago
bankers acceptances were very popular
it's a means to finance short short term
loans made by small companies across the
world let me give you a specific example
that explains bankers acceptances
suppose you have a company called the
forest products company
it's a wholesale lumber seller ok the
forest products company sells lumber
worth $25,000 to clucks and lumber
company which is a retail Lumber Company
and it offers Clarkson 30 day credit
when the lumber as well as the invoice
is delivered to Clarkson Clarkson's
manager signs the invoice saying they've
received this lumber and they intend to
pay the invoice in 30 days and returns
that signed invoice to the forest
products company now previously Clarkson
and its Bank the Seattle Bank have
agreed into an agreement have entered
into an agreement that allows the
seattle bank to finance short term loans
to provide short-term loans to Clarkson
and this is how it works the forest
perks company can take that signed
invoice - Clarkson Bank
Clarkson's Bank and the seattle bank
pays the Forest Products Company a
discounted value of their invoice
right away in this case twenty four
thousand seven hundred and fifty dollars
okay
Seattle Bank holds on to that invoice
for thirty days and that goes to
Clarkson and collects twenty five
thousand dollars from the clocks and
Lumber Company the difference between
what Seattle pays to Forest Products
Company and what it collects two o'clock
from Clarkson is the interest that the
Seattle bank earns on that short-term
loan to the Clarkson Lumber Company so
this means of financing started about
three hundred years ago and it was
phenomenally popular across the world in
even finance international business
suppose the forest products company was
located in Canada while Clarkson is
located in the US so then this becomes
an international transaction in that
case the bankers acceptance is called a
letter of credit so for three hundred
four hundred years bankers acceptances
in letters of credit were like the
primary means of short-term financing
for small to medium sized businesses
with the advent of the internet and
other technological advances bankers
acceptances and letters of credit have
become less popular why is the bankers
of acceptance view as a global financial
instrument because what happens is in
this particular example that I gave you
the Seattle Bank holds on to that
bankers acceptance and collects the
money after 30 days from Clarkson but
more commonly what might happen is
Seattle Bank takes all such bankers
acceptances that is hands and sells them
to a hedge fund the hedge fund has a
diversified portfolio of bankers
acceptances that it has in
today when the time comes it's actually
the hedge fund that collects from these
variety of different companies okay so
there are hedge funds in this world that
focus on just investing in bankers
acceptances and this is why the bankers
acceptance is viewed as being a global
financial instrument okay euro dollars
let me give you an example that will
make this more specific companies like
Volkswagen do business in the u.s. they
sell their cars in the US
obviously the revenue that they make in
the u.s. is in terms of US dollars okay
but Volkswagen is a German company
ultimately it will convert those US
dollars into euros the currency of its
home country but for a little while it
may choose to deposit those u.s. dollars
in dollar
DeMarre denominated deposits in a bank
in Frankfurt when that happens it's
called a euro dollar deposit it doesn't
necessarily have to be in Europe
physically okay so just to give you
another example energy corporation that
also does business in the u.s. by
selling dishwashers and washing machines
and dryers and all that kind of stuff
makes substantial revenues in u.s.
dollars again just like walks wagon it
may choose to deposit those dollars in
its home country and its home bank just
before it converts US dollars into the
home currency so why those deposits
remain in a dollar denominated account
they are called u dollar deposits
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