Global Financial Instruments I

Premal Vora

10 Jan 202013:06

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

00:00

💼 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.

05:01

🏦 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.

10:04

💡 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

Money market instruments are short-term financial investments with a maturity of one year or less. These instruments provide liquidity and are generally considered low-risk. In the script, examples include Treasury bills and certificates of deposit (CDs), which are used by governments and corporations to borrow money for short durations.

💡Treasury Bill

A Treasury bill is a short-term debt security issued by the US government to finance its budget deficit. These are zero-coupon instruments, meaning they don't pay interest directly but are sold at a discount and mature at face value. The difference represents the investor’s return. In the script, the example given is purchasing a $10,000 Treasury bill at a discounted price of $9,500.

💡Certificate of Deposit (CD)

A certificate of deposit (CD) is a savings product offered by banks, where an individual or company deposits a fixed amount of money for a set period in exchange for interest. CDs come in retail and commercial forms, the latter involving large amounts like $100,000 or more. In the video, both personal and commercial CDs are discussed as money market instruments.

💡Commercial Paper

Commercial paper is an unsecured, short-term debt issued by corporations like Hershey to finance their short-term needs. It typically has a maturity of 185 days or less, avoiding the lengthy process of registering with the Securities and Exchange Commission (SEC). Companies issue commercial paper to meet immediate financial obligations, and the script highlights how businesses like IBM might buy it to earn interest on their excess cash.

💡Bankers Acceptance

A bankers acceptance is a short-term debt instrument issued by a company and guaranteed by a bank. These were historically used to finance international trade transactions. In the video, a detailed example involving the Seattle Bank, the Forest Products Company, and Clarkson Lumber Company illustrates how bankers acceptances function as a secure means of financing trade.

💡Letter of Credit

A letter of credit is a financial document issued by a bank guaranteeing payment to a seller in international transactions. It is similar to a banker’s acceptance but used in cross-border deals. The script notes how letters of credit facilitated global trade, acting as guarantees for payments between international buyers and sellers, such as between a Canadian and a US company.

💡Eurodollars

Eurodollars are US dollars deposited in foreign banks or in the foreign branches of US banks. The term doesn’t necessarily mean the dollars are physically in Europe. For instance, the script explains how companies like Volkswagen may temporarily hold US dollars in a Frankfurt bank before converting them into euros, creating Eurodollar deposits.

💡Budget Deficit

A budget deficit occurs when a government spends more money than it collects in revenue. To finance this gap, the US government borrows money by selling Treasury bills, notes, and bonds. In the lecture, the budget deficit serves as a key reason why the US Treasury issues short-term borrowing instruments like Treasury bills.

💡Zero-coupon Instrument

A zero-coupon instrument is a type of bond that doesn’t pay periodic interest but is issued at a discount and repaid at full face value. Treasury bills are an example, as discussed in the script. Investors make a profit from the difference between the purchase price and the amount received at maturity, such as buying a $10,000 bill for $9,500.

💡Securities and Exchange Commission (SEC)

The Securities and Exchange Commission (SEC) is a US government agency that regulates the securities markets and protects investors. The script mentions that companies issuing securities with maturities of more than 185 days must register them with the SEC, which can be a costly and time-consuming process, leading companies to prefer issuing short-term securities like commercial paper.

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.