Complete The Following Textbook Problems: Ch. 6, P. 158, # 1

Complete the following textbook problems: Ch. 6, p.158, # 1. Primary Market Explain how the Treasury uses the primary market to obtain adequate funding. Ch. 6, p.158, # 4. Commercial Paper Who issues commercial paper? What types of financial institutions issue commercial paper? Why do some firms create a department that can directly place commercial paper? What criteria affect the decision to create such a department? Ch. 6, p.158, # 8. Repurchase Agreements Based on what you know about repurchase agreements, would you expect them to have a lower or higher annualized yield than commercial paper? Why? Ch. 6, p.158, # 9. Banker's Acceptances Explain how each of the following would use banker's acceptances: (a) exporting firms, (b) importing firms, (c) commercial banks, and (d) investors. Ch. 7, p.184, #10. Global Interaction of Bond Yields If bond yields in Japan rise, how might U.S. bond yields be affected? Why? Ch. 7, p.184, #11. Impact of Credit Crisis on Junk Bonds Explain how the credit crisis affected the default rates of junk bonds and the risk premiums offered on newly issued junk bonds. Ch. 9, p.241, #2. Mortgage Rates and Risk What is the general relationship between mortgage rates and long-term government security rates? Explain how mortgage lenders can be affected by interest rate movements. Also explain how they can insulate against interest rate movements. Ch. 9, p.241, #4. Mortgage Maturities Why is the 15-year mortgage attractive to homeowners? Is the interest rate risk to the financial institution higher for a 15-year or a 30-year mortgage? Why?

Paper For Above instruction

The primary market serves as a fundamental mechanism through which government entities, corporations, and financial institutions obtain funding necessary to support their operations and financing requirements. In particular, the U.S. Treasury utilizes the primary market extensively to issue government securities, such as Treasury bonds, notes, and bills. By doing so, the Treasury raises funds directly from investors through the sale of these securities, which are initially issued in the primary market. This process involves competitive or auction-based sales, where institutional and individual investors purchase new securities to finance government expenditures and manage national debt levels. The primary market thus provides a controlled and transparent avenue for the Treasury to meet its funding needs efficiently, manage monetary policy implications, and control the supply of government debt in the economy.

Commercial paper is a short-term unsecured promissory note issued primarily by large corporations, financial institutions, and other eligible entities seeking to meet short-term financing needs. Financial institutions such as banks, savings associations, and credit corporations frequently issue commercial paper as a means of raising liquid funds quickly without resorting to long-term debt issuance. Creating a department dedicated to directly placing commercial paper can offer firms advantages in terms of cost efficiency, faster access to capital, and tailored marketing strategies. Firms often establish such departments when they regularly issue large volumes of commercial paper or seek to maintain flexibility in their short-term funding operations. The decision largely depends on factors such as the firm's access to capital markets, the frequency of issuance, the expertise of the internal team, and the desire for operational control over the issuance process.

Repurchase agreements, or repos, are short-term borrowing arrangements typically used by financial institutions, broker-dealers, and central banks to manage liquidity and funding needs. Given the short duration and the collateralized nature of repos, they often offer lower risk and, consequently, lower yields compared to unsecured instruments like commercial paper. Therefore, repos generally present a lower annualized yield than commercial paper, reflecting their reduced risk profile due to collateral backing. Central banks and institutions engaging in repos do so for liquidity management purposes, benefitting from the safety and short-term nature of these agreements while accepting a lower return than more unsecured funding options.

Bankers’ acceptances are utilized in international trade transactions, serving different roles for various participants. Exporting firms often rely on banker's acceptances as a means of ensuring payment from foreign buyers, as these acceptances can be sold at a discount to generate immediate funds. Importing firms may use banker's acceptances to finance the purchase of goods, securing favorable credit terms from their banks. Commercial banks issue banker's acceptances to provide guarantees of payment on behalf of their clients, thereby facilitating trade and enhancing their fee income. Investors, on the other hand, purchase banker's acceptances as a relatively safe, short-term investment instrument, often seeking to diversify their portfolios with instruments backed by bank guarantees and commercial transactions. These acceptances thus play a crucial role in bridging international trade financing needs while providing liquidity options for investors.

In the context of global bond markets, an increase in bond yields in Japan typically affects U.S. bond yields through capital flow shifts and relative return considerations. When Japanese bond yields rise, yield differentials between the two countries change, potentially making U.S. bonds less attractive if U.S. yields remain unchanged. To maintain competitiveness and attract investors, U.S. bond yields may also increase to stay aligned with global interest rate movements, or investors might withdraw capital from U.S. markets in favor of higher-yielding Japanese bonds, leading to downward pressure on U.S. bond prices and upward pressure on yields. Consequently, bond yield interdependence reflects the interconnectedness of global capital markets, driven by currency considerations, monetary policy expectations, and risk appetite.

The credit crisis significantly impacted the risk profile of junk bonds, which are high-yield, high-risk debt securities issued by companies with weaker credit ratings. During the crisis, the default rates for junk bonds increased sharply due to deteriorating financial conditions and reduced investor confidence. As default risk grew, risk premiums—additional yields demanded by investors over safer bonds—also expanded to compensate for elevated risk levels. Newly issued junk bonds became more expensive to issue, reflecting heightened risk perception, and investors demanded higher yields as compensation for the greater likelihood of default. This dynamic exemplifies how systemic financial shocks elevate borrowing costs for high-risk issuers, further constraining their access to capital during periods of economic distress.

Mortgage rates typically correlate closely with long-term government security rates, such as the 10-year Treasury yield, since both reflect expectations about future interest rates, inflation, and economic growth. When long-term rates increase, mortgage rates tend to follow suit, raising borrowing costs for homeowners. Mortgage lenders, however, face interest rate risk as they tend to lend at fixed rates while their funding sources (deposits or wholesale funding) may vary in cost. To hedge against this risk, lenders often employ derivative instruments such as interest rate swaps or futures, which help mitigate exposure to rising rates. Alternatively, some lenders may adjust their lending criteria or interest rate spreads to pass the risk onto borrowers, thus insuring against interest rate fluctuations.

The 15-year mortgage attracts homeowners owing to its shorter repayment period, lower total interest costs, and faster equity buildup compared to 30-year loans. This shorter term can make homeownership more affordable and enable quicker mortgage payoff. Financial institutions face higher interest rate risk with 30-year mortgages because of their extended duration and exposure to interest rate fluctuations over a longer horizon. Movements in interest rates can significantly impact the value of these longer-term assets, increasing the risk of interest rate mismatch. A 15-year mortgage presents a lower duration and thus reduces interest rate sensitivity for lenders, but it still involves some interest rate risk, especially if the institution funds the mortgage with short-term or variable-rate liabilities.

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