Money Market Instruments and Government Securities
Domain 5 - Money Market Instruments and Government Securities
This domain tests the short end of the curve: how Treasury, agency, and money market instruments are quoted, settled, and regulated.
Instruments
- Treasury bills are sold at a discount and mature at par in one year or less; interest is exempt from state and local tax. T-notes and T-bonds pay semiannual coupons. STRIPS are zero-coupon components of Treasury securities.
- Commercial paper is unsecured corporate promissory debt, typically 270 days or less, which avoids SEC registration under Section 3(a)(3) of the Securities Act.
- Negotiable CDs, banker's acceptances, and repurchase agreements round out the market. In a repo the dealer sells securities and agrees to buy them back; a reverse repo is the mirror image.
- Money market funds under Rule 2a-7 must keep dollar-weighted average maturity at 60 days or less and weighted average life at 120 days or less, with minimum daily and weekly liquidity; government and retail funds may use a stable $1 NAV, while institutional prime funds float.
Quoting
- T-bills use a discount yield on a 360-day basis: (discount ÷ par) × (360 ÷ days). Because the discount is divided by par rather than the price paid, discount yield understates the true return.
- Bond equivalent yield converts to a 365-day, price-based measure and is always higher for the same bill.
Worked example
A 91-day bill with $100,000 par is bought at $98,000. Discount yield = ($2,000 ÷ $100,000) × (360 ÷ 91) = 7.91%. Bond equivalent yield = ($2,000 ÷ $98,000) × (365 ÷ 91) = 8.19%.
Traps
- Mixing 360- and 365-day bases.
- Believing commercial paper is secured or SEC-registered.
- Forgetting that Treasury interest is federally taxable even though it is state-exempt.