Money Market Instrument Questions on the Series 7 Exam - dummies

Money Market Instrument Questions on the Series 7 Exam

By Steven M. Rice

Every Series 7 exam includes a few questions on money market instruments. Money market instruments are relatively safe short-term loans that can be issued by corporations, banks, the U.S. government, and municipalities. Most have maturities of one year or less, and they’re usually issued at a discount and mature at par value. Here are some basic characteristics of money market instruments to help you on the Series 7 exam:

  • Repurchase agreements: Repurchase agreements (Repos) are a contract between a buyer and a seller. The seller of the securities (usually T-bills) agrees to buy them back at a previously determined price and time. Repos are short-term loans.

  • Federal Funds: Federal Funds are loans between banks to help meet reserve requirements. Federal Funds are usually overnight loans for which the rates change constantly depending on supply and demand.

    Reserve requirements are the percentage of deposits that member banks must hold each night. Banks that aren’t able to meet their reserve requirements may borrow from other banks at the Fed Funds rate.

  • Corporate commercial paper: Commercial paper is unsecured corporate debt. Commercial paper is issued at a discount and matures at par value. Commercial paper is issued with an initial maturity of 270 days or less and is exempt from SEC registration.

  • Brokered (negotiable) certificates of deposit: Brokered CDs are low-risk investments, which originate from a bank and are outsourced to broker-dealers to sell to investors. Unlike typical CDs, which are purchased directly from a bank, brokered CDs can be traded in the market. Negotiable certificates of deposit that require a minimum investment of $100,000 are often called jumbo CDs.

  • Eurodollars: Eurodollars are American dollars held by a foreign bank outside the U.S. This situation is usually the result of payments made to overseas companies. Eurodollars are not to be confused with Eurodollar bonds (dollar-denominated bonds issued and held overseas).

  • Bankers’ acceptances: A bankers’ acceptance (BA) is a time-draft (short-term credit investment) created by a company whose payment is guaranteed by a bank. Companies use BAs for the importing and exporting of goods.

  • T-bills: The U.S. government issues T-bills at a discount, and they have initial maturities of 4, 13, 26, or 52 weeks. T-bills are somewhat unique in that they’re sold and quoted on a discount-yield basis (YTM). U.S. government securities — and especially T-bills — are considered the safest of all securities.

Here’s what a question on money market instruments may look like.

SNK Surfboard Company wants to import boogie boards from an Italian manufacturer in Sicily. SNK would use which of the following money market instruments to finance the importing of the boogie boards?

(A)    T-bills

(B)    Collateral trust bonds

(C)    Repurchase agreements

(D)    Banker’s acceptances

The correct answer is Choice (D). You can eliminate Choice (B) right away because collateral trust bonds aren’t money market instruments; they’re secured long-term bonds. A banker’s acceptance is like a post-dated check that’s used specifically for importing and exporting goods.

Word association can help you here. If you see importing, exporting, or time draft, your answer is probably bankers’ acceptance (BA).