Financial Markets and Institutions (2-downloads)


Bruce Bent and the Money Market Mutual Fund



Download 8,77 Mb.
Pdf ko'rish
bet459/591
Sana31.12.2021
Hajmi8,77 Mb.
#214090
1   ...   455   456   457   458   459   460   461   462   ...   591
Bog'liq
Mishkin Eakins - Financial Markets and Institutions, 7e (2012)

Bruce Bent and the Money Market Mutual Fund

Panic of 2008

Bruce Bent, one of the originators of money market

mutual funds, almost brought down the industry dur-

ing the financial crisis in the fall of 2008. Mr. Bent

told his shareholders in a letter written in July 2008

that the fund was managed on a basis of “unwaver-

ing discipline focused on protecting your principal.”

He also wrote the Securities and Exchange

Commission in September 2007, “When I first cre-

ated the money market fund back in 1970, it was

designed with the tenets of safety and liquidity.” He

added that these principles had “fallen by the way-

side as portfolio managers chased the highest yield

and compromised the integrity of the money fund.”

Alas, Bent did not follow his own advice, and his

fund, the Reserve Primary Fund, bought risky assets so

that its yield was higher than the industry average.

When Lehman Brothers went into bankruptcy on

September 15, 2008, the Reserve Primary Fund, with

assets over $60 billion, was caught holding the bag

on $785 million of Lehman’s debt, which then had to

be marked down to zero. The resulting losses meant

that on September 16, Bent’s fund could no longer

afford to redeem its shares at the par value of $1, a

situation known as “breaking the buck.” Bent’s share-

holders began to pull their money out of the fund,

causing it to lose 90% of its assets.

The fear that this could happen to other money

market mutual funds led to a classic panic in which

shareholders began to withdraw their funds at an

alarming rate. The whole money market mutual fund

industry looked like it could come crashing down. To

prevent this, the Federal Reserve and the U.S.

Treasury rode to the rescue on September 19. The

Fed set up a facility, discussed in Chapter 8, to make

loans to purchase commercial paper from money

market mutual funds so they could meet the demands

for redemptions from their investors. The Treasury

then put in a temporary guarantee for all money mar-

ket mutual fund redemptions and the panic subsided.

Not surprisingly, given the extension of a govern-

ment safety net to the money market mutual fund

industry, there are calls to regulate this industry more

heavily. The money market mutual fund industry will

never be the same.



468

Part 6 The Financial Institutions Industry

One problem for investors in long-term coupon bonds, even when investors have

a long holding period, is that there is some uncertainty in their returns arising from

what is called reinvestment risk. Even if an investor holding a long-term coupon

bond has a holding period of 10 years, the return on the bond is not certain. The prob-

lem is that coupon payments are made before the bond matures in 10 years, and these

coupon payments must be reinvested. Because the interest rates at which the coupon

payments will be reinvested fluctuate, the eventual return on the bond fluctuates

as well. In contrast, long-term zero-coupon bonds have no reinvestment risk because

they make no cash payments before the bond matures. The return on a zero-coupon

bond if it is held to maturity is known at the time of purchase. The absence of rein-

vestment risk is an attractive feature of zero-coupon bonds, and as a result, investors

are willing to accept a slightly lower interest rate on them than on coupon bonds,

which do bear some reinvestment risk.

The fact that zero-coupon bonds have lower interest rates, along with the abil-

ity to use computers to create so-called hybrid securities, which are securities derived

from other underlying securities, gave employees of Salomon Brothers and Merrill

Lynch a brilliant idea for making profits. They could use computers to separate

(“strip”) a long-term Treasury coupon bond into a set of zero-coupon bonds. For

example, a $1 million 10-year Treasury bond might be stripped into ten $100,000

zero-coupon bonds, which, naturally enough, are called Treasury strips. The lower

interest rates on the more desirable Treasury strip zero-coupon bonds would mean

that the value of these bonds would exceed the price of the underlying long-term

Treasury bond, allowing Salomon Brothers and Merrill Lynch to make a profit by pur-

chasing the long-term Treasury bond, separating it into Treasury strips, and selling

them off as zero-coupon bonds.

To see in more detail how their thinking worked, let’s look more closely at a

$1 million 10-year Treasury bond with a coupon rate of 10% whose yield to maturity

is also 10%, so it is selling at par. The cash payments for this bond are listed in the

second column of Table 19.1. To make things simple, let’s assume that the yield curve

is absolutely flat so that the interest rate used to discount all the future cash pay-

ments is the same. Because zero-coupon bonds, which have no reinvestment risk,

are more desirable than the 10-year Treasury coupon bond, the interest rate on

the zero-coupon bonds is 9.75%, a little lower than the 10% interest rate on the

coupon bond.

How would Fran, a smart and sophisticated financial institution manager, fig-

ure out if she could make a profit from creating and selling the Treasury strips? Her

first step is to figure out what the zero-coupon Treasury strips would sell for. She

would find this easy to do if she had read Chapter 3 of this book: Using Equation 1

in that chapter, she would figure out that each of the Treasury strip zero-coupon

bonds would sell for its present discounted value:

The results of this calculation for each year are listed in column (4) of Table 19.1.

When Fran adds up the values of the collection of the Treasury strip zero-coupon

bonds, she gets a figure of $1,015,528, which is greater than the $1 million purchase

price of the Treasury bond. As long as it costs less than $15,528 to collect the pay-

ments from the Treasury and then pass them through to the owners of the zero-

coupon strips, which is likely to be the case since computer technology makes the

Cash payment in year n

11 ⫹ 0.097522



n


Chapter 19 Banking Industry: Structure and Competition

469

TA B L E   1 9 . 1

Market Value of Treasury Strip Zero-Coupon Bonds Derived from a

$1 Million 10-Year Treasury Bond with a 10% Coupon Rate and Selling at Par




Download 8,77 Mb.

Do'stlaringiz bilan baham:
1   ...   455   456   457   458   459   460   461   462   ...   591




Ma'lumotlar bazasi mualliflik huquqi bilan himoyalangan ©hozir.org 2024
ma'muriyatiga murojaat qiling

kiriting | ro'yxatdan o'tish
    Bosh sahifa
юртда тантана
Боғда битган
Бугун юртда
Эшитганлар жилманглар
Эшитмадим деманглар
битган бодомлар
Yangiariq tumani
qitish marakazi
Raqamli texnologiyalar
ilishida muhokamadan
tasdiqqa tavsiya
tavsiya etilgan
iqtisodiyot kafedrasi
steiermarkischen landesregierung
asarlaringizni yuboring
o'zingizning asarlaringizni
Iltimos faqat
faqat o'zingizning
steierm rkischen
landesregierung fachabteilung
rkischen landesregierung
hamshira loyihasi
loyihasi mavsum
faolyatining oqibatlari
asosiy adabiyotlar
fakulteti ahborot
ahborot havfsizligi
havfsizligi kafedrasi
fanidan bo’yicha
fakulteti iqtisodiyot
boshqaruv fakulteti
chiqarishda boshqaruv
ishlab chiqarishda
iqtisodiyot fakultet
multiservis tarmoqlari
fanidan asosiy
Uzbek fanidan
mavzulari potok
asosidagi multiservis
'aliyyil a'ziym
billahil 'aliyyil
illaa billahil
quvvata illaa
falah' deganida
Kompyuter savodxonligi
bo’yicha mustaqil
'alal falah'
Hayya 'alal
'alas soloh
Hayya 'alas
mavsum boyicha


yuklab olish