Money, Banking, and International Finance Negotiable Bank Certificates of Deposit (CDs) are loans to banks that banks sell directly
to depositors. CDs have a fixed time period. If a depositor withdraws a CD early, then the
depositor forfeits the interest. Consequently, CDs usually pay a greater interest rate than a
savings account.
Repurchase Agreements (repos) are short-term loans. For example, a bank sells T-bills to
a customer and promises to buy it back the next day for a higher price. Greater price
reflects interest. Banks used repos to circumvent the law, so banks could pay businesses
interest on their checking accounts. Before the 1980s, U.S. banks could not pay interest on
checking accounts. For example, IBM has excess funds in their checking account. Bank
sells IBM T-bills and uses IBM’s funds. Next day, the bank returns IBM’s funds with
interest and takes the T-bills back. Consequently, the bank paid interest on a checking
account, although the U.S. law prohibited banks to pay interest on checking accounts.
Federal Funds are overnight loans between banks. For example, a bank with excess funds
deposited at the Federal Reserve can lend these funds to another bank. Market analysts and
the Fed scrutinize the interest rate in this market because monetary policy influences
immediately the federal funds interest rate.
Eurodollars are U.S. dollars that people deposit in foreign commercial banks outside the
United States and in foreign branches of U.S. banks. Eurodollars are an important source of
funds in the international market. Furthermore, the euro has become a popular currency for
investors, who have bank accounts denominated in euros that are located outside the
Eurozone. The Eurozone comprises of the 17 countries within the European Union that use
the euro as its currency. If people and investors have euro denominated accounts outside
the Eurozone, then we still call it Eurodollars.
Capital market securities have maturities longer than a year, and we list the common ones: U.S. Treasury securities are loans to the U.S. government. The U.S. government issues
Treasury Notes or T-notes from one to 10 years, while Treasury Bonds or T-bonds have
maturities greater than 10 years. These Treasury securities have a stated interest rate, and
government usually pays interest every six months.
State and local governments can issue bonds, called municipal bonds. The U.S. federal
government encourages investors to buy these bonds by exempting investors from U.S.
income taxes. Furthermore, municipal bonds fall under two categories: General-obligation
bonds and revenue bonds. For general-obligation bonds, a state or local government
guarantees the bonds payment with its taxing power. For instance, a city government builds
a new firehouse. Then the city government guarantees payment of the bonds with its power
to tax. For revenue bonds, local or state government secures the bonds’ payment by the
revenues that the project generates. For example, a college builds a new dormitory, using