Federal Reserve Impact on Mortgages and Money Markets

Federal Reserve Influence on Mortgage Payments

The Federal Reserve influences interest rates, which directly affect the rates paid by homeowners on mortgages. When the Fed reduces interest rates, it lowers the monthly payment for new mortgages, potentially increasing consumer demand for homes. Conversely, if the Fed increases interest rates, it may reduce the demand for homes.

Market Dynamics and Interest Rate Expectations

• Falling Rates: If interest rates are expected to decrease, demand may drop as buyers wait, creating a buyer's market. In this scenario, an adjustable-rate mortgage is often preferred.
• Rising Rates: If interest rates are expected to rise, more people seek to lock in borrowing costs, increasing demand and creating a seller's market. In this scenario, a fixed-rate mortgage is preferred.

Chapter 6: Money Market Characteristics

Money market securities are debt instruments with a maturity of less than one year. They are issued in the primary market by the Treasury, corporations, and financial intermediaries to obtain short-term financing. These instruments are commonly purchased by households, corporations, and governments, and they remain highly liquid in the secondary market.

Types of Money Market Instruments

• T-Bills: Issued by the U.S. government in $1,000 increments. They have a maturity of less than one year, are sold at a discount from par value (no coupon rate), are default-free, and are highly liquid.
• Commercial Paper: Short-term, unsecured debt issued by creditworthy firms to provide liquidity. These are purchased at a discount and typically offer higher yields than T-Bills due to credit risk.
• Negotiable CDs: Issued by large commercial banks or depository institutions with a minimum denomination of $100,000 and a maturity of less than one year. They offer higher rates than T-Bills and maintain a large secondary market.

Calculations and Auctions

T-Bill Yield Formulas

• Newly Issued: (Par - Purchase Price) / Par * 360 / n
• Secondary Market: (Selling Price - Purchase Price) / Purchase Price * 365 / n
• Price: Par Value / (1 + RRR)

Auctions

• Competitive: The bidder specifies both the quantity and the yield they desire.
• Non-competitive: The bidder specifies only the quantity, guaranteeing they will receive the securities.

Example Calculations

Scenario 1: An investor purchased a six-month T-bill with a $10,000 par value for $9,000 and sold it ninety days later for $9,100. What is the secondary market yield?

($9,100 – $9,000) / $9,000 * 365 / 90 = 4.51%

Scenario 2: You paid $98,000 for a $100,000 T-bill maturing in 120 days. If you hold it until maturity, what is the T-bill yield and discount?

Discount: ($100,000 - $98,000) / $100,000 * 360 / 120 = 6%