2/28 Banking notes

Suppose the Fed wants tot buy 100 mortgage backed securities
Assets                                    Liability
MBS 100                              Reserve 100
suppose MBS down by 85, what Fed does is to sell the entire securities, on liability side, 85 is taken out by other banks, and Fed creates assets worth 15 on the balance sheet.

Regulation Q prohibited banks from being able to pay interest on deposits within checking accounts. This is strange:
(1) A deposit is an input for the output of an event. Deposit is the input of the bank's production function. Labor, similarly, is the input of firm's production function. We actually want to pay labor as little as we can in order to squeeze them.
(2) The reason why investment and commercial banks are forced to tear apart is that we think commercial banks are safe and we don't want commercial banks do anything that is risky as investment banks. But regulation Q implies that commercial banks are not safe.
(3) loanable funds market, demand and supply of loanable funds and a required low interest rate. Analysis of demand and supply function. The effect is small when curves are elastic or spread isn't big. When there is inflation, deposit flee happens.

Two types of depositors:
(1) retail customers: went to MMMFs,
(2) corporation

If the corporation is worried about its investment, it can (1) ask money back from investment bank (2) ask for collateral (3) ask bank to make more collateral
Shadow banking


The commercial paper
Commercial paper issuance is an important alternative to bank loans as a means of short-term financing. Some paper is sold unsecured (that is,without specific collateral), while other paper is
secured by bank-issued letters of credit or pools of assets, including a firm’s receivables.

Aside: letter of credit is A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.

The rise of MMMFs (money market mutual fund) during the 1970s boosted the growth of CP by (indirectly) allowing small investors access to CP investments. During the 1980s, the CP market began to develop into its current form, particularly with the creation of the asset-backed commercial paper (ABCP) conduit.

 In its traditional form, CP is an unsecured promissory note issued by a business (either financial or nonfinancial) for a specific dollar amount and with maturity on a specific date. (It is exempt from SEC registration)

Similar to Treasury bills, CP is typically issued at a discount, meaning that the buyer pays less
than face value and receives face value at maturity: The “interest” is equal to the face value minus the purchase price.

Although CP is issued at short maturities to minimize interest expense, many issuers roll over CP by selling new paper to pay off maturing paper. Because of modest credit risk, yields on CP are slightly higher than on Treasury bills of similar maturity. Large denominations and short maturities typically limit the CP market to large institutional investors, such as MMMFs.

CP generally is classified in three broad (but overlapping) categories: nonfinancial, financial, and asset-backed. Further, CP may be classified as being sold with the assistance of a CP dealer (dealer placed) or without (directly placed).

Traditional nonfinancial and financial paper, respectively, are unsecured short-term debt issued by highly rated corporations. The simplest description of ABCP is as a form of securitization: it is CP with specific assets attached.

Why is the yield of ABCP higher than unsecured CP?
(1) the lack of transparency

Why did bank market share fall in 1970s?
(1) technology
(2) regulation

Interest rate and bond pricing
If I know an interest rate, I can convert PV to FV and vice versa. interest rate and discount rate
The interest rate moves in the same direction as the future value does.

Buy a bond at par value of 10000$, with maturity of 1 year and interest rate as 10%, PV=10000/1.1

Interest rate and asset price move in opposite directions. 
Multiperiod compounding