Eligible Paper

Definition of Eligible Paper

Eligible paper refers to financial instruments that meet specific criteria set by central banks, making them acceptable for rediscounting or as security for loans. This term is closely associated with highly liquid assets deemed secure and reliable for trade and lending purposes. There are two notable classifications:

In the United Kingdom: Includes Treasury bills, short-dated gilts, and any first-class security accepted by British banks or an accepting house, which are rediscountable by the Bank of England. This characteristic enhances their liquidity as they are quickly convertible to cash, reinforcing the Bank’s role as the lender of last resort.
In the United States: Consists of acceptances by US banks that are available for rediscounting by the Federal Reserve System.

By categorizing certain financial assets as eligible paper, central banks can significantly influence portfolios by increasing the liquidity of these investments.

Examples of Eligible Paper

Treasury Bills (T-Bills):
- Short-term government securities typically with maturities less than one year.
- Offered at a discount, maturing at face value.
- Example: A 3-month T-Bill issued by the US Department of the Treasury.
Short-Dated Gilts:
- UK government bonds with short maturities, commonly less than five years.
- Example: A 2-year Gilt issued by the UK Debt Management Office.
Bank Acceptances:
- Time drafts that a bank has guaranteed payment for at a future date.
- Example: A trade acceptance drawn by a company on a bank for payment in 90 days.
First-Class Securities:
- Highly rated corporate or government bonds that maintain high creditworthiness.
- Example: A AAA-rated corporate bond maturing within a short term.

Frequently Asked Questions (FAQs)

What makes an asset eligible for rediscounting?

An asset becomes eligible for rediscounting if it meets the criteria set by the central bank, such as maturities, creditworthiness, and acceptance by reputable financial institutions.

Why are Treasury bills considered eligible paper?

Treasury bills are backed by the government, offering high security and liquidity, which are key requirements for eligible paper accepted by central banks for rediscounting.

How does eligible paper influence liquidity?

Eligible paper can be quickly turned into cash via rediscounting with the central bank, enhancing the liquidity of financial institutions holding such assets.

Can commercial paper be classified as eligible paper?

Yes, provided it meets the quality, maturity, and acceptance criteria set by the central bank for rediscounting or as collateral.

How does the Federal Reserve use eligible paper?

The Federal Reserve rediscounts eligible paper to provide liquidity to banks and stabilize financial markets during times of stress.

Rediscounting: The act of providing liquidity by central banks through the acquisition of eligible paper from commercial banks at a discount.
Lender of Last Resort: A central bank’s function to provide liquidity to financial institutions facing short-term liquidity crises.
Liquidity: The ease with which an asset can be converted into cash without significant loss in value.
Accepting House: Financial institutions that guarantee payment of a purchaser’s debt in commercial transactions.

Online References

Bank of England - Understanding the role and policies of the Bank of England regarding eligible paper. Bank of England
U.S. Federal Reserve - Learn about rediscounting and eligible paper through the Federal Reserve. Federal Reserve

Suggested Books for Further Studies

“Financial Markets and Institutions” by Frederic S. Mishkin and Stanley Eakins - This book provides comprehensive insights into financial instruments including eligible paper.
“The Economics of Money, Banking, and Financial Markets” by Frederic S. Mishkin - A detailed exploration of how financial markets function, highlighting liquidity and central bank policies.
“Money, Banking, and Financial Markets” by Stephen G. Cecchetti and Kermit L. Schoenholtz - Covers the foundational aspects of banking systems and the role of eligible assets.

Accounting Basics: “Eligible Paper” Fundamentals Quiz

### What defines eligible paper? - [x] Financial instruments acceptable for rediscounting by central banks. - [ ] Any form of equity securities. - [ ] Non-marketable securities. - [ ] Personal loans accepted by local banks. > **Explanation:** Eligible paper consists of financial instruments that meet specific criteria set by central banks, making them eligible for rediscounting. ### Which of the following is an example of eligible paper? - [ ] Long-term corporate bonds. - [x] Treasury bills. - [ ] Common shares of a company. - [ ] Mutual fund units. > **Explanation:** Treasury bills are short-term government securities that are highly liquid and accepted for rediscounting by central banks, making them eligible paper. ### Why does the classification of eligible paper influence financial portfolios? - [x] Due to its liquidity and ability to be quickly converted into cash. - [ ] It appreciates in value faster than other securities. - [ ] It incurs higher fees and commissions. - [ ] It is not affected by market volatility. > **Explanation:** Eligible paper is highly liquid and can be quickly converted into cash via rediscounting, which significantly influences how portfolios are managed. ### What role does the Bank of England play in the context of eligible paper? - [ ] It purchases all securities issued by companies. - [x] It rediscounts eligible paper to provide liquidity. - [ ] It provides direct loans to individual investors. - [ ] It only deals with foreign exchanges. > **Explanation:** The Bank of England rediscounts eligible paper to maintain liquidity and stability in financial markets, fulfilling its role as the lender of last resort. ### How does the Federal Reserve system relate to eligible paper? - [ ] It bans use of any form of eligible paper. - [ ] It directly issues eligible paper. - [x] It rediscounts eligible paper to provide liquidity to banks. - [ ] It determines the eligible paper criteria for international banks only. > **Explanation:** The Federal Reserve rediscounts eligible paper to provide liquidity to banks and stabilize the financial system. ### What key characteristic must eligible paper possess? - [x] High creditworthiness and liquidity. - [ ] Long maturity periods. - [ ] High interest payments. - [ ] Issued by any financial entity. > **Explanation:** Eligible paper must have high creditworthiness and liquidity to be acceptable for rediscounting by central banks. ### Can short-dated gilts be considered eligible paper in the UK? - [x] Yes, they are rediscountable by the Bank of England. - [ ] No, gilts are not considered eligible paper. - [ ] Only long-dated gilts are eligible. - [ ] Only Treasury bills can be eligible paper. > **Explanation:** Short-dated gilts are indeed considered eligible paper as they are rediscountable by the Bank of England. ### What does the term "first-class security" imply in the context of eligible paper? - [ ] Any investment backed by shares of top companies. - [x] Highly rated government or corporate bonds of excellent credit. - [ ] All publicly traded stocks. - [ ] Personal term deposits. > **Explanation:** First-class security refers to highly rated government or corporate bonds considered of excellent creditworthiness. ### Which institution in the US is authorized to rediscount eligible paper? - [ ] Commercial banks. - [ ] Investment houses. - [x] The Federal Reserve System. - [ ] State treasuries. > **Explanation:** The Federal Reserve System is the institution that rediscounts eligible paper in the US, ensuring liquidity. ### Why is the liquidity aspect of eligible paper crucial? - [x] It ensures that financial institutions can quickly convert assets to cash. - [ ] It means low-interest payouts. - [ ] It creates long-term debt obligations. - [ ] It restricts the trading of the asset. > **Explanation:** The liquidity of eligible paper is crucial as it ensures that financial institutions can quickly convert assets to cash, maintaining stability in financial operations.

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