Principles of Finance/Section 1/Chapter/Financial Markets and Institutions/Money Markets

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As money became a commodity, the money market became a component of the financial markets for assets involved in short-term borrowing, lending, buying and selling with original maturities of one year or less. Trading in the money markets is done over the counter, is wholesale. Various instruments like Treasury bills, commercial paper, bankers' acceptances, deposit deposits, certificates of deposit, bills of exchange, repurchase agreements, federal funds, and short-lived mortgage-backed security|mortgage- and asset-backed securities do exist.[1] It provides market liquidity funding for the global financial system. Money markets and capital markets are parts of financial markets. The instruments bear differing maturities, currencies, credit risks, and structure. Therefore they may be used to distribute the exposure.[2]

History[edit]

The money market developed because parties had surplus funds, while others needed cash.[3][4] Today it comprises cash instruments as well.

Participants[edit]

The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods of time, typically up to thirteen months. Money market trades in short-term financial instruments commonly called "paper." This contrasts with the capital market for longer-term funding, which is supplied by Bond (finance)|bonds and stock|equity.

The core of the money market consists of interbank lending--banks borrowing and lending to each other using commercial paper, repurchase agreements and similar instruments. These instruments are often benchmarked to (i.e. priced by reference to) the London Interbank Offered Rate (LIBOR) for the appropriate term and currency.

Finance companies typically fund themselves by issuing large amounts of asset-backed commercial paper (ABCP) which is secured by the pledge of eligible assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial mortgage loans, mortgage-backed security|mortgage-backed securities and similar financial assets. Certain large corporations with strong credit ratings, such as General Electric, issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf via commercial paper lines.

In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issue municipal bond|municipal paper, while the US Treasury issues Treasury bills to fund the US public debt.

  • Trading companies often purchase bankers' acceptances to be tendered for payment to overseas suppliers.
  • Retail and institutional money market funds
  • Banks
  • Central banks
  • Cash management programs
  • Merchant Banks

Functions of the money market[edit]

The money market functions are[5][6][citation needed]:

  • transfer of large sums of money
  • transfer from parties with surplus funds to parties with a deficit
  • allow governments to raise funds
  • help to implement monetary policy
  • determine short-term interest rates

Common money market instruments[edit]

  • Certificate of deposit - Time deposit, commonly offered to consumers by banks, thrift institutions, and credit unions.
  • Repurchase agreements - Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.
  • Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270 days; usually sold at a discount from face value.
  • Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located outside the United States.
  • Federal agency short-term securities - (in the U.S.). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association.
  • Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.
  • Municipal notes - (in the U.S.). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.
  • Treasury bills - Short-term debt obligations of a national government that are issued to mature in three to twelve months.
  • Money funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors.
  • Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal of the exchange of currencies at a predetermined time in the future.
  • Short-lived mortgage-backed security mortgage- and asset-backed securities

Discount and accrual instruments[edit]

There are two types of instruments in the fixed income market that pay the interest at maturity, instead of paying it as coupons. Discount instruments, like repurchase agreements, are issued at a discount of the face value, and their maturity value is the face value. Accrual instruments are issued at the face value and mature at the face value plus interest.[7]

References[edit]

  1. Frank J. Fabozzi, Steve V. Mann, Moorad Choudhry, The Global Money Markets, Wiley Finance, Wiley & Sons (2002), ISBN 0-471-22093-0
  2. Money Market, Investopedia.
  3. Foreign Trade and the Money Market, Felix Schuster, 1903.
  4. Bill of Exchange, Encyclopædia Britannica, 1911.
  5. Money Market and Money Market Instruments
  6. Functions and importance of Money Market
  7. Discount Instrument, riskglossary.com, accessed 2012-05-14.

External links[edit]