Presentation on

Money Market

Prepared by Monzur Morshed PatwaryPrepared for Dr. Serpil ALTINIRMAK

Money Market Definition

A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year.

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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 money markets is done over the counter.

Distinguishing features of money market1. Constituents/Elements of Money

Market: Like other markets, money market also has

three constituents: (a) It has buyers and sellers in the form of borrowers and lenders, (b) It has a commodity; it deals with short-maturity credit instruments, like commercial bills, treasury bills, etc. (c) It has a price in the form of rate of interest which is an item of cost to the borrower and return to the lender.

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2. Heterogeneous Market: The money market is not a single homogeneous market but consists of several sub-markets, each market dealing with a specific short-term credit instrument.

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3. Dealers of Money Market: The borrowers in the money market

are traders, manufactures, speculators, and even government institutions. The lenders in the money market are commercial banks, central banks, non-bank financial intermediaries, etc.

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4. Short-term Loans: Money market deals with short-term

loans. In a money market, the borrowers can obtain funds for periods varying from a day, a week, a month, or three to six months.

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5. near-Money Assets: Money market does not deal in money,

but in short-term financial instruments or near-money assets. These assets are relatively liquid and readily marketable. The assets against which the funds can be borrowed in the money market include short-term government securities, bills of exchange, bankers' acceptances, etc.

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6. Physical Contact Not Necessary:

Money market does not refer to a specific place where borrowers and lenders meet each other. In fact, it is not necessary that the borrowers and lenders should have personal contact with each other at a particular place.

It’s a OTC maket

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7. Different from Capital Market: Money market is different from

capital market on the basis of maturity period. Money market deals with the short-term lending and borrowing of funds, while capital market deals with medium and long-term lending and borrowing of funds.

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8. Change with Place and Time: Though the functions of money markets in

different countries are broadly the same, the instruments, institutions and practices of these markets vary considerably from country to country. Money markets also change with time.

For example, in London money market, bill of exchange used to be of great importance. But, now because of change in business practices and the growth of public debt, government treasury bills have become more important.

Functions of the money market

Money markets serve five functions such asFinancing trade The money market plays crucial role in

financing domestic and international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.

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Financing industryThe money market contributes to the growth of

industries in two ways:They help industries secure short-term loans

to meet their working capital requirements through the system of finance bills, commercial papers, etc.

Giving idea about long term financial markets

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Profitable investment The money market enables the commercial

banks to use their excess reserves in profitable investment.

In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g., short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without sacrificing liquidity.

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Self-sufficiency of commercial bank In the situation of emergency, when the

commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market.

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Help to central bank Money markets help central banks in two ways:Short-run interest rates serve as an indicator of

the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy,

Sensitive and integrated money markets help the central bank secure quick and widespread influence on the sub-markets, thus facilitating effective policy implementation

Money market instruments Money market securities consist

of negotiable certificates of deposit (CDs), bankers acceptances, Treasury bills, commercial paper, municipal notes, federal funds, eurodollars and repurchase agreements (repos).

Characteristics of Money Market Instruments Liquidity - Since they are fixed-income securities with

short-term maturities of a year or less, money market instruments are extremely liquid.

Safety - They also provide a relatively high degree of safety because their issuers have the highest credit ratings. 

Discount Pricing- A third characteristic they have in common is that they are issued at a discount to their face value.

Treasury Bills (T-Bills) Treasury Bills (T-bills) are the most

marketable money market security. T-bills are short-term securities that

mature in one year or less from their issue date.

They are issued with three-month, six-month and one-year maturities.

T-bills are purchased for a price that is less than their par (face) value; when they mature, the government pays the holder the full par value.

Example of T-Bills you bought a 90-day T-bill at $9,800

(face value is $10000) and held it until maturity, you would earn $200 on your investment. This differs from coupon bonds, which pay interest semi-annually. 

• Treasury bills (as well as notes and bonds) are issued through a competitive bidding process at auctions. If you want to buy a T-bill, you submit a bid that is prepared either non-competitively or competitively.

• The biggest reasons that T-Bills are so popular is that they are one of the few money market instruments that are affordable to the individual investors. T-bills are usually issued in denominations of $1,000, $5,000, $10,000, $25,000, $50,000, $100,000 and $1 million.

Pros & Cons of Treasury Bills Other positives are that T-bills (and all

Treasuries) are considered to be the safest investments in the world because the government backs them.

In fact, they are considered risk-free. Furthermore, they are exempt from state and local taxes.

The only downside to T-bills is that you won't get a great return because Treasuries are exceptionally safe.

Certificate Of Deposit (CD) A certificate of deposit (CD) is

a time deposit with a bank. CDs are generally issued by

commercial banks but they can be bought through brokerages.

They bear a specific maturity date, a specified interest rate, and can be issued in any denomination, much like bonds.

Like all time deposits, the funds may not be withdrawn on demand like those in a checking account. 

• CDs offer a slightly higher yield than T-Bills because of the slightly higher default risk.

• A fundamental concept to understand when buying a CD is the difference between annual percentage yield (APY) and annual percentage rate (APR)

• APY is the total amount of interest you earn in one year, taking compound interest into account.

• APR is simply the stated interest you earn in one year, without taking compounding into account.

• The difference results from when interest is paid. The more frequently interest is calculated, the greater the yield will be. When an investment pays interest annually, its rate and yield are the same. But when interest is paid more frequently, the yield gets higher.

• The main advantage of CDs is their relative safety and the ability to know your return ahead of time.

Certificate Of Deposit (CD) Despite the benefits, there are two main

disadvantages to CDs. First of all, the returns are paltry

compared to many other investments. Furthermore, your money is tied up for

the length of the CD and you won't be able to get it out without paying a harsh penalty.

Commercial Paper Commercial paper is

an unsecured, short-term loan issued by a corporation, typically for financing accounts receivable and inventories.

It is usually issued at a discount, reflecting current market interest rates.

Maturities on commercial paper are usually no longer than nine months, with maturities of between one and two months being the average.

Commercial Paper For the most part, commercial paper is a

very safe investment because the financial situation of a company can easily be predicted over a few months.

Furthermore, typically only companies with high credit ratings and credit worthiness issue commercial paper.

Commercial paper is usually issued in denominations of $100,000 or more.

Banker's Acceptance A bankers' acceptance (BA) is a short-term

credit investment created by a non-financial firm and guaranteed by a bank to make payment.

Acceptances are traded at discounts from face value in the secondary market. 

For corporations, a BA acts as a negotiable time draft for financing imports, exports or other transactions in goods.

Example of BA Acceptances sell at a discount from the face value: 

One advantage of a banker's acceptance is that it does not need to be held until maturity, and can be sold off in the secondary markets where investors and institutions constantly trade BAs.

Face Value of Banker\'s Acceptance- $1,000,000

Minus 2% Per Annum Commission for One Year-

$20,000

Amount Received by Exporter in One Year- $980,000

Repurchase agreement or Repo Those who deal in government securities use

repos as a form of overnight borrowing. A dealer or other holder of government

securities (usually T-bills) sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed price.

They are usually very short-term, from overnight to 30 days or more.

This short-term maturity and government backing means repos provide lenders with extremely low risk. 

Repurchase agreement or Repo There are also variations on standard

repos:  Reverse Repo - The reverse repo is the

complete opposite of a repo. In this case, a dealer buys government securities from an investor and then sells them back at a later date for a higher price 

Term Repo - exactly the same as a repo except the term of the loan is greater than 30 days. 

MUNICIPAL NOTE Debt issued by state and local

governments to finance capital expenditures such as construction projects. Municipal notes are appealing to investors because they mature in one year or less, offer fixed income and are often exempt from income tax at the local, state and/or federal levels.

Federal Funds Excess reserves that commercial banks deposit

at regional Federal Reserve banks. Federal funds can then be lent to other

commercial banks with insufficient reserves. These loans are made at a relatively low

interest rate, called the federal funds rate or overnight rate, and they typically have an extremely short duration: overnight.

Federal funds help commercial banks meet their daily reserve requirements.