Money Markets

Money

Money is the current medium of exchange. I have seen that often people get confused with money. The money that is in our bank accounts is not real money. Money that is on account of the Central Bank of a country is the Real Money.  All other forms for example, the account balances with the commercial banks, even cash are promises to pay money, but not real money. Like individuals, banks and larger institutions also transact money amongst each other. In these transactions cash is not involved, but real money kept in accounts with the Central Bank of a country is involved.

Money Markets

Money market provides short term finance(for a period less than 1 year). The parties involved in Money Markets are Central Banks, Commercial Banks, FIs, Mutual Funds and Primary Dealers. One of the main differences between money markets and stock markets is that most money market securities trade in very high volume thus limiting accessing individual investors. The easiest way for an individual to access money market is through money market mutual funds. However, some money market instruments like Treasury bills may be purchased directly. Below we will have a look at major money market instruments:

Treasury Bills(T-Bills)

T-Bills are the most liquid money market securities. T-Bills are a way for the US government to raise money from the public. I am refering to the T-Bills issued by the US government, but many governments issue T-Bills in a similar fashion. Treasury Bills are issued through a competitive bidding process. The biggest reason that the T-Bills are so popular is that they one of the few money market instruments that are affordable by individual investors. Another important reason for their popularity is that they are considered to be the safest investment in the world because they are backed by US government. But this safety comes at a cost. They have very low returns. And this is the basic rule in finance: The higher the risk, the higher the return.

Certificate of Deposit

A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. CDs are similar to saving accounts in that they are insured and hence virtually risk-free. They are different from saving accounts in that CDs have a specific and fixed term(often 1 month, 3 months, 6 months, 1 year). CDs generally give higher rate of return than Bank term deposit.

Commercial Paper

An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. Commercial papers are not backed by collateral. Since these are not backed by collateral, only firms with high credit ratings from a recognized rating agency would be able to sell its commercials papers at a reasonable price.

Banker's Acceptance

BA is a promised future payment which is guaranteed by a bank and drawn on a deposit at a bank. A BA specifies the amount of money, date and the person to which the payment is due. Now the holder of the draft can sell it for cash to a buyer who is willing to wait until the matutity date of the funds in the deposit. BAs make the transaction between 2 parties who do not know each other to be more safe because they allow parties to substitute the banks's creditworthiness for that who owes the payment.

Eurodollars

Eurodollars are US dollar denominated deposits at banks outside United States and are thus not under the jurisdiction of Federal Reserve. These are called Eurodollars because most of the initially most of the US dollar reserves outside the United States were in Europe. Eurodollar market is relatively free of regulations and hence banks can operate at lower margins than their counterparts in United States.

Repo

A repurchase(repo) agreement can be seen as a short term swap between cash and securities. If a security holder wants to maintain his long-term position but needs cash for a short term period, he or she can enter into a repo contract whereby the securities are sold together with a binding agreement to repurchase them at a future date.. The effect is to provide the security holder with a short-term loan based on the collateral of the government securities he or she owns.