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Money Market Instruments

Money Market
Money Theories

The money market is the arena in which financial, nonfinancial, and banking institutions make available to a broad range of creditors, borrowers and investors, the opportunity to buy and sell, on a wholesale basis, large volumes of bills, notes, and other forms of short-term credit. These instruments have maturities ranging from one day to one year and are extremely liquid. Consequently, they are considered to be near-cash equivalents, hence the name money market instruments.

Retail money market dealers work independently or in syndicated groups to efficiently distribute available supplies of money market instruments to securities dealers, banks, and other financial intermediaries who broker them to retail clients. In addition to dealers, institutions and funds repackage money market instruments into money market mutual funds to allow participation at almost any level.

The suppliers of funds for money market instruments are institutions and individuals with a preference for the highest liquidity and the lowest risk. Often, money market instruments are a parking place for temporary excess cash of investors and corporations. Interest rates on money market instruments are typically quoted on a bank discount basis.

Certificates of Deposits

Certificates of deposit (CDs) are certificates issued by a federally chartered bank against deposited funds that earn a specified return for a definite period of time. Large denomination (jumbo) CDs of $100,000 or more are generally negotiable and pay higher interest than smaller denominations. However, such certificates are insured by the FDIC only up to $100,000. A Yankee CD is a CD issued by domestic branches of foreign banks. Eurodollar CDs are negotiable certificates issued against U.S. dollar obligations in a foreign branch of a domestic bank.

Brokerage firms have a nationwide pool of bank CDs and receive a fee for selling them. Since brokers deal in large sums, brokered CDs generally pay higher interest rates and offer greater liquidity than CDs purchased directly from a bank, since brokers maintain an active secondary market in CDs.

Eurodollar deposit

Deposits made in U.S. dollars at a bank or bank branch located outside the United States.

Treasury bills

These are short-term obligations sold at a discount and redeemed at face value on maturity. Treasury bills are the major money-market instrument used by the Treasury to finance a deficit.

Commercial Paper

Commercial paper (CP) refers to unsecured short-term promissory notes issued by financial and nonfinancial corporations. CP has maturities of up to 270 days (the maximum allowed without SEC registration requirement). Dollar volume for CP exceeds the amount of any money market instrument other than Treasury bills. CP is typically issued by large, credit-worthy corporations with unused lines of bank credit and, therefore, carries low default risk.

Standard & Poor's and Moody's provide ratings. The highest ratings are Al and P(Prime)l, respectively. A2 and P2 paper is considered high quality, but usually indicates that the issuing corporation is smaller or more debt burdened than Al and PI companies. Issuers, earning the lowest ratings, find few willing investors.

Commercial paper can be issued directly by the company to creditors, using internal transactors or a bank as an agent. The bank assumes no principal position and is in no way obligated with respect to repayment of the CP.

Companies may also sell CP through dealers who charge a fee and arrange for the transfer of the funds from the lender to the borrower.

Bankers' Acceptance

Bankers' acceptances are generally used to finance foreign trade. A buyer's promise to pay a specific amount of money at a fixed or determinable future time (usually less than 180 days) is issued to a seller. A bank then guarantees or "accepts" this promise in exchange for a claim on the goods as collateral. The seller may obtain immediate cash in lieu of future payment by selling the acceptance at a discount.

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