Money Market

Money markets fulfill the short-term monetary requirements of corporations, the government, banks and other financial institutions. The maturity of these short-term loans is usually up to thirteen months.

Money markets fulfill the short-term monetary requirements of corporations, the government, banks and other financial institutions. The maturity of these short-term loans is usually up to thirteen months.

Money markets use different instruments, such as bankers’ acceptances, Treasury bills, commercial papers and repurchase agreements, to borrow or lend money. These instruments are mostly influenced by the central bank’s policies, inflation and the rates of interest. The interest rates on these instruments are usually based on the LIBOR (London Interbank Offered Rate).

Money Market Instruments

Money markets impact economies by providing the necessary funds to large institutions. This, in turn, helps in maintaining the liquidity-profit balance. Popular money market instruments include:

• Bankers’ acceptance: These are bank drafts and are extremely safe investments.

 

• Certificates of deposit (CDs): These are deposits made in a bank for a fixed term. These are also issued by credit union and thrifts to raise immediate funds. Since investments in CDs are time bound, they offer a higher interest rate. CDs of high denominations may be sold before the expiry of the term.
• Commercial papers: These are unsecured notes issued by large corporations with high creditworthiness and banks to fulfill their short-term obligations. These papers are not backed by banks and hence are sold at a discount to their face value. Commercial papers have a lock-in period of up to 270 days.
• Federal agency short-term securities: These are securities, such as the Farm Credit System and the Federal Home Loan Banks, which are issued by the US government.
• Other US government bodies also issue papers, such as municipal notes and Treasury bills, to obtain funds to repay the debt liabilities and immediate expenses.

Risk in Money Markets

Instruments in the money markets vary in terms of their risk quotient. When arranged in the increasing order of risk, treasury bills come first, followed by banker’s acceptances, certificates of deposits and commercial papers. However, instruments with the lowest risk also offer the lowest returns.

The money market attracts risk-averse lenders. This is because the borrowers are all big names and trade securities that are associated with low risk and high liquidity, albeit at a low yield.