Various financial publications make regular references to “the money market.” however, the term is rarely defined to the public because, unlike other marketplaces, the money market is rather nebulous. It consists of interrelationships and transactions among varying participants, rather than a definite group of individuals, such as the members. Nevertheless, the term can be defined as an organized exchange market where members can lend as well as borrow short-term, dependable debt securities with mid-term maturities ranging between one year or less. Governments, banks, as well as other large corporations, are the major participants in the money markets where they sell and buy short-term securities to fund their short-term cash flow needs.
Characteristics of Money Market Instruments
The characteristics include liquidity, lower default risk, and low return, and discount pricing. A majority of the instruments in the money market are liquid to investors since the short maturity period allows them to be sold in the secondary market with ease. According to Taylor and Williams (2009), by being liquid, the instruments make it easy for investors to gain funding in case there are unanticipated expenses. A majority of the money market instruments are issued at a discounted price. For instance, although treasury bills do not provide coupons to the investor, they are sold at a discount, meaning that they are good value for money after the sale.
The money market instruments are also known to be of low risk when compared to other commodities in the secondary markets, such as stocks. Per Kacperczyk and Schnabl (2013), although company stocks have a higher return margin, they are volatile, thus high risk; on the other hand, investors want to avoid risk, and they can purchase government-backed treasury bills that are free of default risk.
Types of Instruments Traded in the Money Market
Several financial instruments are created for short-term lending and borrowing in the money market. One of these is treasury bills, which are the most notable type of securities sold in the money market since they are government-issued and have no attached risk. They are traditionally used to finance government budget deficits varying in maturity ages from one, three, six, or twelve months (Hartmann, Manna, & Manzanares, 2011). Treasury bills are sold at a discount to their current value, the difference between the discounted price and current value is what make up for the interest rate. Lastly, the majority of the parties who purchase treasury bills are predominantly bought by banks, broker-dealers, pension funds, insurance entities as well as other large institutions.
Commercial papers are also a securities instrument. They refer to loans with no gurantees loans from large corporations with a high credit rating to finance short-term cash flow needs such as inventory or accounts payables. These instruments are sold at a discount, similar to Treasury bills; however, their prices range from $100,000 and above with the primary dissimilarity coming in the form of the price and face value in the part of the investor considering they have a maturity period ranging from one month and nine months (Hartmann, Manna, & Manzanares, 2011). Individual investors have the ability to invest in the commercial paper market indirectly through money market funds. Commercial paper has a maturity date between one month and nine months.
A certificate of deposit (CD) and banker’s acceptance are other securities instruments. Certificate of deposit is sold directly by a commercial bank; nevertheless, it can be purchased through brokerage firms. Unlike treasury bills, a majority of CDs have a determined maturity date as well as the interest rate. Additionally, they attract a penalty for withdrawing before the maturity date. On the other hand, banker’s acceptance is a type of short-term debt that is provided by a firm to the investor; however, it is guaranteed by a bank. This instrument is often used in international trade since it is of benefit to both the drawer and the bearer. Moreover, it can be sold on the secondary market after maturity ,which ranges between one month and six months from the issuing date after when the investors can profit from the short-term investment.
Repurchase agreements (repo) are the next instruments. They are short-term loans that involve selling a security with an attached settlement to repurchase at a higher price at a later date (Hartmann, Manna, & Manzanares, 2011). Repos are commonly used by dealers in government securities who sell Treasury bills to lenders who agree to resell them at an agreed price at a later date.
The last instrument is the globalization of the Money Market. Since the turn of the century, the capabilities of globalization have been augmented by the emergence of internet use by the public in business. Currently, the money markets across the globe are open for international business under the supervision of government as well as responsible authority directives. For years, the secondary markets have gained significant prominence through the use of the global platform in securing more trade; but, money markets remained localized. However, because international trade attracts higher prices, the instruments attract higher margins than in local markets, thus become more profitable, a positive incentive of global trade.
The money markets have been a common feature in business magazines, prints, as well as online portals; however, unlike the secondary markets, they have remained unknown to a majority of the public. As aforementioned, unlike the secondary markets that attract high-profit margins, the money markets feature various instruments, such as the treasury bills, repurchase agreements, banker’s acceptance, certificate of deposit, and commercial paper, which are low in return value but have high security. Over the years, the significance of the money markets has increased, leading to their globalization. In the future, it is likely that the money markets will gain more prominence across the world, as seen in the secondary markets.
Hartmann, P., Manna, M., & Manzanares, A. (2011). The microstructure of the euro money market. Journal of International Money and Finance, 20(6), 895-948.
Kacperczyk, M., & Schnabl, P. (2013). How safe are money market funds?. The Quarterly Journal of Economics, 128(3), 1073-1122.
Taylor, J. B., & Williams, J. C. (2009). A black swan in the money market. American Economic Journal: Macroeconomics, 1(1), 58-83.