Money Market and its instruments

1. Presentation
on
Money Market
Prepared by Monzur Morshed Patwary
Prepared for Dr. Serpil ALTINIRMAK

2. 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.

3.  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.

4. 1. 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.

5. 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.

6. 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.

7. 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.

8. 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.

9. 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

10. 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.

11. 8. Change with Place andTime:
 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.

12. Functions of the money market
Money markets serve five functions such as
Financing 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.

13. Continued…
Financing industry
The 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

14. Continued…
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.

15. Continued…
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.

16. Continued…
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

17. 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).

18. 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.

19. 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.

20. 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.

21. • 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.

22. 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.

23. 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

24. • 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.

25. • 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.

26. 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.

27. 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.

28. 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.

29. 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.

30. 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

31. 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.

32. 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.

33. 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.

34. 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.