What Is the Money Market?
Money market refers to a section of the financial market where financial instruments with high liquidity and short-term maturities are traded at over the counter. At the wholesale level, it includes large-volume trades between various institutions and wholesale traders. At the retail level, it includes money market mutual funds (MMFs) bought by individual investors and money market accounts opened by many bank customers.
- Money market components are traded for 1 year or less.
- It is traded over-the-counter in the money market and it is a wholesale procedure.
- It is taken by the participants for borrowing and lending for the short term period.
- Money market is relatively considered a safe place for investment due to the high liquidity of securities.
- It has certain risks of defaults on securities such as commercial papers which investors need to be aware of.
- Money market involves various financial institutions and dealers, who borrow or loan securities for investment in highly liquid assets.
- The money market is an not regulated like the capital markets.
- Money market gives lesser return to investors.
- Withdrawing money from the money market is very easy.
Key Money Market Components:
Treasury bills are safe instruments for investment. They are issued by the U.S. Treasury regularly to refinance Treasury bills to reach upon maturity and to finance the federal government for deficits. They come with maturity of one month, three month, six month, or twelve month. Treasury bills are generally sold at a discount to their face value, and the difference between the discounted purchase price and face value represents the interest rate. Banks, broker-dealers, investors, pension fund institutions, insurance & other large institutions buy these bills.
Certificates of deposits (CDs)
A certificate of deposit (CDs) are issued by a commercial bank, but it can be purchased through brokerage firms also. It comes with maturity date ranging from 3 months to 5 years and can be issued in many denominations. Mostly CDs have a fixed maturity date and interest rate, and it attracts penalty for withdrawing prior to maturity.
Commercial papers are a type of unsecured loan which are issued by large institutions or corporations to arrange short-term cash flow needs for working capital requirement. Individual investors can invest in the commercial paper market through money market funds. Commercial paper generally comes with maturity period between 1 month and 9 months. These are issued at a discount, with the difference between the price and face value of the commercial paper being the profit to the investor.
To raise short term debt, firms issue banker’s acceptance forms that are guaranteed by a bank. Drawer creates and provide the bearer the rights to the money indicated on its face. These are issued for use in international trading activities to withdraw the benefits for drawer and the bearer.It comes with maturity period between 1-6 months from the issuing date.
Another money market instrument repurchase agreement (Repo) are kind of short term borrowing option which involves the securities selling with repurchase agreement at higher price in future. Dealers in government securities generally trade in this money market instrument. It comes with maturity ranges from overnight to 30 days or more.
Other Money Market Instruments
- Bills of exchange
- Federal funds
- Short-lived mortgage
- Asset-backed securities