MODULE 2: MONEY MARKET into the hands of consumers as components of

money market mutual funds and other

What Is the Money Market? investments.
The money market refers to trading in very
short-term debt investments. At the wholesale Money Markets vs. Capital Markets
level, it involves large-volume trades between The money market is defined as dealing in
institutions and traders. At the retail level, it debt of less than one year. It is primarily used by
includes money market mutual funds bought by governments and corporations to keep their cash
individual investors and money market accounts flow steady, and for investors to make a modest
opened by bank customers. Because of these profit. The capital market is dedicated to the sale
attributes, they are often seen as cash and purchase of long-term debt and equity
equivalents that can be interchangeable for instruments.
money at short notice. The money market is a The term "capital markets" refers to the
component of the economy that provides entirety of the stock and bond markets. While
short-term funds. anyone can buy and sell a stock in a fraction of a
The money market deals in short-term second these days, companies that issue stock
loans, generally for a period of a year or less. As do so for the purpose of raising money for their
short term securities became a commodity, the long-term operations. While a stock's value may
money market became a component of the fluctuate, unlike many money market products, it
financial market for assets involved in short-term has no expiration date (unless, of course, the
borrowing, lending, buying and selling with company itself ceases to operate).
original maturities of one year or less. Trading in
money markets is done over the counter and is Participants in the Money Market
wholesale. The money market consists of financial
The money market is crucial for the institutions and dealers in money or credit who
smooth functioning of a modern financial wish to either borrow or lend. Participants borrow
economy. It allows savers to lend money to those and lend for short periods, typically up to twelve
in need of short-term loans and allocates capital months. Money market trades in short-term
towards its most productive use. These loans, financial instruments commonly called "paper".
often made overnight or for a matter of days or This contrasts with the capital market for
weeks, are needed by governments, corporations, longer-term funding, which is supplied by bonds
and banks in order to meet their near-term and equity.
obligations or regulatory requirements. At the The core of the money market consists of
same time, it allows those with excess cash on interbank lending—banks borrowing and lending
hand to earn interest. to each other using commercial paper, repurchase
agreements and similar instruments. These
Understanding the Money Market instruments are often benchmarked to (i.e., priced
The money market is one of the pillars of by reference to) the London Interbank Offered
the global financial system. It involves overnight Rate (LIBOR) for the appropriate term and
swaps of vast amounts of money between banks currency.
and the government. The majority of money ● Trading companies often purchase
market transactions are wholesale transactions bankers' acceptances to tender for
that take place between financial institutions and payment to overseas suppliers.
companies. ● Retail and institutional money market
Institutions that participate in the money funds
market include banks that lend to one another and ● Banks
to large companies in the eurocurrency and time ● Central banks
deposit markets; companies that raise money by ● Cash management programs
selling commercial paper into the market, which ● Merchant banks
can be bought by other companies or funds; and
investors who purchase bank CDs as a safe place
to park money in the short term. Some of those
wholesale transactions eventually make their way
Functions of the Money Market Help to central bank
Financing trade Though the central bank can function and
The money market plays a crucial role in influence the banking system in the absence of a
financing domestic and international trade. money market, the existence of a developed
Commercial finance is made available to the money market smooths the functioning and
traders through bills of exchange, which are increases the efficiency of the central bank.
discounted by the bill market. The acceptance Money markets help central banks in two ways:
houses and discount markets help in financing ● Short-run interest rates serve as an
foreign trade. indicator of the monetary and banking
conditions in the country and, in this way,
Financing industry guide the central bank to adopt an
The money market contributes to the appropriate banking policy,
growth of industries in two ways: ● Sensitive and integrated money markets
● They help industries secure short-term help the central bank secure quick and
loans to meet their working capital widespread influence on the sub-markets,
requirements through the system of thus facilitating effective policy
finance bills, commercial papers, etc. implementation
● Industries generally need long-term loans,
which are provided in the capital market. Types of Money Market Instruments
However, the capital market depends upon Money Market Funds
the nature of and the conditions in the Money market funds are mutual funds that
money market. The short-term interest are offered by brokerages, investment companies,
rates of the money market influence the and financial services firms. They pool money
long term interest rates of the capital from multiple investors and invest in high-quality,
market. Thus, money market indirectly short-term securities. While they are technically
helps the industries through its link with investments, they do act more like on-demand
and influence on long-term capital market. cash accounts since the money is easily
accessible.
Profitable investments These mutual funds may have a minimum
The money market enables commercial initial investment requirement, as well as balance
banks to use their excess reserves in profitable requirements and transaction fees. There are also
investments. The main objective of commercial associated fees that bank accounts do not incur,
banks is to earn income from its reserves as well including an expense ratio, which is a percentage
as maintain liquidity to meet the uncertain cash fee charged on the fund for management
demand of its depositors. In the money market, expenses.
the excess reserves of commercial banks are
invested in near money assets (e.g., short-term Money Market Accounts
bills of exchange), which are easily converted into Money market accounts are a type of
cash. Thus, commercial banks earn profits without savings account. They pay interest, but some
sacrificing liquidity. issuers offer account holders limited rights to
occasionally withdraw money or write checks
Self-sufficiency of commercial banks against the account. (Withdrawals are limited by
Developed money markets help federal regulations. If they are exceeded, the bank
commercial banks to become self-sufficient. In an promptly converts it to a checking account.)
emergency, when commercial banks have Banks typically calculate interest on a money
scarcity of funds, they need not approach the market account on a daily basis and make a
central bank and borrow at a higher interest rate. monthly credit to the account.
They can instead meet their requirements by In general, money market accounts offer
recalling their old short-run loans[clarify] from the slightly higher interest rates than standard savings
money market. accounts. But the difference in rates between
savings and money market accounts has
narrowed considerably since the 2008 financial
crisis. Average interest rates for money market not FDIC insured, and there is a (small) chance
accounts vary based on the amount deposited. that even the most trustworthy borrowers may
default. Some money market accounts have
Certificates of Deposit (CDs) minimum balance requirements or restrictions on
These are time deposit, commonly offered to withdrawals.
consumers by banks, thrift institutions, and credit
unions. Most certificates of deposit (CDs) are not Pros and Cons of Money Market Accounts
strictly money market funds because they are sold Pros
with terms of up to 10 years. However, CDs with ● Extremely low risk.
terms as short as three months to six months are ● May be insured by FDIC.
available. ● Highly liquid.
● Higher returns than most bank accounts.
Commercial Paper
The commercial paper market is for buying and Cons
selling unsecured loans for corporations in need ● Low returns that may not keep pace with
of a short-term cash infusion. Only highly inflation.
creditworthy companies participate, so the risks ● Not all money market securities are
are low. insured.
● May have high minimum investments or
Banker's Acceptances withdrawal restrictions.
The banker's acceptance is a short-term loan that
is guaranteed by a bank. Used extensively in KEY TAKEAWAYS
foreign trade, a banker's acceptance is like a ● Money market accounts and money
post-dated check and serves as a guarantee that market funds are considered among the
an importer can pay for the goods. There is a safest ways to invest one's money. They
secondary market for buying and selling banker's also have much lower returns than other
acceptances at a discount. investments, often even less than inflation
● The money market involves the purchase
Repos and sale of large volumes of very short
The repo, or repurchase agreement (repo), is part term debt products, such as overnight
of the overnight lending money market. Treasury reserves or commercial paper.
bills or other government securities are sold to ● An individual may invest in the money
another party with an agreement to repurchase market by purchasing a money market
them at a set price on a set date. mutual fund, buying a Treasury bill, or
opening a money market account at a
Advantages and Disadvantages of Money bank.
Markets ● Money market investments are
There are several pros and cons of money characterized by safety and liquidity, with
market investments. Most money market money market fund shares targeted at $1.
securities are considered extremely low-risk, due ● Money market accounts offer higher
to the protection of FDIC insurance, backing by a interest rates than a normal savings
government or bank, or the high creditworthiness account, but there are higher account
of the borrowers. They are also very liquid, minimums and limits on withdrawals
meaning that they can readily be exchanged for
cash at short notice.
The tradeoff of having low risk is that
these investments also have low returns. Not only
do money markets underperform other asset
classes, they often don't even keep pace with
inflation. In addition, any fees associated with an
account can easily eat into those slim returns.
Moreover, these advantages do not extend
to all money market securities. Some of them are