The money markets consist of a network of corporations, financial institutions, investors and governments, which need to borrow or invest short-term capital (up to 12 months). For example, a business or government that needs cash for a few weeks only can use the money market. So can a bank that wants to invest money that depositors could withdraw at any time. Through the money markets, borrowers can find short-term liquidity by turning assets into cash. They can also deal with irregular cash flows - in-comings and out-goings of money - more cheaply than borrowing from a commercial bank. Similarly, investors can make short-term deposits with investment companies at competitive interest rates: higher ones than they would get from a bank. Borrowers and lenders in the money markets use banks and investment companies whose business is trading financial instruments such as stocks, bonds, short-term loans and debts, rather than lending money.
Common money market instruments
■ Treasury bills (or T-bills) are bonds issued by governments. The most common maturity - the length of time before a bond becomes repayable - is three months, although they can have a maturity of up to one year. T-bills in a country's own currency are generally the safest possible investment. They are usually sold at a discount from their nominal value - the value written on them - rather than paying interest. For example, a T-bill can be sold at 99% of the value written on it, and redeemed or paid back at 100% at maturity, three months later.
■ Commercial paper is a short-term loan issued by major companies, also sold at a discount. It is unsecured, which means it is not guaranteed by the company's assets.
■ Certificates of deposit (or CDs) are short- or medium-term, interest-paying debt instruments - written promises to repay a debt. They are issued by banks to large depositors who can then trade them in the short-term money markets. They are known as time deposits, because the holder agrees to lend the money - by buying the certificate - for a specified amount of time.
Note: Nominal value is also called par value or face value.
Another very common form of financial contract is a repurchase agreement (or repo). A repo is a combination of two transactions, as shown below. The dealer hopes to find a long-term buyer for the securities before repurchasing them.
A dealer has
Dealer tries to find long-term buyer for securities.
Dealer repurchases securities.
Dealer sells securities, agreeing to repurchase them at a higher price on a fixed future date.
Short-term investor sells securities back to dealer a few days or weeks later.
Short-term investor buys securities. Amount investor lends to dealer, by buying securities, is less than the market value of the securities. This is so investor avoids a loss if price of securities, and their value as collateral, falls.
Dealer sells securities to long- term buyer.
25.1 Are the following statements true or false? Find reasons for your answers in A and B opposite.
1 Organizations use the money markets as an alternative to borrowing from banks.
2 Money markets are a source of long-term finance.
3 All money market instruments pay interest.
4 Certificates of deposit are issued by major manufacturing companies.
5 Commercial paper is guaranteed by the government.
6 Some money market instruments can have more than one owner before they mature.
25.2 Match the words in the box with the definitions below. Look at A and B opposite to help you.
1 a price below the usual or advertised price
2 adjective describing a good price, compared to others on the market
3 the ability to sell an asset quickly for cash
4 (in finance) adjective meaning up to one year
5 adjective meaning with no guarantee or collateral
7 the length of time before a bond has to be repaid
8 the movement of money in and out of an organization
9 the price written on a security
25.3 Match the two parts of the sentences. Look at B and C opposite to help you.
1 Most money market securities
2 A treasury bill is safe because it
3 Commercial paper
4 Certificates of deposit (CDs)
5 Repurchase agreements (repos)
a is issued by corporations, so it is riskier than T-bills.
b are short-term, liquid, safe, and sold at a discount,
e is guaranteed by the government,
d are short-term exchanges of cash for securities,
e are issued to holders of time deposits in a bank.
What kind of money market instruments are you familiar with? Which ones would be most useful for your company, or for a company you would like to work for?