MONEY MARKET AND ITS PARTICIPANTS

UNIT

MONEY MARKET

LEARNING OBJECTIVES

After studying this unit, you should be able to:

· define the notion of money market;

· state the role of money market;

· define the terminology related to money market ;

· outline the main characteristics of money market;

· describe the benefits of money market;

· enumerate the main participants of money market;

· be aware of the money market instruments.

STARTING-UP

1. Comment on the following quotations. What do the authors mean? Do you agree with them? Having discussed these quotations can you guess what the next text is devoted to?

· The rich invest in time, the poor invest in money. Warren Buffett

· Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.Warren Buffett

· Markets are designed to allow individuals to look after their private needs and to pursue profit. It's really a great invention and I wouldn't under-estimate the value of that, but they're not designed to take care of social needs. George Soros

· The financial markets generally are unpredictable. So that one has to have different scenarios... The idea that you can actually predict what's going to happen contradicts my way of looking at the market. George Soros

TEXT A

MONEY MARKET AND ITS PARTICIPANTS

The term money market is actually a misnomer. Money—currency - is not traded in the money markets. Because the securities that do trade there are short-term and highly liquid, however, they are close to being money. Money market securities have three basic characteristics in common:

· They are usually sold in large denominations.

· They have low default risk.

· They mature in one year or less from their original issue date. Most money market instruments mature in less than 120 days.

Money market transactions do not take place in any one particular location or building. Instead, traders usually arrange purchases and sales between participants over the phone and complete them electronically. Because of this characteristic, money market securities usually have an active secondary market. This means that after the security has been sold initially, it is relatively easy to find buyers who will purchase it in the future.

Another characteristic of the money markets is that they are wholesale markets. This means that most transactions are very large, usually in excess of $1 million. The size of these transactions prevents most individual investors from participating directly in the money markets. Instead, dealers and brokers, operating in the trading rooms of large banks and brokerage houses, bring customers together.

Despite the wholesale nature of the money market, innovative securities and trading methods have been developed to give small investors access to money market securities.

In theory, the money markets should not be needed. The banking industry exists primarily to provide short-term loans and to accept short-term deposits. Banks should have an efficiency advantage in gathering information, an advantage that should eliminate the need for the money markets. Furthermore, short-term securities offered for sale in the money markets are neither as liquid nor as safe as deposits placed in banks and thrifts.

The banking industry exists primarily to mediate the asymmetric information problem * between saver-lenders and borrower-spenders, and banks can earn profits by capturing economies of scale while providing this service. However, the banking industry is subject to more regulations and governmental costs than are the money markets. In situations where the asymmetric information problem is not severe, the money markets have a distinct cost advantage over banks in providing short-term funds.

The well-developed secondary market for money market instruments makes the money market an ideal place for a firm or financial institution to "warehouse" surplus funds until they are needed. Similarly, the money markets provide a low- cost source of funds to firms, the government, and intermediaries that need a short-term infusion of funds.

Most investors in the money market use the money market as an interim

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asymmetric information problem * - Information asymmetry arises when the parties to a transaction do not have the same degree of information necessary to make an informed decision.
investment that provides a higher returnthan holding cash or money in banks. It is

important to keep in mind that holding idle surplus cash is expensive for an investor because cash balances earn no income for the owner. Idle cash represents an opportunity cost in terms of lost interest income. The money markets provide a means to invest idle funds and to reduce this opportunity cost.

The sellers of money market securities find that the money market provides a low-cost source of temporary funds.

WHO PARTICIPATES IN THE MONEY MARKETS?

The primary money market players are the U.S. Treasury, the Federal Reserve System, commercial banks, businesses, investments and securities firms, and individuals.

The U.S. Treasury Department is unique because it is always a demander of money market funds and never a supplier. It issues Treasury bills (often called T-bills) and other securities that are popular with other money market participants. Short-term issues enable the government to raise funds until tax revenues are received. The Treasury also issues T-bills to replace maturing issues.

The Federal Reserve is the Treasury's agent for the distribution of all government securities. The Fed holds vast quantities of Treasury securities that it sells if it believes that the money supply should be reduced. Similarly, the Fed will purchase Treasury securities if it believes that the money supply should be expanded. The Federal Reserve's role is in controlling the economy through open market operations.

Commercial banks hold a larger percentage of U.S. government securities than any other group of financial institutions, approximately 12%. Banks are prohibited from owning risky securities, such as stocks or corporate bonds. Banks are also the major issuers of negotiable certificates of deposit (CDs), banker's acceptances, federal funds, and repurchase agreements. In addition to using money market securities to help manage their own liquidity, many banks trade on behalf of their customers.

Many businesses buy and sell securities in the money markets. The money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds.

Investment Companies.Large diversified brokerage firms are active in the money markets. The primary function of these dealers is to "make a market" for money market securities by maintaining an inventory from which to buy or sell. These firms are very important to the liquidity of the money market because they ensure that both buyers and sellers can readily market their securities.

Finance companies raise funds in the money markets primarily by selling commercial paper. They then lend the funds to consumers for the purchase of durable goods such as cars, boats, or home improvements.

Property and casualty insurance companies must maintain liquidity because of their unpredictable need for funds. To meet the demand for funds, the insurance companies sell some of their money market securities to raise cash.

Pension funds invest a portion of their cash in the money markets so that they can take advantage of investment opportunities that they may identify in the stock or bond markets. Like insurance companies, pension funds must have sufficient liquidity to meet their obligations.

Individuals.

When inflation rose in the late 1970s, the interest rates that banks were offering on deposits became unattractive to individual investors. At this same time, brokerage houses began promoting money market mutual funds, which paid much higher rates.

To combat this flight of money from banks, the authorities revised the regulations. Banks quickly raised rates in an attempt to recapture individual investors' dollars. This halted the rapid movement of funds, but money market mutual funds remain a popular individual investment option. The advantage of mutual funds is that they give investors with relatively small amounts of cash to invest access to large-denomination securities.

Date: 2015-12-24; view: 2414