The Money Market

The money market refers to the market for short-term, high quality debt
securities issued by government and corporate borrowers. Maturities can range
from overnight to up to a year.
The money market creates liquidity for these borrowers to fund their
short-term cash flow needs.
Common money market instruments include Treasury bills (T-bills),
certificates of deposit (CDs), commercial paper, bankers acceptances,
eurodollars and repurchase agreements (repos) among others.
The money market is best known as a place for large institutions and
governments to manage their short-term cash needs. However, individual
investors have access to the market through a variety of different securities. In
this tutorial, we'll cover various types of money market securities and how they
can work in your portfolio.
Money market securities are short-term IOUs issued by governments,
financial institutions and large corporations. These instruments are
very liquid and considered extremely safe. Defaults on money market
instruments have been extremely rare. Because of this relative safety, money
market securities offer significantly lower returns than most other securities.
There is no formal money market, rather it is an informal network of
banks, brokers, dealer and financial institutions that are linked electronically.
One of the most important functions of the money market is providing an
outlet for large companies with temporary excess cash to invest that cash in
short-term money market instruments.
Corporations with short-term cash needs can sell securities such as
commercial paper, or borrow funds on a short-term basis.
Larger corporations will generally participate directly via their dealer,
while smaller companies with excess cash might just park it in a money market
mutual fund, a professionally managed fund that invests in various money
market instruments. The best way for individual investors to access the money
market is also via a money market mutual fund, or a money market account with
a bank. These funds pool together the assets of thousands of investors in order to
buy the money market securities on their behalf. However, some money market
instruments, like Treasury bills, may be purchased directly from the Treasury.
Money market funds seek to maintain a stable $1 net asset value while paying a
yield. Although these funds have traditionally held their price at $1 per share,
some recent regulations allow certain funds to break the buck when needed.
Other than T-Bills, money market instruments are not riskless, but the risks are
low. There have been defaults over the years, but they are not common.
Money Market: Treasury Bills (T-Bills)
Treasury bills, or T-bills, are short-term debt instruments issued by the U.S
Treasury. T-bills are issued for a term of one year of less. T-bills are considered
the worlds safest debt as they are backed by the full faith and credit of the
United States government.
The T-bill rate is a key barometer of short-term interest rates. Treasury
bills are sold with maturities of four, thirteen, twenty-six and fifty-two weeks.
They do not pay interest, but rather are sold a discount to their face value. The
full-face value is paid at maturity, and the difference between the discounted
purchase price and the full-face value equates to the interest rate.

Money Market: Certificate Of Deposit

A certificate of deposit (CD) is a time deposit with a bank. CDs are
generally issued directly by commercial banks, but they can be purchased via
brokerage firms. CDs have a specific maturity date (from three months to five
years), a stated interest rate, and can be issued in any denomination, much like
bonds. Most CDs assess a penalty for early withdrawal prior to the CDs date of
maturity.
Insured account
Certificates of deposits are offered by banks and as such are covered by
FDIC insurance just like a savings or checking account. As long as the value of
the CD is under the FDIC limits of $250,000 per depositor per bank, your CD
will be covered.

Money Market: Commercial Paper

Commercial paper is an unsecured, short-term loan used 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.
Commercial paper is considered a very safe investment. Typically, only
companies with high credit ratings and credit-worthiness issue commercial
paper. Over the past 40 years, there have only been a handful of cases where
corporations have defaulted on their commercial paper repayment.
Commercial paper is usually issued in denominations of $100,000 or
more. Therefore, smaller investors can only invest in commercial paper
indirectly through money market funds.
Commercial paper is sold at a discount, with the difference between that
price and the face value at maturity comprising the return to the investor.
Benefits of commercial paper
Commercial paper does not have to be registered with the SEC if the term
to maturity is nine months or less. The average maturity is around 30 days, so
the elimination of the need to comply with SEC rules brings down the
compliance costs of issuing these instruments.
Maturities and the amount of commercial paper can be adjusted to fit the needs
of the borrow

Money Market: 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. Bankers
acceptances are considered very safe instruments and are used extensively in
foreign trade.
Bankers acceptances often arise from a business needing to make a major
purchase overseas. BAs are time drafts that a business can order from the bank.
The financial institution promises to pay the exporting firm a specific amount on
a specific date, at which time it recoups its money by debiting the importers
account. The BA works much like a post-dated check, which is simply an order
for a bank to pay a specified party at a later date. The holder may also choose to
sell the BA for a discounted price on a secondary market, giving investors a
relatively safe, short-term investment.
BAs are frequently used in international trade because of advantages for both
sides. Exporters often feel safer relying on payment from a reputable bank than a
business with which it has little if any history. Once the bank verifies, or
accepts, a time draft, it becomes an obligation of that institution.
Most bankers acceptances are back by invoices, bills of lading or the
physical goods being financed. The issuing bank stamps accepted on the
document, hence the name.
The importer may turn to a bankers acceptance when it has
trouble obtaining other forms of financing, or when a BA is the least expensive
option. The advantage of borrowing is that it receives the goods and has the
opportunity to resell them before making payment to the bank.
Banks typically charge a 2% fee so if the face value is $1 million then the
importer will receive $980,000 net.

Money Market: Eurodollars

Eurodollars are U.S.-dollar denominated deposits held at banks outside of
the United States, including branches of U.S. banks located outside of the U.S.
This market began in Europe (primarily in London) after World War II, hence
the name. Eurodollars can be held anywhere outside the United States however.
Eurodollars escape regulation by the Federal Reserve Board, including
reserve requirements. They are widely held in bank branches located in the
Bahamas and the Cayman Islands.
 The fact that these dollar-denominated deposits are held offshore and not
subject to U.S. banking regulations allow these institutions to pay slightly higher
rates than depositors might receive here in the U.S. Money market funds,
foreign central banks and large corporations are among the more active players
in this market.
The Eurodollar market is one of the worlds major international capital
markets. Major corporations use the Eurodollar market to settle international
transactions, to finance import and export activity, to make short-term loans and
as a place to invest excess cash.
The Eurodollar market is an alternative that many U.S. corporations use to
raise money when conditions are unfavorable in the domestic U.S. market.
The Eurodollar market has evolved to include the ability for U.S.
companies to offer a portion of the shares under an IPO for trading in European
markets. Eurodollar bonds pay investors interest in dollars but issuers do not
have to comply with the same SEC rules as domestic issuers