MONEY MARKET

By JAMES CHEN
Reviewed By GORDON SCOTT 
Updated May 31, 2020
https://www.investopedia.com/terms/m/moneymarket.asp#:~:text=The%20money
%20market%20refers%20to,accounts%20opened%20by%20bank%20customers.

What Is the Money Market?

The money market refers to trading in very short-term debt investments. At the

wholesale level, it involves large-volume trades between institutions and traders. At the
retail level, it includes money market mutual funds bought by individual investors and
money market accounts opened by bank customers.

Money Market is a market where short-term and open-ended funds are traded between
institutions and traders; where the borrower can easily meet with fund requirements
through any financial assets which can be easily converted into money, providing a high
amount of liquidity and transferability to an organization.

 The money market is a fixed income market which means it deals in financial

instruments that pay a fixed rate on the investment. This is the opposite of the
capital markets where there is no fixed return on investments.
 Investing in the money markets is considered to be very safe as the returns are
fixed in nature. Since investing in this market is safe it also means that the
returns are lower. This is on account of the risk-return trade-off. Higher the risk,
the higher is the return and vice-versa. On the other hand, the capital markets
which do not have a fixed return on investments are volatile in nature and riskier
as compared to the money markets. However, capital markets present the
opportunity to earn a high rate of return.
 Money market instruments are highly liquid in nature. This is the reason why
financial institutions and governments approach the market for short-term needs.
The purpose of this market is to tend to short-term cash needs rather than
investing in the needs of various financial institutions.
 Money market instruments are short-term in nature. The maturity of these
instruments is generally less than a year. The maturity of these securities can be
as less as one day also.

In all of these cases, the money market is characterized by a high degree of safety and
relatively low rates of return.

KEY TAKEAWAYS
  The money market involves the purchase and sale of large volumes of very
short-term debt products, such as overnight reserves or commercial paper.
 An individual may invest in the money market by purchasing a money market
mutual fund, buying a Treasury bill, or opening a money market account at a
bank.
 Money market investments are characterized by safety and liquidity, with money
market fund shares targeted to $1.

Money Market

Understanding the Money Market

The money market is one of the pillars of the global financial system. It involves
overnight swaps of vast amounts of money between banks and the U.S. government.
The majority of money market transactions are wholesale transactions that take place
between financial institutions and companies.

Institutions that participate in the money market include banks that lend to one another
and to large companies in the eurocurrency and time deposit markets; companies that
raise money by selling commercial paper into the market, which 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 into the hands of consumers as components of money market mutual funds and
other investments.

In the wholesale market, commercial paper is a popular borrowing mechanism because

the interest rates are higher than for bank time deposits or Treasury bills, and a greater
range of maturities is available, from overnight to 270 days. 1 However, the risk of default
is significantly higher for commercial paper than for bank or government instruments.

Individuals can invest in the money market by buying money market funds, short-term
certificates of deposit (CDs), municipal notes, or U.S. Treasury bills. For individual
investors, the money market has retail locations, including local banks and the U.S.
government's TreasuryDirect website. Brokers are another avenue for investing in the
money market.

The U.S. government issues Treasury bills in the money market, with maturities ranging
from a few days to one year. 2 Primary dealers buy them in large amounts directly from
the government to trade between themselves or to sell to individual investors. Individual
investors can buy them directly from the government through its TreasuryDirect website
or through a bank or a broker. State, county, and municipal governments also issue
short-term notes.

Money market funds seek stability and security with the goal of never losing money and
keeping net asset value (NAV) at $1. This one-buck NAV baseline gives rise to the
phrase "break the buck," meaning that if the value falls below the $1 NAV level, some of
the original investment is gone and investors will lose money. However, this scenario
only happens very rarely, but because many money market funds are not FDIC-insured,
meaning that money market funds can nevertheless lose money.

TYPES OF MONEY MARKET INSTRUMENTS

Money Market Funds

The wholesale money market is limited to companies and financial institutions that lend
and borrow in amounts ranging from $5 million to well over $1 billion per
transaction. Mutual funds offer baskets of these products to individual investors. The net
asset value (NAV) of such funds is intended to stay at $1. During the 2008 financial
crisis, one fund fell below that level. 3 That triggered market panic and a mass exodus
from the funds, which ultimately led to additional restrictions on their access to riskier
investments.

Money Market Accounts 

Money market accounts are a type of savings account. They pay interest, but some
issuers offer account holders limited rights to occasionally withdraw money or write
checks against the account. (Withdrawals are limited by federal regulations. If they are
exceeded, the bank promptly converts it to a checking account.) Banks typically
calculate interest on a money market account on a daily basis and make a monthly
credit to the account.

In general, money market accounts offer slightly higher interest rates than standard
savings 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 accounts vary based on the amount deposited. As of August
2020, the best-paying money market account with no minimum deposit offered 0.99%
annualized interest. 4

 
Funds in money market accounts are insured by the Federal Deposit Insurance
Corporation (FDIC) at banks and the National Credit Union Administration (NCUA) in
credit unions. 

Certificates of Deposit (CDs)

Most certificates of deposit (CDs) are not strictly money market funds because they are
sold with terms of up to 10 years. However, CDs with terms as short as three months to
six months are available.

As with money market accounts, bigger deposits and longer terms yield better interest
rates. Rates in August 2020 for twelve-month CDs ranged from about 0.5% to 1.5%
depending on the size of the deposit. 5 Unlike a money market account, the rates offered
with a CD remain constant for the deposit period. There is a penalty associated with any
early withdrawal of funds deposited in a CD.
Commercial Paper
The commercial paper market is for buying and selling unsecured loans for corporations
in need of a short-term cash infusion. Only highly creditworthy companies participate, so
the risks are low.

Banker's Acceptances
The banker's acceptance is a short-term loan that is guaranteed by a bank. Used
extensively in foreign trade, a banker's acceptance is like a post-dated check and
serves as a guarantee that an importer can pay for the goods. There is a secondary
market for buying and selling banker's acceptances at a discount.

Eurodollars
Eurodollars are dollar-denominated deposits held in foreign banks, and are thus, not
subject to Federal Reserve regulations. Very large deposits of eurodollars are held in
banks in the Cayman Islands and the Bahamas. Money market funds, foreign banks,
and large corporations invest in them because they pay a slightly higher interest rate
than U.S. government debt.

Repos
The repo, or repurchase agreement, is part of the overnight lending money market.
Treasury bills or other government securities are sold to another party with an
agreement to repurchase them at a set price on a set date.

Money Markets vs. Capital Markets

The money market is defined as dealing in debt of less than one year. It is primarily
used by governments and corporations to keep their cash flow steady, and for investors
to make a modest profit.

The capital market is dedicated to the sale and purchase of long-term debt and equity
instruments. The term capital markets refers to the entirety of the stock and bond
markets. While anyone can buy and sell a stock in a fraction of a second these days,
companies that issue stock do so for the purpose of raising money for their long-term
operations. While a stock's value may fluctuate, unlike many money market products, it
has no expiration date (unless, of course, the company itself ceases to operate).

This money market is dominated by wholesale transactions and retail investors like you
and me will not have direct access to this market. The main reason for this is the ticket
size or the value of transactions. Money market transactions are high in value as
opposed to capital market transactions. Individual investors will not have enough funds
to cope up with this market.

 
Participants of the Money Market
 1. The government of different countries
2. Central Banks
3. Private & Public Banks
4. Mutual Funds
5. Insurance Companies
6. Non-banking financial institutions
7. Other organizations (these organizations are generally at the borrowing side of
the market and generally trade in Commercial Papers, Certificate of Deposits,
etc.)

 
Functions

1. Monetary Equilibrium: This market helps to bring a balance between the demand

and supply of short-term funds in the market. This helps to bring a monetary
equilibrium
2. Availability of funds: By making funds available to various different participants in
the market, the money market promotes the economic growth of the country
3. Check on liquidity: The Government can keep a check on the liquidity in the
country by means of the money market. (Please refer Treasury Bills section to
understand how liquidity can be controlled by the Government and the Central
Bank)
4. Check on inflation: By controlling the liquidity in the marketing, the Government
can keep a check on the inflation of the country as well. If the liquidity is
controlled, it will tend to control the ever-increasing prices in the market.
5. Promotes saving and investment in the country by giving a platform to wholesale
as well as retail investors for investing/borrowing of funds.

Reference:

Chen,James (2020), Money Market (Online)

https://www.investopedia.com/terms/m/moneymarket.asp#:~:text=The%20money
%20market%20refers%20to,accounts%20opened%20by%20bank%20customers.

https://www.wallstreetmojo.com/money-market/