Money market

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This article is about the financial market. For the fund type, see Money market fund. For the
bank deposit account, see Money market account.

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v·d·e

The money market is a component of the financial markets for assets involved in short-term
borrowing and lending with original maturities of one year or shorter time frames. Trading in the
money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of
deposit, federal funds, and short-lived mortgage- and asset-backed securities.[1] It provides
liquidity funding for the global financial system.

Contents
[hide]

 1 Overview
 2 Common money market instruments
 3 See also
 4 References
 5 External links

[edit] Overview
The money market consists of financial institutions and dealers in money or credit who wish to
either borrow or lend. Participants borrow and lend for short periods of time, typically up to
thirteen months. Money market trades in short-term financial instruments commonly called
"paper." This contrasts with the capital market for longer-term funding, which is supplied by
bonds and equity.

The core of the money market consists of interbank lending--banks borrowing and lending to
each other using commercial paper, repurchase agreements and similar instruments. These
instruments are often benchmarked to (i.e. priced by reference to) the London Interbank Offered
Rate (LIBOR) for the appropriate term and currency.

Finance companies, such as GMAC, typically fund themselves by issuing large amounts of asset-
backed commercial paper (ABCP) which is secured by the pledge of eligible assets into an
ABCP conduit. Examples of eligible assets include auto loans, credit card receivables,
residential/commercial mortgage loans, mortgage-backed securities and similar financial assets.
Certain large corporations with strong credit ratings, such as General Electric, issue commercial
paper on their own credit. Other large corporations arrange for banks to issue commercial paper
on their behalf via commercial paper lines.

In the United States, federal, state and local governments all issue paper to meet funding needs.
States and local governments issue municipal paper, while the US Treasury issues Treasury bills
to fund the US public debt.

 Trading companies often purchase bankers' acceptances to be tendered for payment to

overseas suppliers.
 Retail and institutional money market funds
 Banks
 Central banks
 Cash management programs
 Arbitrage ABCP conduits, which seek to buy higher yielding paper, while themselves
selling cheaper paper.
 Merchant Banks

[edit] Common money market instruments

 Certificate of deposit - Time deposits, commonly offered to consumers by banks, thrift
institutions, and credit unions.
 Repurchase agreements - Short-term loans—normally for less than two weeks and
frequently for one day—arranged by selling securities to an investor with an agreement to
repurchase them at a fixed price on a fixed date.
 Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270
days; usually sold at a discount from face value.
 Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located
outside the United States.
  Federal agency short-term securities - (in the U.S.). Short-term securities issued by
government sponsored enterprises such as the Farm Credit System, the Federal Home
Loan Banks and the Federal National Mortgage Association.
 Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other depository
institutions at the Federal Reserve; these are immediately available funds that institutions
borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.
 Municipal notes - (in the U.S.). Short-term notes issued by municipalities in anticipation
of tax receipts or other revenues.
 Treasury bills - Short-term debt obligations of a national government that are issued to
mature in three to twelve months. For the U.S., see Treasury bills.
 Money funds - Pooled short maturity, high quality investments which buy money market
securities on behalf of retail or institutional investors.
 Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal of
the exchange of currencies at a predetermined time in the future.
 Short-lived mortgage- and asset-backed securities

[edit] See also

 Liquidity crisis
 Interbank lending market
 Money market account
 Money fund
 Money supply
 Overnight market
 Sweep account
 Lombard Street, A Description of the Money Market, one of the earliest popular books on
the money market

[edit] References
Types of Financial Instruments

Money Market Instruments

Treasury bills
Certificates of deposit
Commercial Paper (Member section)
Bankers Acceptances/Letters of credit (Member section)
Eurodollars (Member section)
Repurchase Agreements (RPs) and Reverse RPs (Member section)
Bank Guarantees (Member section)
Bonds (Member section)
Corporate bonds (Member section)
The Money Market Instruments (Member section)
Money Market Instruments (Click for more)
The major purpose of financial markets is to transfer funds from lenders to borrowers.
Financial market participants commonly distinguish between the "capital market" and
the "money market".  The money market  refer  to borrowing and lending for periods of a
year or less.

Treasury bills (Click for more)

Treasury bills are short-term securities issued by the U.S. Treasury. The Treasury sells
bills at regularly scheduled auctions to refinance maEagle Tradersg issues.  It also
helps to finance current federal deficits. They further sell bills on an irregular basis to
smooth out the uneven flow of revenues from corporate and individual tax receipts.

Certificates of deposit  (Click for more)

A certificate of deposit is a document evidencing a time deposit placed with a depository
institution.  The following information appears on the certificate: 
-  the amount of the deposit;
-  the date on which it matures;
-  the interest rate;  and
-  the method under which the interest is calculated.
 Large negotiable CDs are generally issued in denominations of $1 million or more.

Commercial Paper  (Click for more)

Commercial paper is a short-term unsecured promissory note issued by corporations
and foreign governments.  It is a low-cost alternative to bank loans, for many large,
credit worthy issuers.   Issuers are able to efficiently raise large amounts of funds
quickly and without expensive Securities and Exchange Commission (SEC)
registration.  They sell paper, either directly or through independent dealers, to a
large .............

Treasury Bills
Treasury bills are short-term securities issued by the U.S. Treasury. The Treasury sells
bills at regularly scheduled auctions to refinance maEagle Tradersg issues and to help
finance current federal deficits. It also sells bills on an irregular basis to smooth out the
uneven flow of revenues from corporate and individual tax receipts. Persistent federal
deficits have resulted in rapid growth in Treasury bills in recent years. At the end of
1992 the outstanding volume was $658 billion, the largest for any money market
instrument.

Treasury Bill Issues 

Treasury bills were first authorized by Congress in 1929. After experimenting with a
number of bill maturities, the Treasury in 1937 settled on the exclusive issue of three-
month bills. In December 1958 these were supplemented with six-month bills in the
regular weekly auctions. In 1959 the Treasury began to auction one-year bills on a
quarterly basis. The quarterly auction of one-year bills was replaced in August 1963 by
an auction occurring every four weeks. The Treasury in September 1966 added a nine-
month maturity to the auction occurring every four weeks but the sale of this maturity
was discontinued in late 1972. Since then, the only regular bill offerings have been the
offerings of three- and six-month bills every week and the offerings of one-year bills
every four weeks. The Treasury has increased the size of its auctions as new money
has been needed to meet enlarged federal borrowing requirements. In 1992 the weekly
auctions of three- and six-month bills both ranged from $10.2 billion to $12.5 billion, and
the four-week auctions of one-year bills ranged from $12.8 billion to $15.0 billion.

In addition to its regularly scheduled sales, the Treasury raises money on an irregular
basis through the sale of cash management bills, which are usually "reopenings" or
sales of bills that mature on the same date as an outstanding issue of bills.   Cash
management bills are designed to bridge low points in the

 Prior to 1975, the Treasury raised funds on an irregular basis through the sale of tax
anticipation bills. Nelson (1977) provides a description of these bills. 
Treasury's cash balances. Many cash management bills help finance the Treasury's
requirements until tax payments are received. For this reason they frequently have
maturities that fall after one of the five major federal tax dates. Sixty issues of cash
management bills were sold in the decade from 1983 through 1992. Of these, 29 had
maturities of less than one month, 21 had maturities between one month and three
months, and 10 had maturities between three months and one year.

Auctioning New Bills

Weekly offerings of three- and six-month Treasury bills are typically announced on
Tuesday. The auction is usually conducted on the following Monday, with delivery and
payment on the following ......................

Domestic CDS   (more info)

A certificate of deposit is a document evidencing a time deposit placed with a depository
institution. The certificate states the amount of the deposit, the date on which it matures,
the interest rate and the method under which the interest is calculated. Large negotiable
CDs are generally issued in denominations of $1 million or more.

A CD can be legally negotiable or nonnegotiable, depending on certain legal

specifications of the CD. Negotiable CDs can be sold by depositors to other 
parties who can in turn resell them. Nonnegotiable CDs generally must be held by the
depositor until maturity. During the late 1970s and early to mid-1980s, between 60 and
80 percent of large CDs issued by large banks were negotiable instruments. The
Federal Reserve stopped collecting separate data on negotiable CDs in 1987.
 
A CD may be payable to the bearer or registered in the name of the investor. Most large
negotiable CDs are issued in bearer form because investors can resell bearer CDs
more easily. Registration adds complication and costs to the process of transferring
ownership of CDs.  CDs with original maturities of more than one year must be
registered under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA).

Federal banking agency regulations limit ...........................

Commercial paper is a short-term unsecured promissory note issued by corporations
and foreign governments for many large, creditworthy issuers.  Commercial paper is a
low-cost alternative to bank loans. Issuers are able to efficiently raise large amounts of
funds quickly and without expensive Securities and Exchange Commission (SEC)
registration by selling paper, either directly or through independent dealers, to a large
and varied pool of institutional buyers.  Competitive, market-determined yields in notes
whose maturity and amounts can be tailored to specific needs, can be earned by
investors in commercial paper.

Commercial paper has become one of America's most important debt markets, because
of the advantages of commercial paper for both investors and issuers.  Commercial
paper outstanding grew at an annual rate of 14 percent from 1970 to 1991.  Commercial
paper totaled $528 billion at the end of 1991.

This chapter describes some of the important features of the commercial paper market.
The first section reviews the characteristics of commercial paper. The second section
describes the major participants in the market, including the issuers, investors, and
dealers. The third section discusses the risks faced by investors in the commercial
paper market along with the mechanisms that are used to control these risks. The fourth
section discusses some recent innovations, including asset-backed commercial paper,
the use of swaps in commercial paper financing strategies, and the international
commercial paper markets.

Characteristics of Commercial Paper 

Securities offered to the public must be registered with the Securities and Exchange
Commission according to the Securities Act of 1933.  Registration requires extensive
public disclosure, including issuing a prospectus on the offering.  It is a time-consuming
and expensive process. Most commercial paper is issued under Section 3(a)(3) of the
1933 Act which exempts from registration requirements short-term securities as long as
they have certain characteristics.

The exemption requirements have been a factor shaping the characteristics of the
commercial paper market.  The following are requirements for exemption:
- The maturity of commercial paper must be less than 270 days. In practice, most
commercial paper has a maturity of between 5 and 45 days, with 30-35 days being the
average maturity. Many issuers continuously roll over their commercial paper, financing
a more-or-less constant amount of their assets using commercial paper.  The nine-
month maturity limit is not violated by the continuous rollover of notes, as long as the
rollover is not automatic but is at the discretion of the issuer and the dealer. Many
issuers will adjust the maturity of commercial paper to suit the requirements of an
investor

Notes must be of a type not ordinarily purchased by the general public. In practice, the
denomination of commercial paper is large: minimum denominations are usually
$100,000, although face amounts as low as $10,000 are available from some issuers. 
Typical face amounts are in multiples of $1 million, because most investors are
institutions.  Issuers will usually sell an investor the specific amount of commercial
paper needed.

That proceeds from commercial paper issues be used to finance "current transactions,"
which include the funding of operating expenses and the funding of current assets such
as receivables and inventories. Proceeds cannot be used to finance fixed assets, such
as plant and equipment, on a permanent basis. The SEC has generally interpreted the
current transaction requirement broadly, approving a variety of short-term uses for
commercial paper proceeds as proceeds are not traced directly from issue to use. 
Firms are required to show only that they have a sufficient "current transaction" capacity
to justify the size of the commercial paper program (for example, a particular level of
receivables or inventory). Firms are allowed to finance construction as long as the
commercial paper financing is temporary and to be paid off shortly after completion of
construction with long-term funding through a bond issue, bank loan, or internally
generated cash flow.

Commercial paper is typically a discount security (like Treasury bills): the investor
purchases notes at less than face value and receives the face value at maturity. The
difference between the purchase price and the face value, called the discount, is the
interest received on the investment. Commercial paper is, occasionally, issued as an
interest-bearing note (by request of investors). The investor pays the face value and, at
maturity, receives the face value and accrued interest. All commercial paper interest
rates are quoted on a discount basis.

Until the 1980s, most commercial paper was issued in physical form in which the
obligation of the issuer to pay the face amount at maturity is recorded by printed
certificates that are issued to the investor in exchange for funds. A safekeeping agent
hired by the investor held the certificates, until presented for payment at maturity. The
"settling" of the transaction, (the exchange of funds for commercial paper first at
issuance and then at redemption, occur in one day. On the day the commercial paper is
issued and sold, the investor receives and pays for the notes and the issuer receives
the proceeds. On the day of maturity, the investor presents the notes and receives
payment. Commercial banks, in their role as issuing, paying, and clearing agents,
facilitate the settling of commercial paper by carrying out the exchanges between
issuer, investor, and dealer required to transfer commercial paper for funds.

An increasing amount of commercial paper is being issued in book-entry form whereby

entries in computerized accounts are replacing the physical commercial paper
certificates. Book-entry systems will eventually completely replace the physical printing
and delivery of notes. The Depository Trust Company (DTC), a clearing cooperative
operated by member banks, began plans in September 1990 to convert most
commercial paper transactions to book-entry form. By May 1992, more than 40 percent
of commercial paper was issued through the DTC in book-entry form.
The advantages of a paperless system are significant.  In the long run the fees and
costs associated with the book-entry system will, be significantly less than under the
physical delivery system. The expense of delivering and verifying certificates and the
risks of messengers failing to deliver certificates on time will be eliminated.  As all
transactions between an issuing agent and a paying agent will be settled with a single
end-of-day wire transaction, the problem of daylight overdrafts, which arise from non-
synchronous issuing and redeeming of commercial paper will be reduced.

Market participants 
Issuers and Uses of Commercial Paper  Commercial paper is issued by a wide variety
of domestic and foreign firms, including financial companies, banks, and industrial firms.
Finance companies are the biggest issuers in the financial firm category.  Finance
companies provide consumers with home loans, unsecured personal loans and retail
automobile loans. They provide businesses with a variety of short- and medium-term
loans including secured loans to finance purchases of equipment for resale. Some
finance companies are wholly owned subsidiaries of industrial firms that provide
financing for purchases of the parent firm's products. For example, a major activity of
General Motors Acceptance Corporation (GMAC) is the financing of purchases and
leases of General Motor's vehicles by dealers and consumers.

The three largest issuers--GMAC, General Electric Capital, and Ford Motor Credit--
accounted for more than 20 percent of the total non-bank financial paper outstanding at
the end of 1991.

The financial issuer category also includes securities firms and insurance firms. 
Securities firms issue commercial paper as a low-cost alternative to other short-term
borrowings such as repurchase agreements and bank loans, and they use commercial
paper proceeds to finance a variety of security broker and investment banking
activities.  Insurance companies issue commercial paper to finance premium
receivables and operating expenses. 

Commercial bank holding companies issue commercial paper to finance operating

expenses and various non-bank activities. Due to declines in the perceived
creditworthiness of many major domestic bank issuers, bank holding companies have
recently decreased their commercial paper issues.

More than 500 non-financial firms also issue commercial paper. Non-financial issuers
include public utilities, service and industrial companies. Commercial paper is used by
Industrial and service companies to finance working capital (accounts receivable and
inventory) on a permanent or seasonal basis, to fund operating expenses, and to
finance, on a temporary basis, construction projects. Public utilities also use commercial
paper to fund nuclear fuels and construction. 

Forex - FX
What Does Forex - FX Mean?

The market in which currencies are traded. The forex market is the largest, most liquid market in
the world with an average traded value that exceeds $1.9 trillion per day and includes all of the
currencies in the world. 

GROWTH OF MONEY MARKET IN

INDIA
While the need for long term financing is met by the capital or financial markets, money market is a
mechanism which deals with lending and borrowing of short term funds. Post reforms period in India has
witnessed tremendous growth of the Indian money markets. Banks and other financial institutions have
been able to meet the high expectations of short term funding of important sectors like the industry,
services and agriculture. Functioning under the regulation and control of the Reserve Bank of India (RBI),
the Indian money markets have also exhibited the required maturity and resilience over the past about
two decades. Decision of the government to allow the private sector banks to operate has provided much
needed healthy competition in the money markets, resulting in fair amount of improvement in their
functioning.

Money market denotes inter-bank market where the banks borrow and lend among themselves to meet
the short term credit and deposit needs of the economy. Short term generally covers the time period upto
one year. The money market operations help the banks tide over the temporary mismatch of funds with
them. In case a particular bank needs funds for a few days, it can borrow from another bank by paying the
determined interest rate. The lending bank also gains, as it is able to earn interest on the funds lying idle
with it. In other words, money market provides avenues to the players in the market to strike equilibrium
between the surplus funds with the lenders and the requirement of funds for the borrowers. An important
function of the money market is to provide a focal point for interventions of the RBI to influence the
liquidity in the financial system and implement other monetary policy measures.

Quantum of liquidity in the banking system is of paramount importance, as it is an important determinant

of the inflation rate as well as the creation of credit by the banks in the economy. Market forces generally
indicate the need for borrowing or liquidity and the money market adjusts itself to such calls. RBI
facilitates such adjustments with monetary policy tools available with it. Heavy call for funds overnight
indicates that the banks are in need of short term funds and in case of liquidity crunch, the interest rates
would go up.

Depending on the economic situation and available market trends, the RBI intervenes in the money
market through a host of interventions. In case of liquidity crunch, the RBI has the option of either
reducing the Cash Reserve Ratio (CRR) or pumping in more money supply into the system. Recently, to
overcome the liquidity crunch in the Indian money market, the RBI has released more than Rs 75,000
crore with two back-to-back reductions in the CRR.

In addition to the lending by the banks and the financial institutions, various companies in the corporate
sector also issue  fixed deposits to the public for shorter duration and to that extent become part of the
money market mechanism selectively. The maturities of the instruments issued by the money market as a
whole, range from one day to one year. The money market is also closely linked with the Foreign
Exchange Market, through the process of covered interest arbitrage in which the forward premium acts as
a bridge between the domestic and foreign interest rates.

Determination of appropriate interest for deposits or loans by the banks or the other financial institutions is
a complex mechanism in itself. There are several issues that need to be resolved before the optimum
rates are determined. While the term structure of the interest rate is a very important determinant, the
difference between the existing domestic and international interest rates also emerges as an important
factor. Further, there are several credit instruments which involve similar maturity but diversely different
risk factors. Such distortions are available only in developing and diverse economies like the Indian
economy and need extra care while handling the issues at the policy levels.

Diverse Functions

Money markets are one of the most important mechanisms of any deve-loping economy. Instead of just
ensuring that the money market in India regulates the flow of credit and credit rates, this mechanism has
emerged as one of the important policy tools with the government and the RBI to control the monetary
policy, money supply, credit creation and control, inflation rate and overall economic policy of the State.

Hence, the first and the foremost function of the money market mechanism is regulatory in nature.  While
determining the total volume of credit plan for the six monthly period, the credit policy also aims at
directing the flow of credit as per the priorities fixed by the government according to the needs of the
economy. Credit policy as an instrument is important to ensure the availability of the credit in adequate
volumes; it also caters to the credit needs of various sectors of the economy. The RBI assists the

government to implement its policies related to the credit plans through its statutory control over
the banking system of the country.

Monetary policy, on the other hand, has longer term perspective and aims at correcting the imbalances in
the economy. Credit policy and the monetary policy, both complement each other to achieve the long
term goals determined by the government. It not only maintains complete control over the credit creation
by the banks, but also keeps a close watch over it. The instruments of monetary policy, including the repo
rate, cash reserve ratio and bank rate are used by the Central Bank of the country to give the required
direction to the monetary policy.

Inflation is one of the serious economic problems that all the developing economies have to face every
now and then. Cyclical fluctuations do affect the price level differently, depending upon the demand and
supply scenario at the given point of time. Money market rates play a major role in controlling the price
line. Higher rates in the money markets reduce the liquidity in the economy and have the effect of
reducing the economic activity in the system. Reduced rates, on the other hand, increase the liquidity in
the market and bring down the cost of capital substantially, thereby increasing the investment. This
function also assists the RBI to control the overall money supply in the economy. Such operations
supplement the efforts of direct infusion of newly printed notes by the RBI.

Future of Open Markets

Financial openness is said to be a situation under which the residents of one country are in a position to
trade their assets with residents of another country. A slightly mild definition of openness may be referred
to as financial integration of two or more economies. In recent years, the process of globalization has
made the money market operations and the monetary policy tools quite important. The idea is not only to
regulate the economy and its money markets for the overall economic development, but also to attract
more and more foreign capital into the country. Foreign investment results in increased economic activity,
income and employment generation in the economy. Free and unrestricted flow of foreign capital and
growing integration of the global markets is the hallmark of openness of economies.

Indian experience with open markets has been a mixed one. On the positive side, the growth rate of the
country has soared to new levels and the foreign trade had been growing at around 20 per cent during the
past few years. Foreign exchange reserves have burgeoned to significantly higher levels and the country
has achieved new heights in the overall socio-economic development. The money market mechanism
has played a significant role in rapid development of the country during the post-reforms era.

On the flip side, the post-reforms period has witnessed relatively lesser growth of the social
sector. Money market mechanism has kept the markets upbeat, yet the social sector needs more focused
attention. With the base of the economy now strengthened, the money market mechanism must also
focus on ensuring that proper direction is provided to the credit flows so that the poorest sections of the
society also gain.

History…………

In 2000, what was a single U.S. dollar in 1900 was equivalent to US$24 in the United States, US$48 in
the UK, and US$12 in Switzerland just one hundred years later, according to Elroy Dimson, Paul Marsh
and Mike Staunton in their book "Triumph Of The Optimists: 101 Years Of Global Investment Returns"
(2002). These differences are quite startling to an international long-term investor. In this article, we'll take
you through a history of how inflation impacted the market, and tell you how to use it to help you make
future investments

Few things are more devastating to your returns than unexpected inflation because it diminishes
purchasing power. Throughout history, periods of high inflation or hyperinflation have decimated the
savings of investors. Therefore, you can't completely understand your returns unless you look at them  in
relation to inflation.

In this segment of the "Look Back" series, we consider inflation and the subsequent real rates of return of
holding cash (defined as holding Treasury bills or T-bills) over the past century. (To look back at other
markets during this period, see The Bond Market: A Look Back, The Stock Market: A Look Back and
Equity Premiums: Looking Back And Looking Ahead.)
Fixed income and cash have been influenced by similar events throughout history, as have the markets in
which they trade. Two world wars and a global depression had a major impact on both cash and fixed
income returns for the first half of the century. While lower real returns are likely for cash going forward,
when compared to the post-1980 period, their importance as the benchmark for the risk-free return is
likely to remain intact.

A Century of Two Tales

While th

e money (or cash) market did perform much better in the second half of the last century, it was really the
last 20 years which have made the biggest difference. Expectations for high inflation remained intact long
after inflation subsided in the early 1980s. This translated into much higher than normal real returns for
cash during that period

During the last century, all countries in the study at some point experienced deflation and double-digit
inflation. In the 1970s, it was exactly this type of double-digit inflation that set the stage for the high real
returns realized after 1980.

Some countries, like Germany, even experienced hyperinflation, as they did in the early 1920s. This is an
important lesson, because T-bills are often thought of as risk-free investments. German investors, though,
found out during this period that on a real-return basis, even T-bills are not immune to total loss during a
period of hyperinflation, as inflation can far outstrip the returns investors receive.

With that said, T-bills today still handle the function of a short-term risk-free benchmark, while inflation-
protected securities (IPS) are best used as a medium or long-term benchmark. (For more information, see
Inflation-Protected Securities - The Missing Link.)

The hyperinflation experienced by Germany in the 1920s was not common to other countries over the
last century. Inflation in the U.S. saw two peaks just after the World Wars. In 1918, it peaked at 20.4%,
while in 1946 18.2% was the crest. Both periods of inflation were the result of heavy government
spending during the war years. This scenario reveals a valuable lesson - those who have the ability to
print money also have the ability to create inflation.

Interest rates approached 20% in 1981, strangling the world economy into a deep recession. From those
ashes emerged the Great Bull Market (1981 to 2000), as inflation expectations remained much higher
than the actual rate. As a result, high real returns remained intact for an unprecedented period.

What Does the Future Hold?

So what should we expect going forward? First, the real rates of return experienced from 1981 to 2000
were the exception rather than the norm.

Figure 2

The Great Bull Market is now over, but a new era exists for cash investors. Central banks around the
world have a much better understanding of monetary policy than ever before. For the most part, actual
interest rate increases today are a foregone conclusion by the time they are announced. This is a good
thing because the market hates surprises and uncertainty breeds the need for higher risk premiums. For
example, during the 1970s, the money supply was targeted, while today the target is inflation.
With all of the innovations in the financial industry since the 1970s, the definition of exactly what cash is
has changed as well. For example, with the advent of credit and debit cards the need for actual paper
money has decreased. Also, volatility is likely to remain lower in the cash market, an argument that is
support by the fact that seven out of the 16 countries in the "Triumph Of The Optimists" study are now
part of the euro and their monetary policy is dictated from Brussels. With fewer central banks, fewer
things should go wrong. All of this makes unexpected inflation less likely, which makes the need for a
higher risk premium for holding cash less likely as well.

Second, financial engineering has allowed for securitization and hedging capabilities that have never
existed before. These developments have all made the markets more efficient and, therefore, a lower risk
premium is required. For instance, when looking at IPS and regular government bonds of the same
maturity, projected inflation can be forecasted for the economy.

Some critics argue, however, that inflation figures are not as accurate as they should be. For example,
inflation figures do not take into account improvements in goods and services. Furthermore, substitution
between goods is not well accounted for because countries are usually slow in adjusting the basket they
use in inflation measurements like the consumer price index.

For instance, while the UK adjusts its basket of goods and services every year, the U.S. adjusts its basket
only every 10 years. Another example is that the housing component of inflation in the U.S. is based
on imputed rent rather than the cost of purchasing a house. However, while there is certainly room for
improvement, the accuracy of today's inflation calculations has never been better. According to an
Economist article titled, "A Short History Of Inflation" (1992), this is a big difference as, "typically, older
indexes covered only included food and housing, and excluded services".

Conclusion 
In general, the historical movement of inflation provides evidence that real rates of return on T-bills will
revert closer to historical norms rather than what we experienced during the Great Bull Market. With
better control over monetary policy and more efficient markets, the likelihood of high unexpected inflation
and high risk premium is less likely. However, the value of T-bills as a risk-free benchmark will remain
intact - without it, risk premiums can't be calculated and the allocation of capital become less efficient