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and banker’s acceptances are bought and sold. Money market consists of financial institutions and
dealers’ in money or credit who wish to generate liquidity. It is better known as a place where
large institutions and government manage their short term cash needs. For generation of liquidity,
short term borrowing and lending is done by these financial institutions and dealers. Money Market
is part of financial market where instruments with high liquidity and very short term maturities are
traded.
Money Market Instruments: Investment in money market is done through money market
instruments. Money market instrument meets short term requirements of the borrowers and
provides liquidity to the lenders. Common Money Market Instruments are as follows.
Treasury Bills, one of the safest money market instruments, are short term borrowing instruments
of the Central Government of the Country issued through the Central Bank. They are zero risk
instruments, and hence the returns are not so attractive. It is available both in primary market as
well as secondary market. It is a promise to pay a said sum after a specified period. T-bills are
short-term securities that mature in one year or less from their issue date.
Repurchase Agreements
A repurchase agreement (repo) is a short-term form of borrowing that involves selling a security
with an agreement to repurchase it at a higher price at a later date. It commonly used by dealers in
government securities who sell Treasury bills to a lender and agree to repurchase them at an agreed
price at a later date. The Federal Reserve buys repurchase agreements as a way of regulating the
money supply and bank reserves. Their date of maturity ranges from overnight to 30 days or more.
Commercial Paper
Certificate of Deposit:
It is a short term borrowing more like a bank term deposit account. It is a promissory note issued
by a bank in form of a certificate entitling the bearer to receive interest. The certificate bears the
maturity date, the fixed rate of interest and the value. It can be issued in any denomination. They
are stamped and transferred by endorsement.
Banker’s Acceptance
Money market
Is a market instruments and a means of lending (or investing) and borrowing funds for relatively
short periods, typically regarded as from one day to one year.
Money market plays a crucial economic role; that of reconciling the cash needs of so called deficit
unit (such as farmer needing to borrow in anticipation of their later harvest revenue) with the
investment needs of surplus unit.
Basic idea of a return is that you invest today and you get some more back at later date. The
percentage increase of the original investment is how we measure return.
If you invest Tshs 1,000,000 in money market instrument today and you receive Tshs 1,070,000
in one year, the return is 7%
Discount rate: This is used for money market instruments such as Treasury bills, Banker’s
acceptance and Commercial paper. These instruments carry no coupon but are sold on a discount
basis from a face-principal value.
Discount rate = (Discount / 100)*(360 / Days)
The add-on yield: It is used on instruments that are issued at par value and the coupon added on at
the end.
Yield to maturity: is the rate that equate the present value of all future interest and principal
payments with the market price of the instrument.
Money market provide a low cost source of funds to firms, the government and intermediaries that
need a short term infusion of fund.
The goal of many investors in the money market who are temporarily warehousing fund, is not to
earn particularly high returns on their funds, rather they use money market as an interim investment
that provides a higher return than holding cash or money in banks.
Idle cash represent an opportunity cost in term of lost interest income, so money markets provide
a means to invest idle funds and to reduce this opportunity cost.
Investment adviser often hold some funds in the money market so that they will be able to act
quickly to take advantage of investment opportunities they might identify.
The seller of money market securities find that the money market provides a low cost source of
temporary funds.
An obvious way to discuss the players in the money market would be to list those who borrow and
those who lend, but it turns to be that these participants operate on both sides of the market.
Treasury department
Federal Reserve
They buy and sell Treasury securities as its primary method of controlling the money supply
Commercial banks
Buy government treasury securities; sell certificates of deposit and make short term loans
Businesses
Buy and sell various short-term securities as a regular part of their cash management
Pension funds
Maintain funds in money market instruments in readiness for investment in stocks and bonds
Allows small to participate in the money market by aggregating their funds to invest in large-
denomination money market securities
A money market exists in virtually every country in the world, and all such markets exhibit the
same characteristics. For instance, they provide a means by which the conflicting needs of
borrowers and lenders can achieve equilibrium, they act as a conduit for financing of all maturities
between one day and one year, and they can be accessed by individuals, corporations, and
governments alike.
In addition to national domestic markets, there is the international cross-border market illustrated
by the trade in Eurocurrencies. A Eurocurrency is a currency that is traded outside of its national
border, and can be any currency rather than just a European one.
In developed economies, the money market is large and liquid. Treasury bills are considered
among the safest and most liquid securities in the money market. Treasury bill yields serve as
benchmark short-term interest rates for markets around the world.
The largest group of players in the global money markets are financial institutions that include
depository institutions, investment banks, and insurance companies. These institutions are
simultaneously the biggest investors in and issuers of money market instruments. There are
specialized instruments that are unique to this group of borrowers which include certificates of
deposits, banker’s acceptances, federal funds, and funding agreements.
CD may be either nonnegotiable or negotiable. If nonnegotiable, the initial depositor must wait
until the CD’s maturity date for the return of their deposits plus interest. An early withdrawal
penalty is imposed if the depositor chooses to withdraw the funds prior to the maturity date. In
contrast, a negotiable CD allows the initial depositor (or any subsequent owner of the CD) to sell
the CD in the open market prior to the maturity date.
FEDERAL FUNDS
Depository institutions are required to hold reserves to meet their reserve requirements, these
reserves are called federal funds. Because no interest is earned on federal funds, a depository
institution that maintains federal funds in excess of the amount required incurs an opportunity cost
of the interest forgone on the excess reserves. Correspondingly, there are also depository
institutions whose federal funds are short of the amount required. The federal funds market is
where depository institutions buy and sell federal funds to address this imbalance.