The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less.
As
short-term securities became a
commodity
In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them.
The price of a comm ...
, the money market became a component of the
financial market
A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets ...
for assets involved in short-term
borrowing,
lending
In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that d ...
, buying and selling with original maturities of one year or less. Trading in money markets is done
over the counter
Over-the-counter (OTC) drugs are medicines sold directly to a consumer without a requirement for a prescription from a healthcare professional, as opposed to prescription drugs, which may be supplied only to consumers possessing a valid prescr ...
and is
wholesale
Wholesaling or distributing is the sale of goods or merchandise to retailers; to industrial, commercial, institutional or other professional business users; or to other wholesalers (wholesale businesses) and related subordinated services. In ...
.
There are several money market instruments in most Western countries, including
treasury bills
United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Since 2012, U.S. gov ...
,
commercial paper
Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of rarely more than 270 days. In layperson terms, it is like an " IOU" but can be bought and sold because its buyers and sellers have some ...
,
banker's acceptances,
deposits
A deposit account is a bank account maintained by a financial institution in which a customer can deposit and withdraw money. Deposit accounts can be savings accounts, Transaction account#Current accounts, current accounts or any of several othe ...
,
certificates of deposit
A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions in the United States. CDs differ from savings accounts in that the CD has a specific, fixed term (often one, t ...
,
bills of exchange
A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, whose payer is usually named on the document. More specifically, it is a document contemplated by or consisting of a ...
,
repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
s, federal funds, and short-lived
mortgage- and
asset-backed securities
An asset-backed security (ABS) is a security whose income payments, and hence value, are derived from and collateralized (or "backed") by a specified pool of underlying assets.
The pool of assets is typically a group of small and illiquid asset ...
. The instruments bear differing maturities, currencies, credit risks, and structures.
A market can be described as a money market if it is composed of highly liquid, short-term assets. Money market funds typically invest in government securities, certificates of deposit, commercial paper of companies, and other highly liquid, low-risk securities. The four most relevant types of money are
commodity money
Commodity money is money whose value comes from a commodity of which it is made. Commodity money consists of objects having value or use in themselves (intrinsic value) as well as their value in buying goods.
This is in contrast to representati ...
,
fiat money
Fiat money (from la, fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was sometime ...
, fiduciary money (
cheque
A cheque, or check (American English; see spelling differences) is a document that orders a bank (or credit union) to pay a specific amount of money from a person's account to the person in whose name the cheque has been issued. The pers ...
s,
banknote
A banknote—also called a bill (North American English), paper money, or simply a note—is a type of negotiable instrument, negotiable promissory note, made by a bank or other licensed authority, payable to the bearer on demand.
Banknotes w ...
s), and
commercial bank money
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are as ...
.
Commodity money relies on intrinsically valuable commodities that act as a medium of exchange. Fiat money, on the other hand, gets its value from a government order.
Money markets, which provide
liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liqui ...
for the
global financial system
The global financial system is the worldwide framework of legal agreements, institutions, and both formal and informal economic actors that together facilitate international flows of financial capital for purposes of investment and trade finan ...
including for
capital market
A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers t ...
s, are part of the broader system of
financial market
A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets ...
s.
Participants
The money market consists of
financial institution
Financial institutions, sometimes called banking institutions, are business entities that provide services as intermediaries for different types of financial monetary transactions. Broadly speaking, there are three major types of financial inst ...
s and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods, typically up to twelve months. Money market trades in short-term
financial instruments commonly called "paper". This contrasts with the
capital market
A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers t ...
for longer-term funding, which is supplied by
bonds and
equity
Equity may refer to:
Finance, accounting and ownership
* Equity (finance), ownership of assets that have liabilities attached to them
** Stock, equity based on original contributions of cash or other value to a business
** Home equity, the dif ...
.
The core of the money market consists of
interbank lending—banks borrowing and lending to each other using
commercial paper
Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of rarely more than 270 days. In layperson terms, it is like an " IOU" but can be bought and sold because its buyers and sellers have some ...
,
repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
s and similar instruments. These instruments are often benchmarked to (i.e., priced by reference to) the
London Interbank Offered Rate
The London Inter-Bank Offered Rate is an interest-rate average calculated from estimates submitted by the leading banks in London. Each bank estimates what it would be charged were it to borrow from other banks. The resulting average rate is u ...
(LIBOR) for the appropriate term and currency.
Finance companies typically fund themselves by issuing large amounts of
asset-backed commercial paper
Asset-backed commercial paper (ABCP) is a form of commercial paper that is collateralized by other financial assets. Institutional investors usually purchase such instruments in order to diversify their assets and generate short-term gains.
Str ...
(ABCP), which is secured by the
pledge
Pledge may refer to:
Promises
* a solemn promise
* Abstinence pledge, a commitment to practice abstinence, usually teetotalism or chastity
* The Pledge (New Hampshire), a promise about taxes by New Hampshire politicians
* Pledge of Allegianc ...
of eligible assets into an ABCP conduit. Examples of eligible assets include
auto loans, credit card receivables, residential/commercial
mortgage loans
A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any p ...
,
mortgage-backed securities
A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a government agency or investment ba ...
and similar financial assets. Some large corporations with strong
credit rating
A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting.
...
issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf.
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
U.S. Treasury
The Department of the Treasury (USDT) is the national treasury and finance department of the federal government of the United States, where it serves as an executive department. The department oversees the Bureau of Engraving and Printing and t ...
issues
Treasury bills
United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Since 2012, U.S. gov ...
to fund the
U.S. public debt:
* Trading companies often purchase
bankers' acceptance
A banker's acceptance is a commitment by a bank to make a requested future payment. The request will typically specify the payee, the amount, and the date on which it is eligible for payment. After acceptance, the request becomes an unconditional ...
s to tender for payment to overseas suppliers.
* Retail and institutional money market funds
* Banks
*
Central bank
A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union,
and oversees their commercial banking system. In contrast to a commercial bank, a central ba ...
s
* Cash management programs
* Merchant banks
Functions
Money markets serve five functions—to finance trade, finance industry, invest profitably, enhance commercial banks' self-sufficiency, and lubricate
central bank
A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union,
and oversees their commercial banking system. In contrast to a commercial bank, a central ba ...
policies.
"Functions and importance of Money Market"
/ref>
Financing trade
The money market plays a crucial role in financing domestic and international trade
International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. (see: World economy)
In most countries, such trade represents a significant ...
. Commercial finance is made available to the traders through bills of exchange
A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, whose payer is usually named on the document. More specifically, it is a document contemplated by or consisting of a ...
, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.
Financing industry
The money market contributes to the growth of industries in two ways:
* They help industries secure short-term loans to meet their working capital
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
requirements through the system of finance bills, commercial papers, etc.
* Industries generally need long-term loans, which are provided in the capital market
A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers t ...
. However, the capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.
Profitable investments
The money market enables commercial banks to use their excess reserves in profitable investments. The main objective of commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of its depositors. In the money market, the excess reserves of commercial banks are invested in near money assets (e.g., short-term bills of exchange), which are easily converted into cash. Thus, commercial banks earn profits without sacrificing liquidity.
Self-sufficiency of commercial banks
Developed money markets help commercial banks to become self-sufficient. In an emergency, when commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. They can instead meet their requirements by from the money market.
Help to central bank
Though the central bank
A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union,
and oversees their commercial banking system. In contrast to a commercial bank, a central ba ...
can function and influence the banking system in the absence of a money market, the existence of a developed money market smooths the functioning and increases the efficiency of the central bank.
Money markets help central banks in two ways:
* Short-run interest rates serve as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy,
* Sensitive and integrated money markets help the central bank secure quick and widespread influence on the sub-markets, thus facilitating effective policy implementation
Instruments
* Certificate of deposit
A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions in the United States. CDs differ from savings accounts in that the CD has a specific, fixed term (often one, th ...
– Time deposit, commonly offered to consumers by banks, thrift institutions, and credit unions.
* Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
s – Short-term loans—normally for less than one week 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.
*Money market mutual funds - short term investment debt, operated by professional institutions. Money market mutual funds are an investment fund where a number of investors invest their money in mutual fund institutions, and they diversify the funds in various investments.
* Commercial paper
Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of rarely more than 270 days. In layperson terms, it is like an " IOU" but can be bought and sold because its buyers and sellers have some ...
– Short term instruments promissory notes issued by company at discount to face value and redeemed at 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 enterprise
A government-sponsored enterprise (GSE) is a type of financial services corporation created by the United States Congress. Their intended function is to enhance the flow of credit to targeted sectors of the economy, to make those segments of the ...
s such as the Farm Credit System
The Farm Credit System (FCS) in the United States is a nationwide network of borrower-owned lending institutions and specialized service organizations. The Farm Credit System provides more than $304 billion in loans, leases, and related services t ...
, the Federal Home Loan Banks
The Federal Home Loan Banks (FHLBanks, or FHLBank System) are 11 U.S. government-sponsored banks that provide liquidity to the members of financial institutions to support housing finance and community investment.
Overview
The FHLBank System was ...
and the Federal National Mortgage Association
The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the Ne ...
. Money markets is heavily used function.
* Federal funds
In the United States, federal funds are overnight borrowings between banks and other entities to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear ...
– In the U.S., interest-bearing deposits held by banks and other depository institutions at the Federal Reserve
The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate
In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an uncollateralized basis. Reserve balances a ...
.
* Municipal notes – In the U.S., short-term notes issued by municipalities in anticipation of tax receipts or other revenues
* Treasury bills
United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Since 2012, U.S. gov ...
– Short-term debt obligations of a national government that are issued to mature in three to twelve months
* Money fund
A money market fund (also called a money market mutual fund) is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a ...
s – Pooled short-maturity, high-quality investments that buy money market securities on behalf of retail or institutional investors
* Foreign exchange swap
In finance, a foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward) and may use foreign exchange derivatives. ...
s – 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
An asset-backed security (ABS) is a security whose income payments, and hence value, are derived from and collateralized (or "backed") by a specified pool of underlying assets.
The pool of assets is typically a group of small and illiquid asset ...
Discount and accrual instruments
There are two types of instruments in the fixed income market that pay interest at maturity, instead of as coupons
In marketing, a coupon is a ticket or document that can be redeemed for a financial discount or rebate when purchasing a product.
Customarily, coupons are issued by manufacturers of consumer packaged goods
or by retailers, to be used in r ...
—discount instruments and accrual instruments. Discount instruments, like repurchase agreements
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
, are issued at a discount of face value, and their maturity value is the face value. Accrual instruments are issued at face value and mature at face value plus interest.
See also
* Interbank lending market
The interbank lending market is a market in which banks lend funds to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being over day. Such loans are made at the interbank rate (also call ...
* Liquidity crisis In financial economics, a liquidity crisis is an acute shortage of ''liquidity''. Liquidity may refer to market liquidity (the ease with which an asset can be converted into a liquid medium, e.g. cash), funding liquidity (the ease with which borrow ...
* '' Lombard Street: A Description of the Money Market'' – One of the earliest popular books on the money market
* Money fund
A money market fund (also called a money market mutual fund) is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a ...
* Money market account
* Money supply
In macroeconomics, the money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include Circulation (curren ...
* Demand for money
In monetary economics, the demand for money is the desired holding of financial assets in the form of money: that is, cash or bank deposits rather than investments. It can refer to the demand for money narrowly defined as M1 (directly spendable ...
* Liquidity preference
__NOTOC__
In macroeconomic theory, liquidity preference is the demand for money, considered as liquidity. The concept was first developed by John Maynard Keynes in his book '' The General Theory of Employment, Interest and Money'' (1936) to e ...
* Overnight market
The overnight market is the component of the money market involving the shortest term loan. The overnight market is primarily used by banks and other financial institutions. Lenders agree to lend borrowers funds only "overnight" i.e. the borrowe ...
* Sweep account
References
External links
"Money Market Funds Enter a World of Risk"
''New York Times'', September 18, 2008
Study on the identification of euro money market transactions in TARGET2
{{Authority control
Money market instruments
Financial markets