Money Market Instruments | What is Money Market | Assets Classification and Financial Instruments | Investment Management

What is Money Market

The market for trading short-term securities is known as the Money market. Money market securities are issued by high quality (that is, low default risk) economic units such as governments, financial institutions, and other corporate organizations of sound financial standing that require short-term funds. These securities are sold in large denominations and therefore are purchased by economic units such as banks, financial institutions, and corporate organizations that have excess short-term funds.

Money Market Instruments

Treasury Bills

Short-term securities issued by the government of the related nation. Treasury bills are the short-term debt issued by the government of the country. T-bills are issued at discount from the face value and investors receive face value at maturity. Most of the T-bills are issued with the denomination of $100 and $1000. These T-bill securities are exempt from all state and local taxes, another characteristic distinguishing them from other money market instruments. The difference between the face value and the discounted price is earning for the investors.

T-bills are issued with initial maturities of 4, 13, 26, or 52 weeks. Generally, T-bills are issued for institutional investors first, and with the help of government security dealers, individual investors can purchase by auction from the secondary market easily. When an individual investor wants to buy T-bills from the secondary market they have to pay an Ask price and when he/she wants to sell the T-bills will get a Bid price that is slightly lower than the Ask price. The difference between an Ask price and a bid price is called a bid-ask spread which represents dealers’ profit. Yield is the most effective instrument of evaluating the

Treasury bill’s quality and it is calculated on four methods. Those are as follows:-

Bank discount yield = discount on T-bills as a fraction of face value which is annualized using 360 days in a year.

Bank discount Yield = (F.V.-P)/(F.V.)×360/t

Where,

F.V. = Face value
P = Discounted Value
t = maturity Period

Bond Equivalent Yield = discount on T-bills as a fraction of price which is annualized using 365 days a year.
Bond Equivalent Yield = (F.V.-P)/P×365/t

Bond equivalent yield is always higher than the bank discount yield since it is based on the price of the bill rather than face value and it is annualized using 365 days in a year rather than 360 days.

Holding Period Return = The rate of return realized for a given holding period. It is also known as the periodic rate of return.
Holding period rate of return = ( F.V.-P)/P

Effective annual yield =  the annual equivalent yield of quoted annual nominal interest rate on money market securities with less than one year of maturity. (interest also earns interest)
Effective annual yield (EAY) =(〖1+HPR)〗^(365/t)- 1
or,
EAY=〖(1+BEY/(365/t))〗^(365/t) -1

Treasury Bills MCQs

Why do u.s. treasury bills have lower interest rates than large-denomination negotiable bank cds?

A sale of treasury bills by the federal reserve _____ interest rates and _____ the money supply.

 

Certificate of Deposit

A certificate of deposit, or CD, is a time deposit with a bank. Time deposits may not be withdrawn on demand. In other words, the CD is the evidence of the deposit of funds in a commercial bank or saving or loan association for a specified period at a specified rate of interest. The bank pays interest and principal to the depositor only at the end of the fixed term of the CD.

CDs issued in denominations greater than $100,000 are usually negotiable, however; that is, they can be sold to another investor if the owner needs to cash in the certificate before its maturity date. Short-term CDs are highly marketable, although the market significantly thins out for maturities of 3 months or more.

Certificate of Deposit MCQs

In which situation would a certificate of deposit (cd) be the best banking choice?

Which statements apply to a certificate of deposit (cd)? check all that apply.

Commercial paper

A short-term, unsecured negotiable promissory note issued by a company to raise funds from the money market. Commercial paper is an unsecured short-term promissory note issued by well-established companies having unquestionable financial soundness. Only the most creditworthy companies issue short-term negotiable promissory notes as a money market instrument to raise the funds for the short term. Generally, Commercial papers are issued a maturity period of fewer than 270 days in a variety of large denominations.

Commercial papers are not traded in the secondary market as bonds and shares. The trading of commercial paper occurs among institutional investors rather than individual investors. Commercial papers are highly risky because it is less flexible i.e. it cannot be redeemed before maturity time.

There are two types of commercial papers;

Direct paper

It is issued mainly by large finance companies and banks holding companies directly to the investor.

Dealer paper

It is issued by security dealers on behalf of corporate customers. (Mainly non-financial companies and smaller financial companies.

Commercial paper MCQs

Which of the following companies would most likely be able to issue commercial paper?

Commercial paper offers which of the following advantages to the issuer?

Bankers Acceptance

The draft is accepted by the bank and used in financing foreign and domestic trade. Banker’s Acceptance is the promised future payment or time draft which is accepted and guaranteed by a bank and drawn on a deposit at the bank. In other words, the buyer, to ensure payment to the seller, request its bank to issue a written promise on its behalf, authorizing the seller to draw a time draft(that is on order to pay a specified amount at a specified time) on the bank in payment for the goods is called Banker’s Acceptance.

Banker’s Acceptance specifies the amount of money, the date, and the person to whom the payment is due after acceptance. The draft becomes an unconditional liability of the bank but the holder of the draft can sell, exchange it for cash at a discount to a buyer who is willing to wait until the maturity date for the funds in the deposit.

 

Euro Dollar

Eurodollar deposit is the dollar-dominated bank deposit held in a bank outside the United States. Eurodollars are dollar-denominated the time deposit at foreign or branches of American banks. It is similar to a certificate of deposit. A certificate of deposit is a time deposit on the domestic bank but Eurodollar deposits are time deposits on a non-U.S. branch of a bank. Most of the Eurodollars are issued for less than 6 months. Euro-dollar deposits are less liquid and riskier than domestic CDs, however, and thus offer higher yields. Eurodollars are used in international trade payments.

 

The LIBOR Market

London interbank offered rate is the benchmark interest rate that banks charge each other for short-term loans. It refers to the rate of interbank short-term borrowing which is quoted on dollar denomination. In other words, The London Interbank Offered Rate (LIBOR) is the rate at which large banks in London are willing to lend money among them. It is a short-term market rate for banks where one bank borrows from others at a LIBOR rate. This rate is a benchmark for bank rates all over the world. Corporations also borrow loans from institutions 1or 2 percent above the LIBOR market. So, LIBOR is the reference for all financial transactions.

 

Money Market Instruments Quizlet

Prices of money market instruments undergo the least price fluctuations because of

Which of the following are money market instruments? check all that apply.

Which of the following instruments is not traded in a money market?

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