Money Market
Why Money Markets Exist?
the regulation of banks creates distinct cost advantaged for the necessary use of money markets:
- reserve requirements create additional expense for banks that money markets dint have
- regulations on level of interest banks should offer depositors lead to a significant growth in money markets
- cost structure of banks limit their competitiveness to situations where their informational advantages outweigh their regulatory costs
Money Markets
enable the flow of funds between institutions with surplus money to land & those needing to borrow (money not actually traded in the market)
securities in money market are short term with high liquidity (so very close to being money) usually in large denominations
it is a wholesale market rather than retail thus low default risks & transaction costs
mature one year or less from the issue date, returns are low because of the low risk & high liquidity
Purpose of Money Markets
investors in money markets provide a place for warehousing surplus for short periods of time
borrowers from money markets provide low cost source of temporary funds
corporations & government use these markets because the timing of cash inflows & outflows are not well synchronised
money markets provide a way to solve each timing problem
Federal Funds
short term funds transferred between financial institutions, period of one day
used by banks to meet short term needs to meet reserve requirement s
Us banks analyse their reserve position daily & either borrow/invest in Fed funds
Repurchase Agreements
similar to arket for Fed funds but non-banks can't participate
a firm sells Treasury securities but agrees to buy them back at a certain date, usually up to 14 days for a certain price, there is low risk in this deal,
Commercial Paper
unsecured promissory notes, issued by corporations that mature in no more than 270 days
used to finance operating expenses or current assets, they help finance companies use for loans
only largest & most credit worthy corporations issue commercial paper, are sold directly or via a dealer in the secondary market
usually issued at a discount & redeemed at face value rather than the borrower paying interest - discount rate higher than t-bills due to greater default risk & less liquidity
Asset Backed Commercial Paper
secured on income receivable from mortgage interest, cash flow is used to pay for CP earn due & need to provide collateral
played a key role in financial crisis backed by securities mortgages
when the poor quality of the underwriting assets as exposed , a run on ABCP began as ABCP was held by many money market mutual funds
Banker's Acceptance
order to pay a specified amount to the bearer on a given date if specified conditions have been met, used when buyers/sellers of expensive good live abroad
exporter doesn't have to assess financial security of importer, payment of the bill on maturity is now guaranteed by the endorsing bank
acceptance fee must be paid - maturity 30-180 days
intererst rates are ,ow as they are crucial to international trade
Eurodollars
represent dollar denominated deposits held in foregone banks
market essential since many foreign contracts call for payments in US dollars due to the stability of the dollar relative to other currencies
- London Interbank Bid Rate - rate paid by banks buying funds
- London Interbank Offer Rate- rate offered for sale of funds
- Time Deposits with Fixed Maturities - largest short term security in the world