Money markets

Essential components of any country's financial system

There a number of individual money markets each of which is defined by its own respective instrument

Derive their name because they are wholesale financial markets that deal with the buying and selling of money or near money instruments which can be converted into cash at very short notice

The money markets are considered to be a group of individual sub markets, each of which is characterised by its own inherent financial instruments with their own unique features

All of the individual markets trade in low risk unsecured debt instrument which facilitate or act as mechanisms for the movement of short term finance from those parties with a short term need for liquidity

The movement of these short term funds are facilitated by the markets key participants which are a network of banks including central and overseas banks, institutional investors and government bodies which borrow and lend among themselves

All of the individual markets are highly organised however no formal exchanges are involved and there are no central locations

Participants may be lenders in one market while being borrowers in other depending on their particular short term funding requirements

The main money markets are

Deposit (cash) market

Treasury Bill (T-Bill) market

Commercial paper (CP) market

Certificates of deposit (CD) market

Main users of money market instruments

Governments: usually act via their central banks. In the UK this role is executed through the Debt Management Office

Central banks

Commercial banks, including overseas banks: Supply and utilise money market funds and can also act as intermediaries between other participants. Banks with a surplus of funds may wish to utilise the funds to their best advantage. Other banks might well be short of funds. By using MMIs, commercial banks can thus ensure that excesses and shortages are reallocated

Large national and multinational corporations insurance companies and pension funds: Companies can be both borrowers and providers of finance in the money markets. Those with cash surpluses may invest in these short instruments while those who need to borrow for short-term period can do so. Larger corporations will participate in the market either directly or through brokers, whereas smaller companies will invest in money market funds consisting of only short instruments

Money market instruments

Fall into two broad categories

Those with coupons

Those without coupons

These are issued at a discount to their par value which means that any purchaser will pay less than the par value of the instrument however they will still receive their face value at maturity

All are debt instruments used by its key participants in order to facilitate the movement of large amount of short term money between themselves

Usually have maturities of less than one year although potentially could be for longer period

The amounts traded each working day tend to be for many billions of pounds or dollars

The two key considerations are the short term nature of the market together with the vast sizes of the individual trades

Returns tend to be low as they are considered exceptionally safe and hence the degree of risk is deemed low

Shown as cash on a lenders balance sheet

Have no central trading venue with dealing in MMIs taking place by telephone and also via computer terminals rather than on any formal exchange

Issuers of MMIs are borrowers while purchasers are lender

Core characteristics of MMIs

All are debt instruments of short-tenor (short term to maturity from one to 360 days)

No security is provided by borrowers to lenders. The reputation of the issuer is deemed sufficient

There is no public register although they are recorded by issuers

There is a perception of low risk

Instruments are of large denominations

They are predominately although not exclusively used by institutional rather than individual investors

They are always OTC

They are unregulated yet sophisticated

They have no central trading location

They are used as mechanisms for the absorption and redistribution of cash surpluses

Interbank deposits

The simplest and most liquid of all MMIs; they are available for varying maturities. The majority of interbank deposits are for three months or less. They are unsecured and are usually for a minimum amount of £500,000

Interest on such deposits is calculated on a simple interest rather than a compound interest basis

Certificates of Deposit

Fully negotiable short term MMIs that are acknowledgements of indebtedness issued by banks and other financial organisations to other institutional investors

Have specific maturity dates ranging from thee months to one year

Rank as unsecured creditors

Can only be issued by those institutions that have been authorised to accept deposits in possession of a Part IV permission under the Financial Services and Markets Act 2000

Coupon payments are made

The issuer will acknowledge that in relation the value of certificates issued a sum has been deposited with it on terms that the principal amount is repayable together with interest on the maturity date payable at the rate and under the terms and conditions set out

At the end of the fixed term, the deposit is returned to the investor together with interest

Coupon can be either fixed or floated

Minimum denomination of £100,000

As there is a perception of higher risk, interest rates tend to be higher than on T-Bills

Predominately issued in dematerialised form and held in CREST but they can also be issued in paper form if they keep to conditions laid down by the British Banker's Association

All CD payments are made through CREST including interest and it is necessary for both issuers and purchasers to be CREST member

Yields depend on

Credit rating of the issue

Amount invested

Level of interest rates for the currency in which the CD is denominated