Money Market Instruments

Money Market Instruments
 money market instruments are defined as debt instruments with a maturity of one year or less.
Money Markets serve important functions:
 Transfer Funds (savers to borrowers)
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Serves as a pricing benchmark
Facilitates monetary policy by allowing the FRB to control inflation by buying and selling money market instruments

Types of Instruments
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Method of payment of interest
– Interest bearing vs. Discount Instruments
Currency Denominations
– US Dollar vs. Non-USD Instruments
Issuance Market
– United States vs. the “Euro” Markets
Structure
– Fixed-Rate vs. Floating-Rate
Nationality of Borrower
– Domestic vs. Foreign

Interest-Bearing vs. Discount
Instruments
 Interest-Bearing
– Referred to as Coupon Bearing
– The investor pays face value and at maturity received face value plus interest.
 Discount Instruments
– Purchased at a discount from face value; upon maturity the investor receives full face value rather than interest.

Types of Interest-Bearing
Instruments
 Negotiable Certificates of Deposits
(CDs)
– Issued by banks to raise short-term money.
– Negotiable CDs are issued as securities
(versus CDs which are a form of deposit at retail banks).
– No deposit insurance.
– Typical maturity one to twelve months.

Types of Interest-Bearing
Instruments
 Three Types of CDs issued in USD:
– Domestic CD: issued by a US bank in the
US for local markets.
– Foreign or Yankee CD: issued by a foreign bank in the US.
– Eurodollar CD: issued by a large US or foreign bank in the “Euro” market (an offshore market primarily located in London).

Types of Interest-Bearing
Instruments
 Floating-Rate CD: securities issued with a 3 to 5 year maturity have coupons that change (or float) based on a spread over a benchmarked reference rate.

Types of Interest-Bearing
Instruments
 Federal Funds Market
– Controlled by the Federal Reserve.
– Provides overnight liquidity solutions.
– The Fed requires that all depositories keep
“reserves” on-hand in their Federal
Reserve account.
– Non-Collateralized.

Types of Interest-Bearing
Instruments
 Repurchase Agreements
– Institutions can also borrow/invest using repurchase argeements or in the repo market.
– Typically overnight investments
– Collateralized.

Types of Interest-Bearing
Instruments
 Interbank Markets
– Bank-to-Bank borrowing.
– Highly developed interbank market within the Euro market.
– LIBOR: London Interbank Offered Rate
– Unregulated Market (since it is off-shore).

Types of Discount Instruments
 Treasury Bills
– US government issues:
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Three- and six-month T-Bills weekly
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Twelve month T-Bills monthly
– Threemonth bill is known as the “risk-free” rate.
– Issued through an auction processes:
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Competitive bid (indicates price bidder is willing to pay).
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Non-Competitive bid (indicates the average price bidders are willing to pay).

Types of Discount Instruments
 Commercial Paper
– Short-term debt instrument issued by corporations.
– Issued on a discount basis in maturities ranging from one to 270 days.
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Securities in this maturity range are exempt from SEC registration requirements.
– Global CP markets.

Types of Discount Instruments
 Bankers Acceptances
– Form of short-term bank borrowing created by facilitating import/export transactions.
– Bank provides a letter of credit to an exporter

LC guarantees payment at the end of a set periods for goods that they have exported.
– Bank sells this commitment in the money market
(making it into a security) and creating a bankers acceptance.

Types of Discount Instruments
Exporter
LC
Bank
LC guarantees payment to
Exporter Bank assumes risk from Importer
LC
Importer
Goods received
Payment Rec’d
Payment
Rec’d