Financial Management

Maam Asifa Maqbool

Muhammad Umar Raza

BE-13-30

What Are Money Markets?

They provide a means for lenders and borrowers to satisfy their short-term financial
needs
UNTIL problems surfaced during the global financial crisis, money markets were
often taken for granted as plain-vanilla, low-volatility segments of the financial
system.
For the most part, money markets provide those with fundsbanks, money
managers, and retail investorsa means for safe, liquid, short-term investments,
and they offer borrowersbanks, broker-dealers, hedge funds, and nonfinancial
corporationsaccess to low-cost funds. The term money market is an umbrella that
covers several market types, which vary according to the needs of the lenders and
borrowers.
One consequence of the financial crisis has been to focus attention on the
differences among various segments of money markets, because some proved to be
fragile, whereas others exhibited a good deal of resilience

Participants in Money Markets:

The money market consists of financial institutions and dealers in money or credit
who wish to either borrow or lend. Participants borrow and lend for short periods,
typically up to thirteen months. Money market trades in short-term financial
instruments commonly called "paper". This contrasts with the capital market for
longer-term funding, which is supplied by bonds and equity.
The core of the money market consists of interbank lendingbanks borrowing and
lending to each other using commercial paper, repurchase agreements and similar
instruments. These instruments are often benchmarked to (i.e., priced by reference
to) the London Interbank Offered Rate (LIBOR) for the appropriate term and
currency.
Finance companies typically fund themselves by issuing large amounts of assetbacked commercial paper (ABCP) which is secured by the pledge of eligible assets
into an ABCP conduit. Examples of eligible assets include auto loans, credit card
receivables, residential/commercial mortgage loans, mortgage-backed securities
and similar financial assets. Some large corporations with strong credit ratings, such
as General Electric, issue commercial paper on their own credit. Other large
corporations arrange for banks to issue commercial paper on their behalf.

Trading companies often purchase bankers' acceptances to be tendered for

payment to overseas suppliers.

Retail and institutional money market funds

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Banks

Cash management programs

Merchant banks

Functions of the money market:

Money markets serve five functions
1.
2.
3.
4.
5.

Finance trade
Finance industry
Invest profitably
Enhance commercial banks
Self-sufficiency & Lubricate central bank policies.

Financing trade
The money market plays crucial role in financing domestic and international trade.
Commercial finance is made available to the traders through bills of exchange,
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 requirements through the system of finance bills, commercial papers,
etc.

Industries generally need long-term loans, which are provided in the capital
market. 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 investment
The money market enables the commercial banks to use their excess reserves in
profitable investment. The main objective of the commercial banks is to earn
income from its reserves as well as maintain liquidity to meet the uncertain cash
demand of the depositors. In the money market, the excess reserves of the
commercial banks are invested in near-money assets (e.g., short-term bills of
exchange) which are highly liquid and can be easily converted into cash. Thus, the
commercial banks earn profits without sacrificing liquidity.

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 Self-sufficiency of commercial bank

Developed money markets help the commercial banks to become self-sufficient. In
the situation of emergency, when the commercial banks have scarcity of funds, they
need not approach the central bank and borrow at a higher interest rate. On the
other hand, they can meet their requirements by recalling their old short-run loans
from the money market.

Help to central bank

Though the central bank can function and influence the banking system in the
absence of a money market, the existence of a developed money market
smoothens 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

Money market instruments:

Certificate of deposit Time deposit, commonly offered to consumers by

banks, thrift institutions, and credit unions.

Repurchase agreements Short-term loansnormally for less than two

weeks and frequently for one dayarranged by selling securities to an
investor with an agreement to repurchase them at a fixed price on a fixed
date.

Commercial paper Short term usanse 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 enterprises such as the Farm Credit System,
the Federal Home Loan Banks and the Federal National Mortgage Association.

Federal funds In the U.S., interest-bearing deposits held by banks and other
depository institutions at the Federal Reserve; these are immediately
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available funds that institutions borrow or lend, usually on an overnight basis.

They are lent for the federal funds rate.

Municipal notes In the U.S., short-term notes issued by municipalities in

anticipation of tax receipts or other revenues.

Treasury bills Short-term debt obligations of a national government that are

issued to mature in three to twelve months.

Money funds Pooled short-maturity, high-quality investments which buy

money market securities on behalf of retail or institutional investors.

Foreign exchange swaps 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

Discount and accrual instruments

There are two types of instruments in the fixed income market that pay interest at
maturity, instead of as couponsdiscount instruments and accrual instruments.
Discount instruments, like repurchase agreements, 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.

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Thank You

Institute of Management Sciences, B.Z.U Multan