Must know money market instruments

The money market is a place where issuers go to obtain short-term financing. An issuer who needs funds for a short term, typically under one year, will sell short-term instruments known as money market instruments to obtain the necessary funds. Corporations, Municipalities, and the US Government will all use the money market to obtain short-term financing.

Money Market Instruments

Money market instruments are highly liquid, fixed-income securities issued by governments and corporations with high credit ratings. Because of the high quality of the issuers and because of the short-term maturities, money market instruments are considered very safe.

Corporate Money Market Instruments

Both corporations and banks sell money market instruments to obtain short term financing. These money market instruments issued will include:

  • Banker’ acceptances
  • Negotiable certificates of deposit
  • Commercial paper
  • Federal funds loans
  • Repurchase agreements
  • Reverse repurchase agreements

Banker’s Acceptances

Corporations, in order to facilitate foreign trade, import/export, use Banker’s acceptances. The Banker’s acceptance acts like a line of credit or a post-dated check. The BA (Banker’s Acceptance) is a time draft that will be cleared by the issuing bank on the day it comes due to whomever presents it for payment. The maturity dates on banker’s acceptances range from as little as one day to a maximum of 270 days (9 months).

Negotiable Certificates of Deposit

A negotiable CD is a time deposit with a fixed interest rate and a set maturity ranging from 30 days to 10 years or more. A negotiable CD, unlike the traditional CD, may be exchanged or traded between investors. The minimum denomination for a negotiable CD is $100,000. Many negotiable CDs are issued in denominations exceeding $1,000,000 but FDIC only insures the first $250,000.

Commercial Paper

The largest and most creditworthy corporations use commercial paper as a way to obtain short-term funds. Commercial paper is an unsecured promissory note or an IOU issued by the corporation. Corporations will sell commercial paper to finance such things as short-term working capital or to meet their cash needs due to seasonal business cycles. Commercial paper maturities range from one day to a maximum of 270 days. It is issued at a discount to its face value and has an interest rate that is below what a commercial bank would typically charge for the funds. Commercial paper is typically issued in book entry form. There are two types of commercial paper: direct paper and dealer paper. With direct paper, the issuer sells it directly to the public without the use of a dealer. Dealer paper is sold to dealers who then resell the paper to investors.

Federal Fund Loans

Federal fund loans are loans between two large banks that are typically made for short periods of time in amounts of $1,000,000 or more. Should the lender wish to sell the fed funds loan the loan may be exchanged in the money market between investors.

Repurchase Agreements

A repurchase agreement is a fully collateralized loan made between a dealer and a large institutional investor. These loans are usually collateralized with US Government securities that have been sold to the lender. The borrower (Seller) agrees to repurchase the securities from the lender at a slightly higher price. The slightly higher price represents the lender’s interest.

Reverse Repurchase Agreement

In a reverse repurchase agreement, the institutional investor initiates the transaction by selling the securities to the dealer and agrees to repurchase them at a later time. In a reverse repurchase agreement the borrower (seller) is the institution, not the dealer.

Fixed Vs. Open Repurchase Agreements

With a fixed repurchase agreement, the borrower (seller) agrees to repurchase the securities at a fixed price on a specified date. With an open repurchase agreement, the date of the repurchase is not fixed and the open repurchase agreement becomes a demand note for the lender and may be called in.

Note:
Corporate issues with less than one year to maturity, regardless of the original maturity, may be traded in the money market.

Government Money Market Instruments

The Government and many of its agencies will go to the money market to obtain short-term funds. Some of the government money market instruments include:

  • Treasury Bills
  • Treasury and agency securities with less than one year remaining
  • Short term discount notes issued by government agencies

Municipal Money Market Instruments

State and local government will sell securities in the municipal money market to obtain short-term financing. The municipal money market instruments are:

  • Bond anticipation notes
  • Tax anticipation notes
  • Revenue anticipation note
  • Tax and revenue anticipation notes
  • Tax exempt commercial paper

Government and municipal issues with less than one year to maturity, regardless of the original maturity, may be traded in the money market.

International Money Market Instruments

Often large institutions will place US dollars in foreign accounts to earn a higher rate of interest. These dollars being held outside of the US are known as Eurodollars. A US dollar denominated account outside of the US is known as a Eurodollar deposit. These deposits typically have maturities of up to 180 days and they are traded between large European banks and institutions, much like federal fund loans in the US.

 

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The Securities Institute of America, Inc.

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