Money market
Encyclopedia
The money market is a component of the financial market
s for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper
, bankers' acceptance
s, certificates of deposit, federal funds, and short-lived mortgage-
and asset-backed securities
. It provides liquidity
funding for the global financial system
.
s and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods of time, 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 lending
--banks borrowing and lending to each other using commercial paper
, repurchase agreement
s 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, such as GMAC, typically fund themselves by issuing large amounts of asset-backed
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. Certain large corporations with strong credit rating
s, such as General Electric
, issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf via commercial paper lines.
In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issue municipal paper
, while the US Treasury issues Treasury bills to fund the US public debt
.
Financial market
In economics, a financial market is a mechanism that allows people and entities to buy and sell financial securities , commodities , and other fungible items of value at low transaction costs and at prices that reflect supply and demand.Both general markets and...
s for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper
Commercial paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...
, bankers' acceptance
Bankers' acceptance
A banker's acceptance, or BA, is a promised future payment, or time draft, which is accepted and guaranteed by a bank and drawn on a deposit at the bank. The banker's acceptance specifies the amount of money, the date, and the person to which the payment is due. After acceptance, the draft...
s, certificates of deposit, federal funds, and short-lived mortgage-
Mortgage-backed security
A mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
and asset-backed securities
Asset-backed security
An asset-backed security is a security whose value and income payments are derived from and collateralized by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually...
. It provides liquidity
Market liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
funding for the global financial system
Global financial system
The global financial system is the financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level...
.
Overview
The money market consists of financial institutionFinancial institution
In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...
s and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods of time, typically up to thirteen months. Money market trades in short-term financial instruments commonly called "paper." This contrasts with the capital market
Capital market
A capital market is a market for securities , where business enterprises and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets...
for longer-term funding, which is supplied by bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
and equity
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
.
The core of the money market consists of interbank lending
Interbank lending market
The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate...
--banks borrowing and lending to each other using commercial paper
Commercial paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...
, repurchase agreement
Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...
s and similar instruments. These instruments are often benchmarked to (i.e. priced by reference to) the London Interbank Offered Rate
London Interbank Offered Rate
The LIBOR rate is the average interest rate that leading banks in London charge when lending to other banks. It is an acronym for London Interbank Offered Rate Banks borrow money for one day, one month, two months, six months, one year etc. and they pay interest to their lenders based on...
(LIBOR) for the appropriate term and currency.
Finance companies, such as GMAC, typically fund themselves by issuing large amounts of asset-backed
Asset-backed security
An asset-backed security is a security whose value and income payments are derived from and collateralized by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually...
commercial paper
Commercial paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...
(ABCP) which is secured by the pledge
Pledge (law)
A pledge is a bailment or deposit of personal property to a creditor to secure repayment for some debt or engagement, The term is also used to denote the property which constitutes the security....
of eligible assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial mortgage loans, mortgage-backed securities
Mortgage-backed security
A mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
and similar financial assets. Certain large corporations with strong credit rating
Credit rating
A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by a credit rating agency of the debt issuers likelihood of default. Credit ratings are...
s, such as General Electric
General Electric
General Electric Company , or GE, is an American multinational conglomerate corporation incorporated in Schenectady, New York and headquartered in Fairfield, Connecticut, United States...
, issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf via commercial paper lines.
In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issue municipal paper
Municipal bond
A municipal bond is a bond issued by a city or other local government, or their agencies. Potential issuers of municipal bonds includes cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any...
, while the US Treasury issues Treasury bills to fund the US public debt
United States public debt
The United States public debt is the money borrowed by the federal government of the United States at any one time through the issue of securities by the Treasury and other federal government agencies...
.
- Trading companies often purchase bankers' acceptanceBankers' acceptanceA banker's acceptance, or BA, is a promised future payment, or time draft, which is accepted and guaranteed by a bank and drawn on a deposit at the bank. The banker's acceptance specifies the amount of money, the date, and the person to which the payment is due. After acceptance, the draft...
s to be tendered for payment to overseas suppliers. - Retail and institutional money market funds
- Banks
- Central banks
- Cash management programs
- ArbitrageArbitrageIn economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...
ABCP conduits, which seek to buy higher yielding paper, while themselves selling cheaper paper. - Merchant Banks
Common money market instruments
- Certificate of depositCertificate of depositA certificate of Deposit is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions....
- Time deposits, commonly offered to consumers by banks, thrift institutions, and credit unions. - Repurchase agreementRepurchase agreementA repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...
s - Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date. - Commercial paperCommercial paperIn the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...
- Unsecured promissory notes with a fixed maturity of one to 270 days; usually sold at a discount from 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 SystemFarm Credit SystemThe Farm Credit System is a federally chartered network of cooperatives and related service organizations that lends to agricultural producers, rural homeowners, farm-related businesses, and agricultural, aquatic, and public utility cooperatives in the United States...
, the Federal Home Loan BanksFederal Home Loan BanksThe Federal Home Loan Banks are 12 U.S. government-sponsored banks that provide stable, on-demand, low-cost funding to American financial institutions for home mortgage loans, small business, rural, agricultural, and economic development lending...
and the Federal National Mortgage AssociationFederal National Mortgage AssociationThe Federal National Mortgage Association , commonly known as Fannie Mae, was founded in 1938 during the Great Depression as part of the New Deal. It is a government-sponsored enterprise , though it has been a publicly traded company since 1968...
. - Federal fundsFederal fundsIn the United States, federal funds are overnight borrowings by banks to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions...
- (in the U.S.). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rateFederal funds rateIn the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend...
. - Municipal notesMunicipal bondA municipal bond is a bond issued by a city or other local government, or their agencies. Potential issuers of municipal bonds includes cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any...
- (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 fundMoney fundA money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely regarded as being as safe as bank deposits yet providing a higher yield...
s - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors. - Foreign Exchange SwapsForex swapIn finance, a forex swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates .; see Foreign exchange derivative.-Structure:...
- 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-Mortgage-backed securityA mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
and asset-backed securitiesAsset-backed securityAn asset-backed security is a security whose value and income payments are derived from and collateralized by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually...
See also
- Liquidity crisisLiquidity crisisIn financial economics, liquidity is a catch-all term that may refer to several different yet closely related concepts. Among other things, it may refer to Asset Market liquidity In financial economics, liquidity is a catch-all term that may refer to several different yet closely related...
- Interbank lending marketInterbank lending marketThe interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate...
- Money market account
- Money fundMoney fundA money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely regarded as being as safe as bank deposits yet providing a higher yield...
- Money supplyMoney supplyIn economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
- Overnight marketOvernight marketThe overnight market is the component of the money market involving the shortest term loan. Lenders agree to lend borrowers funds only "overnight" i.e. the borrower must repay the borrowed funds plus interest at the start of business the next day...
- Sweep accountSweep accountA sweep account is an account set up at a bank or other financial institution where the funds are automatically managed between a primary cash account and secondary investment accounts.- Overview :...
- Lombard Street, A Description of the Money MarketLombard Street, A Description of the Money MarketLombard Street: A Description of the Money Market is an influential book by Walter Bagehot. Bagehot was one of the first writers to describe and explain the world of international and corporate finance, banking, and money in understandable language....
, one of the earliest popular books on the money market
External links
- Money Market Funds Enter a World of Risk September 18, 2008, New York Times.