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Money Market Funds: Major Investors in Commercial
Money Market Funds: Major Investors in Commercial
Money Market Funds: Major Investors in Commercial
-Even investors who focus on long-term securities tend to 1. a short-term debt instrument issued only by well-
hold some money market securities known, creditworthy firms that is typically unsecured.
2. normally issued to provide liquidity or to finance a
-enable financial market participants to maintain liquidity. firm’s investment in inventory and accounts
receivable.
3. The issuance is an alternative to short-term bank
MONEY MARKET SECURITIES loans.
4. Preferred to be issued by some large firms rather than
1. debt securities with a maturity of one year or less borrow from a bank because it is usually a cheaper
2. issued in the primary market through a source of funds.
telecommunications network by the Treasury, 5. Nevertheless, even the large creditworthy firms that
corporations, and financial intermediaries that wish to are able to issue commercial paper normally obtain
obtain short-term financing. some short-term loans from commercial banks in
3. The U.S. Treasury issues money market securities order to maintain a business relationship with them.
(Treasury bills) and uses the proceeds to finance the
budget deficit.
4. Issued by Corporations and use the proceeds to
support their existing operations or to expand their
operations.
5. May be issued by financial institutions and bundle the
proceeds to make loans to households or Major issuers of Commercial Paper
corporations.
6. The Treasury and some corporations commonly pay -Financial institutions such as finance companies and bank
off their debt from maturing money market securities holding companies are major issuers of commercial paper.
with the proceeds from issuing new money market
securities. In this way, they are able to finance
expenditures for long periods of time even though Denomination
money market securities have short-term maturities.
7. allow households, corporations, and the U.S. minimum denomination is usually $100,000, and
government to increase their expenditures; thus the typical denominations are in multiples of $1 million.
markets finance economic growth. Maturities are normally between 20 and 45 days but
8. commonly purchased by households, corporations can be as short as 1 day or as long as 270 days.
(including financial institutions), and government The 270-day maximum is due to a Securities and
agencies that have funds available for a short-term Exchange Commission ruling that paper with a
period. maturity exceeding 270 days must be registered.
9. Because they have a short-term maturity and can Because of the high minimum denomination,
typically be sold in the secondary market, they provide individual investors rarely purchase commercial paper
liquidity to investors directly, although they may invest in it indirectly by
investing in money market funds that have pooled the
funds of many individuals.
More popular money market securities Money market funds: major investors in commercial
paper.
1. Treasury bills (T-bills) Although the secondary market for commercial paper
2. Commercial paper is very limited, it is sometimes possible to sell the
3. Negotiable certificates of deposit paper back to the dealer who initially helped to place
4. Repurchase agreements it. However, in most cases, investors hold commercial
5. Federal funds paper until maturity
6. Banker’s acceptances
T-BILLS
Credit Risk
-When the U.S. government needs to borrow funds, the
U.S. Treasury frequently issues short-term securities issued by corporations that are susceptible to
known as Treasury bills. business failure so it is subject to credit risk.
The risk of default is affected by the issuer’s financial
-The Treasury Issues T-bills with 4-week, 13-week, and 26- condition and cash flow.
week maturities on a weekly basis. Investors can attempt to assess the probability that
commercial paper will default by monitoring the
-It periodically issues T-bills with terms shorter than four issuer’s financial condition.
weeks, which are called cash management bills. It also
The focus is on the issuer’s ability to repay its debt Backing Commercial Paper
over the short term because the payments must be
completed within a short-term period. Some commercial paper is backed by assets of the
Although issuers of commercial paper are subject to issuer.
possible default, historically the percentage of issues Commercial paper that is backed by assets should
that have defaulted is very low, as most issuers of offer a lower yield than if it were not secured by
commercial paper are very strong financially. assets.
In addition, the short time period of the credit reduces However, the issuers of asset-backed commercial
the chance that an issuer will suffer financial problems paper tend to have more risk of default than the well-
before repaying the funds borrowed. known firms that can successfully issue unsecured
However, during the credit crisis in 2008, Lehman commercial paper, and the value of assets used as
Brothers (large securities firm) failed. This made collateral may be questionable.
investors more cautious before purchasing securities Thus yields offered on asset-backed commercial
paper are often higher than the yields offered on
unsecured commercial paper.
Some issuers of asset-backed commercial paper
Credit Risk Ratings obtain credit guarantees from a sponsoring institution
in the event that they cannot cover their payments on
Commercial paper is commonly rated by rating
commercial paper. This allows them to more easily
agencies such as:
sell their commercial paper to investors
o Moody’s Investors Service
Issuers of commercial paper typically maintain backup
o Standard & Poor’s Corporation
lines of credit in case they cannot roll over (reissue)
o Fitch Investor Service.
commercial paper at a reasonable rate because, for
Rating serves as an indicator of the potential risk of example, their assigned rating has been lowered.
default. A backup line of credit provided by a commercial
Some investors rely heavily on the rating to assess bank gives the company the right (but not the
credit risk, rather than assess the risk of the issuer obligation) to borrow a specified maximum amount of
themselves. funds over a specified period of time.
A money market fund can invest only in commercial The fee for the credit line can either be a direct
paper that has a top-tier or second-tier rating, and percentage (e.g., 0.5 percent) of the total accessible
second-tier paper cannot represent more than 5 credit or be in the form of required compensating
percent of the fund’s assets. balances (e.g., 10 percent of the credit line).
Thus, corporations can more easily place commercial
paper that is assigned a top-tier rating.
Junk Commercial Paper: commercial paper that is
rated low or not rated at all. Estimating the Yield