Financial Markets

Chapter 3
Money Markets

Money Markets
● we don't actually trade currency/money here
● wholesale markets
● doesn't give a higher return as other investment; but earns higher return than keeping
the money in banks

Money Market Securities

● security traded in money markets
● short-term
● maturity value: 1 year or less
● highly liquid
● large denomination
● low default risk
● flexible
● readily used for short-term needs
● issued in bulk

Purpose of Money Markets

● ideal for those who are not/willing to commit to long-term investments
● Many investors temporarily house their extra funds because it is less risky

Major Participants in Money Markets

1. Treasury department
- largest money borrowers worldwide
- issues T-bills to raise funds for the gov’t until taxes are collected.
2. Federal Reserve System (or BSP in Ph)
- treasury’s agent for issuing gov’t securities
- when money supply needs to be reduced, they issue treasury securities
- when additional money supply needs to be circulated, it buys back its treasury
securities
- controls money supply with the help of money market securities
3. Commercial Banks
- invest in money market securities because they are not risky
- issues money market securities to raise funds.
4. Businesses
- big corporations buy & sale money market securities to temporarily invest their
extra funds and raise funds to finance their short-term needs
5. Investments and Securities Firms
 - investment companies, finance companies, insurance companies, and pension
funds trade money market securities
6. Individuals

Types of Money Market Securities

1. Treasury Bills
- issued by gov’t when they need to raise/borrow funds and come with a very short
maturity
- 28 days, 91 days, 182 days
- doesn’t technically pay interest on t-bills; issue it at a discount instead
- sold at less than its par value
- market for this is said to be extremely deep, because it has many different buyers
and sellers
- liquid because it can be traded quickly with low transaction costs
- zero default risk; very close to being risk free,thus returns is among the lowest in
the economy (lower risk, lower rewards/return)
2. Federal Funds
- short-term funds transferred between financial institutions, usually for a period of
one day
- main purpose: provide banks with am immediate infusion of reserves should they
run short of minimum reserve requirements
- usually overnight investments
- interest rates: Effective Federal Fund Rate (EFFR); influenced by supply and
demand; usually higher than the returns in t-bill
3. Repurchase Agreements (REPO)
- happens when one party sells securities to another with an agreement to
repurchase the securities at a specified date and price.
- quite similar to Fed Funds except it is not limited to bank/financial institutions
- similar to a loan backed by securities
- borrower fails to buy the securities back, lender has claimed to the said securities
- very short term (3-14 days usually); collateralized with t-securities, they're usually
low-risk investments, thus low interest rate/returns also
- higher returns than bank deposit rates
4. Negotiable Certificate of Deposit (NCD)
- bank-issued securities that document a deposit and specify the interest rate and
the maturity date
- called term deposit; carried on a maturity date unlike regular bank savings w/c
can be withdrawn at any time or on demand
- bearer instruments; whoever holds the instruments at maturity, receives the
maturity value
- Why negotiable? because it can be bought and sold until the maturity date
- maturity; 1-4 months or 6 months or longer; longer maturity, lesser demand
- interest rate is negotiated between banks and customer
5. Commercial Paper
- unsecured promissory notes, issued only by the largest and most creditworthy
corporations, that mature in a short period of time (no more than 27 days)
- usually issued on a discounted basis similar to T-bills
- don’t have strong secondary market because they are less secured compared to
gov’t-issued securities
- most issuers back up their paper with a line of credit at the bank; if issuer can't
pay, bank will lend the firm funds for this purpose
6. Banker’s Acceptance
- indicates that a bank accepts responsibility for a future payment
- ”Exporter that is sending goods to an importer whose credit rating is not known
will often prefer that a bank act as a guarantor
- bearer instruments
- sold on a discounted basis similar to commercial papers and t-bills