Chapter- Money Markets

 Money Market:
Money markets are used to facilitate the transfer of short term funds from individuals,
corporations or government , with excess funds to those with deficit funds.

 Money Market Securities:

Securities with maturities within one year are referred to as money market securities. They are
issued by corporations & governments to obtain short term funds.
In other words we can say that- “ Money Market securities are those that are commonly
purchased by households, corporations and government agencies having funds available for a
short term period”.

 Popular Money Market Securities:

1. Treasury Bill:
When the government needs to borrow funds, they frequently issues short term securities known
as treasury bills or T-bills. It’s a secured money market instrument. The investors in treasury
bills are-
 Depository institutions
 Other financial institutions
 Individuals and
 Corporations
The treasury issues T-bills on a weekly basis with 4-weeks,13-weeks and 20-weeks
maturities. 𝑺𝑺−
𝑺𝑺𝑺𝑺𝑺 𝟑𝟑𝟑𝟑𝟑𝟑
Yt=
𝑺𝑺𝑺𝑺
× 𝒏𝒏

2. Commercial Paper:
Commercial paper is a short term debt instrument issued only by well known creditworthy firms
& is typically unsecured. However-
 The issuance of commercial is an attractive to short term bank loans
 Money market funds are major investors in commercial paper.
  Financial institutions such as finance companies & bank holding companies are major
issuers of commercial paper.
 The maturity period of commercial paper is minimum 20-25 days and maximum 270
days.
𝑷−𝑷
𝑷𝑷𝑷𝑷𝑷
𝑷 𝟑𝟑𝟑𝟑𝟑𝟑
Ycp= ×
𝑷𝑷𝑷𝑷 𝒏𝒏

3. Repurchase Agreement:
With a repurchase agreement (or repo), one party sells securities to another party with an
agreement to repurchase the securities of a specified date & price.
A reverse repo refers to the purchase of securities by one party from another with an agreement
to sell them. In essence, repo transaction represents a loan balanced by the securities. If the
borrower defaults on the loan, the lender has claim to the securities.
 Financial Institutions and money market investors are the major issuers.
 The maturity period ranges from 1-15 days.
𝑷−𝑷
𝑷𝑷
𝑺𝑺 𝟑𝟑𝟑𝟑𝟑𝟑
Repo Rate=
𝑷𝑷𝑷𝑷
× 𝒏𝒏

4. Negotiable Certificate of Deposit:

NCD’s are certificates that are issued by large commercial banks and other depository
institutions as a short term source of funds. The minimum denomination is $1 million. The
maturity period of NCD ranges from 2 weeks to 1 year.
Non- financial corporations often purchase NCD’s. Also NCD’s denomination are typically too
large for individual investors, they are sometimes purchased by money market funds that pooled
individual investors fund. Thus money market funds allow individual to be indirect investors in
NCD’s creating a more active NCD market.
𝑺𝑷𝑷
−𝑷𝑷
𝑷𝑷+𝒏
𝑷
𝑰𝒏
𝑰𝑷
𝑰
YNCD=
×𝟏
𝟑
𝑷𝑷𝑷𝑷
 5. Federal Funds:
The federal funds market allows depository institution to effectively lend or borrow short term
funds from each other at the so called federal funds rate or bank rate.
The federal funds rate is the rate charged on federal funds transactions. It is normally slightly
higher than the T-bill rate at any point of time.
Commercial banks are the most active participants in the federal funds market and federal funds
brokers serve as intermediaries in the market.

6. Banker’s Acceptance/ LC:

A banker’s acceptance indicates that a bank accepts responsibility for future payment. It is
commonly used for international trade transactions.
The investors return on banker’s acceptance is derived from the difference between the
discounted price paid for the acceptance & the amount to be received in the future. The maturity
period of banker’s acceptance ranges from 30-270 days.

 Steps involved in Banker’s Acceptance:

 Step – 1:
The importer from USA places a purchase order for the goods. If the Japanese exporter is
unfamiliar with the US importer, it may demand payment before delivery of goods,
which the US importer may be unwilling to make. A compromise maybe reached through
the creation of a banker’s acceptance.
 Step- 2:
The importer asks it’s bank to issue a letter of credit (L/C).
 Step -3:
The L/C represents a commitment by the importer’s bank to back the payment owed to
the Japanese exporter. Then the L/C is presented to the exporters bank with the
commitment of making payment.
 Step – 4:
Exporter’s bank inform the exporter that the L/C has been received.
 Step – 5:
After the notification of L/C, the exporter then sends the goods to the importer.
 Step- - 6:
 Exporter sends shipping documents to its bank.
 Step – 7:
The exporter’s bank passes the shipping documents to the importer’s bank. At this point,
the banker’s acceptance is created, which obliges the importer’s bank to make payment to
the holder of the banker’s acceptance at a specified future date.
The creation of the banker’s acceptance allows the importer to receive goods from an exporter
without sending immediate payment.