Financial market’s main purpose is to transfer funds from lenders to borrowers. It is distinguished between the capital market and the money market. Of the two divisions of the financial market, the money market deals with borrowing and lending for a period of a year or less. Money Market is so important the banks often maintain a screen showing the current prices at which they are willing to lend and borrow money (Wiseman 2001). The need for money market arises from the receipt of economic units that do not coincide with their expenditures (Cook & Laroche 1993).
This means that money balances must be held in order to ensure that cash receipts can be maintained independently. However, holding balances involves costs that are in the form of foregone interest. In order to minimize the costs of the balances, only those required for day-to-day transactions are being held. Balance supplements are in the form of money market instruments that can be easily converted into cash. This money market instruments have relatively low costs and low price risks because of their short maturities.
Instruments of the money market are characterized by high degree of principal safety. The maturity of money market instruments range from one day to one year. However, the most common maturity period is three months (Cook & Laroche 1993). It is also the case that active secondary markets, for most instruments, allow them to be sold even before maturity.
There a number of money market instruments that can be used in order to maintain the safety and liquidity of the balances. For the purpose of discussion, this paper will be presenting four common money market instruments. The following section of this paper will be describing the four money market instruments.
Repurchase Agreement
Repurchase Agreements better known as Repos are loan that are collateralized by securities. Repos are also associated with insolvency risk. It is similar to a secured loan where the lender receives securities as collateral that would protect them from defaults (Wikipedia Contributors 2006a).
For example, bank A owes want to lend money to bank B. Before bank be lends bank A the money, a repurchase agreement can be completed to protect the interest of the lender. Collaterals will be set, so incase the borrowers, in any case, will not be able to pay the lender, the lender can recover their losses by selling the collateral made available through the Repurchase Agreement. The coupons that are paid out on the securities are passed on directly to the seller of the repo. Usually, the principal borrowers of this instrument are securities dealers, governments, banks and non-financial corporations.
Commercial Papers
Commercial papers are shot-termed corporate debts. They usually mature after two to three months. In addition, they are issued in multiples of 100,000 by financial subsidiaries of financial companies such as general Electric Financial, Ford Credit and Chrysler Financial or by banks and finance companies. Commercial papers are not used for long-term financing. Rather, they are used to purchase inventory and to manage working capital (Wikipedia Contributors 2006c).
Two methods are being used to issue commercial papers. First, the issuer can directly issue the commercial papers to the investor who sell and hold it through money funds. Second, the issuer of the commercial papers can sell it to dealers who in turn, will sell the papers into the market. In dealing commercial papers, large security firms and subsidiaries of bank companies are the ones who are often involved. For direct issuers of commercial papers, they deem it more economical to sell them without intermediaries. It is also the case that most direct issuers of commercial papers are companies who have frequent as well as sizeable borrowing needs.
Certificates of Deposit
Certificates of deposits are issued by banks. When a purchaser opens a certificate of deposit he or she will be given a passbook were the transaction relating to the certificate of deposit opened will be noted. Upon opening the certificate of deposit, the purchaser can arrange how the interest rates will be received. It can either be by cheque that will be mailed to the owner of the account or it can automatically be transferred to the chequing or savings account of the owner of the certificate of deposit. It is also the case that withdrawals made before the maturity of the account will cause the owner to be subjected to fines in relation to the policies of the banking where the account was opened and being maintained (Wikipedia Contributors 2006a).
T-Bills
It takes one year or less for treasury bills to mature. No interests are accumulated before the treasury bills mature. This means that they are like zero coupon bonds. Nevertheless, they are being sold at discount prices of the par value before they mature. This is done to create a positive yield to maturity. Banks as well as financial institutions are the biggest purchasers of treasury bills (Wikipedia Contributors 2006d).
Credit:ivythesis.typepad.com
0 comments:
Post a Comment