Money Markets Flashcards
What is a money market?
A financial market in which only short-term debt instruments are traded
Typically have a maturity within one year
What are the money market instruments?
- US treasury bills
- Negotiable Certificates of Deposit (CD’s)
- Commercial paper
- Repurchase Agreements
- Fed Funds
Money market instruments
What is a Repurchase Agreement?
Issued by businesses and banks
Short-term loans but treasury bills serve as collateral, an asset that the lender receives if the borrower does not pay back
E.g. Microsoft has £1m idle funds, so uses to buy £1m treasury bills from a bank which agrees to repurchase them next week at a price slightly above Microsoft’s purchase price
Money market instruments
What are Fed funds?
Banks to other banks loan
Overnight loans between banks of their deposits at the Federal Reserve
Money market instruments
What is a US Treasury Bill?
Issued by the US government
They either have 1, 3 or 6 month maturity
They are sold at a discount initially so the buyer receives more back at maturity
Virtually no chance of default
What is the safest money market instrument?
US Treasury Bills
They are the safest because the Fed government can always meet its debt obligations by raising tax or issuing currency
Money market instruments
What is a Negotiable Certificate of Deposit (CD)?
Sold by a bank to a depositor
Pays annual interest and the depositor receives the original purchase price at maturity
Money market instruments
What is Commercial Paper?
They are issued by large banks and well known companies (Microsoft)
Companies may issue commercial paper to pay accounts payable and purchasing new inventory (short-term)
Unsecured debt - not backed by any collateral
Pays back at a higher rate at maturity (usually no longer than 270 days)
What is the money market used for?
Banks and corporations use the money market to earn interest on surplus funds that they expect to have only temporarily
Why are money market securities safer investments than capital market securities?
They are more liquid - because they are traded more widely than longer-term securities
They have smaller fluctuations in prices than longer-term securities, making them safer investments
When do banks borrow money from the Federal Reserve?
When they don’t have enough deposits at the Fed to meet the amount required
(Reserve requirements)
