Money Markets

Question 1

What are money markets?

Answer 1

A wholesale market where financial institutions and large corporations can exchange large sums of money. It is designed to help provide liquidity.

Question 2

How is the interest in money markets determined?

Answer 2

Interest (also called yield) is determined through discounting.

Question 3

Why is discounting used in money markets?

Answer 3

If the lender and borrower remain the same throughout the contract there is no difference between adding an interest to the initial sum or discounting a future sum.

Question 4

What comprises the money market?

Answer 4

• Domestic money markets (exchanges of domestic currencies)

- International money markets (exchange different international currencies)

Question 5

What is the history of the Eurodollar market?

Answer 5

• Originally consisted of dollar deposits held in European accounts during the Marshall Plan after WWII
• This helped the dollar rise as a global currency
• London was chosen as the place to deposit Eurodollars due to its financial expertise

Question 6

What are the advantages of international money market funds?

Answer 6

• Transaction costs are lowered as multiple exchanges of currencies are avoided
• Dollar is a stable currency so currency risks are hedged
• Helps avoid Dutch Disease
• Many domestic markets don’t have the capacity to accommodate the size of some loan requests.

Question 7

Who are the main participants in money markets?

Answer 7

• Large banking institutions
• Pension funds (have to maintain sufficient cash to pay recurring liabilities)
• Insurance funds (could suddenly incur additional liabilities)
• Large corporations (settle international deals)
• Governments (manage recurring liabilities)
• Central banks (monitor liquidity of banking sector)
• Money market funds

Question 8

What are money market funds?

Answer 8

A way for small investors to invest in money markets. They’re similar to collective investments where small investors can buy shares in them. Administered by financial institutions.

Question 9

What are the main securities traded on money markets?

Answer 9

• Treasury bills
• Municipal bills
• Repurchase agreements
• Commercial papers
• Certificate of deposit
• Bill of exchange
• Bankers acceptance

Question 10

What are treasury bills?

Answer 10

Government bonds with short maturity. Used by governments to raise funds and roll over debt to meet current liabilities.

Question 11

What are municipal bills?

Answer 11

Similar to treasury bills but not issued by governments. They are issued by federal states (e.g US states) and government owned organisations like post and rail

Question 12

What are repurchase agreements?

Answer 12

A financial asset is sold for a couple of days at a discount. The selling party repurchases the asset at its original value at the time the contract was written.

Question 13

What are commercial papers?

Answer 13

Contracts defining the amount a corporation will pay in the future. Similar to bonds

Question 14

What is a certificate of deposit?

Answer 14

Issued by banks when someone deposits money with them. The certificate can be sold on if money is required earlier.

Question 15

What is a bill of exchange?

Answer 15

Drafted by the buying party as an IOU, stating money will be sent on a given date.

Question 16

What is a banker’s acceptance?

Answer 16

Like a bill of exchange but there is a guarantee that a third party (bank) will pay the certain amount of money in the future.

Question 17

What is the interbank market?

Answer 17

The central money market in the economy and the interest rate determined in this market influences all major consumer interest rates in the economy.
It is where banks lend and borrow funds to each other.

Question 18

How does the interest rate impact lending and borrowing on the interbank market?

Answer 18

Low interest rate= more banks willing to borrow and less willing to lend
High interest rate= more banks willing to lend and less willing to borrow

Question 19

How do changes in the demand for funds on the interbank market impact the interest rate and quantity if funds?

Answer 19

Increase in demand= shift to right 
- interest rate increases
-quantity of funds increases 
Decrease in demand= shift to left
- interest rate decreases
- quantity of funds decreases

Question 20

How do changes in the supply of funds on the interbank marker impact the interest rate and quantity of funds?

Answer 20

Increase in supply= shift to right 
- interest rate decreases
- quantity of funds increases 
Decrease in supply= shift to the left 
- interest rate increases 
-quantity of funds decreases

Question 21

What does high interest on the interbank market suggest?

Answer 21

Implies there is a scarcity in liquid funds (demand is high/supply is low)

Question 22

How can central banks influence the level of liquid funds?

Answer 22

They can print more liquid money and exchange it on the open market for less liquid assets

Question 23

What is the London Interbank Market?

Answer 23

The market where the interest rate for overnight to 12 month loans is determined.

Question 24

What is the LIBOR?

Answer 24

The London Interbank Offered Rate
It is influential in determining the interest on UK consumer loans.
It can be viewed as the average cost a bank incurs to finance itself on the interbank market

Question 25

What are the three functions of money?

Answer 25

• A means of exchange
• A unit of account (express prices in one unit)
• A store of value (doesn’t need to be spent immediately)

Question 26

Why is money today worth more than the same amount of money tomorrow?

Answer 26

• Impatience to consume
• Inflation
• Risk