Introduction to Money Market
money market is a significant part of the financial system which is specialized
in short-term debt securities. Its basic function is the exchange of funds between lenders,
investors and borrowers- just like other financial markets in the financial
the money market trades securities from one day and up to one year of maturity.
The money market provide large financial institutions, corporations, the
federal government and government agencies with the access to liquidity, which
allows to finance short-term operations and needs. It is the most important
feature of the money market that made it inevitable part of the financial
system. Safety is another feature of money market.
Money market instruments
are issued by money market institutions like mutual funds, brokerage firms and banks. These instruments are
used by corporations, governments, and individual investors seeking short-term
Types of money market
Money Market instruments are the means by which the money
market facilitate the financial system. Some of the most common types of money
market instruments which have strong secondary market include:
T-bills or Treasury
bills: T-bills are short-term money market instruments that are
issued by the U.S. government. T-bills are issued at various maturities and are
sold at a discount to their face value and can be purchased at auction through
ii. Negotiable Certificate of Deposit: Negotiable Certificate of Deposit or simply NCDs
are certificates that are issued by the commercial banks.
iii. Commercial paper: Large corporations and financial
companies issue these unsecured money market instrument. These papers are primarily
issued to provide liquidity and to raise short-term funds.
agreements (repos): Treasury
securities that the buyers and seller agree upon with the consent to repurchase
it later at a predetermined time. That means, they will be sold with an
agreement of purchasing them back at a given date in future for a higher price
v. Bankers Acceptances: Banker’s Acceptance (BA) is a short-term credit investment created to
provide guarantee by a bank to make payment in the future. Bankers
Acceptances are commonly used for international trade transactions and the holder
of this BA can sell it at a discount price prior to maturity.
of money market
market have some unique characteristics that make it differ from other
financial markets. Some characteristics of the money markets are given below:
is a collection of markets of several instruments, not a single market
is likely, a wholesale market of short-term financing need
main players are: Federal Reserve or central bank, Discount and Finance Houses,
mutual funds, commercial banks, corporate investor, non-banking finance
companies, state government itself, government agencies, provident funds, etc.
demand and supply of money shape this market, as it is a need based market
and safety are its major features, for which this market is renowned for
is from overnight up to less than one year
of the money markets’ instruments are traded at discount rate
market securities offer a lower return than other securities
Role of Money Market in the Financial System
Money market plays very crucial role
in the development and stabilization of the financial system of a country. It works
as a subsidiary for the capital market. There are many ways by which money
markets influence, affect and help controlling the financial system. Here are
some relative ways by which money market plays role in the financial system:
funding federal deficit
government do need money to run its operations. The federal government borrows
money from the money market through the Treasury (for U.S. it is U.S. Treasury)
by issuing shorter-term securities called T-bills or Treasury Bills. When the
federal government face budget deficits and other cash shortages, these T-bills
provide liquidity that allows the federal government to continue to finance its
operations and services and stabilizes the country’s development that have
impacts the financial system.
short-term commercial papers
also need short-term funding as their working capital, payroll or a specific
project and other operations. They can issue short-term commercial papers and
borrow money from the money market. Commercial papers are sometimes cheaper,
and mostly flexible than traditional corporate bank loans. Thus theses
commercial papers allow the firms to continue their operations and provide
economic boost by assisting the firms.
encouraging economic growth
money market allows large corporations and the government to borrow with
flexible conditions for a shot-term maturity. These borrowings allow both
corporations, federal government and government agencies to continue their
programs, projects and operations which help them to expand operations that
ultimately encourage the economic growth, which directly influence the
By providing information for monetary
The basic function of money
market is to liquidity to the borrowers by collecting funds from lenders (fund
providers) by meeting the short-term requirements of the borrowers and
provides, which also involves transferring of information of the underlying
conditions of supply and demand and other monetary information. The money
markets provide these necessary information for monetary policy formulation and
management, which is crucial for the financial system as it helps to make
decision on maintaining continuous growth, equity and price stability.
By helping Central Bank to smoothening
operations and efficiency
Central bank of a country plays
most important role in the financial system. By facilitate changing the level
of liquidity in the economy through open market operations and by regulating
the access of the banks to its accommodation, it occupied a most strategic
position in the money market.
A well-developed money market
increases the efficiency and smoothens the functioning of the central Bank. The
money market assist the central bank to adopt an appropriate banking policy by
using short-run interest rates of the money market as a direct indicator of
both the monetary and banking conditions.
By facilitating interbank lending
Commercial banks need a lot of
short term money to run their certain operations. The money market is a great
source of funds for these commercial banks (including foreign banks). There is
a term called ‘Interbank Offered Rate’-the rate at which banks loan each other
that mature over-night up to not more than one week. This loaning occur in the
money market on a very short notice with much flexibility which helps these
banks to meet their short-term needs.
facilitating international trade
International trade or simply
import-export is one of the biggest source of a countries income that
contribute to the financial system by both the fact of inflow and outflow of
money (including foreign money). This international trade needs a secure means
of transaction to take place. Banker’s acceptance is an instrument of money
market which facilitate international trade. It provide guarantee to the
relevant party that if the LC issuer fails to pay the stipulated amount of
trade money, the LC issuing institution will provide the money to the party. As
both parties are guaranteed safety through this instrument, it directly
influence the economic development by facilitating international trade.
central bank’s short-term lending
Sometimes, commercial banks need
a large amount of loan for very short time with a short notice. Central bank
used to be a top reservoir of reserve, which provide such loans to commercial
banks through its discount window to let the banks operate with sufficient
Through commercial banks
Commercial banks are the largest
source for private financing and individual loans. This banks take deposits
from people and organizations and loans out to those who need money. Small
businesses sometimes do not have access to upper level loaning corporations for
short-term financing. Commercial banks do this sort of short-term financing
that makes those businesses operate properly. Ultimately, this help develop the
economy of the nation.
By help regulating the money supply and bank reserves
Repurchase agreement or REPO is one of the
mostly used money market instruments. Usually, the Federal Reserve enters into repurchase agreements, where
individuals use these agreements to finance the purchase of debt securities or other investments for a short term basis.
Usually the agreements settle overnight. Repo allows federal
government to control the money supply within its economy by either increasing
or decreasing total available funds. A decrease in repo rate (the rate at which
the repo settles) pools banks to sell securities back to the government, which
boost the money supply to the financial system. Again, an increase in repo rate
discourage banks from reselling these securities resulting a decrease the money
In brief, the roles of money market are:
§ This market enhances the amount of
liquidity available to the entire country
§ It helps to make proper monetary
policy, control money supply and reserve
§ It assists in mobilization of
the savings of the community
international trade and interbank lending
funds the federal government as needed
§ Finally, satisfy all the short-term
financial needs for different participants and help stabilizing business
operations to grow the economy.
For industrial and developing
countries, money markets are integral to the financial system. These markets,
which serve as channels for the execution and transmission of monetary policy
and also trading for the shortest-term using its own specialized instruments.
Money market is the efficient distributor of liquidity among financial
institutions, and the hedging of short-term risks and works as a trade settler
for shorter-term. These facilities have made this market so important in the
whole financial system.
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