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Money Market
Course Title: Financial Institutions & Markets
Submitted By:
Md. Amanullah
ID: 10254015
Year of Study: 5th Batch 4th Semester
EMBA Program
Dept. of Finance and Banking
Rajshahi University
Submitted to:
Professor Dr. A.H.M. Ziaul Haq
Dept. of Finance and Banking
Rajshahi University
Rajshahi University
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Money Market @ Amanullah Trino, Finance and Banking, Rajshahi University
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Contents
Introduction
What is Money market?
What the Money Market does?
Why is such a Market needed?
The Need for a Money Market
Who are the Principal Borrowers and Lenders in the Money Market?
Who Participates in the Money Markets?
The Goals of Money Market Investors
What kind of risk do investors face in the financial markets?
Money Market Maturities
Depth and Breadth of the Money Market
Money Market Instruments
Certificate of deposit.
Repurchase agreements
Commercial paper
Treasury bill.
References
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Introduction:
The financial markets channel savings to those individuals and institutions needing
more funds for spending than are provided by their current incomes.
The financial markets make possible the exchange of current income for future
income and the transformation of savings into investment so that production,
employment, and income can grow.
A financial
market is
market
in
and
low transaction
costs and
at
prices
that
which
people
reflect supply
and
and
entities
of
value
demand.
at
Securities
include stocks and bonds, and commodities include precious metals or agricultural
goods.
There
are
both
general
markets
(where
many commodities
are
traded)
and
many
interested
buyers
and
sellers,
including
households,
firms,
and
government agencies, in one "place", thus making it easier for them to find each
other. An economy which relies primarily on interactions between buyers and
sellers to allocate resources is known as a market economy in contrast either to
a command economy or to a non-market economy such as a gift economy.
In finance, financial markets facilitate:
Price discovery
Financial Market
Money market
Capital Market
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Money Market:
Money market means market where money or its equivalent can be traded. Money is
synonym of liquidity. Money market consists of financial institutions and dealers in money or
credit who wish to generate liquidity. It is better known as a place where large institutions
and government manage their short term cash needs. For generation of liquidity, short term
borrowing and lending is done by these financial institutions and dealers. Money Market is
part of financial market where instruments with high liquidity and very short term maturities
are traded. Due to highly liquid nature of securities and their short term maturities, money
market is treated as a safe place. Hence, money market is a market where short term
obligations such as treasury bills, commercial papers and bankers acceptances are bought and
sold.
Money markets exist to facilitate efficient transfer of short-term funds between holders and
borrowers of cash assets. For the lender/investor, it provides a good return on their funds. For
the borrower, it enables rapid and relatively inexpensive acquisition of cash to cover shortterm liabilities. One of the primary functions of money market is to provide focal point for
RBIs intervention for influencing liquidity and general levels of interest rates in the
economy. RBI being the main constituent in the money market aims at ensuring that liquidity
and short term interest rates are consistent with the monetary policy objectives.
Money Market & Capital Market: Money Market is a place for short term lending and
borrowing, typically within a year. It deals in short term debt financing and investments. On
the other hand, Capital Market refers to stock market, which refers to trading in shares and
bonds of companies on recognized stock exchanges. Individual players cannot invest in
money market as the value of investments is large, on the other hand, in capital market,
anybody can make investments through a broker. Stock Market is associated with high risk
and high return as against money market which is more secure. Further, in case of money
market, deals are transacted on phone or through electronic systems as against capital market
where trading is through recognized stock exchanges. The money market consists of financial
institutions and dealers in money or credit who wish to either borrow or lend. Participants
borrow and lend for short periods of time, typically up to thirteen months. Money market
trades in short-term financial instruments commonly called "paper." This contrasts with the
capital market for longer-term funding, which is supplied by bonds and equity. The core of
the money market consists of interbank lending--banks borrowing and lending to each other
using commercial paper, repurchase agreements and similar instruments. These instruments
are often benchmarked to (i.e. priced by reference to) the London Interbank Offered Rate
(LIBOR) for the appropriate term and currency.
What is Money market?
The money market is the market for short-term (one year or less) credit.
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The money market is a component of the financial markets for assets involved in
short-term borrowing and lending with original maturities of one year or shorter time
frames.
What the Money Market does?
The money market, like all financial markets, provides a channel for the exchange of
financial assets for money. To meet short-term cash needs
The money market is the mechanism through which holders of temporary cash
surpluses meet holders of temporary cash deficits.
Why is such a Market needed?
The money market arises because for most individuals and institutions, cash inflows
and outflows are rarely in perfect harmony with each other, and the holding of idle
surplus cash is expensive.
To cover the wages and salaries of government employees, office supplies, repairs,
and fuel costs as well as unexpected expense.
The Need for a Money Market
Regulate the liquidity and interest rates in the conduct of monetary policy to achieve
the broad objective of price stability, efficient allocation of credit and a stable foreign
exchange market
Who are the Principal Borrowers and Lenders in the Money Market?
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Currency risk The risk that adverse movements in the price of a currency will
reduce the net rate of return from a foreign investment. Also called exchange rate risk.
Political risk The probability that changes in government laws or regulations will
reduce the expected return from an investment.
In secondary market trading, the bank discount rate (DR) is used as a measure of CD
yields.
DR =
360
.
days to maturity
The principal buyers of negotiable CDs include corporations, state and local
governments, foreign central banks and governments, wealthy individuals, and a variety
of financial institutions.
Most buyers hold CDs until they mature. However, prime-rate CDs are actively traded in
the secondary market.
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Bankers are becoming increasingly innovative in packaging CDs to meet the needs of
customers.
New types of CDs include variable-rate CDs, rollover or rolypoly CDs, jumbo CDs,
Yankee CDs, brokered CDs, bear and bull CDs, installment CDs, rising-rate CDs, and
foreign index CDs.
Repurchase agreements - Short-term loansnormally for less than two weeks and
frequently for one dayarranged by selling securities to an investor with an
agreement to repurchase them at a fixed price on a fixed date.
Repurchase transactions, called Repo or Reverse Repo are transactions or short term
loans in which two parties agree to sell and repurchase the same security. They are
usually used for overnight borrowing. Repo/Reverse Repo transactions can be done only
between the parties approved by RBI and in RBI approved securities viz. GOI and State
Govt. Securities, T-Bills, PSU Bonds, FI Bonds, Corporate Bonds etc. Under repurchase
agreement the seller sells specified securities with an agreement to repurchase the same at
a mutually decided future date and price. Similarly, the buyer purchases the securities
with an agreement to resell the same to the seller on an agreed date at a predetermined
price. Such a transaction is called a Repo when viewed from the perspective of the seller
of the securities and Reverse Repo when viewed from the perspective of the buyer of the
securities. Thus, whether a given agreement is termed as a Repo or Reverse Repo depends
on which party initiated the transaction. The lender or buyer in a Repo is entitled to
receive compensation for use of funds provided to the counterparty. Effectively the seller
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of the security borrows money for a period of time (Repo period) at a particular rate of
interest mutually agreed with the buyer of the security who has lent the funds to the seller.
The rate of interest agreed upon is called the Repo rate. The Repo rate is negotiated by the
counterparties independently of the coupon rate or rates of the underlying securities and is
influenced by overall money market conditions.
Under a repurchase agreement (RP), the dealer sells securities to a lender but makes a
commitment to buy back the securities at a later date at a fixed price plus interest.
RPs is simply a temporary extension of credit collateralized by marketable securities.
Term RPs are for a set length of time (overnight, a few days, 1 month, 3 months, )
while continuing contracts may be terminated by either party on short notice.
Interest income from RPs
= Amount of loan Current RP rate Number of days loaned
360 days
Periodically, RPs are marked to market. If the price of the pledged securities has dropped,
the borrower may have to pledge additional collateral.
Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270
days; usually sold at a discount from face value. Commercial paper consists of shortterm, unsecured promissory notes issued by well-known and financially strong
companies.
Commercial paper is traded mainly in the primary market. Opportunities for resale in the
secondary market are more limited.
Commercial paper is rated prime, desirable, or satisfactory, depending on the credit
standing of the issuing company.
Types of Commercial Paper:
There are two major types of commercial paper.
Direct paper is issued mainly by large finance companies and bank holding companies
directly to the investor.
Dealer paper, or industrial paper, is issued by security dealers on behalf of their
corporate customers (mainly nonfinancial companies and smaller financial companies).
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360
.
Days to maturity
Advantages
Relatively low interest rates
Flexible interest rates - choice of dealer or direct paper
Large amounts may be borrowed conveniently
The ability to issue paper gives considerable leverage when negotiating with banks
Disadvantages
Risk of alienating banks whose loans may be needed when an emergency develops
May be difficult to raise funds in the paper market at times
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Commercial paper must generally remain outstanding until maturity - does not permit
early retirement without penalty
Treasury bills - Short-term debt obligations of a national government that are issued
to mature in three to twelve months. Treasury bills (T-bills) are direct obligations of
the U.S. government that have an original maturity of one year or less.Tax revenues
or any other source of government funds may be used to repay the holders of these
financial instruments.They carry great weight in the financial system due to their zero
(or nearly zero) default risk, ready marketability, and high liquidity.
Types of Treasury Bills:
Regular-series bills are issued routinely every week or month in competitive auctions
with original maturities of three months (13 weeks), six months (26 weeks), and one year
(52 weeks).
Irregular-series bills are issued only when the Treasury has a special cash need. These
instruments include strip bills and cash management bills.
How Bills Are Sold
T-bills do not carry a promised interest rate. Instead, they are sold at a discount from their
par or face value.
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Bill yields are determined by the bank discount method, which does not compound
interest rates and uses a 360-day year for simplicity.
The bank discount rate (DR) on T-bills
=
360
.
Days to maturity
Because the rates of return on most other debt instruments are not figured in the same
way, comparisons with other securities cannot be made directly.
The investment yield or rate (IR) on T-bills
=
365
.
Days to maturity
Bankers Acceptances
It is a short term credit investment created by a non financial firm and guaranteed by a
bank to make payment. It is simply a bill of exchange drawn by a person and accepted by
a bank. It is a buyers promise to pay to the seller a certain specified amount at certain
date. The same is guaranteed by the banker of the buyer in exchange for a claim on the
goods as collateral. The person drawing the bill must have a good credit rating otherwise
the Bankers Acceptance will not be tradable. The most common term for these
instruments is 90 days. However, they can very from 30 days to180 days. For
corporations, it acts as a negotiable time draft for financing imports, exports and other
transactions in goods and is highly useful when the credit worthiness of the foreign trade
party is unknown. The seller need not hold it until maturity and can sell off the same in
secondary market at discount from the face value to liquidate its receivables.
A bankers acceptance is a time draft drawn on and endorsed by an importers bank.
Acceptances are used in international trade because most exporters are uncertain of the
credit standing of their importers.
The issuing bank unconditionally guarantees to pay the face value of the acceptance when
it matures, thus shielding exporters and investors in international markets from default
risk.
Acceptances carry maturities ranging from 30 to 270 days, with 90 days being the most
common.
They are traded among financial institutions, industrial corporations, and securities
dealers as a high-quality investment and source of ready cash.
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Money Market @ Amanullah Trino, Finance and Banking, Rajshahi University
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The money market is a wholesale market for funds most trading occurs in multiples of a
million dollars.
The market is dominated by a relatively small number of large financial institutions that
account for the bulk of federal funds trading.
Securities also move readily from sellers to buyers through the market-making activities
of major security dealers and brokers.
And, of course, governments and central banks around the world play major roles in the
money market as the largest borrowers and as regulators. The money market supplies the
cash needs of short-term borrowers and provides savers who hold temporary cash
surpluses with an interest-bearing outlet for their funds.
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Reference:
1. Money and Capital Market
2.
3.
4.
5.
Peter S. Rose
Milton H. Marquis
Capital Budgeting and long-term Financing Decisions
Neil Seitz
Mitch Ellison
www.investopedia.com/university/moneymarket/
http://en.wikipedia.org/wiki/Money_market
http://www.caalley.com/
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