The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As short-term securities became a

commodity In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a co ...

, the money market became a component of the

financial market A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial ma ...

for assets involved in short-term borrowing,

lending In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that ...

, buying and selling with original maturities of one year or less. Trading in money markets is done over the counter and is

wholesale Wholesaling or distributing is the sale of goods or merchandise to retailers; to industrial, commercial, institutional or other professional business users; or to other wholesalers (wholesale businesses) and related subordinated services. I ...

. There are several money market instruments in most Western countries, including treasury bills, commercial paper, banker's acceptances, deposits, certificates of deposit, bills of exchange, repurchase agreements, federal funds, and short-lived mortgage- and

asset-backed securities An asset-backed security (ABS) is a security whose income payments, and hence value, are derived from and collateralized (or "backed") by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid asse ...

. The instruments bear differing maturities, currencies, credit risks, and structures. A market can be described as a money market if it is composed of highly liquid, short-term assets. Money market funds typically invest in government securities, certificates of deposit, commercial paper of companies, and other highly liquid, low-risk securities. The four most relevant types of money are

commodity money Commodity money is money whose value comes from a commodity of which it is made. Commodity money consists of objects having value or use in themselves (intrinsic value) as well as their value in buying goods. This is in contrast to representa ...

, fiat money, fiduciary money (

cheque A cheque, or check (American English; see spelling differences) is a document that orders a bank (or credit union) to pay a specific amount of money from a person's account to the person in whose name the cheque has been issued. The pers ...

banknote A banknote—also called a bill (North American English), paper money, or simply a note—is a type of negotiable instrument, negotiable promissory note, made by a bank or other licensed authority, payable to the bearer on demand. Banknotes w ...

s), and commercial bank money. Commodity money relies on intrinsically valuable commodities that act as a medium of exchange. Fiat money, on the other hand, gets its value from a government order. Money markets, which provide liquidity for the global financial system including for

capital market A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers ...

s, are part of the broader system of

Participants

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, typically up to twelve months. Money market trades in short-term

financial instrument Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity or a contractual right to receive or deliver in the form ...

s commonly called "paper". This contrasts with the

for longer-term funding, which is supplied by bonds and

equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the diff ...

. 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. Finance companies typically fund themselves by issuing large amounts of

asset-backed commercial paper Asset-backed commercial paper (ABCP) is a form of commercial paper that is collateralized by other financial assets. Institutional investors usually purchase such instruments in order to diversify their assets and generate short-term gains. Str ...

(ABCP), which is secured by the

pledge Pledge may refer to: Promises * a solemn promise * Abstinence pledge, a commitment to practice abstinence, usually teetotalism or chastity * The Pledge (New Hampshire), a promise about taxes by New Hampshire politicians * Pledge of Allegianc ...

of eligible assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial

mortgage loans A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any ...

, mortgage-backed securities and similar financial assets. Some large corporations with strong credit rating issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf. In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issue municipal paper, while the U.S. Treasury issues Treasury bills to fund the

U.S. public debt The national debt of the United States is the total national debt owed by the federal government of the United States to Treasury security holders. The national debt at any point in time is the face value of the then-outstanding Treasury secu ...

: * Trading companies often purchase bankers' acceptances to tender for payment to overseas suppliers. * Retail and institutional money market funds * Banks *

Central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a centra ...

s * Cash management programs * Merchant banks

Functions

Money markets serve five functions—to finance trade, finance industry, invest profitably, enhance commercial banks' self-sufficiency, and lubricate

central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a centra ...

policies."Functions and importance of Money Market"
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Financing trade

The money market plays a crucial role in financing domestic and

international trade International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. (see: World economy) In most countries, such trade represents a significa ...

. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.

Financing industry

The money market contributes to the growth of industries in two ways: * They help industries secure short-term loans to meet their

working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...

requirements through the system of finance bills, commercial papers, etc. * Industries generally need long-term loans, which are provided in the

. However, the capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.

Profitable investments

The money market enables commercial banks to use their excess reserves in profitable investments. The main objective of commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of its depositors. In the money market, the excess reserves of commercial banks are invested in near money assets (e.g., short-term bills of exchange), which are easily converted into cash. Thus, commercial banks earn profits without sacrificing liquidity.

Self-sufficiency of commercial banks

Developed money markets help commercial banks to become self-sufficient. In an emergency, when commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. They can instead meet their requirements by from the money market.

Help to central bank

Though the

can function and influence the banking system in the absence of a money market, the existence of a developed money market smooths the functioning and increases the efficiency of the central bank. Money markets help central banks in two ways: * Short-run interest rates serve as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy, * Sensitive and integrated money markets help the central bank secure quick and widespread influence on the sub-markets, thus facilitating effective policy implementation

Instruments

Certificate of deposit A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions in the United States. CDs differ from savings accounts in that the CD has a specific, fixed term (often one, ...

– Time deposit, commonly offered to consumers by banks, thrift institutions, and credit unions. * Repurchase agreements – Short-term loans—normally for less than one week and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date. *Money market mutual funds - short term investment debt, operated by professional institutions. Money market mutual funds are an investment fund where a number of investors invest their money in mutual fund institutions, and they diversify the funds in various investments. * Commercial paper – Short term instruments promissory notes issued by company at discount to face value and redeemed at face value * Eurodollar deposit – Deposits made in U.S. dollars at a bank or bank branch located outside the United States. * Federal agency short-term securities – In the U.S., short-term securities issued by government sponsored enterprises such as the Farm Credit System, the

Federal Home Loan Banks The Federal Home Loan Banks (FHLBanks, or FHLBank System) are 11 U.S. government-sponsored banks that provide liquidity to the members of financial institutions to support housing finance and community investment. Overview The FHLBank System wa ...

and the Federal National Mortgage Association. Money markets is heavily used function. *

Federal funds In the United States, federal funds are overnight borrowings between banks and other entities to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to cle ...

– In the U.S., interest-bearing deposits held by banks and other depository institutions at the

Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...

; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate. * Municipal notes – In the U.S., short-term notes issued by municipalities in anticipation of tax receipts or other revenues * Treasury bills – Short-term debt obligations of a national government that are issued to mature in three to twelve months * Money funds – Pooled short-maturity, high-quality investments that buy money market securities on behalf of retail or institutional investors *

Foreign exchange swap In finance, a foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward) and may use foreign exchange derivatives ...

s – Exchanging a set of currencies in spot date and the reversal of the exchange of currencies at a predetermined time in the future * Short-lived mortgage- and

Discount and accrual instruments

There are two types of instruments in the fixed income market that pay interest at maturity, instead of as

coupons In marketing, a coupon is a ticket or document that can be redeemed for a financial discount or rebate when purchasing a product. Customarily, coupons are issued by manufacturers of consumer packaged goods or by retailers, to be used in r ...

—discount instruments and accrual instruments. Discount instruments, like repurchase agreements, are issued at a discount of

face value The face value, sometimes called nominal value, is the value of a coin, bond, stamp or paper money as printed on the coin, stamp or bill itself by the issuing authority. The face value of coins, stamps, or bill is usually its legal value. Howe ...

, and their maturity value is the face value. Accrual instruments are issued at face value and mature at face value plus interest.

References

External links

"Money Market Funds Enter a World of Risk"
''New York Times'', September 18, 2008
Study on the identification of euro money market transactions in TARGET2
{{Authority control Money market instruments Financial markets