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 goods, good, usually a resource, that specifically has full or substantial fungibility: that is, the Market (economics), market treats instances of the good as equivalent or nearly so with no regard to w ...

, 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 marke ...

for assets involved in short-term borrowing,

lending In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for the use of the money. The document evidencing the debt ( ...

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

over the counter Over-the-counter (OTC) drugs are medicines sold directly to a consumer without a requirement for a prescription from a healthcare professional, as opposed to prescription drugs, which may be supplied only to consumers possessing a valid pres ...

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. In ...

. There are several money market instruments in most Western countries, including

treasury bills United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as a supplement to taxation. Since 2012, the U.S. ...

commercial paper Commercial paper, in the global financial market, is an Unsecured debt, unsecured promissory note with a fixed Maturity (finance), maturity of usually less than 270 days. In layperson terms, it is like an "IOU" but can be bought and sold becaus ...

banker's acceptance A banker's acceptance is a document issued by a bank institution that represents a bank's commitment to make a requested future payment. The request will typically specify the payee, the amount, and the date on which it is eligible for payment. Af ...

deposits A deposit account is a bank account maintained by a financial institution in which a customer can deposit and withdraw money. Deposit accounts can be savings accounts, current accounts or any of several other types of accounts explained below. ...

certificates of deposit A certificate of deposit (CD) is a time deposit sold by banks, thrift institutions, and credit unions in the United States. CDs typically differ from savings accounts because the CD has a specific, fixed term before money can be withdrawn with ...

bills of exchange A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, whose payer is usually named on the document. More specifically, it is a document contemplated by or consisting of a ...

repurchase agreement A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of secured short-term borrowing, usually, though not always using government securities as collateral. A contracting party sells a security to a lend ...

s, federal funds, and short-lived mortgage- and asset-backed securities. 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 Fiat money is a type of government-issued currency that is not backed by a precious metal, such as gold or silver, nor by any other tangible asset or commodity. Fiat currency is typically designated by the issuing government to be legal tende ...

, fiduciary money (

cheque A cheque (or check in American English) is a document that orders a bank, building society, 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 person writing ...

banknote A banknote or bank notealso called a bill (North American English) or simply a noteis a type of paper money that is made and distributed ("issued") by a bank of issue, payable to the bearer on demand. Banknotes were originally issued by commerc ...

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 Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quic ...

for the

global financial system The global financial system is the worldwide framework of legal agreements, institutions, and both formal and informal agent (economics), economic action that together facilitate international flows of financial capital for purposes of investme ...

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 institution A financial institution, sometimes called a banking institution, is a business entity that provides service as an intermediary for different types of financial monetary transactions. Broadly speaking, there are three major types of financial ins ...

s 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. The heart of the money market revolves around the concept of interbank lending, where banks lend and borrow from each other using financial instruments such as commercial paper and repurchase agreements. These instruments are often valued with reference to the London Interbank Offered Rate (LIBOR) for the specific term and currency. Finance companies usually secure their funding by issuing substantial amounts of asset-backed commercial paper (ABCP). This paper is backed by the commitment of valuable assets placed into an ABCP conduit. These assets can include things like auto loans, credit card receivables, residential or commercial mortgage loans, mortgage-backed securities, and other financial assets. Some large, financially stable corporations even issue their own commercial paper, while others prefer to have banks issue it 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 The Department of the Treasury (USDT) is the Treasury, national treasury and finance department of the federal government of the United States. It is one of 15 current United States federal executive departments, U.S. government departments. ...

issues

Treasury bills United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as a supplement to taxation. Since 2012, the U.S. ...

to fund the U.S. public debt: * Trading companies often purchase

bankers' acceptance A banker's acceptance is a document issued by a bank institution that represents a bank's commitment to make a requested future payment. The request will typically specify the payee, the amount, and the date on which it is eligible for payment. Af ...

s to tender for payment to overseas suppliers. * Retail and institutional money market funds * Banks *

Central bank A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...

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, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...

policies.

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 significan ...

. Commercial finance is made available to the traders through

, 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 significantly enhances monetary policy transmission and central bank efficiency. Money markets help central banks in three primary ways: Interest Rate Signaling: Short-term interest rates in money markets serve as immediate indicators of monetary and banking conditions, guiding central bank policy decisions. As Chen & Valcarcel (2021) demonstrate, money market rates respond quickly to policy changes, providing real-time feedback on policy effectiveness. Bech & Klee (2011) further show how segmentation in money markets can affect this transmission mechanism. Policy Implementation: Well-integrated money markets enable central banks to achieve widespread influence across financial sub-markets efficiently. When the central bank adjusts its policy rate, these changes transmit rapidly through interbank markets to other financial instruments and ultimately to the broader economy. Carpenter & Demiralp (2012) highlight how this transmission has evolved beyond traditional money multiplier frameworks. Liquidity Management: Money markets facilitate efficient distribution of liquidity among financial institutions, reducing the need for direct central bank intervention. This market-based approach to liquidity allocation improves the overall efficiency of monetary policy operations. However, as Brunnermeier & Koby (2018) note, there are limits to the effectiveness of monetary policy through these channels, particularly in low-interest-rate environments.

Instruments

Certificate of deposit A certificate of deposit (CD) is a time deposit sold by banks, thrift institutions, and credit unions in the United States. CDs typically differ from savings accounts because the CD has a specific, fixed term before money can be withdrawn wit ...

– Time deposit, commonly offered to consumers by banks, thrift institutions, and credit unions. *

Repurchase agreement A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of secured short-term borrowing, usually, though not always using government securities as collateral. A contracting party sells a security to a lend ...

s – 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 Commercial paper, in the global financial market, is an Unsecured debt, unsecured promissory note with a fixed Maturity (finance), maturity of usually less than 270 days. In layperson terms, it is like an "IOU" but can be bought and sold becaus ...

– 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 enterprise A government-sponsored enterprise (GSE) is a type of financial services corporation created by the United States Congress. Their intended function is to enhance the flow of credit to targeted sectors of the economy, to make those segments of the ...

s such as the

Farm Credit System The Farm Credit System (FCS) in the United States is a nationwide network of borrower-owned lending institutions and specialized service organizations. The Farm Credit System provides more than $373 billion (as of 2022) in loans, leases, and relat ...

, 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 financial institutions to support housing finance and community investment. Overview The FHLBank System was chartered by ...

and the

Federal National Mortgage Association The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the Ne ...

. 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 clea ...

– 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. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of ...

; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the

federal funds rate In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an collateral (finance), uncollateralized basis ...

. * Municipal notes – In the U.S., short-term notes issued by municipalities in anticipation of tax receipts or other revenues *

– Short-term debt obligations of a national government that are issued to mature in three to twelve months *

Money fund A money market fund (also called a money market mutual fund) is an open-end mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a hig ...

s – Pooled short-maturity, high-quality investments that buy money market securities on behalf of retail or institutional investors * Foreign exchange swaps – 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 asset-backed securities

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 ...

—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. Ho ...

, 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