Money market and money market instruments

Money Market and Money Market Instruments

For an investor, there are numerous opportunities available in the different financial markets. Some of these investments trade on regulated, organised and formalised markets (known as exchanges); other investments trade on an informal basis between buyers and sellers. Informal trading can take place over a counter, by telephone or even electronically via computer systems. Informal trading where an instrument does not trade through an exchange is known as over-the-counter trading (OTC trading).

The financial instruments trading in the above markets can be classified into different categories according to the nature of the instruments and the market. In general the financial markets are split into the following categories:

  • Equity Market – a market where the shares of companies and related instruments such as equity derivatives are traded publicly. The Johannesburg Securities Exchange (JSE) is a formalised exchange in SA where shares that are listed on this exchange are traded. A company must apply to list, and is subject to certain listing qualifying criteria which must be met prior to its listing
  • Money Market – comprises of short-term loans and investments in short term debt instruments. These instruments do not trade through an exchange, but rather OTC (over-the-counter)
  • Bond Market – comprises of long-term loans. The Bond Exchange of SA (BESA) is the exchange through which the instruments (called bonds) trade
  • Derivative Market – A derivative instrument traded on a derivatives market derives its value from an underlying instrument. This market gives the investor the opportunity to hedge against the risk of dramatic price fluctuations. Numerous instruments known as derivatives trade in this market on an OTC basis, except for futures and options which trade on the South African Futures Exchange (SAFEX)
  • Foreign Exchange Market – Foreign currencies can be bought and sold through this market; it is regulated in SA by the SA Reserve Bank who acts in a supervisory capacity. No formalised exchange exists and currencies are traded on an OTC basis directly between authorised dealers

Finance

Finance studies and addresses the ways in which individuals, businesses, and organisations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. The term finance may thus incorporate any of the following:

  • The study of money and other assets
  • The management and control of those assets
  • Profiling and managing project risks
  • The science of managing money
  • As a verb, “to finance” is to provide funds for business

The activity of finance is the application of a set of techniques that individuals and organisations (entities) use to manage their financial affairs, particularly the differences between income and expenditure and the risks of their investments.

An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary, such as a bank or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference.

A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity. Banks are thus compensators of money flows in space.

A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who in turn generally sell it to the public. The stock gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and they have 100 shares outstanding (held by investors), you are 1/100 owner of that company. You own 1/100 of the net difference between assets and liabilities on the balance sheet. Of course, in return for the stock, the company receives cash, which it uses to expand its business in a process called “equity financing”. Equity financing mixed with the sale of bonds (or any other debt financing) is called the company’s capital structure.

Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), etc., as well as by a wide variety of organisations including schools and non-profit organisations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments, with consideration to their institutional setting.

Finance is one of the most important aspects of business management. Without proper financial planning a new enterprise is unlikely to be successful. Managing money (a liquid asset) is essential to ensure a secure future, both for the individual and an organisation.

Financial markets

In economics a financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect efficient markets.

Financial markets have evolved significantly over several hundred years and are undergoing constant innovation to improve liquidity.

Both general markets, where many commodities are traded and specialised markets (where only one commodity is traded) exist. Markets work by placing many interested sellers in one “place”, thus making them easier to find for prospective buyers. 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 that is based, such as a gift economy.

In Finance, financial markets facilitate:

  • The raising of capital (in the capital markets)
  • The transfer of risk (in the derivatives markets)
  • International trade (in the currency markets)

They are used to match those who want capital to those who have it.

Typically a borrower issues a receipt to the lender promising to pay back the capital. These receipts are securities which may be freely bought or sold. In return for lending money to the borrower, the lender will expect some compensation in the form of interest or dividends.

Money market

The money market is the global financial market for short-term borrowing and lending. It provides short term liquid funding for the global financial system.

In the money markets, participants borrow and lend for short periods of time, typically up to 13 months. Money market trades in short term financial instrument commonly called “paper”. This contrasts with the capital market for longer-term funding, which is supplied by bonds and equity.

Borrowers

  • The core money market consists of banks borrowing and lending to each other, using commercial paper, repurchase agreements and similar instruments. These instruments are often benchmarked to LIBOR
  • Finance companies, such GMAC, typically fund themselves by issuing large amounts of asset-backed commercial paper which is secured by the pledge of eligible assets into an asset-backed commercial paper conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial mortgage loans, mortgage backed securities and similar financial assets
  • Certain large corporations with strong credit ratings, notably General Electric, issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf via commercial paper lines
  • The governments issues bills for short term funding needs
  • Trading companies often purchase bankers acceptances to be tendered for payment to overseas suppliers

Lenders

  • Retail and Institutional Money Market Funds
  • Banks
  • Central Banks
  • Cash management programmes
  • Arbitrage Asset-backed commercial paper conduits, which seek to buy higher yielding paper, while themselves selling cheaper paper

Common money market instruments

T-Bills – These are the most liquid money market instrument. They are issue by the government. Most common maturities are 90 days, 180 days and 360 days.

Negotiable Certificates of Deposit – Short term debt instrument offered by banks. They offer better returns than T-Bills due the fact that there is a slight degree of credit risk.

Commercial Paper - an unsecured, short-term loan issued by a corporation, typically for financing accounts receivable and inventories. It is usually issued at a discount, reflecting current market interest rates. Maturities on commercial paper are usually no longer than nine months, with maturities of between one and two months being the average.

What influences the Money Market?

Both the monetary and fiscal policy influences the money market.

Monetary policy is the process by which the government, central bank, or monetary authority manages the money supply to achieve specific goals—such as constraining inflation or deflation, maintaining an exchange rate, achieving full employment or economic growth. (Usually the goal of monetary policy is to accommodate economic growth in an environment of stable prices.) Monetary policy can involve changing certain interest rates, either directly or indirectly through open market operations, setting reserve requirements, acting as a last-resort lender (i.e. discount window lending), or trading in foreign exchange markets.

Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. Fiscal policy and monetary policy are the macroeconomic tools that governments have at their disposal to manage the economy. Fiscal policy is the deliberate and thought out change in government spending, government borrowing or taxes to stimulate or slow down the economy. It contrasts with monetary policy, which describes policies concerning the supply of money to the economy.