Although commercial paper, as noted, is the largest sector of the money market, there is relatively little trading in the secondary market. The reason being is that most investors in commercial paper follow a “buy and hold” strategy. This is to be expected because investors purchase commercial paper that matches their specific maturity requirements. Any secondary market trading is usually concentrated among institutional investors in a few large, highly rated issues. If investors wish to sell their commercial paper, they can usually sell it back to the original seller either dealer or issuer.
The largest players in the global money markets are financial institutions — namely depository institutions (i.e., commercial banks, thrifts, and credit unions), insurance companies, and investment banks. [3, p.89] These institutions are simultaneously among the biggest buyers and issuers of money markets instruments. Moreover, there are certain short-term debt instruments peculiar to financial institutions such as certificates of deposits, federal funds, bankers acceptances, and funding agreements.
Depository institutions are required to hold reserves to meet their reserve requirements. The level of the reserves that a depository institution must maintain is based on its average daily deposits over the previous 14 days. To meet these requirements, depository institutions hold reserves at their district Federal Reserve Bank. These reserves are called federal funds. [5, p.100]
Because no interest is earned on federal funds, a depository institution that maintains federal funds in excess of the amount required incurs an opportunity cost of the interest forgone on the excess reserves. Correspondingly, there are also depository institutions whose federal funds are short of the amount required. The federal funds market is where depository institutions buy and sell federal funds to address this imbalance. Typically, smaller depository institutions (e.g., smaller commercial banks, some thrifts, and credit unions) almost always have excess reserves while money center banks usually find themselves short of reserves and must make up the deficit. The supply of federal funds is controlled by the Federal Reserve through its daily open market operations.
Most transactions involving federal funds last for only one night; that is, a depository institution with insufficient reserves that borrows excess reserves from another financial institution will typically do so for the period of one full day. Because these reserves are loaned for only a short time, federal funds are often referred to as “overnight money.” [5, p.101]
The interest rate at which federal funds are bought (borrowed) by depository institutions that need these funds and sold (lent) by depository institutions that have excess federal funds is called the federal funds rate. The federal funds is a benchmark short-term interest. Indeed, other short-term interest rates (e.g., Treasury bills) often move in tandem with movements in the federal funds rate. The rate most often cited for the federal funds market is known as the effective federal funds rate. [5, p.101]
But, coming back to corporations, it is necessary to note, that managers base decisions about investing in short-term projects on judgments about future cash flows, the uncertainty of those cash flows, and the opportunity costs of the funds to be invested.
Cash flows out of a firm as it pays for the goods and services it purchases from others. Cash flows into the firm as customers pay for the goods and services they purchase. When we refer to cash, we mean the amount of cash and cash-like assets—currency, coin, and bank balances. [6, p.642] When we refer to cash management, we mean management of cash inflows and outflows, as well as the stock of cash on hand.
The primary players in the global money markets are banking and financial institutions which include investment banks, commercial banks, thrifts and other deposit and loan institutions. Banking activity and the return it generates reflects the bank’s asset allocation policies. Asset allocation decisions are largely influenced by the capital considerations that such an allocation implies and the capital costs incurred. The cost of capital must, in turn, take into account the regulatory capital implications of the positions taken by a trading desk. [5, p.307] Therefore, money market participants must understand regulatory capital issues regardless of the products they trade or they will not fully understand the cost of their own capital or the return on its use.
The rules defining what constitutes capital and how much of it to allocate are laid out in the Bank for International Settlements (BIS) guidelines, known as the Basel rules. [5, p.310] Although the BIS is not a regulatory body per se and its pronouncements carry no legislative weight, to maintain investors and public confidence national authorities endeavor to demonstrate that they follow the Basel rules at a minimum.
So, any firm can deal in government securities; the primary dealer system was established in 1960. Primary dealers include diversified and specialized firms, money center banks, and foreign-owned financial entities. The dealer responding to a bid or offer by “hitting” or “taking” pays a commission to the interdealer broker. Only six interdealer brokers handle the bulk of daily trading volume.
Dealers use interdealer brokers because of the speed and efficiency with which trades can be accomplished. They use LIBOR. LIBOR is the interest rate which major international banks offer each other on Eurodollar certificates of deposit (CD) with given maturities.
U.S. money market is managed by U.S. government agencies. Federal agencies are fully owned by the U.S. government and have been authorized to issue securities directly in the marketplace.
The largest players in the global money markets are financial institutions — namely depository institutions (i.e., commercial banks, thrifts, and credit unions), insurance companies, and investment banks. Most transactions involving federal funds last for only one night.
The primary players in the global money markets are banking and financial institutions. The rules defining what constitutes capital and how much of it to allocate are laid out in the Bank for International Settlements (BIS) guidelines.
Conclusion
So, we have considered the global money markets. It is possible to draw the following conclusions. The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services. But money carries out also other functions. These are function of money as a general medium of payment, and the functions of money as a transmitter of value through time and space. There are 3 categories of money: commodity money, fiat money, credit money. And the last - money is not a free good.
The money market is a market in which the cash requirements of market participants who are long cash are met along with the requirements of those that are short cash. The money market is traditionally defined as the market for financial assets that have original maturities of one year or less. In essence, it is the market for short-term debt instruments. Financial assets traded in this market include such instruments as U.S. Treasury bills, commercial paper, some medium-term notes, bankers acceptances, federal agency discount paper, most certificates of deposit, repurchase agreements, floating-rate agreements, and federal funds.
There are three types of money market funds: (1) general money market funds; (2) U.S. government short-term funds; and (3) short-term municipal funds. A money market exists in virtually every country in the world, and all such markets exhibit the characteristics we described in this chapter to some extent.
Money market securities are short-term indebtedness. These are treasury bills (T-bills), commercial paper, certificates of deposit (CDs), Eurodollar certificates of deposit, bankers’ acceptances.
U.S. financial sector divided on: equity markets, stock exchanges, OTC market, stock market indicators, bond markets, options and futures markets, money markets. The United States has a central monetary authority known as the Federal Reserve System.
Monetary policy is the set of tools that a central bank can use to control the availability of loanable funds. These tools can be used to achieve goals for the nation’s economy. Along with the U.S. Treasury, the Fed determines policies that affect employment and prices.
Any firm can deal in government securities; the primary dealer system was established in 1960. Primary dealers include diversified and specialized firms, money center banks, and foreign-owned financial entities. The dealer responding to a bid or offer by “hitting” or “taking” pays a commission to the interdealer broker. Only six interdealer brokers handle the bulk of daily trading volume.
U.S. money market is managed by U.S. government agencies. Federal agencies are fully owned by the U.S. government and have been authorized to issue securities directly in the marketplace.
The largest players in the global money markets are financial institutions — namely depository institutions (i.e., commercial banks, thrifts, and credit unions), insurance companies, and investment banks.
Bibliography
1. Ludwig von Mises. The Theory of Money and Credit. Indianapolis: Liberty Fund, 1982.
2. Ralph Vince. The Mathematics of Money Management. New Jersey: John Wiley & Sons, Inc., 1992.
3. Dr. Randall G. Holcombe. Public Finance. New York: Academic Press, 2000.
4. J. Orlin Grabbe. Chaos & Fractals in Financial Markets. 2001. [http://www.aci.net/kalliste/chaos_index.htm]
5. Frank J. Fabozzi, Steven V. Mann, Moorad Choudhry. The Global Money Markets. New Jersey: John Wiley & Sons, Inc., 2002.
6. Frank J. Fabozzi. Financial Management and Analysis. New Jersey: John Wiley & Sons, Inc., 2003.
[1]A Eurocurrency is a currency that is traded outside of its national border, and can be any currency rather than just a European one.