location. Available from financial institutions, money markets give the smaller investor the opportunity to get in on treasury securities. The institution buys a variety of treasury securities with the money you invest. The rate of return changes daily, and services such as check writing may be offered.
The range of products enables user to spread their exposures before differing:
- maturity
- currencies
- credit risks
- structures
The major participants in the money market are commercial banks, governments, corporations, government-sponsored enterprises, money market mutual funds; futures market exchanges, brokers and dealers. Some of the money market instruments are:
a. Treasury Bills(T-bills)
Treasury bills (T-bills) are short-term notes with maturity period less than 1 year. In US, they come in three different lengths to maturity:90, 180, and 360 days. The two shorter types are auctioned on a weekly basis, while the annual types are auctioned monthly. T-bills can be purchased directly through the auctions or indirectly through the secondary market. Purchasers of T-bills at auction can enter a competitive bid (although this method entails a risk that the bills may not be made available at the bid price) or a noncompetitive bid. T-bills for noncompetitive bids are supplied at the average price of all successful competitive bids.
These are issued by the Reserve Bank usually a period of 91 days. The Reserve Bank uses these bills to take money out of the market. This will reduce a banks ability to lend to its clients leading to a contraction of the money supply. The bill consists of an obligation to pay the bearer the face value of the bill upon a given date. A bank buying such a bill will not pay face value for it but would instead buy it at a discount. The bill is tradable so
the purchaser does not have to hold it until the due date. If interest rates decrease during the term of the bill, the holder can sell the bill at a profit before the due date.
b. Bankers Acceptance(BA)
"A banker's acceptance begins life as a written demand for the bank to pay a given sum at a future date," Brealey and Myers noted. "The bank then agrees to this demand by writing 'accepted' on it. Once accepted, the draft becomes the bank's IOU and is a negotiable security. This security can then be bought or sold at a discount slightly greater than the discount on Treasury bills of the same maturity." Bankers' acceptances are generally used to finance foreign trade, although they also arise when companies purchase goods on credit or need to finance inventory. The maturity of acceptances ranges from one to six months.
Although BA’s, as they are known, have their origin in trade bills issued by merchants, today they are an important money market instrument. A banker’s acceptance is simply a bill of exchange drawn by a person and accepted by a bank. The person drawing the bill must have a good credit rating otherwise the
BA will not be tradable. The drawer promises to make payment of the face value upon a given future date. The most common term for these instruments is 90 days. They can very from 30 days to180 days. The BA has the advantage of locking the borrower in to a fixed rate over the term of the bill. This can be important if a rise in short-term rates is expected.
c. CERTIFICATES OF DEPOSIT. Certificates of deposit (CDs) are certificates issued by a federally chartered bank against deposited funds that earn a specified return for a definite period of time. They are one of several types of interest-bearing "time deposits" offered by banks. An individual or company lends the bank a certain amount of money for a fixed period of time, and in exchange the bank agrees to repay the money with specified interest at the end of the time period. The certificate constitutes the bank's agreement to repay the loan. The maturity rates on CDs range from 30 days to six months or longer, and the amount of the face value can vary greatly as well. There is usually a penalty for early withdrawal of funds, but some types of CDs can be sold to another investor if the original purchaser needs access to the money before the maturity date.
Large denomination (jumbo) CDs of $100,000 or more are generally negotiable and pay higher interest than smaller denominations. However, such certificates are insured by the FDIC only up to $100,000. There are also eurodollar CDs, which are negotiable certificates issued against U.S. dollar obligations in a foreign branch of a domestic bank. Brokerage firms have a nationwide pool of bank CDs and receive a fee for selling them. Since brokers deal in large sums, brokered CDs generally pay higher interest rates and offer greater liquidity than CDs purchased directly from a bank.
d. Negotiable Certificates of Deposit (NCD)
NCD’s are like fixed deposits except they are bearer documents. They offer a market related rate of interest and are completely liquid because they can be negotiated during the term of the deposit. Most NCD’s have a term of less than one year. They usually offer a rate of return slightly higher than banker’s acceptances which makes them extremely popular instruments.
e. Deposits
- Call deposits - are transactions that the depositor has the right to call at any time, depending on the notice period agreed at the time the deal was transacted(normally 1 - 7 days)
- Fixed deposit ( term or time deposit ) Under this scheme money is deposited for a fixed period of time so it is also called Fixed Deposit. Investor can withdraw the money only after the time period. Premature withdrawals are also allowed by paying a penalty. Interest is calculated on monthly, quarterly or yearly depends on the bank and scheme. Many banks offers loan or overdraft facility as an added features with fixed deposits. Term deposits is a safe investment and it is therefore a very good option for conservative, low-risk investors.
- Overnight lending - are usually midday to midday, where an averaged overnight rate of interest is used. The rate in euro area is called Eonia(Euro overnight indexed average rate). It represents the effective overnight reference rate for euro and is calculated by the weighted of all overnight unsecured euro lending transactions undertaken in the internet bank. In the US, federal fund rate is the interest rate at which the banks lend to each other on overnight basis.
f. REPURCHASE AGREEMENTS (Repo or buyback) and Reverse Repo
These also known as repos or buybacks—are Treasury securities that are purchased from a dealer with the agreement that they will be sold back at a future date for a higher price. These agreements are the most liquid of all money market investments, ranging from 24 hours to several months. In fact, they are very similar to bank deposit accounts, and many corporations arrange for their banks to transfer excess cash to such funds automatically.
A repo agreement is the sale of a security with a commitment to repurchase the same security as a specified price and on specified date while a reverse repo is purchase of security with a commitment to sell at predetermined price and date. A repo transaction for party would mean reverse repo for the second party. In liew of the loan, the borrower pays a contracted rate to the lender, which is called the repo rate. As against the call money market where the lending is totally unsecured, the lending in the repo is backed by a simultaneous transfer of securities. The main players in this market are all institutional players like banks, primary dealers like PNB Gilts Limited, financial institutions, mutual funds, insurance companies etc. allowed to operate a SGL with the Reserve Bank of India.
Further RBI also operates daily repo/ reverse repo auctions to provide a benchmark rates in the markets as well as managing in the liquidity in the system. RBI sucks or injects liquidity in the banking system by daily repo/ reverse operations.
g. Tax-Exempt Bonds
Often referred to as municipal bonds, tax-exempt bonds represent state and local government debt. A City, town, or a village and also states, territories, and housing authorities, port authorities, and local government agencies may issue these bonds. Interest earned is exempt from income taxes and from state and local income taxes if bonds issued are from your state or city. Interest rates are determined by the general level of
interest rates and by the credit rating of the issuer. The seller of these bonds has tables showing you what the taxexempt yields of these bonds are equivalent to in taxable yield for your tax bracket. As little as $1,000 may be invested in these bonds, available from a broker or a financial institution.
Type 3 investments include corporate bonds and corporate stocks. Higher investment risk and lower purchasing power risk are represented by these investment alternatives.
i. COMMERCIAL PAPER(CP).
Commercial paper refers to unsecured short-term promissory notes issued by financial and nonfinancial corporations. Commercial paper has maturities of up to 270 days (the maximum allowed without SEC registration requirement). Dollar volume for commercial paper exceeds the amount of any money market instrument other than T-bills. It is typically issued by large, credit-worthy corporations with unused lines of bank credit and therefore carries low default risk.
Standard and Poor's and Moody's provide ratings regarding the quality of commercial paper. The highest ratings are A1 and P1, respectively. A2 and P2 paper is considered high quality, but usually indicates that the issuing corporation is smaller or more debt burdened than A1 and P1 companies. Issuers earning the lowest ratings find few willing investors.
Unlike some other types of money-market instruments, in which banks act as intermediaries between buyers and sellers, commercial paper is issued directly by well-established companies, as well as by financial institutions. "By cutting out the intermediary, major companies are able to borrow at rates that may be 1 to 1 ½ percent below the prime rate charged by banks," according to Brealey and Myers. Banks may act as agents in the transaction, but they assume no principal position and are in no way obligated with respect to repayment of the commercial paper. Companies may also sell commercial paper through dealers who charge a fee and arrange for the transfer of the funds from the lender to the borrower.
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