In this video, I explain fixed income money market. The money market is part of the fixed-income market that specializes in short-term debt securities that mature in less than one year. Bonds are the most common type of fixed-income security, but others include CDs, money markets, and preferred shares.
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The money market consists of very short-term highly marketable debt securities. Many of these securities trade in large denominations and so are out of the reach of individual investors. Money market mutual funds, however, are easily accessible to small investors. These mutual funds pool the resources of many investors and purchase a wide variety of money market securities on their behalf.
U.S. Treasury bills (T-bills, or just bills, for short) are the most marketable of all money market instruments. T-bills represent the simplest form of borrowing. The government raises money by selling bills to the public. Investors buy the bills at a discount from the stated maturity value. At the bill’s maturity, the government pays the investor the face value of the bill. The difference between the purchase price and the ultimate maturity value constitutes the investor’s earnings.
A certificate of deposit (CD) is a time deposit with a bank. Time deposits may not be withdrawn on demand. The bank pays interest and principal to the depositor only at the end of the fixed term of the CD. CDs issued in denominations larger than $100,000 are usually negotiable, however; that is, they can be sold to another investor if the owner needs to cash in the certificate before it matures. Short-term CDs are highly marketable, although the market significantly thins out for maturities of three months or more. CDs are treated as bank deposits by the Federal Deposit Insurance Corporation, so they are insured for up to $250,000 in the event of a bank insolvency.
Commercial Paper
The typical corporation is a net borrower of both long-term funds (for capital investments) and short-term funds (for working capital). Large, well-known companies often issue their own short-term unsecured debt notes directly to the public, rather than borrowing from banks. These notes are called commercial paper (CP). Sometimes, CP is backed by a bank line of credit, which gives the borrower access to cash that can be used if needed to pay off the paper at maturity.
A banker’s acceptance starts as an order to a bank by a bank’s customer to pay a sum of money at a future date, typically within six months. At this stage, it is like a postdated check. When the bank endorses the order for payment as “accepted,” it assumes responsibility for ultimate payment to the holder of the acceptance. At this point, the acceptance may be traded in secondary markets much like any other claim on the bank. Bankers’ acceptances are considered very safe assets, as they allow traders to substitute the bank’s credit standing for their own. They are used widely in foreign trade where the creditworthiness of one trader is unknown to the trading partner. Acceptances sell at a discount from the face value of the payment order, just as T-bills sell at a discount from par value.
Eurodollars are dollar-denominated deposits at foreign banks or foreign branches of American banks. By locating outside the United States, these banks escape regulation by the Federal Reserve Board. Despite the tag “Euro,” these accounts need not be in European banks, although that is where the practice of accepting dollar-denominated deposits outside the United States began.
Dealers in government securities use repurchase agreements, also called repos (RPs), as a form of short-term, usually overnight, borrowing. The dealer sells securities to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price. The increase in the price is the overnight interest. The dealer thus takes out a one-day loan from the investor. The securities serve as collateral for the loan.
Individuals who buy stocks on margin borrow part of the funds to pay for the stocks from their broker. The broker in turn may borrow the funds from a bank, agreeing to repay the bank immediately (on call) if the bank requests it. The rate paid on such loans is usually about one percentage point higher than the rate on short-term T-bill.
