Professional Documents
Culture Documents
The Money
Markets
Now thats a lot!
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Chapter Preview
We review the money markets and the securities
that are traded there. In addition, we discuss why
the money markets are important in our financial
system. Topics include:
The Money Markets Defined
The Purpose of Money Markets
Who Participates in Money Markets?
Money Market Instruments
Comparing Money Market Securities
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The Money Markets Defined
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Definition of Money Markets
According to Crowther, "The money market is a name
given to the various firms and institutions that deal in the
various grades of near money."
According to the RBI, "The money market is the centre for
dealing mainly of short character, in monetary assets; it
meets the short term requirements of borrowers and
provides liquidity or cash to the lenders. It is a place where
short term surplus investible funds at the disposal of
financial and other institutions and individuals are bid by
borrowers, again comprising institutions and individuals
and also by the government."
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The Money Markets Defined
A segment of the financial market in which financial instruments
with high liquidity and very short maturities are traded. The
money market is used by participants as a means for borrowing
and lending in the short term, from several days to just under a
year. Money market securities consist of negotiable certificates
of deposit (CDs), bankers acceptances, U.S. Treasury bills,
commercial paper, municipal notes, federal funds and
repurchase agreements (repos).
History: The money market developed because there are
parties that had surplus funds, while others needed cash. [3
Today it comprises cash instruments as well.
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The Money Markets Defined
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The Money Markets Defined:
Why Do We Need Money Markets?
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Functions of Money Market
Money market is an important part of the economy. It plays very
significant functions. As mentioned above it is basically a market for
short term monetary transactions. Thus it has to provide facility for
adjusting liquidity to the banks, business corporations, non-banking
financial institutions (NBFs) and other financial institutions along with
investors.
The major functions of money market are given below:-
To maintain monetary equilibrium. It means to keep a balance
between the demand for and supply of money for short term monetary
transactions.
To promote economic growth. Money market can do this by making
funds available to various units in the economy such as agriculture,
small scale industries, etc
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Functions of Money Market
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Characteristics of Money
Markets
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The Money Markets Defined:
Cost Advantages
Reserve requirements create additional expense for
banks that money markets do not have
Regulations on the level of interest banks could
offer depositors lead to a significant growth in
money markets, especially in the 1970s and 1980s.
When interest rates rose, depositors moved their
money from banks to money markets to earn a
higher interest rate.
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The Money Markets Defined:
Cost Advantages
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3-month T-bill rates and
Interest Rate Ceilings
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The Purpose of Money Markets
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The Purpose of Money Markets
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The Importance of Money
Markets
A well-developed money market is essential for a modern economy.
Though, historically, money market has developed as a result of
industrial and commercial progress, it also has important role to play
in the process of industrialization and economic development of a
country. Importance of a developed money market and its various
functions are discussed below:
1. Financing Trade: Money Market plays crucial role in financing both
internal as well as international trade. Commercial finance is made
available to the traders through bills of exchange, which are
discounted by the bill market. The acceptance houses and discount
markets help in financing foreign trade.
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The Importance of Money
Markets
2. Profitable Investment: Money market enables the
commercial banks to use their excess reserves in
profitable investment. The main objective of the
commercial banks is to earn income from its reserves as
well as maintain liquidity to meet the uncertain cash
demand of the depositors. In the money market, the
excess reserves of the commercial banks are invested in
near-money assets (e.g. short-term bills of exchange)
which are highly liquid and can be easily converted into
cash. Thus, the commercial banks earn profits without
losing liquidity.
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The Importance of Money
Markets
3. Self-Sufficiency of Commercial Bank: Developed
money market helps the commercial banks to become
self-sufficient. In the situation of emergency, when the
commercial banks have scarcity of funds, they need not
approach the central bank and borrow at a higher interest
rate. On the other hand, they can meet their requirements
by recalling their old short-run loans from the money
market.
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The Importance of Money
Markets
4. Self-Sufficiency of Commercial Bank: Developed
money market helps the commercial banks to become
self-sufficient. In the situation of emergency, when the
commercial banks have scarcity of funds, they need not
approach the central bank and borrow at a higher interest
rate. On the other hand, they can meet their requirements
by recalling their old short-run loans from the money
market.
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The Importance of Money
Markets
5. Financing Industry: Money market contributes to the growth of
industries in two ways:
(a) Money market helps the industries in securing short-term loans to
meet their working capital requirements through the system of finance
bills, commercial papers, etc.
(b) Industries generally need long-term loans, which are provided in
the capital market. However, 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.
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The Importance of Money
Markets
5. Help to Central Bank: Though the central bank can function and
influence the banking system in the absence of a money market, the
existence of a developed money market smoothens the functioning
and increases the efficiency of the central bank. Money market helps
the central bank in two ways:
(a) The short-run interest rates of the money market serves as an
indicator of the monetary and banking conditions in the country and, in
this way, guide the central bank to adopt an appropriate banking
policy,
(b) The sensitive and integrated money market helps the central bank to
secure quick and widespread influence on the sub-markets, and thus
achieve effective implementation of its policy.
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Who Participates
in the Money Markets?
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Who Participates in the Money Markets?:
A Sample from the Wall Street Journal
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Who Participates
in the Money Markets?
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Money Market Instruments
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Money Market Instruments
(cont.)
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Money Market Instruments:
Treasury Bills
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Money Market Instruments:
Treasury Bills Discounting Example
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Money Market Instruments:
Treasury Bills Discounting Example
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Money Market Instruments:
Treasury Bill Auctions
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Money Market Instruments:
Treasury Bill Auctions Example
The Treasury auctioned $2.5 billion par value
91-day T-bills, the following bids were received:
Bidder Bid Amount Bid Price
1 $500 million $0.9940
2 $750 million $0.9901
3 $1.5 billion $0.9925
4 $1 billion $0.9936
5 $600 million $0.9939
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Money Market Instruments:
Treasury Bill Rates
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Money Market Instruments:
Treasury Bill Auction Results
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Money Market Instruments:
Treasury Bill Rates
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Money Market Instruments:
Treasury Bills
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Mini-Case: Treasury Bill
Auctions Go Haywire
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Money Market Instruments:
Fed Funds
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Money Market Instruments:
Fed Funds Rates
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Money Market Instruments:
Fed Funds Rates
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Chapter Summary
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Chapter Summary (cont.)
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