The money market

The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short lived mortgage and asset backed securities. It provides liquidity funding for the global financial system. Money markets and capital markets are parts of financial markets.
The money market is used by a wide array of participants, from a company raising money by selling commercial paper into the market to an investor purchasing CDs as a safe place to park money in the short term. The money market is typically seen as a safe place to put money due the highly liquid nature of the securities and short maturities, but there are risks in the market that any investor needs to be aware of including the risk of default on securities such as commercial paper

The money market specializes in debt securities that mature in less than one year. Money market securities are very liquid, and are considered very safe. As a result, they offer a lower return than other securities. The easiest way for individuals to gain access to the money market is through a money market mutual fund. T-bills are short-term government securities that mature in one year or less from their issue date. T-bills are considered to be one of the safest investments - they don't provide a great return. A certificate of deposit is a time deposit with a bank. Annual percentage yield takes into account compound interest, annual percentage rate does not. CDs are safe, but the returns aren't great, and your money is tied up for the length of the CD. Commercial paper is an unsecured, short-term loan issued by a corporation. Returns are higher than T-bills because of the higher default risk. Bankers acceptances are negotiable time draft for financing transactions in goods. BAs are used frequently in international trade and are generally only available to individuals through money market funds. Eurodollars are U.S. dollar-denominated deposit at banks outside of the United States. The average Eurodollar deposit is very large. The only way for individuals to invest in this market is indirectly through a money market fund. Repurchase agreements (repos) are a form of overnight borrowing backed by government securities.

The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods of time, typically up to thirteen months. Money market trades in short-term financial instruments commonly called "paper." This contrasts with the capital market for longer-term funding, which is supplied by bonds and equity.

The core of the money market consists of interbank lending--banks borrowing and lending to each other using commercial paper, repurchase agreements and similar instruments. These instruments are often benchmarked to (i.e. priced by reference to) the London Interbank Offered Rate (LIBOR) for the appropriate term and currency. Finance companies, such as GMAC, typically fund themselves by issuing large amounts of asset-backed commercial paper (ABCP) which is secured by the pledge of eligible assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial mortgage loans, mortgagebacked securities and similar financial assets. Certain large corporations with strong credit ratings, such as 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. In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issue municipal paper, while the US Treasury issues Treasury bills to fund the US public debt.
Whenever a bear market comes along, investors realize (yet again!) that the stock market is a risky place for their savings. It's a fact we tend to forget while enjoying the returns of a bull market! Unfortunately, this is part of the risk-return tradeoff. To get higher returns, you have to take on a higher level of risk. For many investors, a volatile market is too much to stomach - the money marketoffers an alternative to these higher-risk investments. The money market is better known as a place for large institutions and government to manage their shortterm cash needs. However, individual investors have access to the market through a variety of different securities. In this tutorial, we'll cover various types of money market securities and how they can work in your portfolio. The money market is a subsection of the fixed income market. We generally think of the term fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short-term debt securities (debt that matures in less than one year). Money market investments are also called cash investments because of their short maturities. Money market securities are essentially IOUs issued by governments, financial institutions and large corporations. These instruments are very liquid and considered extraordinarily safe. Because they are extremely conservative, money market securities offer significantly lower returns than most other securities.

One of the main differences between the money market and the stock market is that most money market securities trade in very high denominations. This limits access for the individual investor. Furthermore, the money market is a dealer market, which means that firms buy and sell securities in their own accounts, at their own risk. Compare this to the stock market where a broker receives commission to acts as an agent, while the investor takes the risk of holding the stock. Another characteristic of a dealer market is the lack of a central trading floor or exchange. Deals are transacted over the phone or through electronic systems. The easiest way for us to gain access to the money market is with money market mutual funds, or sometimes through a money market bank account. These accounts and funds pool together the assets of thousands of investors in order to buy the money market securities on their behalf. However, some money market instruments, like Treasury bills, may be purchased directly. Failing that, they can be acquired through other large financial institutions with direct access to these markets. There are several

different instruments in the money market, offering different returns and different risks. In the following sections, we'll take a look at the major money market instruments.

Money Market: Treasury Bills (T-Bills)

Treasury Bills are the most marketable money market security. Their popularity is mainly due to their simplicity. Essentially, T-bills are a way for the U.S. government to raise money from the public. In this tutorial, we are referring to T-bills issued by the U.S. government, but many other governments issue Tbills in a similar fashion. T-bills are short-term securities that mature in one year or less from their issue date. They are issued with three-month, six-month and one-year maturities. T-bills are purchased for a price that is less than their par (face) value; when they mature, the government pays the holder the full par value. Effectively, your interest is the difference between the purchase price of the security and what you get at maturity. For example, if you bought a 90-day T-bill at $9,800 and held it until maturity, you would earn $200 on your investment. This differs from coupon bonds, which pay interest semi-annually.

Treasury bills (as well as notes and bonds) are issued through a competitive bidding process at auctions. If you want to buy a T-bill, you submit a bid that is prepared either non-competitively or competitively. In non-competitive bidding, you'll receive the full amount of the security you want at the return determined at the auction. With competitive bidding, you have to specify the return that you would like to receive. If the return you specify is too high, you might not receive any securities, or just a portion of what you bid for. (More information on auctions is available at the TreasuryDirect website.)

The biggest reasons that T-Bills are so popular are that they are one of the few money market instruments that are affordable to the individual investors. T-bills are usually issued in denominations of $1,000, $5,000, $10,000, $25,000, $50,000, $100,000 and $1 million. Other positives are that T-bills (and all Treasuries) are considered to be the safest investments in the world because the U.S. government backs them. In fact, they are considered risk-free. Furthermore, they are exempt from state and local taxes. (For more on this, see Why do commercial bills have higher yields than T-bills?) The only downside to T-bills is that you won't get a great return because Treasuries are exceptionally safe. Corporate bonds, certificates of deposit and money market funds will often give higher rates of interest. What's more, you might not get back all of your investment if you cash out before the maturity date.

Money Market: Certificate Of Deposit (CD)

A certificate of deposit (CD) is a time deposit with a bank. CDs are generally issued by commercial banks but they can be bought through brokerages. They bear a specific maturity date (from three months to five years), a specified interest rate, and can be issued in any denomination, much like bonds. Like all time deposits, the funds may not be withdrawn on demand like those in a checking account. CDs offer a slightly higher yield than T-Bills because of the slightly higher default risk for a bank but, overall, the likelihood that a large bank will go broke is pretty slim. Of course, the amount of interest you earn depends on a number of other factors such as the current interest rate environment, how much money you invest, the length of time and the particular bank you choose. While nearly every bank offers CDs, the rates are rarely competitive, so it's important to shop around.

A fundamental concept to understand when buying a CD is the difference between annual percentage yield (APY) and annual percentage rate (APR). APY is the total amount of interest you earn in one year,

taking compound interest into account. APR is simply the stated interest you earn in one year, without taking compounding into account. (To learn more, read APR vs. APY: How The Distinction Affects You.) The difference results from when interest is paid. The more frequently interest is calculated, the greater the yield will be. When an investment pays interest annually, its rate and yield are the same. But when interest is paid more frequently, the yield gets higher. For example, say you purchase a one-year, $1,000 CD that pays 5% semi-annually. After six months, you'll receive an interest payment of $25 ($1,000 x 5 % x .5 years). Here's where the magic of compounding starts. The $25 payment starts earning interest of its own, which over the next six months amounts to $ 0.625 ($25 x 5% x .5 years). As a result, the rate on the CD is 5%, but its yield is 5.06. It may not sound like a lot, but compounding adds up over time. The main advantage of CDs is their relative safety and the ability to know your return ahead of time. You'll generally earn more than in a savings account, and you won't be at the mercy of the stock market. Plus, in the U.S. the Federal Deposit Insurance Corporation guarantees your investment up to $100,000. Despite the benefits, there are two main disadvantages to CDs. First of all, the returns are paltry compared to many other investments. Furthermore, your money is tied up for the length of the CD and you won't be able to get it out without paying a harsh penalty.

Money Market: Commercial Paper

For many corporations, borrowing short-term money from banks is often a laborious and annoying task. The desire to avoid banks as much as possible has led to the widespread popularity of commercial paper. Commercial paper is 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. For the most part, commercial paper is a very safe investment because the financial situation of a company can easily be predicted over a few months. Furthermore, typically only companies with high credit ratings and credit worthiness issue commercial paper. Over the past 40 years, there have only been a handful of cases where corporations have defaulted on their commercial paper repayment. Commercial paper is usually issued in denominations of $100,000 or more. Therefore, smaller investors can only invest in commercial paper indirectly through money market funds.

Money Market: Banker's Acceptance

A bankers' acceptance (BA) is a short-term credit investment created by a non-financial firm and guaranteed by a bank to make payment. Acceptances are traded at discounts from face value in the secondary market. For corporations, a BA acts as a negotiable time draft for financing imports, exports or other transactions in goods. This is especially useful when the creditworthiness of a foreign trade partner is unknown. One advantage of a banker's acceptance is that it does not need to be held until maturity, and can be sold off in the secondary markets where investors and institutions constantly trade BAs.

Money Market: Eurodollars

Contrary to the name, Eurodollars have very little to do with the euro or European countries. Eurodollars are U.S.-dollar denominated deposits at banks outside of the United States. This market evolved in Europe (specifically London), hence the name, but Eurodollars can be held anywhere outside the United States. The Eurodollar market is relatively free of regulation; therefore, banks can operate on narrower margins than their counterparts in the United States. As a result, the Eurodollar market has expanded largely as a way of circumventing regulatory costs. The average Eurodollar deposit is very large (in the millions) and has a maturity of less than six months. A variation on the Eurodollar time deposit is the Eurodollar certificate of deposit. A Eurodollar CD is basically the same as a domestic CD, except that it's the liability of a non-U.S. bank. Because Eurodollar CDs are typically less liquid, they tend to offer higher yields. The Eurodollar market is obviously out of reach for all but the largest institutions. The only way for individuals to invest in this market is indirectly through a money market fund.

Money Market: Repos

Repo is short for repurchase agreement. Those who deal in government securities use repos as a form of overnight borrowing. A dealer or other holder of government securities (usually T-bills) sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed price. They are usually very short-term, from overnight to 30 days or more. This short-term maturity and government backing means repos provide lenders with extremely low risk. Repos are popular because they can virtually eliminate credit problems. Unfortunately, a number of significant losses over the years from fraudulent dealers suggest that lenders in this market have not always checked their collateralization closely enough. There are also variations on standard repos: Reverse Repo - The reverse repo is the complete opposite of a repo. In this case, a dealer buys government securities from an investor and then sells them back at a later date for a higher price Term Repo - exactly the same as a repo except the term of the loan is greater than 30 days.

Capital market:
A capital market is a market for securities, where business enterprises (companies) and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market includes the stock market and the bond market. Money markets and capital markets are parts of financial markets. Financial regulators, such as the UK's Financial Services Authority or the U.S. Securities and Exchange Commission, oversee the capital markets in their designated jurisdictions to ensure that investors are protected against fraud, among other duties. Capital Market Purpose is providing a source of funds from which corporations and governments borrow based on potential future cash flows. For example, a large manufacturing company borrows money by selling bonds to investors to finance an upgrade in machinery. The upgrade is calculated to increase production and profits beyond current levels. The increase in profit makes it possible to pay back bond holders and increase the value of the company for stock holders. Therefore, the company bet that the increase in future income from the upgrade financed with bonds would be sufficient to cover the bond issue and make money for the company.

Capital markets may be classified as primary markets and secondary markets. In primary markets, new stock or bond issues are sold to investors via a mechanism known as underwriting. In the secondary markets, existing securities are sold and bought among investors or traders, usually on a securities exchange, over-the-counter, or elsewhere. Both the stock and bond markets are parts of the capital markets. For example, when a company conducts an IPO, it is tapping the investing public for capital and is therefore using the capital markets. This is also true when a country's government issues Treasury bonds in the bond market to fund its spending initiatives. Capital markets in the United States provide the lifeblood of capitalism. Companies turn to them to raise funds needed to finance the building of factories, office buildings, airplanes, trains, ships, telephone lines, and other assets; to conduct research and development; and to support a host of other essential corporate activities. Much of the money comes from such major institutions as pension funds, insurance companies, banks, foundations, and colleges and universities. Increasingly, it comes from individuals as well. As noted in chapter 3, more than 40 percent of U.S. families owned common stock in the mid-1990s. Very few investors would be willing to buy shares in a company unless they knew they could sell them later if they needed the funds for some other purpose. The stock market and other capital markets allow investors to buy and sell stocks continuously. The markets play several other roles in the American economy as well. They are a source of income for investors. When stocks or other financial assets rise in value, investors become wealthier; often they spend some of this additional wealth, bolstering sales and promoting economic growth. Moreover, because investors buy and sell shares daily on the basis of their expectations for how profitable companies will be in the future, stock prices provide instant feedback to corporate executives about how investors judge their performance. Stock values reflect investor reactions to government policy as well. If the government adopts policies that investors believe will hurt the economy and company profits, the market declines; if investors believe policies will help the economy, the market rises. Critics have sometimes suggested that American investors focus too much on short-term profits; often, these analysts say, companies or policy-makers are discouraged from taking steps that will prove beneficial in the long run because they may require shortterm adjustments that will depress stock prices. Because the market reflects the sum of millions of decisions by millions of investors, there is no good way to test this theory. In any event, Americans pride themselves on the efficiency of their stock market and other capital markets, which enable vast numbers of sellers and buyers to engage in millions of transactions each day. These markets owe their success in part to computers, but they also depend on tradition and trust -- the trust of one broker for another, and the trust of both in the good faith of the customers they represent to deliver securities after a sale or to pay for purchases. Occasionally, this trust is abused. But during the last half century, the federal government has played an increasingly important role in ensuring honest and equitable dealing. As a result, markets have thrived as continuing sources of investment funds that keep the economy growing and as devices for letting many Americans share in the nation's wealth. To work effectively, markets require the free flow of information. Without it, investors cannot keep abreast of developments or gauge, to the best of their ability, the true value of stocks. Numerous sources of information enable investors to follow the fortunes of the market daily, hourly, or even minute-by-minute. Companies are required by law to issue quarterly earnings reports, more elaborate annual reports, and proxy statments to tell stockholders how they are doing. In addition, investors can read the market pages of daily newspapers to find out the price at which particular stocks were traded during the previous trading session. They can review a variety of indexes that measure the overall pace of market activity; the most notable of these is the Dow Jones Industrial Average, which tracks 30 prominent stocks. Investors also can turn to magazines and newsletters devoted to analyzing particular stocks and markets. Certain cable television programs provide a constant flow of news about movements in stock prices. And now, investors can use the Internet to get up-to-the-minute information about individual stocks and even to arrange stock transactions

The difference between the capital markets and the money markets?
The key distinguishing feature between the money and capital markets is the maturity period of the securities traded in them. The money market refers to all institutions and procedures that provide for transactions in short-term debt instruments generally issued by borrowers with very high credit ratings. By financial convention, short-term means maturity periods of one year or less. Notice that equity instruments, either common or preferred, are not traded in the money market. The major instruments issued and traded are U.S. Treasury bills, various federal agency securities, bankers" acceptances, negotiable certificates of deposit, and commercial paper. Keep in mind that the money market is an intangible market. You do not walk into a building on Wall Street that has the words "Money Market" etched in stone over its arches. Rather, the money market is primarily a telephone and computer market. The subject matter of capital market is long-term financial instruments having maturity of more than one year. on the other hand, the thrust of MM is on short-term instruments only. Money market is a wholesale market and the participants in money market are large institutional investors, commercial banks, mutual funds, and corporate bodies. However, in case of capital market even a small individual investor can deal by sale/purchase of shares, debentures or mutual fund units. In capital market, the two common segments are primary market and secondary market. Both these segments are interrelated. Securities emerge in primary segment and their subsequent dealings take place in secondary market. However, in case of money market, there is no such sub-division in general. In efficient money market, secondary market transactions may also take place. Total volume of trade occur per day in money market is many fold that of the volume per day taking place in capital market. In capital market, the financial instruments being dealt with are shares (equity as well as preference), debentures (a large variety), public sector bonds and units of mutual funds. On the other hand, money market has different financial instruments such as treasury bills, commercial papers, call money, certificate of deposits The capital market refers to all institutions and procedures that provide for transactions in long-term financial instruments. Long-term here means having maturity periods that extend beyond one year. In the broad sense, this encompasses term loans and financial leases, corporate equities, and bonds. The funds that comprise the firm's capital structure are raised in the capital market. Important elements of the capital market are the organized security exchanges and the over-the-counter markets. Basically the difference between the capital markets and money markets is that capital markets are for long term investments, companies are selling stocks and bonds in order to borrow money from their investors to improve their company or to purchase assets. Whereas money markets are more of a short term borrowing or lending market where banks borrow and lend between each other, as well as finance companies and everything that is borrowed is usually paid back within thirteen months. Another difference

between the two markets is what is being used to do the borrowing or lending. In the capital markets the most common thing used is stocks and bonds, whereas with the money markets the most common things used are commercial paper and certificates of deposits

Significance Capital markets and money markets are an integral part of the modern capitalist financial system.

Function Both money markets and capital markets share the common function of providing companies with capital funds. Time Frame One major difference between capital markets and money markets is the time frame for investment in each. Capital markets generally have investments with a maturity of greater than one year. Money markets have investments that mature over a period of less than one year. Types of Instruments Common instruments in the money market are treasury bills, commercial paper and certificates of deposit. Common investments in capital markets include stocks and bonds issued by companies. Risk Level Because of the longer time frame in the capital market, those investments tend to have a higher level of risk than investments in the money market. Rate of Return While investments in the capital market tend to have a higher level of risk, they also generally offer a higher rate of return. This is a common dichotomy in the investment world. Features of a Capital Market Capital markets are used for businesses and governments to obtain access to long-term funds. nvestors in capital markets take on greater risk and earn greater returns.

Features of a Money Market Money markets are used by governments and businesses that wish to raise short-term funds. Investors in money markets take on less risk but earn lower returns. Key Differences The main differences between money markets and capital markets are what are traded and for how long. Money markets trade CDs and commercial paper over a short time horizon, while capital markets trade stocks and bonds over a long time horizon

Relationship between Money Market & Capital Market:

The relationship between the money market and capital market helps explain the basic framework of the financial system. Under this framework, businesses and government agencies access sources of shortterm and long-term funds to generate immediate cash flow or finance long-term projects. Both markets have a particular role in how money flows from savers to businesses and government to finance operations and investment. As a result, both markets provide investors with opportunities to generate earnings and premiums from risky ventures

Risk:
Short-term securities correlate with lower levels of risk while long-term securities are exposed to greater amounts of risk. This occurs from long-term securities being exposed to the volatility in the securities market for a much longer period of time. Generally, short-term securities are less risky because there is less market volatility in the short term. This difference in risk also corresponds to returns. Returns are generally higher with riskier investments and than in safer investments.