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Money market

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  • 1. Money market<br />This article is about the financial market. For the fund type, see Money market fund. For the bank deposit account, see Money market account.<br />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.[1] It provides liquidity funding for the global financial system.<br />Overview<br />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.<br />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.<br />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, mortgage-backed 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.<br />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.<br />Trading companies often purchase bankers' acceptances to be tendered for payment to overseas suppliers.<br />Retail and institutional money market funds<br />Banks<br />Central banks<br />Cash management programs<br />Arbitrage ABCP conduits, which seek to buy higher yielding paper, while themselves selling cheaper paper.<br />Merchant Banks<br />[edit] Common money market instruments<br />Certificate of deposit - Time deposits, commonly offered to consumers by banks, thrift institutions, and credit unions.<br />Repurchase agreements - Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.<br />Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270 days; usually sold at a discount from face value.<br />Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located outside the United States.<br />Federal agency short-term securities - (in the U.S.). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association.<br />Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.<br />Municipal notes - (in the U.S.). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.<br />Treasury bills - Short-term debt obligations of a national government that are issued to mature in three to twelve months. For the U.S., see Treasury bills.<br />Money funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors.<br />Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal of the exchange of currencies at a predetermined time in the future.<br />Short-lived mortgage- and asset-backed securities<br />Money market fund<br />A money market fund (also known as money market mutual fund) is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Regulated in the US under the Investment Company Act of 1940, money market funds are important providers of liquidity to financial intermediaries.<br />Explanation<br />Money market funds seek to limit exposure to losses due to credit, market, and liquidity risks. Money market funds in the United States are regulated by the Securities and Exchange Commission's (SEC) Investment Company Act of 1940. Rule 2a-7 of the act restricts the quality, maturity and diversity of investments by money market funds. Under this act, a money fund mainly buys the highest rated debt, which matures in under 13 months. The portfolio must maintain a weighted average maturity (WAM) of 60 days or less and not invest more than 5% in any one issuer, except for government securities and repurchase agreements.[2]<br />Unlike most other financial instruments, money market funds seek to maintain a stable value of $1 per share. Funds are able to pay dividends to investors.[2]<br />Securities in which money markets may invest include commercial paper, repurchase agreements, short-term bonds and other money funds. Money market securities must be highly liquid and of the highest quality.<br />History<br />In 1971, Bruce R. Bent and Henry B. R. Brown established the first money market fund in the U.S.[3] It was named The Reserve Fund and was offered to investors who were interested in preserving their cash and earning a small rate of return. Several more funds were shortly set up and the market grew significantly over the next few years.<br />Money market funds in the US created a loophole around Regulation Q,[4] and they can be seen as a substitute for banks.<br />Outside of the U.S., the first money market fund was set up in 1968 and was designed for small investors. The fund was called Conta Garantia and was created by John Oswin Schroy. The fund's investments included low denominations of commercial paper.<br />In the 1990s, bank interest rates in Japan were near zero for an extend period of time. To search for higher yields from these low rates in bank deposits, investors used money market funds for short-term deposits instead. However, several money market funds fell off short of their stable value in 2001 due to the Enron bankruptcy, in which several Japanese funds had invested, and investors fled into government-insured bank accounts. Since then the total value of money markets have remained low.[4]<br />Money market funds in Europe have always had much lower levels of investments capital than in the United States or Japan. Regulations in the EU have always encouraged investors to use banks rather than money market funds for short term deposits.[4]<br />[edit] Breaking the buck<br />Money market funds seek a stable net asset value, or NAV (which is generally $1.00 in the US); they aim never to lose money. If a fund's NAV drops below $1.00, it is said that the fund "broke the buck".<br />This has rarely happened; however, as of September 16, 2008, two money funds have broken the buck (in the 37-year history of money funds) and from 1971 to September 15, 2008, there was only one failure.<br />It is important to note that, while the funds are managed in a fairly safe manner, there would have been many more failures except that the companies offering the money market funds had, in the past, stepped in when necessary to support the fund and avoid having the funds "break the buck". This was done because the expected cost to the business from allowing the fund value to drop -- in lost customers and reputation -- was greater than the amount needed to bail it out.[5]<br />The Community Bankers US Government Fund broke the buck in 1994, paying investors 96 cents per share. This was the first failure in the then 23-year history of money funds and there were no further failures for 14 years. The fund had invested a large percentage of its assets into adjustable rate securities. As interest rates increased, these floating rate securities lost value. This fund was an institutional money fund, not a retail money fund, thus individuals were not directly affected.<br />No further failures occurred until September 2008, a month that saw tumultuous events for money funds. Though, as noted above, other failures were only averted by infusions of capital from the fund sponsors.[6]<br />[edit] September 2008<br />See also: Financial crisis of 2007–2010<br />Money market funds increasingly became important to the wholesale money market leading up to the crisis. Their purchases of asset-backed securities and large-scale funding of foreign bank's short-term US denominated debt put the funds in a pivotal position in the market place.[4]<br />The week of September 15, 2008 to September 19, 2008 was very turbulent for money funds and a key part of financial markets seizing up.[7]<br />[edit] Events<br />On Monday, September 15, 2008, Lehman Brothers Holdings Inc. filed for bankruptcy. On Tuesday, September 16, 2008, Reserve Primary Fund, the oldest money fund, broke the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers.[8]<br />The resulting investor anxiety almost caused a run on money funds, as investors redeemed their holdings and funds were forced to liquidate assets or impose limits on redemptions: through Wednesday, September 17, 2008, prime institutional funds saw substantial redemptions.[9][10] Retail funds saw net inflows of $4 billion, for a net capital outflow from all funds of $169 billion to $3.4 trillion (5%).[9]<br />In response, on Friday, September 19, 2008, the U.S. Department of the Treasury announced an optional program to "insure the holdings of any publicly offered eligible money market mutual fund—both retail and institutional—that pays a fee to participate in the program". The insurance will guarantee that if a covered fund breaks the buck, it will be restored to $1 NAV.[10][11] This program is similar to the FDIC, in that it insures deposit-like holdings and seeks to prevent runs on the bank.[7][12] The guarantee is backed by assets of the Treasury Department's Exchange Stabilization Fund, up to a maximum of $50 billion. It is very important to realize that this program only covers assets invested in funds before September 19, 2008 and those who sold equities, for example, during the recent market crash and parked their assets in money funds, are at risk. The program immediately stabilized the system and stanched the outflows, but drew criticism from banking organizations, including the Independent Community Bankers of America and American Bankers Association, who expected funds to drain out of bank deposits and into newly insured money funds, as these latter would combine higher yields with insurance.[7][12]<br />[edit] Analysis<br />The crisis almost developed into a run on the shadow banking system: the redemptions caused a drop in demand for commercial paper,[7] preventing companies from rolling over their short-term debt, potentially causing an acute liquidity crisis: if companies cannot issue new debt to repay maturing debt, and do not have cash on hand to pay it back, they will default on their obligations, and may have to file for bankruptcy. Thus there was concern that the run could cause extensive bankruptcies, a debt deflation spiral, and serious damage to the real economy, as in the Great Depression.[citation needed]<br />The drop in demand resulted in a "buyers strike", as money funds could not (because of redemptions) or would not (because of fear of redemptions) buy commercial paper, driving yields up dramatically: from around 2% the previous week to 8%,[7] and funds put their money in Treasuries, driving their yields close to 0%.<br />This is a bank run in the sense that there is a mismatch in maturities, and thus a money fund is a "virtual bank": the assets of money funds, while short term, nonetheless typically have maturities of several months, while investors can request redemption at any time, without waiting for obligations to come due. Thus if there is a sudden demand for redemptions, the assets may be liquidated in a fire sale, depressing their sale price.<br />An earlier crisis occurred in 2007–2008, where the demand for asset-backed commercial paper dropped, causing the collapse of some structured investment vehicles.<br />[edit] Statistics<br />The Investment Company Institute reports statistics on money funds weekly as part of its Mutual Fund Statistics, as part of its industry statistics, including total assets and net flows, both for institutional and retail funds. It also provides annual reports in the ICI Fact Book.<br />As of December 11, 2008, almost 2,000 money funds are in operation,[citation needed] with total assets of nearly US$3.8 trillion.[13] Of this $3.8 trillion, retail money market funds had $1.282 trillion in Assets Under Management (AUM), of which 77% was in tax-exempt funds. Institutional funds had $2.5 trillion under management of which the overwhelming majority - 93% - was tax-exempt.[14]<br />iMoneyNet is the leading provider of money fund statistics. iMoneyNet has been collecting money fund data since the early 1970's.<br />[edit] Types of money funds<br />[edit] Institutional money fund<br />Institutional money funds are high minimum investment, low expense share classes which are marketed to corporations, governments, or fiduciaries. They are often set up so that money is swept to them overnight from a company's main operating accounts. Large national chains often have many accounts with banks all across the country, but electronically pull a majority of funds on deposit with them to a concentrated money market fund.<br />The largest institutional money fund is the JPMorgan Prime Money Market Fund, with over US$100 billion in assets. Among the largest companies offering institutional money funds are BlackRock, Western Asset, Federated, Bank of America, Dreyfus, AIM and Evergreen (Wachovia).<br />Retail money fund<br />Retail money funds are offered primarily to individuals. Retail money market funds hold roughly 33% of all money market fund assets.<br />Retail money funds come in a few different breeds: government-only funds, non-government funds and tax-free funds. Yields are typically somewhat higher than in savings accounts.[citation needed] Investors will obtain a slightly higher yield in the non-government variety, whose principal holdings are high-quality commercial paper and other instruments; of course, such funds may get in trouble if fears emerge about previously well-regarded companies.<br />Instruments of the United States Government (and funds holding them) are usually exempt from state income taxes, and conversely, "muni bond funds" are generally exempt from federal income tax. In both cases, yields are (almost always) lower, but may result in better conservation of value depending an individual investors' tax situation.<br />The largest money market mutual fund is Fidelity Investments' Cash Reserves (Nasdaq:FDRXX), with assets exceeding US$110 billion. The largest retail money fund providers include: Fidelity, Vanguard (Nasdaq:VMMXX), and Schwab (Nasdaq:SWVXX).<br />[edit] Similar investments<br />[edit] Money market accounts<br />Main article: Money market account<br />Banks in the United States offer savings and money market deposit accounts, but these shouldn't be confused with money mutual funds. These bank accounts offer higher yields than traditional passbook savings accounts, but often with higher minimum balance requirements and limited transactions. A money market account may refer to a money market mutual fund, a bank money market deposit account (MMDA) or a brokerage sweep free credit balance.<br />[edit] Ultrashort bond funds<br />Main article: Ultrashort bond funds<br />Ultrashort bond funds are mutual funds, similar to money market funds, that, as the name implies, invest in bonds with extremely short maturities. Unlike money market funds, however, there are no restrictions on the quality of the investments they hold. Instead, ultrashort bond funds typically invest in riskier securities in order to increase their return. Since these high-risk securities can experience large swings in price or even default, ultrashort bond funds, unlike money market funds, do not seek to maintain a stable $1.00 NAV and may lose money or dip below the $1.00 mark in the short term.[15] Finally, because they invest in lower quality securities, ultrashort bond funds are more susceptible to adverse market conditions such as those brought on by the Financial crisis of 2007–2010.<br />Enhanced cash funds<br />Enhanced cash funds are bond funds similar to money market funds, in that they aim to provide liquidity and principal preservation, but which:[16]<br />invest in a wider variety of assets, and do not meet the restrictions of SEC Rule 2a-7;<br />aim for higher returns;<br />have less liquidity;<br />do not aim as strongly for stable NAV.<br />Enhanced cash funds will typically invest some of their portfolio in the same assets as money market funds, but others in riskier, higher yielding, less liquid assets such as:[16]<br />lower -rated bonds;<br />longer maturity;<br />foreign currency denominated debt;<br />asset-backed commercial paper (ABCP);[17]<br />Mortgage-backed securities (MBSs);[18]<br />Structured investment vehicles (SIVs).<br />In general, the NAV will stay close to $1, but is expected to fluctuate above and below, and will break the buck more often.[17][18][19] Different managers place different emphases on risk versus return in enhanced cash – some consider preservation of principal as paramount,[17] and thus take few risks, while others see these as more bond-like, and an opportunity to increase yield without necessarily preserving principal. These are typically available only to institutional investors, not retail investors.<br />The purpose of enhanced cash funds is not to replace money markets, but to fit in the continuum between cash and bonds – to provide a higher yielding investment for more permanent cash. That is, within one's asset allocation, one has a continuum between cash and long-term investments:<br />cash – most liquid and least risky, but low yielding;<br />money markets / cash equivalents;<br />enhanced cash;<br />long-term bonds and other non-cash long-term investments – least liquid and most risky, but highest yielding.<br />Enhanced cash funds were developed due to low spreads in traditional cash equivalents.[17]<br />There are also funds which are billed as "money market funds", but are not 2a-7 funds (do not meet the requirements of the rule).[16] In addition to 2a-7 eligible securities, these funds invest in Eurodollars and repos (repurchase agreements), which are similarly liquid and stable to 2a-7 eligible securities, but are not allowed under the regulations.<br />iMoneyNet provides detailed information on more than 200 enhanced type products with it's quarterly Enhanced Cash Report.<br />Money Market and its Instruments<br />Money Market: Money market means market where money or its equivalent can be traded.<br />Money is synonym of liquidity. Money market consists of financial institutions and dealers in<br />money or credit who wish to generate liquidity. It is better known as a place where large<br />institutions and government manage their short term cash needs. For generation of liquidity, short<br />term borrowing and lending is done by these financial institutions and dealers. Money Market is<br />part of financial market where instruments with high liquidity and very short term maturities are<br />traded. Due to highly liquid nature of securities and their short term maturities, money market is<br />treated as a safe place. Hence, money market is a market where short term obligations such as<br />treasury bills, commercial papers and banker’s acceptances are bought and sold.<br />Benefits and functions of Money Market: Money markets exist to facilitate efficient transfer of<br />short-term funds between holders and borrowers of cash assets. For the lender/investor, it<br />provides a good return on their funds. For the borrower, it enables rapid and relatively<br />inexpensive acquisition of cash to cover short-term liabilities. One of the primary functions of<br />money market is to provide focal point for RBI’s intervention for influencing liquidity and<br />general levels of interest rates in the economy. RBI being the main constituent in the money<br />market aims at ensuring that liquidity and short term interest rates are consistent with the<br />monetary policy objectives.<br />Money Market & Capital Market: Money Market is a place for short term lending and<br />borrowing, typically within a year. It deals in short term debt financing and investments. On the<br />other hand, Capital Market refers to stock market, which refers to trading in shares and bonds of<br />companies on recognized stock exchanges. Individual players cannot invest in money market as<br />the value of investments is large, on the other hand, in capital market, anybody can make<br />investments through a broker. Stock Market is associated with high risk and high return as against<br />money market which is more secure. Further, in case of money market, deals are transacted on<br />phone or through electronic systems as against capital market where trading is through<br />recognized stock exchanges.<br />Money Market Futures and Options: Active trading in money market futures and options<br />occurs on number of commodity exchanges. They function in the similar manner like any other<br />futures and options.<br />Money Market Instruments: Investment in money market is done through money market<br />instruments. Money market instrument meets short term requirements of the borrowers and<br />provides liquidity to the lenders. Common Money Market Instruments are as follows:<br /> T reasury Bills (T-Bills): Treasury Bills, one of the safest money market instruments, are<br />short term borrowing instruments of the Central Government of the Country issued through<br />the Central Bank (RBI in India). They are zero risk instruments, and hence the returns are not<br />so attractive. It is available both in primary market as well as secondary market. It is a<br />promise to pay a said sum after a specified period. T-bills are short-term securities that<br />mature in one year or less from their issue date. They are issued with three-month, six-month<br />and one-year maturity periods. The Central Government issues T- Bills at a price less than<br />their face value (par value). They are issued with a promise to pay full face value on maturity.<br />So, when the T-Bills mature, the government pays the holder its face value. The difference<br />between the purchase price and the maturity value is the interest income earned by the<br />purchaser of the instrument. T-Bills are issued through a bidding process at auctions. The bid<br />can be prepared either competitively or non-competitively. In the second type of bidding,<br />return required is not specified and the one determined at the auction is received on maturity.<br />Whereas, in case of competitive bidding, the return required on maturity is specified in the<br />bid. In case the return specified is too high then the T-Bill might not be issued to the bidder.<br />At present, the Government of India issues three types of treasury bills through auctions,<br />namely, 91-day, 182-day and 364-day. There are no treasury bills issued by State<br />Governments. Treasury bills are available for a minimum amount of Rs.25K and in its<br />multiples. While 91-day T-bills are auctioned every week on Wednesdays, 182-day and 364-<br />day T-bills are auctioned every alternate week on Wednesdays. The Reserve Bank of India<br />issues a quarterly calendar of T-bill auctions which is available at the Banks’ website. It also<br />announces the exact dates of auction, the amount to be auctioned and payment dates by<br />issuing press releases prior to every auction. Payment by allottees at the auction is required to<br />be made by debit to their/ custodian’s current account. T-bills auctions are held on the<br />Negotiated Dealing System (NDS) and the members electronically submit their bids on the<br />system. NDS is an electronic platform for facilitating dealing in Government Securities and<br />Money Market Instruments. RBI issues these instruments to absorb liquidity from the market<br />by contracting the money supply. In banking terms, this is called Reverse Repurchase<br />(Reverse Repo). On the other hand, when RBI purchases back these instruments at a specified<br />date mentioned at the time of transaction, liquidity is infused in the market. This is called<br />Repo (Repurchase) transaction.<br /> R epurchase Agreements: Repurchase transactions, called Repo or Reverse Repo are<br />transactions or short term loans in which two parties agree to sell and repurchase the same<br />security. They are usually used for overnight borrowing. Repo/Reverse Repo transactions can<br />be done only between the parties approved by RBI and in RBI approved securities viz. GOI<br />and State Govt Securities, T-Bills, PSU Bonds, FI Bonds, Corporate Bonds etc. Under<br />repurchase agreement the seller sells specified securities with an agreement to repurchase the<br />same at a mutually decided future date and price. Similarly, the buyer purchases the securities<br />with an agreement to resell the same to the seller on an agreed date at a predetermined price.<br />Such a transaction is called a Repo when viewed from the perspective of the seller of the<br />securities and Reverse Repo when viewed from the perspective of the buyer of the securities.<br />Thus, whether a given agreement is termed as a Repo or Reverse Repo depends on which<br />party initiated the transaction. The lender or buyer in a Repo is entitled to receive<br />compensation for use of funds provided to the counterparty. Effectively the seller of the<br />security borrows money for a period of time (Repo period) at a particular rate of interest<br />mutually agreed with the buyer of the security who has lent the funds to the seller. The rate of<br />interest agreed upon is called the Repo rate. The Repo rate is negotiated by the counterparties<br />independently of the coupon rate or rates of the underlying securities and is influenced by<br />overall money market conditions.<br /> C ommercial Papers: Commercial paper is a low-cost alternative to bank loans. It is a short<br />term unsecured promissory note issued by corporates and financial institutions at a<br />discounted value on face value. They are usually issued with fixed maturity between one to<br />270 days and for financing of accounts receivables, inventories and meeting short term<br />liabilities. Say, for example, a company has receivables of Rs 1 lacs with credit period 6<br />months. It will not be able to liquidate its receivables before 6 months. The company is in<br />need of funds. It can issue commercial papers in form of unsecured promissory notes at<br />discount of 10% on face value of Rs 1 lacs to be matured after 6 months. The company has<br />strong credit rating and finds buyers easily. The company is able to liquidate its receivables<br />immediately and the buyer is able to earn interest of Rs 10K over a period of 6 months. They<br />yield higher returns as compared to T-Bills as they are less secure in comparison to these<br />bills; however chances of default are almost negligible but are not zero risk instruments.<br />Commercial paper being an instrument not backed by any collateral, only firms with high<br />quality credit ratings will find buyers easily without offering any substantial discounts. They<br />are issued by corporates to impart flexibility in raising working capital resources at market<br />determined rates. Commercial Papers are actively traded in the secondary market since they<br />are issued in the form of promissory notes and are freely transferable in demat form.<br /> C ertificate of Deposit: It is a short term borrowing more like a bank term deposit account. It<br />is a promissory note issued by a bank in form of a certificate entitling the bearer to receive<br />interest. The certificate bears the maturity date, the fixed rate of interest and the value. It can<br />be issued in any denomination. They are stamped and transferred by endorsement. Its term<br />generally ranges from three months to five years and restricts the holders to withdraw funds<br />on demand. However, on payment of certain penalty the money can be withdrawn on demand<br />also. The returns on certificate of deposits are higher than T-Bills because it assumes higher<br />level of risk. While buying Certificate of Deposit, return method should be seen. Returns can<br />be based on Annual Percentage Yield (APY) or Annual Percentage Rate (APR). In APY,<br />interest earned is based on compounded interest calculation. However, in APR method,<br />simple interest calculation is done to generate the return. Accordingly, if the interest is paid<br />annually, equal return is generated by both APY and APR methods. However, if interest is<br />paid more than once in a year, it is beneficial to opt APY over APR.<br /> B anker’s Acceptance: It is a short term credit investment created by a non financial firm and<br />guaranteed by a bank to make payment. It is simply a bill of exchange drawn by a person and<br />accepted by a bank. It is a buyer’s promise to pay to the seller a certain specified amount at<br />certain date. The same is guaranteed by the banker of the buyer in exchange for a claim on<br />the goods as collateral. The person drawing the bill must have a good credit rating otherwise<br />the Banker’s Acceptance will not be tradable. The most common term for these instruments<br />is 90 days. However, they can very from 30 days to180 days. For corporations, it acts as a<br />negotiable time draft for financing imports, exports and other transactions in goods and is<br />highly useful when the credit worthiness of the foreign trade party is unknown. The seller<br />need not hold it until maturity and can sell off the same in secondary market at discount from<br />the face value to liquidate its receivables.<br />An individual player cannot invest in majority of the Money Market Instruments, hence for<br />retail market, money market instruments are repackaged into Money Market Funds. A<br />money market fund is an investment fund that invests in low risk and low return bucket of<br />securities viz money market instruments. It is like a mutual fund, except the fact mutual funds<br />cater to capital market and money market funds cater to money market. Money Market funds can<br />be categorized as taxable funds or non taxable funds.<br />Having understood, two modes of investment in money market viz Direct Investment in Money<br />Market Instruments & Investment in Money Market Funds, lets move forward to understand<br />functioning of money market account.<br />Investment in<br />Money Market<br />Direct Investment<br />in Money Market<br />Instruments<br />Investment in<br />Money Market<br />Funds<br />Parking money in<br />Money Market<br />Account<br />Money Market Account: It can be opened at any bank in the similar fashion as a savings<br />account. However, it is less liquid as compared to regular savings account. It is a low risk account<br />where the money parked by the investor is used by the bank for investing in money market<br />instruments and interest is earned by the account holder for allowing bank to make such<br />investment. Interest is usually compounded daily and paid monthly. There are two types of<br />money market accounts:<br />Money Market Transactional Account: By opening such type of account, the account<br />holder can enter into transactions also besides investments, although the numbers of<br />transactions are limited.<br />Money Market Investor Account: By opening such type of account, the account<br />holder can only do the investments with no transactions.<br />Money Market Index: To decide how much and where to invest in money market an investor<br />will refer to the Money Market Index. It provides information about the prevailing market rates.<br />There are various methods of identifying Money Market Index like:<br />Smart Money Market Index- It is a composite index based on intra day price pattern<br />of the money market instruments.<br />Salomon Smith Barney’s World Money Market Index- Money market instruments are<br />evaluated in various world currencies and a weighted average is calculated. This<br />helps in determining the index.<br />Banker’s Acceptance Rate- As discussed above, Banker’s Acceptance is a money<br />market instrument. The prevailing market rate of this instrument i.e. the rate at which<br />the banker’s acceptance is traded in secondary market, is also used as a money<br />market index.<br />LIBOR/MIBOR- London Inter Bank Offered Rate/ Mumbai Inter Bank Offered Rate<br />also serves as good money market index. This is the interest rate at which banks<br />borrow funds from other banks.<br />By: Abhishikta Chadda, Associate Chartered Accountant, Membership No: 500597<br />http://www.caalley.com/art/Money_Market_and_Money_Market_Instruments.pdf<br />Money Market Instruments: Treasury Bills and Certificate of Deposit<br />Money Market Instruments provide the tools by which one can operate in the money market.Types Of Money Market Instruments<br /> Treasury Bills: The Treasury bills are short-term money market instrument that mature in a year or less than that. The purchase price is less than the face value. At maturity the government pays the Treasury Bill holder the full face value.The Treasury Bills are marketable, affordable and risk free. The security attached to the treasury bills comes at the cost of very low returns.<br /> Certificate of Deposit: The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.Advantages of Certificate of Deposit as a money market instrument1. Since one can know the returns from before, the certificates of deposits are considered much safe.2. One can earn more as compared to depositing money in savings account.3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.Disadvantages of Certificate of deposit as a money market instrument:1. As compared to other investments the returns is less.2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.<br /> Commercial Paper: Commercial Paper is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. Commercial Papers have higher denominations as compared to the Treasury Bills and the Certificate of Deposit. The maturity period of Commercial Papers are a maximum of 9 months. They are very safe since the financial situation of the corporation can be anticipated over a few months.<br /> Banker's Acceptance: It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the Secondary market. The banker's acceptance is mostly used to finance exports, imports and other transactions in goods. The banker's acceptance need not be held till the maturity date but the holder has the option to sell it off in the secondary market whenever he finds it suitable.<br /> Euro Dollars: The Eurodollars are basically dollar- denominated deposits that are held in banks outside the United States. Since the Eurodollar market is free from any stringent regulations, the banks can operate at narrower margins as compared to the banks in U.S. The Eurodollars are traded at very high denominations and mature before six months. The Eurodollar market is within the reach of large institutions only and individual investors can access it only through money market funds.<br /> Repos: The Repo or the repurchase agreement is used by the government security holder when he sells the security to a lender and promises to repurchase from him overnight. Hence the Repos have terms raging from 1 night to 30 days. They are very safe due government backing. <br />Money Market Instruments <br />Money Market means market where money or its equivalent can be traded. Money is synonym of liquidity. Money Market consists of financial institutions and dealers in money or credit who wish to generate liquidity. It is better known as a place where large institutions and governments manage their short term cash needs. For generation of liquidity, short term borrowing and lending is done by these financial institutions and dealers. Money Market is part of financial market where instruments with high liquidity and very short term maturities are traded. Due to highly liquid nature of securities and their short term maturities, money market is treated as a safe place. Hence, money market is a market where short term obligations such as treasury bills, commercial papers and banker's acceptances are bought and sold.<br />Benefits and functions of Money MarketMoney Markets exist to facilitate efficient transfer of short-term funds between holders and borrowers of cash assets. For the lender/investor, it provides a good return on their funds. For the borrower, it enables rapid and relatively inexpensive acquisition of cash to cover short-term liabilities. One of the primary functions of Money Market is to provide focal point for RBI's intervention for influencing liquidity and general levels of interest rates in the economy. RBI being the main constituent in the Money Market aims at ensuring that liquidity and short term interest rates are consistent with the monetary policy objectives.<br />Money Market & Capital Market:Money Market is a place for short term lending and borrowing, typically within a year. It deals in short term debt financing and investments. On the other hand, Capital Market refers to stock market, which refers to trading in shares and bonds of companies on recognized stock exchanges. Individual players cannot invest in money market as the value of investments is large, on the other hand, in capital market, anybody can make investments through a broker. Stock Market is associated with high risk and high return as against Money Market which is more secure. In case of money market, deals are transacted on phone or through electronic systems as against capital market where trading is through recognized stock exchanges.Treasury Bills:-<br />Treasury Bills are Money Market instruments to finance the short term requirements of the Government of India. These are discounted securities and thus are issued at a discount to face value. The return to the investor is the difference between the maturity value and issue price<br />Treasury Bills or T-Bills as they are known are issued by the Government of India to meet their short-term requirement. T-Bills are issued for 91-day, 182-day and 364-day maturities. T-Bills are issued at a discount to their face value and redeemed at par.<br />364-day T-Bills forms part of the government borrowing programme.There are three types of Treasury Bills.<br />91-day T-bill - maturity is in 91 days. Its auction is weekly on every Wednesday.<br />182-day T-bill - maturity is in 182 days. Its auction is on every alternate Wednesday other than a reporting week.<br />364-Day T-bill - maturity is in 364 days. Its auction is on every alternate Wednesday in a reporting week. Features of T-Bills auction<br />All T-Bills auctions are Price-based.<br />All T-Bills are auctioned on Multiple-Price basis.<br />The RBI auctions 91-day T-Bills every Wednesday, 182-day T-Bills on every alternate wednesday and 364-day T-Bills on the Wednesday of the reporting Friday week. <br />Commercial Papers:<br />Commercial Paper is a low-cost alternative to bank loans. It is a short term unsecured promissory note issued by corporates and financial institutions at a discounted value on face value. They are usually issued with fixed maturity between one to 270 days and for financing of accounts receivables, inventories and meeting short term liabilities. Say, for example, a company has receivables of Rs 1 lacs with credit period of 6 months. It will not be able to liquidate its receivables before 6 months. The company is in need of funds. It can issue commercial papers in form of unsecured promissory notes at discount of 10% on face value of Rs 1 lacs to be matured after 6 months. The company has strong credit rating and finds buyers easily. The company is able to liquidate its receivables immediately and the buyer is able to earn interest of Rs 10K over a period of 6 months. They yield higher returns as compared to T-Bills as they are less secure in comparison to these bills. Chances of default are almost negligible but are not zero risk instruments. Commercial Paper being an instrument not backed by any collateral, only firms with high quality credit ratings will find buyers easily without offering any substantial discounts. They are issued by corporates to impart flexibility in raising working capital resources at market determined rates. Commercial Papers are actively traded in the secondary market since they are issued in the form of promissory notes and are freely transferable in demat form.<br />Certificate of Deposit: It is a short term borrowing more like a bank term deposit account. It is a promissory note issued by a bank in form of a certificate entitling the bearer to receive interest. The certificate bears the maturity date, the fixed rate of interest and the value. It can be issued in any denomination. They are stamped and transferred by endorsement. Its term generally ranges from three months to five years and restricts the holders to withdraw funds on demand. However, on payment of certain penalty the money can be withdrawn on demand. The returns on Certificate of Deposits are higher than T-Bills because it assumes higher level of risk. While buying Certificate of Deposit, return method should be seen. Returns can be based on Annual Percentage Yield (APY) or Annual Percentage Rate (APR). In APY, interest earned is based on compounded interest calculation. However, in APR method, simple interest calculation is done to generate the return. Accordingly, if the interest is paid annually, equal return is generated by both APY and APR methods.<br />However, if interest is paid more than once in a year, it is beneficial to opt APY over APR.Advantages of Certificate of Deposit as a money market instrument<br />Since one can know the returns from before, the certificates of deposits are considered much safe. <br /> <br />One can earn more as compared to depositing money in savings account.<br />Disadvantages of Certificate of Deposit as a Money Market instrument: <br />As compared to other investments the returns is less.<br />The money is tied up along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.<br />Money Market Instruments<br />The money market is the arena in which financial, nonfinancial, and banking institutions make available to a broad range of creditors, borrowers and investors, the opportunity to buy and sell, on a wholesale basis, large volumes of bills, notes, and other forms of short-term credit. These instruments have maturities ranging from one day to one year and are extremely liquid. Consequently, they are considered to be near-cash equivalents, hence the name money market instruments.<br />Retail money market dealers work independently or in syndicated groups to efficiently distribute available supplies of money market instruments to securities dealers, banks, and other financial intermediaries who broker them to retail clients. In addition to dealers, institutions and funds repackage money market instruments into money market mutual funds to allow participation at almost any level.<br />The suppliers of funds for money market instruments are institutions and individuals with a preference for the highest liquidity and the lowest risk. Often, money market instruments are a parking place for temporary excess cash of investors and corporations. Interest rates on money market instruments are typically quoted on a bank discount basis.<br />Certificates of Deposits<br />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. 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. A Yankee CD is a CD issued by domestic branches of foreign banks. Eurodollar CDs are negotiable certificates issued against U.S. dollar obligations in a foreign branch of a domestic bank.<br />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, since brokers maintain an active secondary market in CDs.<br />Eurodollar deposit<br />Deposits made in U.S. dollars at a bank or bank branch located outside the United States.<br />Treasury bills<br />These are short-term obligations sold at a discount and redeemed at face value on maturity. Treasury bills are the major money-market instrument used by the Treasury to finance a deficit. <br />Commercial Paper<br />Commercial paper (CP) refers to unsecured short-term promissory notes issued by financial and nonfinancial corporations. CP has maturities of up to 270 days (the maximum allowed without SEC registration requirement). Dollar volume for CP exceeds the amount of any money market instrument other than Treasury bills. CP is typically issued by large, credit-worthy corporations with unused lines of bank credit and, therefore, carries low default risk.<br />Standard & Poor's and Moody's provide ratings. The highest ratings are Al and P(Prime)l, respectively. A2 and P2 paper is considered high quality, but usually indicates that the issuing corporation is smaller or more debt burdened than Al and PI companies. Issuers, earning the lowest ratings, find few willing investors.<br />Commercial paper can be issued directly by the company to creditors, using internal transactors or a bank as an agent. The bank assumes no principal position and is in no way obligated with respect to repayment of the CP.<br />Companies may also sell CP through dealers who charge a fee and arrange for the transfer of the funds from the lender to the borrower.<br />Bankers' Acceptance<br />Bankers' acceptances are generally used to finance foreign trade. A buyer's promise to pay a specific amount of money at a fixed or determinable future time (usually less than 180 days) is issued to a seller. A bank then guarantees or "accepts" this promise in exchange for a claim on the goods as collateral. The seller may obtain immediate cash in lieu of future payment by selling the acceptance at a discount. <br />Money Market<br />What Does Money Market Mean?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). <br />Investopedia explains Money MarketThe 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. <br />Link for PPT<br />http://www.slideshare.net/vidyut_jain25/money-market-instuments-presentation<br />http://www.slideshare.net/adhwaryu/money-market-2394006<br />http://www.slideshare.net/shael_kumar/money-market-ppt<br />http://www.slideshare.net/pujil2009/money-market-1926090<br />http://www.slideshare.net/pujil2009/money-market-2<br />http://www.slideshare.net/pujil2009/9329365-a-ppt-on-money-market<br />http://www.slideshare.net/nino31/m10-mish1520-06ppwc09<br />

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