1. Introduction to Money Market Themoney market is a significant part of the financial system which is specializedin short-term debt securities. Its basic function is the exchange of funds between lenders,investors and borrowers- just like other financial markets in the financialsystem. Usually,the money market trades securities from one day and up to one year of maturity.
The money market provide large financial institutions, corporations, thefederal government and government agencies with the access to liquidity, whichallows to finance short-term operations and needs. It is the most importantfeature of the money market that made it inevitable part of the financialsystem. Safety is another feature of money market.Money market instrumentsare issued by money market institutions like mutual funds, brokerage firms and banks. These instruments areused by corporations, governments, and individual investors seeking short-termfunding. Types of money marketinstrumentsMoney Market instruments are the means by which the moneymarket facilitate the financial system. Some of the most common types of moneymarket instruments which have strong secondary market include: i.
T-bills or Treasurybills: T-bills are short-term money market instruments that areissued by the U.S. government. T-bills are issued at various maturities and aresold at a discount to their face value and can be purchased at auction throughbidding.ii. Negotiable Certificate of Deposit: Negotiable Certificate of Deposit or simply NCDsare certificates that are issued by the commercial banks.iii.
Commercial paper: Large corporations and financialcompanies issue these unsecured money market instrument. These papers are primarilyissued to provide liquidity and to raise short-term funds.iv. Repurchaseagreements (repos): Treasurysecurities that the buyers and seller agree upon with the consent to repurchaseit later at a predetermined time. That means, they will be sold with anagreement of purchasing them back at a given date in future for a higher priceas stipulated.v. Bankers Acceptances: Banker’s Acceptance (BA) is a short-term credit investment created toprovide guarantee by a bank to make payment in the future. BankersAcceptances are commonly used for international trade transactions and the holderof this BA can sell it at a discount price prior to maturity.
Characteristicsof money marketMoneymarket have some unique characteristics that make it differ from otherfinancial markets. Some characteristics of the money markets are given below: i. Itis a collection of markets of several instruments, not a single market ii. Itis likely, a wholesale market of short-term financing need iii. Themain players are: Federal Reserve or central bank, Discount and Finance Houses,mutual funds, commercial banks, corporate investor, non-banking financecompanies, state government itself, government agencies, provident funds, etc.iv.
Thedemand and supply of money shape this market, as it is a need based marketv. Liquidityand safety are its major features, for which this market is renowned forvi. Maturityis from overnight up to less than one yearvii. Mostof the money markets’ instruments are traded at discount rateviii. Moneymarket securities offer a lower return than other securities 2. Role of Money Market in the Financial System Money market plays very crucial rolein the development and stabilization of the financial system of a country. It worksas a subsidiary for the capital market. There are many ways by which moneymarkets influence, affect and help controlling the financial system.
Here aresome relative ways by which money market plays role in the financial system: i. Byfunding federal deficitThegovernment do need money to run its operations. The federal government borrowsmoney from the money market through the Treasury (for U.S. it is U.
S. Treasury)by issuing shorter-term securities called T-bills or Treasury Bills. When thefederal government face budget deficits and other cash shortages, these T-billsprovide liquidity that allows the federal government to continue to finance itsoperations and services and stabilizes the country’s development that haveimpacts the financial system. ii.
Throughshort-term commercial papersCorporationsalso need short-term funding as their working capital, payroll or a specificproject and other operations. They can issue short-term commercial papers andborrow money from the money market. Commercial papers are sometimes cheaper,and mostly flexible than traditional corporate bank loans. Thus thesescommercial papers allow the firms to continue their operations and provideeconomic boost by assisting the firms. iii.
Byencouraging economic growthThemoney market allows large corporations and the government to borrow withflexible conditions for a shot-term maturity. These borrowings allow bothcorporations, federal government and government agencies to continue theirprograms, projects and operations which help them to expand operations thatultimately encourage the economic growth, which directly influence thefinancial system. iv. By providing information for monetarypolicyThe basic function of moneymarket is to liquidity to the borrowers by collecting funds from lenders (fundproviders) by meeting the short-term requirements of the borrowers andprovides, which also involves transferring of information of the underlyingconditions of supply and demand and other monetary information. The moneymarkets provide these necessary information for monetary policy formulation andmanagement, which is crucial for the financial system as it helps to makedecision on maintaining continuous growth, equity and price stability. v. By helping Central Bank to smootheningoperations and efficiencyCentral bank of a country playsmost important role in the financial system.
By facilitate changing the levelof liquidity in the economy through open market operations and by regulatingthe access of the banks to its accommodation, it occupied a most strategicposition in the money market. A well-developed money marketincreases the efficiency and smoothens the functioning of the central Bank. Themoney market assist the central bank to adopt an appropriate banking policy byusing short-run interest rates of the money market as a direct indicator ofboth the monetary and banking conditions. vi. By facilitating interbank lendingCommercial banks need a lot ofshort term money to run their certain operations.
The money market is a greatsource of funds for these commercial banks (including foreign banks). There isa term called ‘Interbank Offered Rate’-the rate at which banks loan each otherthat mature over-night up to not more than one week. This loaning occur in themoney market on a very short notice with much flexibility which helps thesebanks to meet their short-term needs. vii. Byfacilitating international trade International trade or simplyimport-export is one of the biggest source of a countries income thatcontribute to the financial system by both the fact of inflow and outflow ofmoney (including foreign money). This international trade needs a secure meansof transaction to take place. Banker’s acceptance is an instrument of moneymarket which facilitate international trade.
It provide guarantee to therelevant party that if the LC issuer fails to pay the stipulated amount oftrade money, the LC issuing institution will provide the money to the party. Asboth parties are guaranteed safety through this instrument, it directlyinfluence the economic development by facilitating international trade. viii.Throughcentral bank’s short-term lendingSometimes, commercial banks needa large amount of loan for very short time with a short notice.
Central bankused to be a top reservoir of reserve, which provide such loans to commercialbanks through its discount window to let the banks operate with sufficientliquidity reserve. ix. Through commercial banksCommercial banks are the largestsource for private financing and individual loans. This banks take depositsfrom people and organizations and loans out to those who need money. Smallbusinesses sometimes do not have access to upper level loaning corporations forshort-term financing. Commercial banks do this sort of short-term financingthat makes those businesses operate properly.
Ultimately, this help develop theeconomy of the nation. x. By help regulating the money supply and bank reservesRepurchase agreement or REPO is one of themostly used money market instruments. Usually, the Federal Reserve enters into repurchase agreements, whereindividuals use these agreements to finance the purchase of debt securities or other investments for a short term basis.Usually the agreements settle overnight. Repo allows federalgovernment to control the money supply within its economy by either increasingor decreasing total available funds. A decrease in repo rate (the rate at whichthe repo settles) pools banks to sell securities back to the government, whichboost the money supply to the financial system. Again, an increase in repo ratediscourage banks from reselling these securities resulting a decrease the moneysupply.
In brief, the roles of money market are:§ This market enhances the amount ofliquidity available to the entire country§ It helps to make proper monetarypolicy, control money supply and reserve§ It assists in mobilization ofthe savings of the community§ Facilitiesinternational trade and interbank lending § Itfunds the federal government as needed § Finally, satisfy all the short-termfinancial needs for different participants and help stabilizing businessoperations to grow the economy. 3. ConclusionFor industrial and developingcountries, money markets are integral to the financial system. These markets,which serve as channels for the execution and transmission of monetary policyand also trading for the shortest-term using its own specialized instruments.Money market is the efficient distributor of liquidity among financialinstitutions, and the hedging of short-term risks and works as a trade settlerfor shorter-term.
These facilities have made this market so important in thewhole financial system. Appendix a. References i.
Madura, J. (n.d.). Money Markets. In FinancialMarkets and Institutions (11th ed., pp.
135-162). Cengage learning.ii. Fuentes,G. (2017, July 27). Importance of MoneyMarket. Retrieved December 02, 2017, from https://pocketsense.
com/importance-money-market-6305912.html iii. Sinha, A.
(2017). What are the functions and importance ofMoney Market?. Retrieved December 02, 2017, from http://www.
preservearticles.com/201012281812/functions-and-importance-of-money-market.htmliv. The Money Market. (2017, May 05).Retrieved December 02, 2017, from https://www.investopedia.com/university/moneymarket/moneymarket2.
aspv. Rai,D. (n.
d.). Money Market: Objectives,Functions and Limitations. Retrieved December 2, 2017, from http://www.yourarticlelibrary.com/business/money-market/money-market-objectives-functions-and-limitations/75923vi.
Definitionof repurchase agreement. (n.d.). Retrieved December 2, 2017, from http://lexicon.ft.com/Term?term=repurchase-agreement