U.S. Treaserury bills (T-bills) are the most marketable of all money market instruments. The government raises money by selling bills to the public. They are highly liquid and sold at low transaction cost and with minimum price risk. Investors buy the bills at a discount from the stated maturity value. They are issued with initial maturities of 4, 13, 26, or 52 weeks.
A certificate of deposit is a time deposit with a bank. Time deposit may not be withdrawn on demand. The bank pays interest and principal to the depositor only at the end of the fixed term of the CD. CD are insured for up to $250’000 in the event of a bank insolvency.
Commercial Paper
Large, well-known companies often issue their own short-term unsecured debt notes rather than borrow directly from banks. Very often, commercial paper is backed by a bank line of credit. CP range up to 270 days, longer maturities would require registration with the Securities and Exchange Commission. Most commercial paper is issued by nonfinancial firms, in recent years there was a sharp increase in asset-backed commercial paper. This was short-term commercial paper typically used to raise funds for the institution to invest in other assets. These assets were in turn used as collateral for the commercial paper.
Bankers Acceptances
A banker’s acceptance starts as an order to a bank by a bank’s customer to pay a sum of money at a future date, typically within 6 months. They are used widely in foreign trade where the creditworthiness of one trader is unknown to the trading partner. They sell at a discount from the face value, just as T-bills do.
Eurodollars CD and bonds
Eurodollars are dollar-denominated deposits at foreign banks or foreign branches of American banks, whose do not need to be in Europe. These banks escape regulation by the Fed. Most Eurodollar deposits are for large sums, and most are time deposit of less than six months’ maturity. Eurodollar CDs are considered less liquid and riskier than domestic CDs and offer higher yields.
Repos and Reverses
The dealer sells government securities to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price. The increase in the price is the overnight interest. A term repo is essentially an identical transaction, except that the term of the implicit loan can be 30 days or more. They are considered very safe because they are backed by government securities. A reverse repo is the mirror image of a repo.
Federal Funds
Banks maintain deposit of their own at a Federal Reserve bank. Some banks have more funds than the minimum balance they are required to maintain while others, primarily big banks in New York tend to be short. The bank with excess lend to those with a shortage at a rate of interest called the federal funds rate. Today the market has evolved to the point that many large bank use federal funds in a straightforward way as one component of their total sources of funding. Therefore, the fed funds rate is simply the rate of interest on very short-term loans among financial institutions
Brokers’Calls
The broker borrow funds from a bank, agreeing to repay the bank immediately (on call) if the bank requests it. The rate on such loan is usually about 1% higher than the rate on short term T-bills.
The LIBOR Market
The London Interbank Offered Rate (LIBOR) is the rate at wich large banks in London are willing to lend money among themselves. It has become the premier short-term interest rate quoted in the European money market and serve as reference for a wide range of transactions.
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