Types of Instruments Traded in the Money Market
Several financial instruments are created for short-term lending and borrowing in the money market, they include:
1. Treasury Bills
Treasury bills are considered the safest instruments since they are issued with a full guarantee by the United States government. They are issued by the U.S. Treasury regularly to refinance Treasury bills reaching maturity and to finance the federal government’s deficits. They have a maturity of one, three, six, or twelve months. Treasury bills are sold at a discount to their face value, and the difference between the discounted purchases price and face value represents the interest rate. They are purchased by banks, broker-dealers, individual investors, pension funds, insurance companies, and other large institutions.
2. Certificate of Deposit
A certificate of deposit (CD) is issued directly by a commercial bank, but it can be purchased through brokerage firms. It has a maturity date ranging from three months to five years and can be issued in any denomination. Most CDs have a fixed maturity date and interest rate, and they attract a penalty for withdrawing prior the time of maturity. Just like a bank’s checking account, a certificate of deposit is insured by the Federal Deposit Insurance Corporation (FDIC).
3. Commercial Paper
Commercial paper is an unsecured loan issued by large institutions or corporations to finance short-term cash flow needs such as inventory and accounts payables. It is issued at a discount, with the difference between the price and face value of the commercial paper being the profit to the investor. Only institutions with a high credit rating can issue commercial paper, and it is therefore considered a safe investment. Commercial paper is issued in denominations of $100,000 and above. Individual investors can invest in the commercial paper market indirectly through money market funds. Commercial paper has a maturity date between one month and nine months.
4. Banker’s Acceptance
A banker’s acceptance is a short-term debt instrument issued by a non-financial institution but guaranteed by a commercial bank. It is created by a drawer, providing the bearer the right to the money indicated on its face at a specified date. It is often used in international trade because of the benefits to both the drawer and bearer. The holder of the acceptance may decide to sell it on a secondary market, and investors can profit from the short-term investment. The date of maturity ranges between one month and six months from the date of issue.
5. Repurchase Agreements
A repurchase agreement (repo) is a short-term form of borrowing that involves selling a security with an agreement to repurchase it at a higher price at a later date. It commonly used by dealers in government securities who sell Treasury bills to a lender and agree to repurchase them at an agreed price at a later date. The Federal Reserve buys repurchase agreements as a way of regulating the money supply and bank reserves. Their date of maturity ranges from overnight to 30 days or more.