2.10 Money Market Instruments

Money market instruments are short-term, highly liquid debt securities used by governments, corporations, and financial institutions to manage short-term funding needs. These instruments are considered low-risk and are essential to understanding the fixed-income markets tested on the SIE exam.

What Is the Money Market?

The money market is where short-term debt instruments are traded. Key characteristics:

- Maturity: One year or less

- Liquidity: Very high - can be quickly converted to cash

- Safety: Generally low-risk

- Purpose: Short-term borrowing and lending

Types of Money Market Instruments

Treasury Bills (T-Bills)

T-Bills are short-term government securities and the benchmark for money market rates.

Issuer: U.S. Treasury

Maturities: 4, 8, 13, 26, 52 weeks

Interest: None - sold at discount

Minimum: $100

Risk: Virtually risk-free

Tax: Federal only (exempt from state/local)

Most Liquid: T-Bills are considered the most liquid and safest of all money market instruments.

Commercial Paper

Commercial paper is unsecured, short-term corporate debt issued by large, creditworthy corporations.

Issuer: Corporations with strong credit

Maximum maturity: 270 days

Interest: Sold at discount

Registration: Exempt from SEC if 270 days or less

Risk: Low but higher than T-bills

Why 270 Days? If maturity exceeds 270 days, the issuer must register with the SEC, which is costly and time-consuming.

Key Points:

- Used for short-term working capital needs

- Only issued by companies with excellent credit ratings

- Not backed by collateral (unsecured)

Banker's Acceptances (BAs)

Banker's acceptances are time drafts "accepted" (guaranteed) by a bank, primarily used in international trade.

Issuer: Created by corporations, guaranteed by banks

Maturities: 30-180 days

Interest: Sold at discount

Primary use: International trade financing

Risk: Low (bank guarantee)

How BAs Work:

1. Importer's bank "accepts" responsibility to pay

2. The BA becomes a negotiable instrument

3. Can be sold in secondary market before maturity

Example: A U.S. company imports goods from Japan. A bank issues a BA promising to pay the Japanese exporter in 90 days. The exporter can sell the BA at a discount for immediate cash.

Negotiable Certificates of Deposit (CDs)

Negotiable CDs are large-denomination bank deposits that can be traded in the secondary market.

Issuer: Commercial banks

Minimum: $100,000 (typically $1 million+)

Maturities: 2 weeks to 1 year

Interest: Pays interest at maturity

Trading: Trades with accrued interest

Negotiable vs. Regular CDs: Unlike retail CDs from your local bank, negotiable CDs can be bought and sold in the secondary market before maturity.

Repurchase Agreements (Repos)

Repos are short-term loans collateralized by securities, typically Treasury securities.

Structure: Sell securities + agree to repurchase

Collateral: Usually Treasury securities

Maturities: Overnight to 30 days

Users: Banks, dealers, Federal Reserve

Risk: Very low (collateralized)

How Repos Work:

1. Party A sells securities to Party B

2. Party A agrees to buy them back at a higher price

3. The difference is the interest earned by Party B

Reverse Repo: From the buyer's perspective (Party B), it's a "reverse repurchase agreement."

Fed and Repos: The Federal Reserve uses repos extensively to manage the money supply and implement monetary policy.

Comparison of Money Market Instruments

T-Bills: Issuer - U.S. Treasury; Maturity - 4-52 weeks; Interest Style - Discount; Collateral - N/A (full faith)

Commercial Paper: Issuer - Corporations; Maturity - Up to 270 days; Interest Style - Discount; Collateral - None

Banker's Acceptances: Issuer - Banks; Maturity - 30-180 days; Interest Style - Discount; Collateral - Bank guarantee

Negotiable CDs: Issuer - Banks; Maturity - 2 weeks-1 year; Interest Style - Accrued interest; Collateral - None

Repos: Issuer - Dealers/Banks; Maturity - Overnight-30 days; Interest Style - Interest; Collateral - Securities

Key Characteristics Summary

Discount Instruments (No Periodic Interest)

- Treasury Bills

- Commercial Paper

- Banker's Acceptances

Interest-Bearing Instruments

- Negotiable CDs (pay interest at maturity)

- Repos (implicit interest in repurchase price)

Key Takeaways

- Money market instruments have maturities of one year or less

- T-Bills are the safest and most liquid money market instrument

- Commercial paper maximum maturity is 270 days (SEC exemption)

- Banker's acceptances facilitate international trade

- Negotiable CDs are large deposits ($100,000+) that trade in secondary markets

- Repos are collateralized short-term loans using securities

- Most money market instruments are sold at a discount