Money Markets

Money markets are global platforms for trading highly liquid short-term financial investments with maturities of one year or less, such as certificates of deposit, government securities, and commercial paper. Key participants include banks, corporations, governments, and institutional investors, who use these markets to meet short-term funding needs, manage liquidity, and earn returns on surplus cash. Money markets are crucial for treasury professionals, providing essential liquidity to the financial system and enabling efficient allocation of short-term funds.

Types of its instruments

1. Commercial Paper: Commercial paper (CP) are unsecured promissory notes issued at a discount without interest, redeemed at face value at maturity. CP offers diverse maturities and liquidity, but lacks asset backing, often mitigated by credit enhancement. Asset-backed commercial paper (ABCP) is secured by specific assets and issued through financial conduits, providing enhanced security but posing risk assessment challenges. The CP market's characteristics vary by jurisdiction, with the U.S. hosting the largest market and Europe featuring significant international euro CP issuance.

2. Bank Obligations: Banks utilize various instruments in money markets to raise funds, including time deposits, banker's acceptances, and repurchase agreements, collectively termed as bank obligations. Time deposits encompass savings accounts, certificates of deposit (CDs), and negotiable CDs, with negotiable CDs traded in the secondary market in high values. Eurodollar deposits, utilized by non-U.S. banks and foreign branches of U.S. banks, attract foreign investors with higher interest rates and fewer regulations. Yankee CDs, USD-denominated CDs by U.S. branches of non-U.S. banks, offer similar benefits and geographic diversification. Deposit insurance protects time deposits and CDs, while banker's acceptances, arising from commercial trade, guarantee payment at maturity and can be sold at a discount before maturity.

3. Government Paper: Government agencies raise funds in the money market through short-term promissory notes known as government paper, issued at national, provincial, and local levels. Examples include U.K. Treasury bills, U.S. T-bills, German Bubills, and Japanese Treasury discount bills, with maturities of up to a year. Backed by respective governments, these instruments ensure market liquidity and activity, offering varying maturities to suit investor liquidity needs. Issued at a discount, government paper provides lower yields due to lower default and liquidity risks compared to other instruments. While U.S. Treasuries are deemed risk-free and set interest rate benchmarks, sovereign risk varies among countries based on past debt defaults.

4. Floating-rate notes: Various entities, including firms, banks, governments, and agencies, raise longer-term funds through floating rate notes (FRNs) in the money market. FRNs feature large minimum denominations, maturities of a year or more, and regular coupons tied to a reference rate like the U.S. Fed funds rate. They offer flexibility and relatively higher yields in uncertain interest rate environments, with published credit ratings aiding creditworthiness assessment. However, their capital value may fluctuate between rate resets, and wider bid-offer spreads compared to other instruments can reduce yield advantages.

5. Repurchase agreements: In a repurchase agreement (repo), a security owner sells a security to an investor with a commitment to repurchase it later at a slightly higher price, functioning as short-term borrowing for the original owner and a short-term investment for the investor (often called a reverse repo). Repos typically involve government debt but can use any security and come in three types: overnight, term (lasting two or more days), or open (with no maturity). Term repos can be tailored to specific maturities and yields, determined by market repo rates. To mitigate settling risk, transactions are often overcollateralized, and repos can be sold if the selling counterparty defaults. Bilateral repos involve direct exchange, while tri-party repos, considered the safest method, are managed by a broker-dealer.

6. Money Market Funds: Money market funds (MMFs) are pooled investments managed by financial institutions and experts, with investors purchasing shares representing fund ownership. Regulated by authorities like the SEC in the U.S., ESMA in the EU, and the China Securities Regulation Commission, MMFs offer tailored options such as U.S. Treasury funds, government funds, and retail funds in the U.S., and short-term or standard MMFs in the EU. MMFs provide treasurers with principal security, daily liquidity, diversification, and economies of scale, managed by professionals to offer hassle-free, cost-effective, and risk-reduced short-term investment options.

7. Short-duration mutual funds: Short-duration mutual funds invest in securities with maturities ranging from one to three years, exceeding traditional money market instruments. While offering higher potential returns, they also exhibit increased price volatility due to sensitivity to interest rate changes, measured by duration. Portfolios typically include government issues, CDs, or CP, with no fixed unit currency value like MMFs. These funds strategically match investments with expected cash flow needs, allowing treasury professionals to allocate cash to MMFs for immediate liquidity and invest additional funds in short-duration mutual funds to align with future cash flow requirements based on specific maturity profiles.

Role of treasury in money markets

Treasury professionals in money markets serve as both buyers and sellers, issuing securities to borrow short-term funds and investing excess cash in money market securities. This dual role allows them to adjust positions based on immediate liquidity needs, showcasing the flexibility and liquidity management inherent in money market activities.

Conclusion

Money markets offer a diverse array of short-term financial instruments, including commercial paper, bank obligations, government paper, floating-rate notes, repurchase agreements, and money market funds. Treasury professionals play a vital role in these markets, acting as both buyers and sellers to meet short-term funding needs, manage liquidity, and earn returns on surplus cash. Their ability to strategically allocate funds across various instruments ensures efficient cash flow management and risk mitigation. Overall, the flexibility and liquidity management inherent in money market activities make them indispensable for treasury professionals in navigating short-term financial requirements.