Types of Money Market Instruments

The money market is basically an open global forum in which banks and financial institutions provide a variety of investment opportunities to investors and borrowers. It is important to note that the money market isn’t actually a physical location, but rather a digital network of financial institutions and traders that exchange information related to short-term securities via computer, fax, and telephone. The investments/short-term securities offered within the money market are called money market instruments, and offer maturities from a single day to 12 months. Money market instruments give business owners and investors the opportunity to invest surplus funds into short-term securities. Some of the more popular money market instruments are federal notes, commercial paper, treasury bills, Eurodollar deposits, bankers’ acceptances, repurchase agreements, and certificates of deposit (CD). The following paragraphs briefly review the aforementioned money market instruments.

Federal Agency Notes
Federal agency notes are uninsured long term and short term securities offered by government agencies. Although these notes are not backed by the federal government, they do tend to offer a higher yield than other government notes such as treasury bills. It is also important to note that the default risk for federal agency notes is extremely low. The majority of federal agency notes are purchased by larger corporations, as they are considered to be relatively stable in comparison to other types of money market instruments.

Treasury Bills
A popular type of short-term promissory notes provided by the federal government are treasury bills. Treasury bills are offered in 3 different maturity lengths – 90 days, 100 days, and 360 days. 90 and 180 day treasury bills are routinely auctioned every week, while the 360 day treasury bills are auctioned once a month. Aside from auctions, treasury bills can also be purchased indirectly/secondarily from individuals and companies that have purchased the treasury bill through an auction.

Certificates of Deposit (CDs)
CDs (certificates of deposit) are promissory certificates that are issued by federally chartered financial institutions which state that deposited funds will learn a predefined return after a specified time period. CDs are one of many types of time deposits provided by financial institutions that bear interest. In basic terms, the CD holder is loaning the bank or financial institution a specific monetary amount for a predefined time period, in exchange for a hefty rate of return. In essence, the certificate of deposit represents the bank’s commitment to pay back the deposit plus interest.

Short-Term Tax Exempts
Short-term tax exempts are money market instruments that are issued by municipal and state governing authorities. While these government notes are slightly more risky than treasury bills, and provide less flexibility in terms of negotiation, they provide the additional benefit of tax-free interest returns. Thus, since the interest rate returns on short-term tax exempts are not subject to income tax, many corporations choose to utilize these instruments despite the relatively low return.

Commercial Paper
Commercial paper notes are basically promissory notes that are issued by banks and financial institutions and corporations on a short-term basis. Commercial paper notes are offered in maturities of as long as 270 days. Commercial paper notes have the second highest dollar volume behind treasury bills, and are therefore one of the most popular types of m is oney market instruments. These notes are usually issued by reputable corporations that have excellent credit histories, so there is very little default risk associated with them.

Repurchase Agreements
Repurchase agreements, which are also commonly referred to as “buybacks” or “repos”, are treasury securities which are bought from certified dealers. These securities are issued under the terms that they’ll be sold back to the dealer at a specified date in the future for a profit. Thus, repurchase agreements are some of the most liquidated types of money market investments available, with maturity lengths ranging from as little as one day to a couple of months.

Bankers’ Acceptances
Bankers’ acceptances are simply negotiable securities/obligations issued by banks which state that the bank will pay a specific amount of money on a specified date in the future. Bankers acceptances can be bought and sold for a profit, and are usually slightly more profitable than treasury bills. Bankers acceptances are typically used in foreign trade financing, however they are also commonly utilized by large corporations and companies that need access to a loan for purchasing equipment and goods.

Comments are closed.