Money Markets: Fundamentals

Financial markets can be broadly divided into short-term finance and long-term finance. Long-term finance is provided by capital markets. Short-term finance is provided by money markets.

The borrowing and lending in money markets is high volume, low risk and short-term. Because it is short-term, transaction costs are high relative to the interest that can be earned. And because transaction costs are high relative to the interest that can be earned, transactions in the money market tend to be for very large amounts.

Short-term is generally understood as ‘less than one year’, although, in fact, most money market activity is concentrated in terms to maturity between overnight and one-week.

Money market borrowing and lending utilises a variety of different instruments. These include:

• deposits and loans,
• repurchase agreements,

and number of securitised debt instruments:

• Treasury bills,
• bankers’ acceptances,
• commercial paper, and
• certificates of deposit.

Borrowers in money markets are all high quality names and so the securities issued and traded have low risk, low yield, high liquidity characteristics which are attractive to risk averse lenders.

In this context, quality means creditworthiness (the ability to repay debt) and, as with capital market debt, rating agencies analyse and rate the credit standing of issuers (borrowers). The two best known rating agencies are Moodys and Standard and Poors.