The Money Market - Part 1: Traditional Instruments

Part 1: Traditional Instruments

Money market instruments are investments that are suitable for investors who prefer an investment time period of one year or less. These instruments are divided into two categories: traditional and nontraditional instruments. Traditional money market instruments include:

  • U.S. Treasury Bills - Also known as Treasuries, these fixed-income security instruments are issued by the United States Treasury. They make up the largest, most important, and most liquid fixed-income marketplace in the world. They’re backed by the full faith and credit of the United States government, which makes them an extremely safe investment vehicle. For a detailed discussion of Treasuries, please read the article U.S. Treasury Securities.
  • Insured Certificates of Deposit - An insured CD represents a loan from an investor to a bank or savings & loan, usually ranging from a fixed time period of ninety days to as long as ten years. The first $100,000 that an investor deposits in most banks (including CD deposits) is insured by the Federal Deposit Insurance Corporation (FDIC). Many securities dealers make a secondary market in certificates of deposit. For a more detailed look at this instrument, please see the article Certificates of Deposit (CDs).
  • Negotiable Certificates of Deposit - Negotiable CDs are large $5 million-plus certificates which are issued by the largest and safest banks. They’re sold exclusively to large institutional investors such as money market funds. Again, as with insured CDs, only the first $100,000 is insured.
  • Bankers Acceptances - Bankers acceptances are of short-term loans which are sold to investors. For example, a company borrows $980,000 from a bank in order to complete an order transaction. It agrees to pay the bank back $1 million in 120 days, signing a document that resembles a check as evidence of its promise to pay. This receivable is an asset of the bank. The bank can choose to hold onto or sell the asset. However, in order to sell it, the bank must first eliminate the credit risk to the buyer (who may not be familiar with the company). The bank does this by guaranteeing the credit quality of the asset; it stamps the word “Accepted” on the back of the document and a bank officer signs it. The instrument can now be traded on the credit quality of the bank, and not the company owing the debt.
  • Commercial Paper - Commercial paper represents an unsecured short-term loan from an investor to a corporation. It is sold to investors at a discount to its face value and is redeemed at face value by the investor upon maturity. Most commercial paper has a very short maturity term of between 30 and 90 days. The maximum maturity time for commercial paper is 270 days, because any public debt offering with a maturity longer than 270 days must be registered with the Securities and Exchange Commission (SEC), which is a lengthy and expensive process.
  • Repurchase Agreements - These are very short-term secured loans that securities dealers use to finance their fixed income inventory (bonds, for example). The loans are usually made by investors who are allowed to hold the collateral (the fixed income instrument bought by the dealer) that they are financing. In the event that the dealer does not repay the loan, the investors can sell the collateral to recoup their losses. Repurchase transactions are favorites of institutional investors and money market funds. Usually $1 million-plus in size, the terms are most often as short as overnight. Longer terms, from two- to thirty days, are known as term repos.

Part 2 of this series will look at the second category of money market investments: nontraditional instruments.

blog comments powered by Disqus