Fundamentals of Financial Instruments: An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives

CHAPTER 5

Money Markets

Introduction

The money market is an important segment of the debt market of countries with active financial markets. Debt markets exist so that parties in need of funds can interact with those who are seeking to deploy surplus funds. So there are two key constituents of such markets: borrowers or issuers, or those who are ready to borrow money by issuing securities; and lenders or holders, or those who are willing to lend in the process of acquiring securities. However, all debt-market transactions are not comparable. There are differences between a 20-year term loan negotiated by a company with its bank, a 30-year mortgage loan negotiated by a home buyer with a savings-and-loan institution, and a 3-month bank loan that is arranged by a corporation with its bank to fund its inventories.

The purpose for which money is borrowed varies from borrower to borrower. And, in the case of the same borrower, it may vary from transaction to transaction. A company may be negotiating a term loan to facilitate the construction of a factory. The nature of the requirement is such that it needs capital for a relatively long period of time. At the same time, however, the company may need an overdraft from its bank to pay outstanding wages. The first is a capital market transaction, and the second is a short-term or current account transaction.

The different motives for borrowing funds led to the creation of different types of debt securities that differ with respect to their ...