The money market refers to trading in very short-term debt investments. At the wholesale level, it involves large-volume trades between institutions and traders. At the retail level, it includes money market mutual funds bought by individual investors and money market accounts opened by bank customers.
Money Market focuses on debt instruments only the maturities of which range from one day to one year. It also involves a complex of instruments dominated by the central bank as agent of the sole intent and commercial banks. It purchases and sells new instruments rather than trading in outstanding claims.
The money market involves the purchase and sale of large volumes of very short-term debt products, such as overnight reserves or commercial paper.
An individual may invest in the money market by purchasing a money market mutual fund, buying a Treasury bill, or opening a money market account at a bank.
Money market investments are characterized by safety and liquidity, with money market fund shares targeted at $1.
Money market accounts offer higher interest rates than normal savings accounts, but there are higher account minimums and limits on withdrawals.
Characteristics of Money Market
Money market is not an unique place or mechanism where short-term debt instruments are traded among investors rather there are several locations where direct transactions take place between borrowers and lenders.
Under an efficient system to handle any amount and volume of transactions at any time, regional submarkets are also linked together with the centrally organized market.
However, the basic characteristics of money market are given below:
Short-term securities with maturity of less than one year are traded in the money market
Central and regional short-term markets create a national short-term interest rate structure.
They also create a national short-term credit.
Idle funds are transferred through the intermediaries from all over the country to the central open market.
Funds are largely transferred on a wholesale basis, although the large institutions deal directly with each other.
The whole role of the institutions involved in the money market is controlled by the monetary and credit system of the country.
The major participants in the money markets are the central bank, commercial banks, and other finance companies.
Related: What is Capital Market Theory?
Money Market Instruments
Money market instruments are summarized below:
Certificates of deposits-CDs
Any firm distinction between money and capital market is somewhat arbitrary.
Suppliers of funds may direct them to one or both markets and users of fund may draw funds from either market.
Furthermore, funds flow back and forth between the two. Any institution serves both markets.
Rates of interest or fund acquisition costs are interrelated with changes in the general demand and supply of funds.
Who Uses the Money Market?
In the wholesale market, commercial paper is a popular borrowing mechanism because the interest rates are higher than for bank time deposits or Treasury bills, and a greater range of maturities is available, from overnight to 270 days.
However, the risk of default is significantly higher for commercial paper than for bank or government instruments.
Individuals can invest in the money market by buying money market funds, short-term certificates of deposit (CDs), municipal notes, or U.S.
Treasury bills. For individual investors, the money market has retail locations, including local banks and the U.S. government’s TreasuryDirect website. Brokers are another avenue for investing in the money market.
The U.S. government issues Treasury bills in the money market, with maturities ranging from a few days to one year.
Primary dealers buy them in large amounts directly from the government to trade between themselves or to sell to individual investors.
Individual investors can buy them directly from the government through its TreasuryDirect website or through a bank or a broker.
State, county, and municipal governments also issue short-term notes.
Money market funds seek stability and security with the goal of never losing money and keeping net asset value (NAV) at $1.
This one-buck NAV baseline gives rise to the phrase “break the buck,” meaning that if the value falls below the $1 NAV level, some of the original investment is gone and investors will lose money.
However, this scenario only happens very rarely, but because many money market funds are not FDIC-insured, meaning that money market funds can nevertheless lose money.
Why Is It Called the Money Market?
The money market refers to the market for highly liquid, very safe, short-term debt securities.
Because of these attributes, they are often seen as cash equivalents that can be interchangeable for money at short notice.
Why Money Market Is Important?
The money market is crucial for the smooth functioning of a modern financial economy. It allows savers to lend money to those in need of short-term loans and allocates capital towards its most productive use.
These loans, often made overnight or for a matter of days or weeks, are needed by governments, corporations, and banks in order to meet their near-term obligations or regulatory requirements.
At the same time, it allows those with excess cash on hand to earn interest.