2.10 Money Market Instruments

Key Takeaways

• Money market instruments have maturities of one year or less and are highly liquid, low-risk debt securities

• Commercial paper is unsecured corporate debt with maximum 270-day maturity to avoid SEC registration

• Banker's acceptances are bank-guaranteed time drafts primarily used for international trade with 30-180 day maturities

• Negotiable CDs have $100,000 minimum (typically $1 million+) and can be traded in secondary markets unlike retail CDs

• Repurchase agreements (repos) are short-term loans collateralized by Treasury securities, used by the Federal Reserve for monetary policy

Money market instruments are short-term, highly liquid debt securities used by governments, corporations, and financial institutions to manage short-term funding needs. These instruments are considered low-risk and are essential to understanding the fixed-income markets tested on the SIE exam.

What Is the Money Market?

The money market is where short-term debt instruments are traded. Key characteristics:

• Maturity: One year or less
• Liquidity: Very high—can be quickly converted to cash
• Safety: Generally low-risk
• Purpose: Short-term borrowing and lending

Types of Money Market Instruments

Treasury Bills (T-Bills)

T-Bills are short-term government securities and the benchmark for money market rates.

Most Liquid: T-Bills are considered the most liquid and safest of all money market instruments.

Commercial Paper

Commercial paper is unsecured, short-term corporate debt issued by large, creditworthy corporations.

Why 270 Days? If maturity exceeds 270 days, the issuer must register with the SEC, which is costly and time-consuming.

Key Points:

• Used for short-term working capital needs
• Only issued by companies with excellent credit ratings
• Not backed by collateral (unsecured)

Banker's Acceptances (BAs)

Banker's acceptances are time drafts "accepted" (guaranteed) by a bank, primarily used in international trade.

How BAs Work:

1. Importer's bank "accepts" responsibility to pay
2. The BA becomes a negotiable instrument
3. Can be sold in secondary market before maturity

Example: A U.S. company imports goods from Japan. A bank issues a BA promising to pay the Japanese exporter in 90 days. The exporter can sell the BA at a discount for immediate cash.

Negotiable Certificates of Deposit (CDs)

Negotiable CDs are large-denomination bank deposits that can be traded in the secondary market.

Negotiable vs. Regular CDs: Unlike retail CDs from your local bank, negotiable CDs can be bought and sold in the secondary market before maturity.

Repurchase Agreements (Repos)

Repos are short-term loans collateralized by securities, typically Treasury securities.

How Repos Work:

1. Party A sells securities to Party B
2. Party A agrees to buy them back at a higher price
3. The difference is the interest earned by Party B

Reverse Repo: From the buyer's perspective (Party B), it's a "reverse repurchase agreement."

Fed and Repos: The Federal Reserve uses repos extensively to manage the money supply and implement monetary policy.

Comparison of Money Market Instruments

Key Characteristics Summary

Discount Instruments (No Periodic Interest)

• Treasury Bills
• Commercial Paper
• Banker's Acceptances

Interest-Bearing Instruments

• Negotiable CDs (pay interest at maturity)
• Repos (implicit interest in repurchase price)

Key Takeaways

• Money market instruments have maturities of one year or less
• T-Bills are the safest and most liquid money market instrument
• Commercial paper maximum maturity is 270 days (SEC exemption)
• Banker's acceptances facilitate international trade
• Negotiable CDs are large deposits ($100,000+) that trade in secondary markets
• Repos are collateralized short-term loans using securities
• Most money market instruments are sold at a discount