Money Market – Definition, Participants and its Types

Retail investors across the world do not have a high level of knowledge when it comes to money markets. This is because of the fact that money markets have been largely invisible to retail investors.

For a significant amount of time, money markets have only been used by large corporations, banks, and other entities to either borrow or lend money for the short term. The only way retail investors can invest in the money market is via using the services of mutual funds i.e. of a big corporation.

In this article, we will have a closer look at what a money market is.

What is a Money Market?

A money market is a market where investors who have excess cash interact with other investors who are short of cash. The specialty of this market is that transactions happen for a very short period of time.

A money market has been defined as a market where the maturity of the securities being traded is less than one year. It is important to note that money markets are not necessarily restricted to a certain geography. Cross-border money markets have also been in existence for a long period of time.

It is important to note that money markets exist in almost every country in the world. The smooth functioning of a money market is crucial to a thriving economy. Adverse events in the money market can have ripple effects on the economy.

For instance, the famous credit freeze which followed the Lehman collapse in 2008 was a money market incident that impacted the entire global economy.

The money market plays a very important role in helping borrowers and lenders meet their needs. This is because it is impossible for the market participants to have their short-term cash flows completely synchronized.

Securities in the Money Market

The following types of securities can be classified as money market securities if they have a maturity of less than one year:

1. Treasury bills issued by governments

2. Commercial paper issued by private corporations

3. Certificate of deposits issued by banks and financial institutions

4. Bills of Exchange

5. Bankers’ Acceptance

6. Repurchase Agreements

7. Stock Borrowing and Lending

Participants In the Money Market

There are several types of participants in the money market. Some of the important ones have been listed below:

1. Banks are amongst the most important participants in the money markets. This is because all over the world, banks face statutory regulations wherein they are supposed to keep a certain amount of cash as regulatory capital. However, a lot of the time, they are not able to do so. Hence, in such cases, they borrow overnight funds from the market just to ensure that they abide by the statutory rules. The overnight funds market is probably the largest segment in the money market.

2. Investment banks, companies working in the insurance sector, finance companies, and mortgage institutions are also important players in the money market. This is because of the fact that these businesses can have erratic cash flow schedules in the short run.

3. All types of corporations need to borrow funds in the short run in order to meet their working capital requirements.

4. Brokerage firms such as stockbrokers, insurance brokers, money-market brokers, shipbrokers all use money markets to transact in the short run.

Types of Money Market Funds

Money market funds can be classified based on the participants. Some examples of these different types of funds have been explained below:

1. Overnight Funds: Overnight funds market is mostly composed of banks willing to borrow and lend to each other. The requirement of these banks is to ensure that they have enough regulatory capital.

   It is uncommon for firms other than banks to borrow money from the overnight market. The LIBOR and LIBID interest rates are famous examples of overnight market interest rates which are known to a lot of investors.

2. Treasury Funds: There are some funds which only buy securities that have been issued by sovereign governments. A lot of corporations have excess cash which they want to park for the short run. These corporations want a high degree of liquidity and also want that the investment does not witness any loss of value.

   Sovereign securities are both liquid and safe. Hence, they are quite popular in the money market.

3. Municipal Funds: Municipal funds are also like treasury funds in the sense that the debt is issued by a government body that is backed by taxpayer money. However, the difference is that municipal funds are not as creditworthy as sovereign funds. Hence, the liquidity, as well as safety, is relatively less. However, these funds tend to offer a higher interest rate which compels investors to choose these funds.

4. Corporate Funds: Lastly, some corporations also want to borrow money for the short term. This is generally done by corporations who are witnessing a sudden surge in their working capital requirements.

   There are many blue-chip corporations that routinely issue commercial paper in the market to borrow funds. Some of these securities can be considered to be at par with sovereign securities since the issuing companies have stellar credit ratings.

The bottom line is that money markets are considered to be an important pillar of any national economy and the global financial system in particular.