The money market is a very complex and widespread system. Understanding the essence helps acquaintance with its tools. In turn, they are also very diverse, have their own characteristics. In the article, we briefly analyze money market instruments and their classification. We give each a brief description.
Definition
Money market instruments are certain investment objects that can bring current income. Feature - in the secondary market it is easy to repay them ahead of schedule.
In the financial world, there are two classifications of money market instruments:
- By circulation. These are securities traded as well as deposits.
- By income. Two groups - profitable and coupon instruments.
Classification
All money market instruments fall into three broad categories:
- Circulating paper.
- Deposits
- Derivatives.
Each of the categories of these financial instruments has its own division.
Deposits in the money market are its coupon instruments. This category includes the following:
- Certificates of deposit.
- Buyback Agreements.
Circulating papers are already discount instruments. Within this category, it is customary to distinguish the following:
- Commercial papers.
- Treasury bills.
- Bank acceptances (bills of exchange).
The largest group of financial instruments is derivatives. This includes the following:
- Future Interest Rate Agreements.
- Percentage swap.
- Interest Futures.
- Interest option. An option on interest rate swaps, an option on future interest rate agreements, an option on interest futures are additionally allocated inside it.
But it is worth noting that if swaps and interest rate swaps have been circulating in the financial markets for more than one year, then they can already be attributed to debt obligations.
Hand tools
Let's move on to characterizing money market instruments. The referring group here can be either sold or bought in the secondary markets. In addition, it has the following distinctive features:
- Fixed core cost (or nominal amount).
- A certain maturity date, after which the holder is guaranteed to receive the principal or face value.
- A fixed percentage that can be paid both at maturity and throughout the term. The interest rate itself will be fixed at the time of the issue of the security.
Revenues from traded instruments are easy to calculate in advance, since the terms of the contract remain unchanged.
Hence, circulating monetary instruments in the securities market can be bestowed with the following characteristics:
- Any tool here has a predetermined income. Regardless of the frequency of payments, future cash receipts are discounted.
- The higher the interest rate, the lower the market value, the current price of such an instrument.
Discount tools
What is the difference between operations with money market instruments of this type? For them you will not receive a clear payment of interest. Instead, such tools are produced and sold at a discount. In other words, below its nominal value. This discount is in the financial market and is considered a kind of alternative to paying interest. In fact, this is the difference between the price of the instrument upon its acquisition and upon maturity at par.
Three types of discounts will be applied on money markets:
- Bill of exchange.
- Commercial paper.
- Treasury bill.
Their quote is determined on the basis of a discount against the face value (the total price of the instrument at the time of its redemption). This tradition dates back to the time when the first bills of exchange appeared. The largest market for discount instruments today are the United States.
Derivatives
The second name for derivatives is derivatives. So-called derivatives contracts for the sale, purchase or exchange of derivatives on a specified day and at a pre-negotiated price.
In the money markets today, a wide variety of instruments related to interest rates. What applies to them? Interest rate swaps and options, futures, future interest rate agreements. We will consider some of them in detail below.
Interest rate instruments
Now the next category. Interest (or coupon) - one of the main tools of the money market. For them, the creditor (holder) receives certain interest payments throughout the life of the instruments.
What is in this category? Three types of tools are distinguished here:
- Non-convertible. These are deposits of money markets.
- Addressing. Certificates of deposit are implied.
- Separately, this type of negotiable instruments, such as return purchase agreements, stands out.
And now we will get to know each of the main instruments and participants of the money market more closely.
Deposits
Deposits, in turn, are divided into two categories:
- Urgent. Having a fixed interest rate and expiration date.
- Poste restante. Accordingly, the deposit is repaid only on demand. Here the interest rate may vary.
For depository instruments, the rates of the English (London) market are more important:
- LIBOR - this is how the offer rate is called on the London depositary interbank market. According to it, the bank can both offer money and charge it for a loan.
- LIBID - on the depositary interbank market of the UK capital, this is the name of the buyer's rate. According to it, the bank “buys” money or gives it as a loan.
Certifications
Money market instruments also include certificates of deposit. This is the name of circulating securities that indicate the presence in the bank (or other financial institution) of a deposit with a clear storage period and a fixed interest rate. This can be a paper confirming the presence of debt at the loaned, with a fixed coupon.
Most of the certificates of deposit issued by banks are negotiable bearer securities. In other words, they will belong to the one in whose hands they are.
How is a regular deposit different from such certificates? There are two signs:
- Deposit - a non-negotiable document having a fixed term.
- Certificate of Deposit - an already circulating document with a fixed term. In other words, it can be sold and bought.
REPO transactions
REPO transactions are the so-called repurchase agreements. This is the name of a loan secured by government securities. Be sure to negotiate the sale of securities and the terms of their repurchase already at a higher price. The difference in value will be the payment for the loan received.
Treasury bills
Let us now consider bill circulation as an instrument of the money market.
A Treasury bill is a short-term negotiable bill of exchange issued by the government to finance certain government programs.
For example, the Federal Reserve Program, acting on behalf of the United States Government, typically sells Treasury bills with maturities of 13 and 36 weeks every Monday (delivered on Thursday). At the same time, treasury bills of action of 52 weeks are delivered once a month to the auction.
A similar system is successfully operating in the UK. There, bills for a period of 91 and 182 days are delivered for auction. According to statistics, their main holders are accounting houses. Intermediaries between state commercial banks and the English Bank.
Bills of exchange
The second common name is bank acceptance. There is also the name "trade bill." Tools are widely used for additional financing of international trade.
Commercial bill of exchange - a decision to pay the agreed amount of money to its holder at a strictly defined time or upon request. Hence, two types of commercial acceptances - urgent draft with a fixed payment period and demand instrument. One of the simplest short-term debt documents that are issued for commercial transactions.
What then will be a bank acceptance, a bank draft? This is a bill of exchange, which as issued by a commercial bank, and accepted by him. Becomes circulating after acceptance.
Commercial paper
Commercial paper refers to unsecured simple short-term bills with a specified term and a certain amount. These are bearer financial assets in circulation.
Usually issued for up to 270 days by various large organizations. This is a kind of counterbalance to bills of exchange and loans from banks.
It is worth noting that commercial paper does not have its own security. That is, making a responsible decision to purchase such an instrument, an investor can focus only on the issuer's reputation. This is the reason that commercial papers are issued only by large companies with high ratings.
Future Interest Rate Agreements
They are themselves in demand from derivatives in the OTC derivatives markets. This is the name of the contract concluded between the two parties, which fixes the rate on the size of the future loan or deposit. For the latter, the following must be established:
- Currency and amount.
- Maturity.
- The time of the loan or deposit.
Accordingly, the parties first agree on the interest rate of the future transaction. Then they compensate for the difference between the real and the agreed rate at the beginning of the agreed period. The main amount of the agreement will not be provided, since there is no real lending or borrowing.
The interest rate agreement is determined in just two digits. For example:
- 1 x 4. Will take effect in a month. Has a final term of 3 months (4 - 1 = 3).
- 3 x 6. Will take effect in three months. Has a final period of 3 months (6 - 3 = 3).
Interest futures
The interest rate futures are based on instruments, the value of which depends on interest rates. For example, 3-month deposits.
Interest Futures - forward transactions with standard terms and sizes of the contract. The underlying asset for short-term types is Euro-currency deposits. They are calculated either at the price of the last transaction, or at the estimated price.
As for long-term interest-bearing futures, they are calculated based on the value of government bonds, coupon securities with terms set by the exchange.
Interest swap
An interest-rate swap is an over-the-counter transaction in which two parties exchange interest on loan commitments of equal value but with different interest rates.
Typically, interest rate swaps are long-term instruments whose purpose is somewhat similar to that of an agreement on a future interest rate. But at the same time their (swaps) validity period is 2-10 years for major world currencies. Thus, the interest rate swap will be equivalent to several future interest rate agreements.
A swap is an agreement between two parties on a series of payments to each other during certain periods until the expiration of their contract. The size of these interest payments by each of the parties can be calculated on the basis of various formulas (based on the basic conditional amount of such an agreement).
As you have already seen, the tools for regulating the money market today are quite diverse. They are combined by various classifications by type, category, group. In this case, each of the tools can have its own distinguishing features, as well as some moments that make it look like another.