The market that helps short term borrowers find the lenders or vice versa, is known as money market (similar to the other financial markets however “short term” is the key word that distinguishes money market from other financial markets). Borrowers go to the money markets when they are in need of short term loan and the lenders provide them with the required financing. However, both borrowers and lenders do not trade in cash. Securities which are traded in money markets are called money market instruments. Following are some of the most commonly used money market instruments.
Commercial Papers:
Normally banks and financial institutions issue commercial paper, which is a promissory note that entitles note holder to get the face amount on a fixed date. Usually commercial papers are issued for short terms and their maturity period ranges from 1 to 270 days. The only guarantee you have when purchasing commercial paper (to get the promised amount or at least the amount you’ve invested) is issued by the bank or corporation itself, which is why they are known as unsecured promissory notes. Because of the high risk involved, issuing companies offer higher interest rates to investors.
Treasury Bills:
Very similar to commercial papers, however treasury bills come with the guarantee of the treasury department of United States, making them an investment with very little risk. The maturity periods often extends to one year (starting from 4 weeks) with no payments preceding the maturity date. These bills are divided into two categories known as marketable and non-marketable securities. You can buy directly from treasurydirect.gov or from brokers.
Certificate of Deposit:
The investors deposit some amount into banks or financial institution and get a certificate known as Certificate of Deposit. Interest rate is fixed (the bigger the amount, the higher the interest rate will be) and a fixed maturity period as well. You cannot take out your money before the fixed date, in case you really need to withdraw; you’ll have to pay a penalty.
Banker’s Acceptance:
Banker’s Acceptance is basically a draft accepted and signed by some well known bank. The acceptance by that particular bank makes it an instrument used in money market as it carries very little risk. Once a time draft is approved (accepted) by some bank, the drawee can sell it in secondary market in case he/she is in need of immediate cash (of course at a price lesser than its face value). It is very similar to US Treasury bill; however the guarantee comes from some reputed bank instead of US government.
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