Historic Returns: Money market instruments and functions
The money market is the set of wholesale markets where the exchange of short-term financial assets, up to 18 months, takes place; with a very low level of risk, largely thanks to the solvency of their issuers and high liquidity. This type of financial market includes the interbank market, the Treasury bills, and notes market, the certificates of deposit market, the bills of the exchange market, and, in general, the market for all short-term financial assets.
What determines the money market?
The main objective of the money market is to provide users and economic agents with the possibility of holding part of their wealth in the form of securities or bonds, with a high degree of liquidity and an acceptable return. The main economic agents participating in the money market, both offering and demanding short-term funds, tend to be mainly banks, savings banks, and public administrations.
Non-bank financial institutions, such as life insurance companies, also frequently use the money market as an outlet for surplus cash, although they usually invest their cash holdings in long-term securities.
Characteristics of the money market
The money market is characterized above all by the following features:
- The participants in the money market tend to be specialized and well-resourced financial institutions.
- The assets traded have a very low level of risk thanks to the solvency of the organizations. There is a high level of security.
- They are highly liquid because they have a very short maturity. Investors will have liquidity at the moment they need it.
- Transactions can be carried out directly or through specialized intermediaries.
- They are very flexible: the money market investor has the flexibility to invest in a large portfolio of securities and securities, which will result in a diversification of risk even if the options for return diminish.
A distinction must be made between the primary and secondary markets. The primary market is where new securities, commercial paper, are issued and can be issued. The secondary market is where securities that have already been issued are traded. This implies that the purchasers of the securities buy them from the owners and not from the issuers.
Types of money markets
There are several types of money markets, as detailed below:
- Corporate asset market: corporate bonds stand out, where debt instruments are issued by a company on a short-term basis and have a payment obligation. It is a way of financing businesses and the guarantee of payment is the company itself.
- Interbank money markets: in this market financial firms conduct credit and lending operations through short-term derivatives, interbank deposits, short-term interest rate swaps, and other financial assets, with a maturity period of either one day or one week.
- Government debt money market: this market deals with government debt. Normally after notification of the calendar, the Treasury issues a series of auctions each year.
When to use it?
Money market investments should be made when you have the liquidity to invest, but you will need it soon and without being able to take excessive risk. This is when the money market is used because of its high liquidity and safety. In this way, the money is not tied up in the bank, but the investor knows that he can access it at any time and that it is safe because of the guarantees offered by the issuers.
Generally, money market assets can fulfill three roles in portfolios:
- to support planned (and even unplanned) expenses
- to act as a buffer against unexpected liquidity events
- to lessen the negative impact of future negative corrections in financial markets and to have an amount available to take advantage of future investment opportunities.
How do learn more about this?
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