FINANCIAL AND MONEY MARKET
Classifications
of Financial Markets
Classification
by nature of Claim:
Debt market bonds, CDs
Equity market Common stocks
Classification by maturity
of Claim:
Money Market Short-term
(maturity < 1 year)
Capital Market Long-term (maturity > 1
year)
Classification by seasoning
of Claim:
Primary Market New security issues sold
to initial buyers
Secondary Market Securities previously
issued are bought and sold
Classification by
organizational structure:
Exchanges Market Trades conducted in
central locations (e.g. stock exchange)
Over-the-Counter Market Dealers at different
locations buy and sell
Classification by immediate
delivery or future delivery:
Cash or Spot Market assets or financial
services are traded for immediate delivery (usually within two business days).
Derivative Market Contracts calling for the
future delivery of financial instruments are traded in the futures or forward
market.
Characteristics and Purpose of
the Money Market
The money market is the market for
short-term (one year or less) credit.
The money market is the mechanism through
which holders of temporary cash surpluses meet holders of temporary cash
deficits.
The money market arises because for most
individuals and institutions, cash inflows and outflows are rarely in perfect
harmony with each other, and the holding of idle surplus cash is expensive.
The money market provides low-cost source of
funds to firms, financial institutions, and government
Investors purchase money market instruments
for:
temporary
purpose. They have cash to invest for a short period of time, such as a
corporate cash manager. Or, they are shifting funds among longer-term assets
and have not yet made a permanent allocation.
strategic
purpose. Based on the different risk/return characteristics of
equities, bond and cash, the investor has decided upon an allocation that
includes money market securities.
Characteristics
and Purpose of
the Money Market
The
money market is a wholesale
market for funds – most trading occurs in multiples of a million
dollars.
money
market securities usually have an active secondary market. this makes them very
flexible instruments to use to fill short term financial needs.
Governments
and central banks around the world play major roles in the money market as the
largest borrowers and as regulators.
Money
market investors seek mainly safety and
liquidity,
plus the opportunity to earn some interest income.
Risk that
investors face include:
Market risk – The risk that the market value of
an asset will decline, resulting in a capital loss when sold. Also called interest rate risk.
Reinvestment risk – The risk that an investor will be
forced to place earnings from a security into a lower-yielding investment
because interest rates have fallen.
Default risk – The probability that a borrower
fails to meet one or more promised principal or interest payments on a
security.
Inflation risk – The risk that increases in the
general price level will reduce the purchasing power of earnings from the
investment.
Currency risk – The risk that adverse movements in
the price of a currency will reduce the net rate of return from a foreign
investment. Also called exchange rate risk.
Political risk – The probability that changes in
government laws or regulations will reduce the expected return from an
investment.
Money market instrument are securities with
an original maturity of no more than one year.
Money market instruments are issued by
government and its agencies, Banking institutions, Non-financial corporate
entities, Security dealers
The key money market instruments include
Treasury
bills
Repurchase
agreements
Federal
funds
Federal
agency notes
CDs
and eurocurrency deposits
Commercial
paper and bankers’ acceptances
Most money market securities do not pay
interest. instead, they are issued at a discount from par (their value at
maturity). The increase in price provides a return. this is called discounting.
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