Bonds and Bond Derivatives, Second Edition

5

MONEY MARKET INSTRUMENTS AND RATES

The most active market for securities as measured by daily volume of trading is the money market, which is defined as the market for securities with less than 1 year to maturity at the original issue date. Money market instruments include the following: Treasury bills, federal funds, repurchase agreements, certificates of deposit (CDs), commercial paper, and bankers' acceptances (BAs). Each of these instruments has slightly different characteristics, and thus each has a slightly different interest rate. Since many investors regard the individual money market instruments as close substitutes, changes in all the money market interest rates are highly correlated.

Money market instruments allow some issuers to raise funds for short periods of time at relatively low interest rates. These issuers include the US Treasury, which issues Treasury bills; corporations that sell commercial paper; banks which issue CDs; and security dealers, who finance their holdings in the money market. Simultaneously, many investors find money market instruments to be highly liquid investments with relatively low default risk. An investment is liquid if it can be bought or sold rapidly without affecting the market price and if the risk of price fluctuation is small. These money market investors include individuals, corporations, banks, and other institutions with temporary excess funds, and money market mutual funds. The money market is largely a wholesale (as opposed ...