Financial Markets, Banking, and Monetary Policy

CHAPTER 7 The Money Market

WHAT YOU WILL LEARN IN THIS CHAPTER

• Investors in the money market dislike risk—both price (interest rate) and credit risk.
• The money market is largely a wholesale market.
• Instruments are sold at a discount, and a straightforward formula can be used to compute annual yield.
• The Treasury auctions bills to meet shorter-term cash needs.
• Commercial paper is issued by large, well-known corporations and financial institutions to meet short-term financing needs.
• Asset-backed commercial paper (ABCP) had been used by large commercial banks to reduce the amount of costly regulatory capital they need to maintain, but regulators have tightened up on this subterfuge.
• The money market is of critical importance for commercial banks that daily must deal with mismatches between inflows of funds through core deposits and outflows through loans.
• Some banks use money market assets primarily to meet these imbalances while others use money market liabilities.
• Letters of credit (L/Cs) play a vital role in international trade, and commercial banks are at the heart of this market.
• L/Cs can become money market instruments in the form of bankers’ acceptances.
• Monetary policy, working through the policy interest rate, affects other short-term interest rates.

BACKGROUND AND BASIC FEATURES OF THE MONEY MARKET

Why do investors want to hold money market instruments when they can typically get a higher return on longer-term investments? Why do issuers of money market instruments ...