Fundamentals of Financial Instruments, 2nd Edition

CHAPTER 5Money Markets

INTRODUCTION

The money market is an important segment of the debt market of countries with active financial markets. Debt markets exist so that parties in need of funds can interact with those seeking to deploy surplus funds. Thus there are two key constituents of such markets, those who are ready to borrow money by issuing securities, called borrowers or issuers, and those willing to lend in the process of acquiring securities, called lenders or holders. But all debt market transactions are not comparable. Clearly there is a difference between a 20-year term loan negotiated by a company with its bank, a 30-year mortgage loan negotiated by a home buyer with a savings and loan institution, and a three-month bank loan that is arranged by a corporation with its bank to fund its inventories.

The purpose for which money is borrowed varies from borrower to borrower. And, in the case of the same borrower it may vary from transaction to transaction. A company may be negotiating a term loan to facilitate the construction of a factory; in this case, the company needs capital for a relatively long period of time. At the same time, however, the company may need an overdraft from its bank to pay outstanding wages. The first is a capital market transaction, whereas the second is clearly a short-term or current account transaction.

The different motives for borrowing funds lead to the creation of different types of debt securities that vary with respect to their magnitude, ...