see also: money market funds
Financial Markets
Financial markets are made up of two different types of markets:
1. Capital Markets - markets for long-term debt and for equity shares (stocks and bonds)
- traded on exchanges
- use broker, who acts as agent for buyer, but they do not take ownership (no inventory)
2.Money Markets - markets for short term debt (less than one year)
- group of loosely connected markets
- dealer markets where dealers take ownership, and build inventory of assets to sell (at own risk)
- read more here...
Money Market
In Finance, the money market is the global financial market for short-term borrowing and lending. It provides short-term liquid funding for the global financial system. The money market is where short-term obligations such as Treasury bills (T-bills), commercial paper and bankers' acceptances are bought and sold.
The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods of time, typically up to thirteen months. Money market trades in short term financial instruments commonly called "paper". This contrasts with the capital market for longer-term funding, which is supplied by bond and equity.
Participants
The core money market consists of banks borrowing and lending to each other (the money market banks), using commercial paper, repurchase agreements and similar instruments. These instruments are often benchmarked to LIBOR. Also, there are 30+ government securities dealers, and 15+ commerical paper dealers, and many money brokers. These money brokers find short term money for borrowers, and help sell short term money for lenders.
Finance companies such as GMAC typically fund themselves by issuing large amounts of asset-backed commercial paper (ABCP) which is secured by the pledge of eligible assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial mortgage loans, mortgage backed securities and similar financial assets. Certain large corporations with strong credit ratings, such as General Electric, issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf via commercial paper lines.
In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issue municipal paper, while the US Treasury issues T-bills to fund the US public debt.
Common money market instruments
- Bankers' acceptance - A draft issued by a bank that will be accepted for payment, effectively the same as a cashier's check.
- Certificate of deposit - A time deposit at a bank with a specific maturity date; large-denomination certificates of deposits can be sold before maturity.
- Repurchase agreements - Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.
- commercial paper - An unsecured promissory notes with a fixed maturity of one to 270 days; usually sold at a discount from face value.
- Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located outside the United States. see Eurocurrency
- Federal Agency Short-Term Securities - (in the US). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association.
- Federal funds - (in the US). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.
- Municipal notes - (in the US). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.
- Treasury bills - Short-term debt obligations of a national government that are issued to mature in 3 to 12 months. For the U.S., see T-bills.
- Money market mutual funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors.
Hedging Currency risk
- this is the only currency hedge choice in which you actually have to spend the money today
- money out of pocket now
- all of the others have Liability now, but no cash out of pocket now.
Risk Management
When dealing with foreign exchange risk, you have a few choices as a business manager
- Operationally hedge - balance your assets and liabilities so that currency is generated in revenues in the same country where liabilities are owed. Another way to operationally hedge is to have operations in multiple countries, so that if one currency goes down, another will go up, etc.
- Avoid - you can try to avoid currency risk by passing along the risk premium to your customers. You can charge a risk premium, say for example 7% extra to all clients, and keep a fund ready for in case the currencies change, and then, that way...you will have money ready. Its not a very good method, but some companies do it.
- Protect yourself - hedge - transfer the risk to someone else that is more willing / able to take on that risk... if there is someone that is willing to take on risk for a fee, then sell them that risk, and take the money now. This is the essence of currency hedging .
- The four main choices for currency hedging are
- (a) forward contracts (see forward exchange rate)
- (b) futures contracts (see Futures market)
- (c) options (see Options)
- (d) use the money market to hedge
- (e) sell your A/R to someone else ....companies that buy your receivables at a discount.
- Bankers Acceptance -
- is an agreement between an importer and exporter,
- with payment in 30 days
- cover goods in transit
- irrevocable letter of credit (L/C) = confirmation + insurance + Bill of Lading (BL)
- Then, if you have the irrevocable L/C...then you can get the "Bankers Acceptance
- you sell the package of contracts
- go to bank
- sell those receivables at a discount...to get money today.
- factoring
- might buy next 15 shipments
- multiple shipments
- but, because there is no guarantee, then the banks charge a higher commission
- get money today
- forefeiting
- commitment by a country (government)
- host country guarantee
- popular in older times, and in Middle east.
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