6.1 Global money markets and instruments

Global money markets are the lifeblood of short-term finance, offering high liquidity and low-risk instruments. These markets facilitate quick access to funds, enable central bank monetary policy, and aid in cash management for businesses and financial institutions worldwide.

From T-bills to Eurodollar deposits, money market instruments play crucial roles in cash management, liquidity buffers, and risk mitigation. Interest rates in these markets are influenced by factors like central bank policies, inflation expectations, and global economic conditions, shaping the financial landscape.

Global Money Markets Overview

Characteristics of global money markets

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• Short-term nature typically deals with financial instruments maturing within one year provides liquidity for short-term financing needs (commercial paper, T-bills)
• High liquidity instruments can be easily bought and sold with low transaction costs enables quick access to funds
• Low risk generally considered safe investments due to short maturities reduces default probability
• Functions facilitate short-term borrowing and lending provide mechanism for central banks to implement monetary policy aid in cash management for businesses and financial institutions
• Global interconnectedness allows for cross-border transactions and investments facilitates international trade and finance (Eurodollar deposits, forex swaps)

Instruments in international money markets

• Treasury bills (T-bills) short-term government securities issued by national governments considered virtually risk-free
• Commercial paper unsecured promissory notes issued by corporations used for short-term financing needs typically have maturities up to 270 days
• Certificates of deposit (CDs) time deposits issued by banks fixed maturity and interest rate can be negotiable or non-negotiable
• Repurchase agreements (repos) short-term loans secured by securities commonly used by central banks for open market operations
• Bankers' acceptances time drafts guaranteed by a bank often used in international trade finance
• Eurodollar deposits U.S. dollar-denominated deposits held in banks outside the United States
• Money market mutual funds investment vehicles that pool money to invest in various money market instruments

Interest Rates and Market Dynamics

Factors affecting money market rates

• Central bank policies monetary policy decisions affect short-term interest rates open market operations influence money supply (Federal funds rate, ECB refinancing rate)
• Inflation expectations higher expected inflation leads to higher interest rates impacts purchasing power of future cash flows
• Economic growth stronger growth typically results in higher interest rates increases demand for credit
• Supply and demand for short-term funds increased demand for short-term borrowing pushes rates up reflects market liquidity conditions
• Credit risk higher perceived risk leads to higher yields compensates investors for additional default risk
• Currency exchange rates affects yields on foreign currency-denominated instruments influences international capital flows
• Term structure of interest rates relationship between short-term and long-term rates reflects market expectations of future rates
• Global economic conditions international events and crises can impact interest rates across markets (financial crises, geopolitical tensions)
• Regulatory environment changes in financial regulations can affect money market operations impacts bank reserve requirements and lending practices

Role of money market instruments

• Cash management provides options for parking excess cash while maintaining liquidity allows businesses to earn interest on idle funds
• Liquidity buffer helps companies meet short-term obligations and unexpected cash needs enhances financial flexibility
• Risk management offers low-risk investment options for conservative portfolios provides means to diversify investment holdings
• Working capital management assists in matching short-term assets with short-term liabilities improves operational efficiency
• Foreign exchange risk mitigation allows hedging against currency fluctuations through short-term instruments (forward contracts, currency swaps)
• Interest rate risk management short-term nature reduces exposure to long-term interest rate changes minimizes duration risk
• Funding source provides alternative to bank loans for short-term financing needs expands financing options for businesses
• Yield enhancement offers slightly higher yields than traditional savings accounts improves returns on short-term investments
• Collateral money market instruments can be used as collateral for other financial transactions facilitates secured lending
• Benchmark rates serves as reference rates for pricing other financial products (LIBOR, SOFR)