What are Money Markets?

Summary

This video explains the key differences between capital markets and money markets, focusing on money market instruments. It describes three main types of money market instruments in the UK: Treasury Bills, Certificates of Deposit (CDs), and Commercial Paper (CP). Treasury Bills are issued at a discount, and investors make a return at maturity. CDs are tradable bank deposits, while CP is issued by large companies and also does not pay interest. These instruments are generally low-risk, short-term investments favored by institutional investors, especially during periods of market uncertainty.

Takeaways

• 😀 Capital markets are financial markets where long-term capital is raised by companies and governments in the form of shares and bonds.
• 😀 The money market is different as it involves shorter-term bonds and addresses short-term borrowing needs for companies and governments.
• 😀 Money market instruments have a short maturity period, usually less than one year, often around three months.
• 😀 The three main types of money market instruments in the UK are Treasury Bills, Certificates of Deposit (CDs), and Commercial Paper (CP).
• 😀 Treasury Bills are issued by the UK government at a discount to par value, and investors make a profit based on the difference between the purchase price and the par value at maturity.
• 😀 A Treasury Bill example shows an investor purchasing a £990 bill, which matures to £1,000 in three months, resulting in a £10 profit.
• 😀 Certificates of Deposit (CDs) are tradable bank deposit accounts issued by banks, where the investor receives interest after a set period, and the deposit can be bought or sold before maturity.
• 😀 Commercial Paper (CP) is issued by large companies, does not pay interest like Treasury Bills, and is typically sold through pre-arranged programs with varying maturity dates.
• 😀 Money market instruments are attractive to institutional investors such as pension funds and insurance companies due to the large sums of money often required for investment.
• 😀 These instruments are considered low-risk, offering investors relatively stable returns, making them popular during times of market uncertainty and inflation.

Q & A

What are capital markets?

Capital markets are financial markets where long-term capital is raised by companies and governments through the issuance of shares and bonds.

How do money markets differ from capital markets?

Money markets are used for short-term borrowing needs, typically with instruments having a maturity period of less than a year, while capital markets are focused on long-term funding through shares and bonds.

What are treasury bills?

Treasury bills are short-term money market instruments issued by the UK government. They are sold at a discount to their par value, and at maturity, the government pays the full par value to the investor.

How does an investor earn a return from treasury bills?

An investor earns a return from treasury bills by purchasing them at a discount to their par value and receiving the full par value upon maturity. The return is the difference between the purchase price and the maturity amount.

What is a certificate of deposit (CD)?

A certificate of deposit (CD) is a tradable bank deposit account issued by banks, representing a deposit made by a customer. It can be bought and sold, with the depositor receiving the deposit amount plus interest at maturity.

What happens if a customer needs to access their money before the maturity of a CD?

If a customer needs to access their money before the maturity of a certificate of deposit, they can sell the CD to another investor in the money market.

What is commercial paper (CP)?

Commercial paper is a type of short-term money market instrument issued by large companies. It does not pay interest and is sold at a discount, with repayment of the face value at maturity.

How are commercial papers issued by companies?

Companies and banks typically agree in advance on the issuance of commercial papers, including the total value to be issued and the maturity dates for different CPs within that program.

Why are money market instruments attractive to institutional investors?

Money market instruments are attractive to institutional investors, such as pension funds and insurance companies, because they are low-risk investments and preserve par value, making them safer during periods of market uncertainty.

What is the typical return on money market instruments after taxes and inflation?

The typical return on money market instruments, after taxes and inflation, may be modest, often just positive, but they remain attractive due to their low risk and short-term nature.