Money Markets: Other kinds of Money Market
Securities
Commercial Paper (CP):
To help meet their immediate needs for cash, banks and corporations
sometimes issue unsecured, short-term debt instruments known as commercial
paper, typically for
financing
accounts receivable and inventories. Commercial paper can be a good place
for investors and institutional investors in particular to park cash
temporarily. That's because commercial paper is liquid and essentially risk
free, since it is typically issued by profitable, long-established
organizations.
Furthermore, typically only companies with high credit ratings and credit
worthiness issue commercial paper. Over the past 40 years, there have only
been a handful of cases where corporations have defaulted on
their commercial paper repayment. It is usually issued at a discount,
reflecting current market interest rates. Maturities on commercial paper are
usually no longer than 9 months, with maturities of 1-2 months being the
average. It is usually issued with denominations of $100,000 or more.
Therefore, smaller investors can only invest in commercial paper indirectly
through money market funds.
Bankers' Acceptance (BA):
A BA is a short-term credit investment created by a non-financial firm and
guaranteed by a bank to make payment.
For corporations, a BA acts as a negotiable time draft for financing
imports, exports, or other transactions in goods. This is especially useful
when the creditworthiness of a foreign trade partner is unknown. Acceptances
sell at discount from the face value (see example below).
One advantage of a bankers acceptance is that they do not need to be held on
until maturity. Instead they can be sold off in the secondary
markets where investors and institutions constantly trade BAs.
|
Face value
of Bankers Acceptance |
$1,000,000
|
|
Minus 2% per
annum commission for one year |
-$20,000
|
|
Amount
received by exporter in one year |
$980,000
|
Eurodollars:
Contrary to the name, Eurodollars have very little to do with the Euro
or European countries. Eurodollars are US currency deposited in banks
outside the US, usually but not always in Europe. Certain debt securities
are issued in eurodollars and pay interest in US dollars into non-US bank
accounts. Eurodollars are a form of eurocurrency. This market evolved in Europe, hence the name, but Eurodollars can be held
anywhere outside the United States.
The
Eurodollar market is relatively free of regulation, and so banks can
operate on narrower margins than their counterparts in the United
States. As a result, the Eurodollar market has expanded largely as a way
of circumventing regulatory costs. The
average Eurodollar deposit is very large (in the millions) and has a
maturity of less than 6 months. A variation on the Eurodollar time
deposit is the Eurodollar certificate of deposit. A Eurodollar CD is
basically the same as a CDs in the states, except that it's the liability of a
non-U.S. bank, and they are typically less liquid and so offer higher
yields. The
Eurodollar market is obviously out of reach for all but the largest
institutions. The only way for individuals to invest in this market is
indirectly through a money market fund.
Re-purchase agreement (Repos):
Repo is short for repurchase agreement. Those who deal in
government securities use repos as a form of overnight borrowing. A
dealer or other holder of government securities (usually T-bills) sells
the securities to a lender and agrees to repurchase them at an agreed
future date at an agreed price. They are usually very short-term, from
overnight to 30 days or more. This short-term maturity and government
backing means repos provide lenders with extremely low risk.
Repos are popular because they can virtually eliminate credit problems.
Unfortunately, a number of significant losses over the years from
fraudulent dealers suggest that lenders in this market have not always
checked their collateralization closely enough.
There are also variations on standard repos:
-
Reverse Repo - The complete opposite of a repo, where a
dealer buys government securities from an investor and then sells
them back on a later date at a higher price.
-
Term Repo - Exactly the same as a repo except the term of
the loan is greater than 30 days.
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How do I invest in Money Markets?
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