Money Market Instruments Overview
CISI – Financial Products, Markets & Services
Topic – The Financial Services Industry
(3.2) The Money Market
What is the Money market?
Generally speaking, it is a market for
shorter-term bonds
.
What is the difference between Capital Market and Money Market instruments?
Capital Market instruments refers to equities and bonds, used to raise
long-
term capital.
Money Market instruments raise cash for
shorter term
periods of
up to a year.
Investing in Money Market instruments
There is a
high minimum subscription
- more suitable for institutional investors
like pension funds and insurance companies –
‘Wholesale’
institutional market
Accessible to retail investors
indirectly
through
collective investment funds
Administrative
costs are low
– they are issued in ‘bearer’ form – no register
maintenance.
Most are issued
below par value
with
no coupons
In the UK, the three main money market instruments are:
Treasury Bills
Certificates of Deposit (CDs)
Commercial Paper (CP)
Types of Money Market Instruments
Activity
In groups, using the sheets provided and the internet, find out about one of
the three types of market instruments. You will then be asked to tell the rest
of the groups about what you have found out.
Treasury Bills
No coupons
are paid (non-interest bearing)
Issued by the
Debt Management Office
(DMO) on behalf of the UK Treasury
Who issues them and why?
Used to meet
short-term borrowing needs
of the Government
Treasury Bills are a form of
ultra-short gilt
How often are they issued?
Issued
every week
, unlike normal traditional gilts
How do investors make a return?
How long do they take to mature?
Commonly, they will be redeemed after
one, three or six months
Issued
discount to par value
(Par value paid back on maturity)
e.g. Treasury Bill of £1,000 nominal sold for £990
Upon maturity three months later, investor is repaid £1,000,
invests pockets the difference of £10
Return on investment is 1% over three months
AER is
4.06%
Certificates of deposit (CDs)
Resembles an instrument half-way between
a bond and a
cash deposit
Who issues them?
Issued by
banks
in return for deposited money.
The bank will pay interest on the deposited amount, which can be fixed or
variable. The investor receives their deposited sum back at the set end date
How long can they be held for?
The deposit is for a
specified period of time
– it varies
Traditionally this is for a
maximum of five years
but usually much less
How do they work?
They can be thought of as
tradeable or negotiable deposit
accounts
, as they can be bought and sold in a similar way to shares:
Example:
Lloyds Banking Group might issue a CD to represent a deposit of £1
million from a customer, redeemable in six months. The CD will specify
that Lloyds will pay the £1 million back plus interest of, say, 0.5% of £1
million.
If the customer needs the money back before six months has
elapsed, he can sell the CD to another investor in the money market.
Investors deposit a
fixed sum
– minimum in the UK is
£100,000
How do investors make a return?
Commercial Papers (CPs)
Equivalent of a Treasury bill – a
short-term bond
Who issues them and why?
Issued by
large companies
instead of governments – In
the UK, the borrower must be listed on the stock exchange
and must have substantial net assets
To meet a company’s short-term borrowing needs
The company will agree in advance with its banker on a programme
of CP issues – say, £10m over the course of a year
How long can they be held for?
Companies can issue CPs with different maturities depending on it’s
needs e.g. One month, three months, six months etc
In the UK, The maturities of commercial paper must be between 7 and 364
days
How do they work?
Company issues the CP to the bank with a series of different maturities,
depending on its short-term funding needs
Company can also issue CP in different currencies
No coupons
are paid (non-interest bearing)
How do investors make a return?
Issued
discount to par value
(Par value paid back on maturity)
A feature of the 2008 Credit Crunch was the unwillingness of the
banks to lend long-term. This led to a spike in CP issuance, as
companies turned to short-term sources of finance
Source: Bank of England
Commercial Papers (CPs)
Settlement of Money Market Instruments
All money market instruments in the UK have been
“dematerialised”
There are
no actual certificates or bills:
Ownership is registered
electronically
Changes of ownership (i.e trade settlement) is effected
through the
CREST system
Commonly, settlement
on the day of the trade
or the
following business day
Money Market Funds
What are they?
Funds set-up, which contain and invest in Money Market instruments
Pools together the funds of other investors, giving them indirect access to
assets they would not otherwise be able to invest in.
Investors buy into the fund and therefore invest indirectly – they buy units in
the fund, not individual Money Market instruments as private investors
The Investment Management Association (IMA)
introduced
two money market sectors
which came into
effect on 1 January 2012:
Types of Money Market Funds
1. Short-term money market funds:
Can have a
constant
net asset
value
(the NAV remains
unchanged when income in the
fund is accrued daily)
Can also have a
fluctuating
NAV
2. Money market funds:
Must have a
fluctuating net asset value
Money Market Funds
Risks
Placing money with a money market fund may be
less
risky
that Placing funds in a money market account (CDs)
With CDs, the investor is
exposed to the risk of that bank
.
A money market fund will
invest in a range of instruments
from
many providers
, and as long as they are AAA-rated
they can offer high security levels. A rating of AAA is the
highest rating assigned by a credit rating agency.
In the UK, money market funds may only invest in
approved money market instruments and deposits
with credit institutions and meet other conditions on
the structure of the underlying portfolio
Regulations
BUT
money market funds may invest in instruments in which the
capital is at risk
and so
may not be suitable for many investors
.
Investing in Money Market Instruments
Low risk
– the nominal is preserved
Useful during times of
uncertainty
Quick returns
– short-term nature
Only suitable for
short-term investing
Over the medium- to long-term, the money
markets have
under-performed
many other
investment types
Professional market – only accessible to
private investors through money market funds
or money market accounts
Money Market Funds -
pooling of funds
with other investors
gives the investor
access to assets they would not
otherwise be able to invest in.
The money market is a key aspect of the financial services industry, providing short-term investment opportunities. Treasury bills, certificates of deposit, and commercial paper are common money market instruments, each offering unique features for investors. Treasury bills are ultra-short gilts issued by the UK government to meet short-term borrowing needs, while certificates of deposit resemble a mix of bonds and cash deposits, offering fixed returns for deposited amounts. Understanding these instruments is essential for investors looking to diversify their portfolios.
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Presentation Transcript
CISI Financial Products, Markets & Services Topic The Financial Services Industry (3.2) The Money Market
What is the Money market? Generally speaking, it is a market for shorter-term bonds. What is the difference between Capital Market and Money Market instruments? Capital Market instruments refers to equities and bonds, used to raise long- term capital. Money Market instruments raise cash for shorter term periods of up to a year. Investing in Money Market instruments There is a high minimum subscription - more suitable for institutional investors like pension funds and insurance companies Wholesale institutional market Accessible to retail investors indirectly through collective investment funds Administrative costs are low they are issued in bearer form no register maintenance. Most are issued below par value with no coupons
Types of Money Market Instruments In the UK, the three main money market instruments are: Treasury Bills Certificates of Deposit (CDs) Commercial Paper (CP) Activity In groups, using the sheets provided and the internet, find out about one of the three types of market instruments. You will then be asked to tell the rest of the groups about what you have found out.
Treasury Bills Treasury Bills are a form of ultra-short gilt Who issues them and why? Issued by the Debt Management Office (DMO) on behalf of the UK Treasury Used to meet short-term borrowing needs of the Government How often are they issued? Issued every week, unlike normal traditional gilts How do investors make a return? No coupons are paid (non-interest bearing) Issued discount to par value (Par value paid back on maturity) e.g. Treasury Bill of 1,000 nominal sold for 990 Upon maturity three months later, investor is repaid 1,000, invests pockets the difference of 10 Return on investment is 1% over three months AER is 4.06% How long do they take to mature? Commonly, they will be redeemed after one, three or six months
Certificates of deposit (CDs) Resembles an instrument half-way between a bond and a cash deposit Who issues them? Issued by banks in return for deposited money. How long can they be held for? The deposit is for a specified period of time it varies Traditionally this is for a maximum of five years but usually much less How do they work? Investors deposit a fixed sum minimum in the UK is 100,000 They can be thought of as tradeable or negotiable deposit accounts, as they can be bought and sold in a similar way to shares: Example: Lloyds Banking Group might issue a CD to represent a deposit of 1 million from a customer, redeemable in six months. The CD will specify that Lloyds will pay the 1 million back plus interest of, say, 0.5% of 1 million. If the customer needs the money back before six months has elapsed, he can sell the CD to another investor in the money market. How do investors make a return? The bank will pay interest on the deposited amount, which can be fixed or variable. The investor receives their deposited sum back at the set end date
Commercial Papers (CPs) Equivalent of a Treasury bill a short-term bond Who issues them and why? Issued by large companies instead of governments In the UK, the borrower must be listed on the stock exchange and must have substantial net assets To meet a company s short-term borrowing needs How long can they be held for? Companies can issue CPs with different maturities depending on it s needs e.g. One month, three months, six months etc In the UK, The maturities of commercial paper must be between 7 and 364 days How do they work? The company will agree in advance with its banker on a programme of CP issues say, 10m over the course of a year Company issues the CP to the bank with a series of different maturities, depending on its short-term funding needs Company can also issue CP in different currencies How do investors make a return? No coupons are paid (non-interest bearing) Issued discount to par value (Par value paid back on maturity)
Commercial Papers (CPs) Source: Bank of England A feature of the 2008 Credit Crunch was the unwillingness of the banks to lend long-term. This led to a spike in CP issuance, as companies turned to short-term sources of finance
Settlement of Money Market Instruments All money market instruments in the UK have been dematerialised There are no actual certificates or bills: Ownership is registered electronically Changes of ownership (i.e trade settlement) is effected through the CREST system Commonly, settlement on the day of the trade or the following business day
Money Market Funds What are they? Funds set-up, which contain and invest in Money Market instruments Pools together the funds of other investors, giving them indirect access to assets they would not otherwise be able to invest in. Investors buy into the fund and therefore invest indirectly they buy units in the fund, not individual Money Market instruments as private investors Types of Money Market Funds The Investment Management Association (IMA) introduced two money market sectors which came into effect on 1 January 2012: 2. Money market funds: 1. Short-term money market funds: Can have a constantnet asset value (the NAV remains unchanged when income in the fund is accrued daily) Must have a fluctuating net asset value Can also have a fluctuating NAV
Money Market Funds Risks Placing money with a money market fund may be less risky that Placing funds in a money market account (CDs) With CDs, the investor is exposed to the risk of that bank. A money market fund will invest in a range of instruments from many providers, and as long as they are AAA-rated they can offer high security levels. A rating of AAA is the highest rating assigned by a credit rating agency. Regulations In the UK, money market funds may only invest in approved money market instruments and deposits with credit institutions and meet other conditions on the structure of the underlying portfolio BUT money market funds may invest in instruments in which the capital is at risk and so may not be suitable for many investors.
Investing in Money Market Instruments Advantages Low risk the nominal is preserved Disadvantages Only suitable for short-term investing Over the medium- to long-term, the money markets have under-performed many other investment types Useful during times of uncertainty Quick returns short-term nature Money Market Funds - pooling of funds with other investors gives the investor access to assets they would not otherwise be able to invest in. Professional market only accessible to private investors through money market funds or money market accounts
