Money Market Instruments

After covering long-term debt (Treasuries, agencies, corporates, munis), we turn to the short-term end of the debt market. Money market instruments are all about liquidity and safety.

What Are Money Market Instruments?

• Short-term debt securities with maturities of 1 year or less
• Characterized by high liquidity, low risk, and low return
• Used by corporations and governments for short-term funding needs
• Function as near-cash equivalents for investors seeking safety

Think of it this way: Money market instruments are the "savings accounts" of the securities world. You are not looking for big returns; you are parking cash somewhere safe and liquid until you need it.

Key Money Market Instruments

Exam Tip: Gotchas

Three of the instruments above are sold at a discount to face value and generate return from price appreciation rather than periodic interest payments:

• Treasury bills
• Commercial paper
• Bankers' acceptances

For any of these, dollar return at maturity = face value - purchase price. No coupon, no interest payment: you buy low and redeem high.

Negotiable CDs work differently: they pay a stated interest rate, like a traditional bank deposit. Repos also work differently: the return comes from the spread between the sale price and the agreed buy-back price, not from a face-value discount.

Commercial Paper

• Unsecured, short-term promissory notes issued by large, creditworthy corporations
• Used to fund day-to-day operations (payroll, inventory, accounts payable)
• Typically sold at a discount to face value (like Treasury Bills)
• Maturities average about 30 days but can extend up to 270 days
• Exempt from SEC registration under the Securities Act short-term-paper exemption, provided:
  • Maturity does not exceed 270 days
  • Sold to sophisticated (institutional) investors
  • Proceeds are used for current transactions (not long-term investment)

Exam Tip: Gotchas

• Commercial paper is exempt from SEC registration ONLY if maturity does not exceed 270 days. All three conditions must be met.
• Commercial paper is UNSECURED (unlike repos, which are collateralized). If the issuer defaults, holders have no collateral to claim.

Bankers' Acceptances

• A time draft drawn on and guaranteed by a bank
• A time draft is a written order directing a bank to pay a set amount on a specific future date; when the bank accepts (stamps) that order, it commits itself to pay on that date regardless of what happens to the buyer
• Primarily used to facilitate international trade transactions
• The bank's commitment makes the instrument highly creditworthy
• Traded at a discount in the secondary market
• Maturities typically run 30 to 180 days in practice, with a maximum of 270 days

Think of it this way: A bankers' acceptance is like a bank-backed IOU for international deals. An importer's bank tells the exporter: "We will pay you on this date, no matter what." The exporter ships the goods with confidence because it's the bank on the hook, not just the buyer.

Exam Tip: Gotchas

• Bankers' acceptances are specifically for international trade, not domestic lending.
• Often confused with negotiable CDs: a CD is a deposit you make at the bank (you are the creditor; the bank pays you a stated interest rate and returns your principal; FDIC insures it up to $250,000). A BA is not a deposit: the bank stamps an importer's time draft to guarantee payment to an overseas exporter. You are not depositing money with the bank; the bank is guaranteeing someone else's trade obligation.
• BA and commercial paper share the same 270-day maximum. Like commercial paper, BAs are exempt from SEC registration under the Securities Act as long as maturity does not exceed 270 days. In practice, BAs rarely extend past 180 days because the Federal Reserve historically limited its eligibility rules to 6-month maturities. The exam-testable fact is 270 days; 180 days is the practical norm, not the hard ceiling.

Negotiable Certificates of Deposit

• Large-denomination CDs (typically $100,000 or more) issued by commercial banks
• Unlike regular CDs, negotiable CDs can be traded in the secondary market
• FDIC insured up to $250,000 per depositor per institution
• Pay a fixed interest rate

Exam Tip: Gotchas

• Negotiable CDs trade in the secondary market; regular CDs do not. The word "negotiable" is the key distinction.
• FDIC insurance on CDs covers up to $250,000 per depositor per institution, regardless of the CD's face value.

Repurchase Agreements (Repos)

• A dealer sells government securities to an investor and agrees to buy them back at a slightly higher price
• Essentially a collateralized short-term loan: the securities act as collateral
• The difference between the sell and repurchase price represents the interest
• Very short maturities, often overnight
• A reverse repo is the same transaction from the buyer's perspective

Think of it this way: A repo is like pawning your government bonds overnight. You sell them to get cash now, then buy them back tomorrow at a slightly higher price. That price difference is the interest you pay for the short-term loan.

Exam Tip: Gotchas

• Repos are collateralized (backed by government securities), while commercial paper is unsecured. This is a common comparison on the exam.
• A reverse repo is the same transaction viewed from the other side: the investor buys securities and agrees to sell them back.