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
- Serve 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
| Instrument | Issuer | Maturity | Key Feature |
|---|---|---|---|
| Commercial Paper (CP) | Corporations | Up to 270 days | Unsecured; exempt from SEC registration if maturity is 270 days or less |
| Bankers' Acceptance (BA) | Banks | Up to 180 days | Facilitates international trade; bank guarantees payment |
| Certificates of Deposit (CDs) | Banks | Varies (typically 1 month to 5 years) | FDIC insured up to $250,000; negotiable CDs trade in the secondary market |
| Repurchase Agreements (Repos) | Dealers/Banks | Overnight to 14 days | Collateralized short-term borrowing using government securities |
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 Section 3(a)(3) of the Securities Act of 1933, 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
- Primarily used to facilitate international trade transactions
- The bank's guarantee makes the instrument highly creditworthy
- Traded at a discount in the secondary market
Think of it this way: A bankers' acceptance is like a bank-backed IOU for international deals. The buyer's bank promises to pay the seller on a set date, so the seller ships the goods with confidence.
Exam Tip: Gotchas
- Bankers' acceptances are specifically for international trade, not domestic lending.
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 serve 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.