International Money Market

A money market is a market for instruments and a means of lending (or investing) and  borrowing funds for relatively short periods, typically regards as from one day to one year.  Such means and instruments include short term bank loans. Treasury bills, bank certificates  of deposit, commercial paper, banker’s acceptances and repurchase agreements and other  short term asset backed claims.

As a key elements of the financial system of a country, the money market plays a  crucial economic role that if reconciling the cash needs of so called deficit units (such as  farmers needing to borrow in anticipation of their later harvest revenues), with the investment  needs of surplus units (such as insurance companies wanting to invest cash productively prior  to making long term investment choices). Holding or borrowing liquid claims is more  productive than holding cash balances. A smoothly functioning money market can perform  these functions very efficiently if borrowing lending spreads (or bid offers spreads for traded  instruments) are small (operational efficiency), and if funds are lent to those who can make  the most productive use of them (allocation efficiency). Both borrowers and lenders prefer to  meet their short term needs without bearing the liquidity risk or interest rate risk that  characterizes longer term instruments, and money market instruments allow this. In addition  money market investors tend not to want to spend much time analyzing credit risk, so money  market instruments are generally characterized by a high degree of safety of principal. Thus  the money market sets a market interest rate that balances cash management needs, and sets  different rates for different uses that balance their risks and potential for productive use.  Unlike stock or futures markets, the money markets of the major  industrial countries have no  central location; they operate as a telephone market that is accessible from all parts of the  world.

The international money market can be regarded as the market for short term  financing and investment instruments that are issued or traded internationally. The core of  this market is the  Euro-currency  market, where bank deposits are issued and traded outside of  the country that issued the currency. Other instruments such as  Euro commercial paper and floating rate notes, serve some what different purposes and  attract a different investment clientele. However, each is to a degree a substitute for each of  the other instruments, and the yield and price of each are sensitive to many of the same  influences, so we may feel justified in lumping them together in something called a market.  The fact that many of the other instruments of the international money market are priced off  LIBOR, the interest rate of Eurodollar deposits, suggest that market participants themselves  regard the different instruments as having a common frame of reference.

Today many domestic cash and derivative instruments, such as US. Treasury bills and  Euro-currency  futures contracts are traded globally and so are effectively parts of the  international money market.  Euro-market  instruments simply represent part of a spectrum of  financial claims available in the money market of a particular currency, claims that are  distinguished by risk, cost and liquidity just like domestic money market instruments.  However domestic money markets are called upon to play public as well as private roles. The  latter include the following three functions.

  1. The money market, along with the bond market, is used to finance the government  deficit.
  2. The transmission of monetary policy (including exchange rate policy) is typically  done through the money market, either through banks or through freely traded money  market instruments.
  3. The government uses the institutions of the money market to influence credit  allocation toward favored uses in the economy.

International Money Market Instruments

Euro-currency  Time Deposits and Certificates of Deposit

The overwhelming majority of bank deposits in the  Euro-currency  market take the  forms of non negotiable time deposits. Those who want greater liquidity  invest in shorter maturities. A very high proportion of Eurodollar time deposits, especially in  the  inter-bank  market, mature in one week or less.

Alternatively, the invest can buy a negotiable Euro certificate of deposit (Euro CD),  which is simply a time deposit that is transferable and thus has the elements of a security.  Some banks are a little reluctant to issue CDs, because they would prefer not to have their  paper traded in a secondary market, especially at times when the bank might be seeking  additional short term funding. The secondary paper might compete with the primary paper  being offered. Other will issue CDs readily if investors prefer them, perhaps paying ¼  percent or ore below their equivalent time deposit rate to reflect the additional liquidity and  the somewhat greater documentary inconvenience of CDs.

Other banks (particularly if they wish to have their names better known in the market)  might deliberately undertake a funding program using Euro CDs. In this circumstance, the  CDs are to be distributed like securities, so as to increase awareness of the issuers name and  raise a larger volume of funds for longer maturities than might be possible in the  conventional  euro-deposit  market.

Bankers Acceptances and Letters of Credit

Banker’s acceptances are money market instruments arising, typically, from international  trade transactions that are financed by banks. The banker’s acceptance (BA) itself represents  an obligation be a specific bank to pay a certain amount on a certain date in the future. To  simplify a bit, it is a claim of the bank that differs little from other short term claims such as  CDs. Indeed BAs, when they are traded in a secondary market, trade at a return that seldom  deviates much from comparable CDs issued by the same bank.

Letters of credit (L/C) are documents issued by banks in which the bank promises to pay a  certain amount on a certain date, if and only if documents are presented to the bank as  specified in the terms of the credit. A letter of credit is generally regarded as a very strong  legal commitment on the part of a bank to pay if the conditions of trade documents are  fulfilled.

In a typical export transaction, the exporter will want to be paid once the goods arrive  (and are what they are supposed to be) in the foreign port. So the exporter asks for acceptance  is the importers bank of a time draft (essentially an invoice that requests payment on a future  date). Upon acceptance by the importers bank, the innocuous little time draft becomes a  valuable document, a banker acceptance. Acceptance means that the bank obliges itself to  pay the face amount upon the due date.  The means by which an exporter gets paid is be selling this BA to its own bank, which  can hold it as an investment or sell it in the secondary market, when it becomes a money  market instrument. Bankers acceptances are sold at a discount from face value, like Treasury  bills and Commercial paper, and yields are quoted as discount yields. Why should the bank  pay the exporter? The reason is that it has promised the exporter hat it will do so upon  presentation of documents conveying title to the goods. That promise is what we gave  described as the letter of credit.

Euro-notes  and  Euro-commercial  Paper

These instruments are short term unsecured promissory notes issued by corporations  and banks.  Euro-notes, the more general term, encompasses note issuance facilities, those that  are underwritten, as well as those that are not underwritten. The term  Euro-commercial  paper  is generally taken to mean notes that are issued without being backed by an underwriting  facilities that is, without out the support of a medium term commitment by a group of banks  to provide funds in the event that the borrower is unable to roll over its  Euro-notes  on  acceptable terms. The  Euro-notes  market takes the form of non underwritten  Euro-commercial  paper (ECP), so the actual paper that an investor will find available for investment is likely to  be ECP.

Like US commercial paper,  Euro-notes  and ECP are traded by conversion on a  discount basis, and interest is calculated as “actual/360,” meaning that the price is set as 100  minus the discount interest rate multiplied by the actual number of days to maturity, over  360.

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