Money Market
The money market is a segment of a financial
market in which financial instruments with high liquidity and very short
maturities are traded. The users borrow or lend for a short term which varies
from several days to maybe just under a year. Money market securities consist
of negotiable certificates of deposit (CDs), bankers' acceptances, U.S.
Treasury bill, commercial paper, municipal notes, federal funds, and repurchase
agreements.
A bearish market is considered risky by investors
for their savings. High returns always expose an investor to high risk. For many
investors, the money market offers an alternative to these higher-risk investments.
Financial Market
Financial markets such as money markets, foreign
exchanges and capital markets are an essential part of a financial system.
Following are the main functions of these
financial markets.
The money markets: they provide financial intermediaries, i.e. banks, non-bank financial institutions,
a way by which to borrow and lend in the short term and square their respective
positions.
The foreign exchange markets: They provide a working environment for international trade.
Capital markets: They provide long-term
finance, both equity and debt, for government and the corporate sector.
All these markets work in close collaboration
with each other. The performance of one market affects that of any other, in
one way or another. These markets play an important role in sending monetary
policy signals to the national economy. In fact, monetary policy communications
are initiated by the financial markets, particularly money and Forex markets, which
then impose an impact on the other financial intermediaries (banks, non-bank
financial institutions), firms and households and then finally affect inflation
and economic growth.
Difference between Money Market and Stock Market
The main difference between the money market and the stock market is that
most money securities transactions take place on a very large scale, whereas
stocks are dealt in small proportions. Due to the large size of the
transactions, it becomes difficult for the individual investor to gain access
to the money market, whereas it facilitates firms to buy and sell securities in
their own accounts, at their own risk. In a stock market, a broker receives a commission to act as an agent, and the investor takes the risk of holding the
stock. Another difference is that a money market lacks a central trading floor
for transactions; deals are transacted over the phone or through electronic
systems, while the stock market has a trading floor for transactions.
The money market is accessible for mutual funds
or through a money market bank account. These accounts and funds collect the
assets of thousands of investors in order to buy money market securities on
their behalf. It is possible to purchase some money market instruments, like
treasury bills, directly; otherwise, they can be obtained through large
financial institutions with direct access to these markets.
The primary role of the Money Market
The primary role of the money market is to
encourage trading of money in short-term financial instruments called
"paper". This makes it different from the capital market which allows
investment for shorter as well as longer periods in the form of bonds and
shares.
The main function of the money market is
interbank lending, that is, banks borrowing and lending to each other using
T-bills, commercial paper, repurchase agreements, and similar instruments. The
price of these instruments is determined according to the benchmark, i.e.
'London Interbank Offered Rate (LIBOR).' In Pakistan also there are companies
with strong credit ratings who issue commercial papers/bonds, debentures, etc
to meet their financial needs.
Framework followed by the money market in
Pakistan
Banks operating in the money markets are required
to ensure monetary and financial stability. Some of these operations are
designed basically to implement the monetary policy decisions of the central
bank and others are designed mainly to provide liquidity for the banking
system. The SBP's operating framework costs a number of elements, including
policies on access rights to central bank facilities; collateral policies; and
an operating system.
The
basic tools of this framework are:
The demand for reserves
The demand for reserves can
change for a number of reasons. During pressurize/stressed times, the interbank
market may not work effectively and a bank that is short of liquidity may find
it more difficult than usual to borrow money. The central bank uses reserves as
a tool to check the money market.
Monetary policy implementation by setting interest
rate
Central banks communicate the stance of monetary
policy by setting a short-term interest rate. Their operations in money markets
are conducted with the objective that the interest rates at which banks
transact for short periods of time are close to this policy rate.
Open Market Operations (OMO) is a multilateral
transaction in which the central bank at its own initiative deals in the market
and thus affects the banking system as a whole.
The interbank money market
The interbank money market is the market in which
banks borrow and lend short-term funds to each other; the duration is usually
no longer than a week. These transactions have to be settled via banks' accounts
with the central bank. If payment flows leave one bank with a surplus of
reserves and another with a shortage of reserves, they have an incentive to
trade with each other at a market-determined rate.
The interbank market forms the center of a wider
money market in which non-bank financial institutions often participate.
Overnight liquidity and transparent pricing help to maintain efficient working
of the financial markets.
Performance of Money Market in Pakistan
An efficient money market provides a mechanism
for meeting the short-term liquidity needs of the lenders and borrowers and
facilitates financial intermediation at efficient costs without undue delays.
The money market also provides an instant response to the central bank's policy
actions for influencing and short-term interest rates in the economy.
International money market (IMM)
International trade, financing, and investments,
and related cash and credit transactions developed at a very fast pace in the
1960's and 1970's. The international monetary system has continued to develop
to accommodate the need for foreign-currency-denominated transactions and in
the process has been provided with opportunities for its continuing onward
development.
The International Monetary Market (IMM) was
introduced in December 1971 and started to function in May 1972. The very first
future trading contracts were made against the U.S. dollar with other
currencies such as the British pound, Swiss franc, German Deutschmark, Canadian
dollar, and Japanese yen. In 1992, the German Deutschmark/Japanese yen pair was
introduced as the first futures cross-rate currency.
There were two major challenges faced by IMM. The
first and foremost challenge was to connect values of IMM foreign exchange
contracts to the interbank market and the second way to allow the IMM to be the
free-floating exchange image for the money markets. To solve these problems,
clearing member firms were incorporated to act as a link between banks and the
IMM to facilitate orderly markets between bids and ask spreads. The Continental
Bank of Chicago was later hired as a delivery agent for contracts.
