Money markets facilitate the circulation of money and provide a vital supply of money from those who have it to those who need to borrow it.
Money is widely seen as a commodity in its own right and is traded like one. This transfer of money is vital to the help of an economy and provides an efficient way of distributing capital.
If you went to your bank for a loan for a car, the bank would typically lend you the money by issuing asset-backed commercial paper (ABCP). A mortgage is funded by mortgage-backed securities. These are offered on the money markets and the entity that lent the money to the institution will make a profit relative to the risk of the security.
In the example below the commercial lender and the money market institution make a certain percent of the profit on the deal. The accumulated cost of money + the percentage profits for the commercial lender and the owner of the ABCP should equal the effective percentage you repay on your car loan.
Individual < — (Car Loan) (ABCP) —> Money Market Institution
Types of Money Market Instruments
The money markets contain many types of tradable instruments; the more common types are listed here.
- Certificates of deposit: usually offered to consumers by banks and credit unions
- Commercial notes: Issues by corporations to be able to fund cash flow and short-term debt
- Federal Funds: deposits held by banks that earn interest for the federal reserve. This is immediately available credit for financial institutions to enable liquidity for the institutions to function. The Federal Funds Rate is the cost of the capital for the institutions.
- Municipal Notes: these are issued by cities or municipalities to provide liquidity in advance of receiving tax revenue.
- Treasury Bills: issues by governments, these are debt obligation that pays a fixed interest to the bearer
So now you know what money markets are for and what products can be purchased there.