Money Markets

Money markets facilitate short-term borrowing and lending, typically for durations under one year. These markets provide vital liquidity for financial institutions, corporations, and governments while offering investors safe, liquid alternatives to cash holdings.

Treasury Bills: Short-term government debt instruments with maturities from a few days to one year, T-bills serve as the risk-free benchmark for the financial system. Rather than paying periodic interest, they sell at a discount to face value, with the difference representing implicit interest. The weekly Treasury auctions where these instruments are issued provide critical signals about market liquidity and investor risk appetite.

Commercial Paper: Unsecured short-term corporate debt issued by large corporations to fund operations and manage cash flow. For example, a manufacturing company might issue 90-day commercial paper to finance inventory before seasonal sales, offering slightly higher yields than T-bills due to the added credit risk.

Repurchase Agreements (Repos): Short-term loans secured by financial assets, typically government securities. In a repo transaction, one party sells securities to another with an agreement to repurchase them at a slightly higher price on a specific future date. The repo market, with daily volumes exceeding $1 trillion in the U.S. alone, serves as the primary short-term funding mechanism for financial institutions and the 'plumbing' of the financial system.

Certificates of Deposit (CDs): Time deposits issued by banks with fixed maturities ranging from one month to several years. Unlike demand deposits (checking accounts), CDs cannot be withdrawn before maturity without penalty, allowing banks to use these funds for longer-term lending.

Eurodollars: Dollar-denominated deposits held in banks outside the United States, primarily traded as time deposits between banks. Despite the name, Eurodollars trade worldwide, not just in Europe. The London Interbank Offered Rate (LIBOR), being phased out in favor of SOFR (Secured Overnight Financing Rate), was historically derived from this market.

Federal Funds: The market where U.S. banks lend reserve balances to each other overnight, usually on an unsecured basis. The Federal Reserve targets the federal funds rate as its primary monetary policy tool, influencing broader interest rates throughout the economy.

Systemic Importance: Money markets serve as the nervous system of finance, with disruptions quickly affecting the broader economy. The 2008 financial crisis dramatically illustrated this when the Reserve Primary Fund 'broke the buck' (falling below $1 net asset value) after Lehman Brothers' bankruptcy, triggering widespread panic and freezing short-term funding markets until government intervention restored confidence.

Money Market Funds: Investment vehicles that pool resources to purchase short-term debt instruments, offering individuals and corporations access to money market instruments with check-writing privileges and daily liquidity. These funds manage trillions of dollars and serve as significant purchasers of commercial paper and other short-term corporate debt.