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Part Four Financial Markets Chapter 9 The Money Markets Chapter Preview We review the money markets and the securities that are traded there. In addition, we discuss why the money markets are important in our financial system. Topics include: The Money Markets Defined The Purpose of Money Markets Who Participates in Money Markets? Money Market Instruments Comparing Money Market Securities The Money Markets Defined The term “money market” is a misnomer. Money (currency) is not actually traded in the money markets. The securities in the money market are short term with high liquidity; therefore, they are close to being money. The Money Markets Defined Money Markets Defined Money market securities are usually sold in large denominations ($1,000,000 or more) They have low default risk They mature in one year or less from their issue date The Money Markets Defined: Why Do We Need Money Markets? In theory, the banking industry should handle the needs for short-term loans and accept short-term deposits. Banks also have an information advantage on the credit-worthiness of participants. Banks do mediate between savers and borrowers; however, they are heavily regulated. This creates a distinct cost advantage for money markets over banks. The Money Markets Defined: Cost Advantages Reserve requirements create additional expense for banks that money markets do not have Regulations on the level of interest banks could offer depositors lead to a significant growth in money markets, especially in the 1970s and 1980s. When interest rates rose, depositors moved their money from banks to money markets to earn a higher interest rate. The Money Markets Defined: Cost Advantages Even today, the cost structure of banks limits their competitiveness to situations where their informational advantages outweighs their regulatory costs. Figure 1 shows that limits on interest banks could offer was not relevant until the 1950s. But in the decades that followed, the problem became app