Money market

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money market,
a set of institutions, conventions, and practices, the aim of which is to facilitate the lending and borrowing of money on a short-term basis. The money market is, therefore, different from the capital market, which is concerned with medium- and long-term credit. The definition of money for money market purposes is not confined to bank notes but includes a range of assets that can be turned into cash at short notice, such as short-term government securities, bills of exchange, and bankers’ acceptances.
A brief treatment of money markets follows. For full treatment, see Markets: Money market.
The details and the mechanism of the money market are complex and vary greatly from country to country, but in all cases the basic function, performed by middlemen providing a service for a profit, is to enable those with surplus short-term funds to lend and those with the need for short-term credit to borrow. In most countries the government plays a major role in the money market, acting both as a lender and borrower and often using its position to influence the money supply and interest rates according to its overall economic priorities (see monetary policy). Apart from domestic money markets, there is an international money market, which, although it utilizes many different mechanisms, provides fundamentally the same service by facilitating the borrowing, lending, and exchange of currencies between countries.
Two of the oldest and most developed money markets are those of the United States and Great Britain. In Great Britain the money market is sometimes referred to as the discount market, because one of the key institutions in short-term money transactions are the 12 banks known as discount houses. The main function of discount houses is to buy short-term credit notes and to resell them. The two most important forms of these notes are the commercial bill of exchange, which is a short-term obligation by one party to pay another, and the treasury bill, which is a similar obligation issued by the government. Discount houses borrow call money (that is, money repayable on demand) from commercial banks in order to purchase bills of exchange or treasury bills, which they may resell at a profit to commercial or clearing banks. By lending call money to the discount houses, commercial banks earn interest on reserve assets not required for immediate operations, and by buying bills, which fall due on specific dates usually up to three months, they obtain a regular supply of funds. The government borrows from the banking system by selling treasury bills to discount houses, which sell them in the same way as bills of exchange. The discount and price attached to bills depend on their maturity (the date on which they must be redeemed) and the level of interest rates.
The acceptability and price of commercial bills of exchange also depend on the reputation and standing of the issuer, although they may be guaranteed by one of the acceptance houses for a small fee based on the value of the bill. The government also acts as a lender of last resort. Thus, when commercial banks are short of cash and recall their call money from discount houses, the government, through the Bank of England, will lend to the discount houses at the official minimum lending rate, which includes a penalty component to discourage overuse.
In the United States the money market operates on similar principles, but the institutions and the mechanisms are different. One of the unique features of the U.S. money market is the large number and great variety of participants. This is due partly to a much smaller degree of concentration in the banking system, because of severe restrictions on branch banking, and to the large number of financial and non-financial concerns handling short-term funds. Much of the business in bills of exchange and other liquid financial instruments is transacted by dealers who buy and sell in basically the same way as the discount houses in Britain, using a variety of sources for finance. There is a market for a wide assortment of financial instruments including bills of exchange, government securities, securities issued by official federal agencies, clearinghouse funds (deposits at one bank loaned to another), as well as time certificates of deposit issued by commercial banks. In addition to the availability of these and other financial instruments, the Federal Reserve System provides considerable short-term credit directly to the banking system. For many smaller banking operations, the money market is not always capable of meeting their needs for short-term funds quickly enough to cope with the inevitable peaks and troughs of their business. In situations like this, banks (as long as they are members of the Federal Reserve System) can obtain funding through their own Federal Reserve Bank at the non-penalty discount rate of interest. In addition, banks can acquire immediate funding through the Federal Reserve System at variable rates of interest known as the federal funds rate. The Federal Reserve System also participates on its own accord in the daily market, acting to smooth fluctuations in money supply and distribution and in interest rates.

To cite this page:
“money market” Britannica Online.
[Accessed 09 May 1998].