CISI – Financial Products, Markets & Services

Topic – The Financial Services Industry

(3.2) The Money Market
What is the Money market?
Generally speaking, it is a market for shorter-term bonds.

What is the difference between Capital Market and Money Market instruments?

Capital Market instruments refers to equities and bonds, used to raise long-
term capital.
Money Market instruments raise cash for shorter term periods of up to a year.

Investing in Money Market instruments

 There is a high minimum subscription - more suitable for institutional investors

like pension funds and insurance companies – ‘Wholesale’ institutional market
Accessible to retail investors indirectly through collective investment funds
 Administrative costs are low – they are issued in ‘bearer’ form – no register
maintenance.
 Most are issued below par value with no coupons
Types of Money Market Instruments

In the UK, the three main money market instruments are:

 Treasury Bills

 Certificates of Deposit (CDs)

 Commercial Paper (CP)

Activity
In groups, using the sheets provided and the internet, find out about one of
the three types of market instruments. You will then be asked to tell the rest
of the groups about what you have found out.
Treasury Bills
Treasury Bills are a form of ultra-short gilt
Who issues them and why?
 Issued by the Debt Management Office (DMO) on behalf of the UK Treasury
 Used to meet short-term borrowing needs of the Government
How often are they issued?
 Issued every week, unlike normal traditional gilts
How do investors make a return?
 No coupons are paid (non-interest bearing)
 Issued discount to par value (Par value paid back on maturity)
e.g. Treasury Bill of £1,000 nominal sold for £990
Upon maturity three months later, investor is repaid £1,000,
invests pockets the difference of £10
Return on investment is 1% over three months
AER is 4.06%
How long do they take to mature?
 Commonly, they will be redeemed after one, three or six months
Certificates of deposit (CDs)
Resembles an instrument half-way between a bond and a
cash deposit
Who issues them?
 Issued by banks in return for deposited money.
How long can they be held for?
 The deposit is for a specified period of time – it varies
 Traditionally this is for a maximum of five years but usually much less
How do they work?
 Investors deposit a fixed sum – minimum in the UK is £100,000
 They can be thought of as tradeable or negotiable deposit
accounts, as they can be bought and sold in a similar way to shares:
Example:
Lloyds Banking Group might issue a CD to represent a deposit of £1
million from a customer, redeemable in six months. The CD will specify
that Lloyds will pay the £1 million back plus interest of, say, 0.5% of £1
million. If the customer needs the money back before six months has
elapsed, he can sell the CD to another investor in the money market.

How do investors make a return?

 The bank will pay interest on the deposited amount, which can be fixed or
variable. The investor receives their deposited sum back at the set end date
Commercial Papers (CPs)
Equivalent of a Treasury bill – a short-term bond
Who issues them and why?
 Issued by large companies instead of governments – In
the UK, the borrower must be listed on the stock exchange
and must have substantial net assets
 To meet a company’s short-term borrowing needs
How long can they be held for?
 Companies can issue CPs with different maturities depending on it’s
needs e.g. One month, three months, six months etc
 In the UK, The maturities of commercial paper must be between 7 and 364
days
How do they work?
 The company will agree in advance with its banker on a programme
of CP issues – say, £10m over the course of a year
 Company issues the CP to the bank with a series of different maturities,
depending on its short-term funding needs
 Company can also issue CP in different currencies
How do investors make a return?
 No coupons are paid (non-interest bearing)
 Issued discount to par value (Par value paid back on maturity)
Commercial Papers (CPs)

Source: Bank of England

A feature of the 2008 Credit Crunch was the unwillingness of the

banks to lend long-term. This led to a spike in CP issuance, as
companies turned to short-term sources of finance
Settlement of Money Market Instruments

All money market instruments in the UK have been “dematerialised”

There are no actual certificates or bills:

 Ownership is registered electronically

 Changes of ownership (i.e trade settlement) is effected
through the CREST system
 Commonly, settlement on the day of the trade or the
following business day
Money Market Funds
What are they?
 Funds set-up, which contain and invest in Money Market instruments

 Pools together the funds of other investors, giving them indirect access to
assets they would not otherwise be able to invest in.
 Investors buy into the fund and therefore invest indirectly – they buy units in
the fund, not individual Money Market instruments as private investors

Types of Money Market Funds

The Investment Management Association (IMA)
introduced two money market sectors which came into
effect on 1 January 2012:

1. Short-term money market funds: 2. Money market funds:

 Can have a constant net asset  Must have a fluctuating net asset value
value (the NAV remains
unchanged when income in the
fund is accrued daily)

 Can also have a fluctuating

NAV
Money Market Funds
Risks
Placing money with a money market fund may be less
risky that Placing funds in a money market account (CDs)

With CDs, the investor is exposed to the risk of that bank.

A money market fund will invest in a range of instruments

from many providers, and as long as they are AAA-rated
they can offer high security levels. A rating of AAA is the
highest rating assigned by a credit rating agency.

Regulations
In the UK, money market funds may only invest in
approved money market instruments and deposits
with credit institutions and meet other conditions on
the structure of the underlying portfolio

BUT money market funds may invest in instruments in which the

capital is at risk and so may not be suitable for many investors.
Investing in Money Market Instruments
 Low risk – the nominal is preserved
 Useful during times of uncertainty
 Quick returns – short-term nature
 Money Market Funds - pooling of funds
with other investors gives the investor
access to assets they would not
otherwise be able to invest in.
 Only suitable for short-term investing
 Over the medium- to long-term, the money
markets have under-performed many other
investment types
 Professional market – only accessible to
private investors through money market funds
or money market accounts