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The essence of the money market

Money market is a key link in the system of money turnover, through which the distribution and redistribution of cash flows in the economy is carried out (see Money turnover and cash flows). In the money market, there is a constant migration of funds between various entities, which arises under the influence of the forces of supply and demand for funds.

In any market, the process of buying and selling a certain product (or a group of goods) is carried out, and on the basis of the law of supply and demand, the price of this product is formed. The specificity of the money market is that money itself acts as a commodity on it, respectively, and the elements of the money market themselves have their own specifics: demand has the form of demand for loans (borrowings), supply has the form of supply of temporarily free funds, and price has the form of interest … Thanks to the money market, the economy is balancing supply and demand, as well as the formation of market interest as the price of money.

The money market has its own infrastructure that ensures the flow of funds from sellers (owners of money) to buyers (borrowers), and banks play a key role in this infrastructure. All money market participants are interested in receiving appropriate monetary remuneration from their activities: sellers receive remuneration in the form of interest, buyers – in the form of additional income that they are able to receive from the use of borrowed funds, and intermediaries – in the form of interest margin or commissions from the provision of intermediary services …

You can read more about the money market here.

Subjects (participants) of the money market

There are 3 key categories of participants in the money market:

  1. sellers;
  2. buyers;
  3. intermediaries.

It should be noted that some operations in the money market can be carried out without the participation of intermediaries, i.e. through direct interaction between buyers and sellers.

The sellers and buyers in the money market can be:

  • enterprises and organizations;
  • individuals;
  • state;
  • banks;
  • non-bank financial institutions (pawnshops, credit unions, insurance companies, investment funds, etc.);
  • international financial organizations (World Bank, IFC, IMF, etc.).

Financial intermediaries in the money market are:

  • banks;
  • professional stock market participants:
    • brokers;
    • dealers;
    • management companies;
  • other financial and credit institutions.

Institutional structure of the money market

The institutional structure of the money market is shown in the figure below and includes 2 main sectors:

  1. direct financing sector;
  2. sector of indirect financing.
Institutional structure of the money market
Institutional structure of the money market

In the direct finance sector, money buyers and sellers interact directly with each other. The brokers working here perform rather the technical role of ordinary intermediaries. There are two channels of cash flow in this sector:

  1. capital (equity) financing channel;
  2. a channel for borrowing through bonds and other financial instruments.

The subjects (buyers and sellers) of this sector can be enterprises and organizations, individuals, the state, foreign legal entities and individuals. Banks can also take an active part here – as sellers and buyers of their securities and as ordinary intermediaries – brokers.

In the sector of indirect financing, the connection between sellers and buyers of money is carried out through financial intermediaries, who first accumulate resources offered in the market and then sell them to buyers on their own behalf. Using various instruments of the money market, such intermediaries can independently form supply and demand in the money market. This is precisely why financial intermediaries in the second sector of the money market differ significantly from technical intermediaries in the first sector.

Economic structure of the money market

Depending on the purpose of funds circulating in the money market, two sectors can be distinguished: the money market and the capital market. The money market sells and buys short-term funds (up to 1 year), while the capital market sells medium and long-term funds (more than 1 year) (see Figure).

Economic structure of the money market
Economic structure of the money market

In turn, the money market is divided into a market for short-term bank loans, which satisfies short-term needs for financial resources; market of short-term financial assets and foreign exchange market. It should be noted that the movement of money in the money market is determined by the difference in levels of income and risk, and financial assets operating in the money market are usually liquid and low risk.

The foreign exchange market serves the international payment turnover associated with the payment of monetary obligations of legal and physical obligations of different countries. The specificity of international settlements lies in the absence of a means of payment generally accepted for all countries. Therefore, a necessary means of calculation in foreign trade in goods and services, in interstate payments is the exchange of one currency for another in the form of buying or selling foreign currency. Thus, the foreign exchange markets are the official centers where the purchase and sale of currencies is carried out on the basis of supply and demand.

The capital market acts as a source of long-term investment resources for the government, banks, enterprises and is divided into the securities market and the market for medium and long-term bank loans.

The securities market (medium and long-term) is, first of all, bonds, government treasury bonds, bills of exchange on the one hand, and on the other, all types of shares and their derivatives – options, futures and other similar securities.

The securities market is divided into primary and secondary markets, as well as national and international. The primary market appears at the time of the issue of securities, and financial resources are mobilized on it. In the secondary market, these financial resources are redistributed. In the presence of a viable secondary market, liquidity of financial instruments is achieved, that is, if in the future the buyer needs to sell a security, he will be able to sell it as soon as possible without significant loss of value in the process of such a sale.

The secondary market, in turn, is subdivided into exchange and over-the-counter. At the latter, the purchase and sale of securities takes place, which for some reason are not quoted on the stock exchange (for example, through banks).

Money market instruments

The instruments (objects) of the money market are:

  1. Various short-term securities:
    • bonds;
    • treasury (government) bills;
    • municipal bills (urban, rural, settlement);
    • commercial bills (legal entities);
    • bank bills;
    • accepted bank checks;
    • commercial papers (notes);
    • certificates of deposit;
    • savings certificates;
    • other securities.
  2. Short-term loans:
    • interbank loans;
    • commercial and other loans.
  3. REPO transactions – the sale of securities with a buyback condition.

A feature of money market instruments is a low level of financial risk.

Money market functions

The main function of the money market is to balance the supply and demand of money and to form the market level of interest as the price of money.

Also, the money market performs a redistributive function, which consists in the redistribution of monetary resources between sellers and buyers. In this case, the buyer s task is to more efficiently invest (use) the borrowed resources in order to obtain additional income in excess of the payment for such resources. In turn, the buyer, using various instruments of the money market, can choose an acceptable level of profitability and liquidity of investments.

Post Author: Rachel Reinbauer

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