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 Who issues them and why? How often are they issued? 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? Types of Money Market Funds 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 value (the NAV remains unchanged when income in the fund is accrued daily) Can also have a fluctuating NAV Must have a fluctuating net asset value

Money Market Funds Risks Regulations 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 Advantages Disadvantages Low risk – the nominal is preserved Only suitable for short-term investing Useful during times of uncertainty Over the medium- to long-term, the money markets have under-performed many other investment types 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. Professional market – only accessible to private investors through money market funds or money market accounts