Characteristics of Money Market

In the previous article, we have already learned that the money market is a market for assets that can act as close substitutes for cash. Most of the assets sold here have a very short maturity and the purpose of this market is to ensure that people who have excess cash can connect with people who require cash in the short run.

We also know that each country has its own money market. However, it is important to know that even though these markets may be geographically different from one another, they share certain fundamental characteristics. These characteristics have been explained below in this article.

1. Diverse: It is important to realize that multiple types of financial instruments are traded in the money market. There are incidents that have a maturity of one day as well as instruments that have the maturity of one year. Also, some instruments are extensively used by banks, some by governments, and some others by corporate entities.

   The money market is the sum total of all these diverse instruments which have a different risk-return profile but share the common characteristic that the money being borrowed is short-term in nature.

2. Wholesale Market: Another important thing to note about the money market is that it is a wholesale market. This means that there are no retail participants in the money market.

   Retail investors can participate in money markets via money market funds which consolidate money from various retail investors and transact in wholesale. This is important to note since it means that retail investors cannot access this market on their own.

3. Very Large Size: Money markets tend to be very large in size. This means that transactions of huge sizes are easily absorbed in the market without causing any structural changes.

   For instance, consider the fact that banks and mega-corporations routinely use money markets to borrow and lend funds. Sometimes, the quantum of funds being transacted is huge. However, these huge transactions are easily absorbed by the market. This is an important characteristic of money markets since it provides flexibility to both borrowers as well as lenders.

4. Liquid: Money markets are one of the most liquid markets in the investing world.

   The short-term nature of instruments means that investors use this market to park their discretionary funds. It is possible that the investors may want to use their discretionary funds to make other investments at any moment. This is the reason that the market needs to be liquid.

   Fortunately, since there are so many players in the money market, whenever an investor wants to sell their investment, they are easily able to find a buyer. This means that the time taken to complete the transaction is very less and there is absolutely no loss of value. It is for this reason that money market instruments are often referred to as cash equivalents.

5. Determines Interest Rates: A very important characteristic of money markets is that it is an important determinant of interest rates in the overall economy.

   The money market has other smaller markets such as the interbank market. The interest rates derived from this market based on the demand and supply of money in the money market become an important determinant for the overall interest rates in the economy as well as the derivatives market.

   Hence, money markets are by no way trivial. Changes in the money market can prove to be the undercurrents that end up causing massive changes in the main economic system.

6. Free Market: It is important to note that money markets across the world are largely free. This means that the degree of regulation in such markets is limited given their size and scale.

   The only real intervention by any government authority is in the form of rare central bank intervention in the money markets. Also, it needs to be noted that participants can freely enter and exit the market at any time.

   In most countries, the taxation levied on such markets is also low. This is because levying excess taxes would mean disrupting the pace of short-term transactions in the economy.

7. Unorganized: The money markets are largely unorganized. This means that there is no particular building or even an association of traders which form the money market.

   Instead, the money market is an amorphous body of investors and issuers which keeps changing from time to time. Based on the regulations of the country, international participants may also be allowed to invest in the money market.

   Also, it is important to note that most of the transactions in the money market do not happen using terminals or an organized system. Instead, a large number of transactions happen over the counter. As a result, data related to these transactions are not easily available making this market one of the opaquest financial markets in the world.

The bottom line is that money markets all over the world share some characteristic features. These features influence the manner in which the money market functions. Hence, it is important for an investor to be aware of these features as well as their implications.