Info

Commercial paper

1,539.0

Savings deposits

1,852.6

Money market mutual funds

1,657.1

*Small denominations are less than $100,000.

*Large denominations are greater than or equal to $100,000.

Source: Economic Report of the President, U.S. Government Printing Office, 2001; and Flow of Funds Accounts: Flows and Outstandings, Board of Governors of the Federal Reserve System, June 2000.

fixed term of the CD. CDs issued in denominations larger than $100,000 are usually negotiable, however; that is, they can be sold to another investor if the owner needs to cash in the certificate before its maturity date. Short-term CDs are highly marketable, although the market significantly thins out for maturities of three months or more. CDs are treated as bank deposits by the Federal Deposit Insurance Corporation, so they are insured for up to $100,000 in the event of a bank insolvency.

Commercial Paper commercial paper

Short-term unsecured debt issued by large corporations.

The typical corporation is a net borrower of both long-term funds (for capital investments) and short-term funds (for working capital). Large, well-known companies often issue their own short-term unsecured debt notes directly to the public, rather than borrowing from banks. These notes are called commercial paper (CP). Sometimes, CP is backed by a bank line of credit, which gives the borrower access to cash that can be used if needed to pay off the paper at maturity.

CP maturities range up to 270 days; longer maturities require registration with the Securities and Exchange Commission and so are almost never issued. CP most commonly is issued with maturities of less than one or two months in denominations of multiples of $100,000. Therefore, small investors can invest in commercial paper only indirectly, through money market mutual funds.

CP is considered to be a fairly safe asset, given that a firm's condition presumably can be monitored and predicted over a term as short as one month. It is worth noting, though, that many firms issue commercial paper intending to roll it over at maturity, that is, issue new paper to obtain the funds necessary to retire the old paper. If lenders become complacent about monitoring a firm's prospects and grant rollovers willy-nilly, they can suffer big losses. When Penn Central defaulted in 1970, it had $82 million of commercial paper outstanding—the only major default on commercial paper in the past 40 years.

CP trades in secondary markets and so is quite liquid. Most issues are rated by at least one agency such as Standard & Poor's. The yield on CP depends on the time to maturity and the credit rating.

Bankers' Acceptances bankers' acceptance

An order to a bank by a customer to pay a sum of money at a future date.

A bankers' acceptance starts as an order to a bank by a bank's customer to pay a sum of money at a future date, typically within six months. At this stage, it is like a postdated check. When the bank endorses the order for payment as "accepted," it assumes responsibility for ultimate payment to the holder of the acceptance. At this point, the acceptance may be traded in secondary markets much like any other claim on the bank. Bankers' acceptances are considered very safe assets, as they allow traders to substitute the bank's credit standing for their own. They are used widely in foreign trade where the creditworthiness of one trader is unknown to the trading partner. Acceptances sell at a discount from the face value of the payment order, just as T-bills sell at a discount from par value.

Eurodollars

Dollar-denominated deposits at foreign banks or foreign branches of American banks.

Eurodollars

Eurodollars are dollar-denominated deposits at foreign banks or foreign branches of American banks. By locating outside the United States, these banks escape regulation by the Federal Reserve Board. Despite the tag "Euro," these accounts need not be in European banks, although that is where the practice of accepting dollar-denominated deposits outside the United States began.

Most Eurodollar deposits are for large sums, and most are time deposits of less than six months' maturity. A variation on the Eurodollar time deposit is the Eurodollar certificate of deposit. A Eurodollar CD resembles a domestic bank CD except it is the liability of a non-U.S. branch of a bank, typically a London branch. The advantage of Eurodollar CDs over Eurodollar time deposits is that the holder can sell the asset to realize its cash value before maturity. Eurodollar CDs are considered less liquid and riskier than domestic CDs, however, and so offer higher yields. Firms also issue Eurodollar bonds, that is, dollar-denominated bonds outside the U.S., although such bonds are not a money market investment by virtue of their long maturities.

Repos and Reverses

Dealers in government securities use repurchase agreements, also called repos, or RPs, as a form of short-term, usually overnight, borrowing. The dealer sells securities to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price. The increase in the price is the overnight interest. The dealer thus takes out a one-day loan from the investor. The securities serve as collateral for the loan.

A term repo is essentially an identical transaction, except the term of the implicit loan can be 30 days or more. Repos are considered very safe in terms of credit risk because the loans are backed by the government securities. A reverse repo is the mirror image of a repo. Here, the dealer finds an investor holding government securities and buys them with an agreement to resell them at a specified higher price on a future date.

repurchase agreements (repos)

Short-term sales of government securities with an agreement to repurchase the securities at a higher price.

Brokers' Calls

Individuals who buy stocks on margin borrow part of the funds to pay for the stocks from their broker. The broker in turn may borrow the funds from a bank, agreeing to repay the bank immediately (on call) if the bank requests it. The rate paid on such loans is usually about one percentage point higher than the rate on short-term T-bills.

Federal Funds

Just as most of us maintain deposits at banks, banks maintain deposits of their own at the Federal Reserve Bank, or the Fed. Each member bank of the Federal Reserve System is required to maintain a minimum balance in a reserve account with the Fed. The required balance depends on the total deposits of the bank's customers. Funds in the bank's reserve account are called Federal funds or Fed funds. At any time, some banks have more funds than required at the Fed. Other banks, primarily big New York and other financial center banks, tend to have a shortage of Federal funds. In the Federal funds market, banks with excess funds lend to those with a shortage. These loans, which are usually overnight transactions, are arranged at a rate of interest called the Federal funds rate.

While the Fed funds rate is not directly relevant to investors, it is used as one of the barometers of the money market and so is widely watched by them.

Federal funds

Funds in the accounts of commercial banks at the Federal Reserve Bank.

The LIBOR Market

The London Interbank Offer Rate (LIBOR) is the rate at which large banks in London are willing to lend money among themselves. This rate has become the premier short-term interest rate quoted in the European money market and serves as a reference rate for a wide range of transactions. A corporation might borrow at a rate equal to LIBOR plus two percentage points, for example. Like the Fed funds rate, LIBOR is a statistic widely followed by investors.

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