Abstract
We first describe the market practices regarding interest rates and the valuation of money market instruments, then the main instruments traded on the money market: short-term marketable securities, “repos” (repurchase agreements), and other transactions. Another section covers the market participants and provides the orders of magnitude regarding the volumes of transactions. We then study the interbank market and the Central Bank’s interventions and their role in setting interest rates. Lastly, we define the main references (or indices) for money-market rates.
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Notes
- 1.
Even if there are some instruments using variable rates and indexed bonds, as we will see in Chap. 4.
- 2.
The term “securitization” is above all used to describe more complex arrangements involving the issuing of new securities by an ad hoc entity (a Special Purpose Vehicle) backed by pre-existing assets. Such arrangements are studied in detail in Chap. 29.
- 3.
Belgium is an exception, where a basis of 365 is in use.
- 4.
Note that for interests in advance, FT equals the face value: using the money market yield to calculate the amount of advance interests therefore comes down to calculating this amount with a bank discount rate (see Chap. 2) equal to \( \frac{r}{1+ rT} \) (less than r). The practice of using money market yields is common on the European money market and differs from using a bank discount rate (see Chap. 2).
- 5.
It should be noted that \( 990.10\kern0.5em \text{\EUR} =\frac{006}{1+0.06\times \frac{60}{360}}100,00\times \frac{60}{360} \), so that the bank discount rate is \( \frac{006}{1+0.06\times \frac{60}{360}}=5.94\% \).
- 6.
The 365-day basis assumes that the year is 365 days long, even when it is a leap year and, in this respect, is slightly different from the actual basis used in most bond markets.
- 7.
In particular because in many countries they are considered as bank deposits and insured as such.
- 8.
The issuer pays a commission to the bank that guarantees the note, which benefits from a smaller interest rate because of the guarantee that decreases its risk.
- 9.
Plus the transfer by B of any possible remuneration paid by x from 0 to T (see below). The fee rate is in fact very different according to whether the security is rare, thus in demand, or not. The indicated spread of 15 to 20 bips pro rata temporis corresponds to a standard situation. It should also be noted that the fee effectively paid by the borrower varies over time since it is computed as the product of the fixed interest rate (pro rata temporis) by the variable market value of the security lent.
- 10.
For example, in London, the most active on the Euro Commercial Paper market are Citigroup, JP Morgan, Deutsche Bank, Goldman Sachs, Morgan Stanley, HSBC, among others.
- 11.
Payments are carried out through an intermediary system, such as TARGET in Europe.
- 12.
For example, a payment system called TARGET (Trans-European Automated Real-time Gross-settlement Express Transfer) was introduced with the Euro. This system allows nearly immediate settlements, with maximum security and carries out as many national settlements as it does international. It is mainly for interbank transactions but is also used by nonbank agents.
- 13.
The explanations of stages 1 and 2 of this process found in macroeconomic textbooks (adjustments in r and y in the Keynesian model) are based on a graphical presentation of Eq. (3.3) above (the so called LM curve) and the market equilibrium condition for goods (the IS curve).
- 14.
A reduction in M would produce, ignoring asymmetries that can be important in some cases but whose analysis is outside the scope of this book, the opposite consequences.
- 15.
One recovers therefore the framework of the standard neo-classical model with fixed y and variable P.
- 16.
See later chapters.
- 17.
Also used are purchases and sales of securities (negotiable debt securities, debt certificates), unsecured loans, etc.
- 18.
Other open market interventions, such as longer-term funding (intended to provide liquidity, carried out monthly and with a maturity of 3 months) or “fine-tuning” operations, are also implemented by the ESCB.
- 19.
Only specific securities can be refunded by the Central Bank (they are said to be “eligible”). The ECB and the Fed have substantially lengthened the list of eligible securities to make funding of financially distressed banks easier and to restore trust in sovereign debts issued by some States by making them eligible. For instance, the Fed did it intensively when implementing its Quantitative Easing (QE) policy after the collapse of Lehman Brothers in 2008 and the ensuing financial crisis. This very capacity of Central Banks to alter the list of eligible securities is a powerful instrument of monetary policy.
- 20.
The Euro-LIBOR reflects, as does the EURIBOR, the rates offered in transactions denominated in euros. In contrast to the EURIBOR, it is computed from a panel containing banks outside the Eurozone (mainly British). The differences in value between the EURIBOR and the Euro-LIBOR are very slight (a few bips).
- 21.
The substitutes may be grounded on the new overnight rates compounded (for backward-looking indices, see Sect. 3.5.2 below) or on the term structure implicit in OIS swaps or other liquid derivatives (for forward-looking indices).
- 22.
For a “roll over” of 24 hour transactions, the first 4 days of the week, and for 3 days on Friday.
- 23.
Simple overnight averages are also in use but are less meaningful that compound overnight rates because they are not exactly replicable by a rollover of actual transactions. They may be an acceptable approximation for the compound overnight rates over periods of short duration.
- 24.
The money market is frequently treated along with the bond market, and is often explained in basic texts on interest rates. For example:
Suggestions for Further Reading
The money market is frequently treated along with the bond market, and is often explained in basic texts on interest rates. For example:
Fabozzi, F. (2006). Fixed income mathematics: Analytical and statistical techniques (4th ed.). McGraw-Hill Education.
Fabozzi, F. (2016). Bond markets analysis and strategies (9th ed.).
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Poncet, P., Portait, R. (2022). The Money Market and Its Interbank Segment. In: Capital Market Finance. Springer Texts in Business and Economics. Springer, Cham. https://doi.org/10.1007/978-3-030-84600-8_3
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