Financial Markets and Institutions (2-downloads)

www.

pearsonhighered.com/mishkin_eakins

).

Insurance Companies

Property and casualty insurance companies must maintain

liquidity because of their unpredictable need for funds. When four hurricanes hit Florida

in 2004, for example, insurance companies paid out billions of dollars in benefits to 

policyholders. To meet this demand for funds, the insurance companies sold some of

their money market securities to raise cash. In 2010 the insurance industry held about

the same amount of treasury securities as did commercial banks ($196 billion versus

$199 billion). Insurance companies are discussed in Chapter 21.

Pension Funds

Pension funds invest a portion of their cash in the money markets so

that they can take advantage of investment opportunities that they may identify in

the stock or bond markets. Like insurance companies, pension funds must have suf-

ficient liquidity to meet their obligations. However, because their obligations are

reasonably predictable, large money market security holdings are unnecessary.

Pension funds are discussed in Chapter 21

Individuals

When inflation rose in the late 1970s, the interest rates that banks were offering on

deposits became unattractive to individual investors. At this same time, brokerage

houses began promoting money market mutual funds, which paid much higher rates.

Banks could not stop large amounts of cash from moving out to mutual funds

because regulations capped the rate they could pay on deposits. To combat this flight

of money from banks, the authorities revised the regulations. Banks quickly raised

rates in an attempt to recapture individual investors’ dollars. This halted the rapid

movement of funds, but money market mutual funds remain a popular individual

investment option. The advantage of mutual funds is that they give investors with rel-

atively small amounts of cash access to large-denomination securities. We will dis-

cuss money market mutual funds in more depth in Chapter 20

Money Market Instruments

A variety of money market instruments are available to meet the diverse needs of

market participants. One security will be perfect for one investor; a different secu-

rity may be best for another. In this section we gain a greater understanding of money

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Chapter 11 The Money Markets

261

market security characteristics and how money market participants use them to man-

age their cash.

Treasury Bills

To finance the national debt, the U.S. Treasury Department issues a variety of debt

securities. The most widely held and most liquid security is the Treasury bill. Treasury

bills are sold with 28, 91, and 182-day maturities. The Treasury bill had a minimum

denomination of $1,000 until 2008, at which time new $100 denominations became

available. The Fed has set up a direct purchase option that individuals may use to

purchase Treasury bills over the Internet. First available in September 1998, this

method of buying securities represented an effort to make Treasury securities more

widely available.

The government does not actually pay interest on Treasury bills. Instead, they

are issued at a discount from par (their value at maturity). The investor’s yield comes

from the increase in the value of the security between the time it was purchased

and the time it matures.

C A S E