Financial Markets and Institutions (2-downloads)

Ceiling Rate on Savings Deposits

at Commercial Banks

3-Month Treasury Bill Rate

0

2

4

6

8

10

12

14

16

F I G U R E   1 1 . 1

3-Month Treasury Bill Rate and Ceiling Rate on Savings Deposits at

Commercial Banks

Source:

http://www.stlouisfed.org/default.cfm

.

---

Chapter 11 The Money Markets

257

brokerage firms. These new investors caused the money markets to grow rapidly.

Commercial bank interest rate ceilings were removed in March of 1986, but by then

the retail money markets were well established.

Banks continue to provide valuable intermediation, as we will see in several later

chapters. In some situations, however, the cost structure of the banking industry

makes it unable to compete effectively in the market for short-term funds against the

less restricted money markets.

The Purpose of the Money Markets

The well-developed secondary market for money market instruments makes the

money market an ideal place for a firm or financial institution to “warehouse” surplus

funds until they are needed. Similarly, the money markets provide a low-cost source

of funds to firms, the government, and intermediaries that need a short-term infu-

sion of funds.

Most investors in the money market who are temporarily warehousing funds

are ordinarily not trying to earn unusually high returns on their money market funds.

Rather, they use the money market as an interim investment that provides a higher

return than holding cash or money in banks. They may feel that market conditions

are not right to warrant the purchase of additional stock, or they may expect inter-

est rates to rise and hence not want to purchase bonds. It is important to keep in mind

that holding idle surplus cash is expensive for an investor because cash balances earn

no income for the owner. Idle cash represents an opportunity cost in terms of lost

interest income. Recall from Chapter 4 that an asset’s opportunity cost is the amount

of interest sacrificed by not holding an alternative asset. The money markets provide

a means to invest idle funds and to reduce this opportunity cost.

Investment advisers often hold some funds in the money market so that they will

be able to act quickly to take advantage of investment opportunities they identify.

Most investment funds and financial intermediaries also hold money market securi-

ties to meet investment or deposit outflows.

The sellers of money market securities find that the money market provides a low-

cost source of temporary funds. Table 11.1 shows the interest rates available on a vari-

ety of money market instruments sold by a variety of firms and institutions. For

example, banks may issue federal funds (we will define the money market securities

TA B L E   1 1 . 1

Sample Money Market Rates, April 8, 2010