Introduction to Finance

repurchase agreement
is a short-term debt security sold by a business fi rm or fi n-
ancial institution to another business or institution, where the seller agrees to repurchase the 
security at a specifi ed price and date. Repurchase agreements may be as short as one day 
or involve several months. Most repurchase agreements utilize Treasury bills but may also 
include commercial paper or negotiable certifi cates of deposit. 
Brokers and dealers, through an electronic network, facilitate the bringing together of 
organizations with excess funds and those in need of funds. Since cash receipts relative to 
cash expenditures can change almost daily for business fi rms, a fi rm might be a seller of a 
repurchase agreement at one time and a buyer of a repurchase agreement at another time. No 
secondary market exists for repurchase agreements. 
Federal funds
are very short-term loans, usually with maturities of one day to one week 
made between depository institutions. For example, a commercial bank with excess funds may 
make a short-term loan to another depository institution with a shortage of funds. The interest 
rate on federal funds is determined by supply and demand for very short-term loans by banks. 
The Federal Reserve, as we will see in Chapters 4 and 5, can directly infl uence the federal 
funds rate as it carries out monetary policy.
Federal funds brokers bring together banks who want to purchase federal funds with those 
who want to sell funds. Transactions typically start at $5 million, with the interbank loan 
volume being in the billions of dollars. There is no secondary market for federal funds due 
to their extremely short maturities. A one day or overnight loan is highly liquid. While there 
is some credit risk concerning the ability of the borrowing depository institution to repay the 
loan, very short maturities also mitigate such risk.
2.7
Measures of the U.S. Money Supply
Now that we have a basic understanding how money developed in the United States, it is 
time to examine how the money supply or “stock” is measured today. Since we are trying 
to “count” the money supply in the fi nancial system as of a point in time, this can also be 
viewed as the amount of money stock on a particular date. We will start with a narrow 
defi nition of the money supply referred to as M1 and then consider M2, which is a broader 
defi nition. 
M1 Money Supply
As noted, the basic function of money is that it must be acceptable as a medium of exchange. 
The M1 defi nition of the money supply includes only types of money that meet this basic func-
tion. More specifi cally, the 
M1 money supply
consists of currency, traveler’s checks, demand 
deposits, and other checkable deposits at depository institutions. For December, 2015, the 
Fed reported the not-seasonally adjusted M1 and its four components, as follows (see: www.
federalreserve.gov/releases/h6/current).