The need for money markets arises because receipts of economic units do not coincide with their expenditures. These units can hold money balances — that is, transactions balances in the form of currency, demand deposits, or NOW accounts — to insure that planned expenditures can be maintained independently of cash receipts.

Holding these balances, however, involves a cost in the form of foregone interest. To minimize this cost, economic units usually seek to hold the minimum money balances required for day-to-day transactions.

They supplement these balances with holdings of money market instruments that can be converted to cash quickly and at a relatively low cost and that have low price risk due to their short maturities.

Economic units can also meet their short-term cash demands by maintaining access to the money market and raising funds there when required.

In the money markets, banks lend to and borrow from each other, short-term financial instruments such as certificates of deposits (CDs) or enter into agreements such as repurchase agreements (repos).

Money markets provide short to medium term liquidity in the global financial system.

Trading takes place between banks in the "money centers" (New York and London primarily, also Chicago, Frankfurt, Paris, Singapore, Hong Kong, Tokyo, Toronto, Sydney, San Francisco).

Money market instruments are generally characterized by a high degree of safety of principal and are most commonly issued in units of $1 million or more.

Common Money Market Instruments:

Bankers' Acceptance:

A draft or bill of exchange accepted by a bank to guarantee payment of the bill.

Certificate of Deposit:

A time deposit with a specific maturity date shown on a certificate; large-denomination certificates of deposits can be sold before maturity.

Commercial Paper:

An unsecured promissory note with a fixed maturity of 1 to 270 days; usually it is sold at a discount from face value.

Eurodollar Deposit:

Deposits made in U.S. dollars at a bank or bank branch located outside the United States.

Federal Funds (in the US):

Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.

Municipal Notes (in the US):

Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.

Repurchase Agreements:

Short-term loans -- normally for less than two weeks and frequently for one day -- arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.

Treasury Bills:

Short-term debt obligations of a national government that are issued to mature in 3 to 12 months.