The money markets have been active since the early 1800s but have become much more important...

The money markets have been active since the early 1800s but have become much more important since 1970, when interest rates rose above historic levels. In fact, the rise in short- term rates, coupled with a regulated ceiling on the rate that banks could pay for deposits, resulted in a rapid outflow of funds from financial institutions in the late 1970s and early 1980s. This outflow in turn caused many banks and savings and loans to fail. The industry regained its health only after massive changes were made to bank regulations with regard to money market interest rates.

a) Define the characteristics of the money markets.

b) Explain TWO (2) reasons why businesses use the money markets.

c) Describe TWO (2) purpose of money markets.

Expert Solution

Like any other operating market, there exist two interested parties and involves an commodity. In Money Market those parties are termed as borrower and lender, commodity involved is Money itself. Hence characterstics of money market can be said to have interested borrower, lenders and money Instrument. Apart from these characterstics, another more important characterstics of money market is its liquidity. Every transaction in Money market can be tailor made according to the needs of interested parties.

Business often use money markets for the following reasons,

1. To Fill the short term liquidity mismatch. Business can borrow funds from money market at competitive rates which is suitable for their needs

2. To park excessive funds to earn an incentive.

The basic purpose of Market is to facilitate short term borrowing which can range from overnight borrowing to upto 1 year. Hence the two purpose of Money markets can be summarised as

1. To Facilitate Central bankers to manage the liquidity in the markets. For e.g if there is excessive liquidity in circulation, Central bankers can issue treasury bills to reduce the availability of Money in the market. This will also help the Central bankers to manage inflation

2. To Facilitate easy access to the business to manage their working capital needs.

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