Financial markets take many different forms and

operate in diverse ways. But all of them, whether highly organized, like the
London Stock Exchange, or highly informal, like the money changers on the
street corners of many African capitals, serve the same basic functions.

Mutual funds
The fastest-growing institutional investors are investment companies, which
combine the investments of a number of individuals with the aim of
achieving particular financial goals in an efficient way. Mutual funds and unit
trusts are investment companies that typically accept an un limited number
of individual investments. The fund declares the strategy it will pursue, and
as additional money is invested the fund managers purchase financial
instruments appropriate to that strategy. Investment trusts, some of which
are known in the United States as closed-end funds, issue a limited number
of shares to investors at the time they are established and use the proceeds
to purchase financial instruments in accordance with their strategy. In some
cases, the trust acquires securities at its inception and never sells them; in
other cases, the fund changes its portfolio from time to time. Investors
wishing to enter or leave the unit trust must buy or sell the trust’s shares
from stockbrokers.

The term “money market” refers to the network of corporations, financial

institutions, investors and governments which deal with the flow of short-term
capital. When a business needs cash for a couple of months until a big payment
arrives, or when a bank wants to invest money that depositors may withdraw at any
moment, or when a government tries to meet its payroll in the face of big seasonal
fluctuations in tax receipts, the short-term liquidity transactions occur in the money
market.
What money markets do
There is no precise definition of the money markets, but the phrase is usually applied to the
buying and selling of debt instruments maturing in one year or less. The money markets are thus
related to the bond markets,
in which corporations and governments borrow and lend based on longer-term contracts. Similar
to bond investors, money-market investors are extending credit, without taking any ownership in
the borrowing
entity or any control over management. Yet the money markets serve different purposes

Investing in money markets

Short-term instruments are often unattractive to investors, because the high cost of learning
about the financial status of a borrower can outweigh the benefits of acquiring a security with a
life span of six months. For this reason, investors typically purchase money-market instruments
through funds, rather than buying individual securities directly.

Individual sweep accounts

The investment companies that operate equity funds and bond funds usually provide money-
market funds to house the cash that investors wish to keep available for immediate investment.
People with large amounts of assets often invest in money-market instruments through sweep
accounts. These are multipurpose accounts at banks or stockbrokerage firms, with the assets
used for paying current bills, investing in shares and buying mutual funds. Any uncommitted cash
is automatically “swept” into money-market funds or overnight investments at the end of each
day, in order to earn the highest possible return.

Commercial paper
Commercial paper is a short-term debt obligation of a private-sector firm or a government-
sponsored corporation. In most cases, the paper has a lifetime, or maturity, greater than 90 days
but less than nine months. This maturity is dictated by regulations. In the United States, most
new securities must be registered with the regulator, the Securities and
Exchange Commission, prior to issuance, but securities with a maturity of 270 days
or less are exempt from this requirement. Commercial paper is usually unsecured,
although a particular commercial paper issue may be secured by a specific asset of
the issuer or may be guaranteed by a bank.

Bankers’ acceptances
Before the 1980s, bankers’ acceptances were the main way for firms to raise short-
term funds in the money markets. An acceptance is a promissory note issued by a
non-financial firm to a bank in return for a loan. The bank resells the note in the
money market at a discount and guarantees payment. Acceptances usually have a
maturity of less than six months. Bankers’ acceptances differ from commercial
paper in significant ways. They are usually tied to the sale or storage of specific
goods, such as an export order for which the proceeds will be received in two or
three months. They are not issued at all by financial-industry firms. They do not
bear interest; instead, an investor purchases the acceptance at a discount from face
value and then redeems it for face value at maturity.
Investors rely on the strength of the guarantor bank, rather than of the issuing
company, for their security.

Treasury bills
Treasury bills, often referred to as t-bills, are securities with a maturity of one year
or less, issued by national governments. Treasury bills issued by a government in its
own currency are generally considered the safest of all possible investments in that
currency. Such securities account for a larger share of money-market trading than
any other type of instrument.

Time deposits
Time deposits, another name for certificates of deposit or cds, are interest- bearing
bank deposits that cannot be withdrawn without penalty before a specified date.
Although time deposits may last for as long as five years, those with terms of less
than one year compete with other money-market instruments. Deposits with terms
as brief as 30 days are common. Large time deposits are often used by
corporations, governments and money-market funds to invest cash for brief periods.
Banks
in the United States held $1.4 billion in large time deposits in 2005