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Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace, 8/e

Peter Rose, Texas A & M University

Money Market Instruments: Commercial Paper, Federal Agency Securities, Acceptances, and Eurocurrency Deposits

Chapter Summary

This chapter has focused upon four widely known financial instruments traded in domestic and global money markets. These key instruments are commercial paper, federal agency securities, bankers’ acceptances, and Eurocurrency deposits.

The commercial paper market has grown rapidly in recent years as major industrial corporations and financial-service companies, facing rapidly advancing demands for their products and services, have turned increasingly to the open market for the capital they require. They have seen in the commercial paper market a relatively low cost and flexible vehicle for raising short-term cash.
Commercial paper has offered several distinct advantages over other sources of corporate funds, including ready access to new funds, lower interest rates than on most other sources of capital, and providing leverage to use against other lenders of funds when seeking new financing. Aborrowing company that can tap the paper market for funding can always threaten to go to that market if a lending institution refuses to make a loan on reasonable terms. However, the paper market has some disadvantages as well, being highly volatile at times with a scarce supply of available credit.
Nearly matching the rapid growth of the commercial paper market has been the market for the IOUs issued by federal agencies, such as the Federal National Mortgage Association or the Farm Credit System. These agencies, either owned or sponsored by the federal government, were set up to provide credit or help develop a market for loans to disadvantaged sectors of the economy, such as farms and ranches, new home buyers, and small businesses.
Federal and government-sponsored agencies act like financial intermediaries, borrowing and lending funds at the same time. They rely upon the government’s implied or expressed guarantee to give them an advantage in the competition for funds, lowering their cost of financing. With the government’s implicit or explicit backing these agencies issue securities almost as attractive as government securities to most investors, but with slightly higher yields than are available on direct government obligations.
Bankers’ acceptances are time drafts drawn against a bank. The accepting bank pledges payment upon a specific date in the future. Widely used for many years to fund exports and imports of goods in international markets, the volume of acceptances has recently been declining as other financial instruments have moved in to take over the same role. Moreover, information flows between countries are much more ample today, reducing some of the risk of foreign trade that acceptances were designed originally to deal with.
Eurocurrency deposits consist of bank time deposits denominated in a currency other than the currency of the country where the bank accepting these deposits is located. Thus, a deposit of U.S. dollars in Great Britain is a Eurodollar deposit. They are not immediately spendable funds but constitute a reservoir of liquidity that can be used as a basis for expanding the volume of credit available within the international financial system.
Among the most important sources of Eurocurrency deposits are tourist travel, balance-of- payments deficits with other nations, and investments made overseas. Banks also use Eurocurrency deposits to help supply liquid reserves they need for lending or for raising new funds.

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