This chapter has presented, first of all, a broad overview of one of the most important components of any financial system, the money market. The chapter then explores the roles played by governments and security dealers in keeping the money market functioning efficiently.

• Money markets are defined as the collection of institutions and trading relationships that move short-term funds from lenders to borrowers and back again. All money market loans have an original maturity of one year or less. Thus, money market transactions typically consist of credit flows from lenders and borrowers that last for only hours, days, weeks, or months, unlike the capital markets, where credit transactions may cover many years.



• Most loans extended in the money market are designed to provide short-term working capital to businesses and governments so they can purchase inventories, pay dividends and taxes, and deal with other immediate needs for cash. Their short-term cash needs arise from the fact that inflows and outflows of cash are not perfectly synchronized. In the real world, even with the best planning available, temporary cash deficits and temporary cash surpluses are more often the rule rather than the exception.



• Money market investors are typically extremely conservative when it comes to placing their savings in financial instruments. They usually will accept little or no risk of borrower default, prefer financial instruments whose prices are stable, and usually require an investment from which their funds can be recaptured quickly (i.e., they prefer assets with high liquidity and marketability). The market’s great sensitivity to risk helps explain why money market interest rates are among the lowest interest rates in the financial system.



• One of the most important of all institutions active in the money market is government, which sets the rules by which the money market operates and typically is among the largest of all money market borrowers. Indeed, the market for government securities sets the tone for the whole financial system in terms of interest rates, security prices, and the availability of credit to both governments and private borrowers. It is an indispensable tool for the government to finance its large volume of debt, and interest rates on government securities serve as reference rates for thousands of private loan contracts.



• Moreover, money market investors all over the globe rely upon government securities as a safe haven for their cash reserves. This is especially true of Treasury bills, which are direct government debt obligations with an original maturity of a year or less. And it is in this same market today that most government economic policy changes begin.



• At the heart of the government security market are security dealers that actively make markets for a broad range of government, agency, and private security issues. These dealers actively raise funds to support their purchases of government and other securities from their customers. Among their most important funds sources are demand loans from banks and other lenders and repurchase agreements negotiated with financial and nonfinancial corporations. Demand loans can be canceled at any time by the borrower or the lender and carry daily posted interest rates. Repurchase agreements are collateralized loans, using high-quality securities (especially government IOUs) as collateral.