Money Markets, Short-Term Instruments and Funding
Money markets cover instruments of one year or less: treasury bills, interbank placements and deposits, repos, commercial paper, certificates of deposit and short-dated FX swaps used for funding. The exam tests instrument mechanics, quoting conventions and whether you can compare two short-term offers on a genuinely common basis.
Instruments and conventions
A treasury bill is issued at a discount and redeemed at face value; the quoted discount rate is not the investor's return. Repo is borrowing cash against securities sold with an agreement to repurchase - the cash taker initiates repo; the cash lender does reverse repo. Interbank deposits quote an add-on yield on the amount placed. Central bank operations set the policy corridor: a floor rate on standing deposit facilities and a ceiling on standing lending facilities, with open market operations steering the interbank rate inside it. Corporate paper and CDs add credit and liquidity risk that a sovereign bill does not.
Worked example
A treasurer has 500m for 91 days. Option A is a 91-day T-bill quoted at a 6.00% discount rate. Option B is a bank CD at 6.40% add-on. Convert both to holding-period return. T-bill price = 100 × (1 − 0.06 × 91/365) = 98.504, so return = 1.496/98.504 = 1.519% over 91 days. The CD pays 6.40% × 91/365 = 1.595%. The CD wins on yield, but only 11bp of extra credit exposure to one bank; check the counterparty limit before switching. Never compare the 6.00% discount quote directly with the 6.40% add-on quote.
Traps that cost marks
Comparing discount and add-on yields; mixing 360-day and 365-day bases; ignoring withholding tax on interest income, which narrows the gap; reversing repo and reverse repo; treating interbank placement and T-bill as equal credit risk; overlooking settlement and collateral mechanics in repo.