Interconnectedness of money market

One of the important components of the international financial markets is the money market.

Money Market is concerned with the issue and trading of securities with short-term maturities or quasi-money instruments. The Instruments traded in the money market are Treasury Bills, Certificates of Deposits (CDs), Commercial Paper (CPs), Bills of Exchange, and other such instruments of short-term maturities.

The interconnectedness of the money market:

The money market and capital market are closely interrelated because most corporations and financial institutions are active in both. Firms may borrow funds from the money market for a short period or a loan period from the capital market.

All long-term securities become short-term instruments at the time of maturity. So some capital market instruments also become money market instruments. Funds flow back and forth between the two markets whenever the treasury finances maturing bills with treasury securities.

Yields in the money market are also connected to those of the capital market. A fall in the short-term interest rates in the money market is likely to be followed or accompanied by a more moderate fall in the long-term interest rates in the capital market. However, money market interest rates are more sensitive than long-term interest rates in the capital market.

The vast majority of global finance is intermediated by a few large complex financial institutions (LCFIs), operating out of a small set of countries that serve as global common lenders and borrowers. The LCFIs dominate the markets for debt, equity securities, syndicated loans, securitization, structured financial products, and OTC derivatives. These LCFIs administer structured investment vehicles (SIVs) and attempt to profit from the spread between short-term debt and long-term investments by issuing commercial papers of varying maturities. They use leverage, by reissuing commercial paper, to repay maturing long-term debt coordinated by asset allocation (and, more generally, ALM) strategies and counterparties.

As these lender countries form the core of cross-border financial flows and connect countries. The transmission of shocks and the spillover of policies and financial conditions occur largely through these core economies. While a direct relationship may not be apparent, it’s the ripple effects from a small market disruption that can transcend into different asset classes and financial markets that can trigger larger risk events leading to systemic risk affecting all economies.

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