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Types of Financial Instruments

Money Market Instruments (Click for more)

The major purpose of financial markets is to transfer funds from lenders to borrowers. Financial market participants commonly distinguish between the "capital market" and the "money market".  The money market  refer  to borrowing and lending for periods of a year or less.

Treasury bills (Click for more)

Treasury bills are short-term securities issued by the U.S. Treasury. The Treasury sells bills at regularly scheduled auctions to refinance maEagleTraders.comg issues.  It also helps to finance current federal deficits. They further sell bills on an irregular basis to smooth out the uneven flow of revenues from corporate and individual tax receipts.

Certificates of deposit  (Click for more)

A certificate of deposit is a document evidencing a time deposit placed with a depository institution.  The following information appears on the certificate:

  • the amount of the deposit;

  • the date on which it matures;

  • the interest rate;  and

  • the method under which the interest is calculated.

Large negotiable CDs are generally issued in denominations of $1 million or more.

Commercial Paper  (Click for more)

Commercial paper is a short-term unsecured promissory note issued by corporations and foreign governments.  It is a low-cost alternative to bank loans, for many large, credit worthy issuers.   Issuers are able to efficiently raise large amounts of funds quickly and without expensive Securities and Exchange Commission (SEC) registration.  They sell paper, either directly or through independent dealers, to a large and varied pool of institutional buyers. Investors in commercial paper earn competitive, market-determined yields in notes whose maturity and amounts can be tailored to their specific needs.

Bankers Acceptances/Letters of credit  (Click for more)

A bankers acceptance, or BA, is a time draft drawn on and accepted by a bank. Before acceptance, the draft is merely an order by the drawer to the bank to pay a specified sum of money on a specified date to a named person or to the bearer of the draft, it is not an obligation  of the bank.  Upon acceptance, which occurs when an authorized bank employee stamps the draft "accepted" and signs it, the draft becomes a primary and unconditional liability of the bank. If the bank is well known and enjoys a good reputation, the accepted draft may be readily sold in an active market.

Eurodollars  (Click for more)

Eurodollars are bank deposit liabilities denominated in U.S. dollars.  It's not subject to U.S. banking regulations. For the most part, banks offering Eurodollar deposits are located outside the United States. However, since late 1981 non-U.S. residents have been able to conduct business free of U.S. banking regulations at International Banking Facilities (IBFs) in the United States.  Individuals, corporations, or governments from anywhere in the world may own Eurodeposits.  The exception are that only non-U.S. residents can hold deposits at IBFs.

Repurchase Agreements (RPs) and Reverse RPs  (Click for more)

The terms repurchase agreement (repo or RP) and reverse repurchase agreement refer to a type of transaction in which a money market participant acquires immediately available funds by selling securities and simultaneously agreeing to repurchase the same or similar securities after a specified time at a given price, which typically includes interest at an agreed-upon rate.  A transaction viewed from the perspective of the supplier of securities (the party acquiring funds) is called a repo, and it's a reverse repo or matched sale-purchase agreement when described from the point of view of the supplier of funds.

Bank Guarantees  (Click for more)

A Guarantee by Bank (banker's guarantee) is a written undertaking wherein the bank agrees to make stipulated payments on your behalf should you fail to fulfill or carry out specified terms of a contract. Guarantees may also be issued in respect of the purchase of fixed property and against cash cover.

The bank's liability is restricted to the payment of a sum of money and under no circumstances accepts responsibility for the completion of the customer's contract.

Features

  • Guarantees may be continuing or for a specified period - wherever possible a definite or determined expiry date or a clause specifying a period of notice or withdrawal is to be included in the guarantee.

  • The party in whose favor the guarantee is issued is entitled to specify the wording of the document. (At your request the bank can draft the wording of the document.)

  • Any demands for payment under a guarantee are to be made in writing.

Benefits

  • You can avoid having to pay in advance or lodging cash cover to secure a purchase or contract thereby saving interest on your funds. If cash cover is lodged with the bank under pledge you will be paid interest on the investment.

  • Enables you to bid for contracts which call for guarantees and to purchase fixed property where a guarantee is usually a prerequisite.

Bonds  (Click for more)

A bond is a debt security, similar to an I.O.U.  You are lending money to a government, corporation, municipality, federal agency or other entity known as the issuer, when you purchase a bond.

In return for the loan, the issuer promises to repay the face value of the bond (the principal) when it "matures" or comes due and to pay you a specified rate of interest during the life of the bond.  You can choose among the following types of bonds:  U.S. government securities, corporate bonds, federal age securities, municipal bonds, mortgage and asset-backed securities and foreign government bond.

Corporate bonds  (Click for more)

Corporate bonds (also called corporates) are debt obligations, or IOUs, issued by private and public corporations. They are typically issued in multiples of $1,000 and/or $5,000. The funds raised  by companies from selling bonds are used for a variety of purposes, from building facilities to purchasing equipment to expanding the business. When you buy a bond, you are lending money to the corporation that issued it, which promises to return your money, or principal, on a specified maturity date. Until that time, it also pays you a stated rate of interest, usually semiannually. The interest payments you receive from corporate bonds are taxable. Unlike stocks, bonds do not give you an ownership interest in the issuing corporation.

 

The Money Market Instruments

Instrument

Principal Borrowers

Discount Window

Banks

Negotiable Certificates of Deposit (CDs)

Banks

Eurodollar Time Deposits and CDs

Banks

Repurchase Agreements

Securities dealers, banks, non-financial corporations, governments (principal participants)

Treasury Bills

U.S. government

Municipal Notes

State and local governments

Commercial Paper

Non-financial and financial businesses

Bankers Acceptances

Non-financial and financial businesses

Government-Sponsored Enterprise Securities

Farm Credit System, Federal Home Loan Bank System, Federal National Mortgage Association

Shares in Money Market Instruments

Money market funds, local government investment pools, short-term investment funds

Futures Contracts

Dealers, banks (principal users)

Futures Options

Dealers, banks (principal users)

Swaps

Banks (principal dealers)

Recommended further reading:
Commercial Paper
Bonds
Corporate Debt Securities
Commercial Paper Outstandings Federal Reserve
Bankers Acceptances
Guarantees
Books on Financial Instruments
Online book:
Understanding Financial Markets & Instruments

     Chapter 1: Introduction to Financial Markets
     Chapter 2: The Equity Market
     Chapter 3: The Money Market and Instruments
     Chapter 4: The Capital Market and Instruments
     Chapter 5: The Foreign Exchange Market