Wednesday, September 2, 2009

Federal funds versus clearinghouse funds

How funds move so fast in the money market? The reason is that money market traders usually deal in the federal fund .these funds are mainly deposit balances of commercial bank held at the regional Federal Reserve banks and at larger correspondent banks across the nation. When a dealer firm buys securities from an investor, for example, in immediately contacts its bank and requests that funds be transferred from its account to the investor‘s account at another bank. many of these transactions move through the federal reserve‘s wire transfer network. in this case the fed removes funds from the reserve account of the buyer‘s bank and transfers these reserves to the seller‘s bank. The transaction is so quick that the seller of securities has funds available to make new investments, pay bills, or for other purposes the same day the trade is carried out. Federal funds are often called "immediately available funds" because of the speed with which money moves from one bank‘s reserve account to that of another.
Contrast this method of payment with that used generally in the capital market and by most businesses and households. When most of us purchase goods and services-especially those involving large amounts of money- the check is the most desirable means of paying the bill. Funds transferred by check are known as clearinghouse funds. this is because, once the buyer write a check, it goes to the seller‘s bank, which forwards that check eventually to the bank upon which it was drawn. If the two banks are in the same community, they exchange bundles of checks drawn against each other every day through the local clearinghouse-an agreed-upon location where checks and other cash item are delivered and passed from one bank to another.
Clearinghouse funds are an acceptable means of payments for most purposes, but not in the money market, where speed is of the essence. It takes at least a day to clear local checks and two to three days for checks moving between cities. For money market transactions, this is far too slow, because no interest can be earned until the check collect. Clearinghouse funds also have an element of risk because a check may be returned as fraudulent or for insufficient funds. Federal funds transactions, however, are not only speedy but safe

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