Tuesday, September 1, 2009

The Need for a Money Market

Why is such a market needed? There are two basic reasons. First, inflows of cash and outflows of cash are rarely in perfect harmony with each other. Governments, for example, collect taxes from the public only at certain times of the year, such as in April, when personal and corporate income tax payments are due. Disbursements of cash must be made throughout the year, however, in order to cover such items as wages and salaries of government employees, office supplies, repairs, and fuel costs as well as unexpected expenses. When taxes are collected, governments usually are flush with funds which far exceed their immediate cash needs. At these times they frequently enter the money market as lenders and purchase U.s. Treasury bills, bank deposits, and other attractive financial assets. Later on, however, as cash runs low relative to current expenditures, these same governmental units must once again enter the money market to sell securities, cash in deposits, and even borrow short-term money.
Business firms, too, collect sales revenue from their customers at one point in time and dispense cash at other points in time to cover wages and salaries, make repairs, and meet other operating expenses. The checking account of an active business firm fluctuates daily between large surpluses and low or nonexistent balances. A surplus cash position frequently brings such a firm into the money market as a net lender of funds, investing idle funds in the hope of earning at least a modest rate of return. Cash deficits force it onto the borrowing side of the market, however, seeking other institutions with temporary cash surpluses. Clearly, then, the money market serves to bridge the gap between receipts and expenditures of funds, covering cash deficits with short-term borrowings when current expenses exceed receipts and providing an investment outlet to earn some interest income for those units whose current receipts exceed their expenditures.
To fully appreciate the workings of the money market, we must remember that money is one of the most perishable of all commodities. The holding of idle surplus cash is expensive, since cash balances earn little or no income for the owner. When idle cash is not invested, the holder incurs an opportunity cost in the form of interest income which is foregone. Moreover, each day that idle funds are not invested is a day‘s income lost forever. When large amounts of funds are involved, the income lost from not profitably investing idle funds for even 24 hours can be substantial. For example, the interest income from a loan of $1 million for one day at a 10 percent annual rate of interest amounts to nearly $280. in a week‘s time close to $2,000 in interest would be lost from not investing a million dollars of idle funds. many students of the financial system find it hard to believe that investment outlets exist for loans as short as one day or even two or three days. In fact, however, billions of dollars in credit are extended in the American money market each day to securities dealers, commercial banks, and nonfinancial corporations to cover such temporary shortfalls of cash.

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