MONEY MARKET KNEC NOTES

Money – is anything valuable which is generally acceptable for the discharge or settlement or debt or obligation.

This therefore means that; whatever is used as money should be immediately and unquestionably acceptable in exchange of goods and services.

Money has a legal tender.

Characteristics of Money

  1. Valuable: it has a store of value and must be acceptable.
  2. Portable: easy to move from one place to another.
  3. Durable: it should be used for long.
  4. Homogeneity: it should be looking the same to avoid confusion.
  5. Divisible: should be able to be broken into small units.
  6. Legal tender: it should be accepted by law.
  7. Limited supply: not all would get access to it.
  8. Stability: it should have a stable value for a long time, with very minor variation.
  9. Should be difficult to change: should be easily made.

Money markets

Is a sub category of financial markets.

Financial markets are institutions and organizations that receive and lend large sums of money for a short period of time i.e. they are where credit or primary liabilities are traded.

Most money market transactions are concerned with sale and purchases of near money assets such as                    –    bills of exchange

  • shares
  • Treasury bills
  • Bonds

Near money assets

This is anything that fulfils the store of value function and is readily convertible into medium of exchange but itself is not a medium of exchange also known as Quasi Money and it includes:-Bills of Exchange – a document giving unconditional order to another person to pay to another individual some amount of money.

Treasury bills

Bonds

Company shares:

Money markets make short term loans which are self liquidating and are mostly invested as working capital in the production of consumer goods and the rate of interest is usually low.

The capital market

These are institutions which are concerned with the provision of long term finance/loans.

This may include      –    Bank loans

  • Investment in permanent capital
  • Purchase of shares.

The rate of interest charged is usually higher in order to compensate the lender for the possible risk in capital loss and interest which is normally associated with long term lending.

Importance of Money Markets in the Economy

  1. They help in controlling the amount of money supply in the economy.
  2. It controls the level of demand for money in the economy i.e. the total money balances that every one in the economy wishes to hold.

N/B: By controlling supply and demand for money, money markets help control the problem of inflation.

  1. They enhance or increase the production capacity in the economy by availing money to investors thus increasing the level of output of the economy or Gross Domestic Product.
  2. They enhance extensive investments in the economy especially the private sector thus creating employment opportunities.
  3. They help in diversification of the economy i.e.it enables creation of a wide range of economic activities in almost all sectors of the economy thus leading to diversification of the economy.

 

Central Bank

Is established by the government to control the banking system and formulate and manage the monetary policies in order to control the economy.

Functions of Central Bank

  1. It maintains the financial/monetary control over the commercial banks and other financial institutions i.e. it supervises and provides licenses to the commercial banks.
  2. It issues currencies on behalf of the government i.e. it prints and supply the currency in the economy.
  3. It regulates credit (money supply) and the rate of interest through its monetary tools and therefore maintains price stability.
  4. It acts as a financial advisor to the government i.e. the Central Bank advises the government on its key financial operations.
  5. It is a banker to the government i.e. it keeps and maintains all the financial accounts of the government institutions and its ministries.
  6. It acts as a lender of the last resort i.e.it lends money to the commercial banks and government institutions when they are in temporary financial difficulties.
  7. It is bankers’ bank i.e. every commercial bank is bound by the law to keep certain percentage of its deposits with Central Bank. It also keeps and maintains the foreign exchange reserves in the country.

Monetary tools used by the Central Bank to control the economy

  1. Legal reserve requirement

It is a fraction of the total deposits which commercial banks are required to keep in the Central Bank. During inflationary periods, when the Central Bank wants to restrict credit creation, it raises the legal reserve requirements. This reduces the capacity of the commercial banks to lend money to the public.

During depression or recessionary period, when the Central Bank wants to expand credit and boosts the economy; it lowers the legal reserve requirement so as to increase the capacity of commercial banks to lend money to the public.

  1. Omo (open market operations)

Open market operations involve buying and selling of securities by the Central Bank through commercial banks from or to the public so as to stabilize the economy during periods of recession or inflation respectively. During inflation when there is need to reduce the amount of money circulating in the economy, the Central Bank removes money in the economy by selling to the public the securities. During recessionary periods when there is scarcity of money in the economy the Central Bank injects the money in the economy by buying securities from the economy or public.

  1. Bank rates (interest rates)

When the economy is experiencing inflation, Central Bank raises the bank rates to discourage the public from borrowing and thus encouraging them to save with the bank this helps to control inflationary pressure. However, during recession when there is scarcity of money the Central Bank however lowers the rates to encourage more borrowing to facilitate investments and create employment opportunities.

  1. Selective credit control

It is a tool in which the Central Bank instructs commercial banks to favour/discriminate against certain sectors or borrowers in the country. It is intended to control the flow of credit in different activities in the economy i.e. the Central Bank directs from time to time the commercial banks to give or not give loans.

  1. Liquidity ratio

It involves the control of money supply in the economy by converting the physical assets into money or cash assets.

  1. Special deposit requirement

Are deposits which the Central Bank directs the commercial banks to keep with the Central Bank over and above the legal reserve requirements. It is only used during severe inflation in the economy.

  1. Moral suasion

It is the issuing of persuasive instructions by the Central Bank to commercial banks requiring their cooperation in the implementation of the monetary policies.

Non-Banking financial institutions

Are financial institutions that receive deposits from the public and give loans but don’t create new deposits or new credit.

Examples

Insurance companies

Development banks

Saving and credit schemes

Building societies

Housing finance

Roles or Functions of non-banking financial institutions

  • They facilitate the financing of medium and long term projects which ordinary commercial banks don’t undertake in preference to short projects.
  • They offer unique services e.g. the insurance companies offer unique services which commercial banks can’t undertake e.g the insuring and indemnifying against risks.
  • They promote investment projects; institutions like development banks are very useful in financing industries/projects and undertaking feasibility study on projects.
  • Facilitate the raising of capital for business formation i.e. institutions like stock exchange markets facilitate the transfer of shares and securities which promote the formation and development of large companies large scale business.
  • They cater for small time savers, such institutions assist people who have low incomes to save their money at even very short time deviations.
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