The financial market provides the platform for mobilizing funding for all economic entities - government, businesses, and households. There are two main segments of the financial market, namely the money market and the capital market.
While the money market is structured to mobilize and distribute short-term funds to economic units, the capital market mobilizes funds for long-term needs.
This blog post focuses on the money market.
If you are looking for where to earn a steady income on your money and do so on a continuous basis over time, then read on to learn of the various options in the money market.
What is the Money Market?
As identified in previous paragraphs, the money market exists to supply short-term funds to economic entities such as the government, businesses, and household units.
It is a market where securities with short maturities are traded. 2 Securities traded in the money market have short tenors ranging from a few days to one-year maturity.
The major activity in the money market is financial intermediation i.e taking money fro surplus units and giving the money to the entities that are in deficit. The whole financial intermediation process entails saving, lending and borrowing of money.
The huge volume of transactions that are executed on a daily basis makes the money market a very good source of liquidity and also provides one of the best investment options in Nigeria.
The functions or roles of the money market in the economy are varied. It provides liquidity for businesses, government, and individual; provides the platform through which the Central Bank performs its monetary policy function and helps to ensure self-sufficiency for the banks being the major intermediaries in the money market.
Who Are the Participants?
By participants, we mean the various the various institutions that transact business in the money markets either as providers of funds or users of funds.
The key money market institutions include the Banks, the Central Bank of Nigeria (CBN), large corporate organizations and the investing and/or banking public.
The banks play the role of intermediaries. They bring providers of funds and users of funds together. The providers of funds are simply the business units, government agencies, body corporate and individuals, including you, who keep their money with the bank through the various account types or instruments with which the bank take these monies.
On the other hand, the users of funds are the segment of these units, i.e. businesses, body corporate, agencies and individuals who borrow money from the banks to fund their different needs.
The Central Bank is the regulator of money market activities. Its roles include providing policy direction for operators to conduct their business in line with the provisions of the laws. The CBN uses some monetary policy instruments to regulate activities of the banks and these usually have an impact on key economic indicators such as interest rates, inflation, and money supply.
The large corporate institutions access the money market through the primary intermediaries to raise funds in order to finance mostly working capital needs. They do this by either borrowing directly from the banks or raising instruments through which they borrow from the banking public.
What Are Money Market Instruments?
Money market instruments are simply the tools by which the financial intermediation processes in the money market are carried through. The most common of these instruments are Treasury Bills, Bankers Acceptances, Commercial Papers and Certificate of deposits, Call Deposits and Repurchase Agreement or Repos.
How Can You Make Money With These Instruments
You make money by investing in the money market instruments. We now examine each of the money market instrument in some details to highlight the investment opportunities that are there for you.
This is obviously the safest money market instruments you can invest in. Treasury Bills are short term securities issued by the FederalGovernment for the purpose of borrowing money from the investing public.
In other words, when you buy Treasury Bills, you are actually lending money to the government. But beyond being an instrument of government borrowing, the Central Bank of Nigeria can use the instrumentality of TBs to moderate and control the amount of money in circulation in order to tame inflationary tendencies.
Treasury Bills are sold at regular intervals and can be for 91, 182 and 364 days maturities. The longer the maturity, the higher the interest you will earn. Interest payable on TBs, otherwise called stop rate is determined through the bidding process by the CBN. This interest is payable upfront and this gives higher effective yield.
For example, if you invest N1 million in a one year Treasury Bill, the interest you expect to receive is N100,000. At the point of purchase, you will pay N900,000 and on maturity you will receive N1 million – principal +interest. Interest earned on Treasury Bills is not subject to withholding tax and during the period you hold the investment, you can use it as a collateral for loans.
Investment in Treasury Bills are very safe. In fact, it is considered the safest investment in the money market because it has the guarantee of the government. The instrument is also very liquid because there is an active secondary market for investors who d not wish to hold to maturities.
As at the time of writing this piece, the discount rate across maturities range between 12.5% to 15.60% per annum. With inflation rate currently below 12 percent; the return on Treasury Bills is positive.
However, investing in Treasury Bill in Nigeria is not very easy for small investors as the minimum investment is fixed at NGN50 million for primary auction. This means that only institutional investors, the banks and very high networth individuals can invest in the primary segment of the treasury bill market.
Small retail investors who may want to invest can do so through the secondary market where institutional investors trade their certificates before maturity. With as little as NGN200,000 a small investor can access the secondary treasury bill market.
To invest in Treasury Bill, walk into your bank, make inquiries, collect and fill the necessary forms, fund your account or pronto. For the secondary market transaction, you can as well approach your stockbroker.
2. Commercial Paper (CP)
Big corporate organizations with good credit rating, preferably AA ratings from very credible rating organizations may issue Commercial Papers to enable them raise funds to finance working capital needs, meet immediate orders, fund account receivables and generally meet short-term obligations. To this class of issuers, raising CP’s is considered a low-cost alternative to bank loans. It may also be more feasible to raise CP’s to cover immediate short-term funding gap than approaching the stock market where regulatory issues may make fund raising a cumbersome exercise.The return on CPs is competitiveand market determined, but is generally higher than that on Treaury Billsbecause CPs are riskier and the quality of the instrument is largely a functionof the credibility and capacity of the Issuer.
This is basically an unsecured promissory note issued by large and credible institutions to borrow money from the investing public for a short period of time, usually ranging from less than30 days to a period not exceeding one year.
Your bank will help you to identify quality CPs to invest in. Before now, investors in commercial papers had to hold to maturity due to lack of secondary market but that is changing with the establishment of Financial Market Dealers Quotation (FMDQ) Over the Counter platform which provides formal OTC trading for commercial Papers and other money market instruments.
Generally CP’s appeal to portfolio managers, institutional and high net-worth investors who understand the dynamics and have the wherewithal to hedge the risks on its promise. But retail investors who understands the dynamics and are return-driven are free to invest in commercial papers.
3. Banker’s Acceptance
A Banker’s Acceptance has the features of both commercial paper and treasury bill. Like a commercial paper, bankers acceptances are issued by institutions to raise money from the investing public for a short period of time. But where CPs are unsecured, Banker’s Acceptance is guaranteed by the Bank.
As a matter of fact, we can say that Banker's Acceptances are Commercial Papers that are backed by the guarantee of the Bank. By virtue of that guarantee the instrumentbecome drawn on the bank, conferring liability on the bank to pay investorsshould the issuer reneges.
Thus, while commercial papers are direct indebtedness of the company that issues it, bankers acceptance has a secondary obligor – the bank which is obligated to step in and assume theposition of the primary obligor should the later fail to honour itsobligations.
On the other hand, like treasury bills, BAs are sold at a discount and this means that the investor pays the discounted value at the point of purchasing the BA and receives full amount at maturity. It is also short dated with maturities ranging from 31 days, 91 days,182 days and 364 days. While the interest on BA is higher than that on Treasury Bill, it is usually lower than the interest on commercial papers. This reflects the degree of risks attached to each of the instrument.
4. Certificate of Deposit
Call it a time deposit or fixed deposit, a Certificate of Deposit is an instrument issued by the bank for maturities ranging from 30 days to one year at specified interest rates. The interest you will receive on a time deposit, usually differ from bank to bank and is determined by a lot of factors such as: what the money market rate is at the time, the liquidity levels of the particular bank and general interes trate.
Certificates of Deposits are deposit money banks’ instrument through which they mobilize funds from the banking public for their proprietary trading activities. To evidence your investment, a Certificate of deposit will contain certain information, including name of the investor,Amount invested, date of maturity, interest payable and the amount payable onmaturity.
Some banks may structure their Certificates of Deposit as negotiable CDs in which case it becomes a bearer instrument and whoever holds it at maturity receives the principal andinterest. Negotiable CDs can also betraded in the secondary market for money market instruments.
Investors in a Certificate of Deposit must hold to maturity and if for any reason the investment is to be terminated before the maturity date, the investor is made to pay penal charges on the accrued interest.
5. Call Deposits – These are deposits you place with your bank without fixed maturity date. If you have money that you may need at any time but do not know the exact period you will be needing it, you may place it with your bank on call which means that you are at liberty to call for your money at any time.
Your bank will pay you an interest but not as much as you will earn on Fixed deposit with specific tenor.
Money Market Fund
If you are constrained, perhaps, by the amount of money available to you or knowledge or fear to invest directly in some of theinstruments highlighted above, you can still take advantage of theopportunities in the money market by investing money market fund.
Money Market Funds are mutual funds managed by fund managers that are registered by the Securities and Exchange Commissionwhich invest primarily on highly liquid money market instruments like TreasuryBills, Bankers Acceptances, Promisory Notes and Bank Deposits.
The benefits are many apart from taking the burden of managing the risk off your plate. Some mutual funds accept as little asNGN5,000 minimum investment and you can add to your investment as your capacity increases. The risks are lower because your investment is managed by professionals
Most, if not all, registered fund managers in Nigeria have open-ended money market fund you can easily invest in. Some of these include FBN, ARM and Stanbic IBTC Money Market Fund.
You are at liberty to decide on which of the money market instrument to invest in. Your decision will be guided by the amount of money at your disposal, the rate of return you expect and of course, your risk appetite.
And talking about risks, Treasury Bills are risk-free because it is guaranteed by the full faith of the state but they offer less return compared to other instruments.
Bankers Acceptances, though are not risk-free, they are safer than CP's and Certificate of deposits because of the two-layer comfort they provide. They are guaranteed by the Bank and offer returns higher than that n Treasury Bill.
Bank Deposits are riskier than BAs because they are the direct indebtedness of the individual bank you are placing your money with. Interest rates on a bank certificate of deposits will usually depend on the capacity of the bank, its liquidity level and general industry rate.
Commercial papers are the riskiest of all the money market instruments. They also offer the highest returns. This is because CPs are the direct indebtedness of the companies issuing them. It is therefore important that you do your due diligence before investing in CP's.