An Overview of the Canadian Money Market

According to the literature, the money market is a sub-sector of the fixed income market. Also called the debt, credit or bond market, the latter is a financial market where individuals can buy and sell debt securities.

Money is not traded in the money market: Short-term debt securities (generically known as money-market instruments) that are highly liquid, marketable, and relatively low-risk are traded. The term liquid refers to how easily an asset can be converted to cash.

 In fact, due to their safety and liquidity, these instruments are also called cash equivalents. The buyer of a money-market instrument is called the lender. The seller of the instrument is the borrower.

 Money-Market Instruments

These include:

(1). Treasury Bills (Federal and Provincial)

Also called T-bills, these are highly liquid and the most marketable of all Canadian money-market instruments. The government sells these bills to the public.

Offered in denominations of $1000, $5000, $25, 000, $100, 000, and $1 million, they are primarily purchased by the Bank of Canada, chartered banks, and individual investors. The latter who obtain them on the secondary market from government securities dealers.

Bills with initial term to maturity of 1, 3, and 6 months are issued weekly. Term to maturity refers to the date on which the loan falls due.

Investors purchase the bills at a discount from the stated maturity value. At maturity, the holder receives from the government a payment equal to the face value of the bill. Earnings are the difference between the purchase price and the value at maturity.

According to the literature, T-bills are sold at low transaction cost with not much price risk.

 Sales are conducted through auction via bids. Such bids are classed as competitive and noncompetitive.

 • Competitive Bid – This is an order for a given quantity of bills at a specified offered price: An order filled only if the bid is high enough relative to other bids. Only banks and authorized dealers can submit competitive bids.

• Noncompetitive Bid – This is an unconditional offer to purchase at the average price of the successful competitive bids. Such bids can be submitted for bonds only.

The government rank-orders bids by offering price and accepts bids in order of descending price until the entire issue is absorbed.

As opposed to reporting treasury bill prices, financial pages report the bond equivalent yield. This is the bond yield calculated on an annual percentage rate method. However, this is not an accurate measure of the effective annual rate of return.

(2). Certificates of Deposit and Bearer Deposit Notes

A Certificate of Deposit (or CD) is a time deposit with a bank: Time deposits cannot be withdrawn on demand. The bank pays interest and principal only at the end of the fixed term of the deposit.

Guaranteed investment certificates (or GICs) are similar time deposits offered by Trust Companies.

In Canada, both CDs and GICs are nontransferable and thus not negotiable. This means that both CDs and GICs cannot be transferred and/or sold to another investor before the maturity date.

A Canadian marketable CD is called a bearer deposit note (BDN). This is a negotiable bank time deposit issued in denominations greater than $100,000. In the US, a CD is a marketable instrument, similar to BDNs.

The Canada Deposit Insurance Company (CDIC) treats CDs and GICs as bank deposits, so that they are insured for up to $60,000 in the event of bank insolvency.

(3). Commercial Paper

Large corporations often issue their own short-term unsecured debt notes, called commercial paper: Usually these are backed by a bank line of credit.

Because the financial status of a corporation can be monitored and predicted (at least for the short-term), such notes are considered a relatively safe asset.

Generally, commercial paper is issued with maturities of less than one or two months, and minimum denominations of $50,000. However, maturities can range up to one year. Whereas notes with longer maturities have to be registered, corporations rarely issue them.

Small investors invest in commercial paper indirectly through money-market funds.

(4). Banker’s Acceptances

This consists of an order to a bank by a customer to pay a sum of money at a future date, usually six months. When the bank endorses the order for payment as ‘accepted’, it assumes responsibility for ultimate payment to the holder. The holder can then trade the acceptance in secondary markets.

Because traders can substitute the bank’s credit standing for their own, investors view banker’s acceptances as safe assets.

Acceptances sell at discount from the face value of the payment order.

(5). Eurodollars

The literature defines Eurodollars as U.S. dollar-denominated deposits at foreign banks or foreign branches of American banks.

(6). Repurchase Agreements

Also called repos, repurchase agreements are short-term sales of government securities, with an agreement to repurchase the securities at a slightly higher price.

Essentially a dealer takes out a one-day loan from an investor, government securities functioning as collateral. There is an agreement in place to purchase the securities back the next day at a slightly higher price. The increase in the price is the overnight interest.

A reverse repo is a purchase with an agreement to resell at a specified price on a future date.

A term repo is an identical transaction, except the term for the loan is 30 days or more.

A reverse repo is the replica of a repo. Here, the dealer locates an investor holding government securities: The dealer then purchases securities, agreeing to sell them back at an established higher price on a future date.

Repos are considered safe in terms of credit risk.

(7). Brokers’ Calls

Individuals who purchase stocks on margin borrow part of the funds to pay for the stocks from their broker. The broker in turn may obtain a call loan, that is borrow funds from a bank, agreeing to repay the bank immediately, if the bank calls the loan.

(8). The LIBOR Market

The London Interbank Offered Rate (or LIBOR) is essentially the daily rate based on the interest rate British banks use when lending money to each other.

This rate has become the premier short-term interest rate quoted in the European money-market. In fact, LIBOR rates function as a reference for many global financial markets and/or instruments. For example, research indicates it is utilized by the Swiss National Bank as the reference for their monetary policy.

Money-Market Mutual Funds

The Canadian money-market is used for buying and selling short-term funds in the form of securities and loans. Many securities in this trade are in large denominations, beyond the average investor. However, money-market mutual funds are accessible.

Money-market mutual funds pool the resources of many investors, purchasing an array of the aforementioned instruments on their behalf. According to research, the money invested by these funds is utilized for short-term loans to Canadian companies and government bodies.

A Final Word

By and large Canadian money-market instruments are short-term, debt obligations. Typically, they are highly marketable, with relatively low risk. However, although their low maturities and credit risk do ensure minimal capital losses, generally there is also minimal gains.

Most instruments outlined in this article are regarded as quite safe. Of course, there are some considered more safe than others. For example, T-bills are considered safer than commercial paper. As funds move from Government of Canada to provincial T-bills, then notes issued by major corporations, the risk increases, but remains minimal.

Nonetheless, although most are low risk, it is important to note that they are not risk-free.

(References available upon request.)

 NOTE: This preceding article has been for information purposes only.