MonetaryMix

💰 Money Market and Capital Market Instruments: The Battle of the Maturities

🏦 Why Do Banks Bother with Investment Securities?

Imagine a bank as a hyperactive squirrel. It stores nuts $($cash$)$ for winter $($economic downturns$)$ and pulls them out when hungry. These “nuts” are investment securities, often making up 20% to 33% of a bank’s assets.

Key Roles of Investment Securities:

  • Income stabilization
  • Risk hedging
  • Diversification and liquidity
  • Tax efficiency
  • Balance sheet strength
  • Emergency cash source
  • Collateral utility

They’re known as “crossroads accounts”—pivoting between borrowing and lending as cash needs shift.

👉 But how do we organize these securities to make sense of their behavior and purpose?

⌛ Classification: It’s a Matter of Maturity

Investment securities are sorted by maturity, i.e., “How soon do I get my money back?”

  • Money Market Instruments: Mature in ≤ 1 year $($short-term$)$
  • Capital Market Instruments: Mature in > 1 year $($long-term$)$

Money market instruments are like speed dating: quick and cautious. Capital market instruments are like long-term marriages: deeper, riskier, more rewarding.

👉 Let’s start with the sprinters—what makes money market investments tick?

🏁 Money Market Instruments: The Speedy Saviors

1. Treasury Bills $($T-Bills$)$

  • Zero-coupon, sold at discount, mature at par
  • Backed by U.S. federal government—ultra-safe
  • Yield = difference between issue and maturity price

🧠 Key term: Bank Discount Method – the method used to quote T-bill returns

👉 But what happens if you want your investment to pay regular interest and live longer than a year?

2. Treasury Notes $($T-Notes$)$ and Treasury Bonds $($T-Bonds$)$

  • T-notes $($up to 10 years$)$ and T-bonds $($more than 10 years$)$ become short-term if nearing maturity
  • Coupon-bearing, liquid, collateral-friendly

👉 Still curious about other options with slightly higher returns but implicit government support?

3. Federal Agency Securities

  • Issued by:
    • Fannie Mae $($Federal National Mortgage Association$)$
    • Freddie Mac $($Federal Home Loan Mortgage Corporation$)$
    • Farm Credit System
    • Federal Land Banks
  • Not explicitly government guaranteed—but close
  • Offer higher yields than direct U.S. debt

👉 But what about options from the banking sector itself, especially those that come with insurance?

4. Certificates of Deposit $($CDs$)$

  • Bank-issued, fixed term, insured by the Federal Deposit Insurance Corporation $($FDIC$)$
  • Attractive for low risk and better-than-T-bill yields

👉 Moving internationally—what if we step outside the U.S. and look at global short-term options?

5. Eurocurrency Deposits

  • Issued by large international banks, mainly in London
  • Short maturities, higher yield than U.S. time deposits
  • Not insured, exposed to interest rate risk

👉 So what if you’re dealing with global trade and need a guaranteed payment tool?

6. Bankers’ Acceptances $($BAs$)$

  • Used in trade finance
  • Bank guarantees payment on behalf of a client
  • Issued at a discount, tradable, eligible at the Federal Reserve Bank

👉 Now let’s look at corporations issuing their own short-term instruments. What do they offer?

7. Commercial Paper $($CP$)$

  • Issued by large corporations, up to 90 days
  • Discounted, taxable, widely used in money market funds

👉 Governments issue short-term notes too—but how do they differ from federal debt?

8. Short-Term Municipal Obligations $($TANs and RANs$)$

  • TANs: Tax Anticipation Notes
  • RANs: Revenue Anticipation Notes
  • Interest is usually exempt from U.S. federal income taxes

👉 So, that wraps up the fast lane. What if we need longer-term investments with potentially higher returns and risks?

🧱 Capital Market Instruments: Long-Term, Big Game Players

1. Treasury Notes and Bonds $($At Issuance$)$

  • Long-term versions with higher yield than T-bills
  • Liquid, safe, useful as collateral
  • Price volatility is higher

👉 Besides federal government, who else issues debt—and what do they offer?

2. Municipal Bonds

  • Issued by states/cities
  • Interest is often federally tax-free
  • Two types:
    • General Obligation Bonds $($GO Bonds$)$
    • Revenue Bonds
  • GO Bonds: Backed by taxes
  • Revenue Bonds: Backed by project income

👉 And what about the corporate world? Surely they have something spicy to offer.

3. Corporate Notes and Bonds

  • Notes: ≤ 5 years | Bonds: > 5 years
  • Types: Debentures, Mortgage-backed
  • Higher yields = Higher credit risk
  • Popular with insurance firms and pension funds

👉 Hold up—what about those weird, complex instruments we keep hearing about?

🧪 More Recently Developed Investment Instruments

1. Structured Notes

  • Created from federal agency securities
  • Linked to reference rates, may have caps/floors
  • Yields can step-up or float

👉 What if we pool together loans and sell pieces to investors—what kind of magic is that?

2. Securitized Assets

Types include:

a. Pass-Through Securities

  • Mortgage-backed
  • Payments “pass through” to investors
  • Guaranteed by:
    • Ginnie Mae $($Government National Mortgage Association$)$
    • Fannie Mae

b. Collateralized Mortgage Obligations $($CMOs$)$

  • Divided into tranches with different risks/yields
  • Created from mortgage pools

c. Real Estate Mortgage Investment Conduits $($REMICs$)$

  • Multiple maturity classes to reduce cash flow uncertainty
  • Key Risk: Prepayment Risk

d. Mortgage-Backed Bonds $($MBBs$)$

  • Loans remain on issuer’s balance sheet
  • Trustee monitors loan coverage

👉 What if you could isolate only the interest or only the principal from a bond? That’s where we end—with stripped securities.

3. Stripped Securities

  • IO $($Interest-Only$)$ and PO $($Principal-Only$)$ securities
  • Zero-coupon, sold at discount
  • Hedge against interest rate changes