Explore the critical role of debt instruments like CDs, acceptances, and commercial paper in short-term financing and understand their market impact.
Debt instruments are financial assets or securities that represent a loan made by an investor to a borrower. They are a crucial part of the financial markets, providing ways for governments, corporations, and institutions to raise capital by promising to pay back the principal amount on a specified maturity date, along with interest.
In this section, we focus on primary money market instruments—Certificates of Deposit (CDs), Bankers’ Acceptances, and Commercial Paper—often used in short-term financing.
A Certificate of Deposit is a time deposit offered by banks with a fixed interest rate and maturity date. They are known for their stability and are often viewed as low-risk investments.
Characteristics: CDs typically offer higher interest rates than savings accounts but require the funds to remain deposited for a predetermined period.
Investment Use: They are used by consumers and large institutions alike, providing capital stock that banks can reinvest.
Bankers’ Acceptances are short-term debt instruments issued by companies that allow a company to receive payment on goods or services at a future date.
Function: These are used in international trade to provide assurance that payment will be received once the goods are delivered. Essentially, they are a draft or bill of exchange guaranteed by a bank.
Example Scenario: A U.S. company needing to purchase goods from a European supplier can provide a bankers’ acceptance to assure the supplier of payment on delivery.
Commercial Paper is an unsecured, short-term debt instrument issued by corporations for meeting immediate financial needs.
Characteristics: These are typically issued at a discount from face value and reflect prevailing market interest rates.
Example Usage: A corporation might use commercial paper to raise funds to cover short-term liabilities such as payroll or inventory.
To better understand the relationships between these instruments, consider the following representation of how institutions utilize them for short-term funding:
To deepen your understanding of these instruments and their roles in the economy, consider the following resources:
Books
Online Resources
Websites