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Book title: Understanding Financial Markets & Instruments
Author: Braam van den Berg

Chapter 3:  The Money Market and Instruments

3.1   Introduction 
3.2  Trading in the market 
3.3   Institutions in the market 
3.4   Instruments in the market 
3.4.1 Negotiable certificates of deposit (NCDs) 
3.4.2 Government stock and other short-term interest rate instruments 
3.4.3 Bankers' acceptances 
3.4.4 Treasury bills 
3.4.5 Commercial paper and other discount instruments 
3.5    Discount rates, interest rates and yields 
3.5.1 Comparison between an interest rate and a discount rate 
3.5.2 The effect of compounded interest 
3.5.3 Financial instrument comparisons 
3.6    The money market and the financial world 
3.6.1 Selling money market instruments 
3.6.2 Increasing interest rates by offering less money 
3.7   Conclusion

3.1  Introduction

In general terms, the money market is the market where liquid and short-term borrowing and lending take place.  The lending of funds in this market constitutes short-term investments.  In a certain sense all bank notes, current accounts, cheque accounts, etc. belong to the money market.

In financial market terms, the money market exists for the purpose of issuing and trading of short-term instruments, that is, instruments where the term remaining from the date when trading takes place to the date of redemption of the loan represented by die instrument (commonly referred to as the "term to maturity"), is of a short-term nature.  In theory, this term for classification as a money market instrument is given as one year.  In practice, however (especially in South Africa), instruments with a term to maturity of three years or less are normally classified as money market instruments although this is not a hard and fast rule.

In South Africa the classification of instruments with a term to maturity of three years or less as money market instruments, stems from legislation which had been in place in the '80s whereby banks had to have a certain percentage of their assets in liquid form.  Cash and certain instruments with a term to maturity of three years or less, were defined a liquid assets by the authorities.

3.2   Trading in the market

Money market instruments in South Africa are not traded through an exchange, but by means of informal telephone trading and OTC (over the counter) trading.   The money market is probably the most informal market in South Africa and does not use screen or electronic trading at this stage.  Physical trading documents and settlement procedures are still used in this market.

The rates at which these instruments are issued and traded are quoted by die institutions in the markets via computer systems and can be seen on a computer screen which is linked to one of the participating systems.

3.3   Institutions in the market

There are quite a few active institutions in the market, and it probably has the most active participants of all the financial markets.  Individuals form an important and integral part of the market through cash income and spending, investments and borrowings at banks and funds (e.g. unit trusts, pension funds, etc.) and other short-term funds, which they invest and borrow.

The government is involved in the market through the Treasury and the Reserve Bank.  They interact with other players in the market such as the commercial banks, the merchant banks, the funds and corporate companies.  Other financial institutions such as insurers, money market trusts, micro-lenders, etc. all play a part to keep the money market vibrant and liquid.

3.4   Instruments in the market

There are basically two types of instruments issued and traded in the money market, namely:

  • Instruments which pay interest on the amount invested, where the interest is normally paid to the holder of the instrument (the lender), together with the redemption amount at redemption date.  Interim interest payments may be made in certain cases.  These instruments are called interest instruments.  Instruments in this category include:

Negotiable certificates of deposit (NCDs)
Short-term government stock
Interest rate instruments issued by the private sector, with terms to maturity of less than three years.

  • Instruments that do not pay interest on the amount invested but are issued at a discount on the nominal value (the redemption amount).  These instruments are called discount instruments.  Instruments in this category include:

Bankers' acceptances (BAs)
Treasury bills (TBs)
Commercial paper
Land Bank bills

3.4.1  Negotiable certificates of deposit (NCDs)

A negotiable certificate of deposit is a certificate issued by a bank for a deposit made at the bank.  This deposit attracts a fixed rate of interest, which is normally payable to the holder of the instrument together with the nominal amount invested, at redemption date.  NCDs are normally issued in multiples of R1 million.   The NCD will contain the following information:

  • name of the issuing bank
  • date of issue
  • date of redemption (maturity date)
  • amount of the deposit
  • maturity value
  • annual interest rate paid on the deposit.

NCDs are bearer documents (see appendix 8), which means that the name of the owner (holder or depositor) does not appear on the document.  The bearer or holder of the document will receive the maturity value (the amount deposited plus interest) at maturity date.

The maturity value (MV) of an NCD will be the nominal amount deposited (N) plus the interest for the period.  If for instance a deposit of R1 million is made on 1 March for 90 days, and interest paid on the amount is 15% (referred to as a 15% 90-day NCD), the maturity value is calculated as follows:

Nominal amount R1 000 000
Interest for period (15% x R1 000 000 x 90/365) R     36 986
MV R1 036 986

The general formula would be:
MV = N x (1 + (1 x c/100 x d/365)


MV = maturity value
N     = nominal amount of the certificate (amount deposited)
c      = interest paid on the amount deposited, as indicated on the certificate (referred to as the coupon rate).  This is expressed as a fixed amount and not as a percentage, e.g. 15 and not 15%
d       = period of the instrument in days referred to as the tenor

In this case

N = R1 000 000
c = 15
d = 90
MV = R1 036 986

If the holder sells this instrument to another party before the redemption date, the proceeds can be calculated.  Remember that financial instruments are traded between parties on a yield to maturity (expressed as an interest rate) basis, because interest is the price that is paid for money borrowed.  The proceeds of the sale are calculated as follows:

Proceeds = MV / [1 + (d/365 x i/100)]


MV = maturity value
d = remaining tenor in days
i = yield at which the instrument was traded expressed as a fixed amount

If, in the above example, the NCD is sold on 31 March at a yield of 14%, the proceeds to the seller (the amount the buyer will pay) is:

Proceeds = R1 036 986 / [1 + (60/365 x 14/100)]
                   = R1 013 658


MV = R1 036 986
d = 60
i = 14

The buyer will be the new holder, and he may present the NCD to the bank on redemption date to receive the maturity value of R1 036 986 or sell it in the secondary market prior to maturity.

3.4.2   Government stock and other short-term interest rate instruments

Government stock and other private sector instruments are normally issued for long-term periods with more than one interest payment before redemption.   The explanation and calculation of these instruments will be done in the section on the capital market (chapter 4).

Where the term to redemption of a government stock or other interest rate instrument has moved into the money market category, and there is just one interest payment left, which falls on the same date as the redemption payment, the same calculations as for the NCD (see 3.1) will apply.

3.4.3   Bankers' acceptances

A bankers' acceptance was invented to suit the needs of a party requiring temporary finance to facilitate the trading of specific goods.  The party needing finance would approach investors for this temporary finance.  The investors or lenders would then lend a certain amount to the borrower in exchange for a document stating that the debt would be paid back on a certain date in the short-term future.   For this arrangement to be attractive to the lender, the amount paid back by the borrower (called the nominal amount) would have to be more than the amount advanced by die lender.  The difference between the amount advanced and the amount paid back (the nominal amount) is known as the discount on the nominal amount.  The two parties would normally be brought together by a bank.

The redemption of the loan would have to be guaranteed by a bank, called the acceptance by the bank making the arrangement.  Thus the name "bankers' acceptance".

The holder of the document may, at the redemption date approach the bank who will pay the nominal amount to the holder.  The bank will then claim the nominal amount from the borrower.

A bank acceptance can, in formal terms, be described as an unconditional order in writing

  • addressed and signed by a drawer (the lender)
  • to a bank which signs the document and becomes the acceptor
  • promising to pay a certain amount of money at a fixed date in the future
  • to the bearer or holder (the borrower) of the document (the acceptance).  (See appendix 7 for an example.)

Since there is theoretically no interest payable on a bankers' acceptance, the investor would want to pay less than the nominal amount for the acceptance in order to receive a certain yield on his investment when, at redemption, he receives the nominal amount from the borrower.  The rate quoted on a bank acceptance is the rate of discount on the nominal amount of the acceptance that is used to calculate the amount advanced by the lender.  The rate is given as an annual rate.

In the following example a BA (bank acceptance) is issued at 12%.   The nominal amount of the BA is R1 million and it is issued for 90 days.

The discount on this BA would be worked out as follows:

Discount = N x d/365 x di/100


N = nominal value
d = tenor in days
di = discount rate as a fixed amount

In this case

Discount = R1 000 000 x 90/365 x 12/100
                 = R29 589

The proceeds which the borrower (drawer) would get at issue date, which is equal to the amount that the investor or lender would pay would be:

Proceeds = nominal amount - discount

In this case
Proceeds = R1 000 000 -  R29 589
                   = R 970 411

If the investor needs his money before the redemption date, this BA maybe sold in the market to another investor who would then become the new lender.   This can be done because the BA is a bearer document.  Once again the transaction would take place at a certain discount rate against which the proceeds would be calculated.

If, in the case above, the original investor now sells the BA at a discount rate of 11% when there are still 60 days left to redemption, the proceeds (also called the consideration that the buyer would pay) will be calculated as follows:

Proceeds or consideration = N - (N x d/365 x di/100)

N     = nominal amount of BA
d      = remaining tenor in days
di     = discount rate at which transaction was concluded

In this case
Proceeds or consideration

          = R1 000 000 - (R1 000 000 x 60/365 x 11/100)
          = R981 918

3.4.4   Treasury bills

The government issues treasury bills (see appendix 9).  They are discount instruments issued for the short term, similar to BAs.  The issue and redemption of these instruments are handled by die Reserve Bank on behalf of the government.  Treasury bills are issued in bearer form, and the bearer or holder of the instrument may present it for payment of the nominal amount at redemption date.   The Reserve Bank would normally pay this amount into the holder's current bank account on the redemption date.

Weekly treasury bills are issued and allocated on a tender basis.   These bills have a tenor of 91 days and are allocated to interested parties who submitted tenders on these bills on a Friday for settlement during the following week.   The amount of bills on offer for that week is announced in multiples of R1 million the previous Thursday.

From time to time the Reserve Bank will issue treasury bills other than weekly treasury bills on a special tender basis to parties who regularly participate at weekly tenders.

Tenders are submitted by parties in percentage form to three decimals, that is, R95,125% (price per cent).

Before a party will tender for a bill, he has to decide on the discount rate that he would like to earn on his investment.  This rate will probably be market related and not far from the ruling BA rate.

If, for instance, a party decides on a discount rate of 12% on his investment, the tender price that he would submit on 91-day treasury bills would be:

Price          = 100 - (di x d/365)

di                  = discount rate the party wants to earn expressed as a fixed amount
d                   = tenor in days

In the above example the tender price submitted will be:

Price             = 100 - (12 x 91/365)
                     = 97,008

In the calculation of the discount, proceeds and consideration if sold prior to redemption date, the same formula as that used for the BA (see 3.4.3) can be used.

3.4.5   Commercial paper and other discount instruments

Commercial paper refers to short-term unsecured promissory notes normally issued by corporate companies with a high credit rating.  These instruments are also issued on a discount basis such as BAs.  Because they are unsecured, the risk involved will be higher than that of BAs, and therefore the issuing institution must be financially strong and sound.  Because of the risk attached to these instruments they would normally be issued and traded at a higher discount than the prevailing BA rate.

Finance can be obtained by making use of various alternative kinds of discount instruments.  Other discount instruments that have been used are secured promissory notes and asset backed commercial paper.  The Land Bank and the Reserve Bank also issue discount bills from time to time.  It is thus clear that finance, using money market instruments, can be arranged between parties over the counter, as needs be.  Standardised instruments as discussed above are, however, more liquid and tradable.

3.5   Discount rates, interest rates and yields

3.5.1   Comparison between an interest rate and a discount rate

It is obvious from the previous examples discussed, that the discount rate on an instrument and the interest rate paid on an instrument are not the same, and cannot be compared when deciding on an investment.  The following example will explain this statement:

If a one-year NCD with a nominal amount of R1 million and an interest rate of 11% is to be compared with a one-year BA of R1 million and a discount rate of 10%, the following would apply:

Instrument NCD BA
Amount invested R1 000 000         11% R  900 000          11,1%
Interest/discount R   110 000 R  100 000
Redemption amount R1 110 000 R1 000 000         10%

From the above illustration it is clear that the yield on the NCD is:

Interest received/amount invested
= 110 000/1 000 000
= 11%

The yield on an investment on the BA is, however:

Discount / amount invested
= 100 000/900 000

The BA would thus give a higher yield and is the better investment, if the difference in risk on these instruments is ignored.

The discount rate on discount instruments must thus be converted to yield before it can be compared to interest rates offered on interest rate instruments.   The compounding period of rates must also be equal before they can be compared.

3.5.2   The effect of compounded interest

Interest can be compounded in different periods.  If, for instance, interest on a R1 million investment is compounded monthly  at 10%, the following would apply:

Amount invested R1 000 000
Interest for first month (R1 000 000 x 10% x 1/12) R        8 333
R1 008 333
Interest for second month (R1 008 333 x 10% x 1/12 R        8 403
R1 016 736


It can be seen that from the second month, interest is earned on the interest paid in the previous month.  The value after 12 months will be R1 104 713.   While the nominal rate on this investment is 10%, the annual effective rate is 10,47% because interest is paid monthly and interest is thus earned on interest.

3.5.3   Financial instrument comparisons

In financial market terms, the 10% in the above example will be called the "nominal annual compounded monthly" (NACM) because it is a nominal annual rate which is compounded monthly.

In terms of a 90-day NCD, the maturity value (which includes the interest) can be reinvested every 90 days (called a quarter because it is more or less a quarter of a year).  The interest rate quoted on the 90-day NCD is thus a nominal annual rate compounded quarterly (NACQ).  The yield derived from the discount rate on a 90-day BA (see example in 3.4.1) is also a NACQ.

When comparing yields on different investments with one another, the yields compared have to be similar, such  as NACQ  with NACQ, or NACM with NACM.

Other terminology commonly used is:

NACD      -  nominal annual compounded daily
NACSA    -   nominal annual compounded semi-annually
NACA      -  nominal annual compounded annually (this will be the same as the annual effective  rate).

To convert any yield to another yield with a different compounding period, the following method can be used:

Step 1:
Convert the original yield to an annual effective rate using the following formula:

Annual effective rate = (1 + i/n)^n - 1          
(for clarity: x^n means x to the power of n)


i    =   original yield expressed as a percentage
n   =   number of compounding periods per year for original yield.

Step 2:
Convert the annual effective rate to the new yield with a different compounding period using the following formula:

New yield   =   [(1 + AER)^(1/n)      - 1] x n


AER        =   annual effective rate
n              =    number of compounding periods per year of the new yield

Comprehensive example

The following applies to a 90-day BA:

Nominal amount    :   R1 000 000
BA rate                    :    15%

The decision has to be made whether to invest in this 90-day BA or in a 30-day NCD with an interest rate of 15,2%.

Firstly, the yield on the BA must be calculated:
Discount              =    R1 000 000 x 15/100 x 90/365
                             =    R 36 986
Amount invested =   R1 000 000 - R 36 986
                              =   R 963 014
Yield                       =   36 986/963 014 x 365/90
                               =   15,58%

This is the yield of the BA and because it is a 90-day BA (which could be reinvested every quarter or 90 days) this is also the NACQ.  In this example we accept that 90 days is equal to a quarter of a year and 30 days equals 1 month or 1/12 of a year.

This NACQ must now be converted to an annual effective rate:

AER        =  (1 + 15,58%/4)^4   - 1
                =   16,51%

The annual effective rate must now be converted to an NACM (the NCD is a monthly NCD).

NACM     = [(1 + 16.51%)^(1/12)    - 1] x 12
                 = 15,38%

This NACM can now be compared with the interest rate on the 30-day NCD and we would thus rather invest in the BA because it gives a higher yield on investment from an interest-earned point of view.

In these examples, additional costs such as fees charged by banks, commission, etc. were not taken into account.  These costs should be negligible in terms of the calculations, but can be taken into account before deciding on the final investment.

3.6   The money market and the financial world

The money available to consumers, investors, etc. to spend or invest in products is known as the money supply of the market.  This money supply includes credit available to consumers.  The lower the interest charged on credit facilities, the more consumers are likely to use credit, and the higher the money supply in the country.  An increase in the money supply is referred to as a growth in the money supply.

If the money supply in the country is high, this could result in increased demand for products in the products market, which in turn could lead to inflation (rising prices).

To enable the monetary authorities to guard against this kind of inflation, a few options are available where use is made of the money market, two of which are discussed here.

3.6.1   Selling money market instruments

By selling money market instruments such as treasury bills in the market, cash is withdrawn from the market to be kept in reserve by the authorities.   This results in a decrease in the money supply in the market with a resulting dampening effect on the demand for products.

3.6.2   Increasing interest rates by offering less money

The assets of banks include such assets as overdraft facilities, home loans, credit card facilities and others for which they charge consumers a certain interest rate.  This interest rate is normally linked to a rate called the prime overdraft rate.

To finance such assets, banks obtain their money in the money market by selling instruments, attracting deposits, etc.  If there is not enough money available in the money market to fund the assets of all the banks, it means that there is a shortage of money in the market.  This money market shortage is announced in the media from time to time and daily by the Reserve Bank.  The banks then have to borrow money from the Reserve Bank to fund this shortage.  The Reserve Bank buys certain money market assets from the banks in  exchange for money.  This money is needed by the banks to fund their daily deficit as explained previously.  The Reserve Bank offers a certain amount of money per day for the purchase of these assets.  Banks who need money have to tender for the money by offering assets to the Reserve Bank.  The Reserve Bank then allocates the money to the highest bidders in exchange for the assets that they offered.

The transaction is done on a repurchase basis whereby the Reserve Bank buys the assets from the bank for immediate settlement and agrees to sell the assets back to the  banks after a predetermined period.  This is known as a carry transaction, because the Reserve Bank becomes the owner of the assets for the period that the assets are bought from the bank.  With a repurchase transaction the lender does not become the owner of the assets, but the assets are given as collateral or security for the loan.  The repurchase rate (repo rate) is the rate that the Reserve Bank makes on the transaction done with the bank for the period, and would be the same as an interest rate charged on a loan for that period.  This rate is similar to the short term rate used in London called the LIBOR (London Inter Bank Rate) where the banks borrow money in the interbank market to fund their daily deficits.

For the banks to be able to make a profit, they have to charge their clients more (on lending rates such as the prime overdraft rate) than they have to pay (on borrowing rates such as the repo rate).  The difference between the repo rate and the prime rate is normally around 2%.  Opposed to the previous mechanism where the bank rate was used, the repo rate is market-related rather than policy-related because banks have to tender for cash needs and tenders are at market related rates.

Banks acquiring cash through the repo system must supply the SARB with certain acceptable assets as collateral for cash borrowed.  The assets are supplied to the SARB on a carry transaction deal whereby the SARB buys the asset and sells it back to the bank at a later date.

The Reserve Bank and the government consider the money market shortage and the repossession system as instruments of monetary policy and have for the past few years kept the money supply to a level where there is a constant money market shortage.

If the Reserve Bank thus feels that the supply of credit is too high, adversely affecting the economy, it may decrease the amount offered to banks via the repossession system thus pushing up the tender rates of the banks and the resulting repo rate.  This would most likely have the effect of the banks increasing their prime rate, and less credit being used since the cost is higher.

3.7  Conclusion

As can be seen from this chapter, the money market is a vibrant market, affecting our everyday lives.  As the short-term market for money, money changes hands in a short time frame and the players in the market have to be alert to changes, up to date with news and innovative with strategies and products.


Courses and training in Financial Markets, Instruments, Investments and Derivatives are supplied by the Academy of Financial Markets.  They can be contacted on or via their web site.  New developments in the Financial Markets are incorporated in updates (see index) of this book and can be obtained from The Academy of Financial Markets.