Understanding short-term debt securities

Money markets are financial markets dedicated to short-term financing for businesses, governments, and financial institutions. They connect entities with short-term cash needs to those with surplus liquidity to invest.

By convention, a debt security is considered short term when its contractual maturity is less than one year. This boundary, although arbitrary, separates the money markets from the bond markets, which include medium- and long-term debt securities.

Conceptually, money markets can be divided into two main categories:

• The market for short-term debt securities,
• The interbank lending market.

In this series, we’ll explore each of these markets in its own article, before focusing on the key rates and indicators of the money markets. For today, let's focus on short-term debt securities 🤓

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Treasury Bills, Certificates of Deposit, and Commercial Papers

In contrast to bank financing, short-term debt securities are considered market-based financing. For those familiar with bonds, short-term debts are similar instruments but with shorter maturities, typically under one year, while bonds generally have longer terms measured in years.

There is specific terminology used to distinguish short-term debt securities based on their issuer:

• Treasury bills (T-Bills) are issued by governments,
• Certificates of deposit (CDs) are issued by banks,
• Commercial papers (CPs) are issued by companies.

In practice, these securities offer governments, banks, and businesses a flexible alternative to traditional bank financing for meeting their working capital needs.

Treasury bills currently represent the primary source of short-term financing for governments. Each year, the French government issues several hundred billion euros in Treasury bills, known as BTFs.

For large companies, commercial papers are a crucial source of short-term financing, sometimes even the primary source, ahead of bank credit lines. Major issuers of commercial papers include firms like Airbus, Safran, and LVMH.

Finally, banks also rely significantly on certificates of deposit for their short-term financing, although they have other alternatives, such as:

• The market for retail and corporate deposits (checking accounts, term deposits, etc.),
• The repo market,
• Reserve lending and borrowing operations,
• Refinancing with the central bank.

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Common Features

Although there are different types of issuers, short-term debt securities share common features.

1. Short maturities: from one day (overnight) to one year, as we’ve seen.
2. High liquidity: the money market is very deep, meaning there are many buyers and sellers, making money market instruments easily convertible into cash. In 2022, more than €1.3 trillion was traded daily on the European money market (source: ECB, Euro Money Market Study 2022).
3. Low risk: short-term debt securities are considered very low-risk because they are typically issued by financially sound and highly-rated entities, such as governments, large corporations, or leading financial institutions.

What About Money Market Funds (MMFs)?

MMFs are regulated vehicles that allow investors to acquire a share of a portfolio of money market instruments (short-term debt securities and/or repos) managed by professionals. While it’s possible to directly acquire money market assets (the "underlying" of an MMF), this process is complex and demanding. It requires not only selecting assets but also frequently renewing them due to their short maturities. In most cases, outsourcing this activity to a professional by allocating cash in a money market fund is the most efficient solution.

Conclusion

Money markets play a crucial role in the economy by enabling governments, large businesses, and financial institutions to finance their working capital needs, which in turn offers opportunities for treasury management. To tap into the returns of money markets, the best approach is usually to invest in money market funds, which handle the selection of the most suitable instruments, like Treasury bills, offering liquidity, yield, and security.