A deposit is a sum of money
placed with a bank for safe keeping and possibly to earn interest.
Individuals may be familiar with demand
deposits, which they can place with a bank for no specific
maturity. The money can be withdrawn at any time without penalty. A
time deposit has a fixed maturity, and
there is a penalty for early withdrawal.
This article is about
money market deposits. These are
large-denomination time deposits. Terms range from overnight to one
year. Interest accrues until maturity. Interest rates for most
currencies are quoted as a simple
interest rate with an actual/360 day count. The exception is British
pound deposits, which are also quoted with simple interest but on an
actual/365 basis. For major currencies, the rates banks are offering on
new deposits are reported by the British Bankers Association as their
daily Libor rates. For Euro
deposits, Euribor has become more of
the reference rate.
Money market deposits are non-negotiable. This means
they cannot be traded or otherwise transferred to another party. This is
what distinguishes a money market deposit from a
certificate of deposit,
which is negotiable. To compensate depositors for their relative lack of
liquidity, money market deposits
tend to offer slightly higher interest rates than certificates of
Historically, it was the convention that a bank branch
would only accept deposits in the domestic currency where it was
located. For example, a British bank would only accept British pound
deposits at its branches in the UK. If it wanted to accept Japanese yen
deposits, it would open a branch in Japan to accept those deposits.
Prior to the 1950s, exceptions to this convention were rare. Then things
started to change.
During the Cold War, Soviet-block nations often had to
pay for imports with US dollars—or receive US dollars for their exports.
They were loath to leave their dollar deposits with banks in the United
States due to the risk of those
deposits being frozen or seized. Instead, they started placing the
deposits with European banks. Because they were US dollars held in
Europe, the funds came to be known as
Eurodollars, and the deposits were
Eurodollar deposits. The banks
started to lend those deposited dollars out. This was the beginning of
the Eurodollar market.
As the US dollar increasingly became the currency for
international trade, European banks expanded their Eurodollar
operations, taking deposits and making loans in dollars to ensure
themselves a continuing role in international finance. The market was
further fueled by financial regulations in the United States, which
drove dollar deposits offshore.
Q capped the interest rates US banks could offer on domestic
deposits, but Eurodollar deposits were not subject to those caps. When
interest rates shot up in the early 1980s, dollar deposits migrated from
the United States to Europe. Regulation Q was revoked, effective in
1986. However, the United States was then requiring banks to hold
deposits. This was an expense European banks didn't face. They were
still able to offer higher rates on deposits, and the Eurodollar market
continued to grow. Today, America's persistent balance of payments
deficit continues to ensure a ready supply of dollars available for
The Eurodollar market has become global, so its name is
a bit of a misnomer. A bank in Japan or Singapore may accept dollar
deposits, but these are still called Eurodollar deposits. The market
also includes other currencies, so there are Europounds, Euroyen, etc.
Money market deposits tend to be
spot, that is, they commence in
two business days (or two "target" days for deposits of European euros).
Other settlement is available.
An overnight deposit must have cash
(immediate) settlement, by definition. Its interest rate will be close
to the Fed funds rate. Forward deposits are also
possible. A forward
rate agreement (FRA) is a forward on a deposit structured as a
are also cash-settled futures on
money market deposits. These are traded in Chicago and Singapore, and
are called Eurodollar futures, Euroyen futures, etc.
An acceptance that has a bank as its drawee.
bond Securitized debt.
A type of derivative instrument that offers protection against
rising interest rates.
certificate of deposit A money market instrument issued by a depository institution as
evidence of a time deposit.
Short-term promissory notes issued primarily by corporations.
Any of several methods of crediting interest in which interest is earned on interest.
of Funds Index A yield index.
credit risk Risk due to
uncertainty in a counterparty's ability to meet its obligations.
A money market instrument that pays no coupons, matures for its face value, and
is issued at a discount to its face value.
bearer bond issued and traded within the largely unregulated Euromarket.
Fed funds Deposits
held by US banks in accounts at their regional Federal Reserve banks.
term structure Refers collectively to a spot curve, forward curve,
discount curve, yield curve or any other curve that describes the time value of
money at a particulate point in time.
floor A type of
derivative instrument that offers protection against declining interest rates.
forward rate agreement
A cash-settled forward contract on a short-term loan.
rate parity An arbitrage condition that must hold between the spot interest
rates of different currencies.
London Interbank Offered Rate.
A fixed income instrument whose coupon fluctuates with some designated reference
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