Hot Money

Quick Summary of Hot Money

The capital which is frequently transferred between financial institutions in an attempt to maximize interest or capital gain.

Hot money refers to that money, which traverses among financial markets in response to the highest available rates of interest. CDs can be termed as hot money. Hot money moves quickly from one form of investment to another in pursuit of the highest short-run rate of interest (rate of return). Hot money seeks to garner high short-run investment returns. Hot money flies in response to international exchange rate differentials. Hot money affects BOP (balance of payment) of nations. It fortifies the exchange rate of the recipient nation while weakening that of the concerned country from which money flies out.

In currency markets, mostly speculators hold hot money. Hot money is extremely volatile. It is a major component of ‘capital flight’. Hot money flight is often the root cause of a currency crisis. In the 1900s, Mexico and Asia were victims of such crisis. With a view to cut down on volatility rising from hot money, some countries like Chile have stipulated minimum time limit for investment. This type of restrictions contains the issue of capital flight while losing out some investment in the bargain. Financial crises, as well as booms mostly in developing nations, are closely related to the issue of capital flight. Plus it has been observed that nations with weak macroeconomic fundamentals are more susceptible to an economic crisis.

Hot Money Types

Some conventional types of hot money are mentioned below.

• Interest-sensitive deposits, which include short term bank certificates of deposits. Investors (both corporate investors and institutional investors) promptly shift CDs from banks offering lower interest rates to one offering a higher one.
• Surplus funds, which commercial banks buy or sell among each other in the money market. This type of fund transactions are usually conducted on a short term or overnight basis
• Uninsured deposits
• Bait money of bank teller. These are specially marked bills available in a teller’s drawer. This money is marked to aid in the identification of cash robbery.

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Definition Sources