• Investment
  • Car
  • Bike
  • Taxi
  • Term Life
  • Health
  • Travel

Money Market Instruments

As per the Reserve Bank of India, the term ‘Money Market’ is used to define a market where short-term financial assets with a maturity up to one year are traded. The assets are a close substitute for money and support money exchange carried out in the primary and secondary market. In other words, the money market is a mechanism which facilitate the lending and borrowing of instruments which are generally for a duration of less than a year. High liquidity and short maturity are typical features which are traded in the money market. The non-banking finance corporations (NBFCs), commercial banks, and acceptance houses are the components which make up the money market.

Money market is a part of a larger financial market which consists of numerous smaller sub-markets like bill market, acceptance market, call money market, etc. Besides, the money market deals are not out in money / cash, but other instruments like trade bills, government papers, promissory notes, etc. But, the money market transactions can’t be done through brokers as they have to be carried out via mediums like formal documentation, oral or written communication.

What are Money Market Instruments

As the name suggests, money market instrument is an investment mechanism that allows banks, businesses, and the government to meet large, but short-term capital needs at a low cost. They serve the dual purpose of allowing borrowers meet their short-term requirements and providing easy liquidity to lenders.

Examples of Money Market Instrument

  • Banker’s Acceptance
  • Treasury Bills
  • Repurchase Agreements
  • Certificate of Deposits
  • Commercial Papers

Features of Money Market Instruments

  • Liquidity: They are considered highly liquid as they are fixed-income securities which carry short maturity periods of a year or less.

  • Safety: Since the issuers of money market instruments have strong credit ratings, it automatically means that the money instruments issued by them will also be safe.

  • Discounted price: One of the main features of money market instruments is that they are issued at a discount on their face value.

Functions of Money Market Instruments

Provides Funds

The Money Market Instruments help to provide short-term funds to the private and public institutions who need finance for their working capital requirements. These funds are provided by discounting the trade bills through commercial banks, brokers, discount houses, and acceptance houses. Therefore, the money market instruments, in turn, can help the development of trade, industry and commerce within and outside the country.

Use of Surplus Funds

Money market instruments provide opportunity to the banks and financial institutions to use their surplus funds profitably for a small period of time. They include commercial banks as well as large non-financial corporations, states and other local governments.

No need to borrow from banks

In case of a developed money market, there is no need to borrow money from commercial and central bank. However, if there is a short of cash requirement, they can call in some of their loans from the money market. Also, the most of the commercial banks would rather prefer to recall their loans than recalling it from the central banks at a higher rate of interest.

Helps Government

The money market instruments prove helpful to the government in borrowing short-term funds on the basis of treasury bills at low interest rates. Besides, it would lead to inflationary pressures in the economy if the Government had to issue paper money or borrow from the central bank.

Helps in Monetary Policy

The existence of a well-developed money market will help in successfully implementing the monetary policies of central bank. Is only through money market the central banks can control the banking system and therefore Influence commerce and the industry.

Helps in Financial Mobility

The Monet market helps in financial stability by smoothening the transfer for funds from one sector to another. And, financial mobility is important for the development of commerce and industry.

Promotes Liquidity and Safety

Apart from encouraging savings and investments, the money market instruments promote liquidity and safety of financial assets.

Equilibrium between Demand and Supply of Funds

The money market brings a balance between the demand and supply of loanable funds by allocating saving into investment channels.

Economy in Use of Cash

The money market instruments deal with assets which are not cash but equivalent to cash and thus help in economizing the use of cash. And hence it can be considered as a convenient way to transfer funds from one place to another.

Important Objectives of Money Market Instruments

Following are the objectives of served by a money market:

  • The money markets not only help in the storage of short-term surplus funds but also help in lowering short term deficits.

  • Money markets helps the central bank in regulating liquidity in the economy.

  • Money market assists the short-term fund users to fulfill their needs at a very reasonable rate.

  • It helps in the development of capital market and trade and industry.

  • Money markets help in designing effective monetary policies.

  • It also facilitates in streamlined functioning of commercial banks.

Instruments of the Money Market

Following are the types of Money Market Instruments:

Promissory Note:

A promissory note is one of the earliest type of bills. It is a financial instrument with a written promise by one party, to pay to another party, a definite sum of money by demand or at a specified future date, although it falls in due for payment after 90 days within three days of grace. However, Promissory notes are usually not used in the business, but USA is an exception.

Bills of exchange or commercial bills

The bills of exchange can be compared to the promissory note; besides it is drawn by the creditor and is accepted by the bank of the debater. The bill of exchange can be discounted by the creditor with a bank or a broker. Additionally, there is a foreign bill of exchange which becomes due for payment from the date of acceptance. However, the remaining procedure is the same for the internal bills of exchange.

Treasury Bills (T-Bills)

  • The Treasury bills are issued by the Central Government and known to be one of the safest money market instruments available. Besides, they carry zero risk, so the returns are not attractive. Also, they come with different maturity periods like 1 year, 6 months or 3 months and are also circulated by primary and secondary markets. The central government issues them at a lesser price than their face-value.
  • The difference of maturity value of the instrument and the buying price of the bill, which is decided with the help of bidding done via auctions, is basically the interest earned by the buyer.
  • There are three types of treasury bills issued by the Government of India currently that is through auctions which are 91-day, 182-day and 364-day treasury bills.

Call and Notice Money

Call and Notice Money exist in the market. With respect to Call Money, the funds are borrowed and lent for one day, whereas in the Notice Market, they are borrowed and lent up to 14 days, without any collateral security. The commercial banks and cooperative banks borrow and lend funds in this market. However, the all-India financial institutions and mutual funds only participate as lenders of funds.

Inter-bank Term Market

The inter-bank term market is for the cooperative and commercial banks in India who borrow and lend funds for a period of over 14 days and up to 90 days. This is done without any collateral security at the rates determined by markets.

Commercial Papers (CPs)

  • Commercial papers can be compared to an unsecured short-term promissory note which is issued by top rated companies with a purpose of raising capital to meet requirements directly from the market.
  • They usually have a fixed maturity period which can range anywhere from 1 day up to 270 days.
  • They offer higher returns as compared to treasury bills. They are automatically not as secure in comparison. Also, Commercial papers are traded actively in secondary market.

Certificate of Deposits ( CD’s )

  • This functions as a deposit receipt for money which is deposited with a financial organization or bank. The Certificate of Deposit is different from a Fixed Deposit receipt in two ways. i. Certificate of deposits are issued only of the sum of money is huge. ii. Certificate of deposit is freely negotiable.
  • The RBI first announced in 1989 that the Certificate of Investments have become the most preferred choice of organization in terms of investments as they carry low risk whilst providing high interest rates than the Treasury bills and term deposits.
  • CD’s are also issued at discounted price like the Treasury bills and they range between a span of 7 days up to 1 year.
  • The Certificate of Deposit issued by banks range from 3 months, 6 months and 12 months.
  • Note: CD’s can be issued to individuals (except minors), companies, corporations, funds, non–resident Indians, etc.

Banker’s Acceptance (BA)

  • A Banker’s Acceptance is a document that promises future payment which is guaranteed by a commercial bank. Also, it is used in money market funds and will specify the details of repayment like the date of repayment, amount to be paid, and details of the individual to which the repayment is due.
  • BA’s features maturity periods that range between 30 days up to 180 days.

Repurchase Agreements (Repo)

  • Repo’s are also known as Reverse Repo or as Repo. They are loans of short duration which are agreed by buyers and sellers for the purpose of selling and repurchasing.
  • However, these transactions can be carried out between RBI approved parties.
  • Note: Transactions can only be permitted between securities approved by RBI like the central or state government securities, treasury bills, central or state government securities, and PSU bonds.

FAQs on Money Market Instruments

What are the advantages and disadvantages of a money market account?

Advantage:

  • Money market accounts pay higher interest rates as compared to other types of banks accounts that includes passbook savings accounts and regular savings accounts, provided they maintain minimum balance.

  • However, the interest rate is compounded, tiered, and credited monthly so that a money market account gathers more profit as the account balance increases.

Disadvantage:

  • Account holders should maintain a minimum balance in their money market accounts as required by financial institutions.
  • Most of the money market accounts will only allow a limited number of monthly withdrawals and transfers.

Are Options money market instruments?

Yes, options are considered as money market instruments.

What do you mean by call money market?

The call money is an important part of Indian Money market, where surplus funds on day-to-day basis are traded.

What are some examples of money market?

The Treasury bills, repurchase agreements, commercial papers etc. are the examples of money market instrument.

Why is the money market important?

Money market is important for the following reasons:

  • It provides short-term funds

  • It helps in the growth of investments

  • It also provides opportunity for the commercial banks to operate in the economy.

Is money market safe?

Money markets are considered relatively safe as they are insured by the FDIC, ie: Federal Deposit Insurance Corporation.

Features of developed money market?

  • It has an organized banking system

  • It consists of a number of sub-markets dealing in various types of credit instruments

  • It consists of a large number of near-money assets of various types such as the bills of exchange, treasury bills, bonds etc.

  • It also has easy access to financial sources from outside as well as within the country.

What is an example of a capital market instrument?

Capital market instruments include foreign exchange, treasury bills, stocks and bonds etc.

Leave a rating!
5.0 (3 votes)