What is Money Market? And Its Instruments

The money market Is a market for short-term funds which deals in monetary assets whose period of maturity is up to one year. These assets are close substitutes for money. It is a market where low risk, unsecured and short-term debt Instruments that are highly liquid are issued and actively traded every day. It has no physical location.

But is an activity conducted over the telephone and through the internet? It enables the raising of short-term funds for meeting the temporary shortages of cash and obligations and the temporary deployment of excess for earning returns.

The major participants in the market are the Reserve Bank of India (RBI), Commercial Banks, Finance Companies, State Governments. Large Corporate Houses and Mutual Funds.

Money Market Instruments

Money Market Instruments

1. Treasury Bill: A Treasury bill Is basically an instrument of short-term borrowing by the Government or India maturing In less than one year. They are also known as Zero Coupon Bonds Issued by the Reserve Bank of India on behalf of the Central Government to meet its short-term requirement or funds. Treasury bills are Issued in the form of a promissory note.

They are highly liquid and have assured yield and negligible risk of default. They are issued at a price which Is lower than their face value and repaid at par. The difference between the price at which the treasury bills are Issued and their redemption value Is the Interest receivable on them and Is called a discount. Treasury bills are available for a minimum amount of Rs 25.00o and in multiples thereof.

2. Commercial Paper: Commercial paper is a short-term unsecured Promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It Is Issued by large and creditworthy companies to raise short-term funds at lower rates of interest than market rates. It usually has a maturity period of 15 days to one year. The Issuance of commercial paper Is an alternative to bank borrowing for large companies that are generally considered to be financially strong. It is sold at a discount and redeemed at par.

The original purpose of the commercial paper was to provide short-term funds for seasonal and working capital needs. For example companies use this instrument for purposes such as bridge financing.

Example: Suppose a company needs long-term finance to buy some machinery. In order to raise the long-term funds in the capital market, the company will have to incur floatation costs (costs associated with floating or an issue are brokerage, commission, printing of applications and advertising etc.). Funds raised through commercial paper are used to meet the floatation ôosts. This is known as Bridge Financing.

3. Call money: Call money Is short-term finance repayable on demand, with a maturity period of one day to fifteen days, used for Inter-bank transactions. Commercial banks have to maintain a minimum cash balance known as cash reserve ratio. The Reserve Bank of India changes the cash reserve ratio from time to time which In turn affects the number of funds available to be given as loans by commercial banks.

Call money Is a method by which banks borrow from each other to be able to maintain the cash reserve ratio. the Interest rate paid on call money loans Is known as the call rate. It is a highly volatile rate that varies from day-to-day and sometimes even from hour-to-hour. There Is an Inverse relationship between call rates and other short-term money market Instruments such as certificates of deposit and commercial paper.

A rise In call money rates makes other sources of finance such as commercial paper and certificates of deposit cheaper in comparison for banks raise funds from these sources.

4. Certificate of Deposit: Certificates of deposit (CD) are unsecured, negotiable short-term Instruments In bearer form. Issued by commercial banks and development financial institutions. They can be issued to individuals, corporations, and companies during periods of tight liquidity when the deposit growth of banks is slow but the demand for credit is high. They help to mobilize a large amount of money for short periods.

5. Commercial Bill: A commercial bill is a bill or exchange used to finance the working capital requirements of business firms. It is a short-term, negotiable, self-liquidating instrument which is used to finance the credit sales of firms. When goods are sold on credit. the buyer becomes liable to make payment on a specific date in future. The seller could wait till the specified date or make use of a bill of exchange.

The seller (drawer) of the goods draws the bifi and the buyer (drawee) accepts it. On being accepted, the bull becomes a marketable instrument and is called a trade bill. These bills can be discounted with a bank Ir the seller needs funds before the bill matures. When a trade bill Is accepted by a commercial bank It Is as a commercial bill.