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Lecture 39

Lecture 39

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Published by: praneix on Aug 11, 2009
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MONEYLearning outcomes
After studying this unit, you should be able to:
Define Money market
Know constituents of money market
Distinguish between money market and capital market
Identify the features of new money market instruments
Money is something which sounds interesting to each and everyone. Money is not onlyneeded to buy something but it is also needed to various other purpose.
Meaning of Money Market
. A money market is a market for short-term loans.The dealers in the money market comprise various institutions. The borrowers (or buyers) include government and private institutions. The lenders include variousfinancial and other institutions and individuals. The commodities traded in this marketare various types of monetary assets, like the bills, government bonds, hundis, etc.The Reserve Bank defines money market as “
The center for dealings, mainly of short-term character, in monetary assets; it meets the short-term requirements of borrowers and provides liquidity or cash to the lenders. It is the place where short-termsurplus invisible funds at the disposal of financial and other institutions are bid by borrowers, again comprising institutions and individuals and also by the government.” 
Thus, the major function of the market is to provide finance for short term to variouspublic and private institutions.The money market deals in various kinds of loans. Each may be said toconstitute a market by itself, like call money market, bill market, collateral loan market,etc. The money market is a broad term for all these markets put together.
Money Market and Capital Market,
While operations of money market arelimited to short-term loans, a capital market is the market for long-term loans. Such loansare demanded by business houses, governments, and consumers wanting to purchasedurable consumer goods. Some of these borrowings are done directly by the borrowersfrom the general public by the issue of various instruments. But a substantial part of theloans in a capital market is supplied by the financial intermediaries that form part of thecapital market. These intermediaries get their funds primarily from the savings of households to be available for long-term financing of investment and consume goodsexpenditure.
Constituents of the Indian Money Market.
The Major constituents of theIndian money market can be classified into three groups, viz. (i) organised sector, (ii)unorganized sector, and (iii) co-operative sector.(i) The main constituents of the organized sector are the Reserve Bank, the StateBank and the various commercial banks. Quasi-government bodies and large-sizedcommercial firms also operate in this market as lenders and financial intermediaries,such as loan brokers and general finance and stock brokers take part in thetransactions.
(ii) The unorganised market on the indigenous market comprises theindigenous bankers and moneylenders, working both in rural and urban areas. In thismarket, there is no clear demarcation between short-term and long-term finance, nor even between the purposes of finances, inasmuch a there is usually nothing on a
(which is indigenous bill of exchange) to indicate whether it is for financing trade, or for providing financial accommodation; in other words, whether it is a genuine trade bill or afinancial paper. By and large, these bills are accommodation bills.(iii) A somewhat intermediate position between the organized andunorganized sectors of the money market is occupied by the co-operative creditinstitutions. These institutions were set up mainly with a view to supplanting theindigenous sources of rural credit, particularly the moneylenders, since the creditprovided by the moneylenders was subject to many drawbacks, especially high interestrates. While considerable progress has been made in fulfilling this objective in the lastfew years, the total credit requirements of the rural sector have also increasedconsiderably. The Reserve Bank has stepped up substantially the credit assistance tothis sector and to supplement the efforts of the co-operative sector, regional rural banksand commercial banks are also entering the rural economy in a big way. With thenotable increase in the number of commercial bank branches in the rural areas in thelast decade, closer link have been forged between the co-operative credit system andthe organized money market, particularly with the State Bank of India.
Composition of the Organised Market
The organized money market consumeof (i) call money market, (ii) bill market, and (iii) collateral loan market.(i)
Call money
comprises dealings primarily among banks. It is the mostsensitive section of the money market. The rates of interest in this market vary fromtime to time according to the volume of transactions, being higher in the busy seasonthan in the slack season.(ii)
Bill market
comprises dealings in short-term bills of exchange, includinghundis of the indigenous bankers. Bill market in India has developed quite late—it hadits real beginning only after the introduction by the Reserve Bank of its New Bill MarketScheme in 1970. Since then, although this market is developing, it is as yet not a veryprominent feature of the Indian money market.(iii)
Collateral loan market
forms, by and large, the largest and the bestdeveloped section of the money market. It this market, loans are given against thesecurity of government bonds, shares of first class companies, agriculture andmanufactured commodities, and bullion and jewellery.SALIENT FEATURES OF NEW MONEY MARKET INSTRUMENTSThe present position of major money market instruments that are dealt with in theIndian money market is as under:(a)
Call and Notice Money
In this market, funds are borrowed and lent for one day (call) and for a period up to 14days (notice) without any collateral security. However, deposit receipt is issued to the lender whoon recalling the funds, discharges the receipt and gives back to the borrower; upon which theborrower will repay the amount together with interest. The participants in this market arecommercial and co-operative banks, mutual funds and all-India financial institutions approved bythe Reserve Bank of India. From May 1, 1989, the interest rates in the call and notice moneymarket are market-determined. Interest rates in this market are highly sensitive to the demandand supply factors. Within one fortnight, rates are known to move to as high as over 70 per centto as low as 2-3 per cent; intra-day variations are also quite high. Variation of as high as 10percentage points is not uncommon.
Inter-Bank Term Money
This is a market exclusively for banks—commercial and co-operative banks. In thismarket, banks borrow and lend funds for a period over 14 days and generally up to 90 dayswithout any collateral security at market-determined rates. Deposit receipts are exchanged. Asper IBA ground rules lenders cannot prematurely recall these funds. Hence, this instrument is notliquid.
Treasury Bills
Treasury Bills are short-term promissory notes issued by Government of India at adiscount for period of 91 days and 182 days. Presently, 91 days treasury bills are issued by theReserve Bank of India on tap basis at a fixed discount rate of 4.60 per cent per annum. 91 daystreasury bills are rediscounted by the Reserve bank of India but “additional early rediscountingfees” are levied for rediscounting of these bills within 14 days from the date of purchase. Hence,91 days treasury bill has ceased to be of any significance to the money market.
More relevant to the money market is the introduction of 182 Days Treasury Billson auction basis in November 1986. The rate of discount is determined on the basis of the outcome at the auctions. 182 Days Treasury Bills can be purchased by any personresident in India (except State Government and Provident Funds) for a minimumsubscription of Rs. 1 lakh. Every fortnight, the Reserve Bank of India invites bids for sale of 182 Days Treasury Bills. The bids are scrutinized by a committee headed by aDeputy Governor of the Reserve Bank of India. The committee decides on a cut-off price and all bids quoting price equal to or higher than the cut-off price are accepted for allotment. Other bids are rejected.Since 182 Days Treasury Bills can be acquired by any investor (other than StateGovernment and Provident Funds), having short-term surpluses, this instrument haspotentiality of providing a link between various segments of the financial markets throughshift of funds from cash to Treasury Bills and
vice versa.
Commercial Bills
 Bills of exchange are drawn by the seller (drawer) on the buyer (drawee) of thevalue of goods delivered to him. Such bills are called trade bills. When trade bills areaccepted by commercial banks they are called commercial bills. If the seller wishes togive some period for payment, the bill would be payable at a future date (usance bill).During the currency of the bill, if the seller is in need of funds, he may approach his bankfor discounting the commercial bills at a prescribed discount rate. The bank will receivethe maturity proceeds (face value) of discounted bill from the drawee. In the meanwhile,if the bank is in a need funds, it can rediscount the bills already discounted by it in thecommercial bill rediscount market at the market-related rediscount rate. Scheduledcommercial banks, all-India financial institutions, mutual funds and select scheduledState co-operative banks are approved participants in this market.The eligibility criteria prescribed by the Reserve Bank of India for rediscountingcommercial bills
inter alia
are that the bills should arise out of genuine commercial or trade transactions evidencing sale of goods, and maturity date of the bill should not bemore than 90 days from the date of rediscounting.(e)
Certificates of Deposit
Certificates of Deposit (CDs) are negotiable term deposit certificates issued bycommercial banks of bulk depositors at market related rates. In June 1989, the ReserveBank of India issued guidelines for issue of CDs. CDs can be issued by commercialbanks at discount to face value for a period from 3 months up to one year. On maturity,face value of the CDs is paid to the last holder by the issuing bank. CDs can be issuedfor minimum amount of Rs. 25 lakhs to a single investor in the minimum denomination of 

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