Characteristics of the money market

NOVEMBER 9, 2008

in FINANCE MANAGEMENT

The money market is a market for financial assets that are close substitutes for money.
It is a market for overnight short-term funds and instruments having a maturity period of
one or less than one year. It is not a place (like the Stock market), but an activity
conducted by telephone. The money market constitutes a very important segment of the
Indian financial system.

The characteristics of the money market are:

1. It is not a single market but a collection of markets for several instruments

2. It is wholesale market of short term debt instruments
3. Its principal feature is honor where the creditworthiness of the participants is
important.
4. The main players are: Reserve bank of India (RBI), Discount and Finance House of
India (DFHI), mutual funds, banks, corporate investor, non-banking finance companies
(NBFCs), state governments, provident funds, Primary dealers. Securities Trading
Corporation of India (STCI), public sector undertaking (PSUs), non-resident Indians and
overseas corporate bodies.
5. It is a need based market wherein the demand and supply of money shape the
market.
Functions of the Money Market:

A money market is generally expected to perform three broad functions:

1. Provide a balancing mechanism to even out the demand for and supply of short term
funds
2. Provide a focal point for central bank intervention for influencing liquidity and general
level of interest rates in the economy.
3. Provide reasonable access to suppliers and users of short term funds to fulfill their
borrowings and investment requirements at an efficient market clearing price.
Besides the above functions, a well functioning money market facilitates the
development of a market for longer term securities. The interest rates for extremely
short term use of money serve as a benchmark for longer term financial instruments.
Benefits of an Efficient Money Market:

An efficient money market benefits a number of players. It provides a stable source of

funds to banks in addition to deposits allowing alternative financing structures and
competition. It allows banks to manage risks arising from interest rate fluctuations and
to manage the maturity structure of their assets and liabilities.

A developed inter-bank market provides the basis for growth and liquidity in the money
including the secondary market for commercial paper and treasury bills.

An efficient money market encourages the development of non-bank intermediaries

thus increasing the competition for funds. Savers get a wide array of savings
instruments to choose from and invest their savings.

A liquid money market provides an effective source of long term finance to borrowers.
Large borrowers can lower the cost of raising funds and manage short term funding or
surplus efficiently.

A liquid and vibrant money market is necessary for the development of a capital market,
foreign exchange market, and market in derivative instruments. The money market
supports the long term debt market by increasing the liquidity of securities. The
existence of an efficient money market is a precondition for the development of a
government securities market and a forward foreign exchange market.

Trading in forwards, swaps, and futures is also supported by a liquid money market as
the certainty of prompt cash settlement is essential for such transactions. The
government can achieve better pricing on its debt as it provides access to a wide range
of buyers. It facilitates the government market borrowing.

Monetary control through indirect methods (repos and open market operations) is more
effective if the money market is liquid. In such a market response to the central bank’s
policy actions are both faster and less subject to distortion.

The Indian Money Market:

The average turnover of the money market in India is over Rs 40,000 crore daily. This is
more than 3 per cent of the total money supply in the Indian economy and 6 percent of
the total funds that commercial banks have let out to the system. This implies that 2 per
cent of the annual GDP of India gets traded in the money market in just one day. Even
though the money market is many times larger than the capital market, it is not even a
fraction of the daily trading in developed markets.

haracteristics of Money Market Funds

By Sylvia Cochran, eHow Contributor

Characteristics of Money Market Funds

Characteristics of money market funds show that they rank among the relatively safe investments.
Even though there are no guarantees when it comes to any commodity, these funds combine low
risk securities investments with ready liquidity. If you are unsure if you should forego opening a
savings account or interest-bearing checking account in favor of money market funds, read on.

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Identification
1. Money market funds are investments. They work like mutual funds and bundle the funds
from a variety of investors to increase the individual shareholder's buying power. The
commodity that is being traded is short-term debt. The Securities and Exchange Commission
(a link is listed in the resources section) stipulates that money market funds can only invest
in low risk commodities.

Value
2. Each share in a money market fund is worth $1. The goal is to offer you a return on your
investment, but at the very least to preserve the full value of the investment at all times.

Features
3. Some money market funds are tax free but provide a lower yield for the investment. Taxable
funds provide a higher yield, but they also require you to pay tax on your gains. Investopedia
 (a link is provided in the resources section) discusses the tax advantages and disadvantages
of lower yield taxable funds in meticulous detail.

Benefits
4. Consumers like brokerage offered money market funds because they can be cashed out
quickly---like savings account---but have the potential for a higher yield than the low savings
account percentages. Since the commodities they invest in are usually safe, consumers feel
comfortable leaving their ready savings in such accounts. Additionally, since the minimum
purchase requirements are lower than those of other investments, more investors have a
chance to buy into these funds.

Warning
5. The recent default of several financial institutions showcases that investments are only as
good as the brokerages that secure them, and money market funds are no different. They
are not FDIC insured, and if the financial institution that holds them fails, your money is gone.

Prevention/Solution
6. The SEC realized that the September 2008 market crash left investors unfairly deprived of
funds and in an effort to make money market funds more attractive in the future, the agency
temporarily offers a "guarantee program" (a link is posted in the resources section) for
defunct funds that were in existence on or prior to September 2008.

Misconceptions
7. Even though one of the characteristics of money market funds is their ready liquidity,
consumers believe that a second advantage is that they pay a lot more than all of the bank
sponsored investment options. This is incorrect. As a matter of fact, certificates of deposit
frequently pay a higher return on investment than money market funds