“MONEY MARKET AND ITS INSTRUMENTS”

WHAT IS MONEY MARKET?

Money Market is a financial market where short-term financial assets having liquidity of one
year or less are traded on stock exchanges. The securities or trading bills are highly liquid.
Also, these facilitate the participant’s short-term borrowing needs through trading bills. The
participants in this financial market are usually banks, large institutional investors, and
individual investors.
There are a variety of instruments traded in the money market in both the stock exchanges,
NSE and BSE. These include treasury bills, certificates of deposit, commercial paper,
repurchase agreements, etc. Since the securities being traded are highly liquid in nature, the
money market is considered as a safe place for investment.
The Reserve Bank controls the interest rate of various instruments in the money market. The
degree of risk is smaller in the money market. This is because most of the instruments have a
maturity of one year or less.
Hence, this gives minimal time for any default to occur. The money market thus can be
defined as a market for financial assets that are near substitutes for money.

OBJECTIVES OF MONEY MARKET:

 Providing borrowers such as individual investors, government, etc. with short-term
funds at a reasonable price. Lenders will also have the advantage of liquidity as the
securities in the money market are short-term.
 It also enables lenders to turn their idle funds into an effective investment. In this
way, both the lender and borrower are at a benefit.
  RBI regulates the money market. Therefore, in turn, helps to regulate the level of
liquidity in the economy.
 Since most organizations are short on their working capital requirements. The money
market helps such organizations to have the necessary funds to meet their working
capital requirements.
 It is an important source of finance for the government sector for both national and
international trade. And hence, provides an opportunity for the banks to park their
surplus funds.

IMPORTANCE OF MONEY MARKET:

The money market is a market for short term transactions. Hence it is responsible for the
liquidity in the market. Following are the reasons why the money market is essential:
 It maintains a balance between the supply of and demand for the monetary
transactions done in the market within a period of 6 months to one year.
 It enables funds for businesses to grow and hence is responsible for the growth and
development of the economy.
 It aids in the implementation of monetary policies.
 It helps develop trade and industry in the country. Through various money market
instruments, it finances working capital requirements. It helps develop the trade in and
out of the country.
 The short-term interest rates influence long term interest rates. The money market
mobilises the resources to the capital markets by way of interest rate control.
 It helps in the functioning of the banks. It sets the cash reserve ratio and statutory
liquid ratio for the banks. It also engages their surplus funds towards short term assets
to maintain money supply in the market.
 The current money market conditions are the result of previous monetary policies.
Hence it acts as a guide for devising new policies regarding short term money supply.
 Instruments like T-bills, help the government raise short term funds. Otherwise, to
fund projects, the government will have to print more currency or take loans leading
to inflation in the economy. Hence the it is also responsible for controlling inflation.

WHAT ARE MONEY MARKET INSTRUMENTS?

Money market instruments are financial instruments that help companies, corporations, and
government bodies to raise short-term debt for their needs. The borrowers meet their short-
term needs at a low cost and the lenders benefit from interest rates and liquidity. Money
market instruments include bonds, treasury bills, certificates of deposit, commercial paper
and many others.
ADVANTAGES OF MONET MARKET INSTRUMENTS:
Money market instruments offer higher liquidity in comparison to other fixed income
instruments. With no lock-in period, an investor can sell their investments at any time.
Furthermore, the rate of return on a money market instrument is marginally higher in
comparison to interest on savings accounts.

DISADVANTAGES OF MONEY MARKET INSTRUMENTS:

No doubt the interest rate is higher in comparison to savings bank accounts. However, the
rate of interest does not account for the increasing inflation in the economy. While other
investment instruments like mutual funds offer a higher return on investment over the long
term. Hence, if the investment objective is to seek capital appreciation with inflation-beating
returns then money market instruments are not an ideal choice.

CHARACTERISTICS OF MONEY MARKET INSTRUMENTS:

 It is a financial market and has no fixed geographical location.
 It is a market for short term financial needs, for example, working capital needs.
 Its primary players are the Reserve Bank of India (RBI), commercial banks and
financial institutions like LIC, etc.,
 The main money market instruments are Treasury bills, commercial papers, certificate
of deposits, and call money.
 It is highly liquid as it has instruments that have a maturity below one year.
 Most of the money market instruments provide fixed returns.

TYPES OF MONEY MARKETS IN INDIA:

 Treasury bills
 Commercial bills
 Certificate of deposit
 Commercial paper
 Call money

TREASURY BILLS:
Treasury bills are one of the most popular money market instruments. They have varying
short-term maturities. The Government of India issues it at a discount for 14 days to 364
days.
These instruments are issued at a discount and repaid at par at the time of maturity. Also, a
company, firm, or person can purchase TB’s. And are issued in lots of Rs. 25,000 for 14 days
& 91 days and Rs. 1,00,000 for 364 days.

COMMERCIAL BILLS:
Commercial bills, also a money market instrument, works more like the bill of exchange.
Businesses issue them to meet their short-term money requirements.
These instruments provide much better liquidity. As the same can be transferred from one
person to another in case of immediate cash requirements.

CERTIFICATE OF DEPOSIT:
Certificate of Deposit (CD’s) is a negotiable term deposit accepted by commercial banks. It is
usually issued through a promissory note.
CD’s can be issued to individuals, corporations, trusts, etc. Also, the CD’s can be issued by
scheduled commercial banks at a discount. And the duration of these varies between 3
months to 1 year. The same, when issued by a financial institution, is issued for a minimum
of 1 year and a maximum of 3 years.

COMMERCIAL PAPER:
Corporates issue to meet their short-term working capital requirements. Hence serves as an
alternative to borrowing from a bank. Also, the period of commercial paper ranges from 15
days to 1 year.
The Reserve Bank of India lays down the policies related to the issue of CP’s. As a result, a
company requires RBI’s prior approval to issue a CP in the market. Also, CP has to be issued
at a discount to face value. And the market decides the discount rate.
Denomination and the size of CP:
Minimum size – Rs. 25 lakhs
Maximum size – 100% of the issuer’s working capital.

CALL MONEY:
It is a segment of the market where scheduled commercial banks lend or borrow on short
notice (say a period of 14 days). In order to manage day-to-day cash flows.
The interest rates in the market are market-driven and hence highly sensitive to demand and
supply. Also, the interest rates have been known to fluctuate by a large % at certain times.
FEATURES OF MONEY MARKET:
 It can be called as a collection of the market. Its main feature is liquidity. All the
submarkets, such as call money, notice money, etc. have close interrelation with each
other. This helps in the movement of funds from one sub-market to another.
 The volume of traded assets is generally very high.
 It enables the short-term financial needs of the borrowers. Also, it deals with
investments that have a maturity period of 1 year or less.
 It is still evolving. There is always a possibility of adding new instrument.

WHAT IS STOCK MARKET?

A stock market is a marketplace where buyers and sellers transact in securities of publicly
listed companies. The securities that trade in the stock market are equity shares, bonds,
derivatives, commodities, etc. The trading of securities happens over the stock exchanges or
over the counter (OTC) that operate under certain regulations.

MONEY MARKET VS STOCK MARKET:

PARTICULARS MONEY MARKET STOCK MARKET

MATURITY OF THE The money market instruments However tradable in the short term, stocks
INSTRUMENTS carry a maturity period of less than create wealth creation when invested for a
a year. number of years.

FINANCING NEEDS These instruments are used to fund Used for long-term fund requirements.
the short-term needs of the
borrower.

TYPES OF It has instruments like T-bills, It’s a stock of an independently listed

INSTRUMENTS certificate of deposits, inter-bank company
call money, etc.

DEGREE OF RISK Risk is comparatively lower due to Risk is higher.

the short-term maturity period

WHAT ARE MONEY MARKET FUNDS?

Money Market Mutual Funds, MMMFs are highly liquid open-ended dent funds generally
used for short term cash needs. The money market fund deal only in cash and cash
equivalents with an average maturity of a year with fixed income.
The fund manager invests in money market instruments like treasury bills, commercial paper,
certificate of deposits, bills of exchange etc.

FACTORS TO DETERMINE INTEREST RATES OF MONEY MARKET

INSTRUMENTS:
Currently, the interest rate is dependent on the market forces of demand for; and supply of
short-term money.
Fiscal deficit, for example, occurs when the government expenditure is more than
government revenue. To fund this deficit, the government requires money which in turn leads
to borrowing by the government and hence influencing the interest rates. 
In other words, the higher the fiscal deficit more will be the money required by the
government. Hence, it will lead to an increase in interest rates.

WHAT IS MATURITY?
The maturity in respect of money market instruments means the time period within which the
securities will mature. This is generally less than a year in case of money market instruments.

WHAT IS THE YIELD ON SECURITY?

In simple words, the yield is the interest rate earned by investing securities It can be
calculated by the below formula:
Yield = (Face value – Sale value)/sale value * (days or months in a year/period of
discount) * 100
Let’s understand the above with the help of an example:
Face value or amount of issue – Rs. 100
Period – 6 months
Discount rate – 10%
Discount – 100*(6/12) * (10/100) = Rs. 5
By using the above formula for yield we get
Y = (100-95)/100*(12/6) * 100
Y = 10%

WHO CAN INVEST IN MONEY MARKET?

Investors including corporations, banking institutions, companies, and individuals can invest
in money market instruments. Money market instruments are best suited for the short-term
investment objectives of the investors. Hence, an investor who wishes to earn a higher
interest rate on their surplus funds must consider these instruments.