Instruments of Money Market
A market that serves as a link between the savers and borrowers, by transferring the capital or money from those who have a surplus amount of money to those who are in need of money or investment, is known as Financial Market. Simply put, Financial Market is a market that creates and exchanges financial assets. In general, the investors are known as the surplus units and business enterprises are known as the deficit units. Hence, a financial market acts as a link between surplus units and deficit units and brings the borrowers and lenders together. One can allocate funds with the help of the following two main ways:
- Through Banks
- Through Financial Markets
The households (who are the surplus units) may keep their savings in banks or they may use that amount for buying securities from the capital market. The financial market and banks then lend the funds to the business firms (who are the deficit units). The banks and financial market compete with each other. Financial Markets are classified into two broad categories; namely, Capital Market(Primary Market and Secondary Market) and Money Market.
A market for short-term funds that are meant to use for a period of up to one year is known as Money Market. In the general case, the money market is the source of funds or finance for working capital. The transactions held in the money market involve lending and borrowing of cash for a short term and also consist of the sale and purchase of securities with one year term or securities which get paid back (redeemed) within one year. Some of the common instruments of the money market are Call Money, Commercial Bills, T. Bills, Commercial Paper, Certificates of Deposits, etc. A money market does not have a fixed geographical location; however, it includes every organisation and institution dealing with short-term debts. Some of the common institutes are the State Bank of India, Reserve Bank of India, LIC, UTI, other Commercial Banks, etc.
Some of the features of a Money Market are as follows:
1. It is a market for the short term.
2. There is no fixed geographical location of a money market.
3. Some of the common instruments of the money market are Call Money, Commercial Bills, Certificates of Deposits, etc.
4. Some of the major institutions involved in the money market are LIC, GIC, RBI, Commercial Banks, etc.
Instruments of Money Market
Some of the common instruments of the money market are as follows:
1. Call Money
The money borrowed or lent on demand for a short period of time (generally one day) is known as Call Money. The term of the call money does not include Sundays and other holidays. It is used mostly by banks. It means that when one bank faces a temporary shortage of cash, then the bank with surplus cash lends the former bank with money for one or two days. It is also known as Interbank Call Money Market. Besides banks, other organisations like mutual funds companies, insurance companies, etc. also deal with call money. The market of call money takes place over the telephone. The liquidity of call money is just next to cash.
The maturity period of call money is extremely short and varies from one day to 15 days. Call money is required by the banks mostly to meet the minimum requirement of CRR (Cash Reserve Ratio). The interest amount paid on call money is known as the call rate. A call rate is very volatile in nature and varies from day to day, and sometimes from even hour to hour.
There is an inverse relationship between the interest rate of call money and other securities. It means that when the rate of interest of call money increases, other securities become cheap and vice-versa.
2. Treasury Bills (T. Bills)
On behalf of the Government of India, Treasury Bills are issued by the Reserve Bank of India (RBI). With the help of T. Bills, the Government of India can get short-term borrowings, as they are sold to the general public and banks. The Treasury Bills are freely transferable and negotiable instruments and are issued at a discount. As Treasury Bills are issued by the Reserve Bank of India, they are considered the safest investments. The maturity period of the Treasury Bills varies from 14 days to 364 days.
Treasury Bills are also known as Zero Coupon Bonds and are issued at a price lower than their face value and are repaid at par. The T. Bills are available for a minimum amount of ₹25,000 and in multiples thereof.
For example, Suppose Gaurav, an investor purchases a 5 months treasury bill with a face value of ₹3,00,000 for ₹2,80,000. If he holds this treasury bill till the maturity period, he will get ₹3,00,000 and the difference between the bill amount and the amount paid by him to purchase the bill is his interest received.
3. Commercial Bills
Commercial Bills also known as Trade Bills or Accommodation Bills are the bills drawn by one organisation on another. Commercial Bills are the common instruments of the money market, which are used in credit sales and purchases. The maturity period of Commercial Bills is for short-term, generally of 90 days. However, one can get the Commercial Bills discounted with the bank before the maturity period. The Trade Bills are negotiable and easily transferable instruments. The drawee of the Commercial Bill honours the bill on the due date.
A Commercial Bill is a written acknowledgement of debt. Through this written acknowledgement, the drawer or maker directs the drawee or payee to make the payment within a fixed time period. The drawee accepts this bill and becomes liable to the drawer for making the payment on the due date.
4. Commercial Paper (C.P.)
An unsecured promissory note issued by private or public sector companies with a fixed maturity period varying from 15 days to one year is known as a Commercial Paper. It was for the first time introduced in India in 1990. As this instrument is unsecured, it can be issued by companies with creditworthiness and good reputation. The main investors of commercial papers are commercial banks and mutual funds. The funds raised through commercial papers are used by the companies for meeting their floatation cost. This is called Bridge Financing.
For example, a company wants to raise long-term funds for the purchase of a new factory, machinery, and office. The company raises the funds through equity shares, debentures, etc., for which it has to incur floatation costs like brokerage, the printing of prospectus, commission, etc., These costs can be met by the firm through the issue of Commercial Papers.
Therefore, the main aim of issuing Commercial Papers are:
- Meeting Floatation Cost
- Meeting Short-term Funds for Seasonal and Working Capital Needs
5. Certificate of Deposits (C.D.)
A time or deposit that can be sold in the secondary market is known as a Certificate of Deposits (C.D.). It can be issued by a bank only and is a bearer certificate or document of title. A Certificate of Deposits is a negotiable and easily transferable instrument. The banks issue the Certificate of Deposits against the deposit kept by the institutions and companies. The time period of a Certificate of Deposits ranges from 91 days to one year. The C.D.’s can be issued to companies, corporations, and individuals during a period of tight liquidity. It is that time when the bank’s deposit growth is slow, but the credit demand is high.
Certificate of Deposits is different from Fixed Deposits.
Certificate of Deposit (CD)
Fixed Deposit (FD)
The Certificate of Deposits are freely negotiable. The Fixed Deposits are not freely negotiable.
These can be issued for a period of 91 days to one year. These can be issued for a minimum period of 14 days and has not limit on maximum time period.
These are issued at a discount on the actual amount of deposit held. These are issued for the actual amount of deposit held.
Different money market instruments are available for different sectors of a country. These instruments can be classified under each of the sector as follows:
S. No. Government and Semi-Government Private Companies Banks
Treasury Bills (T. Bills) Trade Bills or Commercial Bills Call Money
Government Securities Commercial Papers (CP)
Public Sector Units’ Bonds Certificate of Deposits (CD)
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