The money market is an organized exchange market where participants can lend and borrow short-term, high-quality debt securities with average maturities of one year or less. It enables governments, banks, and other large institutions to sell short-term securities to fund their short-term cash flow needs. Money markets also allow individual investors to invest small amounts of money in a low-risk setting. Some of the instruments traded in the money market include Treasury bills, certificates of deposit, commercial paper, federal funds, bills of exchange, and short-term mortgage-backed securities and asset-backed securities.
Large corporations with short-term cash flow needs can borrow from the market directly through their dealer, while small companies with excess cash can borrow through money market mutual funds.
Features of Money Market Instruments
High Liquidity- One of the key features of these financial assets is high liquidity offered by them. They generate fixed-income for the investor and short term maturity makes them highly liquid. Owing to this characteristic money market instruments are considered as close substitutes of money.
Secure Investment- These financial instruments are one of the most secure investment avenues available in the market. Since issuers of money market instruments have a high credit rating and the returns are fixed beforehand, the risk of losing your invested capital is minuscule.
Fixed returns- Since money market instruments are offered at a discount to the face value, the amount that the investor gets on maturity is decided in advance. This effectively helps individuals in choosing the instrument which would suit their needs and investment horizon.
Types of Instruments Traded in the Money Market
Treasury bills- are short term borrowing instruments issued by the Government of India. These are the oldest money market instruments that are still in use. The Treasury bill does not pay any interest, but are available at a discount of face value at the time of issue. Treasury Bills can be classified in two ways i.e. based on maturity and bases on type. These are the safest instruments as they are backed by a government guarantee. The rate of return, also known as risk-free rate, is low for treasury bills like T-364, T-182 and so on, as compared to all other instruments.
Commercial papers- commercial papers is an unsecured money market instruments issued in the form of promissory note. It was introduced In India in 1990 with the objectives of enabling corporate borrowers diversify their sources of short-term borrowing and to provide an additional investment instrument to investors. Commercial paper is a money-market security issued (sold) by large corporations to obtain funds to meet short-term debt obligations and is backed only by an issuing bank or company’s promise to pay the face value on the maturity date specified on the note.
Certificate of Deposit- A certificate of deposit (CD) is issued directly by a commercial bank, but it can be purchased through brokerage firms. It comes with a maturity date ranging from three months to five years and can be issued in any denomination. Most CDs offer a fixed maturity date and interest rate, and they attract a penalty for withdrawing prior to the time of maturity. Just like a bank’s checking account, a certificate of deposit is insured by the Federal Deposit Insurance Corporation (FDIC).
Banker’s acceptance- a banker’s acceptance is a document that promises future payment that is guaranteed by the commercial bank. It is considered to be a very safe investment option and is widely used in foreign trade, bankers acceptance are time drafts which are accepted and guaranteed by the banks and drawn on a deposit at the bank. The maturity period of banker’s acceptance can range from 30 to 180 days.
Repurchase Agreements- Also known as repos or buybacks, Repurchase Agreements are a formal agreement between two parties, where one party sells a security to another, with the promise of buying it back at a later date from the buyer. It is also called a Sell-Buy transaction. The seller buys the security at a predetermined time and amount which also includes the interest rate at which the buyer agreed to buy the security.
Function of money market
Provides funds– the money market provides short term funds for borrowing at a lower rate of interest. The private and the public institutions can borrow money from the money market to finance capital requirements and fund business growth through the system of finance bills and commercial paper. The govt. can also borrow funds the money market by issuing treasury bills. However, money market issues money market instruments like commercial papers, treasury bills and so on and helps in development of trade, industry and commerce within and outside India.
Central Bank Policies- The central bank is responsible for guiding the monetary policy of a country and taking measures to ensure a healthy financial system. Through the money market, the central bank can perform its policy-making function efficiently.
For example, the short-term interest rates in the money market represent the prevailing conditions in the banking industry and can guide the central bank in developing an appropriate interest rate policy. Also, the integrated money markets help the central bank to influence the sub-markets and implement its monetary policy objectives.
Helps government- the money market instruments helps the government raise money for financing government projects for public welfare and infrastructure development. The govt. can borrow short term funds by issuing treasury bills at low interest rates. On the other hand, if the government were ton issue paper money or borrow short term funds by issuing treasury bills at low interest rates. On the other hand, if the govt. were to issue paper money or borrow from the central bank, it would lead to inflation in the economy.
Helps in Financial Mobility- the money market helps in financial mobility by enabling easy transfer of funds from one sector to the other. Financial mobility is essential for the development of industry and commerce in the economy.
Promote Liquidity and Safety- this is one of the most important functions of money market, as it provides safety and liquidity of funds. It also encourages saving and investments. These investments instruments have shorter maturity which means they can readily be converted to cash. The money market instruments are issues by entities with good credit score which a=makes them safe investment option.
Economy in use of cash- as the money market deals in near-money assets and not proper money; it helps in economizing the use of cash. It provides a convenient and safe way of transferring funds from one place to another, there by immensely helps commerce and industry in India.