Question

Define a money market. (b). State and explain four money market instruments. (c). Explain three functions or uses of money markets. (d). What are the determinants of money market instruments.

Answer 1

a) A section of the financial market where financial instruments with high liquidity and short-term maturities traded is termed as money market. basically it is a component of the financial market for buying and selling of securities of short-term maturities, of one year or less, such as treasury bills and commercial papers.

b) Basically money market instrument refers to an investment mechanism that allows banks, businesses, and the government to meet large, but short-term capital needs at a low cost. Money market instrument serve the dual purpose of allowing borrowers meet their short-term requirements and providing easy liquidity to lenders.

Examples of Money Market Instrument

• Treasury Bills
• Repurchase Agreements
• Certificate of Deposits
• Commercial Papers

1. Treasury Bills (T-Bills)

Treasury bills which is also known as T- Bills are issued by the Reserve Bank of India for raising money on behalf of the Central Government . They have short term maturities with highest upto one year. Right now, T- Bills are issued with 3 different maturity periods, which are, 91 days T-Bills, 182 days T- Bills, 1 year T – Bills.

T-Bills are issued at a discount to the face value. At maturity, the investor gets the face value amount. This difference between the initial value and face value is the return earned by the investor. They are the safest short term fixed income investments as they are backed by the Government of India.

2. Commercial Papers

Large companies and businesses issue promissory notes to raise capital to meet short term business needs, known as Commercial Papers (CPs). These firms have a high credit rating, owing to which commercial papers are unsecured, with company’s credibility acting as security for the financial instrument.

Corporates, primary dealers (PDs) and All-India Financial Institutions (FIs) can issue CPs.

CPs have a fixed maturity period ranging from 7 days to 270 days. However, investors can trade this instrument in the secondary market. They offer relatively higher returns compared to that from treasury bills.

3. Certificates of Deposits (CD)

CDs are financial assets that are issued by banks and financial institutions. They offer fixed interest rate on the invested amount. The primary difference between a CD and a Fixed Deposit is that of the value of principal amount that can be invested. The former is issued for large sums of money ( 1 lakh or in multiples of 1 lakh thereafter).

Because of the restriction on minimum investment amount, CDs are more popular amongst organizations than individuals who are looking to park their surplus for short term, and earn interest on the same.

The maturity period of Certificates of Deposits ranges from 7 days to 1 year, if issued by banks. Other financial institutions can issue a CD with maturity ranging from 1 year to 3 years.

4. 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. The interest rate charged by the buyer for agreeing to buy the security is called Repo rate. Repos come-in handy when the seller needs funds for short-term, s/he can just sell the securities and get the funds to dispose. The buyer gets an opportunity to earn decent returns on the invested money

C) function or uses of money market:

I)It contributes to the growth of industries in two ways: Also, They help industries secure short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc. Industries generally need long-term loans, which are provided in the capital market.

ii)  It plays a very important role of making funds available to many units or entities engaged in diversified field of activities be it agriculture, industry, trade, commerce or any other business.

iii) It provides opportunity for short term investments, which provide for short term savings, which in turn help formation of capital base also.

d) Various types of money market instruments are clubbed together to pose as one of the safest investment tool available in the market. They are still affected by stock market fluctuations, as stated previously. This is basically one of the determinant .

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