Money Market Instruments: Meaning, Types & Features Explained

Money Market: Meaning

The money market is a financial market for short-term funds, where monetary assets with a maturity period of up to one year are traded. It does not have a physical location; instead, most transactions take place through telephone, electronic platforms, and digital networks.

The money market plays a crucial role in meeting the short-term financial needs of businesses, while also providing avenues for the temporary deployment of surplus funds to earn returns.

According to Crowther: “Money market is a collective name given to various firms and institutions that deal in the various grades of near money.”

Common Instruments of the Money Market

The major instruments traded in the money market include:

1. Treasury Bills (T-Bills)
2. Commercial Paper (CP)
3. Call Money
4. Certificate of Deposit (CD)
5. Commercial Bills

These instruments ensure liquidity, safety, and short-term investment opportunities for participants.

Major Participants in the Money Market

The key institutions and entities involved in the functioning of the Indian money market are:

1. Reserve Bank of India (RBI)
2. Commercial Banks
3. Life Insurance Corporation of India (LIC)
4. General Insurance Corporation of India (GIC)
5. Non-Banking Financial Companies (NBFCs)
6. State Governments
7. Large Corporate Houses
8. Mutual Funds

These participants contribute to liquidity, stability, and efficient short-term fund management in the economy.

Features of the Money Market

1. It is a market for short-term funds, dealing in monetary assets with a maturity period of up to one year.
2. Money market instruments can sometimes be relatively expensive due to quick accessibility and high demand.
3. It is a highly liquid market, allowing participants to convert instruments into cash easily.
4. Money market instruments are less risky because of their short maturity period and the involvement of trusted institutions.
5. The expected return from money market instruments is relatively low due to their short duration and safer nature.

Correction

1. NFO – New Fund Offer
2. IPO – Initial Public Offer

Characteristics of the Money Market

1. It deals in short-term financial assets that are close substitutes for money.
2. It is primarily an over-the-phone or electronic market, with no fixed physical location.
3. It operates as a wholesale market for short-term debt instruments.
4. It is not a single market but a collection of sub-markets, each dealing with different instruments (e.g., call money, treasury bills, commercial paper).
5. It helps in the effective implementation of the monetary policy of the central bank.
6. Transactions are generally carried out without brokers, directly between participants.
7. It acts as a link between the RBI and commercial banks, enabling smooth financial operations.
8. Major participants include RBI, commercial banks, financial institutions, and corporate bodies.

Functions of the Money Market

1. It adjusts the liquidity position of commercial banks, business enterprises, and other financial institutions.
2. It helps the central bank regulate and control liquidity in the economy through varied policy tools.
3. It provides quick and reasonably priced short-term funds to borrowers.
4. It offers short-term finance to government agencies to meet their temporary financial needs.
5. It enables businesses to invest their surplus funds for short periods to earn returns.
6. It promotes the efficient flow of funds to sectors where they are most needed.
7. It acts as a coordinator between borrowers and lenders of short-term funds.
8. It enhances the liquidity and safety of financial assets within the financial system.

Instruments of the Money Market

The major instruments of the money market include:

1. Treasury Bills (T-Bills)
2. Commercial Paper (CP)
3. Call Money
4. Commercial Bills
5. Certificates of Deposit (CDs)

1. Treasury Bills (T-Bills)

Treasury Bills are short-term borrowing instruments issued by the Reserve Bank of India (RBI) on behalf of the Government of India. They are also known as Zero-Coupon Bonds and are issued in the form of promissory notes.

Key Features of Treasury Bills

1. They are highly liquid, have assured returns, and carry negligible risk due to RBI’s backing.
2. Maturity period ranges from 14 to 364 days.
3. Issued at a discount and redeemed at face value.
4. Minimum investment amount is ₹25,000.

Example: A T-bill purchased at ₹98,000 with a face value of ₹1,00,000 gives a return of ₹2,000 at maturity.

Purpose

The government uses T-bills to raise short-term funds for meeting temporary budget deficits.

Advantages of Treasury Bills

To the Government (Issuer)

1. Helps raise short-term funds to meet temporary budget deficits.
2. Absorbs excess liquidity from the economy.
3. Does not create inflationary pressure.

To Investors (Purchasers)

1. Provides a ready and liquid investment option.
2. Considered extremely safe.
3. Eligible securities for SLR requirement.
4. Provides hedging benefits.

2. Commercial Paper (CP)

Commercial Paper is a short-term, unsecured, negotiable promissory note issued by companies to raise funds at interest rates lower than market rates.

Its maturity ranges from 15 days to 1 year.

It is also used for bridge financing for example, when a company is preparing to raise long-term funds through shares or debentures and needs money to meet flotation costs (prospectus, brokerage, etc.).

• Minimum investment: ₹5 lakh, in multiples of ₹5 lakh.
• Issued at discount and redeemed at par.

Introduction of CP in India - Based on the recommendations of the Vaghul Committee (1987), RBI introduced CP in January 1990.

Key Recommendations of the Vaghul Committee

• CP can be issued directly to investors or through banks.
• Issuing company must have a net worth of at least ₹5 crore.
• Its shares should be listed on a stock exchange.
• Minimum issue size should be ₹1 crore with ₹5 lakh denomination.
• Issuing cost should not exceed 1% of the amount raised.
• RBI controls the size and timing of issues.
• No stamp duty or TDS should apply.
• Interest rate should be market-determined.
• Companies must obtain credit rating every six months (minimum “A” grade recommended).

3. Call Money

Call Money refers to very short-term finance repayable on demand.

Its maturity varies from:

• 1 day (called Call Money)
• More than 1 day to 14 days (called Short-Notice Money)

The interest paid on call money is known as the Call Rate, which is highly volatile and may change even hourly.

Purpose - Banks use call money to maintain the Cash Reserve Ratio (CRR). It is mainly used for inter-bank transactions.

Participants in the Call Money Market

Lenders and Borrowers

1. Scheduled Commercial Banks
2. RBI
3. Non-Scheduled Commercial Banks
4. Co-operative Banks
5. Foreign Banks
6. Discount and Finance House of India
7. Primary Dealers

Lenders Only

1. LIC
2. UTI
3. GIC
4. IDBI
5. NABARD
6. Specific Mutual Funds

Location - Call money markets in India are primarily located in: Mumbai, Kolkata, Chennai, Delhi, and Ahmedabad.

4. Certificate of Deposit (CD)

A Certificate of Deposit is a short-term, unsecured, negotiable instrument issued by commercial banks and financial institutions in bearer form.

It is issued against deposits made by companies and institutions.

Key Features

1. Maturity ranges from 91 days to 1 year.
2. Issued when banks face tight liquidity or slow deposit growth.
3. Can be issued to individuals, corporations, and institutions.

5. Commercial Bills

A Commercial Bill is a bill of exchange used by businesses to finance working capital needs. It is short-term, negotiable, and self-liquidating.

How It Works

• The seller (drawer) draws a bill on the buyer (drawee) for goods sold on credit.
• When the buyer accepts it, it becomes a trade bill.
• If a bank accepts the bill, it becomes a commercial bill.

Commercial Bill Market

This market deals with the buying and selling of commercial bills and is also called the discount market, as discounting is the main process.

Participants - RBI permits the following institutions to operate in the commercial bill market:

• Financial institutions
• Mutual funds
• Commercial banks
• Cooperative banks

Commercial bills are widely used in domestic and international trade for settling commercial obligations.

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