Money markets play an important role in liquidity management and the implementation of monetary policies in the economy. Money markets are a part of the financial market where short term securities are traded. Money market instruments are among the most liquid investments in the financial sector. By offering instruments like treasury bills, finance bills and commercial paper, the money market allows supply of funds for refinancing of short and medium-term positions and facilitates the mitigation of business’ liquidity risk.
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The money market contributes to the development of the country and economic stability by providing short term liquidity to the government, commercial banks and other organisations. A developed, active and efficient money market enhances the efficiency of central bank’s monetary policies. Historically, the money market was developed as a result of industrial and commercial development. But, it has an important role to play in the growth of the nation. The main functions of money market are discussed below:
The money market provides small tenure loans to meet working capital requirements for the public and the private institutions at a lower interest rate. The private and the public institutions can borrow from the money market for surplus funds required to capitalize business growth through the system of finance bills and commercial paper. Money market issues money market instruments like commercial paper, treasury bills and so on, which helps in the development of trade, industry and commerce within and outside India.
The money market also helps the government raise funds from investors by issuing treasury bills. The money market helps in financing domestic and foreign trade. So, it provides the facility to discount bills of exchange and makes available funds to pay for goods and services. International traders also benefit from the acceptance houses and discount markets.
The money market serves as a medium through which the banks and other lending institutions utilize surplus funds for short periods and earn profits. This fulfils the main purpose of the commercial banks which is to earn income from reserves as well as maintain liquidity to meet uncertain cash demands of customers. In the money market, surplus funds of the commercial banks are invested mainly in short term bills of exchange which are highly liquid and can be readily converted into cash. The money market provides an option for commercial banks to earn profits using surplus funds, without compromising on liquidity. The institutions which can lend in money market not only include commercial banks and other financial institutions, but also non-financial business corporations, central, state and local governments.
SEE ALSO: Functions of a Money Market
The money market provides commercial banks with a ready market, where they can invest surplus funds and earn interest without compromising on liquidity. This helps commercial banks avoid borrowing from RBI and increase capital. A developed money market helps commercial banks become self-sufficient. The short term investments are highly liquid and can be easily converted into cash to support customer withdrawals.
The existence of an established money market increases the options of borrowing money at lower interest rates. When commercial banks face liquidity problems, they can borrow from the money market for short tenure. The money market serves as an alternative to borrowing from the RBI which charges a higher interest rate. The money market generally charges lower interest rate on short term loans vis-à-vis the Central Bank (RBI).
This is one of the key features of the money market. The money market instruments help the government raise funds from investors for financing government projects like public welfare and infrastructural developments.
The government can borrow from the money market by issuing treasury bills. The Treasury bill is issued for varying periods of less than a year. In India, the treasury bills are issued at a discounted rate which is lower than the face value. Each Treasury bill has a specific maturity date, which is when the investor gets his money back. There are three types of Treasury bills in India whose maturity periods are 91 days, 182 days and 364 days.
A well established money market helps the central bank perform smoothly and increase efficiency. The money market helps the central bank implement the monetary policies.
The central bank is responsible for regulating the monetary policy of a country and taking active measures to ensure a healthy financial system. Through the money market, the central bank can perform its policy-making functions efficiently. The integrated money markets help the central bank influence sub-markets and implement monetary policy objectives.
The money market helps the central banks in the following ways:
The money market is a dynamic market in which new money market instruments evolve. A large number of participants are permitted to trade in the money market. The money market helps in financial mobility by enabling movement of funds from one sector to the other.
Financial mobility is essential for the development of industry and commerce in the economy. The money market contributes to the economic stability and development of a country by providing short-term liquidity to governments, commercial banks, and other large organizations. Investors with surplus funds can invest in the money market and earn interest.
This is one of the most important functions of money market; providing safety and liquidity of funds. The money market encourages investors to save which brings investments into the economy. Saving and investment offers equilibrium between demand and supply of short term funds, thus helping in allocation of resources. Money market instruments are short term investments which have high liquidity. They can easily be converted to cash. The money market instruments are issued by entities with good credit rating which makes them a safe investment option.
The money market creates a balance between demand and supply. The money market helps in allocating savings into investment channels. Money market helps mobilize savings and make better use of investments. It helps savers channelize funds and leads to the productive use of money.
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 transfer and allocation of funds from one place to another, thereby helping commerce and industry.
The money market provides an easy platform where businesses can avail short term loans to finance working capital needs. Large companies and Business Corporations carry out large volume of transactions on a daily basis. So, it is quite evident that these business houses face shortage of cash related to buying raw materials, paying employees or meeting other short term expenses.
Although the money market does not offer long-term loans, it influences the capital market and can also help businesses obtain long-term financing.
The money market is a key component of the financial market. It helps the central bank conduct monetary operations and helps achieve monetary policy objectives. It is a market for short-term funds where the maturity period ranges from overnight to one year. It is a market where financial instruments are traded and is considered a close substitute to cash. Thus a well developed money market is important for a well functioning economy.
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