A money market is a component of the financial market where financial instruments with high liquidity and very short maturities are traded. Money market is a platform that enables lenders and borrowers trade in assets that have maturities of less than a year. These short-term instruments are highly liquid, easily marketable, with a minimum chance of a loss.
Money market provides for the quick and dependable transfer of short-term debt instruments maturing in a year or less. Money market instruments are used to finance the needs of consumers, businesses, agriculture and the banks. Money market transactions take place between companies and various financial institutions and not between individuals. However, individuals can invest small amounts in money market funds.
The money market is a wholesale market where many financial instruments are traded. The money market consists of call money market, commercial bills market, commercial paper market, Treasury bill market, inter- bank market and certificates of deposit market.
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SEE ALSO: What is Money Market?
Summarized below are some of the important features of a developed money market:
Bill of exchange/ commercial bills:
A bill of exchange is a written unconditional order by one party to another, to pay a specified amount of money either immediately or on a fixed date. A bill of exchange is a document used in international trade to pay for goods and services. It is signed by the person promising to pay and given to the person receiving the payment. A bill of exchange can be compared to a promissory note.
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 bills do not pay any interest, but are available at a discount to face value at the time of the issue. Treasury bills can be classified in two ways i.e. based on maturity and based 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 Paper is an unsecured money market instrument, issued in the form of a promissory note. It was introduced in India in 1990 with the objective of enabling corporate borrowers diversify their sources of short-term borrowings 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 (for example, payroll), 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.
A certificate of deposit is a savings instrument that is similar to a fixed deposit. Unlike fixed deposit, certificate of deposit cannot be withdrawn before maturity. These deposits have a fixed maturity date and a specified rate of interest.
The certificate of deposit was introduced in the Indian market in the year 1989 to increase the options among money market instruments. Certificates of deposit are issued by scheduled commercial banks and some select financial institutions in India and are monitored by the RBI. The RBI issues guidelines for certificate of deposit from time to time.
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. Banker’s acceptance are time drafts which are accepted and guaranteed by the bank and drawn on a deposit at the bank. The maturity period of banker’s acceptance can range from 30 to 180 days.
These are known as Repo or reverse Repo. They are loans of short duration which are agreed by buyers and sellers for the purpose of trading. However, the transactions are carried out between institutions approved by the Reserve Bank of India.
A money market plays an important role in the allocation of resources in the economy by performing the following important functions.
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 government can also borrow funds from the money market by issuing treasury bills.
Therefore, money market issues money market instruments like commercial papers, treasury bills and so on and helps in the development of trade, industry and commerce within and outside India. The money market plays an important role in financing domestic and international trade.
The money market provides a platform where the banks and other lending institutions can lend excess money for a short period of time and earn profits. This fulfils the main objectives of the commercial banks i.e. to earn income from reserves as well as maintain liquidity to meet the cash required for daily transactions. The institutions that can lend funds in money market not only include commercial banks and other financial institutions, but also comprises of non-financial business corporations, central, state and local governments.
A developed money market helps commercial banks become self-sufficient. The existence of an established money market increases the options of borrowing money at lower interest rates and helps commercial banks and the central bank.
However, if there is a shortage of cash in the commercial banks and central banks, they can call in some of their loans from the money market. Most of the commercial banks like SBI, Union Bank, BOI and others prefer to recall their loans.
The money market instruments help the government raise money for financing government projects for public welfare and infrastructure development. The government can borrow short term funds by issuing treasury bills at low interest rates. On the other hand, if the government were to issue paper money or borrow from the central bank, it would lead to inflation in the economy.
A properly functioning money market helps the central bank successfully implement monetary policies. Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market helps in the efficient functioning and increases the effectiveness of the central banks. The money market helps the central banks in the following ways:
1. Short-run interest rates serve as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy.
2. Sensitive and integrated money markets help the central bank secure quick and widespread influence on the sub-markets, thus facilitating effective policy implementation.
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.
This is one of the most important functions of money market, as it provides safety and liquidity of funds. It also encourages savings and investments. These investment instruments have shorter maturity which means they can readily be converted to cash. The money market instruments are issued by entities with good credit score which makes them safe investment options. Check free credit score on IndianMoney.com.
The money market creates a balance between the demand and supply of loanable funds. The money market helps in allocating savings into investment channels. A money market helps in mobilizing savings and make better use, by allowing them to be invested through the money market. It helps savers channelize funds, thus leading to productive use of money in the economy.
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, thereby immensely helping commerce and industry in India.
SEE ALSO: Functions Of Money Market
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