Money market instruments are debt securities that have short maturity periods. The money market instruments provide investors with a safe investment option for the short term. Money market instruments are liquid assets like treasury bills, repurchase agreements, commercial papers, or certificate of deposits. Money market funds are considered a good option for short term investments.
Some of the important features of money market instruments are as follows:
A money market instrument has an important role to play in the economic development of the country. The main functions of money market are:
The money market issues short term financial instruments for borrowing at a lower rate of interest. The private entities, the public sector companies as well as the government can raise money from the money market by issuing money market instruments to fund business growth through the system of finance bills and commercial papers. The government can also borrow funds from the money market by issuing treasury bills. However these institutions must have strong credit ratings to issue such instruments. Money market helps in the development of trade, industry and commerce within and outside India. The money market plays an important role in financing domestic as well as international trade.
See Also: What are Money Market Instruments?
By issuing money market instruments, the banks and other lending institutions can lend surplus funds for a short period of time and earn good profit. This fulfils the main objectives of the commercial banks i.e. to maximize their income from deposits as well as maintain liquidity that would help them carry out daily transactions and meet cash requirements of the customers as well as offer loans to the people in need of credit.
A developed money market helps the commercial banks become self-sufficient. The existence of an established money market increases the option of borrowing money at lower interest rates. However, if there is 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 prefer to recall their loans rather than recalling from the central banks at higher rate of interest.
The money market instruments help the government raise money for financing government projects for public welfare and infrastructure development. The government issues short term instruments like treasury bills at a discounted price. After maturity the government returns the money at face value which is a source of profit for the investors.
A properly functioning money market helps the central bank successfully implement monetary policies. The money market helps the central banks in the following ways:
The money market helps in financial mobility by enabling fast transfer of funds across sectors. It helps investors use their surplus funds and entities from different sectors raise funds through investors.
This is one of the most important functions of money market; it provides short term funds that have high liquidity. These investments have shorter terms of maturity which is why they can be converted to cash easily. The money market instruments are issued by entities with an excellent credit rating which makes them a safe investment option.
The money market creates a balance between the demand and supply of funds. The money market helps in allocating savings into investment channels. Money markets helps in mobilizing savings and make better use of them. It helps savers channelize funds, thus leading to 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 transferring funds from one place to another, thereby immensely helping commerce and industry.
Given below are the important objectives of money market instruments:
The money market instruments have several advantages. Some of them are as follows:
Money Market Instruments provide the tools by which one can operate in the money market. Money Market Instruments are used by corporations, governments and individual investors. Common types Of Money Market Instruments are:
The Treasury bills are short-term money market instrument that mature in a year or less than that. The purchase price is less than the face value. At maturity the government pays the Treasury Bill holder the full face value. The Treasury Bills are marketable, affordable and risk free. The security attached to the treasury bills comes at the cost of very low returns.
The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.
1. Since one can know the returns from before, the certificates of deposits are considered much safe.
2. One can earn more as compared to depositing money in savings account.
3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.
1. As compared to other investments the returns is less.
2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.
Commercial Paper is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. Commercial Papers have higher denominations as compared to the Treasury Bills and the Certificate of Deposit. The maturity period of Commercial Papers are a maximum of 9 months. They are very safe since the financial situation of the corporation can be anticipated over a few months.
It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the Secondary market. The banker's acceptance is mostly used to finance exports, imports and other transactions in goods. The banker's acceptance need not be held till the maturity date but the holder has the option to sell it off in the secondary market whenever he finds it suitable.
The Eurodollars are basically dollar- denominated deposits that are held in banks outside the United States. Since the Eurodollar market is free from any stringent regulations, the banks can operate at narrower margins as compared to the banks in U.S. The Eurodollars are traded at very high denominations and mature before six months. The Eurodollar market is within the reach of large institutions only and individual investors can access it only through money market funds.
The Repo or the repurchase agreement is used by the government security holder when he sells the security to a lender and promises to repurchase from him overnight. Hence the Repos have terms raging from 1 night to 30 days. They are very safe due government backing.
Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.
(in the US). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association.
(in the US). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.
(in the US). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.
Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors.
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