India’s financial market is classified into two parts – the capital market and the money market. They both fulfill the various credit needs of the economy. But what is money market? And what are the securities that are a part of the money market? Let’s find out.
What is Money Market?
The money market is one of the two major components of the financial markets of any economy. But what money market exactly? Well, it is a market where short-term financial instruments and securities are exchanged and traded. It helps in fulfilling the short-term fund requirements of the borrowers. And it provides the lenders with liquidity.
Securities of Money Market
Now that we have seen what is money market, let us focus on the major securities related to the money market.
1] Commercial Papers
Sometimes large corporates and companies will issue commercial papers to raise short term funds. These commercial papers are promissory notes that are unsecured, short-term, negotiable, transferable (via endorsement) with a fixed maturity period of less than 365 days.
The companies prefer commercial papers than borrowing funds because they can get funds at lower rates than the prevailing market rate of interest. And large credit-worthy companies will have no trouble collecting funds via commercial papers. They are issued at a discount and redeemed at par.
2] Treasury Bills
Treasury Bills or T-Bills are issued by the government, usually through the Reserve Bank of India. They are instruments of short-term borrowing. T-bills are sold to commercial banks and to the public as well. They are generally considered to be an extremely safe investment, as the government is unlikely to default.
T-bills are also in the form of promissory notes. They have a maturity period between 14 days and 364 days. T-bills are highly liquid and freely endorsable. These are also issued at lower than face value and redeemed at face value. The difference in amounts is the interest known as the discount.
3] Call Money
Most banks have to maintain some minimum cash balance as per the instructions of the RBI, known as the cash reserve ratio (CRR). This ratio changes from time to time as per the liquidity in the economy.
So banks sometimes borrow money from each other for a short duration to maintain their CRR. This is known as the call money market. The interest rate on such call money is known as the call rate.
4] Commercial Bills
Commercial bills or bills of exchange are the most common negotiable instruments used in the world of trade. These negotiable instruments are used to fulfill the working capital requirements of businesses. They have a short-term maturity (usually 60 or 90 days) and are easily transferable.
The drawer of the bill can wait until the due date, i.e. the date o which the drawee will honor the bill. Or if he doesn’t wish to wait he can discount the trade bill with a bank before the maturity period is over. This makes the bills very flexible and easily marketable.
5] Certificate of Deposits
These are instruments of the money market that can only be issued by banks and financial institutes. And they are negotiable and unsecured and usually in bearer form. Banks issue these in times where funds are low but the demand for credit is high. They help channel savings into investment. They are usually issued for 90 to 365 days. Banks cannot discount certificate of deposits.
Solved Question on Money Market
Q: A buys a T-bill of Rs. 150,000 for Rs 142,000. What is the interest in this case?
Ans: T-bills are issued at less than face value and redeemed at face value. If A holds the bill till maturity he will receive Rs. 150,000 and the interest will be Rs. 8,000/- (150,000-142,000).