Money Market means market where money or its equivalent can be traded. Money is synonym of liquidity. Money Market consists of financial institutions and dealers in money or credit who wish to generate liquidity. It is better known as a place where large institutions and governments manage their short term cash needs. For generation of liquidity, short term borrowing and lending is done by these financial institutions and dealers. Money Market is part of financial market where instruments with high liquidity and very short term maturities are traded. Due to highly liquid nature of securities and their short term maturities, money market is treated as a safe place. Hence, money market is a market where short term obligations such as treasury bills, commercial papers and banker’s acceptances are bought and sold.
Benefits and functions of Money Market:
Money Markets exist to facilitate efficient transfer of short-term funds between holders and borrowers of cash assets. For the lender/investor, it provides a good return on their funds. For the borrower, it enables rapid and relatively inexpensive acquisition of cash to cover short-term liabilities. One of the primary functions of Money Market is to provide focal point for RBI’s intervention for influencing liquidity and general levels of interest rates in the economy. RBI being the main constituent in the Money Market aims at ensuring that liquidity and short term interest rates are consistent with the monetary policy objectives.
Money Market & Capital Market:
Money Market is a place for short term lending and borrowing, typically within a year. It deals in short term debt financing and investments. On the other hand, Capital Market refers to stock market, which refers to trading in shares and bonds of companies on recognized stock exchanges. Individual players cannot invest in money market as the value of investments is large, on the other hand, in capital market, anybody can make investments through a broker. Stock Market is associated with high risk and high return as against Money Market which is more secure. In case of money market, deals are transacted on phone or through electronic systems as against capital market where trading is through recognized stock exchanges.
Treasury Bills:
Treasury Bills are Money Market instruments to finance the short term requirements of the Government of India. These are discounted securities and thus are issued at a discount to face value. The return to the investor is the difference between the maturity value and issue price.
Treasury Bills or T-Bills as they are known are issued by the Government of India to meet their short-term requirement. T-Bills are issued for 91-days, 182-days and 364-days maturities. T-Bills are issued at a discount to face value and redeemed at par. Currently, T-Bills are being issued on a weekly basis on Wednesdays.
Features of T-Bills auction
- All T-Bills auctions are Price-based.
- All T-Bills are auctioned on Multiple-Price basis.
Commercial Papers:
Commercial Paper is a low-cost alternative to bank loans. It is a short term unsecured promissory note issued by corporates and financial institutions at a discounted value on face value. They are usually issued with fixed maturity between one to 270 days and for financing of accounts receivables, inventories and meeting short term liabilities. Say, for example, a company has receivables of Rs. 1 crore with credit period of 6 months. It will not be able to liquidate its receivables before 6 months. The company is in need of funds. It can issue commercial papers in form of unsecured promissory notes at discount of 10% on face value of Rs. 1 crore maturing after 6 months. The company has strong credit rating and easily finds buyers. The company is able to liquidate its receivables immediately and the buyer is able to earn interest of Rs. 5 lakhs over a period of 6 months. They yield higher returns as compared to T-Bills as they are less secure in comparison to these bills. Chances of default are almost negligible but are not zero risk instruments. Commercial Paper being an instrument not backed by any collateral, only firms with high quality credit ratings will find buyers easily without offering any substantial discounts. They are issued by corporates to impart flexibility in raising working capital resources at market determined rates. Commercial Papers are actively traded in the secondary market since they are issued in the form of promissory notes and are freely transferable in demat form.
Certificate of Deposit:
It is a short term borrowing more like a bank term deposit account. It is a promissory note issued by a bank in form of a certificate entitling the bearer to receive interest. The certificate bears the maturity date, the fixed rate of interest and the value. It can be issued in any denomination. They are stamped and transferred by endorsement. Its term generally ranges from three months to five years and restricts the holders to withdraw funds on demand. However, on payment of certain penalty the money can be withdrawn on demand. The returns on Certificate of Deposits are higher than T-Bills because it assumes higher level of risk. While buying Certificate of Deposit, return method should be seen. Returns can be based on Annual Percentage Yield (APY) or Annual Percentage Rate (APR). In APY, interest earned is based on compounded interest calculation. However, in APR method, simple interest calculation is done to generate the return. Accordingly, if the interest is paid annually, equal return is generated by both APY and APR methods.
However, if interest is paid more than once in a year, it is beneficial to opt APY over APR.
Advantages of Certificate of Deposit as a money market instrument:
- Since issuers are Banks, certificates of deposits are considered much safe. Further, returns are known upfront/at the beginning of the trade itself.
- One can earn more as compared to depositing money in savings account.
Disadvantages of Certificate of Deposit as a Money Market instrument:
- As compared to other investments the returns are less.
- Funds are tied up till the maturity of the Certificate of Deposit. Early exit option is available through the secondary market but is subject to interest rate risk.
Repo / Reverse Repo:
A repo agreement is the sale of a security with a commitment to repurchase the same security as a specified price and on specified date while a reverse repo is purchase of security