Instruments of Money Market

Dr. Minakshi Duggal Mehta

Assistant Professor

PG Department of Commerce and Management

Introduction

• Money Market is a financial market where short-term financial assets having liquidity of one year or less are traded on stock exchanges.
• The securities or trading bills are highly liquid. Also, these facilitate the participant’s short-term borrowing needs through trading bills. The participants in this financial market are usually banks, large institutional investors, and individual investors.
• There are a variety of instruments traded in the money market in both the stock exchanges, NSE and BSE.
• These include treasury bills, certificates of deposit, commercial paper, repurchase agreements, etc. Since the securities being traded are highly liquid in nature, the money market is considered as a safe place for investment.
• The Reserve Bank controls the interest rate of various instruments in the money market.
• The degree of risk is smaller in the money market. This is because most of the instruments have a maturity of one year or less.
• Hence, this gives minimal time for any default to occur. The money market thus can be defined as a market for financial assets that are near substitutes for money.

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Objectives of Money Market�

Below are the main objectives of the money market:

• Providing borrowers such as individual investors, government, etc. with short-term funds at a reasonable price. Lenders will also have the advantage of liquidity as the securities in the money market are short-term.
• It also enables lenders to turn their idle funds into an effective investment. In this way, both the lender and borrower are at a benefit.
• RBI regulates the money market. Therefore, in turn, helps to regulate the level of liquidity in the economy.
• Since most organizations are short on their working capital requirements. The money market helps such organizations to have the necessary funds to meet their working capital requirements.
• It is an important source of finance for the government sector for both national and international trade.

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Importance of the Money Market�

• It maintains a balance between the supply of and demand for the monetary transactions done in the market within a period of 6 months to one year..
• It enables funds for businesses to grow and hence is responsible for the growth and development of the economy.
• It aids in the implementation of monetary policies.
• It helps develop trade and industry in the country. Through various money market instruments, it finances working capital requirements. It helps develop the trade in and out of the country.
• The short term interest rates influence long term interest rates. The money market mobilises the resources to the capital markets by way of interest rate control.
• It helps in the functioning of the banks. It sets the cash reserve ratio and statutory liquid ratio for the banks. It also engages their surplus funds towards short term assets to maintain money supply in the market.
• The current money market conditions are the result of previous monetary policies. Hence it acts as a guide for devising new policies regarding short term money supply.
• Instruments like T-bills, help the government raise short term funds. Otherwise, to fund projects, the government will have to print more currency or take loans leading to inflation in the economy. Hence the it is also responsible for controlling inflation.

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Instruments of Money Market

Various instruments of money market are as follows:

1. Commercial Paper
2. Certificate of Deposits
3. Treasury Bills
4. Call Loans

Commercial Paper�

• Commercial paper is an unsecured, short period debt tool issued by a company, usually for the finance and inventories and temporary liabilities.
• These papers are unsecured promissory notes issued by highly rated companies and financial institutions.
• Most of the commercial paper investors are from the banking sector, individuals, corporate and incorporated companies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs), etc.
• However, FII can only invest according to the limit outlined by the Securities and Exchange Board of India (SEBI)

Commercial Paper in India�

On 27th March 1989, commercial paper in India was introduced by RBI in the Indian money market. It was initially recommended by Vaghul working Group on the basis of the following points.

• The registration of commercial papers should only be granted to companies having Rs. 5 cores and above net worth with excellent dividend payment record.
• No limitation on the commercial paper market apart from the least size of the note. However, the size of one issue and each lot should not be less than Rs. 1 crore and Rs. 5 lakhs respectively.
• It should be eliminated from the provision of insecure advances in the state of banks.
• The company using commercial paper should have minimum 5 cores as net worth, a debt ratio maximum of 105, a debt servicing ratio closer to 2, current ratio minimum 1033, and should be recorded on the stock exchange.
• The paper can be made in terms of interest or at a discount rate to face value.
• It should not be compelled to stamp duty while issuing and transferring.

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Features of Commercial Paper�

• It is a short-term money market tool, including a promissory note and a set maturity.
• It acts as an evidence certificate of unsecured debt.
• It is subscribed at a discount rate and can be issued in an interest-bearing application.
• The issuer guarantees the buyer to pay a fixed amount in future in terms of liquid cash and no assets.
• A company can directly issue the paper to investors, or it can be done through banks/dealer banks.

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Advantages of Commercial Paper�

• Contributes Funds – It contributes extra funds as the cost of the paper to the issuing company is cheaper than the loans of the commercial bank.
• Flexible – It has a high liquidity value and flexible maturity range giving it extra flexibility.
• Reliable – It is highly reliable and does not have any limiting condition.
• Save Money – On commercial paper, companies can save extra cash and earn a good return.
• Lasting Source of Funds– Maturity range can be customised according to the firm’s requirement, and matured papers can be paid by selling the new commercial paper.

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• The Certificate of Deposit (CD) is an agreement between the depositor and the bank where a predetermined amount of money is fixed for a specific time period
• Regulated by the Reserve Bank of India, the CD is a promissory note, the interest on which is paid by the bank
• The Certificate of Deposit is issued in dematerialised form i.e. issued electronically and may automatically be renewed if the depositor fails to decide what to do with the matured amount during the grace period of 7 days
• It also restricts the holder from withdrawing the amount on demand or paying a penalty, otherwise. When the Certificate of Deposit matures, the principal amount along with the interest earned is available for withdrawal

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Features of Certificate of Deposit

• Eligibility: Not all institutions or banks are allowed to issue Certificates of Deposit and not every individual or organization can purchase one. There are certain conditions laid down by the RBI that allow the purchase of CDs
• Maturity Period: A Certificate of Deposit issued by the commercial banks can have a maturity period ranging from 7 days to 1 year. For financial institutions, it ranges from 1 year to 3 years
• Minimum investment amount– A CD can be issued to a single issuer for a minimum of Rs.1 Lakh and its multiples
• Transferability: Certificates that are available in Demat forms must be transferred according to the guidelines followed by Demat securities. While dematerialised/electronic certificates can be transferred by endorsement or delivery
• Non-availability of loan: Since these instruments do not have any lock-in period, banks do not grant loans against them. In fact, banks cannot even buy back certificates of deposit before maturity
• Discount offered– Certificate of deposit is issued at a discounted rate on the face value. Moreover, banks and financial institutions can also issue CDs on a floating rate basis

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Advantages of Investing in Certificate of Deposit�

• Since these are government-backed securities, the investor’s principal amount is kept safe. Hence, it can be said that CDs are a less risky investment option than stocks or bonds
• Certificate of Deposit is known to offer a higher rate of interest and better returns in comparison to the traditional savings accounts
• Investments in CD grant a grace period of 7 days to the investor to decide whether or  not he/she wants to reinvest the matured amount

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Eligibility

The Reserve Bank of India has laid down the following specifications for the lenders and investors of the certificate of deposit-

• Scheduled commercial banks or financial institutions in India that have been granted the permission by RBI can issue certificates of deposit
• CDs can only be issued to individuals, companies, fund houses, and such
• Co-operative banks and regional rural banks cannot issue these certificates
• It must be noted that CDs can be issued to Non-Residential Indians (NRIs) on non-repatriable basis
• However, banks and financial institutions cannot provide loans against the certificate of deposit. Moreover, banks cannot buy their own CDs prior to the latter’s maturity
• As per RBI, banks are bound to maintain the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) on the price of a certificate of deposit

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Treasury Bill

Treasury bills which are generally known as T-bills are the money market instruments categorized under short-term debt instruments. T-bills are issued by the government of India in the form of a promissory note with the repayment guarantee on the mentioned date. Funds collected through treasury bills are typically for the central government to meet the short-term needs such as building necessary infrastructure- hospitals, roads, highways, etc.

Types of Treasury Bill �

• 91 days Bill
• 182 days Bill
• 364 days Bill

Features of Treasury Bills�

• As per the regulations put forward by the RBI, a minimum of Rs. 25,000 has to be invested by individuals willing to procure a short term treasury bill. Furthermore, any higher investment has to be made in multiples of Rs. 25,000.
• G-Sec treasury bills don’t yield any interest on total deposits. Instead, investors stand to realise capital gains from such investments, as such securities are sold at a discounted rate in the market. Upon redemption, the entire par value of this bond is paid to investors, thereby allowing them to realise substantial profits on total investment.
• The method of investment forms an integral part of essential treasury bill details. The RBI, on behalf of the central government, auctions such securities every week (on Wednesday) in the market, depending upon the total bids placed on major stock exchanges. Investors can choose to procure such government assets through depository participant commercial banks, or other registered primary dealers (PDs), wherein the security transfer follows a T+1 settlement process.

Advantages of Government Treasury Bills�

• Risk Free

Treasury bills are one of the most popular short-term government schemes issued by the RBI and are backed by the central government. Such tools act as a liability to the Indian government as they need to be repaid within the stipulated date. Hence, individuals enjoy comprehensive security on the total funds invested as they are backed by the highest authority in the country, and have to be paid even during an economic crisis.

• Liquidity

As stated above, a government treasury bill is issued as a short-term fundraising tool for the government and has the highest maturity period of 364 days. Individuals looking to generate short term gains through secure investments can choose to park their funds in such securities. Also, such G-secs can be resold in the secondary market, thereby allowing individuals to convert their holding into cash during emergencies.

• Non Competitive Bidding

Treasury bills are auctioned by the RBI every week through non-competitive bidding, thereby allowing retail and small-scale investors to partake in such bids without having to quote the yield rate or price. It increases the exposure of amateur investors to the government securities market, thereby creating higher cash flows to the capital market.

Call Loans

• Call money is a short-term, interest-paying loan from one to 14 days made by a financial institution to another financial institution. Due to the short term nature of the loan, it does not feature regular principal and interest payments, which longer-term loans do.�
• Brokerages use call money as a short-term origin of funding to support margin accounts for the interest of their customers who wish to leverage their investments. The funds can shift quickly between lenders and brokerage firms. For this purpose, it is the second most liquid asset that arises on a balance sheet behind cash.

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The Call Money Market Features are as Follows:�

• There is no set global position.
• Commercial banks, finance companies, insurance, and other large organizations active in the financial markets.
• This market offers overnight funds to 14 days funds.
• The important feature of this market is that the borrower has to return the money when called by the lender.

Benefits of the Call Money Market�

• Because lending expenses are more volatile in this sector, they can be returned.
• It is conceivable to have financial intermediaries and transfer funds.
• It provides a lucrative space for the leftover money. It helps the institutions such as commercial banks to fulfill their RBI reserve requirements whenever there is a shortage of money. 
• It aids the management in collecting fairly small sums of money.
• Because the members possess a great reputation and the calls are safe.It's indeed beneficial to the actions of central banks.