Money Market is the element of the economy which deals in short-term funds or short-term loans, generally for the period of one year or less than one year.
Money Market is the part of the financial market in which assets are involved for short-term lending, borrowing and deals in original maturities for one year or less than one year. There are over the counter and wholesale trading is done by Money Market.
Money Market serves a dual purpose of not only allowing borrowers to meet their short-term requirements but also provide easy liquidity to lenders. Money market instruments are highly liquid because they are fixed-income securities that carry short maturity periods of a year or less.
Some tools help to operate in the Money Market called Money Market Instruments. Some of the common money market instruments include Banker’s Acceptance, Treasury Bills, Repurchase Agreements, Certificate of Deposits, Bills of exchange and Commercial Papers.
Short maturity period and high liquidity are two characteristic features of the instruments which are traded in the money market. Institutions like commercial banks, non-banking finance corporations (NBFCs) and acceptance houses are the components that make up the money market.
Money market instruments allow governments, financial organizations, and businesses to finance their short-term cash requirements.
Money market performs its duties in five functions:
- Financing Industry: With the help of the following two methods Money Market helps industries for their growth.
- With the help of Instruments such as commercial papers and finance bills. The money market helps industries to secure their short-term loan to meet industries working capitals.
- Every industry needs long-term loans (loans above one year) which are provided in the capital market. The nature of the money market and the condition in the money market affect the capital market. Short-term rates of money market affect the long-term rates of the capital market. Thus, the money market indirectly helps the industries with their links in long-term capital markets.
- Financing Trade: The Money market plays an important role in both the financing of domestic and international markets.
- With the help of the discount market and acceptance houses, it helps in international trade.
- With the help of Bills of exchange which are discounted by the bill market, it helps to trade finance from domestic finance.
- Help to Central Bank: The Money market helps central market in two ways:
- 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,
- Sensitive and integrated money markets help the central bank secure quick and widespread influence on the sub-markets, thus facilitating effective policy implementation.
- Self-efficiency of commercial banks: In an emergency when there is a shortage of funds, and commercial banks don’t need to borrow from Central Banks at higher rates. Thus, developed money markets help banks to become self-sufficient and then commercial banks can fulfill their requirements by instead recalling their old term loans from the money market.
- Profitability Investments: The money market authorized commercial banks to use their excess reserves in profitable investment. It helps commercial banks to earn income which maintains its liquidity and helps in future uncertain cash demands of its depositors. Commercial banks invest excess reserves of money market in near money assets (Instruments which are converted into cash easily such as Bills of exchange, Savings account, and treasury bills, etc.). Thus, commercial banks earn profit without sacrificing their liquidity.
Types of Money Market instruments
Treasury Bills (T-Bills): Treasury Bills, also known as T-bills are the short-term money market instrument, issued by the central bank on behalf of the government. These are the safest investment instrument of its category, as the risk of default is negligible. Treasury bills are presently issued in three maturities, namely, 91 days, 182 days and 364 days. Treasury bills are zero-coupon securities and pay no interest. They are auctioned by Reserve Bank of India at regular intervals and issued at a discount to face value.
Commercial Papers (CPs): Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue.
Certificate of Deposit: Certificate of Deposit (CD) is a negotiable money market instrument issued by banks and Financial Institutions. They are unsecured and negotiable. Such instruments are usually issued by banks when they have a tight liquidity position because of the slow growth of bank deposits but the demand for credit is high.
Repurchase Agreements (Repo): A repurchase agreement, or repo for short, is a type of short-term loan much used in the money markets, whereby the seller of a security agrees to buy it back at a specified price and time. The seller pays an interest rate, called the repo rate when buying back the securities.
Banker’s Acceptance (BA): A banker’s acceptance is an instrument representing a promised future payment by a bank. Banker’s Acceptance is often used in money market funds and specifies the details of the repayment like the amount to be repaid, date of repayment and the details of the individual to which the repayment is due.