The participants in the money market include commercial banks, corporations, governments, and other financial institutions. These participants borrow and lend money in order to meet their short-term cash requirements. The money market provides a platform for these participants to carry out their transactions. The money market helps in the efficient allocation of funds by providing a platform for short-term borrowing and lending. It also provides an important source of liquidity for the financial system.
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Instruments Traded in the Money Market
- Treasury bills (T-bills): These are short-term debt instruments issued by the government to fund its short-term requirements. They have a maturity of less than one year.
- Commercial paper (CP): These are unsecured short-term promissory notes issued by corporations to meet their short-term cash requirements. They have a maturity of less than one year.
- Certificates of deposit (CDs): These are time deposits issued by banks and other financial institutions. They have a fixed maturity and interest rate.
- Repurchase agreements (repos): These are short-term loans where one party sells securities to another party with an agreement to buy them back at a later date.
What is call money?
Call money is a type of very short-term loan that is borrowed and lent in the money market. It is an unsecured loan that has a maturity of one day or overnight. The term “call” refers to the fact that the lender can “call” the loan back at any time by demanding repayment from the borrower.
In India, call money is commonly used by banks and financial institutions to manage their short-term liquidity needs. Banks and financial institutions can borrow or lend call money to each other at the prevailing market interest rates. Call money rates can vary depending on the demand and supply of funds in the market.
The Reserve Bank of India (RBI) plays a significant role in regulating the call money market. The RBI sets the minimum reserve requirements that banks must maintain, and it also sets the benchmark policy rates that influence the overall interest rates in the economy.
What is Treasury Bill?
A Treasury Bill, also known as T-Bill, is a short-term debt instrument issued by the government to finance its short-term requirements. T-Bills are considered one of the safest forms of investment as they are backed by the government.
T-Bills are issued at a discount to their face value and mature at their face value. For example, a T-Bill with a face value of Rs. 100 will be issued at a discount, say Rs. 95, and will mature at Rs. 100. The difference between the issue price and the maturity value is the interest earned by the investor.
T-Bills are available in different maturities ranging from 91 days, 182 days, and 364 days. T-Bills are highly liquid as they can be easily traded in the secondary market before their maturity. They are also tax-efficient as they are exempted from tax deduction at source (TDS) and capital gains tax if held till maturity.
Overall, T-Bills are an important tool for the government to manage its short-term funding requirements, while providing a safe and attractive investment option for investors.
What is Certificate of Deposit
A Certificate of Deposit (CD) is a financial instrument issued by banks and other financial institutions that allows investors to earn interest on their deposits for a fixed period of time. It is a time deposit that has a fixed maturity, usually ranging from 7 days to 10 years, and a fixed interest rate.
CDs are similar to savings accounts, but they offer higher interest rates as they require the investor to deposit the money for a specific period of time. CDs also have a penalty for early withdrawal, which encourages the investor to keep the money invested until maturity.
The interest rate on a CD is determined by the market forces of demand and supply. Generally, the longer the term of the CD, the higher is the interest rate offered. CDs can be issued in different denominations, ranging from a few thousand rupees to several lakhs.
What is Commercial Paper?
Commercial paper (CP) is an unsecured money market instrument issued by large corporations, financial institutions, and banks to meet their short-term funding requirements. It is a promissory note that has a fixed maturity, typically ranging from 7 days to 1 year, and a fixed interest rate.
CPs are a cost-effective way for companies to raise short-term funds as they offer higher interest rates than bank deposits and are issued at a discount to their face value. The interest rate on a CP is determined by market forces, and it can vary depending on the creditworthiness of the issuer, the term of the CP, and the prevailing market interest rates.
CPs are highly liquid as they can be traded in the secondary market before their maturity. They are also exempt from tax deduction at source (TDS) if held till maturity, making them a tax-efficient investment option.
CPs are regulated by the Reserve Bank of India (RBI) and can only be issued by companies that meet certain eligibility criteria, such as a minimum credit rating, financial soundness, and adherence to certain disclosure requirements.
Overall, CPs are an important source of short-term funding for companies and financial institutions, and they play a crucial role in maintaining the liquidity and stability of the financial system.
What is Repurchase Agreements
Repurchase agreements are short-term loans that are collateralized by government securities or other high-quality assets. In a repo transaction, one party sells securities to another party and agrees to buy them back at a later date at a slightly higher price, which represents the interest rate on the loan. Repos are typically used by banks and other financial institutions to manage their short-term liquidity needs.
Classification of Money Supply
Money supply refers to the total amount of money that is circulating in an economy at a given point in time. In India, there are different measures of money supply, which are commonly referred to as “M”s. The different types of money are defined as follows:
- M0: This is the narrowest measure of money supply, and it includes the physical currency in circulation, which includes coins and notes held by the public and cash in bank vaults.
- M1: M1 is broader than M0, and it includes all the components of M0 plus the current account deposits held by individuals and businesses in banks. Current account deposits refer to the money that individuals and businesses hold in their bank accounts that can be withdrawn on demand.
- M2: M2 is a broader measure of money supply that includes M1 plus savings deposits, time deposits, and other deposits with a maturity of less than one year. Savings deposits refer to the money that individuals and businesses hold in their bank accounts that earn interest, while time deposits refer to deposits that have a fixed maturity period.
- M3: M3 is the broadest measure of money supply and includes all the components of M2 plus the deposits with a maturity of over one year, such as bonds, debentures, and other long-term deposits.
Overall, the different types of money supply measures are used by economists and policymakers to analyze the money supply and its impact on the economy.
Money Market : Summary
- The money market is an important part of the global financial system.
- Instruments traded in the money market are used for short-term borrowing and lending of funds.
- Treasury Bills (T-Bills) are short-term debt instruments issued by the government to finance short-term borrowing requirements.
- Commercial Papers (CPs) are unsecured, short-term promissory notes issued by corporations, banks, and financial institutions to finance short-term funding needs.
- Certificates of Deposit (CDs) are time deposits issued by banks and financial institutions.
- Repurchase Agreements (Repos) are short-term loans that are collateralized by government securities or other high-quality assets.
- Bankers’ Acceptances (BAs) are short-term, time drafts issued by banks that guarantee payment at a future date.
- Money Market Funds (MMFs) are investment vehicles that invest in a portfolio of short-term, low-risk money market instruments.
- These instruments are generally considered to be low-risk investments and provide investors with a range of options to manage their short-term funding needs.
- Understanding these instruments is important for investors looking to participate in the money market and for institutions looking to manage their short-term liquidity needs.
Money Market : Questions
Q. Which of the following instruments is issued by corporations, banks, and financial institutions to finance their short-term funding needs?
a) Treasury Bills (T-Bills)
b) Commercial Papers (CPs)
c) Certificates of Deposit (CDs)
d) Repurchase Agreements (Repos)
Answer: b) Commercial Papers (CPs). Commercial Papers are unsecured, short-term promissory notes issued by corporations, banks, and financial institutions to finance their short-term funding needs.
Q. Which of the following money market instruments is backed by the full faith and credit of the government?
a) Bankers’ Acceptances (BAs)
b) Repurchase Agreements (Repos)
c) Treasury Bills (T-Bills)
d) Certificates of Deposit (CDs)
Answer: c) Treasury Bills (T-Bills). Treasury Bills are short-term debt instruments issued by the government to finance its short-term borrowing requirements. They are considered to be one of the safest money market instruments as they are backed by the full faith and credit of the government.
Q. Which of the following money market instruments is a time deposit issued by banks and financial institutions?
a) Treasury Bills (T-Bills)
b) Certificates of Deposit (CDs)
c) Repurchase Agreements (Repos)
d) Commercial Papers (CPs)
Answer: b) Certificates of Deposit (CDs). Certificates of Deposit are time deposits issued by banks and financial institutions. They have a fixed maturity period ranging from a few days to several years and pay a fixed interest rate.
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