Reading time: 8 minutes

Money Market Instruments – Meaning, Objectives, Types, and features

Money Market Instruments

The money market is referred to as dealing in debt instruments with less than a year to maturity bearing fixed income. In this article, we will cover the meaning of money market instruments along with its types and objectives

What is the Money Market?

It is a market where short-term financial assets having liquidity of one year or less are traded. The securities traded in the money market are highly liquid. Also, these facilitate the participant’s short-term borrowing needs. The participants in this market are usually banks, large institutional investors, and individual investors.

There are a variety of instruments traded in the money market. 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.

What are the objectives of the Money Market?

Below are the main objectives of the money market:

  1. 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.
  2. 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.
  3. RBI regulates the money market. Therefore, in turn, helps to regulate the level of liquidity in the economy.
  4. 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.
  5. It is an important source of finance for the government sector for both national and international trade. And hence, provides an opportunity for the banks to park their surplus funds.

What are Money Market Instruments in India?

Below are a few of the money market instruments in India:

Call/notice money

It is a segment of the market where scheduled commercial banks lend or borrow on short notice (say a period of 14 days). In order to manage day-to-day cash flows.

Treasury bills

T-bills are one of the safest money market instruments. The Central Government issues these bills and carries an attractive interest rate. Also, these come with different maturity periods of 3, 6 months, and 1 year.

Inter-Bank Term Market

This market was initially only for commercial and co-operative banks but are now available to various financial institutions as well. The interest rates are market-driven. Also, the market is predominantly a 90-day market.

Certificate of Deposit

  • These are term-deposits accepted by the commercial banks at market rates.
  • Also, all scheduled banks (except RRB’s and Cooperative banks) are allowed to issue CP. It can be issued for a period of 3 months to 1 year.
  • For a single investor, the CD can be issued up to 5 lakhs.

Features of the Money Market Instruments

  • The money market can be called as a collection of the market. Its main feature is liquidity. All the submarkets, such as call money, notice money, etc. have close interrelation with each other. This helps in the movement of funds from one sub-market to another.
  • The volume of traded assets is generally very high.
  • It enables the short-term financial needs of the borrowers. Also, it deals with investments that have a maturity period of 1 year or less.
  • The money market is still evolving. There is always a possibility of adding new instrument

Types of Money Market Instruments

Below are the types of money market instruments:

Treasury Bills

T-bills are one of the most popular money market instruments. They have varying short-term maturities. The Government of India issues it at a discount for 14 days to 364 days.

These instruments are issued at a discount and repaid at par at the time of maturity. Also, a company, firm, or person can purchase TB’s. And are issued in lots of Rs. 25,000 for 14 days & 91 days and Rs. 1,00,000 for 364 days.

Commercial Bills

Commercial bills, also a money market instrument, works more like the bill of exchange. Businesses issue them to meet their short-term money requirements.

These instruments provide much better liquidity. As the same can be transferred from one person to another in case of immediate cash requirements.

Certificate of Deposit

Certificate of deposit or CD’s is a negotiable term deposit accepted by commercial banks. It is usually issued through a promissory note.

CD’s can be issued to individuals, corporations, trusts, etc. Also, the CD’s can be issued by scheduled commercial banks at a discount. And the duration of these varies between 3 months to 1 year. The same, when issued by a financial institution, is issued for a minimum of 1 year and a maximum of 3 years.

Commercial Paper

Corporates issue CP’s to meet their short-term working capital requirements. Hence serves as an alternative to borrowing from a bank. Also, the period of commercial paper ranges from 15 days to 1 year.

The Reserve Bank of India lays down the policies related to the issue of CP’s. As a result, a company requires RBI‘s prior approval to issue a CP in the market. Also, CP has to be issued at a discount to face value. And the market decides the discount rate.

Denomination and the size of CP:

Minimum size – Rs. 25 lakhs

Maximum size – 100% of the issuer’s working capital

Call Money

It is a segment of the market where scheduled commercial banks lend or borrow on short notice (say a period of 14 days). In order to manage day-to-day cash flows.

The interest rates in the market are market-driven and hence highly sensitive to demand and supply. Also, the interest rates have been known to fluctuate by a large % at certain times.

Money Market Instruments vs Stocks

Particulars Money Market Instruments Stocks
Maturity of the instruments The money market instruments carry a maturity period of less than a year. However tradable in the short term, stocks create wealth creation when invested for a number of years.
Financing needs These instruments are used to fund the short-term needs of the borrower. Used for long-term fund requirements.
Types of instruments It has instruments like T-bills, certificate of deposits, inter-bank call money, etc. It’s a stock of an independently listed company
Degree of risk Risk is comparatively lower due to the short-term maturity period Risk is higher.

Frequently Asked Questions

What is the importance of money markets in the economy?

The money market plays a very significant role in the economy. It allows a variety of participants to raise funds. It offers liquidity to both the investors and the borrowers. And hence maintaining a balance between the demand and supply for money. Thus facilitating the development and growth of the economy.

Are money market instruments entirely risk-free?

Even though the money market instruments do not carry many risks, it would be incorrect to say that they are entirely risk-free. The reason is simple. While getting money is easier for borrowers with an outstanding track record, there is always a possibility that the borrower might default in the repayment.

Who regulates the money market in India?

The money market in India is regulated by both the Reserve Bank of India and the Securities & Exchange Board of India.

What is the yield on security?

In simple words, the yield is the interest rate earned by investing securities It can be calculated by the below formula:

Yield = (Face value – Sale value)/sale value* (days or months in a year/period of discount)*100

Let’s understand the above with the help of an example:

Face value or amount of issue – Rs. 100
Period  – 6 months
Discount rate – 10%
Discount – 100*(6/12)*(10/100) = Rs. 5

By using the above formula for yield we get

Y = (100-95)/100*(12/6)*100
   = 10%

What is maturity?

The maturity in respect of money market instruments means the time period within which the securities will mature. This is generally less than a year in case of money market instruments.

How are Government Securities  (G-secs) such T-Bills issued?

T-bills are one of the most popular money market instruments. They provide instruments with varying short-term maturities. The Government of India issues these bills at a discount for 14 days to 364 days.
In order to provide the investors with instruments of varying duration, the Government of India also introduced 14 days, 28 days, 91 days and 364 days T-bills on an auction basis.

Who is eligible to invest in Commercial Papers (CPs)?

Individuals, banking companies, other corporate bodies (registered or incorporated in India), and unincorporated bodies, non-resident Indians (NRIs) and foreign institutional investors (FIIs), etc can invest in CPs. Foreign Institutional investors can invest in CP subject to the criteria and conditions laid down by SEBI.

What factors determine interest rates of money market instruments?

Currently, the interest rate is dependent on the market forces of demand for; and supply of short term money.
Fiscal deficit, for example, occurs when the government expenditure is more than government revenue. To fund this deficit, the government requires money which in turn leads to borrowing by the government and hence influencing the interest rates. 
In other words, the higher the fiscal deficit more will be the money required by the government. Hence, it will lead to an increase in interest rates.

Published on June 3, 2020