Module 2

MONEY MARKET
The money market is a component of the economy which provides short-term
funds. The money market deals in short-term loans, generally for a period of a year
or less. As short-term securities became a commodity, the money market became a
component of the financial market for assets involved in short-
term borrowing, lending, buying and selling with original maturities of one year or
less. Trading in money markets is done over the counter and is wholesale.

FEATURES

It is market purely for short-term funds or financial assets called near money. It
deals with financial assets having a maturity period up to one year only. It deals
with only those assets which can be converted into cash readily without loss and
with minimum transaction cost

[Link] Liquidity

The maturity period of one year offered by these funds makes them highly
liquid. Additionally, these funds tend to generate fixed income for the
investors in such a short period; owing to which they are taken for close
substitutes of money. Moreover, it is easy to trade money market instruments
across currencies, maturities, debt structure as well as credit risk, which
makes it ideal for institutions seeking to borrow or invest for the short term.

 Secure Investment

These financial instruments are considered one of the most secure investment
avenues available in the market. Since issuers of money market instruments
have a high credit rating and the returns are fixed beforehand, the risk of
losing the invested capital is minuscule.

 Fixed returns

Since money market instruments are offered at a discount to the face value,
the amount that the investor gets on maturity is decided in advance. This
effectively helps individuals in choosing the instrument that would suit their
financial needs and investment horizon.

 Physical trading

Money markets across the world essentially operate over the counter, which
implies that the trading of these funds cannot be made online. Hence,
investments in the money market are made physically by authorized
representatives or in person. Later, a physical certificate is issued to the buyer
of the money market instrument.

 Wholesale Market

Money markets are designed to provide and accept bulk orders. Thus, retail
investors who have enough capital can directly participate in money markets,
while individual investors must invest in debt mutual funds that invest in
money markets in order to benefit from this market.

 Multiple Instruments

Unlike capital markets which usually trade in one single type of instrument,
money markets trade is multiple instruments. These instruments differ in
terms of maturity periods, debt structure, credit risk, currency, among others.
Money market instruments are therefore considered ideal for diversification
through exposure.

 Key Money Market Participants

Since money markets deal with only bulk orders, they are not open to
individual investors. As a result of which, multiple institutional investors such
as financial institutions and dealers looking to borrow or lend money for a
short term participate in the trading of these instruments.

 Regulated by RBI

The Indian money market is controlled and regulated by the Reserve Bank of
India. RBI is the only institution that can influence the organised sector, while
the smaller unorganised sector is largely beyond its control. However, due to
the considerably larger size of this organised sector, regulatory actions taken
by the RBI can produce a substantial impact on the way in which this entire
market operates.

FUNCTIONS OF MONEY MARKET/ IMPORTANCE

 Providing Trade Financing

Modern day money markets play a vital role in ensuring that there is
adequate capital available to institutions engaged in domestic as well as
international trade. Internationally, short term funding for ventures may be
available to traders through ‘bills of exchange’ apart from other routes. These
are instruments that are discounted by the bill market. In common practice,
discount markets and acceptance houses are engaged in financing overseas
trading ventures using these ‘bills of exchange’.

 Ensuring Industrial Financing

Many industries and industrial houses issue bonds on the bond market or
shares on the stock market in order to receive long term financing of their
operations. There are two ways in which money markets help with industrial
financing- providing short term funding and producing an impact on capital
markets. Short term funding from money markets can help industries finance
their day to day operations and meet working capital requirements. The long
term capital is obtained by industries through the issue of bonds or shares on
applicable capital markets. However, since the rate applicable to short term
lending determines the applicable yield of long term capital market
instruments, the market is clearly impacted by money market movements.

 High Liquidity Investment Solution

The money market offers a lucrative, low risk route to institutions such as
commercial banks in using their excess funds to earn additional income.
Commercial banks need to generate this additional income in order to ensure
that they have sufficient liquidity so as to meet uncertain demands such as
withdrawal of consumer deposits. Usually, commercial banks invest their
funds in near money assets that have a short maturity period. This way, the
banking sector is able to generate additional income while maintaining
sufficient liquidity.
  Ensuring Self Sufficiency of Banks

Commercial banks operating in developed money markets have ample

opportunities to invest and generate further income such that their self
sufficiency improves in the long term. In case of dire cash crunch, banks can
borrow funds from the RBI. Thus, money market instruments can help banks
achieve their needs through the availability of funds at rates that are lower
than those charged by the central bank. Additionally, money markets provide
twin benefits of helping banks earn additional income and also acting as a
source of funds to banks when required.

 Maintaining Money Supply for Central Banks

Central Banks are responsible for maintaining and controlling both the
money market and capital market. As these markets operate using short term
interest rates, they serve as an indicator of the country’s overall economic
health. Such information provides accurate guidance to the central bank
regarding how it should rectify any problems that might occur in the current
situation. Thus, in the presence of a developed money market, the central
bank has access to a secure, quick as well as effective way to influence various
submarkets without having to overextend itself.

COMPONENTS OF MONEY MARKET

The following are the instruments that are integral parts of the Indian money
market system.
 Call money or notice money. ...
 Treasury bills. ...
 Commercial bills. ...
 Certificate of deposits. ...
 Commercial paper. ...
 Money market mutual funds (MMMFs) ...
 Repo and the reverse repo market
  Call/Notice-Money Market: Call/Notice money is the money borrowed or
lent on demand for a very short period. When money is borrowed or lent for
a day, it is known as Call (Overnight) Money. Intervening holidays and/or
Sunday are excluded for this purpose. Thus money, borrowed on a day and
repaid on the next working day, (irrespective of the number of intervening
holidays) is "Call Money". When money is borrowed or lent for more than a
day and up to 14 days, it is "Notice Money". No collateral security is
required to cover these transactions.

Treasury Bills: Treasury Bills are short term (up to one year) borrowing
instruments of the union government. It is an IOU of the Government. It is a
promise by the Government to pay a stated sum after expiry of the stated period
from the date of issue (14/91/182/364 days, i.e. less than one year). They are issued
at a discount to the face value and on maturity the face value is paid to the holder.
The rate of discount and the corresponding issue price are determined at each
auction.

Certificate of Deposits: Certificates of Deposit (CDs) is a negotiable money

market instrument and issued in dematerialised form or as a Usance Promissory
Note for funds deposited at a bank or other eligible financial institution for a
specified time period. Guidelines for issuance of CDs are presently governed by
various directives issued by the Reserve Bank of India as amended from time to
time. CDs can be issued by (i) scheduled commercial banks excluding Regional
Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India
Financial Institutions that have been permitted by RBI to raise short-term resources
within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs
depending on their requirements.

. 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.
Money Market Funds
MMMFs are highly liquid open-ended dent funds generally used for short term
cash needs. The money market fund deal only in cash and cash equivalents with an
average maturity of an year with fixed income.

Reverse repo market

Repo Market is a tool to manage liquidity in financial institutions. Repo is used

in India as an instrument for monetary policy by institutionalizing daily Liquidity
Adjustment Facility (LAF). It allows banks and Primary Dealers to manage their
liquidity needs.