MONEY MARKET

Meaning of Money Market:

Money market refers to the market where money and highly liquid marketable securities are
bought and sold having a maturity period of one or less than one year. The money market
constitutes a very important segment of the Indian financial system.
Definitions of Money Market:
According to the Geoffrey, "Money market is the collective name given to the various firms
and institutions that deal in the various grades of near money"
Features of Money Market:
The following are the general features of a money market:
1) It is a market purely for short-term funds or financial assets called near money.
2) It deals with financial assets having a maturity period up to one year only.
3) It deals with only those assets which can be converted into cash readily without loss and
with minimum transaction cost.
4) Generally, transactions take place through phone i.e., oral communication. Relevant
documents and written communications can be exchanged subsequently. There is no formal
place like stock exchange as in the case of a capital market.
5) Transactions have to be conducted without the help of brokers.
6) The components of a money market are the Central Bank, Commercial Banks, Non-
banking financial companies, discount houses and acceptance house. Commercial banks
generally play a dominant role in this market.
Functions of money market:
1. Financing Trade
Money Market plays crucial role in financing both internal as well as international trade.
Commercial finance is made available to the traders through bills of exchange, which are
discounted by the bill [Link] acceptance houses and discount markets help in financing
foreign trade.
2. Financing Industry
Money market contributes to the growth of industries in two ways:
(a) Money market helps the industries in securing short-term loans to meet their working
capital requirements through the system of finance bills, commercial papers, etc.
(b) Industries generally need long-term loans, which are provided in the capital market.
However, capital market depends upon the nature of and the conditions in the money market.
The short-term interest rates of the money market influence the long-term interest rates of the
capital market. Thus, money market indirectly helps the industries through its link with and
influence on long-term capital market.
3. Profitable Investment
Money market enables the commercial banks to use their excess reserves in profitable
investment. The main objective of the commercial banks is to earn income from its reserves
as well as maintain liquidity to meet the uncertain cash demand of the depositors.
4. Self-Sufficiency of Commercial Bank
Developed money market helps the commercial banks to become self-sufficient. In the
situation of emergency, when the commercial banks have scarcity of funds, they need not
approach the central bank and borrow at a higher interest rate. On the other hand, they can
meet their requirements by recalling their old short-run loans from the money market.
5. Help to Central Bank
Though the central bank can function and influence the banking system in the absence of a
money market, the existence of a developed money market smoothens the functioning and
increases the efficiency of Central Bank.
6. Money market helps the Central Bank in two ways
(a) The short-run interest rates of the money market 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.
(b) The sensitive and integrated money market helps the central bank to secure quick and
widespread influence on the sub-markets and thus achieve effective implementation of its
policy.
Instruments of Money Market:
 1. Treasury Bills
2. Commercial Papers
3. Certificate of Deposits
4. Repurchase Agreement (Repo)
5. Reserve Repos
6. Inter-Corporate Deposits (ICD)
1. Treasury Bills
Treasury bills are short-term instruments issued by the Reserve Bank on behalf of the
government to tide over short-term liquidity shortfalls. This instrument is used by the
government to raise short-term funds to bridge seasonal or temporary gaps between its receipt
(revenue and capital) and expenditure.
2. Commercial Papers
A commercial paper is an unsecured short-term instrument issued by the large banks and
corporations in the form of promissory note, negotiable and transferable by endorsement and
delivery with a fixed maturity period to meet the short-term financial requirement. There are
four basic kinds of commercial paper: promissory notes, drafts, cheques and certificates of
deposit.
3. Certificate of Deposits
Certificates of deposit are unsecured, negotiable, short-term instruments in bearer form,
Issued by commercial banks and development financial institutions.
4. Repurchase Agreement (Repo)
Repo is a money market instrument, which enables collateralized short term borrowing and
lending through sale/purchase operations in debt instruments. Under a repo transaction, a
holder of securities sells them to an investor with an agreement to repurchase at a
predetermined date and rate.
5. Reserve Repos
A reverse repo is the mirror image of a repo. For, in a reverse repo, securities are acquired
with a simultaneous commitment to resell. When the reverse repurchase transaction matures,
the counter party returns the security to the entity concerned and receives its cash along with
a profit spread.
6. Inter-Corporate Deposits (ICD)
An Inter-Corporate Deposit (ICD) is an unsecured borrowing by corporate and Fis from other
corporate entities registered under the Companies Act 1956. The corporate having surplus
funds would lend to another corporate in need of funds. This lending would be an
uncollateralized basis and hence a higher rate of interest would be demanded by the lender.

CAPITAL MARKET
Meaning of Capital Market
Capital market is a place where the medium-term and long-term financial needs of business
and other undertakings are met by financial institutions which supply medium and long-term
resources to borrowers.
Functions of Capital Market
1. Link between Savers and Investors
The capital market functions as a link between savers and investors. It plays an important role
in mobilising the savings and diverting them in productive investment.
2. Encouragement to Savings
With the development of capital market, the banking and non-banking institutions provide
facilities, which encourage people to save more.
3. Encouragement to Investment
The capital market facilitates lending to the businessmen and the government and thus
encourages investment. It provides facilities through banks and nonbank financial
institutions.
4. Promotes Economic Growth
The capital market not only reflects the general condition of the economy but also smoothens
and accelerates the process of economic growth. Various institutions of the capital market,
like non-banking financial intermediaries, allocate the resources rationally in accordance with
the development needs of the country.
5. Stability in Security Prices
The capital market tends to stabilise the values of stocks and securities and thereby reduce the
fluctuations in the prices to the minimum. The process of stabilisation is facilitated by
providing capital to the borrowers at a lower interest rate and reducing the speculative and
unproductive activities.
6. Benefits to Investors
The credit market helps the investors, i.e., those who have funds to invest in long-term
financial assets, in many ways:
(a) It brings together the buyers and sellers of securities and thus ensures the marketability of
Investments.
(b) By advertising security prices, the Stock Exchange enables the investors to keep track of
their investments and channelize them into most profitable lines.
(c) It safeguards the interests of the investors by compensating them from the Stock
Exchange Compensating Fund in the event of fraud and default.
Instruments of Capital Market

1. Debt Instruments
A debt instrument is used by either companies or governments to generate funds for capital-
intensive projects. It can be obtained either through the primary or secondary market. The
contract is for a specific duration and interest is paid at specified periods as stated in the trust
deed.
2. Equities (also called Common Stock)
This instrument is issued by companies only and can also be obtained either in the primary
market or the secondary market. Investment in this form of business translates to ownership
of the business as the contract stands in perpetuity unless sold to another investor in the
secondary market.
3. Preference Shares
This instrument is issued by corporate bodies and the investors rank second on the scale of
preference when a company goes under liquidation. Preference shares can also be treated as a
debt instrument as they do not confer voting rights on its holders and have a dividend
payment that is structured like interest paid for bonds issues.
Preference shares may be:
[Link], convertible.
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These are instruments that derive from other securities, which are referred to as underlying
assets. The price, riskiness and function of the derivative depend on the underlying assets
since whatever affects the underlying asset must affect the derivative.
5. Mutual Fund
Mutual fund is an investment vehicle that is made up of a pool of funds collected from many
investors for the purpose of investing in securities such as stocks, bonds, money market
Instruments and similar assets. Mutual funds are operated by money managers, who invest
the fund's capital and attempt to produce capital gains and income for the fund's investors.

Difference between Money Market and Capital Market

Basis Money Market Capital Market

Meaning A market for short-term funds that is A marketer including all institutions,
meant to use for a period of up to one organisations, and instruments providing
year is known as Money Market. medium and long-term funds is known as
a Capital Market
Participants The participants of money market are The participants of capital market are
banks, financial institutions, foreign banks, financial institutions, foreign
investors, and public and private investors, ordinary retail investors from
companies. However, ordinary retail public, and public and private companies
investors from public do not
participate in this market.
Duration The money market deals in securities The capital market deals in securities of
of short-term with a maximum tenure medium and long term.
of one year.
Instruments Some of the common instruments of Some of the common instruments of a
money market are Call Money, capital market are debentures, equity
Commercial Bills, Treasury Bills, shares, bonds, preference shares, and
Commercial Paper, Certificate of other innovative securities.
Deposits, etc.
Investment The instruments of the money market As the value of securities in the capital
outlay are quite expensive; therefore, the market is generally low (of about ?10 to
financial investment requirement of 7100), the investment in this market does
this market is huge. not require a huge financial investment.
Liquidity Money market securities are highly The securities that come under the capital
liquid. market are considered liquid. It is
because of the stock exchange. However,
these securities are less liquid compared
to the instruments of money market.
Safety The instruments of a money market The instruments of a capital market are
are less risky or safe as they are used riskier. The investors may face the risk in
for a short period of time and also return as well as principal repayment, as
because of the soundness of the the companies issuing the securities may
issuers. fail.
Expected The duration of the money market is he expected return of a capital market is
Return short; therefore, the expected return higher. It is because along with regular
here is less. interest or dividend, the investors have
chances of capital gain.
Type of Companies approach money market Companies approach capital market
Capital when they need working capital. when they need fixed capital.
Derivatives

Meaning of Derivatives
The term "Derivative" indicates that it has no independent value, i.e. its value is entirely
"derived" from the value of the underlying asset. The underlying asset can be securities,
commodities, bullion, currency, livestock or anything else)
In other words, Derivative means a forward, future, option or any other hybrid contract of
pre-determined fixed duration, linked for the purpose of contract fulfilment to the value of a
specified real or financial asset or to an index of securities.
Definitions of Derivatives
According to D. G. Gardener, "Derivative is a financial product which has been derived
from market for another product."
Functions of Derivatives
1. Risk management: The prices of derivatives are related to their underlying assets, as
mentioned before. They can thus be used to increase or decrease the risk of owning the asset.
2. Price discovery: Derivative market serves as an important source of information about
prices. Prices of derivative instruments such as futures and forwards can be used to determine
what the market expects future spot prices to be. In most cases, the information is accurate
and reliable.
3. Operational advantages: Derivative markets have greater liquidity than the spot markets.
The transactions costs therefore, are lower. This means commissions and other costs for
traders are lower in derivatives markets. Further, unlike securities markets that discourage
shorting, selling short is much easier in derivatives.

Advantages of Derivatives
1. Hedging risk exposure: Since the value of the derivatives is linked to the value of the
underlying asset, the contracts are primarily used for hedging risks.
2. Underlying asset price determination: Derivatives are frequently used to determine the
price of the underlying asset.
3. Market efficiency: It is considered that derivatives increase the efficiency of financial
markets. By using derivative contracts, one can replicate the payoff of the assets.
4. Access to unavailable assets or markets: Derivatives can help organizations get access to
otherwise, unavailable assets or markets. By employing interest rate swaps, a company may
obtain a more favourable interest rate relative to interest rates available from direct
borrowing.
Disadvantages of Derivatives
1. High risk
2. Speculative features
3. Counter-party risk
Classification of Derivatives
1. On the basis of linear and non-linear
On the basis of this classification the financial derivatives can be classified into two bag class
namely linear and non-linear derivatives:
(a) Linear derivatives: Those derivatives whose values depend linearly on the underling's
value are called linear derivatives. They are following:
(i) Forwards
(ii) Futures
(iii) Swaps
(b) Non-linear derivatives: Those derivatives whose value is a non-linear function of the
underlying are called non-linear derivatives. They are following
(i) Options
(ii) Convertibles
(iii) Equity linked bonds
(iv) Reinsurances
2. On the basis of financial and non-financial
On the basis of this classification the derivatives can be classified into two category namely
financial derivatives and non-financial derivatives.
(a)Financial derivatives: Those derivatives which are of financial nature are called financial
derivatives. They are following:
(i)Forwards
(ii) Futures
(iii) Options
(iv)Swaps
The above financial derivatives may be credit derivatives, forex, currency fixed-income,
interest, insider trading and exchange traded.
(b) Non-financial derivatives: Those derivatives which are not of financial nature are called
non-financial derivatives. They are following:
(i)Commodities
(ii) Metals
(iii)Leather
(iv) Others
[Link] the basis of market where they trade
On the basis of this classification, the derivatives can be classified into three categories
namely, OTC traded derivatives, exchange-traded derivative and common derivative.
(a) Over-the-counter (OTC) traded derivative: These derivative contracts are traded (and
privately negotiated) directly between two parties, without going through an exchange or
other intermediary. The OTC derivative market is the largest market for derivatives and
largely unregulated with respect to disclosure of information between parties. They are
following:
(i) Swaps
(ii) Forward rate agreements
(iii) Exotic options
(iv) other exotic derivative
(b) Exchange traded derivative: Those derivatives instrument that are traded via specialized
derivatives exchange of other exchange. A derivatives exchange is a market where individual
trade standardized contracts that have been defined by the exchange. A derivative exchange
act are the intermediary to all related transactions and takes initial margin from both sides of
the trade to act as a guarantee. They may be followings:
(I) Futures
(ii) Options
(iii)Interest rate
(iv) Index product
(v) Convertible
(vi) Warrants
(vii) Others
(c) Common derivative: These derivatives are common in nature/trading and classification.
They are following:
(i) Forwards
(ii) Futures
(iii) Options
(iv) Binary options
(v) Warrant
(vi) Swaps