Every modern economy is based on a sound financial system that helps in production, capital, and economic growth by encouraging saving habits, mobilizing savings from households and other segments, and allocating savings into productive usage such as trade, commerce, manufacture, etc. The financial system covers both credit and cash transactions. Thus, a financial system is a set of institutional arrangements through which financial surpluses are mobilized from the units generating surplus income and transferring them to the others in need of them. Money Market is a very important segment of this financial system.
What is Money Market?
Money Market refers to the market where the borrowers and lenders exchange short-term funds to solve their liquidity needs. Money Market instruments are generally financial claims that have low default risk, maturities under one year, and high marketability. Short-term funds up to one year and financial assets that are close substitutes for money are dealt in the money market. In India, this market is regulated by the Reserve bank of India (RBI) or SEBI (Securities Exchange Board of India).
Money Market Accounts
Money market accounts are a type of savings account. They pay interest but offer limited rights on withdrawal or writing checks against the account. If they exceed the prescribed limit, the bank promptly converts it to a checking account. Banks typically calculate interest on a money market account on a daily basis and credit the amount monthly.
Since Money Market instruments are virtually risk-free, money market investments come with very low-interest rates - often the risk-free rate of return. However, money market accounts anyway offer slightly higher interest rates than the standard savings accounts. But the difference in rates between savings and money market accounts has narrowed considerably since the 2008 financial crisis. Average interest rates for money market accounts vary based on the amount deposited. As of August 2020, the best-paying money market account with no minimum deposit has offered 0.99% annualized interest.
Money Market deals in the lending and borrowing of short-term finance varying for one year or less.
The main credit instruments of the money market are call money, treasury bills, commercial bills, commercial papers, and bills of exchange.
Money Market Instruments have the characteristics of liquidity, minimum transaction cost, and no loss in value.
Important Institutions operating in the money market are central banks, commercial banks, acceptance houses, non-banking financial institutions, bill brokers, etc. Mostly government banks and financial institutions dominate this market. It is a formal financial market that deals with short-term fund management.
Purpose of Loan
The Money Market meets the short-term credit needs of the business; it provides working capital to the industrialists.
Risk and Liquidity
The degree of risk is less and that of liquidity is higher in the money market as compared to the capital market.
Money Market Instruments
Treasury bills are money market instruments issued by the RBI to finance the short-term requirements of the government of India. These are discounted securities and thus are issued at a discount to face value. The return to the investor is the difference between the maturity value and the issue price.
There are four types of treasury bills; 14 day T bill, 91 day T bill, 182 day T bill, and 364 day T bill.
The usual investors in these bills are banks who invest not only to invest their short-term surpluses but also to get benefited from maintaining the statutory Liquid Ratio (SLR) requirements in T-bills is reckoned for the purpose of statutory reserves. Bids for treasury bills are to be made for a minimum amount of Rs.25000/- only and in multiples thereof. T Bills are repaid at par on the expiry of their tenure at the office of the Reserve Bank of India.
Yield Calculation: The yield of a T Bill is calculated as per the following formula:
Y= (100-P) x 365 x 100/ P x D
Y= Discounted yield
D= Days to Maturity.
What are the Benefits of Investment in Treasury Bills?
Zero default risk being sovereign paper
Highly liquid money market instruments
Better returns especially in the short term.
Certificate of Deposits
Certificate of Deposits (CD) is a negotiable money market instrument and issued in dematerialized form. Banks, merchant banks and building societies issue CDs to raise funds to finance their business activities.
CDs can be issued by scheduled commercial banks, selected all-India financial institutions.
The amount of CDs allowed to be issued by Banks varies as per the requirements keeping in limit the CRR and SLR requirements. The CDs issued to the Financial Institutions shall not exceed 100% of its net owned funds, as per the latest audited balance sheet.
Minimum amount of a CD should be Rs.1 Lakh i.e., the minimum deposit that could be accepted from a single subscriber should not exceed Rs.1 lakh and in the multiples of it thereafter. CDs can be issued to individuals, corporations, companies, trusts, funds, associations, etc.
Physical CDs are freely transferable by endorsement and delivery. Demat CDs can be transferred as per the procedure applicable to other demat securities. There is no Lock-in period for the CDs.
Commercial bills are basically negotiable instruments accepted by buyers for good or services obtained by them on credit. Such bills are bills of exchange and hence can be kept upto the due maturity date and can be encashed by the seller or maybe endorsed to a third party in payment of duties owing to the seller. The most common practice is that the seller who gets the accepted bills of exchange discounts it with the bank or financial institution or a bill discounting house and collects the money (less the interest charged for the discounting).
Commercial Paper is an unsecured money market instrument issued in the form of a promissory note.
Who can Issue?
Corporate and all Indian financial institutions (FIs) that have been permitted to raise short-term resources under the umbrella limit fixed by the RBI are eligible to issue Commercial Papers.
The Minimum credit rating requirement to issue Commercial Paper is A3.
Commercial Paper can be issued for maturities between a minimum of 7 days and a maximum of upto 1 year from the date of issue.
Commercial Papers can be issued in denominations of Rs.5 Lakh or in multiples thereof.
The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors or the quantum indicated by the Credit rating Agency for the specified rating, whichever is lower.
Only a scheduled bank can act as an Issuing and Paying agent for the issuance of CP.
Repurchase agreements are also called repos. Repos are short-term loans that buyers and sellers agree upon for selling and repurchasing. Repo transactions are allowed only among RBI-approved securities like state and central government securities, T-bills, PSU bonds, FI bonds, and corporate bonds. Repurchase agreements, on the other hand, are sold off by sellers, held back with a promise to purchase them back at a certain price and that too would happen on a specific date. The same is the procedure with that of the buyer, who purchases the securities and other instruments and promises to sell them back to the seller at the same time.
Long story short, Money market funds need stability and security. In general, money market instruments are not well suited for individuals who require a high rate of returns. Money Market instruments provide a market for investors to earn a return on liquid assets and borrowers who need short-term liquidity have access to these funds.