Money Market Instruments: Meaning, Types & Purpose

What is a money market instrument?

Money market instruments are short-term financing instruments aimed at increasing businesses' financial liquidity. The key feature of these types of securities is that they can quickly be turned to cash while maintaining an investor's cash needs. The money market and its securities are commonly traded over the counter, and should thus not be carried out by individual investors alone. It has to be done through certified brokers, or a mutual fund for the money market. The interest rates of different instruments in the money market are regulated by the Reserve Bank. In the money market, the degree of risk is smaller. This is because there is a maturity of one year or less for most instruments.

Types of Money Market Instruments  

There are different types of money market instrument such as -

1. Treasury Bills (T-Bills)

Treasury bills or T-Bills are released on behalf of the Central Government by the Reserve Bank of India to raise money. They have the highest short-term maturities of up to one year. Actually, 3 separate maturity periods are released by T-Bills, 91 days T-Bills, 182 days T-Bills, 1-year T-Bills. T-Bills are distributed at a discount to the face value amount. The investor gets the face value amount at maturity. The return gained by the investor is this difference between the original price of the instrument and the face value. As they are backed by the Government of India, they are the safest short-term fixed-income investments.

2. Commercial Papers

Big firms and corporations issue promissory notes, known as Commercial Papers (CPs), to collect money to meet their short-term business needs. Such companies have such a high credit record, due to which business papers are unsecured, with the reputation of the firm serving as protection for the financial instrument. The maturity period of these debt instruments is anywhere from 7 days to 1 year, attracting a lower interest rate than that of equivalent securities sold on the financial market.

3. Certificates of Deposits (CD)

Certificates of Deposits are financial instruments that banks and financial institutions issue. They give fixed interest rates on the amount invested. The main difference between a Certificate of Deposits and a fixed deposit is the value of the principal amount which can be invested. The former (1 lakh or in multiples of 1 lakh thereafter) is issued for large amounts of money.

4. Call and Notice Money

Call and Notice Money exist in the market. In the context of Call Money, funds are borrowed and lent for one day, while they are borrowed and lent for up to 14 days on the Notice Market, without any collateral protection. In this market, commercial banks and co-operative banks borrow and lend funds. All-India financial institutions and mutual funds, however, only participate as fund lenders.

5. Inter-bank Term Market

In India, the inter-bank term market is for cooperative and commercial banks that borrow and lend funds over a span of 14 days and up to 90 days. At the prices set by markets, this is achieved without any collateral protection.

6. Repurchase Agreements (Repo)

Repurchase agreements, also classified as Reverse Repo, are short-term loans negotiated between buyers and sellers for sale and repurchase purposes. Such transactions may be carried out only between RBI approved parties Transactions between RBI-approved securities such as treasury bills, central or state government securities, corporate bonds, and PSU bonds are only allowed.

7. Banker's Acceptance

A banker's acceptance, one of the most common money market instruments exchanged in the financial industry, implies a loan issued to the stipulated bank, with a signed repayment promise in the future. As money market instruments are traded wholesale over the counter, they can not be bought by an individual investor in regular units.

Purpose of Money Market Instruments

  1. Provides funds

The Money Market Instruments help provide private and public institutions the capital that they need for funding their working capital needs. By discounting the trade bills through commercial banks, brokers, discount houses, and acceptance houses, these funds are provided. In exchange, money market instruments can also support the growth of commerce, business, and trade.

2. Maintains Liquidity in the Market

Maintaining liquidity in the economy is one of the most important features of a money market. Any of the instruments in the money market are an essential part of the system for monetary policy. To have the liquidity in the market inside the appropriate range, RBI uses these short-term securities.

3. Application of excess funds

Money market instruments offer banks and financial institutions an opportunity to efficiently utilize their surplus funds for a short period of time. Commercial banks and large non-financial companies, states, and other local bodies are listed.

4. Support the Government

Money market instruments prove beneficial to the government in lending short-term funds at low-interest rates on the basis of treasury bills. Moreover, if the government were to print paper money or borrow from the central bank, it would lead to inflationary pressures on the economy.

5 Economy in Cash Use

The instruments of the money market work with commodities that are not currency but cash equivalent and therefore help capitalize on the use of money. And it can also be used as a simple means of moving funds from one location to another.

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