Money market instruments are short-term financial instruments used to raise capital. Money market instruments, regulated by the Reserve Bank of India (RBI), are considered low-risk investments since the government or corporations with good creditworthiness back them.
Objectives of the money market
- To facilitate short-term borrowing/lending of funds to meet the short-term liquidity needs of the government, financial institutions, and corporations.
- To provide a source of short-term investment for individuals and institutions.
- To promote monetary stability by controlling the supply of money and credit in the economy
Importance of the money market
- Providing short-term funding for borrowing and lending by the government, financial institutions, and corporations.
- Promoting financial stability by regulating the supply and demand for short-term funds.
- Supporting economic growth by providing funds for various productive activities.
- Offering investment options to individuals and institutions with surplus funds.
What are the advantages and disadvantages of money market instruments?
Since the government and reputed corporations issue these instruments, investors’ money will be safe, and the returns assured. You can use these instruments as collateral for loans. However, the return on investment will be lower, given the nature of these instruments.
Characteristics of money market instruments
- Most money market instruments have a maturity period of up to one year.
- They are easily tradable and can be quickly converted into cash.
- They are considered low-risk investments.
- Due to their low risk, they typically offer low returns.
Types of money market instruments in India
Treasury bills are short-term, highly liquid debt instruments issued by the government of India to meet its short-term funding requirements. They have a maturity period of up to one year and are issued at a discount to the face value. Banks, corporates, and individuals hold them widely, and you can use them as collateral for loans.
Commercial bills are negotiable instruments to facilitate the purchase of goods and services. Businesses use them as a means of payment and to obtain short-term financing. Inland Bills are issued within the country, while Foreign Bills are issued between a buyer and seller in two countries.
Certificates of deposit
Banks issue these debt instruments to raise funds for a specified time. They offer a fixed interest rate and provide a higher return rate than a savings account. The tenure ranges from seven days to ten years and is usually tradable in the secondary market.
Commercial papers are short-term debt instruments companies use to raise funds for short-term funding needs. Companies issue them as unsecured promissory notes with a maturity of less than one year.
Call money is a short-term borrowing mechanism where banks and financial institutions lend money to each other overnight to meet their daily liquidity needs. The interest rate charged is known as the call rate.
Features of the money market
- It is a market for short-term investments with a maturity of up to one year.
- It is a low-risk investment option compared to other markets.
- It provides high liquidity to investors as you can easily convert investments into cash.
- It offers a range of instruments, such as treasury bills, commercial papers, certificates of deposit, etc.
- It comprises various participants such as commercial banks, primary dealers, nonbanking financial companies, and mutual funds.
Money market vs. stock market
The money market is where you trade financial instruments. These have high liquidity and short maturities. Money market is a low-risk, low-return investment.
The stock market is a market for equity securities, where investors buy and sell stocks of companies. Companies issue stocks to raise capital and the supply and demand in the market determine the price. Investing in stocks is risky, but it has the potential for higher returns.
What are money market funds?
A money market fund is a type of mutual fund that invests in short-term debt instruments. Money market funds are low-risk investments and provide higher returns than savings accounts, but lower than fixed deposits. The Securities and Exchange Board of India regulates money market funds in India.
Factors that determine interest rates of money market instruments
- RBI sets monetary policy and adjusts interest rates to control inflation and manage the money.
- The growth rate of the economy influences the interest rate.
- If inflation is high, the interest rate is likely to be higher to combat inflationary pressures.
- The government borrows money from the market to finance its expenses. This increases the demand for money, leading to an increase in interest rates.
- The availability of funds in the market influences the market. If there is a surplus of funds, interest rates decrease, and interest rates increase if there is a shortage of funds.
- Changes in global interest rates and economic conditions affect the demand for and supply of money in the Indian economy.
The money market in India plays a crucial role in ensuring the economic stability of financial markets. As the scenario is dynamic, it would be prudent to research India’s top-performing money market funds before investing in them.
What are treasury bills?
These are short-term, highly liquid debt instruments issued by the Government of India to meet its short-term funding requirements. They have a maturity period of up to one year. Government issues them at a discount to the face value. Banks, corporates, and individuals hold them and use them as collateral for loans.
What is the difference between the money market and the capital market?
The money market deals only with instruments like treasury bills. Governments and corporations use them to raise short-term capital, whereas the capital market trades in stocks of companies.
Who can invest in money market instruments?
Commercial banks, non-banking financial companies, mutual funds, and individual investors can invest.