Types and Instruments of Money Market Explained

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The money market plays a crucial role in the economy by facilitating short-term borrowing and lending of funds. It is a part of the financial market where instruments with high liquidity and short maturities are traded. Understanding the meaning of the money market is essential for UGC NET Commerce aspirants, as it forms a vital component of the financial system. Key instruments like Treasury Bills, Commercial Paper, and Certificates of Deposit are commonly traded, offering both security and flexibility to market participants. In this article, we will explore the types of money market instruments and their significance in the financial landscape.

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What is Money Market?

The money market is a segment of the financial market that facilitates the transfer of funds between lenders/investors and borrowers/users.
It deals with short-term funds and financial assets with a maturity of up to one year (365 days).
The money market does not involve cash but provides a platform for credit instruments like bills of exchange, promissory notes, commercial paper, and treasury bills.
In India, the money market includes the Reserve Bank of India (RBI), commercial banks, co-operative banks, and specialized financial institutions.
The RBI acts as the primary controller of the Indian money market, with NBFCs and institutions like LIC, GIC, and UTI also playing a role.

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Structure of Indian Money Market

The Indian money market is a network that facilitates the short-term borrowing and lending of funds. It plays a vital role in maintaining liquidity in the economy. The Indian Money Market comprises of 2 sectors: Organized and Unorganized.

Organized Sector:

Includes RBI, commercial banks, NBFCs.
Regulated and transparent.
Offers instruments like Treasury Bills, Commercial Paper.
Facilitates short-term borrowing for businesses and government.

Unorganized Sector

Comprises money lenders, hawala operators
Unregulated and risky
Provides informal credit at higher interest rates
Serves individuals with limited access to formal finance

Instrument of Money Market

The main instrument of the Indian money market are as follows:

1. Treasury Bills (T-Bills):

Treasury Bills (T-Bills) are short-term debt instruments issued by the Reserve Bank of India (RBI) on behalf of the central government. They are typically issued when there is a liquidity shortage or when the RBI aims to control cash flow in the economy. Here are the key features of Treasury Bills:

Maturity: T-Bills have a maturity period of one year or less.
Liquidity & Risk: They are highly liquid and carry a very low risk.
Discounted Issuance: Treasury Bills are issued at a discount to their face value, meaning the holder purchases them for less than the amount they will be repaid at maturity.
Example: For instance, a 124-day T-Bill with a face value of ₹10,000 might be issued at ₹9,000. Upon maturity, the holder would receive ₹10,000, making the ₹1,000 difference the discount or interest earned.

2. Commercial Paper (CP):

Commercial Paper (CP) is a short-term, unsecured debt instrument issued by corporations to meet their short-term financing needs. Here are its features:

Maturity: Typically ranges from 7 days to 1 year.
Issuer: Issued by large corporations with high credit ratings.
Discounted: Issued at a discount to face value, with no periodic interest payments.
Liquidity: Highly liquid and can be easily traded in the secondary market.
Use: Commonly used to raise funds for working capital, inventory financing, or other short-term requirements.
Risk: Low risk for investors, but higher than Treasury Bills due to the issuer’s credit rating.

3. Certificate of Deposit (CD):

A Certificate of Deposit is a time deposit issued by banks, offering a fixed interest rate over a specific period (usually 7 days to 1 year).
It’s a low-risk investment, typically issued at face value and can be traded in the secondary market.

4. Repurchase Agreements (Repos):

A Repurchase Agreement (Repo) is a short-term borrowing arrangement where one party sells securities to another with an agreement to repurchase them at a later date for a higher price.
Repos provide liquidity and are typically used by financial institutions for short-term financing.

5. Call Money

Call Money is a short-term loan between banks, typically for a period of 1 to 14 days. It is used for managing daily liquidity needs.
Interest rates on call money fluctuate based on demand and supply, making it one of the most liquid money market instruments.

Money Market Conclusion

In conclusion, the money market plays a crucial role in maintaining liquidity and stability in the financial system. It offers various instruments such as Treasury Bills, Commercial Paper, Certificate of Deposit, and Repurchase Agreements to facilitate short-term borrowing and lending. These instruments provide businesses, governments, and financial institutions with the means to meet their short-term funding needs efficiently. Understanding the dynamics of the money market is essential for both investors and financial professionals, especially in the context of UGC NET Commerce preparation, as it forms a critical component of the broader financial markets.

UGC NET MCQ based on Money Market

Q1. Which of the following is NOT a money market instrument?
a) Treasury Bills
b) Commercial Paper
c) Bonds
d) Repurchase Agreements

Answer: c) Bonds

Q2. What is the maximum maturity period for Treasury Bills in India?
a) 180 days
b) 360 days
c) 1 year
d) 2 years

Answer: c) 1 year

Q3. Which of the following sectors is directly involved in the Indian money market?
a) Stock Exchanges
b) Commercial Banks
c) Foreign Exchange Market
d) Real Estate Market

Answer: b) Commercial Banks

Q4. Which of the following is TRUE about Repurchase Agreements (Repos)?
a) They are a type of equity instrument
b) They are used for long-term borrowing
c) The seller agrees to repurchase securities at a future date
d) They are issued by the government only

Answer: c) The seller agrees to repurchase securities at a future date