Money Market & Instruments

Money Market

The money market is the organised market for short-term funds. It deals in financial assets whose maturity does not exceed one year. The money market does not trade in physical cash but provides a market for credit instruments that are close substitutes for money, for example bills of exchange, promissory notes, commercial paper and treasury bills. These instruments enable business firms, financial institutions and the government to borrow to meet short-term needs such as working capital, temporary cash mismatches and short-term public expenditure.

• Nature and maturity: Instruments in the money market are short-term, highly liquid and usually carry low risk. Their maturity ranges from one day to up to 364 days (one year minus one day).
• Major participants (India): The Indian money market is led by the Reserve Bank of India (RBI) and includes commercial banks, co-operative banks, specialised financial institutions, some Non-Banking Financial Companies (NBFCs) and large financial organisations such as LIC, GIC and UTI. These participants borrow and lend short-term funds and help determine short-term interest rates.

Money Market Instruments

Following are some of the important money market instruments or securities.

• Call money (and notice money)
  Call money is the short-term interbank borrowing and lending market used mainly by banks to meet temporary cash needs. It is repayable on demand and its maturity typically ranges from one day (overnight) up to a fortnight. Notice money refers to funds lent for a few days (commonly 2-14 days). The interest rate in this market is called the call rate, which is a key indicator of liquidity conditions in the banking system.
• Treasury bills (T-bills)
  A treasury bill is a short-term promissory instrument issued by the government (through the RBI) to meet short-term fiscal requirements. T-bills are issued at a discount to their face value; the difference between the purchase price and the face value at maturity represents the investor's return. They are highly liquid and virtually risk-free since they are backed by the government. Common tenors issued in India are 91 days, 182 days and 364 days.
• Commercial paper (CP)
  Commercial paper is an unsecured promissory note issued by corporations to finance short-term working capital needs. It was introduced in India in 1990 to provide an alternative source of short-term funds for creditworthy corporates. CPs are issued for maturities from 15 days up to one year, are transferable by endorsement and delivery, and are typically issued by high-rated (blue-chip) companies.
• Certificate of Deposit (CD)
  A certificate of deposit is a short-term negotiable instrument issued by commercial banks and select financial institutions to raise funds. CDs are freely transferable and are issued to individuals, corporates and other entities. Their maturity typically ranges from 91 days to one year.
• Trade bills (Bills of exchange / Commercial bills)
  A trade bill arises when a seller (drawer) draws a bill of exchange on the buyer (drawee) for payment after a credit period. When the buyer accepts the bill it becomes a negotiable instrument and can be discounted with a bank before maturity. If a commercial bank accepts such a bill, it is often called a commercial bill. Discounting trade bills provides immediate short-term funds to the seller.
• Repurchase agreements (Repos) and reverse repos
  A repo is a short-term collateralised borrowing in which the seller of a security agrees to repurchase it at a future date at a predetermined price. A reverse repo is the corresponding lending operation. Repos are used extensively for overnight and short-term liquidity management, and the RBI uses repo and reverse repo operations as monetary policy instruments.

Key features and functions of the money market

• Short maturity: Instruments have maturities up to one year, so the market deals only with short-term finance.
• High liquidity: Most instruments are easily marketable and can be converted into cash quickly.
• Low risk: Instruments such as T-bills are backed by the government and are low risk; other instruments depend on issuer quality.
• Price discovery and interest rate signalling: Money-market rates (for example the call rate and repo rate) indicate short-term liquidity conditions and guide monetary policy transmission.
• Liquidity management: The market enables banks, corporates and the government to manage daily and short-term mismatches in cash flows.
• Financial intermediation: It provides an efficient channel for short-term surplus funds to reach deficit units.

Participants and their roles

• Reserve Bank of India (RBI): Acts as the leader and regulator of the money market, conducts open market operations and repo/reverse repo auctions to manage liquidity and implement monetary policy.
• Commercial banks and co-operative banks: Primary borrowers and lenders in call, notice and term money markets and major participants in T-bill and CD markets.
• Financial institutions and NBFCs: Participate in instruments such as CDs, CPs and other short-term instruments to manage funds and lend to end users.
• Corporates: Issue commercial paper, negotiate trade bills and invest surplus cash in T-bills, CPs and CDs.
• Primary dealers and mutual funds: Active in government securities and T-bill markets, helping with liquidity and market making.

Practical notes for students

• Remember that the money market is distinct from the capital market: the former deals with short-term finance (≤ 1 year), while the latter deals with long-term instruments (> 1 year).
• Key rates to watch: call rate, repo rate and the yields on short-term government securities; these indicate liquidity and monetary policy stance.
• Study examples: a company issuing commercial paper to meet seasonal working capital; a bank discounting an accepted trade bill to provide immediate cash to a seller.