The Money Market is a market for lending and borrowing of short-term funds. It deals in funds and financial instruments having a maturity period of one day to one year. It covers money and financial assets that are close substitutes for money. The instruments in the money market are of short term nature and highly liquid.
Money market transactions are wholesale, meaning that they are for large denominations and take place between financial institutions and companies rather than individuals. Money market funds offer individuals the opportunity to invest smaller amounts in these assets.
Instruments of the Money Market:
The money market operates through a number of instruments which are explained as follows
Promissory Note –
The promissory note is the earliest types of bill. It is a written promise on the part of a businessman today to another a certain sum of money at an agreed future data. Usually, a promissory note falls due for payment after 90 days with three days of grace. A promissory note is drawn by the debtor and has to be accepted by the bank in which the debtor has his account, to be valid. The creditor can get it discounted from his bank till the date of recovery.
Bill of Exchange or Commercial Bills –
Bills of exchange are negotiable instruments. Which contain an order to pay a certain amount to a particular person within a stipulated period of time. Creditor issues the bill of exchange to the debtor when the debtor owes money for goods or services.
Treasury Bill –
But the major instrument of the money markets is the Treasury bill which is issued for varying periods of less than one year.
[In India, the treasury bills are issued by the Government of India at a discount generally between 91 days and 364 days. There are three types of treasury bills in India—91 days, 182 days and 364 days.
They are issued by the Secretary to the Treasury in England and are payable at the Bank of England.
There are also the short-term government securities in the USA which are traded by commercial banks and dealers in securities.]
Call and Notice Money –
There is the call money market in which funds are borrowed and lent for one day. In the notice market, they are borrowed and lent up to 14 days without any collateral security. But deposit receipt is issued to the lender by the borrower who repays the borrowed amount with interest on call.
[In India, commercial banks and cooperative banks borrow and lend funds in this market but mutual funds and all-India financial institutions participate only as lenders of funds.]
Inter-bank Term Market –
This market is exclusively for commercial and cooperative banks in India, which borrow and lend funds for a period of over 14 days and upto 90 days without any collateral security at market-determined rates.
Certificates of Deposits (CD) –
Certificates of deposits are issued by commercial banks at a discount on face value. The discount rate is determined by the market.
[In India the minimum size of the issue is Rs. 25 lakhs with the minimum subscription of Rs. 5 lakhs. The maturity period is between 3 months and 12 months.]
Commercial Paper (CP) –
Commercial papers are issued by companies with high credit ratings to raise short-term working capital requirements directly from the market instead of borrowing from the banks. CP is a promise by the borrowing company to repay the load at a specified date, normally for a period of 3 months to 6 months.
Investors usually purchase commercial paper below par and then receive its face value at maturity. The discount, or the difference between the purchase price and the face value of the note, is the interest received on the investment. All commercial paper interest rates are quoted on a discounted basis.
[This instrument is very popular in the USA, UK, Japan, Australia and a number of other countries. It has been introduced in India in January 1990.]
Working of the money market-
The money market consisting of commercial banks, discount houses, bill brokers, acceptance houses, non-bank financial houses and the central bank operates through the bills, securities, treasury bills, government securities and call loans of various types. As the money market consists of varied types of institutions dealing in different types of instruments, it operates through a number of sub-markets.
First, the money market operates through the call loan market. It has been defined as “a market for marginal funds, for temporarily unemployed or unemployable funds”. In this market the commercial banks use their un-issued funds to lend for very short periods to bill brokers and dealers in stock exchange. In developed countries, even big corporations lend their dividends before distribution to earn interest for a very short period.
The central bank also lends to commercial bank is for very short periods. Such loans are mostly for a week even for a day or a night and can be recalled at very short notice. That is why a short period loan is known as call loan or call money market. Bill brokers and stock brokers who borrow such funds use them to discount or purchase bills or stocks.
Such funds are borrowed at the “call rate” which is generally one per cent below the bank rate. But this rate varies with the volume of funds lent by the bank. If the brokers are asked to pay off loans immediately, then they are forced to get funds from large corporations and even from the central bank at high interest rate.
Second, the money market also operates through the bill market. The bill market is the short-period loan market. In this market, loans are made available to businessmen and the government by the commercial banks, discount houses and brokers. The instruments of credit are the promissory notes. Internal bills of exchange and treasury bills.
The commercial banks discount bills о exchange, lend against promissory notes or through advances or overdrafts to the business community. Similarly, the discount houses and bills brokers lend to businessmen by discounting their bills of exchange before they mature within 90 days. On the other hand, government borrows through the treasury bills from the commercial banks and non-bank financial institutions.
Third, the money market operator through the collateral loan market for a short period. The commercial banks lend to brokers and discount houses against collateral bonds, stock, securities, etc. In case of need, commercial banks themselves borrower from the large banks and the central bank on the basis of collateral securities.
Finally, the other important sub-market through which the money market operates is the acceptance market. The merchant bankers accept bills drawn on domestic and foreign traders whose financial standing is not known. When they accept a domestic or foreign trade bill, they guarantee its payment at maturity. In recent years, the commercial banks have also started the acceptance business.