CENTRAL UNIVERSITY OF SOUTH BIHAR

PROJECT-TOPIC
“Money Market & Its Instruments”

Submitted To Course Instructor

Submitted By Student

Dr. kumari Nitu Dharam Deepak Vishwash

BA.LLB.(Hons)
Assistant Professor, School of 8th Semester
Law & Governance 4th Year
Subject- Financial Market
Enrollment No. CUSB1713125013
Regulation
Course Code – LAW 456

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 ACKNOWLEDGEMENT

This project consumed huge amount of work, research and dedication. Still, implementation
would not have been possible if we did not have a support of many individuals and
organizations. Therefore I would like to extend my sincere gratitude to all of them.

In preparation of my assignment, I had to take the help and guidance of some respected
persons, who deserve my deepest gratitude. As the completion of this assignment gave me
much pleasure, I would like to show my gratitude to Dr. Kumari Nitu Course Instructor, of
Central University of South Bihar for giving me good guidelines for project throughout
numerous consultations. I would also like to expand my gratitude to all those who have directly
and indirectly guided me in writing this project.

Secondly I would also like to thank my parents and friends who helped me a lot in finalizing
this project within the limited time frame.

Many people, especially my classmates have made valuable comment suggestions on my paper
which gave me an inspiration to improve the quality of the project.

At last but not the least, a big thank you to the college library, writers of the book and sites
which gave me an expanded form of information about my topic.

DHARAM DEEPAK VISHWASH

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 INDEX

1. Money Market………………………………………………..……..4-5
2. Role of Money Market In Economy………………………………..….6
2.1 Producing Information & Allocating Capital……………………....6
2.2 Risk Sharing……………………………………………………..6-7
2.3 Liquidity………………………………………………………...…7
2.4 Diversification…………………………………………………..…8
2.5 Encouragements To Saving & Investment………………………8-9
3. Money Market Instruments………………………………………..…10
3.1 Treasury Bill………………………………………………..…10-11
3.2 Commercial Papers………………………………………….....…11
3.3 Participatory Notes……………………………………………11-12
3.4 Certificate of Deposit……………………………………………..12
3.5 Bankers Acceptance……………………………………………...12
4. Conclusion…………………………………………………………...13

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 1. Money Market
The Money Market is a very important segment of the Indian financial system. It is the market
where short term monetary assets are dealt in to raise short term requirements of funds and/ or
to park short term surpluses. The main characteristic of the Money Market is the liquid nature.

The money market transactions may range from overnight to one year. It has minimum
transaction cost. This unit encompasses the structure of the Money Market that has undergone
vast changes in the last decade. In this unit, we are going to discuss the different instruments
and the defect of Indian Money Market. The unit also discusses the bill market. Thus, you will
be able to understand through this unit the structure, instrument as well as the defect of the
Indian money market. Financial openness is often regarded as providing important potential
benefits. Access to money markets expands investors’ opportunities for a potential for
achieving higher risk adjusted rates of return. It also allows countries to borrow to smooth
consumption in the face of adverse shocks, the potential growth and welfare gains resulting
from such international risk sharing can be large (Obstfeld, 1994). It has also been argued that
by increasing the rewards of good policies and the penalties for bad policies, free flow of capital
across borders may induce countries to follow more disciplined macroeconomic policies that
translate into greater macroeconomic stability. An increasingly common argument in favour of
financial openness is that it may increase the depth and breadth of domestic financial markets
and lead to an increase in financial intermediation process by lowering costs and “excessive”
profits associated with monopolistic or cartelized markets, thereby lowering the cost of
investment and improving resource allocation. 12 Organized financial markets have existed in
India for more than a century. Today, markets of varying maturity exist in equity, debt,
commodities and foreign exchange. There are 25 stock markets all over the country, the most
important of which, are the Bombay Stock Exchange and the National Stock Exchange. The
rupee has been convertible on the current account since 1992. India Financial Market helps in
promoting the savings of the economy - helping to adopt an effective channel to transmit
various financial policies. The Indian financial sector is well- developed, competitive, efficient
and integrated to face all shocks. In Indian financial market there are various types of financial
products whose prices are determined by the numerous buyers and sellers in the market. The
other determinant factor of the prices of the financial products is the market forces of demand
and supply. The India money market is a monetary system that involves the lending and

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borrowing of short-term funds. India money market has seen exponential growth just after the
globalization initiative in 1992. It has been observed that financial institutions do employ
money market instruments for financing short-term monetary requirements of various sectors
such as agriculture, finance and manufacturing. The performance of the India money market
has been outstanding in the past 20 years. Central bank of the country - the Reserve Bank of
India (RBI) has always been playing the major role in regulating and controlling the India
money market. The intervention of RBI is varied - curbing crisis situations by reducing the
cash reserve ratio (CRR) or infusing more money in the economy

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 2. Role of Money Market In Economy
Money markets play a key role in banks’ liquidity management and the transmission of
monetary policy. In normal times, money markets are among the most liquid in the financial
sector. By providing the appropriate instruments and partners for liquidity trading, the money
market allows the refinancing of short and medium-term positions and facilitates the mitigation
of your business’ liquidity risk. The banking system and the money market represent the
exclusive setting monetary policy operates in. A developed, active and efficient interbank
market enhances the efficiency of central bank’s monetary policy, transmitting its impulses
into the economy best. Thus, the development of the money market smoothes the progress of
financial intermediation and boosts lending to economy, hence improving the country’s
economic and social welfare. Therefore, the development of the money market is in all
stakeholders’ interests: the banking system elf, the Central Bank and the economy on the
whole.

1. Producing Information & Allocating Capital:-

The information production role of financial systems is explored by Ramakrishnan Thakor

(1984), Bhattacharya and P Fleiderer (1985), Boyd and Prescott (1986), and Allen (1990). They
develop models where financial intermediaries arise to produce information and sell this
information to savers. Financial intermediaries can improve the assessment of investment
opportunities with positive ramifications on resource allocation by economizing on information
acquisition costs. As Schumpeter (1912) argued, financial systems can enhance growth by
spurring technological innovation by identifying and funding entrepreneurs with the best
chance of successfully implementing innovative procedures. For sustained growth at the
frontier of technology, acquiring information and strengthening incentives for obtaining
information to improve resource allocation become key issues.

2. Risk Sharing:-

One of the most important functions of a financial system is to achieve an optimal allocation
of risk. There are many studies directly analysing the interaction of the risk sharing role of
financial systems and economic growth. These theoretical analyses clarify the conditions under
which financial development that facilitates risk sharing promotes economic growth and
welfare. Quite often in these studies, however, authors focus on either markets or

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intermediaries, or a comparison of the two extreme cases where every financing is conducted
by either markets or intermediaries. The intermediate case in which markets and institutions
co-exist is rarely analysed in the context of growth models because the addition of markets can
destroy the risk-sharing opportunities provided by intermediaries. In addition, studies focus on
the role of financial systems that face diversifiable risks. The implications for financial
development and financial structure on economic growth are potentially quite different when
markets cannot diversify away all of the risks inherent in the economic environment. One
importance of risk sharing on economic growth comes from the fact that while avers generally
do not like risk, high-return projects tend to be riskier than low return projects. Thus, financial
markets that ease risk diversification tend to induce a portfolio shift onwards projects with
higher expected returns as pointed out by Greenwood and Jovanovic (1990),Saint-Paul (1992),
Devereux and Smith (1994) and Obstfeld (1994). King and Levine (1993a) show that cross
sectional risk diversification can stimulate risky innovative activity for sufficiently risk-averse
agents. The ability to hold a diversified portfolio of innovative projects reduces risk and
promotes investment in growth-enhancing innovative activities.

3. Liquidity:-

Money market funds provide valuable liquidity by investing in commercial paper, municipal
securities and repurchase agreements: Money market funds are significant participants in the
commercial paper, municipal securities and repurchase agreement (or repo) markets. Money
market funds hold almost 40% of all outstanding commercial paper, which is now the primary
source for short-term funding for corporations, who issue commercial paper as a lower-cost
alternative to short-term bank loans. The repo market is an important means by which the
Federal Reserve conducts monetary policy and provides daily liquidity to global financial
institutions. Quantum of liquidity in the banking system is of paramount importance, as it is an
important determinant of the inflation rate as well as the creation of credit by the banks in the
economy. Market forces generally indicate the need for borrowing or liquidity and the money
market adjusts itself to such calls. RBI facilitates such adjustments with monetary policy tools
available with it. Heavy call for funds overnight indicates that the banks are in need of short
term funds and in case of liquidity crunch, the interest rates would go up.

4. Diversification:-

For both individual and institutional investors, money market mutual funds provide a
commercially attractive alternative to bank deposits. Money market funds offer greater

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investment diversification, are less susceptible to collapse than banks and offer investors
greater disclosure on the nature of their investments and the underlying assets than traditional
bank deposits. For the financial system generally, money market mutual funds reduce pressure
on the FDIC, reduce systemic risk and provide essential liquidity to capital markets because of
the funds’ investments in commercial paper, municipal securities and repurchase agreements.

5. Encouragements To Saving & Investment:_

Money market has encouraged investors to save which results in encouragement to investment
in the economy. The savings and investment equilibrium of demand and supply of loan able
funds helps in the allocation of resources.

A. Controls The Price Line In Economy: - Inflation is one of the severe economic
problems that all the developing economies have to face every now and then. Cyclical
fluctuations do influence the price level differently depending upon the demand and
supply situation at the given point of time. Money market rates play a main role in
controlling the price line. Higher rates in the money markets decrease the liquidity in
the economy and have the effect of reducing the economic activity in the system.
Reduced rates on the other hand increase the liquidity in the market and bring down the
cost of capital considerably, thereby raising the investment. This function also assists
the RBI to control the general money supply in the economy.
B. Helps in Correcting the Imbalances in Economy: - Financial policy on the other
hand, has longer term perspective and aims at correcting the imbalances in the
economy. Credit policy and the financial policy both balance each other to achieve the
long term goals strong-minded by the government. It not only maintains total control
over the credit creation by the banks, but also keeps a close watch over it. The
instruments of financial policy counting the repo rate cash reserve ratio and bank rate
are used by the Central Bank of the country to give the necessary direction to the
monetary policy.
C. Regulates The Flow Of Credit & Credit Rates: - Money markets are one of the most
significant mechanisms of any developing financial system. In its place of just ensure
that the money market in India regulate the flow of credit and credit rates, this
instrument has emerge as one of the significant policy tools with the government and
the RBI to control the financial policy, money supply, credit creation and control,
inflation rate and overall economic policy of the State. Therefore the first and the

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 leading function of the money market mechanism are regulatory in nature. While
determining the total volume of credit plan for the six monthly periods, the credit policy
also aims at directing the flow of credit as per the priorities fixed by the government
according to the requirements of the economy. Credit policy as an instrument is
important to ensure the availability of the credit in sufficient volumes; it also caters to
the credit needs of various sectors of the economy. The RBI assist the government to
realize its policies related to the credit plans throughout its statutory control over the
banking system of the country.
D. Transmission of Monetary Policy: - The money market forms the first and foremost
link in the transmission of monetary policy impulses to the real economy. Policy
interventions by the central bank along with its market operations influence the
decisions of households and firms through the monetary policy transmission
mechanism. The key to this mechanism is the total claim of the economy on the central
bank, commonly known as the monetary base or high powered money in the economy.
Among the constituents of the monetary base, the most important constituent is bank
reserves, i.e., the claims that banks hold in the form of deposits with the central bank.
18 The banks’ need for these reserves depends on the overall level of economic activity.
This is governed by several factors:-
(i) Banks hold such reserves in proportion to the volume of deposits in many
countries, known as reserve requirements, which influence their ability to
extend credit and create deposits, thereby limiting the volume of transactions to
be handled by the bank;
(ii) Bank’s ability to make loans (asset of the bank) depends on its ability to
mobilize deposits (liability of the bank) as total assets and liabilities of the bank
need to match and expand/contract together; and
(iii) Banks’ need to hold balances at the central bank for settlement of claims within
the banking system as these transactions are settled through the accounts of
banks maintained with the central bank. Therefore, the daily functioning of a
modern economy and its financial system creates a demand for central bank
reserves which increases along with an expansion in overall economic activity
(Friedman, 2000b).

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 3. Money Market Instruments

Financial instruments with short term maturity up to 1 year, used as tools for raising capital by
the issuer are known as money market instruments.

These are debt securities that offer a fixed interest rate and are generally unsecured. There is
no collateral backing up the security, and the risk of non-repayment is theoretically high.
However, money market instruments have a high credit rating ensuring that issuers don’t
default, which makes them a go-to avenue for investors looking for options to park their money
for the short term and earn fixed returns on the same.

1. Treasury Bill:-

(T-Bill) is a short-term U.S. government debt obligation backed by the Treasury

Department with a maturity of one year or less. Treasury bills are usually sold
in denominations of $1,000. However, some can reach a maximum denomination of $5
million in non-competitive bids. These securities are widely regarded as low-risk and
secure investments.

The Treasury Department sells T-Bills during auctions using a competitive and non-
competitive bidding process. Non-competitive bids also known as non-competitive
tenders have a price based on the average of all the competitive bids received. Treasury
Bills tend to have a high tangible net worth. Therefore, it is an essential monetary
instrument that the Reserve Bank of India uses. It helps RBI to regulate the total money
supply in the economy as well as raising funds.

2. Commercial Papers:-

Commercial paper is a commonly used type of unsecured, short-term debt instrument

issued by corporations, typically used for the financing of payroll, accounts payable and
inventories, and meeting other short-term liabilities. Maturities on commercial paper
typically last several days, and rarely range longer than 270 days.1 Commercial paper

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Board of Governors of the Federal Reserve System. "Commercial Paper Rates and Outstanding
Summary”

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 is usually issued at a discount from face value and reflects prevailing market interest
rates.

Commercial paper was first introduced over 150 years ago when New York merchants
began to sell their short-term obligations to dealers that acted as middlemen in order to
free up capital to cover near term obligations. These dealers would thus purchase the
notes at a discount from their par value and then pass them on to banks or other
investors. The borrower would subsequently repay the investor an amount equal to the
par value of the note.2

Commercial paper is not usually backed by any form of collateral, making it a form of
unsecured debt. It differs from asset-backed commercial paper (ABCP), a class of debt
instrument backed by assets selected by the issuer. In either case, commercial paper is
only issued by firms with high-quality debt ratings. Only these kinds of firms will be
able to easily find buyers without having to offer a substantial discount (higher cost)
for the debt issue. Because commercial paper is issued by large institutions, the
denominations of the commercial paper offerings are substantial, usually $100,000 or
more. Other corporations, financial institutions, wealthy individuals, and money market
funds are usually buyers of commercial paper.

3. Participatory Notes:-

Participatory notes also referred to as P-Notes, or PNs, are financial instruments

required by investors or hedge funds to invest in Indian securities without having to
register with the Securities and Exchange Board of India (SEBI). P-Notes are among
the group of investments considered to be Offshore Derivative Investments. Citigroup
and Deutsche Bank are among the biggest issuers of these instruments. Foreign
institutional investors (FIIs), issue the financial instruments to investors in other
countries who want to invest in Indian securities. An FII is an investor or investment
fund registered in a country outside of the one in which it is investing.

This system lets unregistered overseas investors buy Indian shares without the need to
register with the Indian regulatory body. These investments are also beneficial to India.
They provide access to quick money to the Indian capital market. Because of the short-

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Federal Reserve Bank of Richmond. "Commercial Paper”

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 term nature of investing, regulators have fewer guidelines for foreign institutional
investors. To invest in the Indian stock markets and to avoid the cumbersome regulatory
approval process, these investors trade

4. Certificate of Deposit:-

A certificate of deposit (CD) is a product offered by banks and credit unions that
provides an interest rate premium in exchange for the customer agreeing to leave a
lump-sum deposit untouched for a predetermined period of time. Almost all consumer
financial institutions offer them, although it’s up to each bank which CD terms it wants
to offer, how much higher the rate will be compared to the bank’s savings and money
market products, and what penalties it applies for early withdrawal. While an online
bank or local credit union might pay three to five times the national
average. Meanwhile, some of the best rates come from special promotions, occasionally
with unusual durations such as 13 or 21 months, rather than the more common terms
based on three, six, or 18 months or full-year increments.

5. Bankers Acceptance:-

The banker's acceptance is a negotiable piece of paper that functions like a post-dated
check, although the bank rather than an account holder guarantees the payment.
Banker's acceptances are used by companies as a relatively safe form of payment for
large transactions. They also are known as bills of exchange.

For the company that issues it, a banker's acceptance is a way to pay for a purchase
without borrowing to do so. For the company that receives it, the bill is a guaranteed
form of payment. A banker's acceptance requires the bank to pay the holder a set
amount of money on a set date. They are most commonly issued 90 days before the
date of maturity but can mature at any later date from one to 180 days. BAs are issued
at a discount to their face value. Thus, like a bond, they earn a return. They also can be
traded like bonds in the secondary money market. There is no penalty for cashing them
in early, except for the lost interest that would have been earned had they been held
until their maturity dates.

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 4. Conclusion
To sum up, the money market is a key component of the financial system as it is the fulcrum
of monetary operations conducted by the central bank in its pursuit of monetary policy
objectives. It is a market for short-term funds with maturity ranging from overnight to one year
and includes financial instruments that are deemed to be close substitutes of money. The money
market performs three broad functions. Firstly, it provides an equilibrating mechanism for
demand and supply of short-term funds. Secondly, it enables borrowers and lenders of short-
term funds to fulfil their borrowing and investment requirements at an efficient market clearing
price. Three, it provides an avenue for central bank intervention in influencing both quantum
and cost of liquidity in the financial system, thereby transmitting monetary policy impulses to
the real economy. The objective of monetary management by the central bank is to align money
market rates with the key policy rate. As excessive money market volatility could deliver
confusing signals about the stance of monetary policy, it is critical to ensure orderly market
behaviour, from the point of view of both monetary and financial stability. Thus, efficient
functioning of the money market is important for the effectiveness of monetary policy

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