MONEY

MARKET
 WHAT IS MONEY MARKET?

➢ Money market is a component of financial markets dealing

with market instruments that allow short-term borrowing for
institutions.
➢ An individual may invest in the money market by purchasing a
money market mutual fund, buying a Treasury bill.
➢ Unlike a capital market where long-term securities are
exchanged, here the trades investments range from a day, three
months, 365 days, etc.
➢ Most traded money market instruments include commercial
papers, treasury bills, bills of exchange, certificates of deposits,
repurchase agreement etc.
 WHAT IS MONEY MARKET?

Capital Market instruments refers to equities and bonds, used to raise long-
term capital.

Money Market instruments raise cash for shorter term periods of up to a year.

Investing in Money Market instruments

▪ There is a high minimum subscription - more suitable for institutional investors

like pension funds and insurance companies – ‘Wholesale’ institutional market
▪Accessible to retail investors indirectly through collective investment funds
▪ Administrative costs are low – they are issued in ‘bearer’ form – no register
maintenance.
▪ Most are issued below par value with no coupons
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➢ RBI is the regulator of the money market, which
thus helps in regulating the liquidity and money
supply in the economy.

➢ In inflation, the central bank buys back bonds and

securities. As a result, it reduces the supply of
money in the economy, pushing up the nominal
interest rates

➢ A money market graph depicts the above action of

the central bank.

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 FUNCTIONS OF MONEY MARKET
1. Financing Trade:
➢ Money Market plays crucial role in financing both internal as well as international
trade.
➢ Commercial finance is made available to the traders through bills of exchange.
2. Financing Industry:
Money market contributes to the growth of industries in two ways:

➢ Money market helps the industries in securing short-term loans to meet their
working capital requirements through the system of finance bills, commercial
papers, etc.

➢ Industries generally need long-term loans, which are provided in the capital market.
However, capital market depends upon the nature of and the conditions in the
money market. The short-term interest rates of the money market influence the
long-term interest rates of the capital market.

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3. Profitable Investment:
➢ Money market enables the commercial banks to use their excess reserves in profitable
investment.
➢ In the money market, the excess reserves of the commercial banks are invested in near-
money assets which are highly liquid and can be easily converted into cash.

4. Self-Sufficiency of Commercial Bank:

➢ Developed money market helps the commercial banks to become self-sufficient..
➢ In the situation of emergency, when the commercial banks have scarcity of funds, they
need not approach the central bank and borrow at a higher interest rate. On the other
hand, they can meet their requirements by recalling their old short-run loans from the
money market.

5. Help to Central Bank:

➢ Though the central bank can function and influence the banking system in the absence of
a money market, the existence of a developed money market smoothens the functioning
and increases the efficiency of the central bank.
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 PARTICIPANTS OF MONEY MARKET

The participants of money market are those that which deal in lending and borrowing of
short-term funds . These are not same in all countries of the world, rather they differ from
country to country
Some major participants of money market are:

➢ Commercial banks

➢ Central bank

➢ Acceptance houses

➢ Nonbanking financial intermediaries

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 Commercial banks
➢ Back bone of money market
➢ They lend against promissory notes and through advances and
overdraft
➢ The commercial banks put their excess reserves in different forms or
channels of investment

Central Banks:
➢ It is regarded as an apex institution(the monetary authority).
➢ It raises or reduces the money supply and credit to ensure economic
stability in the economy
➢ The performance of central bank depends on the character
composition of the money market

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Acceptance Houses:
They function as intermediaries between importers and exporters, and
between lenders and borrowers in the short period.
Provide adequate liquidity in the secondary market through accepting
the bills so that these (bills) can easily be discounted by the discount
houses and other banks. short term loans to the traders, regulating their
clients’ open credit, advising on shipping and insurance problems arising
out of the financing of trade, etc. Seen in London
Non-banking Financial Intermediaries:
It includes:
➢ Investment banks
➢ Insurance companies
➢ Provident funds
➢ Pension funds

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ADVANTAGES OF MONEY
MARKET ACCOUNTS

Competitive
Flexibility
rates

Access to
Safety
funds

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 INSTRUMENTS OF MONEY
MARKET

➢ Commercial Paper

➢ Certificate of Deposit

➢ Repurchase Agreement

➢ Money Market Fund

➢ Call Money

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 INSTRUMENTS OF
MONEY MARKET

➢ Treasury Bills

➢ Banker’s Acceptance

➢ Short-term Bonds

➢ Promissory Note

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Commercial paper

• Commercial paper is short term loans issued by company.

• Commercial paper is issued in form of promissory note
• The minimum days of maturity is seven days and maximum are one year.
• If the investor does not have credit rating, he should wait for ten days for filing.
• Commercial paper usually pays higher amount of implied interest.
• If the company is incorporated and built a high credit the commercial paper will become cheaper,
when compared to bank line of credit.
• Commercial paper fetch lower cost of capital with maturity of one year.
• The disadvantage is regulated by RBI guidelines and financially sound company can take benefit of
commercial paper

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 Commercial Papers (CPs)
Equivalent of a Treasury bill – a short-term bond

▪ Issued by large companies instead of governments –the borrower

must be listed on the stock exchange and must have substantial net
assets
▪ To meet a company’s short-term borrowing needs
▪ Companies can issue CPs with different maturities depending on it’s needs e.g. One
month, three months, six months etc

How do they work?

▪ The company will agree in advance with its banker on a programme of CP issues – say,
£10m over the course of a year

▪ Company issues the CP to the bank with a series of different maturities, depending on its
short-term funding needs
▪ Company can also issue CP in different currencies
▪ No coupons are paid (non-interest bearing)
▪ Issued discount to par value (Par value paid back on maturity)
CP
• CPs were introduced in India January 1990.
• CPs were launched in India with a view to enable highly rated corporate borrowers to
diversify their sources of short-term borrowings and also to provide an additional
instrument to investors.
• A corporate can issue CPs provided they fulfill the following conditions:
(a) The tangible net worth of the company is not less than Rs.4 crore.
(b) The company has been sanctioned working capital limit by banks or all India financial
institutions, and
(c) The borrowed account of the company is classified as a standard asset by the financing
institution or bank.
The minimum value of CP is 5 lakhs rupee by a single issuer and in multiples of rupees 5
lakhs.
The aggregate amount to be raised by issuance of CP by a corporate should not exceed the
working capital (fund-based) limit sanctioned to it by bank/banks.

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 Certificate of deposit
• Banks issue certificate of deposit in dematerialized form only.
• It is mandatory for every bank to maintain statutorily liquidity ratio (SLR)
and cash reserve ratio (CRR) on the price of CDs.
• The minimum value of certificate of deposit is 5 lakhs rupee by a single
issuer and in multiples of rupees 5 lakhs.
• The maximum amount of repayment of loan is not less than three years.
• Certificate of deposit have higher rates of interest when compared to saving
and fixed deposit account.
• The interest rate varies based on the time period of amount deposited. The
longer the period, the higher will be rate of interest.

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 Certificates of deposit (CDs)
Resembles an instrument half-way between a bond and a cash deposit

▪ The deposit is for a specified period of time – it varies

▪ Traditionally this is for a maximum of five years but usually much less

▪ They can be thought of as tradeable or negotiable deposit

accounts, as they can be bought and sold in a similar way to shares:

Example:
Lloyds Banking Group might issue a CD to represent a deposit of £1
million from a customer, redeemable in six months. The CD will specify
that Lloyds will pay the £1 million back plus interest of, say, 0.5% of £1
million. If the customer needs the money back before six months has
elapsed, he can sell the CD to another investor in the money market.

▪ The bank will pay interest on the deposited amount, which can be fixed or
variable. The investor receives their deposited sum back at the set end date
CD
• CDs were introduced in India in June 1989.
• The main purpose of the scheme was to enable commercial banks to
raise funds from the market through CDs.
• According to the original scheme, CDs were issued in multiples of
Rs.25 lakh subject to minimum size of an issue being Rs.1 crore.
• They had the maturity period of 3 months to one year.
• They are freely transferable but only after the lock in period of 45 days
after the date of issue.

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 Commercial bills
• Commercial bill is a short-term, negotiable, and self-liquidating instrument with low
risk.
• They are negotiable instruments drawn by a seller on the buyer for the value of
goods delivered by him. Such bills are called trade bills.
• When trade bills are accepted by commercial banks, they are called commercial
bills.
• If the seller gives some time for payment, the bill is payable at future date (i.e.
usance bill).
• Generally the maturity period is upto 90 days.
• During the usance period, if the seller is in need of funds, he may approach his
bank for discounting the bill.
• Commercial banks can provide credit to customers by discounting commercial bills.
• The banks can rediscount the commercial bills any number of times during the
usance period of bill and get money
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Repurchase agreement

• A repurchase contract called a repo, RP, or deal and repurchase

arrangement.
• It is a momentary acquiring, principally in government securities
• The seller offers the security to financial backers and, by
understanding between the two parties, repurchases them quickly
thereafter, normally the next day, at a marginally greater cost.

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Repurchase agreement (or Repo)
Example:
• Party A provides cash of 100 to Party B,
Party B provides a bond worth 120 to Party A.

• Party A promises to return the bond to Party B one day

later,
Party B promises to return 100.01.
Treasury bill
• A Treasury bill is a promissory note issued by the government at a discounted rate for a set length of time.

• On the due date to the holder of bills are bought and sold at a discount. This signifies that the bill's price is less
than its face value.

• A Treasury bill is strictly a finance bill because it is not the result of a commercial transaction.

• Because the bill represents a claim against the government, it does not require any support or approval.

• Treasury bills have essential characteristics such as high liquidity, no danger of default, guaranteed yield, cheap
transaction cost, and availability.

• Treasury bills are classified into three types based on their periodicity: 91-day Treasury bills, 182-day Treasury
bills, and 364-day Treasury bills.

• The government uses treasury bills to control inflation rate of the country. The government issues T-bills so that
inflation rates become 7%-8%.

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Treasury Bills
Treasury Bills are a form of ultra-short gilt
Who issues them and why?
▪ Issued by the Debt Management Office (DMO) of RBI
▪ Used to meet short-term borrowing needs of the Government
How often are they issued?
▪ Issued every week, unlike normal traditional gilts
How do investors make a return?
▪ No coupons are paid (non-interest bearing)
▪ Issued discount to par value (Par value paid back on maturity)
e.g. Treasury Bill of Rs. 1,000 nominal sold for Rs.990

Return on investment is 1% over three months

AER is 4.06%

How long do they take to mature?

▪ Commonly, they will be redeemed after one, three or six months
Eurodollar
• Eurodollars are time deposits denominated in Foreign currencies held in banks
outside the US, and hence are not subject to the Federal Reserve's authority.
• As a result, such accounts are subject to far less control than comparable deposits
in the United States.
• The phrase was originated in European banks to refer to US dollars, but it has
now extended to its current meaning.
• A deposit in US dollars in Tokyo or Beijing would also be considered a
Eurodollar deposit.

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Call money market

• Call money market refers to the market for extremely short period
loans.
• These loans are repayable on demand of either borrower or
lender.
• The main participants in the call money market are commercial
banks (excluding RRBs), cooperative banks and primary dealers.
• Discount and Finance House of India (DFHI), Non-banking
financial institutions such as LIC, GIC, UTI, NABARD etc. are
allowed to participate in the call money market as lenders.

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Call and notice money market
• Under call money market, funds are transacted on overnight basis.
• Under notice money market funds are transacted for the period
between 2 days and 14 days.
• The funds lent in the notice money market do not have a specified
repayment date when the deal is made.
• The lender issues a notice to the borrower 2-3 days before the funds
are to be paid.
• On receipt of this notice, the borrower will have to repay the funds
within the given time.
• Generally, banks rely on the call money market where they raise funds
for a single day. 28
 Money Market Funds

▪ Funds set-up, which contain and invest in Money Market instruments

▪ Pools together the funds of other investors, giving them indirect access to
assets they would not otherwise be able to invest in.

▪ Investors buy into the fund and therefore invest indirectly – they buy units in
the fund, not individual Money Market instruments as private investors
Types of Money Market Funds

1. Short-term money market funds:

2. Money market funds:
▪ Can have a constant net asset
value (the NAV remains ▪ Must have a fluctuating net asset value
unchanged when income in the
fund is accrued daily)

▪ Can also have a fluctuating

NAV
 Investing in Money Market Instruments

Advantages
▪ Low risk – the nominal is preserved Disadvantages
▪ Useful during times of uncertainty

▪ Quick returns – short-term nature ▪ Only suitable for short-term investing

▪ Money Market Funds - pooling of funds
with other investors gives the investor
access to assets they would not ▪ Over the medium- to long-term, the money
otherwise be able to invest in. markets have under-performed many other
investment types

▪ Professional market – only accessible to

private investors through money market funds
or money market accounts