B.Sc. in Agricultural Economics (Hons.

) Level-3 Semester- I
Course Title: Macro Economics -II (Theory) Course Code: AGEC-333
Lecture – 11

Money Market
The money market refers to trading in very short-term debt investments. At the wholesale level,
it involves large-volume trades between institutions and traders. At the retail level, it includes
money market mutual funds bought by individual investors and money market accounts opened
by bank customers. In all of these cases, the money market is characterized by a high degree
of safety and relatively low rates of return.

Understanding the Money Market

The money market is one of the pillars of the global financial system. It involves overnight
swaps of vast amounts of money between banks and the government. The majority of money
market transactions are wholesale transactions that take place between financial institutions
and companies.

Institutions that participate in the money market include banks that lend to one another and to
large companies in the eurocurrency and time deposit markets; companies that raise money by
selling commercial paper into the market, which can be bought by other companies or funds;
and investors who purchase bank CDs as a safe place to park money in the short term. Some
of those wholesale transactions eventually make their way into the hands of consumers as
components of money market mutual funds and other investments.

In the wholesale market, commercial paper is a popular borrowing mechanism because the
interest rates are higher than for bank time deposits or Treasury bills, and a greater range of
maturities is available, from overnight to 270 days. However, the risk of default is significantly
higher for commercial paper than for bank or government instruments

Individuals can invest in the money market by buying money market funds, short-term
certificates of deposit (CDs), municipal notes, or U.S. Treasury bills. For individual investors,
the money market has retail locations, including local banks and the U.S. government's
Treasury Direct website. Brokers are another avenue for investing in the money market.

Functions of the Money Market

The money market contributes to the economic stability and development of a country by
providing short-term liquidity to governments, commercial banks, and other large
organizations. Investors with excess money that they do not need can invest it in the money
market and earn interest. Here are the main functions of the money market:

1. Financing Trade

The money market provides financing to local and international traders who are in urgent need
of short-term funds. It provides a facility to discount bills of exchange, and this provides
immediate financing to pay for goods and services.
International traders benefit from the acceptance houses and discount markets. The money
market also makes funds available for other units of the economy, such as agriculture and
small-scale industries.

2. Central Bank Policies

The central bank is responsible for guiding the monetary policy of a country and taking
measures to ensure a healthy financial system. Through the money market, the central bank
can perform its policy-making function efficiently.

For example, the short-term interest rates in the money market represent the prevailing
conditions in the banking industry and can guide the central bank in developing an appropriate
interest rate policy. Also, the integrated money markets help the central bank to influence the
sub-markets and implement its monetary policy objectives.

3. Growth of Industries

The money market provides an easy avenue where businesses can obtain short-term loans to
finance their working capital needs. Due to the large volume of transactions, businesses may
experience cash shortages related to buying raw materials, paying employees, or meeting other
short-term expenses.

Through commercial paper and finance bills, they can easily borrow money on a short-term
basis. Although money markets do not provide long-term loans, it influences the capital market
and can also help businesses obtain long-term financing. The capital market benchmarks its
interest rates based on the prevailing interest rate in the money market.

4. Commercial Banks Self-Sufficiency

The money market provides commercial banks with a ready market where they can invest their
excess reserves and earn interest while maintaining liquidity. Short-term investments, such as
bills of exchange, can easily be converted to cash to support customer withdrawals. Also, when
faced with liquidity problems, they can borrow from the money market on a short-term basis
as an alternative to borrowing from the central bank. The advantage of this is that the money
market may charge lower interest rates on short-term loans than the central bank typically does.

Money Market Instruments

As per the Reserve Bank of India, the term ‘Money Market’ is used to define a market where
short-term financial assets with a maturity up to one year are traded. The assets are a close
substitute for money and support money exchange carried out in the primary and secondary
market. In other words, the money market is a mechanism which facilitate the lending and
borrowing of instruments which are generally for a duration of less than a year. High liquidity
and short maturity are typical features which are traded in the money market. The non-banking
finance corporations (NBFCs), commercial banks, and acceptance houses are the components
which make up the money market.

Money market is a part of a larger financial market which consists of numerous smaller sub-
markets like bill market, acceptance market, call money market, etc. Besides, the money market
deals are not out in money / cash, but other instruments like trade bills, government papers,
promissory notes, etc. But, the money market transactions can’t be done through brokers as
they have to be carried out via mediums like formal documentation, oral or written
communication.

What are Money Market Instruments

As the name suggests, money market instrument is an investment mechanism that allows banks,
businesses, and the government to meet large, but short-term capital needs at a low cost. They
serve the dual purpose of allowing borrowers meet their short-term requirements and providing
easy liquidity to lenders.

Following are the types of Money Market Instruments

Promissory Note:

A promissory note is one of the earliest type of bills. It is a financial instrument with a written
promise by one party, to pay to another party, a definite sum of money by demand or at a
specified future date, although it falls in due for payment after 90 days within three days of
grace. However, Promissory notes are usually not used in the business, but USA is an exception.

Bills of exchange or commercial bills

The bills of exchange can be compared to the promissory note; besides it is drawn by the
creditor and is accepted by the bank of the debater. The bill of exchange can be discounted by
the creditor with a bank or a broker. Additionally, there is a foreign bill of exchange which
becomes due for payment from the date of acceptance. However, the remaining procedure is
the same for the internal bills of exchange.

Treasury Bills (T-Bills)

The Treasury bills are issued by the Central Government and known to be one of the safest
money market instruments available. Besides, they carry zero risk, so the returns are not
attractive. Also, they come with different maturity periods like 1 year, 6 months or 3 months
and are also circulated by primary and secondary markets. The central government issues them
at a lesser price than their face-value.

The difference of maturity value of the instrument and the buying price of the bill, which is
decided with the help of bidding done via auctions, is basically the interest earned by the buyer.

There are three types of treasury bills issued by the Government of India currently that is
through auctions which are 91-day, 182-day and 364-day treasury bills

Call and Notice Money

Call and Notice Money exist in the market. With respect to Call Money, the funds are borrowed
and lent for one day, whereas in the Notice Market, they are borrowed and lent up to 14 days,
without any collateral security. The commercial banks and cooperative banks borrow and lend
funds in this market. However, the all-India financial institutions and mutual funds only
participate as lenders of funds.

Inter-bank Term Market

The inter-bank term market is for the cooperative and commercial banks in India who borrow
and lend funds for a period of over 14 days and up to 90 days. This is done without any
collateral security at the rates determined by markets.

Commercial Papers (CPs)

• Commercial papers can be compared to an unsecured short-term promissory note which

is issued by top rated companies with a purpose of raising capital to meet requirements
directly from the market.
• They usually have a fixed maturity period which can range anywhere from 1 day up to
270 days.
• They offer higher returns as compared to treasury bills. They are automatically not as
secure in comparison. Also, Commercial papers are traded actively in secondary market.

Certificate of Deposits ( CD’s )

• This functions as a deposit receipt for money which is deposited with a financial
organization or bank. The Certificate of Deposit is different from a Fixed Deposit
receipt in two ways. i. Certificate of deposits are issued only of the sum of money is
huge. ii. Certificate of deposit is freely negotiable.
 • The RBI first announced in 1989 that the Certificate of Investments have become the
most preferred choice of organization in terms of investments as they carry low risk
whilst providing high interest rates than the Treasury bills and term deposits.
• CD’s are also issued at discounted price like the Treasury bills and they range between
a span of 7 days up to 1 year.
• The Certificate of Deposit issued by banks range from 3 months, 6 months and 12
months.
• Note: CD’s can be issued to individuals (except minors), companies, corporations,
funds, non–resident Indians, etc.

Banker’s Acceptance (BA)

• A Banker’s Acceptance is a document that promises future payment which is

guaranteed by a commercial bank. Also, it is used in money market funds and will
specify the details of repayment like the date of repayment, amount to be paid, and
details of the individual to which the repayment is due.
• BA’s features maturity periods that range between 30 days up to 180 days.

Repurchase Agreements (Repo)

• Repo’s are also known as Reverse Repo or as Repo. They are loans of short duration
which are agreed by buyers and sellers for the purpose of selling and repurchasing.
• However, these transactions can be carried out between RBI approved parties.
• Note: Transactions can only be permitted between securities approved by RBI like the
central or state government securities, treasury bills, central or state government
securities, and PSU bonds.