Money market involves transfer of funds in exchange for financial assets. Because of the nature of the money market, the instruments used in it represent short-term financial claims. Though there is no statutory definition for the money market instruments, it is accepted that the maturity profile of money market instruments varies from one day to one year.
With short-term liquidity being the main purpose of the money market, various instruments have been developed to suit these short-term requirements. For instance, the amount of funds required by banks to meet their statutory reserves will vary from one day to a fortnight. Similarly, corporate may require funds for their working capital purpose for any period up to a year. Here is a broad classification of the money market instruments depending upon the type of issuer and the requirements they meet
Banking Sector Securities
Private Sector Securities
Except for their debt nature, the securities above differ from each other in their characteristics relating to maturity, issuer, type of investors, the risk-return profile, liquidity, marketability, negotiability, transferability, etc. Money market instruments, however, do not include any equities. Here is a brief discussion of various money market instruments.
The RBI on behalf of the government issues all T-BiIIs and Government dated securities. Being risk-free securities, they set the benchmark for the interest rates of the other money market instruments. Though the government issues these two categories of securities, they serve different purposes while meeting the government’s fund requirement. .
Treasury bills are short term, money market instruments issued by the RBI on the behalf of Indian Government in the form of “discount” instruments. At the end of the tenor, holders of T-Bills are paid a fixed amount called Maturity Value. Being issued by the government they are considered to be risk-free. Due to this, they are highly marketable.
Investors in T-BiIIs are Banks, Primary Dealers, Financial Institutions for Primary Cash Management, Insurance Companies, Provident Funds (if eligible), Non-Banking Finance Companies, Foreign Institutional Investors and State Government.
Government Dated Securities
These are medium to long-term government securities. Unlike the T-BiIIs which are issued at a discount, these securities carry a coupon rate. In spite of being long-term instruments, these government securities form a part of the money market due to their liquidity. Being government securities, these dated securities have fairly high liquidity and hence form part of the money market. These instruments set a benchmark for the long-term interest rates. Issuers will clearly be the central/state governments and other governmental bodies while the investors will be banks, FIs, other institutional investors and individuals.
Banking Sector Securities
The banking system has a very vital and active role in the money market. The transactions taking place in these securities are large in size, both in terms of the volumes traded and the amount involved in the transactions. The short-term requirements of banks vary from a single day to up to a year to meet the reserves and accommodate credit. Based on this requirement, various instruments/markets with differing maturities have developed.
Call and Notice Money
Call money is a money market instruments wherein funds are borrowed/lent for a tenor of one day/overnight (excluding Sunday/holidays). These funds represent borrowings made for a period of one day to up to a fortnight. However, the mechanism adopted to lend funds to the call and the notice money markets differs. In the call money market, funds are lent for a predetermined maturity period that can range from a single day to a fortnight.
Notice Money is a money market instrument, where the tenor is more than 1 day but less than 15 days. Here, the lender simply issues a notice to the borrower 2-3 days before the funds are to be repaid. On receipt of this notice, the borrower will have to repay the funds within the given time. While both these funds meet the reserve requirements, banks, however, mostly rely on the call money market. It is here that they raise overnight money i.e., funds for a single day.
Purpose of Call and Notice Money Market
Short-term funds having a maturity of 15 days and over are categorized as term money. Banks access this term money route to bring greater stability in their short term deficits. While making a forecast of the fund requirements, banks will be in a position to assess the likely surplus and deficit balances that are to occur during the forecasted period. In view of such forecast, banks assess the amount that needs to be borrowed/lent in order to prevent any severe liquidity mismatch.
Certificates of Deposit (CDs)
CD is a negotiable money market instrument issued as a promissory note for funds deposited at bank or other eligible financial institution for a specified time period.
Banks issue CDs to raise short-term funds having a maturity of 15 days to 1 year. These instruments are issued to individuals/corporate/institutions, etc. These are promissory notes which require the holder to establish his identity before redeeming the amount. They are issued at a discount to face value and transferable. The funds raised through certificate of deposits form a part of the deposits and hence attract reserve requirements.
Certificates of Deposit is
All Banks and DFIs are eligible issuers of CDs. Banks can issue CDs from 15 days (reduced to 7days) to one year maturity. DFIs can issue CDs with an initial maturity of one year to three years.
Participation Certificates (PCs)
The major activity of a bank is credit accommodation. This service of the banks, apart from increasing the risks, may place them in a tight liquidity position. To ease their liquidity, banks have the option to share their credit asset(s) with other banks by issuing Participation Certificates. These certificates are also known as interbank participations (IBPs). With this participation approach, banks and FIs come together either on risk sharing or non-risk sharing basis. Thus, while providing short-term funds, PCs can also be used to reduce risk. The rate at which these PCs can be issued will be negotiable depending on the interest rate scenario.
Private Sector Securities
Commercial Papers (CPs)
CPs (Commercial Papers) may be defined as short-term, unsecured, negotiable promissory notes with fixed maturity issued by rated corporate.
Commercial Papers (CPs) are promissory notes with fixed maturity, issued by highly rated corporate. This source of short-term finance is used by corporate as an alternative to the bank finance for working capital. Corporate prefer to raise funds through this route when the interest rate on working capital charged by banks is higher than the rate at which funds can be raised through CP. The maturity period ranges from 15 days to 1 year.
Commercial Papers (CPs) are
Corporate, Financial Institutions and Primary Dealers can issue Commercial Papers. Individuals, Corporate, Unincorporated Bodies, Insurance Companies and Banks are the eligible investors of Commercial Papers.
Bills of Exchange
It is a financial instrument that facilitates funding of a trade transaction. It is a negotiable instrument and hence is easily transferable. Further, depending on the repayment period and the documents attached, these bills of exchange are classified into different types. The duration of these bills generally ranges between 1 to 6 months.
Money Market Mutual Funds (MMMFs)
Since the operations in the money market are dominated by institutional players, the retail investor’s participation in the market seems to be limited. To overcome this limitation, the Money Market Mutual Funds (MMMFs) provide an avenue to the retail investor to invest in the money market. Retail investors normally deposit short-term surplus funds into a savings bank account, the returns from which are relatively low.
The returns from MMMFs will be higher than the interest earned in a bank. Further, this provides adequate liquidity and the investor can plan for short-term deployment of funds. These funds have high safety levels since the investments are in high quality securities, i.e., government/bank/highly rated corporate securities. These represent a low-risk and high-returns avenue to the retail investor in the money market.
The Money Market mutual Fund / Liquid Funds are the funds that invest in short term liquid instruments. Although Money Market Funds have low risk, there are differences in the risk within and between categories of these funds like Funds investing in the Government Treasury Bill and Call or Notice Money and Funds investing in the securities like Commercial paper, Certificate of Deposit, Treasury Bills etc.
Bond or Debenture is a formal certificate issued by the companies or government agencies acknowledging the indebtedness. The public sector enterprises, financial institutions and the private corporates approach the public to finance their requirements through loans. They can issue either be short- or long-term bonds and debentures. The bond market consists of three different categories of issuers – government owned Financial Institutions (FIs), Public Sector Units (PSUs) and private corporates. Some examples of bonds are Regular bonds, Tax saving bonds, floating rate bonds by ICICI, priority sector bond by NABARD, capital gains bond by National Housing Bank, Deep Discount bonds by IDBI, etc.
Apart from these instruments that enable short-term fund management, another popular mechanism to deploy/borrow short-term funds in the money market is known as the repo transaction. It is basically a contract that is entered into by two parties which may include the RBI, a bank or an NBFC. As per this contract, one· party sells certain securities to the second party with an agreement to buy them back on a predetermined future date at a predetermined rate. This transaction raises short-term funds to the party selling the securities. From the purchaser’s angle, the same repo transaction becomes a reverse repo transaction. The reverse repo transaction enables one party to purchase securities with an agreement to sell them at a later date. Thus reverse repo helps adjust the short-term surplus. The underlying securities that are bought and sold are generally government securities. The nature of the transactions and the time involved in the repo/reverse repo transaction generally varies depending upon the regulations. The Indian money market repos/reverse repos are for a minimum period of one day. While there is no statutory limit to the maximum period, it normally does not exceed 3 months. Repos with RBI can be for the minimum period of one day at the discretion of RBI. Repos are normally done for a minimum maturity period of one day and a maximum maturity period of fourteen days.
A REPO is a transaction in which two parties agree to sell and repurchase the same security at a mutually decided future date and price. Such a transaction is called Repo when viewed from the perspective of seller of securities and Reverse Repo from the point of view of supplier of the fund.
Purpose of Repo
The securities eligible for trading are: