A section of financial markets where short term maturity securities are negotiated is referred to as the money market. It is an area of commercial dealings for accounting instruments with high liquidity. Money market has become a crucial constituent of the financial market where buying and selling of securities of short term maturities takes place for a time period of one year or less.
The transactions of money market are wholesale, which suggests that these transactions does not take place among individuals but among companies and financial institutions and are of large denominations. These funds often offer individuals with opportunity to invest small amounts in such assets. Money market plays a significant role in providing investment in short term money making instruments as an outlet for large corporations with temporary excess cash. It is an unregulated and informal market organised in a formal way.
What are money market instruments?
The short term IOUs issued by government or financial institutions such as treasury bills, commercial papers and certificates of deposit are the negotiable instruments of the money market. These instruments are significantly safe with high liquidity and account for extremely rare defaults and therefore provides comparatively lower returns than most of the other securities. Such instruments are used by many participants including large corporations to raise funds by selling them in the market. These instruments have their own unique short term securities.
Here are few examples of money market :
With a validity of just one working day, call money is one of the most liquid forms of money market instruments. Banks with surplus cash can invest in other banks through call money or can fund their shortfalls through borrowing call money form the money market. Although not restricted to just banks and other financial institutions can also invest/borrow, it is also known as Bank money. Call money helps banks to maintain the statutory reserves which they have t maintain on a day to day basis.
When the government is in need of funds, the money is raised in the markets through treasury bills. These are issued by central bank of the country on behalf of its government. As it is backed by the government, it is considered one of the safest investment with tenure of 14 days to 364 days. The treasury bills are issued at a discount. They are used by government to control the liquidity in the market. These are also known as Zero coupon bonds as the interest is not paid separately on treasury bills. A government can curb or pump up the liquidity in the market using treasury bills.
These are often used by companies to fund their short term working capital needs and are unsecured in nature with average maturity of two odd months. These are also issued at a discount where determination of rate of interest depends upon liquid funds and their demand and supply in the market. Mutual funds and banks are the most common investors of these papers. As already pointed out, these commercial papers are unsecured and therefore have higher rate of interest than that of treasury bills.
Certificate of Deposits
This money market instrument can only be issued by a bank and is a kind of Time deposit with a bank. Certificate of Deposits, have the features of any other time deposit which means they cannot be liquidated prior to their fixed maturity date. Although certificate of deposit lacks the flexibility in terms of time period, it can be re-purchased by someone else as it is a transferable security. A specific brokerage fees and higher rate of interest are some characteristic features of certificates of deposit.
These are short term agreements, fairly popular amongst banks as they eliminate the credit risk involved by directly transferring the securities. They vary in time period from overnight to over a month. If a bank require funds, it can enter into an agreement with another bank with surplus funds and can get the required amount by selling its securities. These securities can be repurchased at a fixed future date and therefore these are known as repurchase agreements.
Money market in india
Money market in India is a monetary system which constitutes lending and borrowing of short term funds and is regulated by Reserve bank of India. After the globalisation initiative in 1992, the money market in India has seen an exponential growth. The money market instruments in India include treasury bills, repurchase agreements, certificate of deposits and commercial papers.
Functions of Money market
The main functions of money market are monetary equilibrium, availability of funds,check on liquidity, check on inflation and promotion of investment.
Money market manages to bring certain balance between demand and supply of short term funds in the market and promotes economic growth of the country by making funds available to different participants in the market such as government of different countries, central banks, insurance companies, non-banking financial institutions etc.
Money market allows the government to control the liquidity in the country and therefore allows to keep a check on the inflation of the country.
Money market vs capital market
Contrary to money market, capital markets are used for long term assets with maturities greater than one year and include the equity and debt market. HIgher risk investments and higher returns are offered in capital market. Both financial markets maintain adequate levels of funding and therefore provide a necessary business function. Investors and buyers seek these markets based on their liquidity needs.
Money market savings and deposit accounts
MMA earns a higher amount of interest than any basic savings account and has higher minimum amount. On the other hand, MM deposit accounts are a cross between a checking and savings account which earns more interest and restricts the number of deposits/ withdrawals per month.