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Learn about the money market – its concept, meaning, and functions

Published : May 22, 2019

Learn about money market – its concept, meaning and functions

Money Market is a segment of the financial market in India where borrowing and lending of short-term funds take place. The maturity of money market instruments is from one day to one year. In India, this market is regulated by both RBI (the Reserve bank of India) and SEBI (the Security and Exchange Board of India). The nature of transactions in this market is such that they are large in amount and high in volume. Thus, we can say that the entire market is dominated by a small number of large players.

Objectives of the money market in India

The following are the important objectives of an Indian money market –

  • Facilitate a parking place to employ short-term surplus funds.
  • Aid room for overcoming short-term deficits.
  • To enable the Central Bank to influence and regulate liquidity in the economy through its intervention in this market.
  • Help reasonable access to users of short-term funds to meet their requirements quickly, adequately and at reasonable costs.

Segments of the Indian money market

The Indian money-market has the following two segments.  The existence of the unorganized market, though illegal, yet operates. However, we that is out of the scope of the present article. So we will concentrate exclusively on the organized money-markets in India. Wherever, in the blog article or elsewhere in the site we refer money-markets, it is in organized money-market only.

1. Unorganized money-market

The unorganized money market is an old and ancient market, mainly it made of indigenous bankers and money lenders, etc.

2. Organized money-market

The organized money market is that part which comes under the regulatory ambit of RBI & SEBI. Governments (Central and State), Discount and Finance House of India (DFHI), Mutual Funds, Corporate, Commercial or Cooperative Banks, Public Sector Undertakings, Insurance Companies, and Financial Institutions and Non-Banking Financial Companies (NBFCs) are the key players of the organized Indian money market.

Structure of organized money market of India

The organized money market in India is not a single market. It is a combination of markets of various instruments. The following are the instruments that are integral parts of the Indian money market system.

1. Call money or notice money

Call money, notice money, and term money markets are sub-markets of the Indian money market. These markets provide funds for very short-term. Lending and borrowing from the call money market for 1 day.

Whereas lending and borrowing of funds from notice money market are for 2 to 14 days. And when there are borrowing and lending of funds for the tenor of more than 14 days, it refers to “Term Money”.

2. Treasury bills

The Bill market is a sub-market of this market in India. There are two types of the bill in the money market. They are treasury bills and commercial bill. The treasury bills are also known as T-Bills, T-bills are issued by the Central bank on behalf of Government, whereas Commercial Bills are issued by Financial Institutions.

Treasury bills do not yield any interest, but it is issued at discount and repaid at par at the time of maturity. In T-bills there is no risk of default; it is a safe investment instrument.

3. Commercial bills

Commercial bill is a money market instrument which is similar to the bill of exchange; it is issued by a Commercial organization to raise money for short-term needs. In India, the participants of the commercial bill market are banks and financial institutions.

4. Certificate of deposits

Certificate of Deposits also known as CDs. It is a negotiable money market instrument. It is like a promissory note. Rates, terms, and amounts vary from institution to institution. CDs are not supposed to trade publically neither it is traded on any exchange.

In general institutions issue certificate of deposit at discount on its face value. The banks and financial institutions can issue CDs on a floating rate basis.

5. Commercial paper

The commercial paper is another money market instrument in India. We also call commercial paper as CP. CP refers to a short-term unsecured money market instrument. Big corporations with good credit rating issue commercial paper as a promissory note. There is no collateral support for CPs. Hence, only large firms with considerable financial strength can issue the instrument.

6. Money market mutual funds (MMMFs)

The money-market mutual funds were introduced by RBI in 1992 and since 2000 they are brought under the regulation of SEBI. It is an open-ended mutual fund which invests in short-term debt securities. This kind of mutual fund solely invests in instruments of the money market.

7. Repo and the reverse repo market

Repo means “Repurchase Agreement”. It exists in India since December 1992. REPO means selling a security under an agreement to repurchase it at a predetermined date and rate. Those who deal in government securities they use the repo as an overnight borrowings.

Features of the Indian money market

The following are the important features of the money market in India –

  1. The money market is purely for short-term funds or assets called near money.
  2. All the instruments of the money market deal only with financial assets that are financial in nature. Also, such instruments have maturity period up to one year.
  3. It deals assets that can convert into cash readily without much loss and with minimum transaction cost.
  4. Generally, transactions take place through oral communication (for eg. phone or mobile). The exchange of relevant documents and written communications take place subsequently. There is no formal place for the trading ( like a stock exchange).
  5. Brokers free transactions are there.
  6. The components of a money market are the Central Bank, Commercial Banks, Non-banking financial companies, discount houses, and acceptance house. Commercial banks are dominant player of this market.

Discount and Finance House of India (the DFHI)

The RBI establishes DFHI in 1988. RBI, Public Sectors Banks, and other Indian financial institutions jointly own DFHI. The DFHI paid-up capital consists of the contribution of these institutions jointly. DFHI plays an important role in developing an active secondary market. It deals in T-Bills, Commercial bills, CDs, CPs, call money market, and government securities.

After learning the structure of the money-market in India and various instruments that are available for an investor in this market, let us understand the function of money market in India.

Functions of Indian money markets

The instruments of this market are liquid when we compare it with other financial instruments. We can convert these instruments into cash easily. Thus, they are able to address the need for the short-term surplus funds of the lenders and short-term fund requirements of the borrowers.

The major functions of such market instrument are to cater to the short-term financial needs of the economy. Some other functions are as following:

  1. It helps in effective implementation of the RBI’s monetary policy.
  2. This market helps to maintain demand and supply equilibrium with regard to short-term funds.
  3. It also meets the need for short-term fund requirement of the government.
  4. It helps in maintaining liquidity in the economy.

One important consideration about money market investment is that retail investors have very limited scope for directly participating in it. Recently with NSE being offering some instruments of the money market for retail investors. However, due to the large ticket size of trade and low liquidity, it is out of reach of retail investors. But nothing to worry much on this front. As retail investors of India, you can passively invest in any of such instruments through money market mutual funds.

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