Money Market - Study Notes

Lesson summary

The money market is a market for purely short-term funds. It deals with financial assets and securities whose maturity does not exceed one year, such as treasury bills, commercial bills, certificates of deposit and government securities.

6.01 Meaning and definition

• Crowther: "the collective name given to the various firms and institutions that deal in the various grades of near money".
• RBI: "a market for short-term financial assets that are close substitutes for money", facilitating the exchange of money for new claims in the primary market and for issued claims in the secondary market.

6.02 Objectives

1. An equilibrium mechanism for ironing out short-term surpluses and deficits.
2. A focal point for central bank intervention to influence liquidity.
3. Access for users of short-term money at a reasonable price.

Characteristics

1. Short-term funds (near money).
2. Maturity period up to one year only.
3. Assets convertible into cash readily, without loss and at minimum cost.
4. No formal place; deals are made over the phone.
5. Sub-markets: call money market, acceptance market, bill market.
6. Role of market: central bank, commercial banks, NBFCs, discount houses and acceptance houses; commercial banks dominate.
7. Highly organised banking system: commercial banks are the nerve centre.
8. Existence of an active secondary market.
9. Large demand and supply of funds.
10. Wholesale market with very large volumes.
11. Flexibility for new instruments.
12. Presence of a central bank that keeps cash reserves and conducts open market operations.

6.03 Money market vs capital market

6.04 Participants

Governments and central banks of different countries, private and public banks, mutual funds, insurance companies, NBFIs, RBI and SBI, commercial banks, State Governments and the public.

6.05 Instruments

Till 1986: treasury bills, money at call and short notice, commercial bills and promissory notes. Later: commercial papers, certificates of deposit, inter-bank participation certificates and repo instruments.

Treasury bills

• Government promissory notes payable to the bearer on the due date; period not over one year; high liquidity because issued by the Government.
• General features: issuer, finance bills, liquidity, vital source, monetary management.
• Types: 91, 182 and 364 days. 91 days bills at a fixed 4 per cent discount rate and through auctions; 91 and 182 days bills issued on tap; 364 days bills have no fixed rate and use the cut off rate.

Certificate of deposit

• Issued by commercial banks and financial institutions as usance promissory notes; also called negotiable certificate of deposit.
• Subscribers: individuals, corporations, trusts, associations and NRIs.
• Features: document of title to time deposit, unsecured negotiable instrument, transferable by endorsement and delivery, issued at a discount, repayable on a fixed date without grace days.

Commercial bills

• Bills of exchange of 30, 60 and 90 days drawn by a seller on a buyer of goods; self-liquidating.
• Features: drawer, acceptor, payee, discounter, endorser, assessment, maturity, credit rating.
• Types: demand, clean and documentary, inland and foreign, indigenous, accommodation bills.

Government or gilt-edged securities

• Issued to refund maturing securities, advance refunding and raising fresh cash.
• Characteristics: agencies, RBI special role, safe nature, liquidity profile, tax rebate, OTC market, forms, participants, trading, issue through the Public Debt Office, issue opening, grooming, switching and auctioning.

London is the oldest and leading money market; New York ranks second.