Composition and importance of Money Market

Composition of money market

The money market is not a single homogeneous market. It consists of a number of sub-markets which collectively constitute the money market. There should be competition within each sub-market as well as between different sub-markets. The following are the main sub-markets of a money market:

  • Call Money Market.
  • Commercial Bills Market or Discount Market.
  • Acceptance Market.
  • Treasury bill Market.

Importance of Money Market

A developed money market plays an important role in the financial system of a country by supplying short-term funds adequately and quickly to trade and industry. The money market is an integral part of a country’s economy. Therefore, a developed money market is highly indispensable for the rapid development of the economy. A developed money market helps the smooth functioning of the financial system in any economy in the following ways:

  • Development Of Trade And Industry: Money market is an important source of financing trade and industry. The money market, through discounting operations and commercial papers, finances the short-term working capital requirements of trade and industry and facilities the development of industry and trade both – national and international.
  • Development Of Capital Market: The short-term rates of interest and the conditions that prevail in the money market influence the long-term interest as well as the resource mobilization in capital market. Hence, the development of capital depends upon the existence of a development of capital money market.
  • Smooth Functioning of Commercial Banks: The money market provides the commercial banks with facilities for temporarily employing their surplus funds in easily realisable assets.
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Characteristic features of a developed Money Market

In every country of the world, some type of money market exists. Some of them are highly developed while others are not well developed. Prof. S.N. Sen has described certain essential features of a developed money market.

  1. Highly organized banking system: The commercial banks are the nerve centre of the whole money market. They are principal suppliers of short-term funds. Their policies regarding loans and advances have impact on the entire money market. The commercial banks serve as vital link between the central bank and the various segments of the highly organized banking system co-exist. In an underdeveloped money market, the commercial banking system is not fully developed.
  2. Presence Of A Central Bank: The Central Bank acts as the banker’s bank. It keeps their cash reserves and provides them financial accommodation in difficulties by discounting their eligible securities. In other words, it enables the commercial banks and other institutions to convert their assets into cash in times of financial crisis. Through its open market operations, the central bank absorbs surplus cash during off-seasons and provides additional liquidity in the busy seasons. Thus, the central bank is the leader, guide and controller of the money market. In an underdeveloped money market, the central bank is in its infancy and not in a position to influence and control the money market.
  3. Availability of Proper Credit Instruments: It is necessary for the existence of a developed money market a continuous availability of readily acceptable negotiable securities such as bills of exchange, treasury bills etc.
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Features and objectives of money market

Money market is a market for short-term loan or financial assets. It as a market for the lending and borrowing of short term funds. As the name implies, it does not actually deals with near substitutes for money or near money like trade bills, promissory notes and government papers drawn for a short period not exceeding one year. These short term instruments can be converted into cash readily without any loss and at low transaction cost.

Money market is the centre for dealing mainly in short – term money assets. It meets the short-term requirements of borrowers and provides liquidity or cash to lenders. It is the place where short-term surplus funds at the disposal of financial institutions and individuals are borrowed by individuals, institutions and also the Government.

Features of Money Market

The following are the general features of a money market:

  1. It is market purely for short-term funds or financial assets called near money.
  2. It deals with financial assets having a maturity period up to one year only.
  3. It deals with only those assets which can be converted into cash readily without loss and with minimum transaction cost.
  4. Generally transactions take place through phone i.e., oral communication. Relevant documents and written communications can be exchanged subsequently. There is no formal place like stock exchange as in the case of a capital market.
  5. Transactions have to be conducted without the help of brokers.
  6. The components of a money market are the Central Bank, Commercial Banks, Non-banking financial companies, discount houses and acceptance house.
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Definition of Certificate of Deposit (CD)

Certificate of deposits(CD) are short term deposit instruments issued by banks and financial institutions to raise large sums of money.

Features of Certificate Of Deposit

  • Document of title to time deposit.
  • Unsecured negotiable promotes.
  • Freely transferable by endorsement and delivery.
  • Issued at discount to face value.
  • Repayable on a fixed date without grace days.
  • Subject to stamp duty like the usince  promissory notes.

The banks in USA in 1960s introduced CDs which are freely negotiable and marketable any time before maturity. The CDs were issued by big banks in the USA of $1 million at face value bearing fixed interest with a maturity generally ranging from 1 to 6 months. Banks sold CDs direct to investors or through dealers who subsequently traded this instrument in secondary market. The American banks issued for the first time dollar CDs in London in 1966. The bank of England gave permission to around 40 banks to make CD issue.

The feasibility of introducing CDs in India was examined by the Tamb Working Group in 1982 which did not, however, favour the introduction of this instrument. The matter was again studied in 1987 by the Vaghul Working Group on the Money Market. The Vaghul Group recognized that CP world be attractive both the banker and investor in that the bank is not required to encase the deposit prematurely while the investor can liquefy the instrument before its maturity in the secondary market.

On the recommendations of the Vaghul Committee, the RBI formulated a scheme in June 1989 permitting scheduled commercial banks (excluding RRBs) to issue CDs.… Read the rest

Definition of commercial paper

What is a commercial paper?

A commercial paper is an unsecured promissory note issued with a fixed maturity by a company approved by RBI, negotiable by endorsement and delivery, issued in bearer form and issued at such discount on the face value as may be determent by the issuing company.

Features of Commercial Paper

  1. Commercial paper is a short-term money market instrument comprising usince promissory note with a fixed maturity.
  2. It is a certificate evidencing an unsecured corporate debt of short term maturity.
  3. Commercial paper is issued at a discount to face value basis but it can be issued in interest bearing form.
  4. The issuer promises to pay the buyer some fixed amount on some future period but pledge no assets, only his liquidity and established earning power, to guarantee that promise.
  5. Commercial paper can be issued directly by a company to investors or through banks/merchant banks.

Advantages of Commercial Paper

  • Simplicity: The advantage of commercial paper lies in its simplicity. It involves hardly any documentation between the issuer and investor.
  • Flexibility: The issuer can issue commercial paper with the maturities tailored to match the cash flow of the company.
  • Easy To Raise Long Term Capital: The companies which are able to raise funds through commercial paper become better known in the financial world and are thereby placed in a more favorable position for rising such long them capital as they may, form time to time,  as require. Thus there is in inbuilt incentive for companies to remain financially strong.
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Treasury Bill markets

Just like commercial bills which represent commercial debt, treasury bills represent short-term borrowings of the Government. Treasury bill market refers to the market where treasury bills are brought and sold. Treasury bills are very popular and enjoy higher degree o9f liquidity since they are issued by the government.

Meaning and Features of Treasury Bills:

A treasury bills nothing but promissory note issued by the Government under discount for a specified period stated therein. The Government promises to pay the specified amount mentioned therein to the beater of the instrument on the due date. The period does not exceed a period of one year. It is purely a finance bill since it does not arise out of any trade transaction. It does not require any ‘grading’ or’ endorsement’ or ‘acceptance’ since it is clams against the Government. Treasury bill are issued only by the RBI on behalf of the Government. Treasury bills are issued for meeting temporary Government deficits. The Treasury bill rate of discount is fixed by the RBI from time-to-time. It is the lowest one in the entire structure of interest rates in the country because of short-term maturity and degree of liquidity and security.

Types of Treasury Bills

In India, there are two types of treasury bills viz. (I) ordinary or regular and (ii) ‘ad hoc’ known as ‘ad hocs’ ordinary treasury bills are issued to the public and other financial institutions for meeting the short-term financial requirements of the Central Government. These bills are freely marketable and they can be brought and sold at any time and they have secondary market also.… Read the rest