The money market is an important part of our economy. The money market fulfills short term fund requirements via various instruments. The money market instrument has a maturity period of up to one year and it can be traded in the money market at a low cost.
Let’s try to understand the money market in simple terms. Suppose institutions, NBFC or government are in need of money for short term requirements. They float this requirement in the money market via instruments approved by RBI. They act as borrower in this case. They clearly define interest rates applicable to the instrument. The lender with surplus money can purchase this instrument. The market where the transaction of lending and borrowing takes place is known as the money market.
The money market is a part of a large financial market. This market consists of various small submarkets such as bill market, call money market, acceptance market, etc. Money market deals in cash as well as various instruments.
What are money market instruments?
The money market instrument as the name suggests it is a tool that helps to operate in the money market. This instrument serves the purpose of a borrower for borrowing money for short term requirements. It also provides easy liquidity for investors/lenders. The examples of a few money market instruments are Treasury bills, repurchase agreements, certificates of deposit, commercial papers, etc.
Features of Money Market Instruments
The features of money market instruments are given below.
Safety – These instruments are relatively safer compared to mutual funds and equity. The issuer of money market instruments have generally strong credit ratings. This means money market instruments are generally safe in nature.
Liquidity – These instruments are highly liquid in nature. You can trade these instrument anytime. Apart from that these are fixed income securities with short maturity period of a year or less.
Discounted Price – Another important feature of money market instrument is they are issued on the discounted price on their face value.
Money market instruments serves important functions such as provide funds, eliminate needs to borrow from banks, help government and economy. It also helps in mobilizing saving and leading to productive use of money in the economy.
Types of Money Market Instruments
A promissory note is signed promise made by one party to other party for paying a definite sum of money by demand at a specific future date. It is a unique instrument that binds borrowers to pay money to the lender as specified in the promissory note. This instrument comes with interest or without interest. This instrument can be handwritten. It is to be stamped as per regulation. There is no maxim limit in terms of the amount can be lent or borrowed using this note.
Treasury bill is one of the popular money market instruments. This instrument is issued by the RBI on behalf of the central government. Treasury bill is risk-free and safest investment option. The return of the treasury bill is comparatively low. Treasury bill means a promise to pay a certain amount after a pre-determined period. These bills are issued for a period of 3 months, 6 months or 1 year.
Commercial papers are unsecured promissory notes issued by the financial and corporate institutions. Commercial papers are issued to meet short term requirements. The interest rate offered by the commercial paper is higher compared to treasury bills. Commercial paper is issued from 1 day to 270 days. CP is less secured compared to treasury bills. The buyer should look at the credit rating before buying commercial papers.
Certificate of Deposit
Certificate of Deposit is another money market instrument (MMI). Certificate of deposit is similar to term deposit. However, it differs from term deposit in two aspects. Certificate of Deposit is issued only for large amount. Certificate of Deposit is freely negotiable. Certificate of deposit is issued by commercial banks and selected financial institution approved by RBI. The interest rate offered on Certificate of deposit is higher compared to treasury bills.
Repurchase agreements are called as REPOS. REPOS are short term loans that buyer and seller aggress upon for selling and purchasing. These transactions are allowed only between RBI approved securities such as state and central government securities, PSU bonds and corporate bonds.
Banker’s acceptance is document that promises future payment guaranteed by a commercial bank. This instrument mentions specific details such as repayment amount, date of repayment and details of the individual to whom payment needs to be given. BA is issued with a maturity period ranging between 30 days to 180 days.
Who should invest in Money market instrument (MMI)?
Money market instruments are liquid in nature and safe for investment. These instruments provide a fixed return as promised. If you are a conservative investor and happy with the fixed return you can think of investing in MMI. However, you should check at credit rating and other details before investing in MMI. The most secured MMI is treasury bills as it is issued by the government.
As per me, instead of investing in MMI you should select mutual funds or equity for the investment. You will be able to earn a higher return in mutual funds or equity.