Money market instruments

What is the Money market?

The money market is a financial marketplace where short-term borrowing and lending take place among financial institutions and corporations. It provides a platform for the buying and selling of short-term debt instruments, which typically have maturities of one year or less. The money market plays a crucial role in facilitating the efficient allocation of funds and liquidity management for participants.

Various financial instruments are traded in the money market on both stock exchanges, namely the NSE (National Stock Exchange) and BSE (Bombay Stock Exchange).

The main objective of the money market is to facilitate short-term borrowing and lending, allowing quick and efficient cash flow adjustments, providing a low-risk avenue for investments, and serving as a benchmark for short-term interest rates.

In India, the regulation of the money market falls under the purview of multiple regulatory authorities, with the Reserve Bank of India (RBI) playing a central role. The RBI is the primary regulator of the money market, and it oversees various aspects to ensure the smooth functioning, stability, and integrity of the financial system.

List of Money Market Instruments

In India, various money market instruments are actively traded. Some of the key money market instruments include:

1. Treasury Bills (T-Bills):

Treasury Bills (T-Bills) in India are short-term debt instruments issued by the Government of India. They come in three maturities: 91 days, 182 days, and 364 days. T-Bills are sold at a discount and don't pay interest; investors earn returns from the difference between the purchase price and face value. They are considered low-risk, and highly liquid, and play a crucial role in government financing and the Indian money market.

2. Commercial Paper (CP):

Unsecured, short-term debt is issued by corporations to raise funds for a specific period, usually up to one year. Regulated by the Reserve Bank of India (RBI), it has maturities of up to one year, is issued at a discount, and requires a credit rating. CP provides companies with a quick source of short-term financing, and investors can trade it in the secondary market for liquidity.

3. Certificates of Deposit (CDs):

Certificates of Deposit (CDs) are time deposits offered by banks with fixed maturity periods and higher interest rates than regular savings accounts. Investors agree to keep funds deposited for a specific period, receive fixed interest, and get the principal back upon maturity. While they provide stability and higher returns, early withdrawals may have penalties, and there's typically a minimum deposit requirement. CDs are considered relatively safe and are used for capital preservation and predictable returns.

4. Call Money:

Call Money in India is a short-term borrowing and lending arrangement among banks for overnight funds. It helps banks manage daily liquidity needs, with fluctuating interest rates influenced by market demand.It plays a crucial role in maintaining stability in the financial system and supports efficient liquidity management among banks.

5. Repo (Repurchase Agreement):

A transaction where one party sells securities to another with an agreement to repurchase them at a later date at a higher price. It is a short-term collateralized lending/borrowing mechanism.

6. Money Market Mutual Funds (MMMFs):

Money Market Mutual Funds (MMMFs) in India are mutual funds that primarily invest in short-term, low-risk instruments. Regulated by SEBI, they aim to provide investors with a safe and liquid investment option with modest returns. The funds typically invest in instruments like Treasury Bills, Commercial Paper, and Certificates of Deposit.

7. Commercial Bills:

Commercial Bills are negotiable instruments used in trade transactions. They represent a commitment by the buyer to pay the seller a specific amount on a predetermined future date. These bills facilitate trade finance by providing a credit mechanism between buyers and sellers in the exchange of goods and services.

8. Tri-Party Repo:

In a tri-party repo, three parties are involved in a repurchase agreement (repo) transaction: the borrower of funds (seller of securities), the lender of funds (buyer of securities), and a tri-party agent or intermediary.

1. Borrower/Seller: This is typically a financial institution seeking short-term funds. They sell securities to the lender in exchange for cash

2. Lender/Buyer: The entity providing funds (cash) in exchange for securities. They act as the lender in the transaction.

3. Tri-Party Agent/Intermediary: A neutral third party, often a clearing bank, serves as an intermediary to facilitate the transaction. The tri-party agent holds the collateral, manages the collateral selection process, and ensures settlement.

9. Inter-Bank Participation Certificates (IBPCs):

IBPCs facilitate the transfer of funds between banks by allowing one bank to participate in the loan portfolio of another bank, often for managing liquidity and meeting regulatory requirements.

When Do corporations invest in Money Market mutual funds?

Corporations frequently invest in money market mutual funds (MMMFs) for diverse reasons, with their decisions shaped by several factors.

The following are common situations prompting corporate investment in MMMFs:

1. Short-Term Cash Management: Corporations utilize money market mutual funds for short-term cash management when holding excess funds not immediately required for operational needs. This allows them to earn returns while ensuring liquidity.

2. Safety and Liquidity: MMMFs, typically invested in short-term, highly liquid, and low-risk instruments like treasury bills, cater to corporations prioritizing safety and liquidity over higher returns.

3. Convenience and Diversification: MMMFs offer a convenient avenue for corporations to access a diversified portfolio of short-term instruments without managing individual securities, appealing to those seeking a hassle-free investment approach.

4. Stable Net Asset Value (NAV): The commitment of money market mutual funds to maintain a stable net asset value (NAV) of $1 per share is attractive to corporations seeking a low-risk investment option with minimal principal volatility.

5. Meeting Regulatory Requirements: Corporations may turn to MMMFs to adhere to specific investment or liquidity requirements imposed by regulators, depending on the regulatory environment and accounting standards.

6. Interim Investment of Funds: When earmarked funds are received but not immediately needed for specific purposes, corporations may opt to invest in MMMFs as an interim measure before deploying the funds for their intended purposes.

7. Yield Enhancement: Despite being low-risk, MMMFs offer a higher yield compared to traditional savings accounts or other low-risk instruments, prompting corporations to invest for a modest return on idle cash.

A list of some of the Best Money market mutual Funds in India of January 2024

source : www.fincash.com

So, in conclusion, market instruments are crucial as they enable organizations to efficiently handle their short-term financial requirements. They are characterized by low risk, offering a swift source of financing, and they hold a key position in maintaining stability within financial markets. Investors utilize these instruments for capital preservation and as a secure element in diversified investment portfolios. Moreover, these financial tools play a role in supporting government financing and aid central banks in implementing policies for economic stability.

Prasanna Laxmi R., Assistant Content Manager

An MBA student specializing in Finance, driven by a keen interest in exploring the complexities of finance to navigate the business landscape.