BBA III YEAR V SEMESTER Introduction to Financial Markets

(Finance Specialization)

Unit 4. Money Market

Money Market:
1. Meaning,
2. Definition,
3. Roles and Function of Money market,
4. Instrument related to Money market.

4.1MONEY MARKET
Money Market - Definition, Participants and its Types
Retail investors across the world do not have a high level of knowledge when it
comes to money markets. This is because of the fact that money markets have
been largely invisible to retail investors.
For a significant amount of time, money markets have only been used by large
corporations, banks, and other entities to either borrow or lend money for the
short term. The only way retail investors can invest in the money market is via
using the services of mutual funds i.e. of a big corporation.
In this article, we will have a closer look at what a money market is.

What is a Money Market?

A money market is a market where investors who have excess cash interact with
other investors who are short of cash. The specialty of this market is that
transactions happen for a very short period of time.
A money market has been defined as a market where the maturity of the
securities being traded is less than one year. It is important to note that money
markets are not necessarily restricted to a certain geography.
It is important to note that money markets exist in almost every country in the
world. The smooth functioning of a money market is crucial to a thriving
economy. Adverse events in the money market can have ripple effects on the
economy.
For instance, the famous credit freeze which followed the Lehman collapse in
2008 was a money market incident that impacted the entire global economy.

The money market plays a very important role in helping borrowers and lenders
meet their needs. This is because it is impossible for the market participants to
have their short-term cash flows completely synchronized.
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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Securities in the Money Market

The following types of securities can be classified as money market securities if
they have a maturity of less than one year:
1. Treasury bills issued by governments
2. Commercial paper issued by private corporations
3. Certificate of deposits issued by banks and financial institutions
4. Bills of Exchange
5. Bankers’ Acceptance
6. Repurchase Agreements
7. Stock Borrowing and Lending

Participants In the Money Market

There are several types of participants in the money market. Some of the
important ones have been listed below:
1. Banks are amongst the most important participants in the money markets.
This is because all over the world, banks face statutory regulations wherein
they are supposed to keep a certain amount of cash as regulatory capital.
However, a lot of the time, they are not able to do so. Hence, in such cases,
they borrow overnight funds from the market just to ensure that they abide
by the statutory rules. The overnight funds market is probably the largest
segment in the money market.

2. Investment banks, companies working in the insurance sector, finance

companies, and mortgage institutions are also important players in the
money market. This is because of the fact that these businesses can have
erratic cash flow schedules in the short run.

3. All types of corporations need to borrow funds in the short run in order to
meet their working capital requirements.

4. Brokerage firms such as stockbrokers, insurance brokers, money-market

brokers, shipbrokers all use money markets to transact in the short run.

4.3Roles of Money Market:

The money market is a financial market in which lending and borrowing of
short-term funds take place. It is a market for 'near money,' i.e., short-term
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instruments. These instruments are highly liquid, less risky, and easily
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BBA III YEAR V SEMESTER Introduction to Financial Markets
(Finance Specialization)

marketable, with a maturity period of one year or less. The role of the money
market in India can be explained as follows:

1. Short-term requirements of borrowers: The money market provides access to

sources of funds for borrowers to meet their short-term requirements at
reasonable interest rates.

2. Liquidity Management: The money market is a dynamic market that

facilitates better management of liquidity and money in the economy by the
monetary authorities. This, in turn, leads to economic stability and the
development of the country.

3. Portfolio Management: The money market deals with different types of

financial instruments designed to suit the risk and return preferences of
investors. This enables investors to hold a portfolio of different financial assets,
which helps minimize risk and maximize returns.

4. Equilibrating mechanism: Through the rational allocation of resources and

mobilization of savings into investment channels, the money market helps
establish equilibrium between the demand for and supply of short-term funds.

5. Economizes the use of cash: The money market deals with various financial
instruments that are close substitutes for money but not actual money. Thus, it
economizes the use of cash.

6. Implementation of monetary policy: Monetary policy is implemented by the

central bank. It aims to manage the quantity of money to meet the requirements
of different sectors and to increase the pace of economic growth. A well-
developed money market ensures the successful implementation of monetary
policy. It also guides the central bank in developing an appropriate interest
policy.

7. Financial requirements of the government: The money market helps the

government fulfill its short-term financial requirements based on Treasury Bills
(T-bills).
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Functions of the Money Market

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BBA III YEAR V SEMESTER Introduction to Financial Markets
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Money markets are large and liquid markets. They exist in almost every country
which has a developed financial system. The existence of a thriving and highly
liquid money market in every economy of the world is not a mere coincidence.
There are certain functions that are performed by the money market.
Some of these functions have been listed and explained in detail in this article.
1. Short Term Funds for Banks and Private Entities
The money market performs a crucial function for all banks and private entities.
Banks are required to maintain reserves to cover the loans that they make.
However, the process of accepting deposits and issuing loans happens
simultaneously. Hence, banks do not have the exact amount of reserves required.
Some banks end up having more reserves than required whereas others end up
with fewer reserves than required. The interbank market which is a component
of the money market allows banks with excess funds to lend money to banks
with deficient funds overnight.
Hence, even though individual banks may have less or more reserves, the
industry as a whole has the required reserves. The existence of an interbank
market allows banks to conduct their deposit-taking as well as lending activity
without fear of being unable to meet the reserve requirements. Hence, the
money market enables the banking system to function at an optimal level.
This is also the case for other private entities. The money market allows for
entities with excess cash to make short-term loans to entities that have deficient
cash holdings. The end result is beneficial to both parties as it helps them meet
their financial needs respectively.
2. Short Term Funds for Governments
The money market enables the government to borrow short-term funds. It may
seem irrelevant since the government can create more money if required.
However, economists are of the opinion that since the creation of money by the
government leads to inflation, the government must only use it for long-term
purposes.
When it comes to short-term loans, the government simply borrows money
from the money market by issuing treasury bills. These do not have an
inflationary effect on the overall economy.
3. Helps In Implementing Monetary Policy Implementation
The money market can be used as a barometer to gauge the success of the
monetary policy. In order to control the interest rates, governments create
monetary policies which specifically target the interbank rate. Since the
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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interbank rate is a benchmark rate, controlling that rate provides a high degree
of control over the interest rates in the entire economy.
It also needs to be understood that the central bank has a great deal of influence
on commercial banks. Also, these commercial banks are huge players in the
various sectors of the monetary market. Hence, the central bank can use the
influence of the commercial banks to influence the operations of the money
market in such a manner that it aligns with the overall objective of the monetary
policy.
4. Promotes Liquidity
In the absence of a highly liquid and short-term money market, entities across
the world would be forced to hoard a large amount of cash for their
transactional purposes. This would lead to lesser productivity as the smooth
flow of funds would not be possible.

Money markets provide the much-needed liquidity to the market. They allow
entities to hold their funds in cash equivalent assets instead of cash. This means
that the funds are not lying idle but instead can be used by other entities.
5. Promotes Utilization of Funds Across Sectors
The money market also performs the function that all financial markets must
perform i.e. it must channelize funds towards the most profitable investments.
There are various types of government and private entities which participate in
the money market. Hence, if a particular sector of the economy is more
profitable, it is able to obtain funds from the other sectors.
For instance, the flow of funds could be from the banking sector to the
industrial sector in the money market. This helps firms diversify their own risks
while also allowing the most efficient sector to have access to large amounts of
funds.
6. Financing International Trade
The money markets play an important role in financing international trade as
well. This is because a large number of private entities utilize money markets to
raise short-term funds. These short-term funds are often used as working capital
for international trade-related activities.
For instance, a company may borrow funds from the money market in order to
open a letter of credit at a bank. Many suppliers do not release the shipment of
goods until the funds have been deposited into the bank issuing the letter of
credit.
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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The fact of the matter is that money markets are very important for the overall
economy. They play a pivotal role in the day-to-day functioning of the economy
and are crucial when it comes to the implementation of monetary policy. It is
therefore impossible for the central banks to have a reasonable amount of
control over the monetary policy unless they have strong and efficient money
markets in place which help in implementing the policy at the grassroots level.

4.4Instrument related to Money market.

1.Treasury Bills
Treasury bills are money market instruments issued by the Government of India
as a promissory note with guaranteed repayment at a later date. Funds collected
through such tools are typically used to meet short term requirements of the
government, hence, to reduce the overall fiscal deficit of a country.
They are primarily short-term borrowing tools, having a maximum tenure of
364 days, available at zero coupons (interest) rate. They are issued at a discount
to the published nominal value of government security (G-sec).
Government treasury bills can be procured by individuals at a discount to the
face value of the security and are redeemed at their nominal value, thereby
allowing investors to pocket the difference.

Why Does the Government Issue Treasury Bills?

A short term treasury bill helps the government raise funds to meet its current
obligations, which are in excess of its annual revenue generation. Its issue is
aimed at reducing total fiscal deficit in an economy, and also in regulating the
total currency in circulation at any given point of time.
The Reserve Bank of India (RBI) also issues such treasury bills under its open
market operations (OMO) strategy to regulate its inflation level and
spending/borrowing habits of individuals. During times of economic boom
leading to high and persistent inflation rates in the country, high-value treasury
bills are issued to the public, which, thereby, reduces aggregate money supply
in an economy. It effectively curbs the surging demand rates, and in turn, high
prices hurting the poorer sections of the society.
Alternatively, a contractionary OMO regime is undertaken by the RBI during
times of recession and economic slowdown through a reduction in treasury
bill circulation and reduced discounted value of the respective bonds. It
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disincentives individuals into channelling their resources in this sector, thereby

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BBA III YEAR V SEMESTER Introduction to Financial Markets
(Finance Specialization)

boosting cash flows to the stock markets instead, ensuring a boost in the
productivity of most companies. Such a rise in productivity has a positive
impact on the GDP and aggregate demand levels in an economy.
Hence, a treasury bill is an integral monetary tool used by the RBI to regulate
the total money supply in an economy, along with its fundraising usage.

Types of Treasury Bill

The distinction between different treasury bill types is made based on their
tenure, as enumerated below:
 14-day treasury bill
 91-day treasury bill
 182-day treasury bill
 364-day treasury bill
While the holding period remains constant for all types of treasury bills issued
(as per the categories mentioned above), face values and discount rates of such
bonds change periodically, depending upon the funding requirements and
monetary policy of the RBI, along with total bids placed.

Features of Treasury Bills

 Minimum investment
As per the regulations put forward by the RBI, a minimum of Rs. 25,000 has to
be invested by individuals willing to procure a short term treasury bill.
Furthermore, any higher investment has to be made in multiples of Rs. 25,000.
 Zero-coupon securities
G-Sec treasury bills don’t yield any interest on total deposits. Instead, investors
stand to realise capital gains from such investments, as such securities are sold
at a discounted rate in the market. Upon redemption, the entire par value of this
bond is paid to investors, thereby allowing them to realise substantial profits on
total investment.
 Trading
The method of investment forms an integral part of essential treasury bill details.
The RBI, on behalf of the central government, auctions such securities every
week (on Wednesday) in the market, depending upon the total bids placed on
major stock exchanges. Investors can choose to procure such government assets
through depository participant commercial banks, or other registered primary
dealers (PDs), wherein the security transfer follows a T+1 settlement process.
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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Alternatively, many open-ended mutual fund schemes also include treasury

bills in their corpus for individuals willing to invest through such funds.

2. Commercial Paper
Corporations regularly utilize commercial paper as a short-term debt instrument
to finance current operations and additional investments. This type of debt
typically has a duration that can range from two days up to 270 days. This
article provides a comprehensive overview of commercial paper, including its
definition, features, working mechanism and potential advantages and
drawbacks. We will explore in depth the details surrounding this financial
instrument to ensure you have all the information needed to make a well
informed decision. Additionally, you'll be made aware of its potential
advantages and drawbacks so that you may make an informed decision when
considering whether or not to invest.
What is Commercial Paper?
Commercial paper is a short-term debt instrument corporations issue to finance
their operations, investments and other activities. It is debt that matures within
270 days and generally has an average maturity of 15-45 days. The issuer
promises to pay the principal amount of the paper plus any applicable interest
on the predetermined maturity date. The commercial paper does not have
collateral backing it, so it is considered unsecured debt.
Commercial paper may be issued as bearer notes or registered notes. Bearer
notes are physical instruments representing commercial paper ownership, while
registered notes are securities that must be held in an investor's name on a
centralized ledger. Additionally, these financial instruments can be secured
(backed by underlying assets) or unsecured (not backed by assets).

Features of Commercial Paper

● Low Cost- Issuing commercial paper is generally less expensive than other
forms of borrowing due to fewer regulations and the short maturity period.
● High Yields- Interest rates earned on commercial paper are usually higher
than those earned on money market accounts and certificates of deposit.
● Flexibility- Commercial paper can be used for various purposes such as
financing working capital, refinancing existing debt or investing in new projects.
● Low Risk- Since large corporations often issue these instruments with
strong credit ratings, relatively low risk is involved compared to other
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securities.
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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● Tax Benefits- Interest earned from commercial paper may be eligible for
preferential income tax treatment due to its status as a debt instrument.
● Liquidity-Investors can easily sell commercial paper before its maturity
date, enabling them to access funds quickly.
● Ease of Access- In some cases, investors can purchase commercial paper
from their broker or the issuer directly.
● Widely Accepted- Financial institutions widely accept commercial paper,
so it may be easier for investors to obtain financing if needed.
● Regulatory Oversight- The SEC monitors and regulates the commercial
paper market, providing an extra layer of protection for investors and issuers.
● Diversification- By investing in commercial paper, you can help diversify
your investment portfolio and reduce the risk of volatility due to its lack of
correlation with stock or bond markets.

Types of Commercial Paper

Investors can choose from different types of commercial paper, depending on
what best suits their needs. These include:
1. Drafts- These are short-term promissory notes companies issue to meet
immediate cash needs. The buyer of the draft is known as the drawee, while the
issuer is known as the drawer.
2. Promissory Notes-
These are contracts that obligate the issuer to repay the principal plus interest on
a specified date.
3. Receivable Backed Commercial Paper- This type of commercial paper is
issued by companies and backed by accounts receivable, such as invoices for
goods sold or services rendered.
4. Asset-Backed Commercial Paper (ABCP)- ABCP is issued by special
purpose vehicles and backed by underlying assets such as mortgages, loans or
other securities.
5. Certificates of Deposit (CDs)- CDs are certificates issued by banks which
guarantee the repayment of principal plus interest on a specific maturity date.
6. Euro Commercial Paper (ECP)- ECP is an unsecured money market
instrument that can be issued in any currency and traded internationally.
7. Letter of Credit (LOC)- LOCs are documents issued by banks that
guarantee payment of goods or services on behalf of an issuer.
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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8. Structured Notes-These are derivative products with a predetermined

return linked to an underlying reference asset, such as stocks, bonds or
commodities.
9. Registered Notes- Registered notes are physical instruments representing
commercial paper ownership, while registered notes are securities that must be
held in an investor's name on a centralized ledger.
Investors should carefully consider the different types of commercial paper
available before deciding which one best suits their needs. Each type has its
advantages and disadvantages, so understanding these differences is key to
making an informed decision.
In addition to the different types of commercial paper, investors should also
consider other factors such as credit ratings, maturity date, liquidity, and
financial regulations when investing in these instruments. By being aware of
these details, investors can maximize their returns while minimizing risk.

3. Call Money
 The call money market is a market for very short-term funds repayable on
demands with a period varying between one day to a fortnight.
 It is the most viable market as the day-to-day surplus funds, mostly of
banks are traded in this market.
 Call money market accounts for a major part of the total turnover of the
money market.

Features of Call Money Market

 Call money market is also known as the “Notice Money” Market.
 The call money market is a highly liquid market.
 Call money market is highly risky and volatile.
 No security or collateral is required to cover the transactions in the call
money market.
 It is basically an “Over-the-counter” market without the intermediation of
brokers.
 The participants in the call money market are-scheduled commercial
banks, non-scheduled commercial banks, foreign banks, state, district and
urban cooperative banks, brokers and dealers in the securities market, and
primary dealers.
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Why Call Money

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BBA III YEAR V SEMESTER Introduction to Financial Markets
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 Commercial banks mostly require call money. Commercial banks

borrow money without collateral from other banks to maintain the reserve
requirements i.e., the Cash Reserve Ratio (CRR).
 Once every fortnight banks have to satisfy the minimum reserve
requirement which often entails borrowing in the call/notice money
market.

Call Rate
 Call rate is the rate of interest paid on call loans, which is highly volatile.
 The volatility of call rate depends on the demand and supply of call loans.
 Call rate is inversely related to the short-term money market instruments.
When call rate is very high, banks raise more funds through Certificate of
Deposits and when call rate is low, banks fund commercial papers by
borrowing from the call money market and earn profits through arbitrage
between money market segments.
 Large issues of government securities affect call rate. When banks
subscribe to large issues of government securities, call rates go up and
vice versa.
 Liquidity conditions, reserve requirements, liquidity changes and gaps in
the foreign exchange market also influence the call rate.

4.Certificate of Deposit
India introduced Certificates of Deposit (CDs) in 1989 to increase the range of
money market instruments in the country and thereby give investors greater
flexibility in terms of utilization of their short-term funds.
What is a Certificate of Deposit?
A Certificate of Deposit (CD) is a money market instrument which is issued in a
dematerialised form against funds deposited in a bank for a specific period. The
Reserve Bank of India (RBI) issues guidelines for Certificate of Deposit from
time to time.
Eligibility for Certificate of Deposit:
Certificates of Deposit are issued by scheduled commercial banks and select
financial institutions in India as allowed by RBI within a limit. Certificates of
Deposits are issued to individuals, companies, corporations and funds among
others. Certificates of Deposits can also be issued to Non-Resident Indians but
on a non-repatriable basis only. It is important to note that banks and financial
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institutions cannot provide loans against Certificates of Deposits. Also, banks

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BBA III YEAR V SEMESTER Introduction to Financial Markets
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cannot buy their own Certificates of Deposits prior to the latter's maturity.
However, the aforementioned norms may be relaxed by the RBI for a specific
period of time. It is important to note that banks have to maintain the statutory
liquidity ratio (SLR) and cash reserve ratio (CRR) on the price of a Certificate
of Deposit.
Format of Certificates of Deposit
Banks and financial institutions should issue a Certificate of Deposit in a
dematerialised form only. However, investors can seek a certificate in physical
form as well as per Depositories Act, 1996. In case an investor seeks a
certificate in a physical form, a bank informs the Financial Markets Department,
Reserve Bank of India, Mumbai. Also, a Certificate of Deposit entails stamp
duty charges as well. Given that Certificates of Deposits are transferable in a
physical form, banks should ensure that they are issued on good quality paper.
A Certificate of Deposit has to be signed by two or more signatories
(authorized).
Minimum size and maturity of a Certificate of Deposit
A certificate of deposit can only be issued for a minimum of Rs.1 lakh by a
single issuer and in multiples of Rs.1 lakh. The maturity of a certificate of
deposit depends on the investor. For instance, for a certificate of deposit issued
by banks, the maturity period is not less than seven days and not above one year
while for financial institutions, a certificate of deposit should not be issued for
less than one year and not above three years.
Transferability
A certificate of deposit which is not held in an electronic form can be
transferred by endorsement and delivery. However, a certificate of deposit held
in a demat form is transferred according to guidelines followed by demat
securities.
Discount
A certificate of deposit can be issued at a discount on its face value.
Furthermore, banks and financial institutions can issue certificates of deposits
on a floating rate basis. However, the method of calculating the floating rate
should be market-based.
Reporting
Banks' fortnightly return should include certificates of deposits as per Section
42 of the RBI Act, 1934. Furthermore, banks and financial institutions should
also report about certificates of deposits under the Online Returns Filing System
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(ORFS).
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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5. Commercial Paper
Financial Institutions and corporations issue commercial papers to finance their
working capital needs, such as inventories, payables, salaries, etc. It provides a
cost-effective way of raising funds for 7 days upto a year and can be issued in a
denomination of 5 lakhs or multiples thereof.
In this article, you’ll check the meaning and definition of commercial papers,
their types, example, features, advantages, who issues them, maturity period,
interest rates, and minimum amount.
What is a Commercial Paper?
Commercial papers are short-term debt instruments companies issue to meet
short-term financing needs, like working capital requirements, including salaries,
inventories, etc. These are unsecured securities.
It is issued as a promissory note with a high denomination and exchanged
between financial entities and primary dealers. The maturity period of a
commercial paper is between 7 days upto a year.
An example is a commercial paper issued by SBI or a corporate firm to meet
their short-term funds’ requirements.
Commercial Paper in India
The Commercial Paper was introduced in India in 1990; its launch symbolised
financial reforms in India. The primary aim of allowing commercial paper in the
market was to enable corporates with good credit ratings to have an additional
channel for borrowings apart from other debt instruments. Through this
instrument, RBI also provided investors with another reliable mode of fixed-
income debt investment. Subsequently, RBI allowed all financial institutions
and primary dealers to issue commercial paper and meet their capital needs, e.g.
project costs and other short-term financial obligations.
Features of Commercial Paper
 It is a short-term debt instrument with a fixed maturity period.
 It usually is an unsecured loan, which means the borrower is not required
to provide any collateral for the loan. The loan is given based on the
borrower’s financial credibility and rating, e.g. company’s cash reserves,
current debt, liquidity, profits, and overall revenues.
 Commercial Paper is a promissory note. The issuer promises to pay the
subscriber a fixed amount at a specified time.
 It is issued at a discount to the face value and can be issued as an interest-
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bearing instrument.
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BBA III YEAR V SEMESTER Introduction to Financial Markets
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Who can Issue a Commercial Paper in India?

The RBI has published clear guidelines on entities that can issue CP
(Commercial Paper) in India. As per these guidelines, primary dealers, \, highly
rated corporate borrowers, and Indian Financial Institutions have the permission
to issue CP and raise funds. Thus, a commercial paper can be issued by the
following:
 Corporate borrowers
 Non-Banking Financial Companies (NBFCs)
 All India Financial Institutions (AIFIs)
 Government Institutions
 Registered Trusts
 Other permitted entities who have a net worth of over Rs. 100 crores or
above.

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