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MODULE - III

8
INTRODUCTION OF MONEY MARKET
Unit Structure

8.1 Meaning of money market

8.2 Features of money market
8.3 Money Markets instruments
8.4 Institutions of money market
8.5 Functions of money markets.

8.1 MEANING OF MONEY MARKET

The money market is a market for short-term funds, which

deals in financial assets whose period of maturity is up to one year.
It should be noted that money market does not deal in cash or
money as such but simply provides a market for credit instruments
such as bills of exchange, promissory notes, commercial paper,
treasury bills, etc. These financial instruments are close substitute
of money. These instruments help the business units, other
organisations and the Government to borrow the funds to meet
their short-term requirement. Money market does not imply to any
specific market place. Rather it refers to the whole networks of
financial institutions dealing in short-term funds, which provides an
outlet to lenders and a source of supply for such funds to
borrowers. Most of the money market transactions are taken place
on telephone, fax or Internet. The Indian money market consists of
Reserve Bank of India, Commercial banks, Co-operative banks,
and other specialized financial institutions. The Reserve Bank of
India is the leader of the money market in India. Some Non-
Banking Financial Companies (NBFCs) and financial institutions
like LIC, GIC, UTI, etc. also operate in the Indian money market.
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8.2 FEATURES OF THE MONEY MARKET

The following are the main features of a money market:-

1. It is a market only for short-term funds.

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. Transactions have to be conducted without the help of brokers.

5. It comprises of several sub-markets, each specializing in

particular type of financing e.g., call money market, acceptance
market, bill market etc.

6. The components of a money market are the central bank,

commercial banks, non-banking financial companies, discount
houses and acceptance houses. Commercial banks are playing
a dominant role in this market.

8.3 MONEY MARKET INSTRUMENTS

Following are some of the important money market instruments or

securities.

(a) Call Money: Call money is mainly used by the banks to meet
their temporary requirement of cash. They borrow and lend money
from each other normally on a daily basis. It is repayable on
demand and its maturity period varies in between one day to a
fortnight. The rate of interest paid on call money loan is known as
call rate.

(b) Treasury Bill: A treasury bill is a promissory note issued by the

RBI to meet the short-term requirement of funds. Treasury bills are
highly liquid instruments that mean, at any time the holder of
treasury bills can transfer of or get it discounted from RBI. These
bills are normally issued at a price less than their face value; and
redeemed at face value. So the difference between the issue price
and the face value of the treasury bill represents the interest on the
investment. These bills are secured instruments and are issued for
a period of not exceeding 364 days. Banks, Financial institutions
and corporations normally play major role in the Treasury bill
market
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(c) Commercial Paper: Commercial paper (CP) is a popular

instrument for financing working capital requirements of companies.
The CP is an unsecured instrument issued in the form of
promissory note. This instrument was introduced in 1990 to enable
the corporate borrowers to raise short-term funds. It can be issued
for period ranging from 15 days to one year. Commercial papers
are transferable by endorsement and delivery. The highly reputed
companies (Blue Chip companies) are the major player of
commercial paper market.

(d) Certificate of Deposit: Certificates Of Deposit (CDs) are short-

term instruments issued by Commercial Banks and Special
Financial Institutions (SFIs), which are freely transferable from one
party to another. The maturity period of CDs ranges from 91 days
to one year. These can be issued to individuals, co-operatives and
companies.

e) Trade Bill: Normally the traders buy goods from the wholesalers
or manufactures on credit. The sellers get payment after the end of
the credit period. But if any seller does not want to wait or in
immediate need of money he/she can draw a bill of exchange in
favour of the buyer. When buyer accepts the bill it becomes a
negotiable instrument and is termed as bill of exchange or trade bill.
This trade bill can now be discounted with a bank before its
maturity. On maturity the bank gets the payment from the drawee
i.e., the buyer of goods. When trade bills are accepted by
Commercial Banks it is known as Commercial Bills. So trade bill is
an instrument, which enables the drawer of the bill to get funds for
short period to meet the working capital needs.

Institutions of the Money Market:

The various financial institutions which deal in short term
loans in the money market are its members. They comprise the
following types of institutions:

1. Central Bank:

The central bank of the country is the pivot around which the
entire money market revolves. It acts as the guardian of the money
market and increases or decreases the supply of money and credit
in the interest of stability of the economy. It does not itself enter into
direct transactions. But controls the money market through
variations in the bank rate and open market operations.
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2. Commercial Banks:

Commercial banks also deal in short-term loans which they

lend to business and trade. They discount bills of exchange and
treasury bills, and lend against promissory notes and through
advances and overdrafts.

3. Non-bank Financial Intermediaries:

Besides the commercial banks, there are non-bank financial

intermediaries which lend short-term funds to borrowers in the
money market. Such financial intermediaries are savings banks,
investment houses, insurance companies, provident funds, and
other financial corporations.
4. Discount Houses and Bill Brokers:

In developed money markets, private companies operate

discount houses. The primary function of discount houses is to
discount bills on behalf of other. They, in turn, form the commercial
banks and acceptance houses. Along-with discount houses, there
are bill brokers in the money market who act as intermediaries
between borrowers and lenders by discounting bills of exchange at
a nominal commission. In underdeveloped money markets, only bill
brokers operate.
5. Acceptance Houses:

The institution of acceptance houses developed from the

bankers who transferred their headquarters to the London Money
Market in the 19th and the early 20 the century. They act as agents
between exporters and importers and between lender and borrower
traders. They accept bills drawn on merchants whose financial
standing is not known in order to make the bills negotiable in the
London Money Market. By accepting a trade bill they guarantee the
payment of bill at maturity. However, their importance has declined
because the commercial banks have undertaken the acceptance
business.

Functions of a Money Market:

A money market performs a number of functions in an economy.

1. Provides Funds: It provides short-term funds to the public and

private institutions needing such financing for their working capital
requirements. It is done by discounting trade bills through
commercial banks, discount houses, brokers and acceptance
houses. Thus the money market helps the development of
commerce, industry and trade within and outside the country.
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2. Use of Surplus Funds: It provides an opportunity to banks and

other institutions to use their surplus funds profitably for a short
period. These institutions include not only commercial banks and
other financial institutions but also large non-financial business
corporations, states and local governments.

3. No Need to Borrow from Banks: The existence of a developed

money market removes the necessity of borrowing by the
commercial banks from the central bank. If the former find their
reserves short of cash requirements they can call in some of their
loans from the money market. The commercial banks prefer to
recall their loans rather than borrow from the central banks at a
higher rate of interests.

4. Helps Government: The money market helps the government in

borrowing short-term funds at low interest rates on the basis of
treasury bills. On the other hand, if the government were to issue
paper money or borrow from the central bank. It would lead to
inflationary pressures in the economy.

5. Helps in Monetary Policy: A well developed money market

helps in the successful implementation of the monetary policies of
the central bank. It is through the money market that the central
banks are in a position to control the banking .system and thereby
influence commerce and industry.

6. Helps in Financial Mobility: By facilitating the transfer for funds

from one sector to another, the money market helps in financial
mobility. Mobility in the flow of funds is essential for the
development of commerce and industry in an economy.

7. Promotes Liquidity and Safety: One of the important functions

of the money market is that it promotes liquidity and safety of
financial assets. It thus encourages savings and investments.

8. Equilibrium between Demand and Supply of Funds: The

money market brings equilibrium between the demand and supply
of loan able funds. This it does by allocating saving into investment
channels. In this way, it also helps in rational allocation of
resources.

9. Economy in Use of Cash: As the money market deals in near-

money assets and not money proper, it helps in economizing the
use of cash. It thus provides a convenient and safe way of
transferring funds from one place to another, thereby immensely
helping commerce and industry.