MONEY MARKET INSTRUMENTS

OVERVIEW OF FINANCIAL MARKETS

FINANCIAL MARKET

MONEY MARKET

DEBT MARKET

FOREX MARKET

CAPTAL MARKET

Money Market
Money Market is the centre for dealings, mainly short term character, in money assets. It meets the short term requirements of the borrowers & provides liquidity or cash to the lenders. Money Market refers to the market for short term assets that are close substitutes of money, usually with maturities of less than a year. Money market means market where money or its equivalent can be traded. Money Market is a wholesale market of short term debt instrument and is synonym of liquidity As per RBI definitions A market for short terms financial assets that are close substitute for money, facilitates the exchange of money in primary and secondary market. Money Market is part of financial market where instruments with high liquidity and very short term maturities i.e. one or less than one year are traded. Due to highly liquid nature of securities and their short term maturities, money market is treated as a safe place. Hence, money market is a market where short term obligations such as treasury bills, call/notice money, certificate of deposits, commercial papers and repos are bought and sold.

The money market is the global financial market for short-term borrowing and lending. It provides short-term liquid funding for the Global Financial System (GFS). In finance, the money market is the global financial market for short-term borrowing and lending. It provides short-term liquidity funding for the global financial system. The money market is where short-term obligations such as Treasury bills, commercial paper and bankers' acceptances are bought and sold.

Objective of Money Market

To provide a reasonable access to users of short-term funds to meet their requirement quickly, adequately at reasonable cost

To provide a parking place to employ short term surplus funds To enable the central bank to influence and regulate liquidity in the economy through its intervention in this market

Features/ Characteristics of Money MarketEvery money is unique in nature. The money market in developed and developing countries differ markedly from each other in many senses. Indian money market is not an exception for this. Though it is not a developed money market, it is a leading money market among the developing countries. Indian Money Market has the following major characteristics :1. Dichotomic Structure : It is a significant aspect of the Indian money market. It has a simultaneous existence of both the organized money market as well as unorganised money markets. The organized money market consists of RBI, all scheduled commercial banks and other recognized financial institutions. However, the unorganized part of the money market comprises domestic money lenders, indigenous bankers, trader, etc. The organized money market is in full control of the RBI. However, unorganized money market remains outside the RBI control. Thus both the organized and unorganized money market exists simultaneously. 2. Seasonality : The demand for money in Indian money market is of a seasonal nature. India being an agriculture predominant economy, the demand for money is generated from the agricultural operations. During the busy season i.e. between October and April more agricultural activities takes place leading to a higher demand for money. 3. Multiplicity of Interest Rates : In Indian money market, we have many levels of interest rates. They differ from bank to bank from period to period and even from borrower to

borrower. Again in both organized and unorganized segment the interest rates differs. Thus there is an existence of many rates of interest in the Indian money market. 4. Lack of Organized Bill Market : In the Indian money market, the organized bill market is not prevalent. Though the RBI tried to introduce the Bill Market Scheme (1952) and then New Bill Market Scheme in 1970, still there is no properly organized bill market in India. 5. Absence of Integration : This is a very important feature of the Indian money market. At the same time it is divided among several segments or sections which are loosely connected with each other. There is a lack of coordination among these different components of the money market. RBI has full control over the components in the organized segment but it cannot control the components in the unorganized segment. 6. High Volatility in Call Money Market : The call money market is a market for very short term money. Here money is demanded at the call rate. Basically the demand for call money comes from the commercial banks. Institutions such as the GIC, LIC, etc suffer huge fluctuations and thus it has remained highly volatile.

7. Limited Instruments : It is in fact a defect of the Indian money market. In our money
market the supply of various instruments such as the Treasury Bills, Commercial Bills, Certificate of Deposits, Commercial Papers, etc. is very limited. In order to meet the varied requirements of borrowers and lenders, It is necessary to develop numerous instruments.

Functions / Importance of Money Market

A well-developed money market is essential for a modern economy. Though, historically, money market has developed as a result of industrial and commercial progress, it also has important role to play in the process of industrialization and economic development of a country. Importance of a developed money market and its various functions are discussed below: 1. Financing Trade: Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade. 2. Financing Industry: Money market contributes to the growth of industries in two ways: (a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc.

(b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market. 3. Profitable Investment: Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity. 4. Self-Sufficiency of Commercial Bank: Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market. 5. Help to Central Bank: Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank. Money market helps the central bank in two ways: (a) The short-run interest rates of the money market serves as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy, (b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy

Common Money Market Instruments (the one in red are explained by us)
Commercial paper Certificate of Deposit

Bankers Acceptance Treasury bills Repurchase Agreement

Commercial PaperHistory
Commercial paper, in the form of promissory notes issued by corporations, has existed since at least the 19th century. For instance, Marcus Goldman, founder of Goldman Sachs, got his start trading commercial paper in New York in 1869.

Definition
An unsecured obligation issued by a corporation or bank to finance its short-term credit needs, such as accounts receivable and inventory. Maturities typically range from 2 to 270 days. Commercial paper is available in a wide range of denominations, can be either discounted or interest-bearing, and usually have a limited or nonexistent secondary market. Commercial paper is usually issued by companies with high credit ratings, meaning that the investment is almost always relatively low risk. Commercial paper is an unsecured and discounted promissory note issued to finance the shortterm credit needs of large institutional buyers. Banks, corporations and foreign governments commonly use this type of funding. An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates. Commercial Paper is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. Commercial Papers have higher denominations as compared to the Treasury Bills and the Certificate of Deposit. The maturity period of Commercial Papers is a maximum of 9 months. They are very safe since the financial situation of the corporation can be anticipated over a few months.

The characteristics of commercial paper

Unsecured debt Bearer or depository trust company eligible. A depository trust company is a firm through which the members can use a computer to arrange for investment securities to be delivered to other members via computer, thus there is no physical delivery of the securities. A depository trust company uses computerized debit and credit entries. Discount (most common). A discount is the difference between the purchase price of a security and its par (face) value. This discount represents the income to be earned on the security, and will be accreted over the life of the security. Purchased direct or through dealers.

Eligibility for issue of CP Highly rated corporate borrowers, primary dealers (PDs) and satellite dealers (SDs) and
all-India financial institutions (FIs) The tangible net worth-not less than Rs.4 crore; the working capital (fund-based) limit-not less than Rs.4 crore & borrowal account- classified as a Standard Asset by the financing banks.

Types of CP Direct Papers :Issued directly by company to investors without any intermediary.

Dealer Papers :Issued by a dealer or merchant banker on behalf of a client.

Rating Requirement
All eligible participants should obtain the credit rating for issuance of CP through the following- Credit Rating Information Services Of India Ltd. (CRISIL) Investment Information & Credit Rating Agency of India Ltd. (ICRA) Credit Analysis & Research Ltd. (CARE) DCR India The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies

To whom issued

CP is issued to and held by individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs). Denomination: min. of 5 lakhs and multiple thereof. Maturity: min. of 7 days and amaximum of upto one year from the date of issue

Maturity
Issued for maturities between a minimum of 30 days and a maximum upto one year from the date of issue. If the maturity date is a holiday, the company would be liable to make payment on the immediate preceding working day.

Formula for calculation of discounted price of a commercial paper is,

Price = Face Value/ [1 + yield x (no. of days to maturity/365)] Yield = (Face value Price)/ (price x no of days to maturity) X 365 X 100

Credit Risk: Moderate to high. The ratings of the company issuing the commercial paper
should be monitored; i.e., A-1/P-1.

Liquidity Risk: Moderate. If a company has credit problems it may receive a negative credit
watch, which will lead to a rating being downgraded. Commercial paper also may be somewhat difficult to sell.

Market Risk: Moderate, due to the short-term nature of this security. The advantages of investing in commercial paper are:
Cheaper source of funds than limits set by banks. Optimal combination of liquidity return. Highly liquid instrument. Transferable by endorsement & delivery. Backed by liquidity & earnings of issuer. Issued for a minimum period of 30 days and a maximum up to one year Issued at a discount to face value Issued in demat form. (Compulsory demat from July '01). To obtain cash with which to take advantage of cash discounts offered by trade creditors To establish national credit To keep a reserve of borrowing power at local banks

To borrow at cheaper rates than is possible at your local banks To establish a broader market for the paper than is possible locally local savers may provide less costly funds; an important habit among clients and the public is rewarded lower interest loans provide experience for MFI in borrowed funds local banks become familiar with MSE (micro and small enterprise) potentials access to larger sums more quickly based on track record allows longer term projections than grants provides a discipline similar to that of MSE clients

Disadvantages:
1. 2. 3. 4. 5. 6. 7. 8. higher financial costs force organizational decisions and changes substantial initial collateral requirements more risky as debt holders can force closure of MFI more tricky cash flow management as principal is repaid early negotiations require a new set of skills and contacts local banks may not be willing to be cooperative loans may be dollarized in an inflationary situation too many subsidized loans can retard move to market rate

Certificate of DepositsHistory of certificate of deposit

CDs are negotiable money market instruments and are issued in dematerialised form or a usance promissory note, for funds deposited at a bank or other eligible financial institution for a specified time period. They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable instruments and are often referred to as Negotiable Certificate of Deposits. While certificates of deposits, otherwise known as CDs or time certificates, have been around since the early periods of banking, as legislation was passed to create a national system of financial reserves, the CD became more popular among those seeking long-term earnings on their money. Banks can only loan money that they have under assets. In order to keep assets under management to loan out for a higher rate of return, banks began to use certificates of deposits to entice customers to leave their money in the bank for long durations of time. The interest paid is the cost of being able to loan the money out. It wasn't until 1961 that a fixed rate time certificate was established.

A Certificate of Deposit, or CD, is a relatively low-risk debt instrument purchased directly through a commercial bank or savings and loan institution. The certificate indicates that the investor has deposited a sum of money for specified period of time and at a specified rate of interest. CD rates, terms and dollar amounts will vary from institution to institution. CDs are not publicly traded securities. As such, you will not find them traded on any exchange. The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.

Definition
Receipt from a bank acknowledging the deposit of a sum of money. The most common type, the time certificate of deposit, is for a fixed-term interest-bearing deposit in a large denomination. It consequently pays higher interest than a savings account, though the investor who withdraws money before its maturity date is subject to a penalty. Introduced in the early 1960s, CDs have become a popular method of saving. A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty.

The characteristics of CD
CDs can be issued by all scheduled commercial banks except RRBs (ii) selected all India financial institutions, permitted by RBI Minimum period 15 days Maximum period 1 year Minimum Amount Rs 1 lac and in multiples of Rs. 1 lac CDs are transferable by endorsement CRR & SLR are to be maintained CDs are to be stamped CDs may be issued at discount on face value Interest calculations are mostly based upon a standard 360 days in a year called actual/360 but some are actual/365 Investment is dependent solely upon the credit worthiness of the bank deposits

Credit Risk: High. The investor should monitor the financial condition of the bank.

Liquidity Risk: High. CDs cannot be liquidated without paying penalty. Market Risk: Moderate. Monitor collateral value and require adequate margins. Advantages of Certificate of Deposit as a money market instrument
1. Since one can know the returns from before, the certificates of deposits are considered much safe. 2. One can earn more as compared to depositing money in savings account. 3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.

Disadvantages of Certificate of deposit as a money market instrument:

1. As compared to other investments the returns is less. 2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity. 3. Investors can redeem bank-issued CDs prior to maturity. However, you will typically be charged an early withdrawal penalty. These penalties are set by each bank and differ nationwide.

4. Unlike Treasury notes, the interest on CDs is not exempt from state and local taxes. CDs are fully taxable at the state, local and federal levels. 5. The investment is locked in at a specific rate, even if interest rates increase.

Banker's Acceptance It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the Secondary market. It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the Secondary market. The banker's acceptance is mostly used to finance exports, imports and other transactions in goods. The banker's acceptance need not be held till the maturity date but the holder has the option to sell it off in the secondary market whenever he finds it suitable.

A bankers acceptance is a money market instrument which is used to finance import or export transactions. Bankers acceptances are essentially checks. They represent a banks promise and ability to pay the face or principal amount on the bankers acceptance on the stipulated maturity date.

The characteristics of bankers acceptances

Trades at a discount Prime bankers acceptances are shorter maturities

Credit Risk: Moderate to high. Ratings banks issuing the bankers acceptance should be
monitored. The short term obligations of the bank must be rated not less than A1/P1.

Liquidity Risk: Moderate. Monitor credit and stability of bank. A bankers acceptance may be
somewhat difficult to sell.

Market Risk: Low to moderate, due to the short-term nature of this security. Advantages of Bankers acceptances
Higher yield, specific maturity dates are chosen by the purchaser within a range of 180 days.

Disadvantages of bankers acceptance

Reduced liquidity. The lack of active secondary market reduces the liquidity of commercial paper, there also may be other associated market pricing difficulties.

Players of Money market

Reserve Bank of India SBI DFHI Ltd (Amalgamation in 2004) Acceptance Houses Commercial Banks, Co-operative Banks and Primary Dealers are allowed to borrow and lend.

Specified All-India Financial Institutions, Mutual Funds, and certain specified entities are allowed to access to Call/Notice money market only as lenders Individuals, firms, companies, corporate bodies, trusts and institutions can purchase the treasury bills, CPs and CDs.

Structure of Indian Money Market

I :- ORGANISED STRUCTURE 1. Reserve bank of India. 2. DFHI (Discount and Finance House of India). 3. Commercial banks i. Public sector banks SBI with 7 subsidiaries Cooperative banks 20 nationalized banks ii. Private banks Indian Banks Foreign banks 4. Development bank IDBI, IFCI, ICICI, NABARD, LIC, GIC, UTI etc. II. UNORGANISED SECTOR 1. Indigenous banks 2 Money lenders 3. Chits 4. Nidhis III. CO-OPERATIVE SECTOR 1. State cooperative Central cooperative banks Primary Agri credit societies Primary urban banks 2. State Land development banks Central land development banks Primary land development banks

Demerits
Though the Indian money market is considered as the advanced money market among developing countries, it still suffers from many drawbacks or defects. These defects limit the efficiency of our market. Some of the important drawbacks of Indian Money Market are :1. Absence of Integration : The Indian money market is broadly divided into the Organized and Unorganized Sectors. The former comprises the legal financial institutions backed by the RBI. The unorganized statement of it includes various institutions such as indigenous bankers, village money lenders, traders, etc. There is lack of proper integration between these two segments. 2. Multiple rate of interest : In the Indian money market, especially the banks, there exists too many rates of interests. These rates vary for lending, borrowing, government activities, etc. Many rates of interests create confusion among the investors. 3. Insufficient Funds or Resources : The Indian economy with its seasonal structure faces frequent shortage of financial recourse. Lower income, lower savings, and lack of banking habits among people are some of the reasons for it. 4. Shortage of Investment Instruments : In the Indian money market, various investment instruments such as Treasury Bills, Commercial Bills, Certificate of Deposits, Commercial Papers, etc. are used. But taking into account the size of the population and market these instruments are inadequate. 5. Shortage of Commercial Bill : In India, as many banks keep large funds for liquidity purpose, the use of the commercial bills is very limited. Similarly since a large number of transactions are preferred in the cash form the scope for commercial bills are limited. 6. Lack of Organized Banking System : In India even through we have a big network of commercial banks, still the banking system suffers from major weaknesses such as the NPA, huge losses, poor efficiency. The absence of the organized banking system is major problem for Indian money market. 7. Less number of Dealers : There are poor number of dealers in the short-term assets who can act as mediators between the government and the banking system. The less number of dealers leads tc the slow contact between the end lender and end borrowers.

Difference of Money Market(Explanation of Money Market) Basically the capital market is a type of financial market, it includes the stocks and bonds market as well. But in general the capital market is the market for securities where either companies or the government can raise long term funds. One way that the companies or the government raise these long term funds is through issuing bonds, which is where a person buys the bond for a set price and allows the government or company to borrow their money for a certain time period but they are promised a higher return for allowing them to borrow the money, the higher return is paid through interest that accrues on the money that the government or company borrows. Another way that the companies or government can raise money in the capital market is through the stock market, most of the time you don't see the government as a part of the stock market, but it can actually happen so we need to include them. But how the stock market works is that the companies decide to sell shares of their stock, which is basically ownership in the company, to ordinary people and other companies, as a way to raise money. The people who buy the stock are usually given dividends each year, if the company has agreed to pay out dividends, so that is another possible return on their investment. The capital market actually consists of two markets. The first market is the primary market and it is where new issues are distributed to investors, and the secondary market where existing securities are traded. Both of these markets are regulated so that fraud does not occur and in the United States the U.S. Securities and Exchange Commission is in charge of regulating the capital market.

What is the difference?

Basically the difference between the capital markets and money markets is that capital markets are for long term investments, companies are selling stocks and bonds in order to borrow money from their investors to improve their company or to purchase assets. Whereas money markets are more of a short term borrowing or lending market where banks borrow and lend between each other, as well as finance companies and everything that is borrowed is usually paid back within thirteen months.

Another difference between the two markets is what is being used to do the borrowing or lending. In the capital markets the most common thing used is stocks and bonds, whereas with the money markets the most common things used are commercial paper and certificates of deposits.