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Detailed Guide To Money Market Instruments – Purpose & Reforms In Indian Market

What do we mean by money market instruments?

Financial tools known as money market instruments assist businesses, organizations, and governmental entities in raising short-term loans for their requirements. The lenders profit from interest rates and liquidity while the borrowers affordably cover their short-term demands. Bonds, Treasury bills, CDs, commercial paper, etc. are examples of money market instruments.

What are the potential benefits and shortcomings of money market instruments?

Benefits of investing in money market instruments

Comparatively speaking, money market instruments provide greater liquidity than other fixed-income securities. Investors may sell their assets at any moment because there is no lock-in period. Furthermore, compared to interest on savings accounts, the rate of profit on a money market instrument is a bit higher.

Disadvantages of investing in money market instruments

Without a doubt, the interest rate in money market instruments is larger than that of savings accounts. The rising rate of inflation in the economy, however, is not justified by the interest rate provided by the same. On the other hand, mutual funds and other investment vehicles provide a better long-term return on investment. Therefore, money market instruments are not the best option if the investing goal is to achieve capital growth with returns that beat inflation.

Money market instruments provide better returns than saving bank accounts.

What are the characteristics of money market instruments?

The following are the characteristics of money market instruments:

  • Since it is a financial market, its location is amorphous.
  • It serves as a market for factors like working capital needs that are short-term financial needs.
  • Commercial banks, the Reserve Bank of India (RBI), and other financial organizations like LIC, among others, are its main participants.
  • Commercial banks, the Reserve Bank of India (RBI), and other financial organizations like LIC, among others, are its main participants. 
  • Call money, treasury bills, and commercial papers are the basic money market instruments.
  • Money market instruments have a maturity of less than one year and that is why it is exceptionally liquid.
  • Most products used in the money market offer fixed returns.

Different types of money market instruments available in India

Here is a list of money market instruments available in India:

Treasury Bills

One of the most common financial products in the money market is Treasury Bills. Depending on their short-term maturity, they have different characteristics. It is offered at a discount by the Indian government for 14 to 364 days.

At the time of maturity, these securities are returned in full after being issued at a markdown price. An individual, business, or organization can also buy TBs. Furthermore, they are distributed in lots of Rs. 25,000 for 14 days, Rs. 91 days, and Rs. 1,000,000 for 364 days.

Repurchase agreements (Repo)

Repo or reverse repo are two popular names for repurchase agreements. These are sales contracts that obligate the person selling the securities to eventually repurchase it from the buyer. A rate of interest, known as the repo rate is also included in the purchase price. Repos are useful instruments for raising quick cash for the seller and giving the buyer a reasonable rate of return on their investment.

Call Money

It is a component of the market where regularly scheduled commercial banks make last-minute loans or borrowings (for example, a period of 14 days). This is to control daily cash flows. Since the market determines interest rates, supply and demand have a significant impact on them. Additionally, it has been demonstrated that interest rates can change significantly at particular times.

If you want to invest your money for a short period of time then money market instruments are ideal investment options for you.

Certificate of Deposit

Commercial banks will take certificates of deposit (CDs), which are negotiable term deposits. It is often given out via a promissory note. CDs may be given out to people, businesses, trusts, etc. Additionally, any scheduled commercial bank can offer the CDs at a discount. They can also last anywhere from three months to a year. A financial institution may issue the same for a minimum of one year and a maximum of three years.

Banker’s Acceptance (BA)

A financial instrument made under the bank’s name is used by some organizations and individuals. These financial instruments are referred to as Banker’s Acceptance. The entity or organization issuing the instrument is required to pay its owner the specified sum within a window of 30 to 180 days. The difference between the issue price and the sale price is the investor’s profit.

Commercial Paper

To address the need for short-term operating capital, corporations issue CPs. Therefore, it acts as a substitute for bank loans. Additionally, commercial paper can be used for a duration of 15 days to 1 year. The Reserve Bank of India establishes the regulations for the issuing of CPs. As a result, in order to issue a CP in the market, a corporation needs RBI’s prior clearance. CP must also be distributed at a discount from face value. The discount rate is also determined by the market.

Specifications of the CP and denomination: The minimum size is Rs. 25 lakhs whereas  100% of the issuer’s operating capital is the maximum size.

Commercial Bills

The money market instrument known as commercial bill functions more like a bill of exchange. They are issued by businesses to cover their short-term cash needs. These financial products offer substantially better liquidity. In the event of an emergency need for cash, the same might be transferred from one person to another.

Features of money market instruments

  • It can be referred to as a collection of markets and liquidity is its key quality. All of the submarkets, including call money, notice money, and others, are closely related to one another. This facilitates the transfer of capital from one submarket to another.
  • A large number of assets are exchanged on a daily basis.
  • It helps borrowers meet their short-term financial demands. Additionally, it deals with assets having maturities of one year or less.
  • It continues to change. It’s always possible to include new instruments.

To conclude

If you have a significant amount of cash laying around and don’t plan to use it for some time then you should consider investing in money market instruments. Not only will you receive a better return on investing in comparison to saving accounts you will receive a fixed return which is a far better option.