Introduction: Financial markets are places for trading financial instruments. There are two types of financial markets: money market and capital market.
• Capital market is the place where securities issued by corporations and governments are traded.
• Money market is where the short-term liquidity needs of companies and governments are met using money market instruments. Almost all financial institutions trade in money market instruments.
What is Money Market
According to the Reserve Bank of India (RBI), the money market is “the center of transactions of primarily short-term character in money assets; it meets the short-term needs of borrowers and provides liquidity or cash to lenders.
This is where short-term surplus investable money, at the disposal of financial and other institutions and individuals, is bid by borrowers, which again includes institutions and the government. The money market is the market for short-term borrowing and money lending. for a period of less than one year.
The money market facilitates quick transactions of large volumes between trading corporations, government agencies, banks, etc. in the short term. Example – A company has cash balances far in excess of its transaction requirements. It can invest it in the money market for a short period and withdraw it when required.
The participants in the money market are financial intermediaries such as currency brokers, large trading corporates, commercial banks, and the RBI. RBI plays an important role in the Indian money market. It modifies the liquidity of financial institutions, affecting market availability and the cost of money.
Some of the features of the Indian money market are:
- It is a market for instruments with a maturity of less than 1 year.
- Interest rates are based on the demand and supply of money.
- The parties mutually agree on the tenure, rate, and terms.
- The operation of the money market is controlled by RBI.
- The players in the money market are commercial banks, private firms, and the government.
What are the objectives of the money market?
The money market serves these purposes:
• Maintain a balance between the demand and supply of short-term funds.
• Act as a facilitator for RBI’s intervention to regulate liquidity in the economy.
• Provide access to users of short-term funds to borrow and invest at effective market prices.
What is an Organized and Unorganized Money Market
The organized money market in India includes RBI, nationalized, scheduled, and non-scheduled commercial banks, and foreign banks. RBI controls the entire banking sector in India.
Non-Banking Financial Institutions such as Life Insurance Corporation (LIC), General Insurance Corporation (GIC) and its subsidiaries, and Unit Trust of India (UTI) operate indirectly through banks in the market. The surplus funds of semi-government and other large organizations are also routed through banks.
The unorganized money market includes unregulated financial intermediaries, indigenous bankers, and private moneylenders. People who borrow in this market include non-corporate and corporate small businesses.
What is Call Money Market
A specific segment of the money market is the call money market. The call money market is a short-term market where financial institutions borrow and lend money. It is also known as the interbank call money market because banks are the major participants.
Day-to-day trading of surplus funds is done in the call money market. The maturity of loans in this market varies between a day and a fortnight. The loan is repaid on demand from the borrower or the lender. Loans in this market often help banks to meet RBI’s reserve requirements.
The features of the Call Money Market are as follows:
- It is a market for short-term funds, also known as money on demand.
- It is highly liquid as funds are repayable on demand.
- It is a sensitive segment of the financial system.
- Changes in the demand and supply of short-term funds are quickly reflected in the financial system.
In India, call loans are unsecured. The demand rate, or the rates of interest paid on a demand loan, is subject to seasonal fluctuations in demand. Intra-day volatility in call rates is also huge and rates may vary from hour to hour.
What is a money market instrument?
In this section, we will discuss the tools with which to operate in the money market.
A plethora of money market instruments take care of the short-term needs of the borrowers and provide the required liquidity to the lenders. We will review the following well-known devices:
1. Treasury bill
2. Commercial paper
3. Certificate of deposits
4. Bills of exchange
5. Repo and Reverse Repo
1. Treasury Bill (T-Bill)
A T-bill is a promissory note issued by the RBI on behalf of the Government of India at a discounted price to meet its short-term requirements. T-bills are highly liquid as they are guaranteed by the central government and can be used as claims against the government without requiring any approval or endorsement.
T-bills are issued in 4 tenures: 14 days, 91 days, 82 days, and 364 days through auction. The auction amounts and dates are announced by the Reserve Bank of India from time to time. Organizations such as the Provident Fund, state-run pension funds, and state governments are allowed to participate in the auction, but not bid. RBI invites bids every fortnight and fixes the cut-off rate on the bids.
T-bill discount rate fluctuations are very low and so are transaction costs.
While T-bills are a good option to reflect the risk-free rate of return, corporate houses prefer the 10-year government bond rate as the benchmark for risk-free returns when calculating their cost of capital cap. . This is because 10-year government bond rates, duly adjusted for the currency of the issue and the economic record of the respective government, reflect a risk-free rate of return better than T-bills.
2. Commercial Paper (CP)
Commercial Paper (CP) was first introduced in India in January 1990. It is a short-term unsecured promissory note issued by large corporations in bearer form at a discount to face value. It meets the short-term requirement of funds of corporations. The maturity period ranges from 7 days to a year. Negotiable by CP approval and delivery. They are highly liquid because they are bought back.
CPs are issued in denominations of ₹ 5 lakh or multiples. CPs are generally issued through banks, dealers, or brokers and are sometimes purchased directly and mostly by commercial banks, non-banking finance companies (NBFCs), and other corporates. CPs issued in international financial markets are known as Euro-commercial papers.
Salient Features of Commercial Paper (CP):
- CP is an unsecured promissory note.
- CPs can be issued for maturities ranging from 7 days to one year.
- CP is issued in the denomination of 5 lakhs. The minimum size of an issue is 25 lakhs.
- The issue size of the CP should not exceed the working capital of the issuing company.
- Investors in the CP market are Banks, NBFCs, Corporates in India, and High Net Worth Individuals (HNIs).
- The interest rate of CP depends on the rates prevailing in the CP market, Forex market, and Call money market.
- RBI Circular RBI/2011-12/89 IDMD.PCD. Updated on 4/14.01.02/2011-12 Regulations include Issuance of commercial paper.
Advantages of Commercial Paper (CP)
- Negotiable by approval and delivery
- Higher returns than risk-free investments
- High security and liquidity – CPs are considered to be one of the highest-quality investments available in the private sector
- The flexible instrument that can be issued with different maturities
CP is a close competitor of T-Bills, but T-Bills have an edge because they are risk-free and more liquid.
3. Certificate of Deposit (CD)
Certificate of Deposit (CD) is a short-term instrument issued by scheduled commercial banks and financial institutions. It is a certificate issued for a deposit amount in a bank at a specified rate of interest for a specified period. The concerned bank issues a receipt that is both marketable and transferable by the holder. Receipts are in bearer form and are transferable by endorsement and delivery.
Basically, they are part of bank deposits; Hence they have less risk associated with repayment. CDs are interest-bearing, maturity-dated obligations of banks. CDs benefit both the banker and the investor. Bankers do not have to worry about premature encashment of the deposit because the investor can sell the CD in the secondary market if he needs the cash.
CDs can be issued only by scheduled banks. It is issued at a discount from the face value. The discount rate depends on the market conditions. CDs are issued in multiples of ₹ 1 lakh and the minimum issue size is ₹ 1 lakh. The maturity period ranges from 7 days to a year. There is no restriction on the discount rate and the bank is free to decide its own rate.
Features of Certificate of Deposit (CD) in the Indian Market
• Scheduled commercial banks are eligible to issue CDs
• Maturity period is from 7 days to one year
• Banks are not allowed to buy back their CDs before maturity or give loans against CDs
• CDs are subject to CRR and Statutory Liquidity Ratio (SLR) requirements
• They are freely transferable by endorsement and delivery. They have no lock-in period.
• CDs have to bear the stamp duty at the rate prevailing in the markets
• NRIs can subscribe to CDs on a repatriation basis
4. Bill of Exchange
A bill of exchange is a financial instrument that is traded in the bill market. According to the Indian Negotiable Instruments Act, of 1881, “It is a written instrument containing an unconditional order, signed by the manufacturer, directing the payment of a certain sum of money to a certain person, or to the holder of the instrument.” on order”.
Bills of exchange are drawn on the buyer by the seller for the value of the goods or services offered by the seller. Therefore they are trade bills. They are negotiable instruments that are freely transferable by endorsement and distribution and are accepted by banks. The liquidity of bills of exchange is only for calling loans and T-bills.
Types of bills of exchange
Broadly speaking, there are two types of bills of exchange: documentary bills and Accommodation bills.
1. Documentary bills of exchange: These bills are accompanied by documents relating to goods such as bill of loading, railway receipt, or bill of lading; of or relating to the performance of the Services. There are several types of documentary bills:
- Demand Bills and Term Bills – Demand Bills are to be paid promptly on demand and there is no waiting period. A term bill is a bill of exchange drawn for a specified period and becomes payable at the end of the specified time.
• Inland Bill – It is drawn in India on a person resident in India and must be payable in India.
• Foreign Bill – It is taken out of India in favor of a person resident outside India or outside India. They are payable both inside and outside India.
• Bill of Supply – This is a bill made by the supplier to receive advance payment for the goods supplied to the Government or Semi-Government.
2. Accommodation Bill: A housing bill is a bill of exchange that is accepted and sometimes endorsed without the backing of any trade in the delivery of goods or services. The bill is created on the basis of a fictitious transaction and is only an ‘accommodation’ for the person in need of money.
Huge amounts of housing bills were a booming business a few decades ago, but have been effectively stopped by regulations prohibiting this.
5. Repo and Reverse Repo
Repo and its structure: Repo is the short form of Repurchase. Repo is a money market instrument. It is a transaction in which one person (seller) sells securities to another (buyer) with an agreement to repurchase them at a specified date and interest rate. The transaction is a repo from the seller’s point of view. Collateralized short-term borrowing or lending enables the sale or purchase of repo debt instruments. The maturity period of the repo ranges from 1 day to one year.
The important features of the repo are:
• Repo has low credit risk as it has collateral and a subsidiary Common Ledger (SGL) mechanism.
• The interest rate risk is low as the lending period is short.
• Low liquidity risk as sellers have surplus funds.
• Settlement risk is small as all transactions are settled through the SGL system and Public Debt Office in RBI.
Reverse repo and its structure
A reverse repo is a cash transaction in which the lender buys a property from the borrower as a guarantee of repaying the loan at an agreed rate of interest on a specified date. It is a transaction similar to repo but from the lender’s point of view. In other words, it is a repo transaction for the borrower, but the same transaction is a reverse repo for the lender.
Repo and reverse repo are used for the following reasons:
• To meet the cash crunch
• To increase the return on money held
What are the Rules and Regulations of the Money Market
The regulatory bodies of financial markets in India are the RBI for the money market and the Securities and Exchange Board of India (SEBI) for capital markets. The money market comes under the direct purview of RBI.
Regulation of the money market is essential for effectively preventing liquidity mismatches in the system and for transmitting policy changes to other parts of the financial system. The continued availability of liquidity helped in handling the stress levels in the market segments.
Their aim was to improve transparency, expand markets, and promote liquidity. Some of the regulatory measures of RBI are as follows:
1. Reporting Platform for CDs and CPs – RBI introduced a reporting platform for CDs and CPs to promote the secondary market. The reporting platform is powered by the Fixed Income Money Market and Derivatives Association of India (FIMMDA).
It spreads the secondary market transactions in CDs and CPs. RBI has directed all its regulated entities to report their over-the-counter (OTC) trades in CDs and CPs to FIMMDA. Other regulators such as SEBI and Insurance Regulatory and Development Authority (IRDA) have also been advised to regulate their CP/CDs in their trading entities on this platform.
2. Repo in Corporate Bonds – RBI has accepted Repo in Corporate Bonds to develop the Corporate Bond Market. All repo trades in the corporate bond market are reported to the FIMMDA reporting platform for dissemination of price/yield information to market participants.
In the case of OTC trades in the corporate bond market, the repo trades in corporate bonds will be settled through the mechanism available. Only listed corporate debt securities, rated ‘AA’ and above, are eligible for repo transactions.
Repo trading transactions in corporate debt securities will be treated as lending/lending transactions. Participants entering into the repo in corporate bonds are required to sign the Global Master Repo Agreement (GMRA) finalized by FIMMDA.
3. Revised Guidelines for Accounting of Repo/Reverse Repo Transactions – The revised guidelines were issued on March 24, 2010, and came into force on April 1, 2010. They need to report the repo/reverse repo transactions as outright sales and purchases. Current market convention. Movements should be reported in the books of counterparties by showing similar contrasting entries for greater transparency.
4. Regulation of Non-convertible Debentures (NCDs) of maturity up to one year – RBI on June 23, 2006, issued directions under Section 45W of the RBI (Amendment) Act, which seeks to reduce the regulatory gap existing in the issuance of NCDs to maturity. was to be removed. Up to one year through private placement.
As per the instructions, which are applicable for secured and unsecured NCDs, NCDs cannot be issued for maturities of less than 90 days, and options that are exercisable within 90 days from the date of issue cannot be modified can go.
Issuers of NCDs have to appoint a debenture trustee and each issue must be reported to RBI. While issuing CPs, NCDs have been prescribed for eligibility criteria, rating requirements, etc.
- The financial market is a place to trade in financial instruments. The money market and capital market are two types of financial markets.
- The money market helps in meeting the short-term liquidity needs of the government and large companies.
- Money market instruments take care of the short-term needs of the borrowers and provide the necessary liquidity to the lenders. Types of money market instruments are Treasury bills, commercial paper, certificates of deposit, bills of exchange, repo, and reverse repo.