Explain the various Money Market Instruments.
Explain the various Money Market Instruments.
Money Market refers to the market where short term funds are traded. Herein, short term funds are in the form of monetary assets having a maturity period of maximum one year. The following are some of the common money market instruments.
(i) Treasury Bil (T-Bills)
Treasury Bill refers to a promissory note used for short term borrowing by the government. They are the most commonly used money market instrument. They are auctioned and issued by the Reserve Bank of India on behalf of the Central Government. T-bills are available for a minimum of Rs 25,000 and in multiples thereof. Generally, three types of treasury bills are issued 91-days, 182-days and 364-days. T-Bills are issued at a discount and redeemed at par. That is, they are issued at a price lower than their face value and at the time of redemption, the investor gets the amount equal to the face value. The difference between the value at which they are issued and the redemption value is the interest received on them. For example, if an investor purchases a 182-days treasury bill with a face value of Rs 56,000 for Rs 50,000. At the time of maturity, the investor will receive Rs 56,000. Thus, the difference of Rs 6,000 (56,000 − 50,000) is the interest receivable on the bill. T-Bills are also called Zero-Coupon Bonds. T-bills are highly liquid bonds. Moreover, as they are issued by the RBI, they have negligible risk and offer assured return.
(ii) Call Money
Call money is an instrument used for interbank transactions. Through call money, the banks borrow from each other to meet any shortage of funds required to maintain CRR. That is, any bank in shortage of funds borrows from other bank having surplus funds. Call money have a very short maturity period ranging from one day to fifteen days. Interest paid on such loans is known as call rate. Call rate is highly volatile and varies from day to day. There exists a negative relationship between call rate and other money market instruments such as Commercial Papers and Certificate of Deposits. That is, as the call rate rise, other instruments of money market become cheaper and their demand increases.
(iii) Commercial Paper (CPs)
Commercial paper is an unsecured short term money market instrument. It is a negotiable and transferable promissory note with a maturity period ranging from a minimum of 15-days to a maximum of one year. They were introduced in India in 1990. CPs are mainly issued by large and creditworthy companies to raise short-term funds. Large companies view Commercial Papers as an alternative to bank borrowings and borrowings through capital market. The rate of interest payable on Commercial Papers is lower than the market rates. Generally, companies use Commercial Papers for bridge financing. That is, to raise the funds required to meet the floatation cost incurred on long term borrowings in the capital market. For example, if a company wishes to raise finance from the capital market to purchase land. For this, it will have to incur floatation cost such as cost related to brokerage, commission, advertising, etc. To finance such floatation costs the company can issue Commercial Paper.
(iv) Certificate of Deposit (CDs)
Certificate of Deposits are time deposits which are negotiable and unsecured in nature. They are bearer instruments for a short and specified time period ranging from one month to more than five years. CDs are a secured form of investment, which are issued to individuals, corporations and companies by the commercial banks and development financial institutions. Herein, higher interests are offered for higher deposits. They are issued to meet the demand for credit in times of tight liquidity position. For example, when a person buys a CD by depositing a specific amount, he receives a certificate wherein the term of deposit, the interest rate applicable and the date of maturity is written. On the date of maturity, the individual gets entitled to receive the principle amount and the earned interest on it.
(v) Commercial Bill
Commercial bill also known as bank bill or bill of exchange refers to the instrument used to finance the working capital requirements of a firm. It is a short term negotiable instrument. Companies use Commercial Bills to finance their credit sales. For example, when an individual makes credit sales, the buyer becomes liable to make the payment on a specified future date. Herein, the seller draws a bill of exchange and gives it to the buyer mentioning a specific maturity period. Once the bill is accepted by the buyer it becomes a marketable instrument which can be discounted with a bank. For instance, if the seller requires funds before the maturity period, he can discount the bill with a commercial bank.
Money Market refers to the market where short term funds are traded. Herein, short term funds are in the form of monetary assets having a maturity period of maximum one year. The following are some of the common money market instruments.
(i) Treasury Bil (T-Bills)
Treasury Bill refers to a promissory note used for short term borrowing by the government. They are the most commonly used money market instrument. They are auctioned and issued by the Reserve Bank of India on behalf of the Central Government. T-bills are available for a minimum of Rs 25,000 and in multiples thereof. Generally, three types of treasury bills are issued 91-days, 182-days and 364-days. T-Bills are issued at a discount and redeemed at par. That is, they are issued at a price lower than their face value and at the time of redemption, the investor gets the amount equal to the face value. The difference between the value at which they are issued and the redemption value is the interest received on them. For example, if an investor purchases a 182-days treasury bill with a face value of Rs 56,000 for Rs 50,000. At the time of maturity, the investor will receive Rs 56,000. Thus, the difference of Rs 6,000 (56,000 − 50,000) is the interest receivable on the bill. T-Bills are also called Zero-Coupon Bonds. T-bills are highly liquid bonds. Moreover, as they are issued by the RBI, they have negligible risk and offer assured return.
(ii) Call Money
Call money is an instrument used for interbank transactions. Through call money, the banks borrow from each other to meet any shortage of funds required to maintain CRR. That is, any bank in shortage of funds borrows from other bank having surplus funds. Call money have a very short maturity period ranging from one day to fifteen days. Interest paid on such loans is known as call rate. Call rate is highly volatile and varies from day to day. There exists a negative relationship between call rate and other money market instruments such as Commercial Papers and Certificate of Deposits. That is, as the call rate rise, other instruments of money market become cheaper and their demand increases.
(iii) Commercial Paper (CPs)
Commercial paper is an unsecured short term money market instrument. It is a negotiable and transferable promissory note with a maturity period ranging from a minimum of 15-days to a maximum of one year. They were introduced in India in 1990. CPs are mainly issued by large and creditworthy companies to raise short-term funds. Large companies view Commercial Papers as an alternative to bank borrowings and borrowings through capital market. The rate of interest payable on Commercial Papers is lower than the market rates. Generally, companies use Commercial Papers for bridge financing. That is, to raise the funds required to meet the floatation cost incurred on long term borrowings in the capital market. For example, if a company wishes to raise finance from the capital market to purchase land. For this, it will have to incur floatation cost such as cost related to brokerage, commission, advertising, etc. To finance such floatation costs the company can issue Commercial Paper.
(iv) Certificate of Deposit (CDs)
Certificate of Deposits are time deposits which are negotiable and unsecured in nature. They are bearer instruments for a short and specified time period ranging from one month to more than five years. CDs are a secured form of investment, which are issued to individuals, corporations and companies by the commercial banks and development financial institutions. Herein, higher interests are offered for higher deposits. They are issued to meet the demand for credit in times of tight liquidity position. For example, when a person buys a CD by depositing a specific amount, he receives a certificate wherein the term of deposit, the interest rate applicable and the date of maturity is written. On the date of maturity, the individual gets entitled to receive the principle amount and the earned interest on it.
(v) Commercial Bill
Commercial bill also known as bank bill or bill of exchange refers to the instrument used to finance the working capital requirements of a firm. It is a short term negotiable instrument. Companies use Commercial Bills to finance their credit sales. For example, when an individual makes credit sales, the buyer becomes liable to make the payment on a specified future date. Herein, the seller draws a bill of exchange and gives it to the buyer mentioning a specific maturity period. Once the bill is accepted by the buyer it becomes a marketable instrument which can be discounted with a bank. For instance, if the seller requires funds before the maturity period, he can discount the bill with a commercial bank.
