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MONEY MARKET

Meaning
Money Market is the part of financial market where instruments with high liquidity and very short-term maturities are traded. It's the place where large financial institutions, dealers and government participate and meet out their short-term cash needs. They usually borrow and lend money with the help of instruments or securities to generate liquidity. Due to highly liquid nature of securities and their short-term maturities, money market is treated as safe place. It is different from stock market. It is not a single market but a collection of markets for several instruments like call money market, Commercial bill market etc. The Reserve Bank of India is the most important constituent of Indian money market. Thus RBI describes money market as the centre for dealings, mainly of a short-term character, in monetary assets, it meets the shortterm requirements of borrowers and provides liquidity or cash to lenders.

Function of Money Market


1. 2. 3. 4. 5. 6. It caters to the short-term financial needs of the economy. It helps the RBI in effective implementation of monetary policy. It provides mechanism to achieve equilibrium between demand and supply of short-term funds. It helps in allocation of short term funds through inter-bank transactions and money market Instruments. It also provides funds in non-inflationary way to the government to meet its deficits. It facilitates economic development.

Features of Organized and Unorganized Money Market


Indian m o n e y m a r k e t i s c h a r a c t e r i z e d b y i t s d i c h o t o m y i . e . There a r e t w o s e c t o r s o f money market. The organized sector and unorganised sector. The organized sector is within the direct purview of RBI regulations. The unorganized sector consists of indigenous bankers, money lenders, non-banking financial institutions etc.

Organized Money Market:


Organized Money Market is not a single market, it consist of number of markets. The most important feature of money market instrument is that it is liquid. It is characterized by high degree of safety of principal.
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1.

Existence of Central Bank: In the developed money market, the role of Central
Bank is notable. It controls the entire money market operations by making the availability of funds depending upon the economic cycles. It can be done through its open market operations.

2. Highly organized Banking System: As they are the main dealers in short-term funds,
the commercial banks are considered as nervous system of the money market. Therefore, a well developed money market will have a highly organized and developed commercial banking system.

3. Existence of sub-markets: In developed money market the various sub-markets existed


and functioning smoothly. That is, the money market will have a developed sub- markets such as bill market, call money market, acceptance market, discount market, etc. It can be said that the larger the number of sub-markets, the broader and more developed will be the structure of the money market.

4. Prevalence of healthy competition: In each sub-market there should be a reasonable


and healthy competition. That is, in a developed money market, there are a large number of borrowers, lenders and dealers. Then only each market will be active enough to achieve the purpose of its existence.

5. Integration of sub-markets: In the developed money market there will be a perfect


integration among various sub- markets of the money market. Their functioning are interdependent. The funds flow from one sub-market to another and the activities of one sub- market should create effects in the other markets also.

6. Availability of proper credit instruments: The developed money market should have
the necessary credit instruments such as treasury bills, promissory notes, bills of exchange, etc. They should be freely available.

7. Flexibility and adequacy of funds: In a developed money market, there must be ample
resources. The flow of funds into the money market should also be flexible enough, i.e., the flow of funds can be increased or decreased depending upon the demand for funds.

8. International attraction: The developed money markets attract funds from foreign
countries also. The dealers, borrowers and lenders of foreign countries are eagerly coming forward to participate in the activities of developed money market.

9. Uniformity of interest rates: Prevalence of uniformity in interest rates in different parts


of the country is the characteristic feature of a developed money market.
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10. Stability of prices: Stability of prices all over the country will be an outcome of the
effective functioning of a developed money market.

11. Highly developed industrial system: The money market will function smoothly and can
achieve the basic purpose of its existence only when there is a highly developed industrial system. Developed money market demands for such a system.

Unorganized Money Market:


The economy on one hand performs through organised sector and on other hand in rural areas there is continuance of unorganised, informal and indigenous sector. The unorganised money market mostly finances short-term financial needs of farmers and small businessmen.

1. Blending of Money-lending and trading: The unorganised agencies of the money


market such as money-lenders and indigenous bankers conduct the mixed business of money-lending and trading.

2. Informality: Money-lenders and indigenous bankers have informal dealings with their
borrowings.

3. Simplicity: Money-lenders and indigenous bankers keep their accounts in a very simple
and indigenous form in the vernacular language. 4.

Flexibility: Their loan operations may be flexible in nature. They may give new loans
to the borrowers even before the repayment of the old ones.

5. Personal Touch: Their business depends on personal contacts with the borrowers. 6. Secrecy of Business: The financial transactions of the money-lenders and indigenous
bankers remain a secret affair

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Money Market Instruments:


Money Market Instruments provide the tools by which one can operate in the money market. Money market instrument meets short term requirements of the borrowers and provides liquidity to the lenders.

1. Treasury Bills (T-Bills): Treasury Bills are one of the safest money market instruments
as they are issued by Central Government. They are zero-risk instruments, and hence returns are not that attractive. T- Bills are circulated by both primary as well as the secondary markets. They come with the maturities of 3-month, 6-month and 1-year. The Central Government issues T-Bills at a price less than their face value and the difference between the buy price and the maturity value is the interest earned by the buyer of the instrument. The buy value of the T-Bill is determined by the bidding process through auctions. At present, the Government of India issues three types of treasury bills through auctions, namely, 91-day, 182-day and 364-day.

2. Certificate of Deposits (CDs): Certificate of Deposit is like a promissory note issued


by a bank in form of a certificate entitling the bearer to receive interest. It is similar to bank term deposit account. The certificate bears the maturity date, fixed rate of interest and the value. These certificates are available in the tenure of 3 months to 5 years. The returns on certificate of deposits are higher than T-Bills because they carry higher level of risk.

3. Commercial Papers (CPs): Commercial Paper is the short term unsecured


promissory note issued by corporate and financial institutions at a discounted value on face value. They come with fixed maturity period ranging from 1 day to 270 days. These are issued for the purpose of financing of accounts receivables, inventories and meeting short term liabilities. The return on commercial papers is higher as compared to T-Bills so as the risk as they are less secure in comparison to these bills. It is easy to find buyers for the firms with high credit ratings. These securities are actively traded in secondary market.

4. Money Market at Call and Short Notice: Next in liquidity after cash, money at call
is a loan that is repayable on demand, and money at short notice is repayable within 14 days of serving a notice. The participants are banks & all other Indian Financial Institutions as permitted by RBI.

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The market is over the telephone market, non bank participants act as lender only. Banks borrow for a variety of reasons to maintain their CRR, to meet their heavy payments, to adjust their maturity mismatch etc.

5. Call Money Market And Short Term Deposit Market: The borrowers are
essentially the banks. Discount And Finance House of India Ltd (DFHI) plays a vital role in stabilizing the call and short term deposit rates through larger turnover and smaller spread. It ascertains the prospective lenders and borrowers, the money available and needed and exchanges a deal settlement advice with them indicating the negotiated interest rates applicable to them. When DFHI borrows, a call deposit receipt is issued to the lender against a cheque drawn on RBI for the amount lent. If DFHI lends it issues to the RBI a cheque representing the amount lent to the borrower against the call deposit receipt.

6. Commercial Bills: Commercial bill is a short term, negotiable, and self-liquidating


instrument with low risk. It enhances the liability to make payment within a fixed date when goods are bought on credit. Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or the value of the goods delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks, they are called commercial bills. The bank discounts this bill by keeping a certain margin and credits the proceeds. Banks can also get such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days, depending on the credit extended in the industry. Commercial bill is an important tool finance credit sales. It may be a demand bill or a usance bill; clean bills or documentary bills. Inland bills or foreign bills.

7. Inter Corporate Deposits: An ICD is an unsecured loan extended by one corporate to


another. This market allows corporate with surplus funds to lend to other corporate. Also the better-rated corporate can borrow from the banking system and lend in this market. As the cost of funds for a corporate is much higher than that for a bank, the rates in this market are higher than those in the other markets. Also, as ICDs are unsecured, the risk inherent is high and the risk premium is also built into the rates.

8.

Inter Bank Participation Certificates: With a view for providing an additional


instrument for evening out short-term liquidity within the banking system, two types of Inter-Bank Participations (IBPs) were introduced, one on risk sharing basis and the other without risk sharing. These are strictly inter-bank instruments confined to scheduled commercial banks excluding regional rural banks. The IBP with risk sharing can be issued for 91-180 days. Under the uniform grading system introduced by Reserve Bank for

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application by banks to measure the health of bank advances portfolio, a borrower account considered satisfactory if the one in which the conduct of account is satisfactory, the safety of advance is not in doubt, all the terms and conditions are complied with, and all the accounts of the borrower are in order. The IBP risk sharing provides flexibility in the credit portfolio of banks. The rate of interest is left free to be determined between the issuing bank and the participating bank subject to a minimum 14% per annum. The aggregate amount of such IBPs under any loan account at the time of issue is not to exceed 40 per cent of the outstanding in the account. The IBP without risk sharing is a money market instrument with a tenure not exceeding 90 days and the interest rate on such IBPs is left to be determined by the two concerned banks without any ceiling on interest rate.

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