The section of financial market, where instruments that have a short term and are highly liquid are traded is called Money Market. It has generally a maturity period of less than one year. The money market contributes to the economic stability and development of a country. It provides short-term liquidity to governments, commercial banks, and other large organizations.
The core of the money market consists of inter bank lending. Wherein banks borrow and lend to each other using commercial paper, repurchase agreements and similar instruments. For the appropriate term and currency these instruments are benchmarked (i.e. reference for pricing) using ,The London Interbank Offered Rate (LIBOR).
Money markets enables government, banks and other large institutions to raise money. It does this by issuing these short-term securities for meeting their short term cash flow needs. Thus enables large institutions and other investors to park their excess funds in these securities or instruments of low risk.
Large corporation with short term capital needs can borrow money from the market. Those companies with excess cash can lend it to the companies in need. Whereas small companies can invest money through money market mutual funds. Individual investors invest through money market mutual funds or bank accounts.
Money Market Instruments
Some of the money market instruments are:
Only Central bank of a country can issue this bill. It issues the bill when it requires to raise funds to meet its short-term obligations
Being backed by government it is one of the safest type of instruments having negligible default risk.
Issue is at discount and redemption at par. The difference in the amount of issue and redemption is the gain to the investor.
Certificate of Deposit
Certificate of Deposit is an instrument issued against the funds deposited by an investor with a bank in a dematerialized form for a specific period of time.
Rs 1 lakh and its multiples are minimum issue.
A type of promissory note issued by the company to raise short term funds.
It generally provides lower interest as compared to other equivalent securities. Since it is highly liquid with maturity period ranging from 7 days to one year.
Some other instruments include call money, commercial bills, Repurchase agreements, etc.
Some of the major functions of money market are:
Provision of funds
Money market provides funds to small and large corporations to meet their short term needs. It also provides capital to the government for the requirement of short term funds. Through various instruments like commercial paper, treasury bills, etc.
Facilitates growth of industries
Money markets helps in the growth of several industries. By providing them the required funds for their working capital at low interest rates. Also, it indirectly affects the capital market as well. The interest rates in the money market affects the long-term loans, to be taken by the companies through the capital market. Thus, it has a hand in providing funds indirectly for the long term needs as well. Which is in turn essential for growth.
Self Sufficiency of Commercial Banks
Money market provides a platform to commercial banks wherein they can park their excess funds and generate interest. Also in situation of shortage of funds, commercial banks can borrow money from money markets and become self-sufficient, with no need to depend on the funds of central bank which is available at a higher interest rate.
Money markets enable easy flow of finance from one sector to another. Thus enhancing mobility of funds which is essential for economic development.
Test your knowledge on money market and churn your brain by giving this quiz.
This article was written by The Actuarial Club and posted by Ayush Upadhyay.
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