Today,Global economy is lacking of short term funds & many companies are struggling to procure short term capital. Short term capital is very important as day to day working operations of company is dependent on short term funds. Some companies collapse due to insufficient short term funds. Such an important fund is made available in money market. The money market is a market for financial assets. It is a wholesale market for short term funds and instruments having a maturity period of less than one year. It is not a single market but a collection of markets for several instruments. The main players are RBI, NBFC`s, STCI (securities trading corporation of India) etc..
Money market provides a balancing mechanism to meet the demand and supply forces of short term funds in economy. Simply a money market is a pool of short term funds. It facilitates central bank in influencing liquidity and interest rates. It is an additional source of funds for banks and financial institutions. Savers get a wide variety of instruments in money market to invest their savings and reap profits. A liquid money market is necessary for development of capital & foreign market. RBI controls liquidity by CRR and other ratios based on money market.Monetary control is more effective if these markets are liquid. Famous money market centers in India are Mumbai, Delhi & Kolkata
Money Market Instruments
Treasury bills: Coming to treasury bills, these are very popular instrument in present scenario of economy. These bills are widely used in economy as they are most liquid and reap short term benefits. T- Bills are short term instruments issued by the RBI which are used in shortfall of liquidity. These are used by govt in case of deficit situations.
At present there is only one type of T-bill that is auctioned T- Bill, which are issued by RBI. These bills are issued by way of auction,where different participants bids in an auction and funds themselves. These bills cannot be re-discounted with RBI. At present RBI issues T- bills of 3 types based on their holding period. Those are for.91,182 & 364 days.Besides these RBI acceptsnon-competitive bids from stategovt, non govt PF`s and other banks. These bidders are allotted bills at a weighted average price of competitive bids. These are repaid at par on maturity
Sale of T- Bills (competitive bids) is made through auction which is of two types namely:-
Multiple price auctions: The bidder has to quote the price of stock which they decided to purchase. Then RBI gives a cut-off rate for stock, and thenthe bidders who quoted above the cut-off rate are allotted securities. Each winning bidder pays the price that they bid in auction.
For e.g.: A quotes a price of 10,000 for a stock and B quotes 4,700 & C quotes 5,500 the price quoted by RBI( cut off rate ) is 5,000. Then A&C are allotted securities as they quoted above the price quoted by RBI and they will be allotted securities at the respective price quoted by them,and B will not be allotted as he quoted below the cut off rate
Uniform price auction: Here, RBI invites bids and accepts in descending order those who fully absorb the issue amount. Winning bidder pays the uniform price decided by RBI
For EG: A bids 20,000 and B at 17,000, C at 12,000, D at 8,000. Let the uniform price decided by RBI is 10,000. Then in descending order A, B, C are allotted securities, as they quoted above the uniform price and they will be allotted securities at the uniform price quoted (decided) by RBI
The difference between the 2 auction types is, in multiple price auctions,securities are allotted at the price quoted by them. But in uniform price method bidders pay at uniform price decided by RBI. The auction is announced and processed in online through straight-through-process (STP) system
A commercial paper is an unsecured short term promissory note, not negotiable and transferable by endorsement with a fixed maturity period. It is generally issued at discount. It is given by companies to meet their working capital needs. It is also known as finance paper or corporate paper. It is mainly to access short term funds. FII`s (foreign instutional investors) can invest in commercial papers pertaining to certain restrictions as these are governed by SEBI.
A commercial bill is a short term, negotiable & self liquidating instrument with low risk. It is nothing but a bill of exchange. These are popular in market same as treasury bills. These commercial bills are mostly used in business where business is involved in trading. The bank discounts these bill by keeping a certain margin (discount) and credits the proceeds. Banks when in need of money, rediscountthese bills with financial institutions such as LIC, GIC, UTI etc…
These may be demand bills (which are payable on demand) or usance bill (which is payable after specified time). A variety of bill of exchange for financing the movement of agricultural produce, called as ‘Hundi’ has a long usage in India. These are local bills.
Certificates of Deposit:
CD`s are unsecured, negotiable short term instruments issued by banks &financial institutions. These are similar to fixed deposits which will mature on expiry of certain period. These are issued by banks during tight financial position and in shortage of working capital, usually at a higher interest rate. Banks resort to these when deposit growth is sluggish but credit demand is very high. The transaction costs of CD`s are low. These are issued at a discount. The minimum amount of deposit that could be accepted by a single subscriber should not be less than $100
Call/Notice Money Market:
Call money market is most visible market as day to day surplus funds are traded in this market. Many banks trade in this market. It constitutes major portion of money markets and a key segment of Indian money market. Call money market is of course market for short term funds which are payable on demand having very low maturity period. These markets are very famous as funds can be obtained without any collateral security. These markets are high liquid and high risk as well as volatile. Under call money market funds are transacted on overnight basis where as notice money market funds are borrowed or lent for a period of 2-14 days. Banks are very much advantaged as they are able to procure money for a short period of time to meet working capital requirements and to maintain minimum amount of CRR(cash reserve requirement)
Money market derivatives:
A derivative security is a financial contract the value of which is derived from the value of an asset, these may be stocks, currencies etc… this help in managing various types of risks through hedging, arbitraging etc… they increase capacity of markets to absorb risks and enhance liquidity and reduce transaction costs in market. The interest rate risks can be managed with the help of derivative instruments. These instruments help banks to manage their interest rate risks with more efficient usage of capital
Interest rate swaps (IRS):
IRS is a financial contract between two parties swapping (i.e., exchanging)a stream of interest payments for a notional principal amount during a specified period. It involves swapping of a fixed to floating or floating to fixed interest rates. If people feel that rates will fall, they could receive fixed and pay floating rates. Vice versa if rates are high. A company will typically use interest rate swaps to limit or manage exposure to fluctuations in interest rates
Plain vanilla interest rate swaps:
Here there are two parties say X, will make fixed & semi-variable annual interest payments to the other party say Y, who will make semi –annual floating interest payments to X. The swap contract specifies the interest rate applicable to each party. Such payments are usually made in same currencies. Payments are netted and only the party with positive difference owed makes a payment equal to the netted amount. Here principle is not exchanged. At present RBI allows only plain vanilla interest rate swap. The purpose of such an exchange might be to reduce interest-rate risk.