Money Market Instruments in India

More often than not, individuals require funds on a short-term basis and Money Market Instruments provide a platform for investors to create short-term wealth. Investors do so by putting a safe deposit in short-term debt securities such as commercial paper. Money Market Instruments require investments for minimum tenure to provide expected returns. Investors count on these funds to meet financial requirements like a planned vacation. Compared to savings accounts, Money Market Instruments attract higher risks, whereas the associated risks are lower than stock trading. However, don’t forget that money market instruments do not generate much wealth compared to mutual fund trading.

Several Indian banks offer money market instruments with competitive interest rates. In this blog, you will get acquainted with the concept of Money Market instruments and their various related features.

What is the Money Market?

Money Market is a platform for investors that involves trading short-term debt securities. An investor here can be an individual or financial institution and traders. The risk factor is considered to be minimal but it is not immune from market dynamics. In case of an uneventful market crash, the money market tends to go down. Investors here trade on a short-term basis, generally less than a year. Banks usually adhere to a minimum balance and minimum tenure policy to tackle the risk factor on their ends.

There are majorly two ways in which an investor parks their monetary capital. It includes money market mutual funds and money market bank accounts. For premature withdrawal, customers have to sell their funds resulting in lesser yields than post-maturity withdrawals. The provision of a premature withdrawal facility allows these instruments to have relatively higher liquidity.

Features of Money Market

Investors opt for a money market with a specific goal in mind. Their major focus usually is not related to capital gains or wealth creation but rather to safekeeping funds for a limited tenure. Investors invest in Money Market Instruments with the purpose to resell the funds with a slight appreciation. They serve the purpose of meeting financial requirements in the short term. It is highly captivating for short-term investors. Features provided by money market instruments are as follows.

• Liquidity Factor – The money Market allows customers to convert their funds to readily available monetary assets. The high liquidity ratio of these investment tools makes them a go-to financial solution for many. Money market investments can be seen as a safe locker for investors to take out their investments anytime. However, many banks have a policy of minimum balance requirement with a specific minimum tenure.
• Medium Risk – Although money market investments are considered to be less risky than stocks and bonds counterparts, they still relatively carry a certain rate of risk owing to the market dynamics. In scenarios of market crashes, money market investments have volatility to crash as well.
• Return factor – The money market has the potential to create higher short-term returns compared to a regular savings account. This gives the investment tool a higher possibility to be picked as a source of income than a savings account.

Types of Money Market Instruments in India

Money Market Instruments in India include short-term debt securities such as treasury bills, commercial papers, certificates of deposit, and so on. This not only helps investors such as individuals, companies, and the government, to acquire money market instruments at a lower price but also enables them to utilise idle funds for short-term gains. Some of the major types of money market instruments in India are as follows:

• Call Money – This is the component of the Money market that facilitates commercial banks to maintain their cash reserve ratio. Commercial banks are required to keep around 7.50% as a reserve. Furthermore, they are required to deposit this in with the Central bank. In cases where banks fail to maintain, they borrow from other banks for the short term to facilitate their CRR. They are charged interest in the form of a call rate. Thus, when one bank borrows money from another bank to maintain CRR for a maturity of less than a year, the raised money can be said to be Call Money.
• Commercial Paper – When big companies issue their shares, there involves a flotation cost. In order to facilitate the same, companies are required to find a brokerage that assists companies to get their shares sold off. There are costs associated with the same and companies resort to borrowing money through commercial papers for the short term. Commercial papers are issued by large and reputed companies and are an unsecured form of lending.
• Certificate of Deposit – When banks have large cash reserves, they use the capital to invest in large companies to raise short-term gains. These are known as certificates of deposit which are issued by financial institutions for a maturity of less than a year. Moreover, they are issued for large companies and individuals as well.
• Treasury bill – In scenarios where the market faces an excess demand from consumers, the money supply is controlled by the Reserve Bank of India. Here RBI makes arrangements to procure excess money from the consumers by issuing Treasury bills. T bills allow investors to generate short-term capital gains. RBI sells the treasury bills on behalf of the government in discounts with the face value being the actual value, and upon maturity, the RBI repays the investors for its power value. These bills are also known as zero coupon bonds.
• Commercial Bill – When an individual or a company borrows short-term money with a payment promissory that they are owed from a third party as collateral, they are known as commercial bills. Here, company X may have purchased commodities from company Y on credit and issued a promissory note of repayment. Company Y can take the promissory note for borrowing. Here the borrower has to incur noting charges as well.

Important Objectives of Money Market Instruments

Money market instruments have been devised to generate short-term funds. However, these are for facilitating various objectives. Some of the objectives of money market instruments are as follows.

• Money market instruments enable investors to set aside their monetary capital safely with a short-term gain.
• Reserve Banks use the money market instruments to create more liquid flow in the market dynamics.
• Investors can meet short-term financial goals with the assistance of money market instruments.
• Government institutions and commercial banks rely on money market instruments to generate short-term funds for various requirements.
• These instruments also serve as a reference point for borrowers and lenders of short-term funds.
• There are various sectors that the government has to take care of and money market instruments assist liquidity for the same.

What are Money Market Funds?

Money Market Funds are a specific type of mutual fund where the investors park their monetary capital on short-term financial instruments such as commercial papers, government treasury bills, certificates of deposits, and so on. The fund managers keep an eye out for reputed companies and banks to allocate the investors towards the pooled cash while giving out dividends returns. These funds are usually risk-volatile with minimal returns. However, customers benefit from short-term income generation when they pin their hopes on money market instruments.

Money Market vs Stock Market

Money Market is considered a popular choice for anyone wanting to park their money aside for the short term to create a reasonable percentage of return. They are highly stable investment instruments. Although money market instruments have low to medium risk involved, they can still be affected by major market fluctuations. Money Market investors are usually large companies and government institutions, who engage in trading in large denominations.

On the other hand, the stock market essentially deals with medium to long-term funds. Investors contributing to the stock market usually expect higher returns with an appetite for higher risk. To say which is better, one has to have a fair understanding of the money market. Usually, the intention of investing in a money market instrument is to create short-term gains, whereas the case is reversed in the case of the stock market. Understanding personal needs can help one determine which one to pick on.

Some of the common money market instruments include commercial papers, treasury, certificates of deposit, bills, trade credit, etc. Some of the common stock market instruments include bonds, debentures, shares, asset secularisation, retained earnings, euro issues, etc. Moreover, capital market instruments are a major source of a country’s economic development via increased savings. However, money market instruments are used merely to increase liquidity.

How Are Interest Rates Decided for the Money Market?

Owing to the high liquidity, money market instruments enable easy withdrawal of funds, making them a relatively safer investment tool. Its main characteristics include a low-interest rate, resulting in minimal returns. In money market instruments, the interest is calculated on a day-to-day basis. The investor then gets a monthly dividend based on the computed values.

Characteristics of Money Market Instruments

We have established that the money market is the kind of investment investors choose if they have less than a year to capitalize on their income. For instance, if someone has a capital of INR 5,00,000 set aside for the purchase of a vehicle and requires the amount to be invested safely, they can consider trading with money market instruments. They are majorly used by big companies, commercial banks, RBI, LIC, financial institutional investors, and so on. With the advancement of globalisation, the money market facilitates online short-term capital gains without geographical barriers.

Importance of the Money Market

There are various ways in which money market instruments contribute to economic growth. Owing to its nature of creating short-term funds, the money market potentially increases the liquid value of monetary capital. Here’s a list of the importance of the money market.

• Trade and Industry sectors get a major boost with the assistance of money market instruments. They not only help with quick funding but also provide sufficient monetary capital.
• It helps to accomplish economic gain, much-needed capital stabilization through short-term generated funds, and high liquidity.
• Banks use money market instruments to meet their cash reserve requirements.
• The central bank uses the money market to control the purchasing power of consumers. They do so in case of excess demand due to escalated cash flow among the consumers.
• The government uses money market instruments as a means of fair judgment of economic status and performance.
• The government uses the money market to avail short-term funds to meet their various financial needs.

What is Maturity?

When you decide to invest your hard-earned money, you do it for a set time frame. You get the returns by the end of the investment tenure. The end of this agreed-upon term is called maturity.

Throughout this term, the investment is pooled with the offered interest benefits. This makes the monetary capital appreciate over time. Thus, maturity simply can be said that the investment period has come to an end and whatever interest is added till the agreed date is the final amount the investor gets back.

There are several related terms to maturity such as amortization, tenure, term, period, etc. In the case of loans, generally, the amortization period is considered. Amortisation is the breakdown of loan payments into equated monthly installments and the complete term one needs to pay off their debts. However, the term maturity is more closely related to bonds. The end of maturity would mean that the bond issuer is liable to repay the investor with their money.

What is the Yield on Security?

Yield is the amount of money that is generated for the investment after the stipulated maturity. The yield is paid out to the investor after the tenure ends. Yield is generally expressed in terms of the percentage of the total invested capital and the market price of the security invested in. When the same investment is contributed for securities such as treasury bills, the produced yield refers to the yield on security. With the yield history of a certain security, one can also ascertain the risk factor. It is considered that a higher yield on security means that the risk associated with the particular investment tool is minimal. Furthermore, the higher yield stats is also indicative of higher revenue generation.

Frequently Asked Questions