Understanding the Money Market Instruments in India

Financial market investing is fraught with inherent risk and uncertainty. Investments often result in more losses than gains if not done carefully. Hence, it is vital to learn a little about the financial market before diving into it.

The financial market comprises two parts – the capital market and the money market. But what are they? 

The money market is suitable for short-term investments. This market deals with money market instruments such as securities and bonds issued by the government, banks, or other trustworthy firms. The Reserve Bank of India and SEBI regulate the workings of the money market. At the same time, the capital market deals with long-term investments. The Securities Exchange Board of India (SEBI) regulates the working of the capital market to ensure fair and reliable trade and investments.

Money market funds are the primary choice for investors with low-risk tolerance. Why is it so? Read on to learn more about how the money market in India functions and identify the components of the money market.

What is Money Market?

If one has to define money market in simple terms: Money market deals with short-term investments and loans, usually with a timespan of less than a year. It is one of the largest organised trading markets and houses various financial institutions, brokers, banks, investors, dealers and even the government.

Governments, banks, and financial institutions sell or issue securities and bonds with a short maturity to accumulate capital. You can buy these securities with a promise of fixed returns. 

Also Read: Stock Market Timings in India: Opening & Closing Times for NSE & BSE

Features of Money Market Instruments

1. High liquidity

The money market offers short-term securities that are highly liquid. Their high liquidity makes them cash equivalents; that is, they can be traded for cash anytime. Several renowned financial institutions and dealers issue these securities to take loans or to generate funds.

2. Secure investment

Risk is inevitable, but not in the case of the money market. Only companies and corporations with high credibility and goodwill issue short-term securities and bonds. Hence, you will receive guaranteed returns on the specified date with negligible risk.

3. Fixed returns

Money market instruments in India are available at a discount on face value. Therefore, the return on securities and bonds is pre-decided. You can rest assured while investing in the money market as it promises fixed returns.

Types of Money Market Instruments in India

Money market instruments are tools allowing businesses, banks, and the government to accumulate funds using short-term securities and bonds. There are different types of money market instruments, depending upon the investment amount and the maturity period.

1. Treasury Bills

Treasury bills or T-Bills are short-term debt money market instruments introduced in 1917. The RBI issues T-Bills on behalf of the government of India. These are available at a discount to their original value, and the buyer gets the face amount on maturity. T-Bills are zero coupon securities as the buyer does not receive any interest. You can buy it in three tenors, 91 days, 182 days, and 364 days. 

For example, a treasury bill of Rs. 100 can be bought at Rs. 95. However, you will get Rs. 100 on the maturity date without any interest in-between. 

Features

• Negligible risk
• No tax deduction 
• The minimum amount to bid is Rs 25,000 and in multiples thereof.
• One can buy them at a discount and get the redemption at par.

2. Commercial Papers

The RBI introduced commercial papers (CPs) in 1990 to diversify the sources of short-term borrowings for corporate borrowers and to provide investors with a new instrument. It is an unsecured money market instrument in the form of a promissory note issued by financial institutions and large corporations. You can buy commercial papers at a discount. The rate of return on CPs is equal to the difference between the purchase price and the face value. Borrowers issue commercial papers for Rs. 5 lakhs or multiples thereof with no minimum value. It has a maturity period of 15 days up to one year.

Commercial papers comprise bills of exchange, customer receipts, promissory notes, delivery orders, and so on. CPs often come into use for accounts payable and inventories, financing payrolls, and other short-term liabilities. 

Features

• Has a fixed maturity period.
• Acts as evidence against unsecured debts as it is in writing.
• Is issued in denominations of Rs. 5 lakhs or multiples thereof.
• Is highly liquid.

3. Banker’s Acceptance

Banker’s Acceptance or BA is probably the oldest money market instrument. It has been in use since the 12th century to facilitate trade. Unlike the other money market instruments, BA is a bank’s obligation to pay an individual account holder. In layman’s words, the bank has to pay a specified amount to the account holder. Banker’s Acceptance is also available at a discounted price and functions like certified checks; the payment of the owed amount is on the specified date. The maturity period falls between 90 days to 180 days. 

Banker’s Acceptance is often used in trade (particularly when there is import-export of goods involved). The importers’ bank guarantees the payment to the exporter. 

Features

• Can be traded as bonds in the secondary money market.
• Is a safe and secure way to make both-end transactions.
• Banks can demand collateral before issuing it.

4. Certificates of Deposit

Another component of the money market is Certificates of Deposit. It was first used in 1989 to increase the range of money market instruments in India. This instrument offers greater flexibility to the investors to utilise their funds. It is issued in a dematerialised form against the deposited amount in a bank for some time. The RBI makes guidelines for CDs and updates them routinely. Companies, corporations, individuals, etc., can purchase them. The maturity period for these instruments varies in accordance with the issuing organisation. Usually, commercial banks offer a maturity period from seven days to a year, while financial institutions offer a maturity period from one to three years.

Features 

• You cannot issue a loan against a Certificate of Deposits.
• You cannot trade it publicly.
• Banks cannot claim or take back the certificate of deposits before the maturity period.
• It is issued in Rs. 1 lakh, and its multiples.

5. Repurchase Agreements

Repurchase Agreements, also known as repo, are short-term borrowings in government securities for dealers. In 1992, repo was introduced to improve the economy’s short-term liquidity management and to manage and even out interest rates in the money market. Dealers sell government securities as collateral to investors and then buy them at a higher price the next day. Repurchase Agreements do not have a maximum maturity period, but the minimum scales down to one week. In some repo securities, there is no fixed maturity period, and there can be regular fluctuations in the interest rates contingent on the market conditions. Repurchase Agreements include agency bonds, government bonds, corporate bonds, emerging market bonds, convertible bonds, and supranational bonds. 

Features

• Security acts as collateral.
• Interest is lower in comparison to other securities.
• Used for lending and borrowing within a tenor of 48 hours or less.
• Investors can sell their collateral in case of bankruptcy.

Read More: Best Corporate Bond Mutual Funds in India

Purpose of Money Market

The money market:

1. Aids in the transparent and smooth flow of funds from one sector to another.
2. Allows you to invest surplus funds in the market to earn a higher return. 
3. Finances short-term money requirements of the government, financial institutions, corporations, and the economy. Any business or corporation is eligible to borrow funds through the money market.
4. Regulates liquidity in the market using commercial papers, banker’s acceptance, and such.

Importance of Money Market

You might be wondering what is the need for these instruments or short-term debts when one can easily access the stock market. Yes, the stock market provides long-term investments and promises wealth creation in the future. But, the role of the money market is equally significant. The following reasons underline the importance of the money market:

• The money market balances the demand and supply of monetary and financial transactions. 
• It helps in implementing monetary policies. 
• It provides a safe method to get funds to businesses, helping them grow and further develop the economy.
• It helps keep inflation on track. The government can easily raise funds through these instruments. In the absence of these instruments, the government would have to print more currency or turn to loans to fund projects for social welfare, leading to inflation.
• Short-term interest rates influence long-term interest rates. 
• It determines the statutory liquid ratio and cash reserve ratio.

Things to consider before investing in money market instruments

Although the money market is a gateway to investing in debt securities, it is not a perfect investment avenue. As the saying goes, “You won’t grow without taking risks.” 

On the bright side, the money market is subject to little to no risks. Yes, some issues might cause minor problems, but nothing major leads to an instant downfall. You must take into account the following points when investing in the money market:

• Figure out your short-term goals.
• Risk level you can endure with ease.
• Assets which you plan to invest in.
• Economic condition and stability of the country.
• Research thoroughly before investing in any company to avoid fraud and scams.

Conclusion

Investments in the money market are an excellent option. If you are looking for a risk-free and short-term investment, you can always turn to the money market to enjoy its benefits with guaranteed returns and minimal exposure.

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