The money market refers to trading in very short-term debt investments. Short-term debt instruments are traded on the money market. It involves an ongoing exchange of funds between businesses, governments, banks and other financial institutions for terms that can range from one night to as long as a year. At the wholesale level, it involves large-volume trade between institutions and traders. At the retail level, it includes money market mutual funds bought by individual investors and money market accounts opened by bank customers.
In all of these cases, the money market is characterized by a high degree of safety and relatively low rates of return.
There are several different types of money market
instruments that are traded in the money market. These are:
1. Certificate of deposit: It is a negotiable term deposit accepted by commercial banks. It is usually issued through a promissory note. CD’s can be issued to individuals, corporations, trust, etc. Also, the CD’s can be issued by scheduled commercial banks at a discount. And the duration of these varies between 3 months to 1 year. It functions similarly to a fixed deposit, but with better negotiating power and more flexible liquidity conditions.
2. Commercial Paper: Corporate issue Commercial Paper (CP’s) to meet their short-term working capital requirement. Hence serves as an alternative to borrowing from a bank. Also, the period of commercial paper ranges from 15 days to 1 year. This money market product functions as a promissory note created by a business or organization to raise short-term capital. It is an unsecured instrument, meaning there is no connected collateral.
3. Treasury bills: Treasury Bills are one of the most popular money market instruments. They have varying short-term maturities. It can only be issued by a nation’s central government, when necessary, funds are needed to fulfil its immediate obligations. These do not pay interest but do allow for capital gains because they can be bought at a discount and paid in full when they mature. Due to the government’s backing of Treasury Bills, there is very little risk.
4. Repurchase Agreement: Repurchase agreements are short-term borrowing instruments in which the issuer receiving the funds makes a promise to pay it back or repurchase it in the future Government securities are typically traded under repurchase agreements.
5. Banker’s Acceptance: In the financial industry, this popular money market product is exchanged. With a signed promise of future repayment, a loan is issued to the designated bank after a banker’s acceptance. A Banker’s Acceptance (BA) is a short-term financial instrument that serves as a guarantee of payment from a bank.
6. Call Money: It is a segment of the market where scheduled commercial banks lend or borrow on short notice (say a period of 14 days). In order to manage day-to-day cash flows. The interest rates in the market-driven and hence highly sensitive to demand and supply. Also, the interest rates have been known to fluctuate by a large % at a certain time.