Money Market Instruments: Functions & Working Of Money

Money market instruments are debt instruments traded for a short period and have a maturity of less than one year. These instruments have a maturity period that ranges from one night and one day to less than one year. The money market has no fixed geographical location, and deals are not carried out in cash. Let’s discuss the features of money market instruments.

Features of Money Market Instruments

1. The Reserve Bank of India (RBI) or the central bank affects the liquidity and market rates of the money market instruments.
2. Banks, financial institutions, Non – banking financial companies (NBFC) and the government use money market instruments to raise funds for short-term needs.
3. They provide the highest liquidity, as they have a maturity of less than one day up to one year.
4. They are the safest investment options because the authorities and governments back them.
5. They are issued at a discounted price and then redeemed at face value, thereby earning profits on the difference between the two amounts.

Functions of Money Market Instruments

1. These instruments help commercial banks meet their short-term Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements.
2. They help industrialists raise money for short-term working capital needs.
3. They also provide the opportunity for banks and other financial institutions to earn interest on the money lying idle with them for a short period of time.
4. It helps the government raise money at lower interest rates. Otherwise, the government would have to print fiat money, which would lead to inflation in the overall economy.
5. Money market instruments are used as a tool by the government to affect the economy through monetary policy.
6. It helps with financial inclusion and financial mobility by acting as a channel to flow money from lenders to borrowers.

Seven types of Money Market Instruments.

Listof Money Market Instruments and their Workings

If you are confused over the best money market instruments, then we have streamlined a few for better search and understanding. Check out these money market instruments and their procedure.

• Commercial Bills

These money market instruments are sometimes also called bills of exchange. They are issued by companies with a maturity of 90 days and can be discounted by banks before the date of maturity. They are transferable and negotiable and are used for credit sales and purchases by companies. The company is obligated to exercise it on the maturity date, which is predetermined to the buyer or the bank.

• Treasury Bills

The Government of India issues T-bills at a discounted price less than the face value and the buyer will get the face value at maturity. The difference in that amount is the earnings for the buyer of the instrument. The maturity period can range from 3 months to 1 year. These money market instruments come in various types and lot sizes, such as 91-day, 182-day, or 364-day. These instruments are the safest investment option because they support the government and provide assured returns. 

• Commercial Papers

Companies issue these instruments to meet their working capital needs. It has the same characteristics as T-bills, as they are also issued at a discounted price. The maturity period can range from 15 days to a year. They are traded actively in the secondary market and have a high risk-return ratio as compared to T-Bills.

• Certificate of Deposits

CDs are negotiable term deposits issued by banks to individuals, companies and other financial institutions and can be discounted by the banks before maturity. They have a maturity range of 3 months to 1 year.

• Banker’s Acceptance

BAs are money market instruments issued by companies and accepted or discounted by banks with maturities ranging from 30 to 180 days. They are used to finance imports and exports.

1. Repurchase Agreements

These repos are traded between parties authorized by the RBI to sell and buy back government securities from one another.

• Call Money

Commercial banks issue these instruments to meet their short-term needs, such as maintaining their CRR and SLR for one day. Another similar instrument is notice money, which is issued having a maturity of 2 days to 14 days.

Money Market Mutual Funds (MMMF)

These mutual funds are open-ended debt funds with a maturity of less than one year. They are liquid and safe investment options to invest in various money market instruments such as T- bills, commercial paper, certificates of deposit, call money, etc.

Conclusion

Money market instruments can provide higher interest rates than any other bank deposits or FDs. They are generally traded on the over-the-counter market, so you cannot buy them individually. Therefore, you can buy them through certified brokers or invest in money market mutual funds (MMMF). They act as a medium by providing advantages to both the issuer to fulfill short-term capital needs and the buyer, as they are very safe and highly liquid.