An arrangement where financial securities or assets like bond equities, forex, stocks etc. are traded between investors and borrowers is termed as financial markets. Money market, capital market, stock market, forex market are the major components of financial markets. Here, I’m going to explain instruments of money markets.
A well developed financial markets are prerequisite for the fuelling productive activities in the market economy. So, let’s take an overview of components of financial markets to get better insight of functioning of financial markets.
Classification of financial markets
On the basis of types of assets, financial markets are categorized as money market and capital market. Following are the components of financial markets
Instruments of Money Market
- Call money,
- Treasury bills,
- Commercial paper,
- Certificate of deposits,
- Trade bills are the major constituents of money market.
And, security and non-security market are the two components of capital market. Besides, primary market and secondary market are the part of security market.
Capital market second instruments of financial markets
A.Security market
1.Initial public offering or IPO
2.Book building
3.Private placement
Above constituents are included in the primary security market. Whereas, equities and debts are traded in the secondary market.
B. Secondary securities market
Stock markets are the examples of secondary market where stocks of companies bought and sold by traders.
C. Non-securities market
- Mutual funds
- Fixed Deposits
- Post office savings
- Insurance
This is an overview and examples of financial markets in operation across the global economies. Being the most reliable, affordable and accessible source of funds for business entities, financial markets are becoming more and more dynamic and developed.
Meaning and definition of financial markets
Financial markets are the sophisticated arrangement by those stakeholders which want either to invest or borrow funds for various reasons and purposes. These markets bring buyers and sellers together to increase the value of theirs capital as well as power productive activities.
Due to better regulations and security, these markets are certified as more reliable and trustworthy for market participants across the world. From retailer to large banks can mobilize and invest theirs financial resources here.
Explaining instruments of money market
- Call money
- Treasury bills
- Commercial paper,
- Certificate of deposits,
- Trade bills
Call money market is the financial arrangement made to meet the liquidity challenges by the central banks of respective countries in the world.
Being the part of money markets, call money market manifests the liquidity stress arising in the system that forces central banks to prepare for actions.
Understanding call money market
As I mentioned earlier that call money market is a part of money markets, and unlike other loans, it is raised as well as returned on demand by market participants.
In short, it is a short term loan that should be returned on demand by lenders from borrowers not by time schedule nor maturity but at call loan rates.
No financial system in the world is absolutely free from liquidity crunch or challenges. So, liquidity stress is bound to occur and it is the duty of central banks to recorrect it with such arrangements to ensure liquidity. It is a short term imbalance and need quick solutions.
Functioning of call money market
Unlike term loans, call money market doesn’t impose interest rates but call loan rates on the basis of auctions made among market participants like commercial banks, financial institutions, dealers, brokerage firms etc.
Highest bidders which means whosoever makes highest bid for loan avails the loan. And, the bid is known as call loan rates like interest rates on term loans by banks. Call money market fulfills the fund requirements for one day only.
Participants of Call money market
Unlike common borrowers and lenders who used to take term loans (term loans is the loans that need to be repaid after fixed tenure with definite interest rates) call money loans are availed on the overnight basis to meet the shortfall of liquidity.
- Commercial banks
- Co-operative banks
- Dealer
- Brokerage firms
- Financial institutions are the major participants in the call money market.
Actually, to ensure smooth functioning of day-to-day business activities, surplus and deficit banks demand and provide call money to one another for a day.
Brokerage firms in the stock, forex, and commodity market provide money for margin account by imposing certain charges.
So, clients with smaller funds can avail large profit and loss with the leverage offered by firms. These funds raised by the means of call money.
Call money market and notice money market
On the overnight basis, in the call money market, loans are availed. But, in the notice money market, loans are availed from two to forteen days. It means that market participants could avail loans for longer duration than that of the call money.
Importance of call money market
Understandably, call money market is a yardstick to judge the state of liquidity in the system by the central banks.
If the central bank realizes that system is under stress, it loosens or decreases CRR to increase sufficient liquidity in the system or vice-versa if the surplus is noticed.
It is done by the means of central bank’s monetary policy instruments on the regular basis. Hence, call money market is more than only short term.
Second instruments of money markets-Treasury bills
In money markets, treasury bills are the short term debt obligations that are issued by the central governments or authorities for one or less than one year.
Usually, treasury bills are issued on the basis of auctions by central banks to mobilize surplus funds to boost infrastructure, school, roads, health etc.
Unlike others, these are the most secured means for investors as these instruments are backed by the central governments itself. On the basis of maturity period these bills are classified as :
1)14 and 36 days treasury bills
2) 91 days treasury bills
3) 182 days treasury bills
4) 364 days treasury bills
Return on treasury bills — Face value, issue price
Generally, central governments doesn’t fix the interest on treasury bills but the difference between face value and issues price of the treasury bills are considered return on the treasury bills.
Technically, treasury bills are issued by the central banks below face value. Face value is the par value or printed value of the bills. But, the bills aren’t sold at the face value but at the discounted price.
And, after the maturity or term, the investors receive the face value of the bills. So, the difference between face value and issue price is the interest the investor receives in return.
Importantly, anyone can purchase treasury bills including financial institutions, companies, individuals, banks etc. 14, 36, and 91 days treasury bills are short term treasury bills and are considered most liquid in nature.
But, these treasury bills could be liquidized even before the maturity period with lesser interest value in case of emergency requirements. People, due to its risk free nature,used to purchase these money market instruments to insure safest means to grow the value of invested capital.
Difference between treasury bills and commercial bills
So far, l have discussed about the types of treasury bills and their natures. We know that treasury bills are issued by the central governments for one or less than one year to mobilize surplus funds to boost infrastructure activities.
These are risk free safe means of investment for investors including individuals, banks, companies, financial institutions etc.
On the other hand, commercial bills, are unsecured, short-term debt instruments that a corporation or other private organization issues to mobilize surplus funds to power developmental activities.
Unlike treasury bills, commercial bills or papers are not risk free or safe to invest given the possibility of company to become defaults. This is all about the treasury bills as a short term money markets instruments.
Describing third instruments of money markets-certificate of deposits
Among the instruments of money markets, certificate of deposit is more conservative means of investment in which there is no risk, nor higher return like stocks and mutual funds.
It is also a short term debt obligations with maturity period ranging from 91 days to upto one year. Unlike treasury bills, certificate of deposit is issued by commercial banks and financial institutions.
Who is eligible to issue and to whom?
In India, not all the financial institutions and banks are eligible to issue the certificate of deposit. It is only issued by the scheduled commercial banks and all India financial institutions to the cooperative banks, companies, and individuals. It is a one of the means to mobilize and uses the surplus capital for multiple purposes.
Unlike commercial papers, certificate of deposit is issued for minimum one lakh rupees in India. Whereas, commercial papers are issued for minimum five lakhs rupees. Besides, certificate of deposit is less liquid as it cannot be converted before maturity period.
Return on certificate of deposit
First of all, let’s understand the difference between face value and discounted or issue price. Face value is the value that is printed on the certificate and it is par value. On the other hand, discounted or issue price is the price by which the certificate is issued or sold in the market.
On maturity, investor receives face value instead of discounted. Suppose, if the face value of certificate is 1lakh rupees, and it is issued in market by issuer for 90 thousands rupees, the return on maturity will be 10 thousands. Simply, it is the difference between face value and discounted price.
Benefits of certificate of deposits
Investment in the certificate of deposit is termed as the risk free safe means of investment that offers lump sum return at the time of maturity. Conservative investors who want assured return free from market volatility, certificate of deposit is the best way to start investing.
Unlike commercial papers which is issued for 5 lakh rupees, certificate of deposit is issued for 1 lakh rupees that is more beneficial for small retailers with multiple terms.
However, it is not free from taxation; not applied for loan against CDs. Moreover, it is less liquid because it cannot be converted to cash before the maturity term.
Further, CDs are not issued by cooperative banks, companies in India. It is only issued by the scheduled banks and all India financial institutions.
Fourth and fifth instruments of money markets -Commercial papers and trade bills
Banks issue Commercial papers to receive short term funds. Also, financial institutions and corporations use this instruments to raise short term funds. This instrument is valid for less than 365 days. Commercial paper is more safe and secure compare to other instruments.
Trade bill or bill of exchange is a written consent but not contract between buyers and sellers to pay fixed amount of money at the decided date.
It is necessary in the international trade to facilitate bilateral, multilateral trade activities in the world.
Importance of financial markets in global economy
Financial resources or fund is the most prerequisite condition for any business entities to be successful. So, availability of funds at reasonable with longer duration is highly essential for both newly formed business or structured.
As usually, people always seek more return on theirs fund than in the fixed deposits kept in banks. If there is guarrenty of safty and regulations against fraud and scams, why don’t investors hesitate to pump theirs surplus capital in the financial markets.
On the borrower’s side, may be in the domestic market, it is too difficult to raise funds with affordable rates for actors which are either new or small. They will be easily crowded out by structured corporates. Hence, such financial markets offer better level playing field for everyone to realize theirs business dreams and goals.
Last thought on financial markets
Obviously, financial markets fule the productive activities and power the pace of economic growth. Consequently, it helps to boost living standards, employment opportunities, and efficient usage of resources. No doubt, it is a better means to bring economic integration and reduce regional disparity.
Unlike other markets, financial markets have multiple instruments to invest like stock, bonds, forex, commodities etc.
Smooth functioning of financial markets is indispensable for the development for the capitalist industrial economic. Any interruptions, might pave the way for disruption for the economic cycle.
Summary of instruments of money markets
Financial securities or assets like bond equities, forex, stocks etc. are traded between investors and borrowers is termed as financial markets.
Call money markets, treasury bills, certificate of deposits, commercial paper, trade bill are the instruments of money markets.
Call money market is the financial arrangement made to meet the liquidity challenges by the central banks of respective countries in the world.
Commercial banks, cooperative banks, financial institutions, dealers, brokerage firms are market participants.
Usually, treasury bills are issued on the basis of auctions by central banks to mobilize surplus funds to boost infrastructure, school, roads, health etc.
Technically, treasury bills are issued by the central banks below face value. Face value is the par value or printed value of the bills.
Certificate of deposit is more conservative means of investment in which there is no risk, nor higher return like stocks and mutual funds.
Trade bill or bill of exchange is a written consent but not contract between buyers and sellers to pay certain amount of money at the decided date.
Banks issue Commercial papers to receive short term funds. Also, financial institutions and corporations use this instruments to raise short term funds.
Solved questions on instruments of money markets
Following are some useful solved questions for in-depth understanding of the given topic.
Q.1. What is mean by Money market?
Ans: An arrangement where financial securities or assets like bond equities, forex, stocks etc. are traded between investors and borrowers is termed as financial markets.
Q. 2. What are the instruments of money markets?
Ans: call money markets, commercial papers, certificates of deposit, treasury bills and Trade Bill are the major instruments of money markets.
Q. 3. What are the market participants of call money market?
Ans: Commercial banks, Co-operative banks
Dealer, Brokerage firms, Financial institutions are the major participants in the call money market.
Q. 4. What are the examples of treasury bills?
Ans: 14, 36, 91, 182, and 364 days treasury bills. Treasury bills are short term debt instruments. Generally, central governments doesn’t fix the interest on treasury bills but the difference between face value and issues price of the treasury bills are considered return on the treasury bills.
Q. 5. What is commercial papers?
Ans: Generally, central governments doesn’t fix the interest on treasury bills but the difference between face value and issues price of the treasury bills are considered return on the treasury bills.
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