MBA III
Tuesday 18 June 2019
Wednesday 29 October 2014
MONEY MARKET
Definitions of Money Market
Following
definitions will help us to understand the concept of money market.
According to Crowther,
"The money market is a name given to the various firms and institutions
that deal in the various grades of near money."
According to the
RBI, "The money market is the centre for dealing mainly of short
character, in monetary assets; it meets the short term requirements of
borrowers and provides liquidity or cash to the lenders. It is a place where
short term surplus investible funds at the disposal of financial and other
institutions and individuals are bid by borrowers, again comprising
institutions and individuals and also by the government."
According to Nadler
and Shipman, "A money market is a mechanical device through which
short term funds are loaned and borrowed through which a large part of the
financial transactions of a particular country or world are degraded. A money
market is distinct from but supplementary to the commercial banking
system."
These
definitions help us to identify the basic characteristics of a money market. A
money market comprises of a well organized banking system. Various financial
instruments are used for transactions in a money market. There is perfect
mobility of funds in a money market. The transactions in a money market are of
short term nature.
Definition of 'Money Market'
A
segment of the financial market in which financial instruments with high
liquidity and very short maturities are traded. The money market is used by
participants as a means for borrowing and lending in the short term, from
several days to just under a year. Money market securities consist of
negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury
bills, commercial paper, municipal notes, federal funds and repurchase
agreements (repos).
'Money Market'
The
money market is used by a wide array of participants, from a company raising
money by selling commercial paper into the market to an investor purchasing CDs
as a safe place to park money in the short term. The money market is typically
seen as a safe place to put money due the highly liquid nature of the
securities and short maturities, but there are risks in the market that any
investor needs to be aware of including the risk of default on securities such
as commercial paper.
Money market
As money became a commodity,
the money market became a component of the financial
markets for assets involved in short-term borrowing, lending, buying and selling with original
maturities of one year or less. Trading in the money markets is done over the counter, is wholesale.
Various instruments exist, such as Treasury bills, commercial
paper, bankers' acceptances, deposits, certificates of deposit, bills
of exchange, repurchase agreements, federal funds, and
short-lived mortgage-, and asset-backed securities.[1]
It provides liquidity funding for the global financial system. Money markets and capital
markets are parts of financial
markets. The instruments bear differing maturities, currencies, credit
risks, and structure. Therefore they may be used to distribute the exposure.[2]
History
The money market
developed because parties had surplus funds, while others needed cash.[3][4]
Today it comprises cash instruments as well.
Participants
The money market
consists of financial institutions and dealers in money
or credit who wish to either borrow or lend. Participants borrow and lend for
short periods of time, typically up to thirteen months. Money market trades in
short-term financial instruments commonly called
"paper." This contrasts with the capital
market for longer-term funding, which is supplied by bonds
and equity.
The core of the
money market consists of interbank lending--banks borrowing and
lending to each other using commercial
paper, repurchase agreements and similar instruments.
These instruments are often benchmarked to (i.e. priced by reference to) the London Interbank Offered Rate (LIBOR)
for the appropriate term and currency.
Finance
companies typically fund themselves by issuing large amounts of asset-backed commercial paper (ABCP)
which is secured by the pledge of eligible assets into an ABCP conduit.
Examples of eligible assets include auto loans, credit card receivables,
residential/commercial mortgage loans, mortgage-backed securities and similar financial
assets. Certain large corporations with strong credit
ratings, such as General Electric, issue commercial paper on their
own credit. Other large corporations arrange for banks to issue commercial
paper on their behalf via commercial paper lines.
In the United
States, federal, state and local governments all issue paper to meet funding
needs. States and local governments issue municipal
paper, while the US Treasury issues Treasury bills to fund the US public debt.
·
Trading
companies often purchase bankers'
acceptances
to be tendered for payment to overseas suppliers.
·
Retail
and institutional money market funds
·
Banks
·
Central
banks
·
Cash
management programs
·
Merchant
Banks
Functions of Money Market
Money market is
an important part of the economy. It plays very significant functions. As
mentioned above it is basically a market for short term monetary transactions.
Thus it has to provide facility for adjusting liquidity to the banks, business
corporations, non-banking financial institutions (NBFs) and other financial
institutions along with investors.
The major functions of money market are
given below:-
1.
To
maintain monetary equilibrium. It means to keep a balance between the demand
for and supply of money for short term monetary transactions.
2.
To
promote economic growth. Money market can do this by making funds available to
various units in the economy such as agriculture, small scale industries, etc.
3.
To
provide help to Trade and Industry. Money market provides adequate finance to
trade and industry. Similarly it also provides facility of discounting bills of
exchange for trade and industry.
4.
To
help in implementing Monetary Policy. It provides a mechanism for an effective
implementation of the monetary policy.
5.
To
help in Capital Formation. Money market makes available investment avenues for
short term period. It helps in generating savings and investments in the
economy.
6.
Money
market provides non-inflationary sources of finance to government. It is
possible by issuing treasury bills in order to raise short loans. However this
dose not leads to increases in the prices.
Apart from
those, money market is an arrangement which accommodates banks and financial
institutions dealing in short term monetary activities such as the demand for
and supply of money.
Functions of the money market
The money market functions are
·
Transfer
of large sums of money
·
Transfer
from parties with surplus funds to parties with a deficit
·
Allow
governments to raise funds
·
Help
to implement monetary policy
·
Determine
short-term interest rates
Common money market instruments
·
Certificate
of deposit
- Time deposit, commonly offered to consumers by banks, thrift institutions,
and credit unions.
·
Repurchase
agreements
- Short-term loans—normally for less than two weeks and frequently for one
day—arranged by selling securities to an investor with an agreement to
repurchase them at a fixed price on a fixed date.
·
Commercial paper - short term
usanse promissory notes issued by company at discount to face value and
redeemed at face value
·
Eurodollar
deposit
- Deposits made in U.S. dollars at a bank or bank branch located outside the
United States.
·
Federal
agency short-term securities - (in the U.S.). Short-term securities issued by government sponsored enterprises such as the Farm
Credit System,
the Federal
Home Loan Banks
and the Federal National Mortgage Association.
·
Federal funds - (in the
U.S.). Interest-bearing deposits held by banks and other depository
institutions at the Federal Reserve; these are
immediately available funds that institutions borrow or lend, usually on an
overnight basis. They are lent for the federal
funds rate.
·
Municipal notes - (in the
U.S.). Short-term notes issued by municipalities in anticipation of tax
receipts or other revenues.
·
Treasury
bills
- Short-term debt obligations of a national government that are issued to
mature in three to twelve months.
·
Money
funds
- Pooled short maturity, high quality investments which buy money market
securities on behalf of retail or institutional investors.
·
Foreign
Exchange Swaps
- Exchanging a set of currencies in spot date and the reversal of the exchange
of currencies at a predetermined time in the future.
Discount and accrual instruments
There are two
types of instruments in the fixed income market that pay the interest at
maturity, instead of paying it as coupons. Discount instruments, like
repurchase agreements, are issued at a discount of the face value, and their
maturity value is the face value. Accrual instruments are issued at the
face value and mature at the face value plus interest.[7]
Indian Money Market
The
entire money market in India can be divided into two parts. They are organized
money market and the unorganized money market. The unorganized money market can
also be known as an unauthorized money market. Both of these components
comprise several constituents. The following chart will help you in
understanding the organizational structure of the Indian money market.
Indian Money Market
UNORGANISED
MONEY MARKET
The unorganized money market mostly finances
short term financial needs of farmers and small businessmen. The main
constituents of unorganized Money market are:
1. Indigenous Bankers (IBs): The IBs are individuals or private firms who receive
deposits and give loans and thereby they operate as banks. Unlike moneylenders
who only lend money, IBs accept deposits as well as lend money. They operate
mostly in urban areas, especially in western and southern regions of the
country. Over the years, IBs faced stiff competition from cooperative banks and
commercial banks. Borrowers are small manufacturers and traders, who may not be
able to obtain funds from the organized banking sector, may be due to lack of
security or some other reason.
2. Money Lenders (MLs): MLs are important participants in unorganized money markets
in India. There are professional as well as non professional MLs. They lend
money in rural areas as well as urban areas. They normally charge an invariably
high rate of interest ranging between 15% p.a. to 50% p.a. and even more. The borrowers
are mostly poor farmers, artisans, petty traders, manual workers and others who
require short term funds and do not get the same from organized sector.
3. Chit Funds and Nidhis: They collect funds from the members for the purpose of
lending to members (who are in need of funds) for personal or other purposes.
The chit funds lend money to its members by draw of chits or lots, whereas
Nidhis lend money to its members and others.
4. Finance Brokers: They act as middlemen between lenders and borrowers. They
charge commission for their services. They are found mostly in urban markets,
especially in cloth markets and commodity markets.
5. Finance Companies: They operate throughout the country. They borrow or accept
deposits and lend them to others. They provide funds to small traders and
others. They operate like indigenous bankers.
MEASURES TO IMPROVE INDIAN MONEY
MARKET
The
major drawback of India Money Market is its high volatility. Gradually the
money market transaction is increasing. But, on the recommendation of the
Sukhmoy Chakravarty Committee (on the review of the working of the Monetary
System) and the Narasimham committee (on the Report on the working of the
financial system in India, 1991), RBI initiated a series of reform in Indian
Money Market. The following are some of the measures undertaken,
ORGANISED
MONEY MARKET
Indian money market can be divided
into various sub-markets depending on their nature and scope of the
transactions and the features of the instruments.
The RBI is the apex
institution which controls and monitors all the organizations in the organized
sector. The commercial banks can operate as lenders and operators. The FIs like
IDBI, ICICI, and others operate as lenders. The organized sector of Indian
money market is fairly developed and organized, but it is not comparable to the
money markets of developed countries like USA, UK and Japan.
1. The Call Money: It is also known as Interbank Call Money Market.
Here, lending and borrowing transactions are carried out for one day.
These one day loans may or may not be renewed the next day. The demand
for call money comes from commercial banks that need to meet requirements of
CRR and SLR, whereas supply comes from commercial banks with excess
funds, and FIs like IDBI, etc.
It
an important sub market of the Indian money market. It is also known as money
at call and money at short notice. It is also called inter bank loan market. In
this market money is demanded for extremely short period. The duration of such
transactions is from few hours to 14 days. It is basically located in the
industrial and commercial locations such as Mumbai, Delhi, Calcutta, etc. These
transactions help stock brokers and dealers to fulfill their financial
requirements. The rate at which money is made available is called as a call
rate. Thus rate is fixed by the market forces such as the demand for and supply
of money.
The
call money market is a system in which dealers and brokers borrow money to
finance their investments on a very short-term basis. The source of the funds,
usually a bank, can request return of the money at any time. This makes
"call money" a risky transaction.
Function: The call money market makes
short-term loans that can be recalled at any time. These loans provide money to
conduct transactions between other market dealers, financial institutions and
banks. The loans can either be secured or unsecured. The lender considers
features such as the credit worthiness of the borrower, the rate at which the
money is being sought and the amount of time until repayment of the loan.
Features: Individual investors do not
usually take part in call money market transactions. The investor approaches a
broker firm that finances the money for the investor. Then the brokerage firm
gets a call money loan from the best source of funds, which are suited to the
individual's specific needs and circumstances.
Time Frame: A call money market is
operational for a very short period of time. The loan must be repaid to the
source, usually a bank, on demand. The time span for repayment usually ranges
from one to less than 15 days. The rate of interest at which the money is
borrowed is known as the call money rate and is determined by the lender.
Banks
borrow in this money market for the following purpose:
• To fill the gaps or temporary mismatches in funds
• To meet the CRR & SLR mandatory requirements as stipulated by the Central bank
• To meet sudden demand for funds arising out of large outflows.
Thus call money usually serves the role of equilibrating the short-term liquidity position of banks
• To fill the gaps or temporary mismatches in funds
• To meet the CRR & SLR mandatory requirements as stipulated by the Central bank
• To meet sudden demand for funds arising out of large outflows.
Thus call money usually serves the role of equilibrating the short-term liquidity position of banks
Call
Money Market Participants :
1.Those who can both borrow as well as lend in the market - RBI (through LAF) Banks, PDs
2.Those who can only lend Financial institutions-LIC, UTI, GIC, IDBI, NABARD, ICICI and mutual funds etc.
Reserve Bank of India has framed a time schedule to phase out the second category out of Call Money Market and make Call Money market as exclusive market for Bank/s & PD/s.
1.Those who can both borrow as well as lend in the market - RBI (through LAF) Banks, PDs
2.Those who can only lend Financial institutions-LIC, UTI, GIC, IDBI, NABARD, ICICI and mutual funds etc.
Reserve Bank of India has framed a time schedule to phase out the second category out of Call Money Market and make Call Money market as exclusive market for Bank/s & PD/s.
Repurchase
agreements: The repurchase agreement or the Repo is
used by the government security holder when he sells the security to a lender
and promises to repurchase from him overnight. These
are short-term borrowings normally for less than two weeks and often for an
overnight basis – arranged by selling securities to an investor with an
agreement to repurchase them at a fixed price on a fixed date. They are very
safe due government backing. In it’s essence, repo transaction can be viewed as
a secured short term cash loan. The buyer of the security effectively acts as
a lender, while the seller of the security is effectively acting as
a borrower that uses a security as collateral for a secured
cash loan at a fixed rate of interest.
Reverse Repo Rate
Affect the Bank Loan interest rates: Reverse Repo rate is the rate
at which Reserve Bank of India (RBI) borrows money from banks. Banks are always
happy to lend money to RBI since their money are in safe hands with a good
interest. An increase in Reverse repo rate can cause the banks to transfer more
funds to RBI due to this attractive interest rates. It can cause the money to
be drawn out of the banking system.
Due to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo Rate and Reverse Repo rate our banks adjust their lending or investment rates for common man.
Due to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo Rate and Reverse Repo rate our banks adjust their lending or investment rates for common man.
2. The Commercial Bill Market: It deals in bills of exchange. A seller draws a bill
of exchange on the buyer to make payment within a certain period of time. The
bills can be domestic bills or foreign bills of exchange. The
commercial bills are purchased and discounted by commercial banks, and
are rediscounted by FIs like EXIM Bank, SIDBI, IDBI, etc.
3. The Treasury Bill Market: This
is a market for sale and purchase of short term government securities. These
securities are called as Treasury Bills which are promissory notes or financial
bills issued by the RBI on behalf of the Government of India. It deals in Treasury Bills of short term duration 14 days, 91 days, 182 days and 364 days. The
treasury bills facilitate the financing of Central Government temporary deficits. From May 2001, the auction
of 14 days and 182 days treasury bills has been discontinued. At present, there
are 91 days and 364 days treasury bills. The rate of interest for treasury
bills is determined by the market,
depending on the demand and supply of funds in the money market.
There
are two types of treasury bills.
(i). Ordinary or Regular Treasury Bills and
(ii). Ad Hoc Treasury Bills. The maturity period of
these securities range from as low as 14 days to as high as 364 days. They have
become very popular recently due to high level of safety involved in them.
4. The Certificate of Deposit : The scheme of Certificate of Deposit (CD) was introduced by
RBI in 1989. The main purpose of CD is to enable the commercial banks to
raise funds from the market. The CDs maturity period ranges from 7 days to
1 year (in case of FIs minimum 1 year and maximum 3 years). The CDs are issued
at a discount to its face value. The CDs are issued in denomination of Rs. 1
lakh and thereafter, multiples of Rs. 1 lakh. The holder is entitled to receive
a fixed rate of interest and have no lock-in period. The return on
the certificate of deposit is higher than the Treasury Bills because it assumes
a higher level of risk.
Advantages of Certificate of Deposit as
a money market instrument:
1. Since one can know the returns from before, the certificates of deposits are considered much safe.
2. One can earn more as compared to depositing money in savings account.
3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.
1. Since one can know the returns from before, the certificates of deposits are considered much safe.
2. One can earn more as compared to depositing money in savings account.
3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.
Disadvantages of Certificate of deposit
as a money market instrument:
1. As compared to other investments the returns is less.
2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.
1. As compared to other investments the returns is less.
2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.
5. The Commercial Paper: Commercial Paper
is short-term loan that is issued by a corporation use for financing accounts
receivable and inventories. Commercial Papers have higher denominations as
compared to the Treasury Bills and the Certificate of Deposit. The maturity
period of Commercial Papers are a maximum of 9 months. They are very safe since
the financial situation of the corporation can be anticipated over a few
months.
The scheme of Commercial Paper (CP)
was introduced in 1990. Blue chip
companies for short term financing issue CPs. As per RBI guidelines, CPs
can be issued on the following conditions:
·
The minimum tangible net worth of
the company to be at least Rs. 4 crores.
·
The CP receives a minimum rating of
A-2 or such other rating from recognized rating agencies like CRISIL, CARE,
ICRA, Fitch Ratings, etc.
·
The company has been sanctioned
working capital limit by bank/s or all-India FIs.
The CPs maturity period ranges from
7 days to 1 year. They can be issued in multiples of Rs. 5 lakhs and in
multiples thereof. They are sold at a discount to its face value and redeemed
at its face value.
Recent Trends: Initially, the CP amount outstanding rose from Rs.86 crore
as at the end of financial year 1989-90 to Rs. 577 crore as at the end of the
year 1992-93 (Table I) and the CP outstanding was declined to Rs.76 crores
since typical discount rate was touched to 20.20 – 20.15 in
1995-96. Following various relaxations in the terms and conditions for
issue of CP, CP issuances gathered momentum thereafter and reached Rs. 7,224
crore by end-March 2002.
A
couple of better rated corporate have managed to raise 90 days money in the CP
market for as low as 5.55%, which is just five basis points above the repo rate
and ACC and L&T are the two players that have raised money at very
fine rates in 1994. The sudden spurt in volumes could indicate revival of
economic activity. The total outstanding amount as on 30th April
2005 is Rs. 15199 and the effective discount rate per annum during the last
fortnight of April 2005 is 5.50-6.65.
6. Money Market Mutual Funds
(MMMFs): The MMMFs were introduced in 1992.
The objective of MMMFs is to provide an additional short term avenue to the
individual investors. In 1995, RBI modified the scheme to allow private
sector organizations to setup MMMFs. During 1996, the scheme of MMMFs was made
more flexible by bringing it on par with all Mutual Funds by allowing
investments by corporate and others. The scheme has been made more attractive
to investors by reducing lock in period from 45 days to 15 days. Resources
mobilized from MMMFs are required to be invested in call money, CDs, CPs,
commercial bills, treasury bills, and government dated securities having an
unexpired maturity of up to 1 year.
7. Banker's
Acceptance:
It is a short-term credit investment. It is guaranteed by a bank to make
payments. The Banker's Acceptance is traded in the Secondary market. The
banker's acceptance is mostly used to finance exports, imports and other
transactions in goods. The banker's acceptance need not be held till the
maturity date but the holder has the option to sell it off in the secondary
market whenever he finds it suitable.
8. Euro Dollars: The Eurodollars
are basically dollar- denominated deposits that are held in banks outside the
United States. Since the Eurodollar market is free from any stringent
regulations, the banks can operate at narrower margins as compared to the banks
in U.S. The Eurodollars are traded at very high denominations and mature before
six months. The Eurodollar market is within the reach of large institutions
only and individual investors can access it only through money market funds.
DEFECTS OF INDIAN MONEY MARKET
Money market is the market for
lending and borrowing of short term funds. A well developed money market
denotes an implementation of effective monetary policy. But the Indian money
market suffers from many weaknesses.
1.
Lack of
integration: The Indian Money Market is divided
into two sectors viz, the organized and unorganized money market. But both the
markets are completely separate from each other. They are working independently
and have little effect on each other. RBI is fully effective in controlling the
organized sector. But, it has very less control on the unorganized sector.
2.
Lack of
rational interest rates structure:
The Indian Money Market exist too many interest rates. For example, the deposit
and lending rates of commercial banks, the borrowing rate of Government etc. In
the past these created excess demand for credit and the RBI had to rely often
on cash reserve ratio. Though the RBI has tried to bring rationality in the
interest rates, the situation in the Indian money market is still not
effective.
3.
Existence
of Unorganized Money Market: The
existence of the unorganized sector in money market still prevails in Indian
Money Market. The indigenous banker does not make any distinction between short
term and long-term finance. They have no coordination with each other and have
no link with other banking sectors. They do not follow any sound banking
regulations. The RBI has no control over these bankers.
4.
Absence of
an organized bill market:
In Indian Money Market, there is an absence of adequate bill market. There is
an absence of commercial bill market or a discount for short term commercial
bills. There are many factors responsible for the underdeveloped bill market
such as (i) relying more on cash transaction, (ii) cash credit of commercial
bank, (iii)seller’s limited use of bills, (iv) imposition of heavy stamp duty,
(v) absence of acceptance houses etc.
5.
Shortage
of funds in the Money Market:
The lack of banking habit, inadequate banking facility, less saving habit, etc
created have shortage of fund in the money market. On the other hand, the
increasing demand for loan able funds in the money market far exceeds its
supply.
6.
Inadequate
banking facility: Now-a-days, the commercial
banks have opened many new branches of banking facilities. But, it still leaves
much scope for further development. In a developing country like India, people
live below poverty line and have less saving habit. Their savings are very
small and they do not have much access to banking facilities till now.
Seasonal
Stringency of Money: During
the part of the year the interest rates are become high due to the increasing
demand for funds in the money market for the operation in the agricultural
sector. Basically, it is seen in the period from October to June.
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