Money market instruments is an important source of finance to industry , trade, commerce, and government sector for meeting their short term requirement for both national and international trade.
These financial instruments provide also an investment opportunity to banks and others to deploy their surplus funds so as to reduce their cost of liquidity and earn some income.
What are the characteristics of money market instruments?
the instruments of money market are characterized by
- Short duration
- Large Volume
- De-regulated interest rates
- The instruments are highly liquid
- They are safe investments owing to issuers inherent financial strength
The traditional short-term MMI consist of mainly call money and notice money with limited players, treasury bills and commercial bills.
Further, the new MMI were introduced giving a wider choice to short term holders of money to reap yield on funds even for a day to earn a little more by parking funds through instruments for a few days more or until such time till they need it for lending at higher rate .
What are the types of money market instruments?
There are various types of instruments of money market are discussed below:
1. Call/Notice money
2. Treasury bills (TBs)
3. Commercial Bills
4. Certificate of deposits
5. Commercial Papers (CP)
6. Repurchase Options (Repo.) and Reverse Repurchase Agreement (Reverse Repo.)
1. Call/Notice money
Call money market or inter-bank call money market is a segment of the money market where schedule commercial banks lends or borrow on call (i.e. overnight) or at short notice (i.e for period upto 14 days ) to manage the day-to-day surpluses and deficits in their cash-flows.
However, under notice money market, funds are transacted for a period between two days and
fourteen days. These day to day surpluses and deficits arises due to the vary nature of their
operations and the peculiar nature of the portfolios of their assets and liabilities.
2. Treasury bills (TBs)
Among MMI TBs provide a temporary outlet for short-term surplus as also provide fiancial instruments of varying short-term maturities to facilitate a dynamic asset-liabilities management.
Further, the interest received on them is the discount which is the difference between the price at which they are issued and their redemption value.
This instrument assured yield and negligible risk of default. Moreover, TBs are short term promissory notes issued by Government of India at a discount.
However, at present, the RBI issues Treasury Bills of three maturities i.e. 91 days, 182 days and
364 days.
Further, TBs are issued at discount and their yields can be calculated with the help of the following formula :
Y = [F-P/P]*365/M*100
Where,
Y= Yield
F = Face Value
P= Issue price/Purchase price
M= Actual days of maturities
3. Commercial Bills
Commercial bills is one which arise out of genuine trade transaction , i.e. credit transaction. As soon as goods are sold on credit , the seller draws a bill on the buyer for the amount due . And than the buyer accept it immediately agreeing to pay amount mentioned therein after a certain specified date .
Thus, bill of exchange contains a written order from the creditor to the debtor to pay a certain sum , to certain person, after certain period.
In addition , a bill of exchange is a ‘self-liquidating’ paper and negotiable; it is drawn always for a short period ranging between 3 months and 6 months.
4. Certificate of deposits
The Certificate of deposits are negotiable term-deposits accepted by commercial bank from bulk depositors at market related rates. Further, CDs are usually issued in demat form or as a Usance Promissory Note.
Just like Commercial bills, Certificate deposit is a front-ended negotiable instruments , issued at discount and the face value is payable at maturity by the issuing bank.
5. Commercial Papers (CP)
Commercial papers are unsecured and negotiable promissory notes issued by high rated corporate entities to raise short term funds for meeting working capital requirements directly from the market instead of borrowing from banks.
Further, its period ranges from 7 days to 1 year. Moreover, CP is issued at discount to face value the issue of CP seeks to by-pass the intermediary role of the banking system through the process of secularization.
Thus, yield on CP is freely determined by the market. he yield on CP can be calculated as follows:
Y= FV-SV/SV*Days or month in a year /M *100
Where,
Y= Yield
FV= Face value
SV= Sale value
M= Period of discount
6. Repurchase Options (Repo.) and Reverse Repurchase Agreement (Reverse Repo.)
Repurchase Options (Repo.) and Reverse Repurchase Agreement (Reverse Repo.) refers to type of transaction in which money market participants raises funds by selling securities and simultaneously agreeing to repurchase the same after a specified time generally at a specified price, which typically includes interest at an agreed upon rate.
Sometimes it is also called Ready Forward Contract as it involves funding by selling securitis and repurchasing them on a forward basis.
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