Money Market Instruments: Meaning, Types & Benefits

Financial market investing is fraught with inherent risk and uncertainty. Investments often result in more losses than gains if not done carefully. Hence, it is vital to learn a little about the financial market before diving into it.

The financial market comprises two parts – the capital market and the money market. But what are they?

Money Market Instruments are short-term financial instruments or securities that are issued by the Government or financial institutions to meet their short-term borrowing needs and are generally repaid in less than a year. Examples and types of money market funds are commercial papers, T-bills, promissory notes, certificates of deposit, etc.

It is one of the largest organised trading markets and houses various financial institutions, brokers, banks, investors, dealers, and even the government. Governments, banks, and financial institutions sell or issue securities and bonds with a short maturity to accumulate capital. You can buy these securities with a promise of fixed returns.

What Are Money Market Instruments?

According to RBI, the money market is a marketplace where the trading of short-term funds and instruments takes place. The participants in this money market are Government, financial institutions, corporations and investors. Reserve Bank of India and SEBI regulate the money market.

The popular types of money market instruments are “treasury bills, bonds, commercial papers, and certificates of deposit.” These money market instruments are the primary choice for investors who want to invest for short duration with no or minimum risk.

In this article, you’ll learn the meaning of money market instruments, their types, features, functions, regulator, who should invest and things to know before investing.

Also Read Stock Market Timings in India: Opening & Closing Times for NSE & BSE

Features Of Money Market Instruments

1. High liquidity

The money market offers short-term securities that are highly liquid. Their high liquidity makes them cash equivalents; that is, they can be traded for cash anytime. Several renowned financial institutions and dealers issue these securities to take loans or generate funds.

2. Secure investment

Risk is inevitable, however in the case of the money market, the risk is significantly reduced due to low tenure. Also, only companies and corporations with high credibility and goodwill issue short-term securities and bonds. Hence, the risk of default is low as compared to higher tenure instruments.

3. Fixed returns

Money market instruments in India are available at a discount on face value. Therefore, the return on securities and bonds is pre-decided. You can be rest assured while investing in the money market, as it promises fixed returns if held till maturity.

Types Of Money Market Instruments In India

Money market instruments are tools allowing businesses, banks, and the government to accumulate funds using short-term securities and bonds. There are different types of money market instruments, depending on the investment amount, the maturity period and the type of issuer.

1. Treasury Bills

Treasury bills or T-Bills are short-term debt money market instruments introduced in 1917. The RBI issues T-Bills on behalf of the Government of India. These are available at a discount to their original value, and the buyer gets the amount equivalent to the face value on maturity. T-Bills are zero coupon securities as the buyer does not receive any interest. You can buy it in three tenors, 91 days, 182 days, and 364 days. 

For example, a treasury bill of Rs. 100 can be bought at Rs. 95. However, you will get Rs. 100 on the maturity date without any interest in between. 

Features

• Negligible risk
• No tax deduction 
• The minimum amount to bid is Rs 10,000 and in multiples thereof.
• One can buy them at a discount and get the redemption at par.

2. Commercial Papers

The RBI introduced commercial papers (CPs) in 1990 to diversify the sources of short-term borrowings for corporate borrowers and to provide investors with a new instrument. It is an unsecured money market instrument in the form of a promissory note issued by financial institutions and large corporations. You can buy commercial paper at a discount. The return on CPs equals the difference between the purchase price and the face value. Borrowers issue commercial papers for Rs. 5 lakhs or multiples thereof with no minimum value. CPs are issued for varied tenors ranging from 15 days to 364 days. 

Commercial papers comprise bills of exchange, customer receipts, promissory notes, delivery orders, etc. CPs often come into use for accounts payable and inventories, financing payrolls, and for managing other short-term liabilities. 

Features

• Has a fixed maturity period.
• It is an easy instrument to raise short-term funds as the issuer need not give any collateral against it.
• It is issued in denominations of Rs. 5 lakhs or multiples thereof.
• Can be traded over exchange if listed.

3. Banker’s Acceptance

Banker’s Acceptance (BA) is probably the oldest money market instrument. It has been in use since the 12th century to facilitate trade. Unlike the other money market instruments, BA is a bank’s obligation to pay an individual account holder. In layman’s words, the bank has to pay a specified amount to the account holder. Banker’s Acceptance is also available at a discounted price and functions like certified checks; the payment of the owed amount is on the specified date. The maturity period falls between 30 days to 180 days. 

Banker’s Acceptance is often used in trade (particularly when there is import-export of goods involved). The importers’ bank guarantees the payment to the exporter. 

Features

• Can be traded as bonds in the secondary money market.
• It is a safe and secure way to make both-end transactions.
• Banks can demand collateral before issuing it.

4. Certificates of Deposit

Another component of the money market is Certificates of Deposit. It was first used in 1989 to increase the range of money market instruments in India. CDs can be issued obly by Scheduled Commercial Banks, Regional Rural Banks and Small Finance Banks. This instrument offers greater flexibility to investors to utilise their funds. It is issued by banks in a dematerialised form against the deposited amount in a bank for some time. The RBI has issued guidelines for CDs and updates them routinely. Companies, corporations, individuals, etc., can purchase them. The tenure of CDs range from seven days to one year

Features 

• Banks are not allowed to grant loans against CDs, unless specifically permitted by the Reserve Bank.
• Cannot be traded publicly.
• Issuing banks are permitted to buyback CDs before maturity subject to conditions specified by RBI.
• It is issued in Rs. 5 lakh and its multiples.

5. Repurchase Agreements

Repurchase Agreements, also known as repo, are short-term borrowings in government securities for dealers. In 1992, repo was introduced to improve the economy’s short-term liquidity management and to manage and even out interest rates in the money market. Dealers sell government securities as collateral to investors and then buy them at a higher price the next day. Repurchase Agreements do not have a maximum maturity period, but the minimum is one week. In some repo securities, there is no fixed maturity period, and there can be regular fluctuations in the interest rates contingent on the market conditions. Repurchase Agreements include agency bonds, government bonds, corporate bonds, emerging market bonds, convertible bonds, and supranational bonds. 

Features

• Security acts as collateral.
• Interest is lower in comparison to other securities.
• Used for lending and borrowing within a tenor of 48 hours or less.
• Investors can sell the collateral in case of bankruptcy.

Importance Of Money Market

You might be wondering what is the need for these instruments or short-term debts when one can easily access the stock market. Yes, the stock market provides long-term investments and promises wealth creation in the future. But, the role of the money market is equally significant. The following reasons underline the importance of the money market:

• The money market balances the demand and supply of monetary and financial transactions. 
• It helps in implementing monetary policies. 
• It provides a safe method to access short term funds to businesses, helping them grow and meet short term expenses and liquidity and in turn, further develop the economy.
• It helps keep inflation on track. The government can quickly raise funds through these instruments. Without these instruments, the government would have to print more currency or turn to longer tenure loans to fund projects for social welfare, leading to inflation.
• Short-term interest rates influence long-term interest rates. 
• It determines the statutory liquid ratio and cash reserve ratio.

Objectives Of Money Market Instruments

• Diversification

Money market instruments are an excellent option to park your idle money and earn interest by bearing less risk. It can help you diversify your portfolio.

• Cash flow management

This is a medium to manage cashflows efficiently. You can earn a fixed and steady interest over a stipulated period.

• Short-term funding

For lenders, it is an excellent source to get loans at lower interest rates to meet their short-term funding requirements. By issuing these securities, they can borrow for a period ranging from a few days to 1 year.

• Liquidity Management

These instruments are highly liquid, so they allow investors to convert their investments into cash when needed. This helps to manage the flow of cash in the economy efficiently.

Things To Consider Before Investing In Money Market Instruments

Although the money market is a gateway to investing in debt securities, it is not a perfect investment avenue. As the saying goes, “You won’t grow without taking risks.”

On the bright side, the money market has little to no risks. Yes, some issues might cause minor problems, but nothing significant leads to an instant downfall. When investing in the money market, you must consider the following points:

• Figure out your short-term goals.
• Risk level you can endure with ease.
• Assets which you plan to invest in.
• Economic condition and stability of the country.
• Research thoroughly before investing in any company to avoid fraud and scams.

Pros and Cons Of Money Market Securities

Pros

1. Short-term investments

Money market instruments focus on short-term maturities ranging from a few days to a year. It helps you to benefit from interest rate changes and quickly diversify your investments.

2. Safe investments

Money market instruments help to secure an investment portfolio. During market instability, they act as a predictable income source for investors.

3. Capital safeguarding

Since these securities are backed by reputed issuers like government and financial institutions, their credibility is high, making them a safe investment option.

Cons

1. Less returns

The returns earned on money market securities are comparatively lesser than stocks and bonds. 

2. Partial risk-free

Money market securities may be less risky than other investment options, but these are not fully risk-free. In times of financial crisis or economic downturn, there may be disruptions that may create risks.

3. Inflation risk

Returns earned from money market securities may not be at par or beat the rising inflation. If the returns are lesser than the inflation rate, it will reduce your purchasing power.

What Is The Difference Between The Money Market and The Capital Market?

Conclusion

Investments in the money market are an excellent option. If you are looking for short-term investment with minimal risks, you can always turn to the money market to enjoy its benefits of fixed returns.

Frequently Asked Questions (FAQs)