Elements of Money Market

The following are the important constituents of money market

Money market is not a homogeneous market. It is composed of heterogeneous sub-markets, each specialising in a specific short- term credit instrument. The following are the important constituents of money market:

 

1. Call Money Market:

The call money market deals with very short-period or call loans. Bill brokers and dealers in the stock exchange generally borrow money at call from the commercial banks.

These loans are granted for a very short period, not exceeding seven days in any case. The borrowers have to repay the loans immediately whenever the banks call them back. No collateral securities are required against these loans.

 

2. Collateral Loan Market:

Collateral loan market refers to a market for loans secured against collateral securities like stocks and bonds. The collateral is returned to the borrower at the time when he repays the loan. In case the borrower fails to repay the loan, the collateral becomes the property of the lender. Collateral loans are mostly granted by the commercial banks to private parties in the market and for a short period of a few months. Sometimes smaller banks also receive collateral loans from bigger banks.

 

3. Acceptance Market:

Acceptance market is a market for banker’s acceptances. A banker’s acceptance is a draft drawn by a business firm upon a bank and accepted by it whereby the bank is required to pay to the order of a specific party or to the bearer a specific sum of money at a specific future date. Banker’s acceptances are used mostly in financing the commercial transactions both within and outside the country. The banker’s acceptance is different from a cheque in that while the former is payable at a specified future date, the letter is payable on demand. Banker’s acceptance can be easily sold or discounted in the money market, called acceptance market.

 

4. Bill Market:

Bill market specializes in the sale and purchase of different types of short-term papers or bills. The important types of bills are: (a) bills of exchange and (b) Treasury bills. Since discounting of bills is the main business in the bill market, it is also known as discount market.

 

It should be noted that the bill market does not deal with long-term treasury bonds and other long-term papers which involve long-term lending,

 

(i) Bill of exchange:

The bill of exchange is a written unconditional order signed by the drawer (seller) requiring the drawer (buyer) to pay on demand or at a fixed future date a definite sum of money. After the bill has been drawn by the drawer (seller), it is accepted by the drawer (buyer).

Once the buyer puts his acceptance on the bill, it becomes a legal document. Such bills of exchange are discounted and re-discounted by the commercial banks for lending credit to the bill brokers or for borrowing from the central banks.

 

(ii) Treasury Bills:

While the bill of exchange is a commercial paper, the Treasury bill is government paper. The treasury bills are short-term government securities generally of three months’ duration. They are sold by the central bank on behalf of the government. They bear no interest rate and are offered on the basis of competitive bidding. Thus those who are satisfied with the lowest interest rate will be allotted the bills. Treasury bills, being government papers, inspire greater confidence among the investors

 

5. Commercial papers

Commercial paper (CP) is a short -term debt instrument issued only by large, well  known, creditworthy companies and is typically unsecured. The aim of its issuance is to provide liquidity or finance company’s investments, e.g. in inventory and accounts receivable. The major issuers of commercial papers are financial institutions, such as finance companies, bank holding companies, and insurance companies. Financial companies tend to use CPs as a regular source of finance. Non-financial companies tend to issue CPs on an irregular basis to meet special financing needs. Thus commercial paper is a form of short-term borrowing. Its initial maturity is usually between seven and forty-five days. In US, the advantage of issuing CPs with maturities less than nine months is that they do not have to register with the Securities Exchange Commission (SEC) as a public offering. This reduces the costs of registration with SEC and avoids delays related to the registration process.

6. Certificates of deposit

 

Certificate of deposit (CD) states that a deposit has been made with a bank for a fixed period of time, at the end of which it will be repaid with interest.  Thus it is, in effect, a receipt for a time deposit and explains why CDs appear in definitions of the money supply such as M4. It is not the certificate as such that is included, but the underlying deposit, which is a time deposit like other time deposits.  An institution is said to ‘issue’ a CD when it accepts a deposit and to ‘hold’ a CD when it itself makes a deposit or buys a certificate in the secondary market. From an institution’s point of view, therefore, issued CDs are liabilities; held CDs are assets. The advantage to the depositories that the certificate can be tradable. Thus though the  deposit is made for a fixed period, he depositor can use funds earlier by selling the  certificate to a third party at a price which will reflect the period to maturity and the  current level of interest rates.  The advantage to the bankis that it has the use of a deposit for a fixed period but, because of the flexibility given to the lender, at a slightly lower price than it would have had to pay for a normal time deposit.

 

7. Repurchase agreements

A repurchase agreement (REPO)is an agreement to buy any securities from a seller with the agreement that they will be repurchased at some specified date and price in the future. In essence the REPO transaction represents a loan backed by securities. If the borrower defaults on the loan, the lender has a claim on the securities. Most REPO transactions use government securities, though some can involve such short-term securities as commercial Papers and negotiable Certificates of Deposit. Since the length of any repurchase agreement is short-term, a matter of months at most, it is usually assumed as a form of short-term finance and therefore, logically, an alternative to other money market transactions.

 

8. International money market securities

Apart from variety of money market instruments which enable short-term lending and borrowing to take place in the domestic currency, in recent years some of the fastest growing markets have been the so-called Eurocurrency markets. These are markets in which the borrowing and lending denominated in a currency of some other country takes place. In general, Eurocurrency market instruments are the same as other money market instruments. When such instruments are denominated in some other currency, they are identified as ‘euro -’, though it can be any currency (e.g. US dollars, or Japanese yen). The trading can also take place anywhere (in European countries or in New York or Tokyo or Hong Kong).

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