Money market instruments refer to short-term financing securities such as Treasury bills, certificates of deposit, commercial paper etc. that provide more financial liquidity to investors. The primary feature of money market instruments is their high liquidity, allowing investors to easily convert them into cash to meet immediate needs. These instruments are typically traded over the counter, requiring transactions to be conducted through certified brokers or money market mutual funds, rather than by individual investors.
What are Money Market Instruments?
The main characteristic of money market instruments is that they can be easily converted to cash, thereby preserving an investor’s cash requirements.
The money market and its instruments are usually traded over the counter and, therefore, cannot be done by standalone individual investors themselves. It has to be done through certified brokers or a money market mutual fund.
Objectives of Money Market
Supplying short-term funds at a fair price to borrowers, including governments and individual investors. Due to the short duration of the assets in the money market, lenders or financial institutions will also benefit from liquidity.
It also enables lenders to invest their idle money profitably, benefiting both the borrower and the lender.
RBI governs the money market. Consequently, this aids in controlling the amount of liquidity in the economy.
Considering that the majority of businesses lack the working capital they need. These kinds of firms can get the money they provide to meet their working capital requirements, thanks to the money market.
It is a significant funding source for domestic and foreign trade for the government sector. This thus offers the banks a chance to store their excess cash.
What are the Types of Money Market Instruments?
The list of money market instruments traded in the money market are-
Certificate of Deposit
Lending substantial financial resources to an organization can be done against a certificate of deposit. The operating procedure is similar to that of a fixed deposit, except the higher negotiating capacity, as well as lower liquidity of the former.
Commercial Paper
This type of money market instrument serves as a promissory note generated by a company to raise short term funds. It is unsecured, and thereby can only be used by large-cap companies with renowned market reputation.
The maturity period of these debt instruments lies anywhere between 7 days to one year, and thus, attracts a lower interest rate than equivalent securities sold in the capital market.
Treasury Bills
These are only issued by the central government of a country when it requires funds to meet its short-term obligations.
These securities do not generate interest but allow an investor to make capital gains as it is sold at a discounted rate while the entire face value is paid at the time of maturity.
Since treasury bills are backed by the government, the default risk is negligible, thus serving as an optimal investment tool for risk-averse investors.
Repurchase Agreements
Commonly known as Repo, it is a short-term borrowing tool where the issuer availing the funds guarantees to repay (repurchase) it in the future.
Repurchase agreements generally involve the trading of government securities. They are subject to market interest rates and are backed by the government.
Banker’s Acceptance
One of the most common money market instruments traded in the financial sector, a banker’s acceptance signifies a loan extended to the stipulated bank, with a signed guarantee of repayment in the future.
Since money market instruments are traded wholesale over the counter, it cannot be purchased in standard units by an individual investor.
However, you can choose to invest in money market instruments through a money market mutual fund. These are interest-earning open-ended funds and bear significantly low risks due to their short maturity period and the collateral guarantee of the central government in most cases.
Money market investments should ideally be undertaken when the stock market poses a great degree of volatility. During this time, investing in equity and debt instruments in the capital market has high risk associated with it, as the chances of underperforming are immense.
The government generally tries to enhance the money circulation in the country to minimize market fluctuations. Thus, government-backed instruments offer higher returns in these circumstances to boost the demand for the same.
Features Of Money Market Instruments
High liquidity
Highly liquid short-term securities are available on the money market. They are cash equivalents because of their great liquidity, which allows them to be exchanged for cash at any moment. These securities are offered by a number of well-known dealers and financial organisations in order to raise money or accept loans.
Secure investment
Although there will always be some danger, because money market investments have short tenure, that risk is much minimised. Additionally, reputable businesses and firms only issue short-term securities and bonds. Because of this, there is less chance of default than with instruments with longer tenure.
Fixed returns
In India, money market instruments can be purchased for less than their face value. As a result, the return on bonds and securities is predetermined. Investing in the money market gives you peace of mind because it offers stable returns if kept until maturity.
Pros and Cons of Money Market Instruments
Pros- Money market instruments are more liquid than other fixed-income securities. Investors can sell their interests at any moment because there is no lock-in period.
The rate of return on a money market instrument is slightly higher than the rate of return on a savings account.
Cons- Without a doubt, the interest rate is larger than that of savings bank accounts. However, the interest rate does not account for the economy’s rising inflation. While other investment tools, such as mutual funds, provide a better return on investment over time.
As a result, if the goal of the investment is to achieve capital appreciation while outperforming inflation, money market instruments are not a suitable alternative.
FAQs
How do capital market instruments differ from money market instruments?
Money markets are utilized for short lending or borrowing; the assets are typically held for a year or less, whereas capital markets are used for long-term securities. They have an impact on the capital, either directly or indirectly. The equities and debt markets are examples of capital markets.
What are the examples of money market instruments?
Some examples of money market instruments are-
Commercial bills, Treasury bills, Certificate of Deposit, and more.