Everything you need to know about money markets, their instrumets and functions: Expert Edition

What are money markets?

An exchange market which is organised can be called a money market. Participants in this organised exchange market can lend and borrow short-term capital. That’s not all; they can also trade high-quality debt securities with an average maturity duration of one year or even less than that. It gives money to the governments and other financial institutions, such as banks and NBFCs, and likes to sell short-term securities.

This, in turn, helps fund their short-term cash flow requirements. Money markets also enable an individual investor to invest small capital in a low-risk setting. 

Functions of money markets

The money market is an integral component of a nation (as a capital entity) to stabilise its economy. It also enables the country to bring in developmental measures financially by allowing the government to liquidate their assets for the short term. And maintain the necessary cash flow required to run the country efficiently. All these are parts of money markets, and learn investment banking you need to know to make a career in this sector. 

But that is not all. The money market has many more roles to play. Some of the important functions of the money market are given below:

• Trade Financing

The money market finances local and international traders. It provides them with the short-term funds they require. They also facilitate the discounting for bills of exchange. 

Likewise, goods and services are funded by the money market. The money market also funds other economic units like agriculture and small-scale industries.

• Helps in Industrial Growth

Besides financing trade, the money market also provides capital for businesses of all sizes. It is an easy avenue for obtaining short-term loans to replenish working capital funds. It includes raw materials, employee payments or other miscellaneous expenses. With the help of financial bills and commercial provisions, borrowing short-term funds is part of the money market.  

Another aspect of the money market is a strange one, but it is an interesting one. The money market does not fund any long-term loans but impacts the capital market and helps the business procure long-term loans. The interest rates are benchmarked based on the prevailing interest rate in the money market.

• Assists in making policies for the central bank

The central bank, or the RBI (Reserve Bank of India), regulates the country's monetary policies. They give the necessary directions to the Indian banking industry to decide the interest rates against the loans in the country. 

The combined money markets also help the central bank control and influence the subsidiary markets in the country. In this way, the money market helps the central bank to perform the function of policymaking efficiently.

• Makes commercial banks self-sufficient

The money market makes provisions for the commercial banks operating under them to invest their reserves that are in excess. It allows commercial banks to earn interest on the principal while maintaining the required liquidity. 

Bills of exchange and other short-term investments can be easily converted into cash to enable seamless customer withdrawals. They can even take short term loans when they face a shortage of funds. The money market often charges lower interest rates on short-term loans.

Instruments of money markets

For short-term lending and borrowing, the money market has several instruments. Have a look at them and try to understand their functions

• Treasury Bills

These are considered to be the safest instruments in the Indian money market. The reason behind this is that they are issued with a guarantee from the Indian Government. They have a maturity period of 1, 3, 6 or 12 months.  Sold at a discount at face value, both individuals and financial institutions can purchase them. 

• Function(s): They help in financing the central reserve’s deficits

• Deposit certificate

Commercial banks and brokerage firms both can issue it. The maturity date spans between 3 months to 5 years. If you withdraw before the maturity period, you face a penalty. 

• Function(s): It provides the money markets with the required liquidity

• Bankers Acceptance

A firm may issue a short-term debt fund, but a bank needs to guarantee it. Maturity lies between 1 to 6 months. These are often used in international trade.

• Function(s): Helps the funds to move in the international markets.  

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