Money Market Instruments in India: Factors to consider before investing

Money Market Instruments in India
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Money Market Instruments in India: What do they mean?

Money Market is one of the financial markets where short-term debt securities are borrowed and lent in large volumes. A market is a place where institutions and investors are dealing in securities with maturities of one year or less.

The Money Market includes huge numbers of smaller sub-markets and the transactions under this market are done through formal documentation, written or oral communication and not via any brokers.

The Money Market is made up of institutions like Non-Banking Finance Corporations (NBFCs), Commercial Banks, Acceptance houses, etc.

Instruments of Money Market

Moving forward let us explain the instrument of the money market. Money Market Instruments have characteristics of high liquidity and short maturity. The deals of instruments of the money market are not carried out in cash or money. Following are the instruments that are used to get short-term capital :

  • Treasury Bills - It is considered one of the popular instruments of the money market. Treasury bills are issued by the government of India at a discount for a period of low as 14 days to upto 364 days.
     
  • Certificate of Deposit - Also known as Negotiable term deposit accepted by commercial banks of India. Duration of Certificate of Deposit can be 3 months to 3 years

and these are issued to corporations, individuals, etc. 

  • Commercial Papers - These are issued by corporates to meet their working capital requirements. The duration of commercial papers varies from 15 days to 1 year.
  • Commercial Bills - Commercial Bills are issued by businesses to meet their short-term capital requirements. Commercial Bills work as Bills of Exchange and they can also be transferred from one person to another.
  • Call Money - In order to manage day-to-day cash flows, commercial banks lend or borrow on short notice in call money.

Money Market Instruments in India: Characteristics

Money Market Instruments serve as a dual benefit of liquidity to lenders and allow borrowers to meet their short-term requirements. Following are the special characteristic of money market instruments :

  • Discount - Instrument of the money market can be issued at discount on the face value.
  • Liquidity - Instruments of the money market are highly liquid and they can be liquidated quickly within a short period.
  • Safety - Money Market instruments are considered a safer option if compared to other types of instruments. These are safer because of the liquidity, short maturity, etc.

Functions of Money Market

Money Markets act as a borrower or lenders for institutions and investors. This is not only the but there are various functions of the money market which are as follows:

  1. Financing Trade - Traders who are in urgent need of funds are looking for a money market as a financing trade. 
  2. Central Bank policies - With the help of the money market, the central bank of a country can take the right measures and ensure that the financial market is running properly and this leads to the making of policy efficiently.
  3. Growth of industries - Money Market helps in growing the industries by fulfilling the need for working capital. Through the instrument of money market industries can easily raise money on a short-term basis and this ensures growth.

Money Market Instruments in India: How do they work?
 

The money market works based on the instrument available in the market. Instruments of the money market (which we have discussed above) such as Treasury Bills, Certificate of Deposits, and Commercial Papers are issued by lenders and bought by borrowers. 

To meet the short-term expenses, money market instruments can be issued and gains from those instruments are taxed. Individuals who make returns from the instrument of money market are liable to capital gains tax which is levied with 20% indexation.

Factors to consider before investing in Money Market

If you are someone who wants or has decided to invest in the money market. Then you need to consider some important aspects before investing your money:

  1. Expense ratio - As this is a short-term market, the return is not high. So before investing one should need to check out the expense ratio. Dealers should select those options which have a lower expense ratio.
  2. Risk and Return - Money Markets carry some sort of risk as it is a debt market. So one should need to check out the risk attached to funds and accordingly, they should take action.
  3. Investment goal - One should always remember his/her investment goal before investing in any kind of assets, debt, or market.

Distinguish between Money Market and Capital Market

  • The money market is a collection of short-term financial instruments where lending and borrowing of short-term debts are settled.

Whereas in the case of the capital market, company or government securities are issued for long-term financing with the necessary capital.

  • Money markets are considered as informal in nature. While capital markets are formal in nature.
  • Liquidity is higher in the case of the money market. Whereas, capital markets are less liquid compared to money markets.
  • Instruments such as Commercial papers, Treasury bills, and Certificates of Deposit are included in money markets. Instruments such as Bonds, debentures, and Shares are included in capital markets.
  • If compared to the capital market, the risk is low in the case of investment in instruments of the money market. The capital market possesses a higher risk.
  • Money market instruments are mature within a year or less than that period. While capital market instruments take a longer time to mature.
  • The purpose of the money market is to achieve short-term credit requirements. The purpose of capital markets is to achieve long-term credit requirements.
  • Return on investment is lower in the case of the money market. In the case of the capital market, the return on investment is higher than in the money market.
Basis of differenceMoney MarketCapital Market
MeaningMoney market is a financial market for the trading of short-term debts.Capital market is a financial market wherein long-term instruments are issued.
NatureInformalFormal
Liquidity HighLess 
Instruments Commercial papers, certificate of deposit, T-bills, etc.Bonds, shares, debentures, etc
RiskLowHigh
Maturity period1 year or less Takes longer period 
PurposeShort-term credit requirements Long-term credit requirements 
Return on investments Lower than capital marketHigher than the money market

Conclusion

Money Market is a financial place where an institution or individual can easily get short-term debt. While the money market is highly liquid but the interest earned on your money will be quite low. The risk is low in the case of the money market and here the transactions are settled within a year. But before investing in any of the markets one should need to do proper research.

  • Who regulates the Money Market?

  • Is Fixed deposit a money market instrument?

  • What is the difference between Money Market and Capital Market?

  • Is it risky to invest in the money market?

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