What is Money Market?

Money market is a place for trading in money and short term financial assets that are
close substitutes of money.
Money market basically refers to a section of the financial market where financial
instruments with high liquidity and short-term maturities are traded. Money market
has become a component of the financial market for buying and selling of securities
of short-term maturities, of one year or less, such as treasury bills and commercial
papers.
Money market provides an opportunity for balancing the short term surplus funds of
investors with short term requirements of borrowers.
Money market consists of negotiable instruments such as treasury bills, commercial
papers. and certificates of deposit. It is used by many participants, including
companies, to raise funds by selling commercial papers in the market. Money market
is considered a safe place to invest due to the high liquidity of securities.

Characteristics of Money Market

Money market instruments channel money from investors to borrowers who need
money. For an investment to qualify as a money market instrument, lenders must be
able to get their money back in a year or less
The different types of money market instruments share basic characteristics which
are as follows;

Variety
Money market instruments include short-term bank certificates of deposit (CDs),
municipal bonds, Treasury bills and other government securities. More sophisticated
examples include commercial paper, repurchase agreements and bankers'
acceptances. Individual investors most commonly invest in money market deposit
accounts and money market mutual funds.

Liquidity
Liquidity of an investment refers to how quickly and easily investors can access their
money. Money market instruments are relatively liquid because the money is
available in a year or less. Fixed terms range from one day to one year. Money
market deposit accounts and money market mutual funds have high liquidity, as
depositors may access money by check when they need it.
Return
Money market instruments pay interest to the lender. Bank money market accounts,
for example, add interest on each monthly statement. Other instruments, including
Treasury bills, pay interest only at maturity
Safety
Money market investments are safer than most due to their liquidity. Their liquidity
minimizes long-term uncertainties about companies and governments and helps
protect against interest rate increases.

Functions of money market

Financing Trade
Money Market plays crucial role in financing both internal as well as international
trade. Commercial finance is made available to the traders through bills of exchange,
which are discounted by the bill market. The acceptance houses and discount
markets help in financing foreign trade.
Financing Industry:
Money market helps the industries in securing short-term loans to meet their
working capital requirements through the system of finance bills, commercial papers,
etc.
Profitable Investment:
Money market enables the commercial banks to use their excess reserves in
profitable investment. The main objective of the commercial banks is to earn income
from its reserves as well as maintain liquidity to meet the uncertain cash demand of
the depositors. In the money market, the excess reserves of the commercial banks
are invested in near-money assets (e.g. short-term bills of exchange) which are
highly liquid and can be easily converted into cash. Thus, the commercial banks earn
profits without losing liquidity.
Self-Sufficiency of Commercial Bank:
Developed money market helps the commercial banks to become self-sufficient. In
the situation of emergency, when the commercial banks have scarcity of funds, they
need not approach the central bank and borrow at a higher interest rate. On the
other hand, they can meet their requirements by recalling their old short-run loans
from the money market
Help to Central Bank:
Though the central bank can function and influence the banking system in the
absence of a money market, the existence of a developed money market smoothens
the functioning and increases the efficiency of the central bank.
Money market helps the central bank in two ways:
(a) The short-run interest rates of the money market serves as an indicator of the
monetary and banking conditions in the country and, in this way, guide the central
bank to adopt an appropriate banking policy,
(b) The sensitive and integrated money market helps the central bank to secure
quick and widespread influence on the sub-markets, and thus achieve effective
implementation of its policy.

Structure of organized Money Market

Call Money Market
Call Money, Notice Money and Term Money markets are sub-markets of the Indian
Money Market. These refer to the markets for very short term funds. Call Money
refers to the borrowing or lending of funds for 1 day. Notice Money refers to the
borrowing and lending of funds for 2-14 days. Term money refers to borrowing and
lending of funds for a period of more than 14 days.
Treasury Bills (T Bills)

The bill market is a sub-market of the money market in India. There are two types of
bills viz. Treasury Bills and commercial bills. While Treasury Bills or T-Bills are issued
by the Central Government; Commercial Bills are issued by financial institutions.
Commercial Bills
Commercial bills market is basically a market of instruments similar to bill of
exchange. The participants of commercial bill market in India are banks and financial
institutions
Certificate Of Deposits (CDs)
Certificate of Deposit (CD) refers to a money market instrument, which is negotiable
and equivalent to a promissory note. All scheduled commercial banks excluding
Regional Rural Banks (RRBs) and Local Area Banks (LABs) and Select All India
Financial Institutions permitted by RBI are eligible to issue certificates of deposits.
Commercial Papers (CP)
Commercial Paper (CP) is yet another money market instrument in India, which was
first introduced in 1990 to enable the highly rated corporates to diversify their
resources for short term fund requirements.
Money Market Mutual Funds (MMMFs)
Money Market Mutual Funds (MMMFs) were introduced by RBI in 1992 but since
2000, they are brought under the purview of the SEBI. They provide additional shortterm avenue to individual investors.
The Repo / Reverse Repo Market
Repo (repurchase agreement ) was introduced in December 1992. Repo means
selling a security under an agreement to repurchase it at a predetermined date and
rate. Repo transactions are affected between banks and financial institutions and
among bank themselves, RBI also undertake Repo.
Reverse Repo means buying a security on a spot basis with a commitment to resell
on a forward basis. Reverse Repo transactions are affected with scheduled
commercial banks and primary dealers.
Discount And Finance House Of India
(DFHI) It was established in 1988 by RBI and is jointly owned by RBI, public sector
banks and all India financial institutions which have contributed to its paid up capital.
DFHI plays important role in developing an active secondary market in Money Market
Instruments. From 1996, it has been assigned status of a Primary Dealer (PD). It
deals in treasury bills, commercial bills, CDs, CPs, short term deposits, call money
market and government securities.
Defects in Indian money market
Existence of Both Organized and Unorganized Markets
The first and foremost defect of Indian money market is existence of both organized
and unorganized money markets. Indigenous bankers and money lenders plays an
important role in unorganized money market. The main problem with indigenous
bankers is that they dont distinguish between short-term and long term credit. the
unorganized money market is not controlled by R.B.I. These features of unorganized
money market, makes the whole Indian money market weak.
Absence of Integration between Various Sectors
There is no proper coordination between the various sectors of Indian money
market. There is no mutual understanding between the banking institutions of

organized sector and indigenous bankers of unorganized sector. Within the organized
sector there is no proper coordination of activities of different banking institutions
Predominance of Unorganized sector
The third important drawback of Indian money market is its predominance of
unorganized sector. The indigenous bankers and money lenders occupies significant
role in rural finance. In this unorganized sector there is no clear cut distinction
between short and long term credit. They will not come under direct control of
Reserve Bank of India and remains outside the organized sector. Therefore, they
seriously restrict the Reserve Bank control over money market.

Differential Interest Rates

Due to lack of homogeneity in the composition of Indian Money Market there is wide
range not only in the interest rates but also in lending policies, of the different
institutions. Money lenders charges exorbitant rates of Interest ranging from 24 per
cent to 40 percent. Even commercial banks also charges different rates of interest
ranging from 12 percent to 18 percent. The interest rates also vary from place to
place.
Inadequate Control by the Reserve Bank of India
The unorganized sector of Indian Money Market is not under direct control of
Reserve Bank of India. The Reserve Bank of India has no adequate control on the
functioning of unorganized sector financial institutions which is quite large in size
playing very important role in financing short term funds.
How RBI controls inflation through money market instruments
Cash Reserve Ratio (CRR)
An increase in CRR leads to an immediate curb on the excess funds of the banks.
When banks credit volume decreases, their profit quantum also decreases. To
maintain the same total profits, a decrease in profitability is to be compensated by
raising the lending rate. Eventually, when the banks lending rates are raised, the
cost of credit increases.
Bank rate- Prime lending rate
Since there is an absence of a well-knit bill market, the bank rate in the Indian
context is defined as the rate at which the Reserve Bank of India makes advances to
the commercial banks against eligible securities