A Business Encyclopedia

Money Market

Definition: Money Market can be understood as the market for short term funds, wherein lending and borrowing of funds varies from overnight to a year. It is an important part of the financial system that helps in fulfilling the short term and very short term requirements of the companies, banks, financial institution, government agencies and so forth.

Salient Features of Money Market

  • It is a wholesale market, as the transaction volume is large.
  • Trading takes place over the telephone, after which written confirmation is done by way of e-mails.
  • Participants include banks, mutual funds, investment institutions and Central Banks.
  • There is an impersonal relationship between the participants in the money market, and so, pure competition exists.
  • Money market operations focus on a particular area, which serves a region or an area. On the basis of the market size and needs, the area may differ.

There are five major segments of money market which are Certificate of Deposits (CD), Commercial Paper, Swaps, Repo and Government treasury securities.

money market segments

Money Market Instruments

In this market, only those financial instruments are traded which are immediate substitutes for money, which includes:

  1. Call/Notice Money: When the money raised or borrowed on demand for a very short term which ranges from one day to 14 days, then it may be called as notice money, and when it exceeds 14 days it is termed as call money.
  2. Treasury Bills: These are short term, negotiable financial assets issued by the central bank, on behalf of the government, for overcoming liquidity shortfalls.
  3. Commercial Bills: A commercial bill is a negotiable, self-liquidating instrument that is less risky in nature. When goods are bought on credit, these bills improve the liability to make payment at the specified date.
  4. Commercial Paper: It alludes to an unsecured promissory note, issued by large and creditworthy companies, at a discount on its face value and redeemable at its face value.
  5. Certificate of Deposit: It is an unsecured, negotiable financial instrument which a bank and financial institution issues to individuals, corporation, trust, funds etc. at a discount on its face value and its maturity vary from 15 days to one year.

The financial assets dealt in the money market possess high liquidity, low transaction cost, less risky and no loss in value. And so, it acts as a whole sale debt market for such instruments.

Functions of Money Market

The three basic functions of money market are:

  • It provides a balancing tool for equating the demand for and supply of short term funds.
  • It provides a centre for the intervention of central bank, for controlling liquidity and general interest rate level.
  • It provides a proper reach to the suppliers and users of the short term funds, to fulfil their requirements, at a reasonable market clearing price.

Money market plays a vital role in equating the short term liquidity imbalances within the country. Indeed, with the help of this market, the central bank controls liquidity and interest rates level in the country.

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