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Money Market: Definition, Participants, Functions and Examples          

Money Market: Definition, Participants, Functions and Examples

Money Market: Definition, Participants, Functions and Examples

The money market is an organised exchange market, which solves the problem of short-term liquidity, by providing debt to governments, private banks and large companies. Money market participants can lend or borrow securities for some time of maximum up to one year. Participants can invest in the market to gain interest over the invested money. This helps the borrowers to meet their short-term financial requirements by lending their valuable securities.

Money markets are considered low-risk investment opportunities for investors, where they can invest their small amount of money in exchange for assured returns. Individual investors who want to make a profit can become a participant in the money market by investing their money in a money market account or money market mutual fund.

The money market mutual fund is an organised entity that buys securities on behalf of individual investors. The main aim of the money market is to fulfil the short-term capital needs of large organisations. Common examples of money market instruments include Treasuries, repurchase agreements and commercial papers. 

What is the Money Market?

The Money market is an exchange market that provides short-term funds for one year or less. A market is called a money market when it contains highly liquid and short-term securities. The participants of the money market include certificates of deposits, bills of exchange, repurchase agreements etc.

Money markets deal in short-term financial instruments known as papers. Investments in the money market are known for their safety and assured returns, although the returns are less as compared to other investment options. The money markets stabilize the economy by resolving the short-term liquidity requirements of banks and governments.

How does the Money Market work?

The participants in money markets include individual investors, banks and larger companies. These entities lend to other companies or banks on behalf of commercial papers. The borrower raises money by lending their vital financial securities, these securities are referred to as ‘papers’. One of the most common ways of boring is by commercial papers mechanism as the interest rates are low and there is a wide variety of maturity available.

For individual investors money markets can be accessed by physical locations like local banks, they can also be accessed by the government’s treasury website. These investors can directly invest in various types of securities like treasury bills, CDs(certificates of deposit) and municipal notes. Individual investors can directly buy these from the treasury website or with the help of a local broker. 

Who are the participants or Financial Institutions that participate in the Money Market?

All the entities that are allowed to borrow or lend assets in the money market are known as the participants of the money market. Technically, everyone can be a part of the money market, but still, in some cases, certain requirements are needed to be fulfilled to be a part of the money market. For example, the call money market is only allowed for banks. Below mentioned are some of the larger entities participating in the money market.

  • Central Government:

Government issues securities and treasury bills to maintain the government cash flow of the economy. For example, in the case of India, these bills are issued by RBI, on behalf of the central government to finance governmental activities like infrastructure development and budgets etc.

  • Public Sector Undertakings:

Public sector undertakings also known as PSU, release long-term maturity bonds to facilitate larger projects in future. These bonds can be classified as taxable and non-taxable. PSU having an excess amount of cash flow also invests in such bonds to gain profit with less risk. 

  • State Government:

The State Government also issues securities known as SDLs (State Development Loans. The aim of raising money from the market is to maintain adequate funds for state-funded activities.

How to invest in the Money Market?

Money market investing is similar to capital market investing, but the only difference is that the money market does not involve the exchange of equity. This market is only used for short-term assets to be exchanged for one year or less. An individual can invest in the money market by investing in the money market mutual fund and buying treasury notes.

The money market provides higher returns compared to fixed deposits, but it also involves a large number of restrictions over money withdrawal. The majority of transactions are wholesale and are conducted by large companies, banks and governments.

What are the functions of the Money Market in the economy?

The money market plays a crucial role in maintaining the cash flow in the economy by providing short-term debt to large banks, governments and companies. It also acts as a risk-free method of investment for individual investors by providing higher returns. It helps in the relocation of assets in the economy by providing liquidity to corporations.

Functions of the Money Market
Functions of the Money Market

1. Financing Trade

The money markets help in financing trade by providing short-term funds. This fund can be used for commercial purposes like financing capital requirements and funding businesses growth. All these activities ultimately help in promoting trade and business. The main aim of the money market is to promote cash flow in the economy, which helps in increasing trade and benefits businesses.

As a result, the money market releases financial instruments like commercial papers and treasury bills, among others, and aids in the growth of Indian trade, industry, and commerce both domestically and abroad. The funding of both local and foreign trade depends heavily on the money market.

2. Financing Industry

The money market helps in promoting financial mobility in the economy, by allowing cash to flow between various sectors of industries. Such kind of financial mobility is necessary for the overall development of the industries of the country.

3. Profitable Investments

The money market assets are low-risk investments with good credit scores, because of which they are considered safe investment options. 

4. Self-sufficiency of Commercial Banks

The money markets act as a helping hand for commercial banks by allowing them to reach self-sufficiency. When the money markets are developed they provide a wide range of borrowing options for commercial banks. In case of liquidity issues, commercial banks can take short-term loans from money markets. SBI, Bank of Baroda and Union Bank are examples of such commercial banks that rely on money markets for their self-sufficiency.

5. Help to Central Bank

A completely developed money market can help Central Banks to efficiently implement monetary policies. Although, the Central Bank is an individual entity and can function even in the absence of any such market. But, the presence of a well-developed money market helps in the proper functioning of the system. For example, the money market interest rates act as a vital Indicator for the central bank to analyse the oral condition of the banking system.

What are examples of Money Market Securities and Instruments?

Money market securities are vital financial assets traded to meet the short-term financial requirements of companies and governments. The main characteristics of these securities include high liquidity and short-term maturity. The transaction of such assets is generally done via an oral medium or written documentation. Some of the notable money markets instruments are given as follows:

Money Market Securities and Instruments

1. Certificate of Deposit

Certificates of Deposit (CD) are similar to fixed deposits in terms of their functionality. But the only difference between CD and fixed deposits is the amount of capital involved. CDs are only issued for large capital investments, unlike fixed deposits which do not have any restrictions on capital involved. CDs were first introduced by the Reserve Bank of India in 1989.

CDs are highly preferred by large organisations for investing large sums of money for a short duration of time. The other big advantage of CD is that it provides higher returns compared to any other instruments of the money market. 

2. Treasury Bills

These bills are directly issued by the central government of the country. Because of this, it is considered the most stable money market asset. Generally, the maturity period for treasury bills is 3 months, 6 months and 12 months. This instrument is considered a zero-risk money market instrument.

But the only problem with this instrument is its unattractive returns. In India, there are three types of treasury bills issued by the central government differentiated based on maturity period (91, 182 and 364 days treasury bill). 

3. Commercial Paper

Commercial papers are issued by highly valued companies to meet their liquidity demands over a fixed interval of time. The maturity period ranges from 1 day to 274 days. These securities are riskier when compared to treasury bills issued by the central government. But these instruments also provide a high rate of returns when compared with most money market instruments. Commercial papers are popular in Western countries.

4. Money Market Mutual Funds

Debt funds are called money market funds to make loans to businesses for a year or less. These Funds are created in such a way that the fund manager can increase returns while reducing risk by adjusting the length of the loans.

5. Money Funds

An open-ended mutual fund called a money market fund invests in short-term debt instruments including US Treasury bills and commercial paper. Money market funds are managed to preserve an extremely steady asset value through liquid investments while providing dividend income to investors.

6. Federal Funds

Federal funds, also known as fed funds, are surplus reserves that commercial banks deposit at regional Federal Reserve banks. These funds can then be lent to other market participants who lack the necessary cash on hand to meet their lending and reserve needs. Since the majority of these loans are issued for the overnight period, they are unsecured and have a relatively low-interest rate known as the federal funds rate or overnight rate.

7. Repurchase Agreements

Loans of a brief period that are agreed upon by buyers and sellers to buy and sell are referred to as repurchase agreements (repo), sometimes known as reverse repo or simply as a repo. These transactions can only be made between parties that the RBI has approved. Transactions involving repo or reverse repo can only be made between parties that the RBI has permitted.

8. Foreign Exchange Swaps

An arrangement to exchange interest payments on a loan issued in one currency for interest payments on a loan made in another currency is known as a foreign currency swap.

9. Municipal Notes

A municipal note is a type of debt that state and local governments issue to pay for capital expenses like building projects. Investors are drawn to municipal notes because they mature in a year or less, offer a fixed income, and are frequently free from federal and/or state income taxes.

10. Asset-Backed Securities

A security that receives income payments from and has a specific pool of underlying assets used as collateral is said to be asset-backed. Usually, the pool of assets consists of a collection of small, inflexible, and immovable assets that cannot be sold separately.

11. Eurodollar Deposit

A time deposit account held in foreign banks with a dollar value is called a “Eurodollar.” Since they were initially only available in Europe, they were given the moniker “eurodollar.” In the end, a number of non-European nations, notably the Bahamas and the Cayman Islands, were included as destinations for the U.S. dollar deposits.

12. Federal Agency Short-term Securities

Marketable securities, commonly referred to as temporary investments or short-term investments, are financial investments that can be quickly converted to cash, usually within five years. After only three to twelve months, many short-term investments are sold or turned into cash.

13. Short-lived Mortgage

A short-term loan is a form of loan taken out to meet a brief demand for funds on the part of the borrower or their business. Given that it is a form of credit, it entails paying back the principal plus interest by a specified due date, which is often one year after receiving the loan.

14. Discount Instruments

Money market instruments known as “discount instruments” are those that are issued for less than their declared face value and mature for that amount.

15. Accrual Instruments

Accrued interest is the total amount of interest that has been owed on a loan or other financial obligation as of a certain date but has not yet been paid. For the lender or the borrower, accumulated interest may take the form of accrued interest revenue or accrued interest expense.

What are the advantages of the Money Market?

Money markets are considered the safest way to invest money to get short-term returns. Below mentioned are some more advantages of the money markets:

  1. Less Risk: Investments in the money market are considered less risky, unlike the money invested in the stock market. The money market accounts are mostly insured, so even if anything goes wrong the investment remains safe.
  2. Easy access: The money invested in the money markets can be easily accessed. The withdrawal process is similar to the bank withdrawal process. In case of emergency, this fund can be used as an emergency fund. In some cases, money markets also have their monthly withdrawal limitations.
  3. Higher Returns: The money markets are not only the safest and risk-free investments, but they also give superior returns. When compared to fixed deposits or saving accounts the returns from money markets are always higher.

What are the disadvantages of the Money Market?

The money market combines the features of a savings account with higher returns. But still, it has some drawbacks that are needed to be considered:

  1. Minimum Balance Requirement:  All banks have minimum balance policies for money market savings accounts. For example, some bank accounts may have a minimum balance requirement of $1 and other banks may have a minimum balance requirement of $500.
  2. Fees: Banks generally charge a monthly maintenance fee for money market accounts. These monthly fees can be a bit higher as compared to the amount charged for a savings account.

How does the Money Market differ from the Stock Market?

Money markets involve the exchange of financial securities like CDs, treasury bills etc. Whereas, in the stock market equity exchange takes place. Money markets are less riskier when compared to stock markets.

The main aim of the money market is to fulfil the short-term liquidity needs of companies or governments. Stock markets can be used as both long-term and short-term investment opportunities for both small and big investors.

What is a Money Market Account?

A money market account is a special kind of account, having similar characteristics to a savings account. The only difference is that it pays the interest depending upon the current interest rates in the money market. Generally, the overall interest rate is higher when compared to the interest rate of a savings account.

How to use Technical Analysis in the Money Market?

The process of technical analysis can be applied to any of the securities having previous trading data. Technical analysis believes that the previous data is a vital indicator for predicting future trends. The money market is no exception and its trend can also be predicted with the help of technical analysis.

To analyse the trends various indicators can be used in technical analysis like price trends, trading volume, volume and momentum indicators and moving averages. But by combining all the observations from these data we can estimate the future trends and prices in the money market.

Is it worth it to invest in the Money Market?

The money markets are known for providing higher returns in a short duration of time. The returns from the money market are higher when compared to the returns from fixed deposits and savings accounts. So it is completely worth it to invest in the money market, it’s not only risk-free but it also provides higher profit in the short term.

Is it risky to invest in the Money Market?

The money markets are considered the safest form of investment. As it involves money market instruments like treasury bills, CDs and commercial paper. These securities are considered risk-free because some of these securities are handled directly by the central government. Also, the investments made by the money market account are covered by the insurance company.

What is the difference between Money Market and Capital Market?

  • In the money market, only short-term instruments like CDs, treasury bills and commercial papers are exchanged. In the capital market, long-term securities are exchanged like stocks and bonds. The risk levels in the money market are deficient compared to the capital market. The investment period in the money market is less than 1 year, and in the capital market, the investment period can be more than one year. The main aim of the money market is to provide funds to government organisations, banks and larger companies for their growth and operations. The main aim of the capital market is gaining wealth, both small and large investors can directly participate in the capital market with no minimum balance requirement. Below are some of the other differences –
  • Purpose: Money Market is designed to provide short-term funding for financial institutions and government entities, while Capital Market is designed to provide long-term financing for companies.
  • Investments: Money Market investments typically include short-term debt instruments such as Treasury bills, commercial paper, and certificates of deposit, while Capital Market investments typically include stocks, bonds, and other long-term securities.
  • Maturities: Money Market instruments have maturities of less than one year, while Capital Market instruments have maturities of more than one year.
  • Risk and Return: Money Market investments are considered low-risk, low-return investments, while Capital Market investments are considered higher-risk, higher-return investments.
  • Regulation: Money Market is heavily regulated by the government, while Capital Market has a lighter level of regulation.
  • Liquidity: Money Market instruments are highly liquid, meaning they can be easily bought and sold, while Capital Market instruments may be less liquid.

Apart from these, the money Market is typically accessed by institutional investors, while Capital Market is accessible to institutional and individual investors.

Arjun
Arjun Remesh

Head of Content

Arjun is a seasoned stock market content expert with over 7 years of experience in stock market, technical & fundamental analysis. Since 2020, he has been a key contributor to Strike platform. Arjun is an active stock market investor with his in-depth stock market analysis knowledge. Arjun is also an certified stock market researcher from Indiacharts, mentored by Rohit Srivastava.

Shivam
Shivam Gaba

Reviewer of Content

Shivam is a stock market content expert with CFTe certification. He is been trading from last 8 years in indian stock market. He has a vast knowledge in technical analysis, financial market education, product management, risk assessment, derivatives trading & market Research. He won Zerodha 60-Day Challenge thrice in a row. He is being mentored by Rohit Srivastava, Indiacharts.

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