The financial market is a marketplace where the government, institutions, and investors trade in financial instruments. It plays a vital role in India’s economy by mobilising funds between investors and borrowers. The financial market comprises of two components, namely, the money market and the capital market. In this article, we have explained in detail the money market and its instruments and how it differs from the capital market.

What is the Money Market?

A money market is a financial market where short-term financial assets, specifically debt assets, with a maturity of up to one year are traded. Since this market has instruments with maturity of less than one year, they are considered close substitutes to money. As such, the typical features of the money market are high liquidity and short maturity.

The money market has several participants, such as the government, large and small companies, financial institutions, and the Reserve Bank of India (RBI). Each of these participants use the money market to either raise money or earn short-term returns. 

The government and companies issue money market instruments to raise short-term money. Banks and individual investors invest in money market instruments to park their surplus funds and earn short-term returns. The RBI uses money market instruments to plan and implement the monetary policy.

Apart from mobilising funds in the market and providing liquidity, a money market is essential for the following reasons.

What are Money Market Instruments?

Money market instruments trade over the counter and are very liquid as they have a low maturity period. They offer higher returns than a savings bank account and have no lock-in period.

Money market instruments are suitable for investors looking to park excess cash for a very short period of time and earn stable returns. Since they are considered as low-risk investments, investors who want to diversify their portfolio can consider investing in them. Moreover, investors nearing their financial goals can transfer their equity investments into money market instruments to safeguard their capital and returns.

Following are the different types of money market instruments.

Types of Money Market Instruments: In Detail

The following are different types of money market instruments:

Treasury-Bills

Treasury Bills are short-term debt instruments issued by the RBI on behalf of the Government of India. These bills are available at a discount to their face value, and you will receive the face value upon maturity.

T-Bills offered for 91 days, 182 days, and 364 days. These are also called zero-coupon securities, i.e., they do not yield any interest.

For example, you can buy a 91-day T-bill with a face value of Rs. 100 T-Bill at Rs. 93.25, and upon maturity, you will redeem it in full, i.e., at Rs. 100.

Features:

Certificates of Deposits (CDs)

CDs can only be issued by Scheduled Commercial Banks, Regional Rural Banks, and Small Finance Banks. CDs offer flexibility to investors and are issued in a dematerialised form against a deposited amount for a specified period. The tenure of CDs ranges from seven days to one year.

Features:

Commercial Papers (CPs)

CPs are unsecured promissory notes issued by financial institutions and large corporations. Similar to T-bills, CPs are purchased at a discount, and the return is the difference between the purchase price and face value.

CPs can be issued for amounts of Rs. 5 lakhs or multiples thereof. They have varied tenors ranging from 15 days to 364 days.

Features:

Treasury Bills Repurchase (TREPS) 

TREPS are short-term money market instruments that earn returns on idle cash. Financial institutions, banks, and mutual funds are the main players in TREPS.

Features:

Call and Notice Money

In a call money market, funds are borrowed and lent for a single day, while in the notice market, the borrowing and lending are for up to 14 days without any collateral security. Commercial and cooperative banks actively borrow and lend in both markets.

Features:

How to Invest in Money Market Instrument?

Though all money market instruments are not available for retail investors, T-bills, certificates of deposits, and commercial papers can be bought through:

You can invest in T-bills directly through primary auctions, secondary markets or RBI’s Retail Direct portal, Or indirectly through mutual funds.

You can invest in certificates of deposits from financial institutions as well as different commercial banks.

Commercial papers are high-ticket investments, and you can invest through brokerage firms. Indirectly, you can invest in commercial papers and all other types of money market instruments through mutual funds .

Only Scheduled Commercial Banks, Cooperative Banks, Primary Dealers, Mutual Funds, Insurance Companies and corporate entities can invest in repurchase agreements. Scheduled commercial banks (excluding RRBs), cooperative banks (other than Land Development Banks) and Primary Dealers (PDs) can borrow or lend in the call/notice money market.

To invest in money market, the most viable option for retail investors is through mutual funds. There are schemes like Liquid Fund, Overnight Fund, Money Market Funds which predominantly invest in these money market instruments. 

Advantages of Money Market Instruments

The following are the advantages of money market instruments:

Disadvantage of Money Market Instruments

The following is the disadvantage of money market instruments:

Money Market Vs Capital Market

The following table highlights the key differences between the money market and the capital market:

Parameter Money Market Capital Market
Participants Government corporations, financial institutions, banks, corporations and retail investors Retail investors, professional brokers, financial institutions, and corporates.
Tenure Short-term: A few days to 3 years. Both short-term and long-term investments
Instruments T-bills, commercial papers, certificates of deposits, Repo, Banker’s acceptance, call and notice money, and commercial bills. Stocks, bonds, and government securities.
Regulator The Reserve Bank of India (RBI) Securities and Exchange Board of India (SEBI)

Conclusion

Money market instruments offer one of the safest options available to beginners who want to get exposure to the investing world. Since they offer stable and predictable returns with low risk and high liquidity, they are the most preferred short-term investments. However, before investing in money market instruments, you must determine your goals and risk tolerance levels.

Money market instruments best suit investors with short-term goals and low-risk appetite. However, due to this high investment requirements these best suit institutional investors. In case retail investors want to invest in them, then mutual funds investing in money market instruments is a viable option. 

Before investing in money market instruments, it is essential to determine which instrument you plan to invest in after doing thorough research about each instrument and the issuer.

Frequently Asked Questions (FAQs)

Who is eligible to invest in Money Market Securities?

Individuals, banking institutions, corporations, and enterprises can buy money market instruments.

Who issues Money Market Instruments?

Money market instruments are issued by borrowers seeking short-term capital, including government agencies, banking institutions, financial entities, companies, and corporations.

Is a bond a Money Market Instrument?

Bonds are not money market instruments. Since bonds have a longer maturity, they are not considered as money market instruments.

Do debt instruments trade in both money and capital markets?

Both private companies and government institutions issue debt instruments to raise funds for both short-term and long-term financing. However, money markets exclusively handle short-term debt instruments, while capital markets are for long-term debt instruments.

Are derivatives part of money market instruments?

No, derivates are not part of money market instruments. Derivates trade on the derivatives exchange or over-the-counter.

What are the factors that determine the interest rates of Money Market Instruments?

Economic conditions, supply and demand dynamics, credit risk, and market sentiments are some of the factors that determine the interest rates of money market instruments.

How is the interest from Money Market Instruments taxed?

The interest earned from investing in money markets is taxed as per your applicable tax slab rate.

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