Money Market Instruments - Complete Info about Money Market

What is a Money Market?

The money market is a tool that makes it easier to lend and borrow short-term funds, which are typically for periods of less than a year. The products traded in the money market have two defining characteristics: a brief maturity time and significant liquidity.

1. The institutions that make up the money market include commercial banks, non-banking finance firms (NBFCs), and acceptance houses.  The products traded in the money market have two defining characteristics: a brief maturity time and significant liquidity.

1. The money market, one of many minor sub-markets that make up the broader financial market, includes the bill market, acceptance market, call money market, etc.

1. Money market transactions are completed using other instruments, such as trade bills, government documents, promissory notes, etc., rather than actual money or cash.

1. Additionally, money market transactions must be carried out through formal documentation, verbal conversation, or both. They cannot be done through brokers. 

Important Objectives of Money Market

The money market serves several objectives in the overall economy. Listed below are some important objectives:

1. The money market doesn't only help in the storage of short-term surplus funds but also helps in lowering short term deficits.
2. They help the central bank in regulating liquidity in the economy.
3. Money markets help short-term fund users to fulfill their needs at reasonable costs.
4. The money market helps in the development of the capital market, trade and industry.
5. To help design effective monetary policies.
6. To facilitate streamlined functioning of commercial banks.

Importance of Money Market Instrument

The following is the list of importances of Money Market Instruments:

1. Vital for seamless functioning of Indian economy
2. Short-term debts can be raised for immediate requirements by the corporates, government, and financial institutions with the help of money market instruments
3. These are safe, secure liquid, short-term financial instruments that operate within regulated environment, thereby ensuring a safe investment option

Key Features of Money Market Instruments

The following are the key features of Money Market Instruments:

1. Highly liquid as these are low-risk instruments with short maturity period
2. These are lucrative option for low-risk appetite investors as investors can avail themselves of discounts on the face value of the money market instruments
3. The money market instruments contribute to the liquidity and security of the financial market as these are regulated by RBI
4. Excess funds can be deposited by banks or retail investors as money market instruments are one of the major sources of funding for government
5. Enables borrowers to meet their immediate cash flow needs

Benefits of Money Market Instruments

The following are some of the significant benefits of money market instruments:

1. Allows diversification of portfolios by investing in money market instruments and are issued by well-established banks and corporations making these funds safe.
2. Offer stable and guaranteed returns, offer interest payments, come with discounted face value prices, thereby making suitable low-risk appetite investors
3. Offers easy access to deposits which ensures safety of your funds as these can be bought or sold over the counter.

How to Invest in Money Market Instruments in India?

The following are the ways to invest in Money Market instruments in India:

1. Make investment via brokerage firms or investment houses in small units.
2. From banks/Reserve Bank of India (RBI) purchase short-term Certificates of Deposit (CDs) or treasury bills.
3. You can also invest in money market instruments via brokerage firms over the counter.

Risks Involved in Money Market Instruments

The following are the risks involved in money market instruments:

1. Inflation: One of the major risk factors that may impact on the returns from money market instruments is inflation. This is becuase money market instruments are susceptible to inflation and if interest rates are not at per with the inflation, then it might affect the returns.
2. Limited options: The options under money market instruments are very limited and changes in regulations affect the profitability of these financial instruments.
3. Limited returns: These financial instruments primarily focus on short-term liquidity and generally offer lower returns than other securities.

Who Should Invest in Money Market Mutual Funds?

The following are the individuals who should invest in money market mutual funds:

1. who are new to the field of investment
2. Those looking for safe options for a short period
3. Those aim to keep diversified portfolio by investing in different types of money market instruments to maximise yield
4. Looking for short-term, open-ended investment option

Characteristics of Money Market Instruments

Money market instruments allow governments, financial organizations and businesses to finance their short-term cash requirements. Some of the notable characteristics of money market instruments are as follows.

1. Liquidity - As they are fixed-income securities with short maturity periods—one year or less—money market instruments are very liquid.
2. Safety - Issuers of money market instruments have strong credit ratings, which automatically means that the money instruments issued by them will also be safe.
3. Discount Pricing - The fact that money market instruments are issued at a discount on their face value is another significant trait.

Types of Money Market Instruments

Treasury Bills (T-Bills)

Treasury Bills, which are issued by the federal government, are among the safest money market securities available. Treasury bills, however, have no risk. i.e., are instruments with zero risk. As a result, the results one receives from them are not desirable.

Treasury bills are traded on primary and secondary markets and have varying maturity terms, such as three months, six months, and one year. The central government issues Treasury banknotes at a discount from their face value.

The difference between the maturity value of the instrument and the purchase price of the bill, which is determined with the aid of bidding conducted through auctions, will be the interest earned by the buyer. The Government of India currently issues three different types of treasury bills through auctions: 91-day, 182-day, and 364-day treasury bills.

Certificate of Deposits (CDs)

When money is deposited with a bank or financial institution, a Certificate of Deposit, or CD, serves as a deposit receipt. A Certificate of Deposit, on the other hand, differs from a Fixed Deposit Receipt in two ways.

The first distinction is that a CD is only ever issued for a higher amount of money. A Certificate of Deposit is moreover freely negotiable. Certificates of Deposits, first introduced by the RBI in 1989, have grown to become a popular investment option for businesses looking to invest short-term surplus funds since they carry no risk while offering interest rates that are greater than those offered by Treasury bills and term deposits.

Another benefit, particularly for issuing banks, is that Certificates of Deposit are relatively liquid. CDs are issued at a discounted rate, similar to treasury bills, and their tenors range from 7 days to 1 year.

Banks, however, provide Certificates of Deposit for terms as little as three months and as long as twelve months. Individuals (with the exception of minors), trusts, businesses, corporations, associations, funds, non-resident Indians, etc. may receive them.

Commercial Papers (CPs)

Commercial Papers are can be compared to an unsecured short-term promissory note which is issued by highly rated companies with the purpose of raising capital to meet requirements directly from the market. CPs usually feature a fixed maturity period which can range anywhere from 1 day up to 270 days.

Highly popular in countries like Japan, UK, USA, Australia and many others, Commercial Papers promise higher returns as compared to treasury bills and are automatically not as secure in comparison. Commercial papers are actively traded in the secondary market.

Repurchase Agreements (Repo)

Loans of a brief period that are agreed upon by buyers and sellers for the purpose of buying and selling are referred to as repurchase agreements (repo), sometimes known as reverse repo or simply as 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. Only transactions involving RBI-approved securities, such as treasury bills, securities issued by the federal, state, or local governments, corporate bonds, and PSU bonds, are allowed. 

Banker's Acceptance (BA)

A Banker's Acceptance, often known as a BA, is essentially a document that guarantees a future payment and is issued by a commercial bank. Banker's Acceptance, which is used in money market funds frequently and is similar to a treasury bill, stipulates the terms of the repayment, including the amount to be repaid, the date of repayment, and the information about the person to whom the payback is due. The durations available with Banker's Acceptance range from 30 to 180 days. 

Advantages and Disadvantages of Money Market Instruments

The various advantages and disadvantages of money market instruments are mentioned below:

Therefore, money market instruments are not a viable solution if the objective of the investment is to achieve capital appreciation while outperforming inflation.

Things to Think About Before Investing in Money Market Mutual Funds

Below mentioned are a few things that one should think about before investing in money market mutual funds - 

1. Such tools have a very brief investment time, ranging from three months to a year.
2. The Income Tax Act of 1961 states that various tax gains apply tomutual-fund/money-market-instruments. Gains from short-term investments are taxed at 15%.
3. In money market mutual funds, expense ratios are applicable and used at the asset management company's discretion. A lower expense ratio, which keeps the overall amount deducted from returns relatively low, should result in higher yields for investors.
4. A mutual fund's Net Asset Value may change depending on the national market trend. Your returns decrease when the NAV of a mutual fund declines due to an increase in the overall interest rate, and vice versa.

Disclaimer

Mutual Fund investments will be subject to market risks. Any mutual fund listed in the document does not guarantee fund performance or its underlying creditworthiness. Do read the mutual fund document thoroughly before investing. Specific investment needs and other factors have to be taken into account while designing a mutual fund portfolio.