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    What are Money Market Instruments?

    Jul 19, 2024
    5 min
    4 Rating

    Money market instruments refer to short-term financing securities such as Treasury bills, certificates of deposit, commercial paper etc. that provide more financial liquidity to investors. The primary feature of money market instruments is their high liquidity, allowing investors to easily convert them into cash to meet immediate needs. These instruments are typically traded over the counter, requiring transactions to be conducted through certified brokers or money market mutual funds, rather than by individual investors.

    Objectives of Money Market Instruments

    The following are the money market's primary goals:

    • Supplying short-term funds at a fair price to borrowers, including governments and individual investors. Due to the short duration of the assets in the money market, lenders or financial institutions will also benefit from liquidity.

    • It also enables lenders to invest their idle money profitably, benefiting both the borrower and the lender.

    • RBI governs the money market. Consequently, this aids in controlling the amount of liquidity in the economy.

    • Considering that the majority of businesses lack the working capital they need. These kinds of firms can get the money they provide to meet their working capital requirements, thanks to the money market.

    • It is a significant funding source for domestic and foreign trade for the government sector. This thus offers the banks a chance to store their excess cash.

    Features Of Money Market Instruments

    1. High liquidity

      Highly liquid short-term securities are available on the money market. They are cash equivalents because of their great liquidity, which allows them to be exchanged for cash at any moment. These securities are offered by a number of well-known dealers and financial organisations in order to raise money or accept loans.

    2. Secure investment

      Although there will always be some danger, because money market investments have short tenure, that risk is much minimised. Additionally, reputable businesses and firms only issue short-term securities and bonds. Because of this, there is less chance of default than with instruments with longer tenure.

    3. Fixed returns

      In India, money market instruments can be purchased for less than their face value. As a result, the return on bonds and securities is predetermined. Investing in the money market gives you peace of mind because it offers stable returns if kept until maturity.

    What are the Types of Money Market Instruments?

    Money market instruments come in various forms, all aiming to increase the nation's overall productive capacity and, consequently, its GDP. Additionally, it offers safe returns to investors searching for short-term, low-risk investment possibilities.

    The following is a list of money market instruments that are traded:

    1. Certificate of Deposit

      With a certificate of deposit, a significant amount of money can be loaned to an organisation. With the exception of a fixed deposit's lower liquidity and larger negotiation capacity, the operational process is comparable to that of a fixed deposit.

    2. Commercial Paper

      This kind of money market instrument functions similarly to a promissory note that a business issues in order to raise short-term capital. Because it is insecure, only large-cap firms with a solid reputation in the market are able to employ it.

      These financial instruments have a maturity duration ranging from seven days to a year, which results in a lower interest rate than comparable securities offered for sale in the capital market.

    3. Treasury Bills

      These are granted access by a nation's central government when it needs money to pay for immediate expenses.

      These securities don't pay interest but provide capital gains for the investor because they are sold at a discount, and the full face value is paid when the securities mature.

      Treasury bills are the best investment option for risk-averse investors because they have a low default risk. After all, the government backs them.

    4. Repurchase Agreements

      It is also known as Repo, which is a type of short-term borrowing instrument in which the issuer obtains the money with an assurance that it will be repaid over time.

      Trading of government securities is typically involved in repurchase agreements. The government backs them, and they are subject to market interest rates.

    5. Banker's Acceptance

      Banker's Acceptance (BA) is most likely the most traditional money market product. Since the 12th century, it has been used to promote trade. In contrast to other money market instruments, a bank's commitment to pay a specific account customer is known as BA.

      But, the bank must reimburse the account holder for a certain sum. Banker's Acceptance works similarly to certified checks in that the outstanding amount must be paid on the designated date. It is also offered at a reduced cost. The maturity period is between thirty to one hundred and eighty days.

      Trade frequently uses banker's Acceptance, especially when items are imported or exported. The importer's bank guarantees the payment to the exporter.

    Things To Consider Before You Invest In Money Market Instruments

    There are better places to invest than the money market, even though it might be a starting point for debt securities. As they say, you can't grow if you don't take risks.

    On the plus side, the money market carries little to no risk. Yes, some difficulties may give rise to smaller ones, but nothing major results in an immediate collapse. The following factors need to be taken into account while making money market investments:

    • Determine your immediate objectives.

    • Level of risk you can comfortably bear

    • Assets that you intend to put money into.

    • The nation's stability and economic situation.

    • Do your homework before investing in any company to prevent fraud and con artists.

    How Do Money Market Instruments Affect the Economy?

    Instruments used in the money market are essential to the economy's operation. They can affect it in the following ways:

    • Financing: To raise money for short-term financing, businesses and governments turn to money market instruments, which promote economic growth.

    • Interest rates: The cost of borrowing for individuals and businesses is influenced by changes in interest rates, which result from the buying and selling of money market instruments.

    Money market products offer financial organisations a source of liquidity that enables them to manage their cash flow and satisfy any short-term funding requirements.

    The Bottom Line

    Money market instruments, which are securities of short-term debt and are important to the economy, provide low-risk investment opportunities for both individuals and institutions. Their reliability and liquidity make them a desirable option for diversifying investment portfolios, even though they might not deliver substantial returns.

    Before investing in these products, it is crucial to weigh the risks involved thoroughly and, if necessary, get advice from a financial professional. Therefore, before introducing money market instruments into your investing strategy, be sure you understand the various kinds of money market instruments and their impact on the economy.

    Mutual Fund investments are subject to market risks, read all scheme related documents carefully.