Money market and Capital Market

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What is Money Market?

Money market refers to the market where borrowers and lenders exchange short-term funds to solve their liquidity needs. Short term refers to a period which is less than one year. Money market instruments are generally financial claims that have low default risk, maturities under one year and high marketability.

Money market is one of the principal components of financial market related to short term buying, selling, lending and borrowing. The trading or dealing in the money market is performed across the table and is carried out at a particular place.

Therefore, the money market value changes with time and place and are heterogeneous. Examples of money market instruments are Treasury bills, commercial papers etc. The assets involved in money market have a high liquid value and can be converted into cash quickly.

Functions of Money Market

The main functions of money market are:

  • Money market fulfils the short-term finance requirements of trade and industries using bills of exchange, commercial papers, etc.

  • Money market helps in the economic growth of a company by making the funds available to different sectors of the society like agriculture, small-scale enterprises, etc.

  • It provides a mechanism through which the monetary policy of the government can be implemented effectively.

  • It keeps equilibrium between demand and supply of short-term money transactions.

  • Money market allows commercial banks to invest their excess reserves in an investment so as to make profit and maintain liquidity of cash at any uncertain demand of account holders. This also helps these banks to become self-sufficient in terms of availability of funds.

Markets and Instruments Used in Organised Indian Money Market

Call, term and notice money market

Call money or term money is a very short-term loan offered by banks. It does not contain regular principal and interest payments and is often used by traders to finance their margin accounts. Call loans are unsecured and call-able and, therefore, prove riskier than most of the other loans and are transacted overnight. However, they help in providing short-term liquidity for lubricating the market.

Banks generally rectify their short-term fund mismatches by the lending and borrowing of funds in the inter-bank market. The money that is lent by one bank to another for one day is called call money, money that is lent for more than two days but less than 14 days is known as notice money and money lent for more than 14 days is called term money.

The market in which banks transact with one another is called the inter-bank money market. The rate at which funds are borrowed and lent in the inter-bank call market is called the call rate, and it is dependent upon the demand and supply of short-term funds. The main players in this call/notice/term money market are commercial banks, co-operative banks and primary dealers. These banks are allowed to participate as borrowers and lenders.

However, the DFHI and NBFIs such as LIC, GIC, UTI, NABARD, etc., are allowed to participate in this market as lenders. The major centres of call/term/notice money are Mumbai, Delhi, Kolkata and Chennai.

Treasury Bills (T-Bills) market

T-bills are (central) government securities offering short-term investment opportunities of up to one year. Therefore, T-bills are useful in managing short-term li- quidity. Presently, the Indian government issues three types of T-bills through auctions held by RBI: 91-day T-bills, 182-day T-bills and 364-day T-Bills. These bills are issued by RBI on behalf of the Government of India. They are generally available for a minimum amount of Rs 25,000 or in multiples of Rs 25,000. They are issued at a discount rate and are redeemed at the face value.

Banks use T-Bills to meet their SLR requirements. The rate of interest for the bills is decided by the market forces of demand and supply. The main advantage of T-bills is that there is almost zero risk of default. The bills can be easily bought and sold. The major players in the T-bills market include commercial banks, primary dealers, mutual funds, corporates, financial institutions, provident or pension funds and insurance companies.

Commercial bills market

A commercial bill is a very liquid short-term negotiable money market instrument. It has low risk and is drawn by the seller on the buyer to make a payment within a particular period of time. The maturity of a commercial bill is generally three months. The bill can be purchased and discounted any number of times during this period. Commercial banks purchase commercial bills and discount them. These discounted bills are further rediscounted by financial institutions such as EXIM, SID- BI, IDBI, etc.

Certificate of Deposits (CDs) market

CDs are a type of unsecured money market instruments that are issued at a discount by commercial banks and developmental financial institutions. CDs are used to raise funds from the market. The maturity period of CDs varies from 3 months to a year. They are issued in multiples of 25 lakhs and the minimum size of issue should be `Rs 1 crore. They are freely transferable but only after an initial lock-in period of 45 days has been exhausted.

Commercial Papers (CPs)

CPs can be issued by listed companies having a working capital of more than Rs 5 crores. CPs are issued at a discount but redeemed at their face value. They are issued in multiples of Rs 25 lakhs and the minimum size of issue should be Rs 1 crore. The maturity of CPs varies between 7 days and a year.

Money Market Mutual Funds (MMMFs)

MMMFs are similar to mutual funds, except that these mutual funds invest exclusively in money market instruments such as CPs and CDs. These funds were introduced by RBI in 1995 to provide a new short-term investment option for retail investors. Banks, public financial institutions and private-sector institutions are allowed to set up MMMFs. MMMFs are regulated by SEBI.

Repo market

Repo refers to a money market instrument and is basically a repurchase agreement. Under this agreement, a seller sells a particular security, and the terms of the agreement include that the seller will repurchase the security from the buyer on a particular date and at a particular rate (repurchase rate). In money market repo agreements, the borrowers and lenders are the banks and financial institutions.

RBI also engages in repo transactions related to the money market. RBI introduced the reverse repo in 1996 under which a buyer could buy a security on spot basis with the commitment to resell it on a later date at a previously agreed rate. The major players in the repo market include commercial banks, NBFCs, mutual funds, housing finance companies, insur- ance companies and primary dealers.

Discount and Finance House of India (DFHI)

DFHI was set up in April 1988 by RBI, public-sector banks and financial institu- tions. DFHI plays an important role in creating a secondary mar- ket for money market instruments. It was accredited the status of a Primary Dealer (PD) in 1996. It deals majorly in T-bills, CDs, CPs, commercial bills, short-term deposits, call money markets and other government securities.

The organised sector for the money market majorly has access in the urban parts of India. The majority of the short-term financial needs of the rural India (small farmers, artisans and businessmen) are met through the participants of the unorganised money market.

Various instruments/participants of the unorganised Indian money market include the following:

Indigenous Bankers (IBs)

These refer to those private individuals or organisations that accept deposits and lend loans to the people who require it. The loan money is granted from the deposits as well as from their own capital. The lending and borrowing activities of these bankers are not regulated or supervised, and they decide the rates of lending and borrowing themselves.

IBs work majorly in the urban parts of India, especially in western and southern regions. The importance of IBs has decreased a lot during the past few years because of growth of the organised banking sector.

Money lenders

These refer to those individuals who operate the business of lending money, and their chief source of income is the interest that they earn on loans. The interest rates charged by money lenders are usually very high. Loan seekers are majorly farmers, artisans, manual workers and small businessmen in rural areas. Money lenders work on their own, and there is no regulatory authority for them.

Non-Banking Financial Companies (NBFCs)

These include various elements such as chit funds, Nidhis, loan or finance companies and finance brokers.

What is Capital Market?

Capital market is a market where stocks, shares and bonds are tradeds in the market which is generally a stock exchange. The capital market is a market for financial investments that are direct or indirect claims to capital. It is wider than the Securities Market and embraces all forms of lending and borrowing, whether or not evidenced by the creation of a negotiable financial instrument.

The capital market comprises the complex of intermediate term funds and long-term funds are pooled and made available to business, government and individuals. It encompasses the process by which securities already outstanding are transferred.

The capital market is highly prone to risks due to the dynamics of the political system, enforcement of government policies, new tax structure, etc. Examples of capital market instruments are equities, insurance instruments, foreign exchange instruments, etc. The capital market helps the investor in accumulating large amount of funds especially when the economy of the country is progressing very well.

The capital market provides medium- and long-term funds unlike the money market that provides only short-term funds. The Indian capital market is usually segregated into two segments:

  • Gilt-edged market: This is the market for the trade of government and semi-government securities backed by RBI. The securities traded in the gilt-edged market are stable in value and are mainly availed by banks and financial institutions that constitute the pre-dominant segment of this market.

  • Industrial securities market: This is the market for issuing and trading of shares and debentures of the existing or new business ventures. Public and private companies can both issue and trade their shares and debentures. The general public and retail investors, along with corporate entities, can buy and sell securities in this market. The industrial securities market is further segregated into primary and secondary markets.

    • Primary market: It is also known as the new issues market. New shares and debentures (known as Initial Public Offering (IPO) in case of shares) are issued for the first time in the primary market. This market allows raising new capital for upcoming ventures. The market relates to the issue of equity shares, preference shares and debentures of non-government public limited companies to raise fresh capital.

    • Secondary market: It is also known as the old issues market or aftermarket. This market deals in the trading of securities already issued by the existing organisations. The maximum volume of trade takes place in the secondary market.

Characteristics of Primary Market

Some of the characteristics of primary market are:

  • New securities are traded in the primary market.

  • New share certificates are issued to investors for shares purchased by them.

  • Primary markets enable organisations to raise funds for their growth and development.

  • They also help in capital formation of the economy.

On the other hand, a secondary market is the one in which the trading of the existed securities takes place in the stock market. These markets basically fulfil the short-term requirements of organisations.

Characteristics of Secondary Market

The characteristics of the secondary market are as follows:

  • It transfers securities from initial purchasers to other buyers and speculators.

  • It needs high liquidity.

  • It deals with high fluctuation in prices of securities.

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