Question 1: Explain the various Money Market instruments.
Answer:
Various instruments available in the money market are:
1. Treasury Bills (T-Bills): It is a short-term borrowing instrument issued by the Government of India. RBI, issue it on behalf of Government of India.
- It is also known as zero coupon bonds.
- It has a maturity of less than one year.
- It is issued at discount and repaid at par.
- It is in the form of a promissory note.
- It is highly liquid and has negligible risk.
- It is available in denominations of ₹ 25000 and its multiples.
2. Commercial Paper: Commercial paper is issued by large creditworthy companies to raise short-term funds at lower rates of interest than the market rate.
- It is an unsecured promissory note, having a maturity of 15 days to one year.
- It is a negotiable instrument, transferable by endorsement and delivery.
- It is sold at discount and redeemed at par.
- It is an alternative to bank borrowing. The original purpose of commercial paper was to meet working capital needs of companies.
- It is used by companies for bridge financing, a method of financing used by companies before issuing shares or debentures, to cover the expenses associated with the issue of such securities, i.e. floatation costs.
3. Call Money: Call money is a method used by commercial banks to borrow funds from each other, in order to maintain the Cash Reserve Ratio (CRR). Cash Reserve Ratio is the minimum balance of cash to be maintained by banks, according to RBI guidelines.
- It is short-term finance repayable on demand.
- Maturity of call money is 1 day to 15 days.
- The interest paid on call money is called the call rate.
- Call rate is highly fluctuating, which varies from day-to-day or even from hour-to-hour.
- There is an inverse relationship between call rates and return on other short-term money market instruments. Increase in call rates make the demand for call money decrease, and increase in demand for other short-term instruments, as they become cheaper in relation to call money.
4. Certificate of Deposit: Certificate of deposits are issued by commercial banks or developmental financial institutions to individuals, institutions, corporations and companies.
- It is an unsecured, negotiable instrument in bearer form.
- It is issued in periods of tight liquidity, when the deposits by individuals and households are less, but the demand for credit is high.
- They help to mobilise large amounts of money in a short time period.
5. Commercial Bill: It is a bill of exchange used by business firms to meet their working capital needs.
- It is an unsecured, negotiable instrument in bearer form.
- When goods are sold on credit, the seller (drawer) draws a bill of exchange on the buyer (drawee), who accepts it. When he accepts the bill, it becomes a marketable instrument, which is called a trade bill. When the seller presents it to the bank for discounting it, to get the funds before the maturity of the bill and the bank accepts it, it is called a commercial bill.
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