Money Market — Meaning and Features

The money market may be defined as the market for short-term financial assets that are close substitutes for money — instruments with a maturity of one year or less, which can be converted into cash quickly, and with minimum loss. It exists mainly to help banks, financial institutions, large companies and the government manage their day-to-day and short-term cash positions, borrowing when they have a temporary shortfall and lending when they have temporary surplus funds, rather than leaving idle cash unused or being forced to borrow long-term for a purely short-term need.

Several features distinguish the money market from the capital market studied later in this chapter. First, it deals exclusively in short-term instruments, with maturities ranging from a single day (in the case of call money) up to, at most, one year. Second, it is highly liquid, since every instrument traded in it is, by design, quickly and easily convertible back into cash without significant loss of value. Third, it is a low-risk market, both because the maturities are short (reducing the time over which anything can go wrong) and because the participants — banks, the government, and highly rated large companies — are themselves of high creditworthiness. Fourth, it is essentially a wholesale market, dealing in large volumes and large-denomination instruments, and its participants are institutions rather than individual retail investors. Fifth, unlike the capital market's stock exchange, the money market has no single physical trading floor — transactions are typically conducted over telephone, through electronic trading platforms, or directly between institutions, which is why it is sometimes described as an over-the-counter market rather than an exchange-traded one. Sixth, most money-market instruments are issued and traded at a discount to their face value, rather than carrying an explicit rate of interest — the investor's return is simply the difference between the discounted purchase price and the face value received at matu …