Commerce · Ch 1 — Financial Markets
Money Market Instruments
Money Market Instruments
The main instruments traded in the money market are treasury bills, commercial paper, call money, certificates of deposit and commercial bills.
1. Treasury Bill (T-bill)
A treasury bill is basically an instrument of short-term borrowing by the Government of India, maturing in less than one year. Treasury bills are also known as Zero Coupon Bonds and are issued by the RBI on behalf of the Central Government to meet its short-term requirement of funds. They are issued in the form of a promissory note, are highly liquid, and carry an assured yield with a negligible risk of default. They are issued at a price lower than their face value and repaid at par; the difference between the issue price and the redemption (face) value is the interest receivable, called the discount. Treasury bills are available for a minimum amount of ₹25,000 and in multiples thereof.
Example: An investor buys a 91-day treasury bill of face value ₹1,00,000 for ₹96,000. On holding it until maturity, the investor receives ₹1,00,000. The difference of ₹4,000 between the maturity proceeds and the purchase price is the interest earned.
2. Commercial Paper
Commercial paper is a short-term, unsecured promissory note, negotiable and transferable by endorsement and delivery, with a fixed maturity period usually of 15 days to one year. It is issued by large and creditworthy companies to raise short-term funds at rates lower than the market rate, and is an alternative to bank borrowing for financially strong companies. It is sold at a discount and redeemed at par. Its original purpose was to provide short-term funds for seasonal and working capital needs. A common use is bridge financing — for example, a company that needs long-term finance and must incur floatation costs (brokerage, commission, printing and advertising) may raise funds through commercial paper to meet those costs.
3. Call Money
Call money is short-term finance repayable on demand, with a maturity of one day to fifteen days, used mainly for inter-bank transactions. Commercial banks must maintain a minimum cash balance known as the cash reserve ratio (CRR), which the RBI changes from time to time. Call money is a method by which banks borrow from each other to maintain this ratio. The interest rate paid on call money is the call rate — a highly volatile rate that can change from day to day and even from hour to hour. There is an inverse relationship between the call rate and other short-term instruments such as certificates of deposit and commercial paper: a rise in the call rate makes these other sources cheaper in comparison for banks to raise funds from.
4. Certificate of Deposit (CD)
Certificates of deposit are unsecured, negotiable, short-term instruments in bearer form, issued by commercial banks and development financial institutions. They can be issued to individuals, corporations and companies during periods of tight liquidity — when the deposit growth of banks is slow but the demand for credit is high — and help to mobilise a large amount of money for short periods.