MONEY MARKET

Money Market acts as an essential part of economic development. It is concerned with that portion of the
financial system where trading of the short-term fund is done for a period of less than 1 year. It is a product
of the capital market, which is treated as a channel of short-term debt capital. Although it is undoubtedly distant
from the capital market, money market deals with short-term call and notice deposit, promissory notes, government
papers, short-period bills, etc.

Functions of Money Market

Following are the functions performed by the Money Market:

 Worthwhile Use of Balance Capital

It facilitates to use of the balance capital funds efficiently for a short period by the financial as well as the non-
financial institution and the government.

 Aids in Monetary Progress

For fulfilling the working capital requirements of the various financial institutions, a money market provides short-
term capital to them. It boosts the expansion of commerce, industry and trade by discounting the trade bills by way
of commercial banks, acceptance houses, brokers, etc.

 Helps the Banks

The commercial bank rather than borrowing from the RBI can borrow some loans from the existing money market,
as the interest rate of the money market is lower than the RBI, which saves the cost of the bank.

 Helps the Government

By issuing Treasury bills, the government can obtain short-term capital from the money market at a minimal rate of
interest rather than financing from RBI.

 Balance amongst demand and supply of capital

By way of transfer of savings into investments, the money market grants money to be used in a balanced way
which maintains the balance amongst demand and supply of the capital amount.

 Competent application of monetary policies

By its monetary policies, RBI may effectively regulate its banking system and can give guidance to the
development of commerce and industry. Competent application of monetary policies is thus effectively managed
by the Reserve Bank of India.

 Effective Use of Money

Money Market aids the development of commerce and industry as it manages the money assets and money can
easily be relocated from one place to another.

Money Market Instruments

The following are some of the instruments of the Money Market:

 Treasury Bills

Treasury Bills are the preeminent instrument of the Money Market which are issued for less than 1 year, i.e., for
91,182,360 days. The Central Government issues them for providing short-term capital to the market. It can be
issued as ordinary or ad hoc treasury bills and any individual who is a resident of India can purchase such bills.
Banks may convert their statutory liquidity ratio held in the form of treasury bills into cash as and when required
for cash reserve ratio obligation.

 Promissory Notes

It is a written promise by one person to another to pay a certain amount at an acknowledged period of time
mentioned in a note. In general, a promissory note is signed for 90 days plus 3 days of the grace period. It is drawn
by the debtor and must be acknowledged by his bank, so that creditor gets it discounted directly from the bank on
the due date.

 Commercial Paper

Commercial Papers are the short-term liability issued by highly ranked companies to lenders for recent fund
received from them. Companies having a minimum net worth of ₹ 4 crores can only raise the commercial papers
for a minimum of 7 days and a maximum of 1 year of time. It is issued in the form of the customed promissory
note at a discount to face value.

 Certificate of Deposits

Certificate of Deposits is the receipts issued by the financial institutions for a particular time at a fixed interest rate.
These certificates can be issued with a minimum size of 5 lacs in a multiple of 1 lac for a minimum period of 7
days and a maximum period of 1 year. They are issued at the rate driven by the market forces at a discount to face
value, here the stamp duty has to be borne by the financial institutions.

 Inter-Bank Participation

The bank has to decrease its advances or need to raise its deposits if it has an extensive credit deposit ratio, which
can be done by decreasing the advances for some-time by granting permission to other banks to participate in its
classified advance. For which a participation certificate is issued to the participating banks. Inter-bank Participation
Certificates are issued:

1. With Risk Sharing: If it is issued with risk sharing, then it is issued for 91 to 180 days with an interest rate
determined by the participating bank.
2. Without Risk sharing: If it is issued without risk sharing, then it is issued for not more than 90 days with
an interest rate decided by the participating bank.

Institutions of the Money Market:

The various financial institutions which deal in short term loans in the money market are its members. They
comprise the following types of institutions:
1. Central Bank:
The central bank of the country is the pivot around which the entire money market revolves. It acts as the guardian
of the money market and increases or decreases the supply of money and credit in the interest of stability of the
economy. It does not itself enter into direct transactions. But controls the money market through variations in the
bank rate and open market operations.

2. Commercial Banks:
Commercial banks also deal in short-term loans which they lend to business and trade. They discount bills of
exchange and treasury bills, and lend against promissory notes and through advances and overdrafts.

3. Non-bank Financial Intermediaries:

Besides the commercial banks, there are non-bank financial intermediaries which lend short-term funds to
borrowers in the money market. Such financial intermediaries are savings banks, investment houses, insurance
companies, provident funds, and other financial corporations.

4. Discount Houses and Bill Brokers:

In developed money markets, private companies operate discount houses. The primary function of discount houses
is to discount bills on behalf of other. They, in turn, form the commercial banks and acceptance houses. Along-with
discount houses, there are bill brokers in the money market who act as intermediaries between borrowers and
lenders by discounting bills of exchange at a nominal commission. In underdeveloped money markets, only bill
brokers operate.

5. Acceptance Houses:
The institution of acceptance houses developed from the me change bankers who transferred their headquarters to
the London Money Market in the 19th and the early 20 the century. They act as agents between exporters and
importers and between lender and borrower traders. They accept bills drawn on merchants whose financial
standing is not known in order to make the bills negotiable in the London Money Market. By accepting a trade bill
they guarantee the payment of bill at maturity. However, their importance has declined because the commercial
banks have undertaken the acceptance business.

All these institutions which comprise the money market do not work in isolation but are interdependent and
interrelated with each other.

ANSWER-2 CAPITAL MARKET

Capital Market is used to mean the market for long term investments, that have explicit or implicit claims to
capital. Long term investments refer to those investments whose lock-in period is greater than one year. In the
capital market, both equity and debt instruments, such as equity shares, preference shares, debentures, zero-coupon
bonds, secured premium notes and the like are bought and sold, as well as it covers all forms of lending and
borrowing. Capital Market is composed of those institutions and mechanisms with the help of which medium and
long term funds are combined and made available to individuals, businesses and government. Both private
placement sources and organized market like securities exchange are included in it.

Functions of Capital Market

1. Capital Formation
In capital markets, there are people who have no immediate need for cash – investors – and those who need cash –
debtors. The capital markets allow unused capital to be invested and employed instead of sitting by idle.
So rather than have $1 million sitting under the mattress, it allows businesses the opportunity to borrow and invest
in new machinery or other capital equipment. In return, the investor receives a yield and the business benefits from
more productive equipment.

2. Ease of Access and Exit

In today’s day and age, capital markets have become increasingly accessible, with investors able to trade off their
mobiles. The advancement of technology has made capital markets almost universally available.
All investors have to do is create an account with a broker and they are essentially ready to invest. At the same
time, we now have global markets too. So that also creates greater demand for assets too – meaning people can exit
the market as easily as they joined.

3. Economic Growth
By facilitating a market place for borrowers and lenders, the capital market creates a more efficient flow of capital.
Businesses that need a corporate loan can come to the capital market, apply, and get it issued by an underwriter.
Alternatively, it can sell some of its company onto the stock exchange in return for capital.
This helps economic growth because it takes capital that is not being used, and it employs it somewhere else in the
economy. Quite simply, it stimulates demand. If businesses that need credit get it, they are able to invest. In turn,
that money goes to the business that provides the capital equipment that it invested in. That money then can
circulate further and further through the economy – meaning an initial $1 million investment turns into $10 million
after being exchanged 10 times.

4. Liquidity of Capital
Capital markets allow those who have capital, to invest it. In return, they have ownership of a bond or equity.
However, they are unable to buy a car, food, or other assets with a bond certificate – which is why it may be
necessary to liquidate these.
In capital markets, it is very easy for those who have previously invested, to sell the asset on to a third party in
return for liquid capital (cash). If you want to sell an asset at the current market price, there is almost always a
buyer – allowing you to turn an asset into cold hard cash.

5. Regulate Prices
One of the key functions of capital markets is to ensure the price of an asset is accurate. The price of a share can
increase rapidly following good news, or tank badly in reaction to a poor annual report. By having thousands of
traders, the prices fluctuate to a point whereby the value of the equity is reflected in its price at that time.
At the same time, the prices for bonds can fluctuate and respond more effectively due to supply and demand. For
instance, bonds are usually seen as a safer investment – so are usually preferred by investors during a recession.
6. Return on Investment
In capital markets there are enough financial instruments to suit any type of investors, whether they want a high
level of risk or a low level of risk – there is something for everyone.
At the same time, capital markets provide investors with an opportunity to enhance their yield on their capital.
Savings accounts offer little interest – particularly in comparison to yields on the majority of stocks. The capital
market, therefore, allows investors the opportunity to make a higher rate of return – although there is an element of
risk too.

Capital Market Instruments

Bond Markets
The bond market is very diverse in its offerings, which is why most of the trades in this market are done ‘Over the
Counter’ (OTC). There are many different types, but let us look at the main ones below:
 1. Corporate Bonds – Investment-Grade
Corporate bonds are simply businesses borrowing money in exchange for a ‘bond’ at a set rate of interest. These
usually come in short-term bonds with a maturity of five years or less; intermediate bonds, with a maturity between
5 to 12 years; and long-term bonds with a maturity of over 12 years.
More specifically, investment-grade bonds are those categorised for big businesses that are highly unlikely to
default. They are riskier than government bonds, yet safer than ‘junk bonds’ – so are a half-way house between risk
levels.
 2. Corporate Bonds – Junk bonds
Junk bonds offer a high yield – much higher than other types. Yet they also offer the highest level of risk. This is
because the companies that issue these bonds are either small or unreliable. In other words, the likelihood of
receiving the initial investment back is not high.
This is a good way for small to medium business to obtain capital and grow as it allows them to access credit they
may not have access to otherwise.
 3. Foreign Bonds
Foreign bonds are issued in the domestic country by a foreign entity in local currency. For instance, an Indian firm
may want to raise some capital in the US as it is unable to raise it in the Indian capital markets. In turn, it may issue
$1 million in foreign bonds – all in US dollars. The debt is therefore repayable in US dollars.
Although this can pose a greater risk to the foreign entity due to currency fluctuations, it provides an avenue to
capital that may be unavailable in its own market. At the same time, it allows investors to diversify their portfolio
to reduce their exposure to economic fluctuations.
 4. Municipal Bonds
A municipal bond differs from a government bond in the fact that they are issued by local government or one of its
agencies – rather than the central/federal government. These are generally safe bonds but present a greater risk than
treasury bonds.
They can be popular as they come in a tax-exempt version, with the investment funding local infrastructural
projects such as new parks, libraries, or bridges.
5. Treasury Bonds
Government bonds, or ‘treasury bonds’, as they are commonly referred to in the US, are issued by central
government over a set period of time – usually greater than 10 years. They earn a small amount of interest – below
the market average, due to the low risk associated with such.
These are considered the holy grail of bonds in the fact they are virtually risk-free. However, some nations have a
better reputation than others. Greece, Italy, and Spain for instance present a greater risk and therefore offer a higher
yield. By contrast, the US offers lower yields that represent its reliability to make repayments.
 6. Zero-coupon Bonds
Zero-coupon bonds are bonds that are sold on the market at a steep discount. This is because there is no interest
due until it expires – so essentially its value gains over time.
Often, these bonds are indexed to inflation to ensure the owner of the bond maintains its purchasing power
throughout time.

Institutional sources of Capital Market:

 
There are a number of financial institutions which are directly involved with real investment in the economy.
These institutions mobilize the saving from the people and channel funds for financing the development
expenditure of the industry and government of a country.
 
The financial institutions take maximum care in investing funds in those projects where there is high degree of
security and the income is certain. The main institutional sources of capital market are as follows:
 
(i) Insurance Companies. Insurance companies are financial intermediaries. They call money by providing
protection from certain risks to individuals and firms. The insurance companies invest the funds in long term
investments primarily mortgage loans and corporate bonds.
 
(ii) Pension Funds. The pension funds are provided by both employees and employers. These funds are now
increasing utilized in the provision of long term loans for the industry and government.
 
(iii) Building Societies. The building societies are now activity engaged in providing funds for the construction,
purchase of buildings for the industry and houses for the people.
 
(iv) Investment Trusts. The investment trust mobilize saving and meet the growing, need of corporate sector, The
income of the investment trust depends upon the dividend it receives from shares invested in various companies. 
 
(v) Unit Trust. The Unit Trust collects the small savings of the people by selling units of the trust. The holders of
units can resell the units at the prevailing market value to the trust itself. 
   
(vi) Saving Banks. The saving banks collect the savings of the people. The accumulated saving is invested in
mortgage loans, corporate bonds.
 
(vii) Specialized Finance Corporation. The specialized finance corporations are being established to help and
provide finance to the private industrial sector in the form of medium and long term loans or foreign currencies.
 
(viii) Commercial banks. The commercial banks are also now activity engaged in the provision of medium and
long terms loans to the industrialists, agriculturists, specialist finance institutions, etc., etc.
 
(ix) Stock Exchange. The stock exchange is a market in existing securities (shares, debentures and securities
issued by the public authorities). The stock exchange provides a place for those persons who wish to sell the shares
and also wish to buy them. Stock exchange, thus helps in raising equity capital for the industry.
ANSWER-3 Role and Functions of Reserve Bank Of India (RBI)

Reserve Bank of India (RBI) is the central bank of India entrusted with a multidimensional role which includes
implementation of monetary policy and maintaining monetary stability in the country. RBI was established on 1st
April 1935 under the Reserve Bank of India Act, 1934. RBI was set up after the recommendations of Hilton young
Commission which had submitted its report in the year 1926. Later on, in 1931 the Indian Central banking enquiry
committee had also recommended for the establishment of the central bank in India.

Initially, Reserve Bank of India was established as a private shareholders bank, but it was nationalized after
independence in the year 1949 through the Reserve Bank (Transfer of public ownership) act, 1948.

Functions of RBI

 NOTE ISSUING AUTHORITY

The Reserve Bank has a monopoly for printing the currency notes in the country. It has the sole right to issue
currency notes of various denominations except one rupee note (which is issued by the Ministry of Finance).
 BANKER TO THE GOVERNMENT

Reserve Bank manages the banking needs of the government. It maintain and operate the government’s deposit
accounts. It collects receipts of funds and make payments on behalf of the government. performs merchant banking
function for the central and the state governments; also acts as their banker.

 BANKER’S BANK

The Reserve Bank performs the same functions for the other commercial bank as the other banks ordinarily perform
for their customers. RBI lends money to all the commercial banks of the country. All banks operating in the country
have account with the Reserve Bank.

 LENDER OF THE LAST RESORT

The commercial banks approach the Reserve Bank in times of emergency to tide over financial difficulties, and the
Reserve bank comes to their rescue though it might charge a higher rate of interest.

 CREDIT CONTROL

Credit control is a major weapon of RBI used to control Demand & Supply of money in the economy

The RBI undertakes the responsibility of controlling credit created by commercial banks. RBI uses two methods to
control the extra flow of money in the economy. These methods are quantitative and qualitative techniques to
control and regulate the credit flow in the country. When RBI observes that the economy has sufficient money
supply and it may cause an inflationary situation in the country then it squeezes the money supply through its tight
monetary policy and vice versa.

 CUSTODIAN OF FOREIGN EXCHANGE RESERVE

For the purpose of keeping the foreign exchange rates stable, the Reserve Bank buys and sells foreign currencies and
also protects the country’s foreign exchange funds. RBI sells the foreign currency in the foreign exchange market
when its supply decreases in the economy and vice-versa.

 COLLECTION OF DATA AND PUBLICATION

RBI collects data about interest rates, inflation, deflation, savings, investment etc. which is very helpful for
researchers and policymakers. It publishes data on different sectors of the economy through its Publication division.
It publishes monthly bulletin, weekly reports, annual reports, reports on trend and progress of commercial bank etc.