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Before going into the details of money Market instruments, let us try and understand the basics and features of the Money Market. By the end, we will be able to answer questions like “What is Commercial paper?” and “what is a certificate of deposit?”
The financial market is broadly categorised into the money market and capital market. This is where the entire cash flow is concentrated. The capital market deals with long-term securities that are bought and sold by investors. However, the money market deals with short-term securities with maturities within a year.
Major distinctions between money market and capital market
The money market is highly fluid and efficient. It is generally more expensive due to the small number of participants. It is also considered more secure than the capital market due to the short maturity time.
While the expected returns are less with the money market, the short duration attracts short-term investors. These individuals are looking for short maturities as they require the money for some other purpose shortly. While companies look for fixed capital from the capital market, they use money markets for working capital.
Instruments of Money Market
Both the money market and capital market use their instruments. The capital market uses bonds, shares, and debentures. The money market, on the other hand, uses federal funds, treasury bills, commercial papers, certificates of deposit, call money, Eurodollars, and mutual funds.
Let’s go through each one in detail and understand the meaning of Commercial papers, treasury bills, commercial bills, and certificates of deposit.
Commercial paper
What is Commercial paper? Commercial paper is a short-term unsecured note issued by foreign governments and large corporations. It is used to raise short-term loans by large companies. It has a maturity status of 15 days to 270 days. It is preferable to loans due to its low cost.
In simple terms, the meaning of Commercial paper is “loan that can be bought and sold .”This “loan” can then be cashed or redeemed later on. The value of this amount is dependent on the value determined by the company. This was started to provide short-term for seasonal and working capital needs. It is generally sold at a discount and redeemed at a higher price. It is put under a continuous rolling program in many countries even though it is a short-term obligation.
Treasury bills
Treasury bills also operate under the same terms as commercial papers. The main difference, however, between Commercial papers and treasury bills is that treasury bills are issued by the Government while Commercial papers are issued by large companies.
After understanding the meaning of Commercial paper, let’s now move on to the concept of call money.
Call money
It is a type of short-term loan that is repayable on demand between one to fifteen days. It’s mostly used for inter-bank transfers. Let’s look at why banks borrow money from other banks. A cash reserve ratio is required of all banks. Call money is a strategy used by these banks to maintain their cash reserve ratio by borrowing from one another. Call interest is the interest paid on call money.
Certificate of Deposit
Investors make deposits in banks which are given as a loan to individuals in need. When the deposits are less than the required, a certificate of deposits is issued. These can be traded and generally issued by Commercial banks. The maturity of the certificate of deposit is up to 1 year.
Commercial bill
A commercial bill is a bill of exchange that is generally used by companies to meet their working capital requirements. It is short-term and negotiable. When goods are sold on credit, the buyer needs to make the payment on a specific day in the future. The seller drafts a bill of exchange and can either wait till the date agreed upon or can exchange it for redeeming his amount.
Conclusion
The money market is a short-term market that allows the liquidity of the money. It is safer, more expensive, and gives lesser returns when compared to the capital market. There are various instruments in the Money Market. We have learnt the meaning of Commercial paper, certificate of deposit, call money, treasury bills, and commercial bills. Commercial papers are issued by large corporations and foreign governments, while treasury bills are issued by the Government. To understand more in detail about the financial market, try and refer to the notes on the capital market.
