Money Market Instruments – Definition, Types, Features & Benefits

Are you looking for a secure and minimal-risk opportunity in a liquid investment option? Money market instruments are the best for you. These are characterised by short-term investments, which provide stability and easy access to funds. You might be still wondering what exactly they are, their benefits, features, etc. Let’s get going towards the journey of money market instruments.

What is a Money Market?

The money market is a specialized type of financial market, in broader terms it involves various big participants including corporates and government. It involves the trade of short-term money market securities with a maturity period of not more than one year (365 days). The securities or trading bills are close substitutes for money in terms of liquidity and are also highly rated. Furthermore, these enable the participation of short-term borrowing requirements for trading in bills. The market participants typically include banking institutions, institutional investors, the government, and RBI as a merchant banker of government banks. It also includes other financial institutions like MFs, FIIs and Corporate units.

Objectives of Money Market

• They assist the central bank in controlling money availability in the economy.
• Money markets offer assistance to short-term fund users as they meet their needs at fundamentally sound costs.
• The money market assists in the development of a stable economy and financial markets and provides short-term finances for trade and industries.
• To assist in coming up with sound monetary policies.
• To enable enhanced operations of the commercial banks.

Understanding Money Market Instruments

Money market instruments are those investment securities through which market participants come forward to organize short-term liabilities. The borrowers can be easily given a loan at a cheap rate so that he or she can be able to meet the immediate needs in place while on the other side, the lender can benefit in terms of rates of interest and liquidations. Money market instruments involve short-term bonds, treasury bills, CDs, commercial papers, etc.

Types of Money Market Instruments

1. Certificate of Deposit

To support an organization with short-term money requirements, there exists the common practice of doing it through a certificate of deposit. The operating procedure is almost like a fixed deposit but the former has a comparatively better negotiating capacity due to the relatively higher liquidity. They are also tradeable in the secondary market. It is issued by banks and financial institutions.

2. Commercial Paper

Commercial paper is one of the money market instruments that works like a financial instrument for lending that can be offered in the money market as well as in the secondary market Commercial paper requires a minimum value of 5 lakhs and then no specific limits for maximum value. It is an unsecured form of financing and they are issued by top corporations, All-India financial institutions and primary dealers.

They have been seen to be debt instruments with a maturity of 7 days to one year, hence this will attract a lower rate as compared to similar instruments in the capital market.

3. Treasury Bills

These are only available to the central government of a country when the government needs cash to finance its short-term commitments.

These securities do not bear any interest to an investor as they are issued at a discount ( say 95) and paid back in full(say 100) as it is bought below its face value while the whole face value is paid at the time of redemption of the securities.

Default risk is minimal since treasury bills are issued by the government, which makes the bills suitable for conservative investors.

4. Repurchase Agreements

A repurchase agreement, or repo, is a borrowing process where the borrower sells a security to the lender for cash under the understanding that the security is to be bought back at a specific date for a certain price. Unlike other securities, ownership of the security does not transfer in a repo transaction.

Repurchase agreements mainly relate to government securities, where sellers agree to buy them back later at a particular price. These are sensitive to the prevailing market rates and the governments usually guarantee them.

5. Banker’s Acceptance

This is a money market instrument used in other aspects of the financial sector as well. A commercial bank will issue a banker’s acceptance, which is a promise to repay money at a later date. Since the bank is the borrower, the bank makes this guarantee. There is a range of 30 to 180 days. 

Features of Money Market Instruments

• Money market instruments can be financed by banks or by the public as they are the main ways through which governments avail funds to meet deficits.
• Helps borrowers to finance their cash requirements in the short run
• Its main feature is liquidity. All the market instruments including call money, notice money and others are various securities that form this market and they have an impact on the overall performance of the economy. They also are used to determine and regulate liquidity in the economy.
• Trading turnover is typically pronounced, which means that the flow of assets is rather heavy.
• It can help meet their small, urgent and immediate monetary requirements. Further, it concerns the investment with a maturity period of one year or less on their investment instruments.
• While there will always be some risk because of the short investment horizon that money market investments entail, that risk is well contained. Besides, short-term securities and bonds are those that are issued by reputable businesses and firms. As a result, the likelihood of default is lower than in the case of longer-term instruments.
• In India, some money market instruments can be bought at a lower price as compared to their face values. Therefore, the rate of return on bonds and securities is finite and agreed on from the onset. Money market investment is secure and offers fixed returns.

Benefits of Money Market Instruments

• Makes it possible to diversify the portfolios by investing in money market instruments that are safe because they are issued by reputable banks and corporations making these funds safe.
• They give assured and fixed rates of return, provide for interest payments through offering securities at lower face value, and thus are appropriate for investors with low-risk tolerance.
• Money market instruments are relatively more liquid than other fixed-income securities.
• A money market instrument’s rate of return is marginally greater than a savings account’s rate of return.

Wrapping Up

Money market instruments are not only the safest and most secure option but also a good liquid investment option. If any investors looking for a short-term investment with all the characteristics mentioned above? Then money market instruments are an ideal option for you.

Money market instruments are a great investment option for short-term investors. Also, risk averse investors, who are willing to diversify their portfolio can go for it.

Please share your thoughts on this post by leaving a reply in the comments section. 

Also, check out our recent post on: “Gold FOF – Meaning and Reasons to Invest in Gold FOFs“

To learn more about mutual funds, contact us via Phone, WhatsApp, Email, or visit our Website.  Additionally, you can download the Prodigy Pro app to start investing today!

Disclaimer – This article is for educational purposes only and by no means intends to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme related document carefully before investing.