moneymaarket

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INTRODUCTION TO FINANCIAL

MARKETS

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Money Market

The term money market is a misnomer. Money

(currency) is not actually traded in the money markets.The securities in the money market are short term withhigh liquidity, therefore they are close to being money.

Money Markets: Markets that trade debt securities orinstruments with maturities of less than one year.

According to Geottery Crowther Money market is thecollective name given to the various firms andinstitutions that deal in the various grades of nearmoney

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Need for Money Market

In theory, the banking industry should handlethe needs for short-term loans and acceptshort-term deposits. Banks also have an

information advantage on the credit-worthiness of participants.

Banks do mediate between savers and

borrowers; however, they are heavilyregulated. This creates a distinct costadvantage for money markets over banks

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Money Market V/S Capital Market

Money Market

1. Market for short term

loanable funds for a period

not exceeding one year.2. Supplies funds for

financing current business

operations, working capital

requirements & shortperiod Govt requirements

3. Each single instrument is of

a large amount.

Capital Market

1. Market for long term

loanable funds for a period

exceeding one year2. Supplies funds for

financing fixed capital &

long period Govt

requirements.3. Each single instrument is of

a small amount.

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Money Market

4. Central Bank and

Commercial Bank are the

major institutions.5. Money market instruments

dont have a secondary

market.

Capital Market

4. Development banks &

Insurance Companies play

a dominant role.5. Capital market instruments

have a secondary market.

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Features

1. Market for short term funds or financial

assets called near money.

2. Financial assets having maturity period of

less than one year.

3. Assets which can be easily converted into

cash without loss and minimum transaction

cost.

4. Not a single homogenous market.

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Composition of Money Market

1. Call Money market.

2. Commercial Bills or Discount market.

3. Acceptance Market.4. Treasury Bill Market.

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Call Money market.

Market for extremely short period loans say oneto fourteen days.

Loans are repayable on demand at the option of

either lender or borrower. these loans are given to brokers and dealers in

stock exchange

banks with surplus lend to other banks with

deficit funds in the call money market. Thus, itprovides an equilibrating mechanism for eveningout short term surpluses and deficits

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Moreover, commercial bank can quickly

borrow from the call market to meet their

statutory liquidity requirements.

They can also maximize their profits easily by

investing their surplus funds in the call market

during the period when call rates are high and

volatile.

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Operations in Call Market

Borrowers and lenders in a call market can

contact each other over telephone or deals

can be routed through the Discount and

Finance House of India (DFHI) .

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Purpose of Call Loans

To commercial banks to meet large payments,large remittances to maintain liquidity with theRBI and so on.

To the stock brokers and speculators to deal instock exchanges and bullion markets.

To the bill market for meeting matured bills.

To the Discount and Finance House of India andthe Securities Trading Corporation of India toactivate the call market.

To individuals of very high status for tradepurposes to save interest on O.D or cash credit.

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The participants in this market can be

classified into categories viz.

Those permitted to act as both lenders and

borrowers of call loans.(commercial banks. Co-

operative banks, DFHI and STCI)

Those permitted to act only as lenders in the

market.(LIC, UTI, GIC, IDBI, NABARD, specified

mutual funds)

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Advantages of call money

High Liquidity

High Profitability

Maintenance of SLR. Safe and Cheap

Assistance to Central Bank Operations

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Draw backs

Uneven development

Lack of integration

Volatility in interest rates.

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Commercial Bills Market

Discount Market

A commercial bill is one which arises out of agenuine trade transaction, i.e. credit transaction.

As soon as goods are sold on credit, the seller

draws a bill on the buyer for the amount due. Thebuyer accepts it immediately agreeing to payamount mentioned therein after a certainspecified date. Thus, a bill of exchange contains a

written order from the creditor to the debtor, topay a certain sum, to a certain person, after acreation period.

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bill of exchange is a self-liquidating paper andnegotiable/; it is drawn always for a short periodranging between 3 months and 6 months

Section 5 of the negotiable Instruments Actdefines a bill exchange a follows:

an instrument in writing containing an

unconditional order, signed by the maker,

directing a certain person to pay a certain sum ofmoney only to, or to the order of a certain personort to the beater of the instrument.

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Types of Bills

Many types of bills are in circulation in a bill

market. They can be broadly classified as follows:

Demand and usance bills.

Clean bills and documentary bills.

Inland and foreign bills.

Export bills and import bills.

Indigenous bills.

Accommodation bills and supply bills.

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Demand and Usance Bills

Demand bills are others called sight bills. These

bills are payable immediately as soon as they are

presented to the drawee. No time of payment is

specified and hence they are payable at sight. Usance bills are called time bills. These bills are

payable immediately after the expiry of time

period mentioned in the bills. The period variesaccording to the established trade custom or

usage prevailing in the country.

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Clean Bills and Documentary Bills

When bills have to be accompanied by documents of titleto goods like Railways, receipt, Lorry receipt, Bill of Ladingetc. the bills are called documentary bills. These bills can befurther classified into D/A bills and D/P bills. In the case ofD/A bills, the documents accompanying bills have to be

delivered to the drawee immediately after acceptance.Generally D/A bills are drawn on parties who have a goodfinancial standing. On the order hand, the documents haveto be handed over to the drawee only against payment inthe case of D/P bills. The documents will be retained by the

banker. Till the payment o0f such bills. When bills aredrawn without accompanying any documents they arecalled clean bills. In such a case, documents will be directlysent to the drawee.

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Inland and Foreign Bills

Inland bills are those drawn upon a person

resident in India and are payable in India.

Foreign bills are drawn outside India an they

may be payable either in India or outside

India. They may be drawn upon a person

resident in India also. Foreign boils have their

origin outside India. They also include billsdrawn on India made payable outside India.

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Export and Foreign Bills

Export bills are those drawn by Indian exports

on importers outside India and import bills are

drawn on Indian importers in India by exports

outside India.

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Indigenous Bills

Indigenous bills are those drawn and accepted

according to native custom or usage of trade.

These bills are popular among indigenous

bankers only. In India, they called hundis thehundis are known by various names such as

Shah Jog, Nam Jog, Jokhani, Termainjog.

Darshani, Dhanijog, and so an.

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Accommodation Bills and Supply Bills

If bills do not arise out of genuine trade transactions, theyare called accommodation bills. They are known as kitebills or wind bills. Two parties draw bills on each otherpurely for the purpose of mutual financial accommodation.These bills are discounted with bankers and the proceeds

are shared among themselves. On the due dates, they arepaid.

Supply bills are those neither drawn by suppliers orcontractors on the government departments for the goodsnor accompanied by documents of title to goods. So, they

are not considered as negotiable instruments. These billsare useful only for the purpose of getting advances fromcommercial banks by creating a charge on these bills.

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Operations in Bill Market:

From the operations point of view, the bill

market can be classified into two viz.

1. Discount Market

2. Acceptance Market

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Discount Market

Discount market refers to the market where short-term genuine trade billsare discounted by financial intermediaries like commercial banks. Whencredit sales are effected, the seller draws a bill on the buyer who accepts itpromising to pay the specified sum at the specified period. The seller hasto wait until the maturity of the bill for getting payment. But, the presenceof a bill market enables him to get payment immediately. The seller can

ensure payment immediately by discounting the bill with some financialintermediary by paying a small amount of money called Discount rate onthe date of maturity, the intermediary claims the amount of the bill fromthe person who has accept6ed the bill.

In some countries, there are some financial intermediaries who specializein the field of discounting. For instance, in London Money Market thereare specialise in the field discounting bills. Such institutions areconspicuously absent in India. Hence, commercial banks in India have toundertake the work of discounting. However, the DFHI has beenestablished to activate this market

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Acceptance Market

The acceptance market refers to the market where short-term genuine trade bills are accepted by financialintermediaries. All trade bills cannot be discounted easilybecause the paties to the bills may not be financially sound.In case such bills are accepted by financial intermediaries

like banks, the bills earn a good name and reputation andsuch bills can readily discounted anywhere. In London,there are specialist firms called acceptance house whichaccept bills drawn by trades and import greatermarketability to such bills. However, their importance has

declined in recent times. In India, there are no acceptancehouses. The commercial banks undertake the acceptancebusiness to some extant.

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Advantages of commercial bills:

Liquidity: Bills are highly liquid assets. In times

of necessity, bills can be converted into cash

readily by means of rediscounting them with

the central bank. Bills are self-liquidating incharacter since they have fixed tenure.

Moreover, they are negotiable instruments

and hence they can be transferred freely by amere delivery or by endorsement and

delivery.

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Ideal Investment: Bills are for periods not

exceeding 6 months. They represent advances

for a definite period. This enables financial

institutions to invest their surplus fundsprofitably by selecting bills of different

maturities. For instance, commercial banks

can invest their funds on bills in such a waythat the maturity of these bills may coincide

with the maturity of their fixed deposits.

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Simple Legal Remedy: In case the bills are

dishonored\, the legal remedy is simple. Such

dishonored bills have to be simply noted and

protested and the whole amount should bedebited to the customers accounts.

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High And Quick Yield: The financial

institutions earn a high quick yield. The

discount is dedicated at the time of

discounting itself whereas in the case of otherloans and advances, interest is payable only

when it is due. The discounts rate is also

comparatively high.

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Easy Central Bank Control: The central bank

can easily influence the money market by

manipulating the bank rate or the

rediscounting rate. Suitable monetary policycan be taken by adjusting the bank rate

depending upon the monetary conditions

prevailing in the market.

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Absence Of Rediscounting Among Banks:

There is no practice of re-discounting of bills

between banks who need funds and those

who have surplus funds. In order to enlargethe rediscounting facility, the RBI has

permitted financial institutions like LIC, UTI,

GIC and ICICI to rediscount genuine eligibletrade bills of commercial banks. Even then, bill

financial is not popular.

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Stamp Duty: Stamp duty discourages the use of

bills. Moreover, stamp papers of required

denomination are not available.

Absence Of Secondary Market: There is no activesecondary market for bills. Rediscounting facility

is available in important centers and that too it

restricted to the apex level financial institutions.Hence, the size of the bill market has bee

curtailed to a large extant.

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Difficulty In Ascertaining Genuine Trade Bills:

The financial institutions have to verify the

bills so as to ascertain whether they are

genuine trade bills and not accommodationbills. For this purpose, invoices have to be

scrutinized carefully. It involves additional

work.

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Limited Foreign Trade: In many developed

countries, bill markets have been established

mainly for financing foreign trade.

Unfortunately, in India, foreign trade as apercentage to national income remains small

and it is reflected in the bill market also.

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Absence Of Acceptance Services: There is nodiscount house or acceptance house in India.Hence specialised services are not available in thefield of discounting or acceptance.

Attitude Of Banks: Banks are shy rediscountingbills even the central bank. They have a tendencyto hold the bills till maturity and hence it affects

the velocity of circulation of bills. Again, banksprefer to purchase bills instead of discountingthem.

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