Money Market Instruments: Everything you need to know
Created on 22 Apr 2021
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From mere paper to the ‘now in use’ digital currency, money has transformed over time and has expanded its definition. And the way we invest has also evolved, altering our investment choices to a great extent. This evolution has brought in new investment options making us doubt whether they would align with our needs and requirements. One such vehicle which is quite obscure to us is the instruments belonging to the money market.
What are Money Market Instruments?
The Indian money market saw an upward trend with the planned economic development of 1935. Unlike their long-term counterparts, money market instruments provide a short-term investment alternative.
The maximum duration an investor can park his money is one year. These securities are traded over-the-counter and usually require a broker’s help to execute the trade.
They are highly liquid and offer fixed returns at the same time. To add on, money market instruments aren’t backed by collateral securities. However, the credit rating also builds trust among investors and ceases the fear of default.
Types of Money Market Instruments
Let’s find out the various money market instruments available in the market.
These are debt instruments issued by high-credit worth companies to fulfill their short-term liquidity requirements. The maturity period might vary anything between 7 days to 1 year. They are unsecured funds. However, over the years, they have given good competition to general commercial banks as companies choose this way to raise funds because of lower interest and other added benefits.
Certificate of deposits
These are debt instruments that banks and financial institutions usually issue. They offer fixed interest during the holding tenure and promise to repay the purchase price at maturity. For banks, the maturity period is 7 days to 1 year, and for other financial institutions, the maturity period will vary anything between 1 year to 3 years. The certificates are issued for a minimum of 1 lakh and in multiples of 1 lakh thereafter.
The government issues these instruments to fund their short-term financial needs. They hold a zero default risk and have a ready market in case of sale before maturity. T-bills are issued for a period of 3, 6, or 12 months. Unlike the others, they don’t offer a regular interest income. But these are sold at a price lesser than the actual (that is, at a discount) and realized a higher price during maturity. Thus, profits will be the result of maturity value less face value.
These are generally used in the case of banks. Among the two parties involved, the issuer sells and agrees to buy back any financial instrument (generally g-sec) within the specified period. Repo or repurchase agreements are made upon underlying instruments with an agreed interest rate. It is also called a sell-buy agreement and comes to the rescue when there is an acute need for funds to fulfill short-term financial obligations.
These sorts of instruments are popular in the international market and hold a relatively smaller secondary market size. They can also be viewed as letters of credit. They are similar to a post-dated cheque or a bank draft. Here, the banker of the trader issues a letter promising or guaranteeing timely payment of dues. The banker will, however, collect interest for the service rendered. In terms of value, it outruns a standard cheque.
Advantages of Money Market Instruments
The following are some of the notable advantages of money market instruments:
They are an essential part of an economy as they offer liquidity and help maintain it in the markets. RBI uses them as a vital element for drafting monetary policies.
They are essential and act as a crucial source for companies as they offer a route to extract funds in the short term at a reasonable cost. The time period also serves as an added advantage.
It helps in mobilizing the excess capital and acts as a vehicle facilitating its movements among various players. Thus the surplus is put to use and contributes to the development rather than staying ideal.
Disadvantages of Money Market Instruments
Some of the shortcomings of money market securities include the following:
Unstable conditions and seasonal variations act as significant drawbacks in the sector.
Inadequate fund flow from the foreign market is another shortcoming of these instruments.
Apart from this, there is also limited participation which is acting as an obstacle.
Should you invest in these instruments?
These are traded in large quantities, and individual investors cannot invest in them. However, they can sort to a money market-based mutual fund. These funds are primarily open-ended and carry an interest.
When the stock market is highly volatile, an investor might prefer such funds. They offer a relatively higher return in the short run. These funds are highly diversified. Also, if you are looking for a liquid investment option, then a money market fund will be apt.
However, if you are all set to opt for the fund, it is essential you take into account the various expenses associated with the same. You should also pay heed to the risk associated and tax obligations to derive the maximum returns from the same.
While they offer a good return, they are not free from risk. And at times of volatility, it is recommended to stay put. You should be invested till maturity and should avoid panic selling of the units held.
To sum up
The money market is undoubtedly a reasonable bid for someone looking to diversify their portfolio or hoping to find a place to park their money for a short duration. However, your goals do matter. Holding a long-term objective and opting a short term funds will be bizarre. So ensure all your needs and comfort zone go well in hand with your investment plan before you put in your money.
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