The financial market in India consists of various instruments that cater to different needs of short-term financing and investment. These instruments play a crucial role in managing liquidity, financing trade, and ensuring the smooth functioning of the financial system.
1. Call Money
Definition: Call money refers to short-term funds that are borrowed and lent in the interbank market, typically for one day. It is also known as the money at call.
Characteristics:
- Short-term: The duration of call money is extremely short, usually one day.
- Unsecured: Call money transactions are typically unsecured, meaning they are not backed by any collateral.
- Liquidity Management: Used by banks and financial institutions to manage their daily liquidity needs.
Example: Suppose Bank A has excess liquidity for a day, and Bank B needs short-term funds to meet its daily reserve requirements. Bank A can lend money to Bank B for one day at the prevailing call money rate. The next day, Bank B repays the borrowed amount with interest.
2. Treasury Bills (T-Bills)
Definition: Treasury Bills are short-term government securities issued by the Reserve Bank of India (RBI) on behalf of the Government of India to meet short-term borrowing needs. They are issued at a discount and redeemed at face value at maturity.
Characteristics:
- Short-term Maturities: Available in 91 days, 182 days, and 364 days.
- Risk-free: Considered virtually risk-free as they are backed by the government.
- Liquidity: Highly liquid and can be easily traded in the secondary market.
- Discounted Issuance: Issued at a discount to face value; the difference between the purchase price and face value represents the interest earned.
Example: An investor buys a 91-day T-Bill with a face value of ₹100,000 at ₹98,000. At maturity, the investor receives ₹100,000, earning ₹2,000 as interest.
3. Commercial Papers (CP)
Definition: Commercial Papers are unsecured, short-term promissory notes issued by corporations, financial institutions, and other large entities to meet their short-term funding needs.
Characteristics:
- Short-term Maturities: Typically range from 7 days to 1 year.
- Unsecured: Not backed by collateral, relying on the issuer’s creditworthiness.
- High Denominations: Usually issued in large denominations, making them more suitable for institutional investors.
- Discounted Issuance: Issued at a discount and redeemed at face value.
Example: A corporation needs ₹50 crore for 90 days to fund its working capital requirements. It issues commercial papers worth ₹50 crore at a discount, say at ₹48 crore. Investors buy these CPs, and the corporation repays ₹50 crore at the end of 90 days, providing a return to the investors.
4. Certificates of Deposit (CD)
Definition: Certificates of Deposit are negotiable, short-term instruments issued by banks and financial institutions to raise funds from the market. They are similar to fixed deposits but are tradable in the money market.
Characteristics:
- Short-term Maturities: Typically range from 7 days to 1 year.
- Issued by Banks: Primarily issued by commercial banks and financial institutions.
- Negotiable: Can be traded in the secondary market.
- Interest Rates: Usually carry higher interest rates compared to regular savings accounts.
Example: A bank issues a CD worth ₹10 crore for 6 months at an interest rate of 6%. An investor buys the CD and receives the principal along with interest at the end of the 6-month period. If the investor needs liquidity before maturity, they can sell the CD in the secondary market.
5. Trade Bills
Definition: Trade Bills, also known as Commercial Bills, are short-term negotiable instruments used in trade transactions. They represent a written order from the buyer to the seller to pay a specified amount on a future date for goods received.
Characteristics:
- Short-term Maturities: Typically range from 30 days to 180 days.
- Negotiable: Can be discounted and traded in the secondary market.
- Used in Trade Finance: Commonly used to finance receivables and payables in commercial transactions.
- Two Types: Bills of Exchange (accepted by the buyer) and Promissory Notes (issued by the buyer).
Example: A seller delivers goods worth ₹10 lakh to a buyer and draws a bill of exchange on the buyer, payable in 90 days. The buyer accepts the bill, committing to pay ₹10 lakh at the end of 90 days. The seller can either wait for the maturity to receive payment or discount the bill with a bank for immediate funds, paying a discounting fee.
Summary
The money market in India includes a variety of instruments such as Call Money, Treasury Bills (T-Bills), Commercial Papers (CP), Certificates of Deposit (CD), and Trade Bills, each serving different purposes and catering to different participants. These instruments are crucial for managing liquidity, financing short-term needs, and facilitating efficient financial transactions. Examples like interbank call money transactions, issuance and trading of T-Bills, corporate funding through CPs, bank fund-raising via CDs, and trade financing with Trade Bills illustrate the practical applications and benefits of these instruments in the financial market.
