Financial Market

1. Unit 4: Financial Markets

4. Basis for Comparison Money Market Capital Market
Meaning
A segment of the financial market where
lending and borrowing of short term
securities are done.
A section of financial market where long
term securities are issued and traded.
Nature of Market Informal Formal
Financial instruments
Treasury Bills, Commercial Papers,
Certificate of Deposit, Trade Credit etc.
Shares, Debentures, Bonds, Retained
Earnings, Asset Securitization, Euro
Issues etc.
Institutions
Central bank, Commercial bank, non-
financial institutions, bill brokers,
acceptance houses, and so on.
Commercial banks, Stock exchange,
non-banking institutions like insurance
companies etc.
Risk Factor Low Comparatively High
Liquidity High Low
Purpose
To fulfill short term credit needs of the
business.
To fulfill long term credit needs of the
business.
Time Horizon Within a year More than a year
Merit
Increases liquidity of funds in the
economy.
Mobilization of Savings in the economy.
Return on Investment Less Comparatively High

5. Money Market
Money market is a place for trading in money and short term financial assets that are
close substitutes for money.
It provides an opportunity for balancing the short term surplus funds of the
lenders/investors with the short term requirements of borrowers.
An important feature of money market instruments is that they are liquid with varying
degree and can be traded in the money market at low cost.

6. Definition of Money Market
Geoffrey Crowther : Money market is a collective name given to various forms and institutions
that deals with the various grades of near money.
S. N Sen : The short term money market is the place where the strain on the banking system is felt
in periods of pressure and it is the place where ease in banking system is first felt in periods of
monetary superfluity.
RBI : Money market is the centre for dealing mainly short term character in monetary assets, it
meets the short requirements of borrowers and provides liquidity or cash to the lenders.

7. The money market is a reservoir of short term funds. It is a region where short term
funds are brought and sold through phone or mail. Funds are borrowed in the market for
a short period of time ranging from a day to six months or less than a year . The assets
which are used as credit instruments are known as near money assets.

8. Characteristics of Money Market
1. A developed commercial banking system
2. Presence of Central Bank
3. Sub Market
4. Near money assets
5. Availability of ample resources
6. Integrated interests rate structure

9. Structure of Money Market
Components
Institutions
Instruments
Call Money
Market
Collateral Loan
Market
Acceptance
Market
Bill Market
Commercial
Banks
Central Bank
Acceptance
Houses
Non
banking
FIs
Commercial bills Treasury bills
Certificate of
Deposits
Call money
Certificate of
Deposits
Commercial
Paper

10. Call Money Market
Call money market refers to the market for short period.
Bill brokers and dealers in Stock exchange usually borrow money at call from the Commercial
banks.
These loans are given for a short period of time (not exceeding seven days but more often from day
to day or for overnight only)
There is no demand for collateral securities against call money.
It possess high liquidity
It is one of the important component of money market.
Call loans are useful to the Commercial Banks because these can be converted into cash at anytime.

11. Collateral Loan Market
 Another specialised sector of the money market.
 The loans are generally advanced by the commercial banks to private parties in the market.
 Collateral loans are backed by the Securities ,stocks and bonds.
 The collateral securities may be in the form of some valuable ,say government bonds which are easily
marketable and do not fluctuate much in prices.
 The collateral money is returned to the borrower when loan is repaid.
 If the borrower is unable to repay the loan, the collateral becomes the property of the lender.
 These loans are given for a few months
 The borrowers are generally the dealers in stocks and shares.
 Sometimes smaller commercial banks borrow collateral loans from the bigger banks.

12. Acceptance Market
Banker’s acceptance are very old form of commercial credit.
Acceptance market refers to the market for banker’s acceptances involved in trade transactions.
This market deals with banker’s acceptances which may be defined as a draft drawn by a business
firm upon a bank and accepted by it.
It is required pay to the order of a particular party or to the bearer a certain specific amount at a
specific date in the future.
These acceptances emerge out of commercial transactions both within the country and abroad.
The market where the banker’s acceptances are easily sold and discounted is known as acceptance
market.
In Indian Money market it has no significance, because there is no development of the acceptance
market

13. Bill Market
It is a market in which short term papers or bills are bought and sold . The important type of short term papers
are ,
1. Bills of exchange: Bill of exchange is commercial papers . It is a written unconditional order which is signed
by the drawer requiring the drawee to pay on demand or at a fixed future time, a definite sum of money .
Once the buyer signifies his acceptance on the bill itself ,it become a legal document. Such bills are
discounted or rediscounted by commercial banks to lend credit to the bill holders or to borrow from the
central bank.
2. Treasury bills : The treasury bills are government papers securities for a short period usually of 91 day’s
duration . It is promissory note of the government to pay a specified sum after a specified period. These are
sold by the Central bank on behalf of the government . Treasury bills are government papers , They inspire
public confidence in the minds of the investors. As no risk is involved in their purchase ,they become good
papers for the commercial banks to invest their short term funds.

14. The Institutions of Money Market
1. Commercial banks
 Commercial banks are the back bone of the money market. They form one of the major constituents of money
markets.
 These banks use their short term deposits for financing trade and commerce for short periods.
 The commercial banks invest their funds in the discounting bill of exchange.
 The commercial banks lend against promissory note and through advances and overdraft.
 The call money loans are also provided by these banks to the bill brokers and dealers in the stock exchange
market.
 The commercial banks put their excess reserve in different forms or channels of investment which satisfy their
conflicting principles of liquidity and profitability.
 Aim is that the funds invested not only remain liquid in the form but also earn high interest or yield income on
them.

15. 2. Central Bank
 The Central bank plays a vital role in the Money market. It is the monetary authority and is regarded as the
apex institution.
 No money market can exist without the Central bank.
 Central bank is the lender of the last resort and controller and guardian of the money market.
 The member banks may approach the Central bank for loans and advances during emergency.
 It controls and guide institutions working in the money market.
 It raises or reduces money supply in the economy and ensure economic stability.
 The performance of the Central bank depends on the character and composition of the money market.
 Central bank does not enter into the direct transaction ,it controls the money market through changes in the
bank rate and open market operations.

16. Acceptance House
 The acceptance house and bill brokers are the main institutions dealing bill market.
 The institution of Acceptance house developed in England where merchant bankers transferred their head
quarters to London Money Market.
 They function as a intermediaries between importers and exporters and between lenders and borrowers in the
short period.
 In the London Money market the acceptance house performed a very useful role as merchant banks.
 These Banks specialised in the acceptance of trade bills /commercial bills.
 They handled the international transactions without any problem.

17. Non-banking Financial intermediaries
There are non banking financial intermediaries which resort to lending and borrowing short
term funds in the money market.
Non-banking financial intermediaries includes saving banks , investment house, insurance
companies, building socities,provident funds and other business corporation

18. Bill Brokers
In developed money markets like London money market and New York Money market ,Private
companies act as discount houses.
The main function of these companies are to discount bills on behalf of others.
Besides these companies there are bill brokers who work as intermediaries between the
borrowers and lenders by discounting bills of exchange at a small commission.
In under developed money market, bill brokers are quite important intermediaries

19. Significance of Money Market
1. Economic development
2. Profitable investment
3. Borrowings by the government
4. Importance for Central bank
5. Mobilisation of funds
6. Self sufficiency of commercial bank
7. Saving and investment

20. Money Market Instruments
Commercial Bills
 Commercial bill or Bill of exchange is a written promise by a businessman to pay his creditor a certain
amount of money on a specific future date.
As per the promise the creditor can expect money after a specified period of time. If the creditor is in
immediate need of money , he can give the bill to a commercial bank.
The bank will take a nominal amount as a commission and rest of the bill amount is given to creditor.
This function of commercial bank known as discounting bill of exchange.
The bank will collect the full amount from the businessman on the specific date.
If the bank is in need of money, they can re-discounted it. The re-discounting facilities are available in
all scheduled banks, GIC,ICICI,UTI, Mutual funds etc.

21. Reasons for the poor development of bill market in India
I. Preference for cash to bills
II. Excessive stamp duty
III.Lack of specialised discount house
IV.Preference for cash credit and over draft arrangement as a means of borrowing from
commercial banks

22. Treasury Bills
 TBs are a means of short term borrowings by the government.
 In India TBs are issued by RBI on behalf of the government of India.
 They are issued for a period of 91 days. At present 364 day treasury bills are available.
 There are two types of treasury bills in India, Ordinary and Ad-hoc.
 Ordinary Treasury bills are issued to the public
 Ad-hoc treasury bills are issued to the state governments, semi government departments and foreign
central banks.
 TBs markets are in the hands of banking sector.
 TBs are repaid at par on maturity.
 At present 91 days treasury bills are auctioned by RBI every Friday and 364 day treasury bills are
every alternative Wednesday. Minimum amount of TB –Rs 25000

23. Call and Short Notice Money
 Call money refers to a money given for a very short period.
 It may be taken for a day or overnight but not exceeding seven days in circumstances.
 Bankers are borrowers as well as lenders for the call funds.
 Bank borrows call funds for short term to meet the CRR requirements.
 Sometimes, individuals of very high financial standing may borrow money for a short period to meet their financial
needs.
 The rate of interest is very low on call funds.
 Another variation of call money is Notice money which can be for a period upto 14 days.
 Money at call appears on the asset side of a bank balance sheet and represents temporary loans to bill brokers, stock
brokers, and other banks.

24. Certificate of Deposits
 Certificate of deposits are marketable receipts in registered form of funds deposited in a banks for a specified period at a
specified rate on interest.
 They are different from the fixed deposits in the sense that they are freely transferable, can be sell to someone and it can be
traded in the secondary market.
 They are liquid and riskless in terms of default of payment of interest and principal.
 RBI launched a scheme in 1989 permitting banks to issue CDs with a view to further widen the range of money market
instruments and to give investor a greater flexibility in the deployment of their short-term surplus funds.
 Originally the CDs were issued in multiples of Rs. 25 lakh subject to the minimum size of each issue being Rs 1
Crore,having maturity period 3 months to 1 year and lock in period of 45 days after the date of issue.

25. Commercial Papers
 CPs are promissory notes issued by reputed companies with good credit standard and having sufficient tangible
assets.
 CPs are unsecured and negotiable by endowment and delivery.
 The issuing company can buy back CPs if the need arise.
 CPs are normally issued by the banks ,public utilities ,insurance and finance companies.
 The buyers of CPs are banking and non banking financial institutions.
 CPs in India launched by RBI’s notification in January ,1990 with a view to enable highly reputed companies to
diversify their sources of short term borrowings and also provide an additional instrument to investors.
 RBI’s guidelines are applicable to all non-banking and non-financial companies who wanted to raise funds through
the issue of CPs.
 The issuing company is required to meet the stamp duty, credit rating agency fee etc.
 The maturity period of CPs was 30 days.(now 15 days)

26. Unorganized Sector in Money Market
The unorganized money market is largely ,made up of indigenous bankers and money lenders.
It is unorganized because the activities of its parts are not systematically coordinated by RBI or any other
authority.
Private money lenders operate through out the length and breadth of the country, but without any link
among themselves.
The unorganized money market also has its sub market namely call money market and hundi market.
The call money market is very small and is restricted only to the Gujarati Schroffs.
The indigenous bills are called hundis and hundi market is quite active.

27. The London Money Market
London money market is one of the most well advanced, and developed money market in the world.
London money market operates in Lombard Street through dealers and bankers.
It composed of the Bank of England ,the commercial bank , the acceptance houses discount houses and the
bill brokers.
All the members of money market closely connected each other through telephones, mail etc.
Till 1914, the position of London money market was unique. Later New York money market and the Paris
money market shared the popularity of London Money Market.
It acts as an intermediary between the commercial banks and Banks of England.

28. Structure of Money Market
 London money market comprises of the commercial banks, the acceptance houses, the discount houses and the
bill brokers.
 Banks: Important constituent of the money market. They use short term deposits for the short term financing
of trade and commerce. Largest supply of short term loanable funds come to the money market from the banks.
 The Acceptance houses: They play an important role in the money market . They specialize in the acceptance
of commercial bills. They guarantee the bill of exchange drawn on the merchants. They charge a commission for
this endorsement. They are specialized private firms of international reputation, about 20 in number. They
contribute a great deal for the smooth functioning of the money market.
 Discount houses: Another strong segment of the money market . They discount the bill of exchange with
money borrowed from the commercial banks. When commercial banks need their funds back, the discount
houses approach Bank of England ,if necessary for financial accommodation. The treasury bills are now the days
preferred to the trade bills by the discount houses.
 Bill brokers: The main business of this group is to find money for bills and bills for money. The brokerage
charged by them is quite nominal. So they act as intermediaries between the lenders and borrowers.

29. New York Money Market
 This market is clustered in Wall Street area. It is the one of the well developed money market which deals
huge amount money everyday.
 It deals with many number of short term near money assets to meet the need of the bankers, business firms
and other financial institutions etc.
 The main institution which deals in the New York Money market are commercial banks ,U S treasury,
Federal Reserve, the foreign bank agencies specialized institutions and dealers in the government securities.
 Since all parts of New York money market cluster around the Wall street area, they referred as “Wall Street”

30. Institutions of New York Money Market
Commercial Banks: Commercial paper resold to the banks. Importance of these paper has declined in recent
times.
Treasury: The treasury bills are the obligations of the US government or state government. These are
discounted in the money are dealers firms are engaged in buying and selling of the US government securities in
the New York market. Wall street banks started another department which deals in treasury bills.
The Federal Reserve System: The Federal Reserve Bank of New York deals with foreign central banks and
government. It is correspondent of all the central banks of the world. The banks receives deposits from other
central banks and government of other countries. Institutions like IMF and IBRD keeps their funds with Federal
Reserve. They enjoy good position in the New York Money market.
 Foreign banking agencies: They enjoy a good reputation on the money market. They provide finical
assistance for trade and international transaction. They facilitate the transfer of funds from one economy to
another. These agencies also resort to buy and sell securities in the New York Money Market.