Question

Q 1. Markets. (a) Money markets: (i) What is the primary role of money markets?

(ii) How do money markets work?

(b) Capital markets:  How do capital market instruments differ from money market instruments?

Answer 1

a) Money Market :

It's a market where transactions in short-term securities are made. It means those securities where the payment period is up to one year.These securities include chiefly Call Money, Treasury Bills, Commercial Bills, Certificate of Deposits, Commercial Paper etc.

i) The primary role of money markets :

Financing Trade

Use of Surplus Funds

Profitable Investment

Promotes liquidity and safety

Self-Sufficiency of Commercial Bank

Help to Central Bank

ii) Working of the money market :

The money market consisting of commercial banks, discount houses, bill brokers, acceptance houses, non-bank financial houses and the central bank operates through the bills, securities, treasury bills, government securities and call loans of various types. As the money market consists of varied types of institutions dealing in different types of instruments, it operates through a number of sub-markets.

First, the money market operates through the call loan market. It has been defined as “a market for marginal funds, for temporarily unemployed or unemployable funds.” In this market the commercial banks use their unused funds to lend for very short periods to bill brokers and dealers in stock exchange.

In developed countries, even big corporations lend their dividends before distribution to earn interest for a very short period. The central bank also lends to commercial bank is for very short periods. Such loans are mostly for a week even for a day or a night and can be recalled at a very short notice.

That is why a short period loan is known as call loan or call money market. Bill brokers and stock brokers who borrow such funds use them to discount or purchase bills or stocks. Such funds are borrowed at the “call rate” which is generally one per cent below the bank rate.

But this rate varies with the volume of funds lent by the bank. If the brokers are asked to pay off loans immediately, then they are forced to get funds from large corporations and even from the central bank at high interest rate.

Second, the money market also operates through the bill market. The bill market is the short-period loan market. In this market, loans are made available to businessmen and the government by the commercial banks, discount houses and brokers. The instruments of credit are the promissory notes. Internal bills of exchange and treasury bills.

The commercial banks discount bills of exchange, lend against promissory notes or through advances or overdrafts to the business community. Similarly, the discount houses and bills brokers lend to businessmen by discounting their bills of exchange before they mature within 90 days. On the other hand, government borrows through the treasury bills from the commercial banks and non-bank financial institutions.

Third, the money market operator through the collateral loan market for a short period. The commercial banks lend to brokers and discount houses against collateral bonds, stock, securities, etc. In case of need, commercial banks themselves borrower from the large banks and the central bank on the basis of collateral securities.

Finally, the other important sub-market through which the money market operates is the acceptance market. The merchant bankers accept bills drawn on domestic and foreign traders whose financial standing is not known. When they accept a domestic or foreign trade bill, they guarantee its payment at maturity. In recent years, the commercial banks have also stared the acceptance business.

b) Capital Markets :

A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold.

Examples of capital markets are the New York Stock Exchange, American Stock Exchange, London Stock Exchange, and NASDAQ.

Capital market instruments differ from Money market instruments In following ways :

Time Horizon Risk Factor Profitability Capital Market Instruments | Money Market Instruments Typically multiple years on the capital market Typically less than a year on the money market Capital markets are potentially high risk depending Money markets are considered low risk on the asset. Capital markets can have considerably higher Money markets have low returns. returns The money market trades instruments such as The capital market trades in most bonds, stocks and Treasury bills, certificates of deposit, promissory other instruments either backed by equity or notes, commercial papers and bonds redeemable in redeemable in more than one year. less than a year Assets Traded