Money Market Instruments: Meaning, Types, Examples, Features & Benefits

Did you know that you can invest in securities for the short term and convert idle capital into beneficial assets? Yes, the money market lets you do just that. You can invest in several money market instruments that can be easily converted to cash, thereby preserving your cash requirements. Let’s explore it in detail!

What is the Money Market?

The money market is the financial market where short-term financial assets with a maturity period of one year or less are traded. It deals with highly liquid and low-risk financial instruments that are traded on stock exchanges. 

The primary purpose of the money market is to offer short-term financing to borrowers such as private investors, governments, and others. It's an essential part of the economy that encourages the efficient flow of funds between those with excess funds and those who require financing.

What are Money Market Instruments?

Money market instruments are financial contracts that are traded in the money market for periods of less than a year. The institutions that offer money market instruments to the lenders (investors) include commercial banks, corporations, government, non-banking financial institutions, etc. 

Some of the examples of money market instruments include commercial papers, treasury bills, certificates of deposits, etc. 

What are the Types of Money Market Instruments? 

In India, the different types of money market instruments offer stable returns to investors looking for low-risk investment options. Some of the popular money market instruments have been defined below: 

• Certificate of Deposit (CD)

These certificates are issued directly by a commercial bank at a discounted rate, and their tenure usually ranges from seven days to one year. CDs function similarly to a bank fixed deposit, except for the higher negotiating factor and higher liquidity. 

Introduced by the Reserve Bank of India (RBI) in 1989, CDs have become a popular investment option for investors looking for short-term assets since they carry no risk while offering interest rates greater than those offered by fixed deposits.

• Treasury Bills 

These are issued by the Government of India when it requires funds to meet its short-term requirements. The treasury banknotes are issued at a discounted value and are traded on primary and secondary markets. 

Since treasury bills are backed by the sovereign, the associated risk is negligible. However, these securities do not generate any interest. The only profit is the difference between the maturity value of the bill and its discounted purchase price. 

• Commercial Papers 

This is an unsecured money market instrument issued by well-established corporations as promissory notes. The maturity period of these instruments is less than a year; hence, the interest rate is quite low if you compare it with other debt securities. 

This money market instrument enables corporate borrowers to avail of short-term borrowing by raising capital directly from the market. 

• Repurchase Agreements 

Also known as buybacks, these are formal agreements between two parties where the issuer offers a guarantee to repurchase the security in the future. These transactions can only be made between two parties that are approved by RBI, as repurchase agreements usually involve trading of government securities. The date of purchase and interest rate is predetermined. 

• Banker’s Acceptance 

Issued by commercial banks, this is a financial document that guarantees a future payment to the lender. The document clearly mentions the repayment terms, including the date of repayment and the amount to be repaid. The maturity period of this safe and reliable instrument usually ranges from 30 days to 180 days.  

Why are Money Market Instruments Important?

The presence and functioning of the money market is crucial for the seamless functioning of the economy. Money market instruments help the government, corporations, and financial institutions raise short-term debt for immediate needs. 

These safe, liquid, short-term financial instruments operate within a regulated environment; hence, they are a popular option for people who are looking to invest in secure securities for the short term. 

Key Features of Money Market Instruments

Some of the features of money market instruments include: 

• As they are low-risk instruments with short maturity periods, they are highly liquid.
• Money market instruments are usually issued by the government, banks and corporations having high credit ratings; hence, they are considered to be quite secure. 
• Money market instruments are issued at a discount on their face value. This makes them a lucrative option for investors with a low-risk appetite. 
• The RBI regulates the money market. Hence, it contributes to the liquidity and security of the financial markets. 
• Money market instruments are a major source of funding for the government. As a result, it provides an opportunity for banks/retail investors to deposit their excess funds.
• For borrowers, money market instruments are convenient financing options that allow them to meet their immediate cash flow needs.

How do you Invest in Money Market Instruments in India?

You can invest in the money market in the following ways: 

• Invest in units of money market funds via brokerage firms or investment houses. 
• Buy short-term Certificates of Deposit (CDs) or treasury bills from banks/Reserve Bank of India. 
• Buy money market instruments over the counter via brokerage firms. 

Benefits of Investing in Money Market Instruments

Discussed below are some of the primary benefits of these instruments: 

• Secured and Stable Returns: These financial instruments offer stable and guaranteed returns, making them suitable for risk-averse investors. They usually offer interest payments or come with discounted face value prices, allowing depositors to earn a predictable return upon maturity. 
• Highly Liquid: Money market instruments can be easily bought or sold in the over-the-counter market. This means investors can get access to their deposits easily, making it a comparatively safe option. 
• Portfolio Diversification: By investing in money market instruments, investors can diversify their portfolios. Well-established banks and corporations generally issue these instruments; hence, they are a safe investment option to include in one’s portfolio. 

Risks of Investing in Money Market Instruments

Before investing in money market instruments, here are some drawbacks of these securities that you should be aware of: 

• Limited Returns: When compared to other securities, money market instruments generally offer lower returns. They don’t provide opportunities for capital growth because the primary focus is on short-term liquidity. 
• Limited Options: The investment options in the money market are quite limited. Additionally, changes in regulations can affect the attractiveness and profitability of these financial instruments. 
• Risk of Inflation: Returns from money market instruments may be susceptible to inflation risk. In case the interest rates on these instruments fail to maintain their pace with inflation, the real value of the deposit can get reduced.

Which is Not a Money Market Instrument?

Financial instruments traded in the capital markets are not considered money market instruments. Some of the examples include equities, bonds, currency, etc. Also, derivative contracts that are traded only on the derivatives market are not money market instruments. Only short-term financial instruments with a maturity period of less than one year are deemed as money market instruments in India. 

Bottom Line

If you are someone planning to invest your surplus funds in low-risk securities, you can consider investing in money market instruments. By investing in these instruments, you can enjoy high liquidity and secured returns.