Money Market Instruments

Money Market Instruments

Money market instruments are short-term investment options that can be converted back to cash options if the investors ever feel the need to get their cash back. Now, this cash can then be spent or reinvested into different investments. That’s what makes money market instruments  favourable for new investors who want a safer alternative to popular investment choices that tend to carry some risks. 

What is a money market instrument? 

It is a form of financing instrument that has a maturity of a year or less. But even before it matures, the investor can always convert it to cash. It essentially facilitates financial borrowing and lending whether that is in a primary or secondary market. Money market instruments’ main features include short-term financing options and high liquidity. 

Understanding money market instruments 

Money market instruments provide a higher degree of safety and are considered a low-risk investment option, which can be perfect for new investors. However, its return on investment is relatively on the lower side. Whether it’s the US Federal Reserve system or the global financial system, money market instruments play a significant role in shaping the financial system in the years to come. 

Uses of money market instruments 

Here are of objectives of money instruments: 

  • Supplying investors with short-term funds at a cost that is relatively fair. 
  • It allows investors to invest their cash into a profitable investment. 
  • The Federal Reserve regulates the money market and helps keep its liquidity level in check. 
  • Most startups and new businesses are low on capital and money market instruments can help them grow their capital for better return on investment. 
  • It provides banks with interesting funding opportunities. 

Types of money market instruments 

There are 5 types of money market instruments that are each targeted for different sets of productivity levels: 

  • Treasury Bills: It is one of the most common forms of money market instruments. The treasury bills have short-term maturity but the exact period varies. It can be from 15 days to 364 days, but it cannot cross 1 year or 365 days. Money market instruments’ maturity must be lower than a year. 
  • Commercial Bills: Another form of money market instrument are commercial bills. Various businesses and startups issue them from time to time in order to meet their short-term cash needs. This type of money market instrument works like the bill of exchange concept. 
  • Certificate of Deposit: This is a type of deposit term that is easily accepted by various commercial banks. The certificate of deposits isn’t strictly issued to individuals. It can also be issued to various corporations and trusts. 
  • Commercial Paper: Commercial papers are issued by corporations as opposed to commercial banks. Commercial papers are issued in order to meet the corporation’s capital requirements. 
  • Call Money: This is a very unique market segmentation that is majorly controlled by scheduled commercial banks and allows individuals and businesses to borrow or lend a certain amount of funds for a short-term period of 14 days or more. 

Importance of money market instruments 

The money market controls and allows for short-term transactions to proceed. It serves as one of the pillars of any financial system and the Federal Reserve system is no different. Here are some of the ways it plays an important role in the market: 

  • Money market instruments provide businesses and corporates with the funds needed for them to invest and grow. The growth of these businesses and corporates will inevitably lead to the growth of the US economy. 
  • The supply and demand in any market can be volatile in nature and having money market instruments in the market can help maintain the balance between the two. 
  • It helps bring new monetary policies into the system. 
  • It helps the growth of the trade industry in the US by supplying and financing the working capital of any and all corporates and businesses. 
  • Money market instruments help banks set a certain statutory liquid and cash reserve ratio. 
  • Everything that happens in the money market is the result of the monetary policies that have been set in place. Having money market instruments in the industry will allow it to devise new monetary policies and control how they will affect the future money market. 
  • Even the government benefits from having money market instruments as treasury bills help them grow their own short-term funds. 

Frequently Asked Questions

Any investor whether individuals, corporations, banking institutes, or businesses, can invest in money market instruments. It helps these investors raise capital for their projects that require short-term funds. 

Some examples of money market instruments are: 

  • Treasury bills 
  • Call money 
  • Commercial bills 
  • CDs 
  • Term money, etc. 

Money market instruments are dedicated to raising funds on a short-term basis for individuals, corporates, businesses, etc. On the other hand, capital market instruments are dedicated to raising equity and debt security in the long run. 

Here are the pros and cons of money market instruments: 

Pros 

  • It is far more liquid than any form of investments that have fixed incomes. 
  • There is no lock-in period and the user can sell any interest they gathered at any moment. 
  • The return on investment is relatively lower than other investments, but it is higher than the return on investment generated on a savings account. 

Cons 

  • Money market instruments are safer and hence the reward is lower. The higher the risks, the greater the benefits. 
  • The interest rates will be at a higher rate as compared to savings accounts. 

Money market instruments are created to fund the growing capital requirements in any industry. These funds are short-term and their primary objective is to raise funds. However, equity securities are used to raise capital for long-term goals. 

Due to the short-term nature of the money marketing instruments, the risks involved are relatively low compared to equity securities. The risks involved in equity securities are higher but so are its benefits. 

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