Economic activities of funds for short duration accounting for various institutions, instruments, and their participants are broadly termed the money market. The money market and its functioning enable stability and liquidity in the financial systems. For business, government, and individual undertakings, the money market is an efficient way of coping with short-term financial needs.
Among the highly liquid short-term instruments tradable in the money market are Treasury bills, commercial papers, and certificates of deposit. Its importance lies in facilitating the smooth balancing of demand and supply for short-term funds, facilitating the flow of money in the economy. The structure of the money market may be broadly divided into organised and unorganised money markets. The organised sector comprises well-regulated financial institutions and instruments, while the unorganised sector comprises informal lending institutions free of regulation.
What is Money Market?
The money market may be defined as a segment of the financial system within which short-term borrowing and lending are conducted. Instruments with high liquidity and a short maturity period, generally below a year, are transacted on the money market. The most significant members of the money market include the central bank, commercial banks, financial institutions, corporations, and governments.
The existence of the money market in the financial system ensures that businesses and institutions meet their short-term financial requirements and that their surplus funds generate returns for investors.
Structure of Money Market
The structure of the money market consists mainly of an organised and unorganised sector. These sectors consist of various bodies and instruments that permit the flow of short-term funds, liquidity management, and other functions.
Organised Money Market
Organised money markets comprise institutions and financial instruments strictly regulated by the country’s Central Bank and other monetary authorities. The organised money market gives assurance of transparency, security, and efficiency in transactions, which is a critical contributor to the economy’s liquidity.
Unorganised Money Market
The unorganised money market exists where informal institutions and lenders operate without regulations. This market aids every fund transaction between individuals or businesses operating in areas of the country where formal banking services are scarce. Highly transparent and almost insecurity-free, this market is often called the Money Market.
Types of Organised Money Market
The organised money market comprises regulated financial institutions where all types of very small transactions can be done conveniently. In addition, this sector operates under harsh supervision, rendering it reliable and efficient.
Call Money Market
The call money market is actually for a day to fourteen days. Such calls are made for a short time, which is defined as borrowing money to satisfy reserve requirements or, simply, liquidating. Banks in this market are well-versed with temporary liquidity mismatches, making bank activities function smoothly.
Treasury Bill Market
The money is borrowed through Treasury Bills by a government instead of its issuance of government-backed short-term instruments termed Treasury Bills (T-bills). The maturity period of these bills is less than a year and is used for government short-term borrowing requirements. They are highly liquid and risk-free because the government backs them.
Commercial Paper Market
Unsecured promissory notes that only large corporations sell to raise short-term capital. The maturity period of such instruments is generally from a few days to a year, and besides, these are issued at a discount to face value.
Certificate of Deposit Market
On these certificates, a bank or financial institution issues Certificates of Deposit as negotiable instruments on fixed interest rates. These short-term time deposits have higher interest rates when compared to state savings accounts.
Repo Market
Repo is the market where short-term borrowing can be made by selling securities and agreeing to repurchase them later. It provides short-term liquidity to banks and financial institutions and furthers monetary policy implementation.
Organised Money Market Features
The central bank supervises transactions that go into developing such banks, thus assuring stability in the monetary sector.
- High Liquidity: The market comprises instruments easily converted into cash.
- Short-Term Instruments: The maturity period of the money market instruments is less than a year.
- Transparency: It sets out that transactions are occurring under stringent internal regulatory guidelines, which reduces risk
- Institutional Participants: This comprises banks, financial institutions, corporations and government.
Types of Organised Market
An unorganised money market consists of informal money lenders carrying out their activities in an unregulated environment. This market is particularly important in rural and semiarid areas, where formal institution access is limited. Nevertheless, they are notorious for high interest rates and virtually no transparency.
Indigenous bankers
Bankers are private lenders or business firms that lend money without the benefit of established regulations. They cater to small businesses and traders who may not apply for loans from mainstream banks. Thus, they charge high interest rates and keep their working agreements with the borrower very informal.
Moneylending
As a trade has rarely grown in capacity to be a formal trade or service. They have been very rare. Individual moneylenders provide loans for daily needs, especially in rural areas. Moneylenders operate without regulation and charge very high interest rates, significantly hindering the borrower from repaying his debt.
Chit funds
As an informal savings or credit scheme, it provides for pooled amounts formed through regular contributions from its members, with one member receiving the pooled amount through a lottery or auction system. Chit funds, therefore, become a good option for saving and borrowing, which is being looked down upon with no regulators to oversee their operations, thus bringing forth cases of fraud.
Pawn Brokers
Individuals or small establishments lend money against the deposition of personal valuables such as gold, silver, etc. Immediately upon furnishing valuables as collateral, borrowers get cash but must repay high-interest costs to redeem the collateral.
Unregulated Financial Firms
Some operate as small individual financial institutions and moneylenders and offer loans and saving schemes without regulating approval. They usually promise high-level returns and operate without accountability, posing significant risks for investors and borrowers.
Features of Unorganised Money Market
Capital markets are typically associated with long-term commitments, whereas the money market mainly concerns liquidity management and financing short-term needs. The market operates without supervision from financial authorities.
- High-interest rates. Lenders charge exorbitant interest rates compared to the so-called organised sector.
- Quick availability of funds. The borrower’s funds are available swiftly with little or no documentation.
- Risky transactions. Due to a lack of regulations, the transactions are unorganised and insecure.
- Limited outreach. Primarily provides services to individuals, small enterprises, and outsiders to business in the formal financial ambit.
Relevance to ACCA Syllabus
The ACCA syllabus covers financial markets and institutions as part of its Financial Management and Advanced Financial Management papers. Understanding ACCA’s topic and the structure of the money market is essential for financial risk management, liquidity management, and investment decisions. Knowledge of money market instruments helps accountants and financial managers analyse short-term financing options and working capital management strategies.
Structure of Money Market ACCA Questions
Q1: What is the primary purpose of the money market?
A) To facilitate long-term investments
B) To provide short-term liquidity for businesses and governments
C) To finance infrastructure projects
D) To trade equities and derivatives
Ans: B) To provide short-term liquidity for businesses and governments
Q2: Which of the following is a characteristic of money market instruments?
A) Long-term maturity
B) High credit risk
C) Low liquidity
D) Short-term maturity
Ans: D) Short-term maturity
Q3: Which of the following is NOT a money market instrument?
A) Treasury bills
B) Commercial paper
C) Corporate bonds
D) Certificates of deposit
Ans: C) Corporate bonds
Q4: Who are the major participants in the money market?
A) Central banks, commercial banks, and corporations
B) Venture capitalists and private equity firms
C) Individual retail investors
D) Pension funds and hedge funds
Ans: A) Central banks, commercial banks, and corporations
Q5: What is the main risk associated with money market instruments?
A) Market risk
B) Interest rate risk
C) Liquidity risk
D) Credit risk
Ans: B) Interest rate risk
Relevance to US CMA Syllabus
The CMA syllabus includes working capital management, which involves understanding short-term financing instruments like Treasury bills and commercial paper. Money market instruments are crucial in CMA as they contain topics like efficient cash flow and liquidity management, enabling businesses to optimise their financial resources.
Structure of Money Market US CMA Questions
Q1: Which money market instrument is issued by the U.S. government and is considered virtually risk-free?
A) Commercial paper
B) Treasury bill
C) Certificate of deposit
D) Banker’s acceptance
Ans: B) Treasury bill
Q2: A company that needs short-term financing with a maturity of less than one year is most likely to issue:
A) Corporate bonds
B) Preferred stock
C) Commercial paper
D) Common stock
Ans: C) Commercial paper
Q3: What role do central banks play in the money market?
A) They invest in hedge funds
B) They regulate the money supply and control interest rates
C) They provide funding for long-term infrastructure projects
D) They issue common stocks
Ans: B) They regulate money supply and control interest rates
Q4: What money market instruments is used by importers and exporters to facilitate international trade?
A) Treasury bills
B) Commercial paper
C) Banker’s acceptance
D) Eurobonds
Ans: C) Banker’s acceptance
Q5: Which financial ratio is most relevant when assessing a firm’s need for money market financing?
A) Debt-to-equity ratio
B) Return on assets (ROA)
C) Current ratio
D) Price-to-earnings ratio
Ans: C) Current ratio
Relevance to CFA Syllabus
The CFA curriculum covers money markets under fixed-income securities and portfolio management. A deep understanding of money market instruments is essential for investment analysts, portfolio managers, and financial strategists managing liquidity and risk in financial markets.
Structure of Money Market CFA Questions
Q1: Which of the following best describes a repurchase agreement (repo) in the money market?
A) A long-term loan agreement
B) The sale of a security with an agreement to repurchase it at a higher price
C) The issuance of new stocks to raise capital
D) A foreign exchange contract
Ans: B) The sale of a security with an agreement to repurchase it at a higher price
Q2: Which money market instrument is most commonly used by banks to manage short-term liquidity needs?
A) Treasury bonds
B) Banker’s acceptance
C) Repurchase agreements
D) Corporate bonds
Ans: C) Repurchase agreements
Q3: A financial analyst evaluating a money market instrument primarily considers:
A) Dividend yield
B) Default risk and liquidity
C) Price-to-earnings ratio
D) Book-to-market ratio
Ans: B) Default risk and liquidity
Q4: What happens to money market interest rates when the central bank increases the money supply?
A) They increase
B) They decrease
C) They remain unchanged
D) They become negative
Ans: B) They decrease
Q5: Which of the following best describes commercial paper?
A) A government-issued short-term debt instrument
B) An unsecured short-term corporate debt instrument
C) A loan secured by real estate
D) A long-term corporate bond
Ans: B) An unsecured short-term corporate debt instrument
Relevance to US CPA Syllabus
The CPA syllabus includes financial management and market instruments, focusing on money markets as a source of short-term financing. CPAs working in treasury management and corporate finance must understand the use of money market instruments to manage cash flows efficiently.
Structure of Money Market US CPAQuestions
Q1: What is the primary function of the money market?
A) To facilitate foreign exchange transactions
B) To provide liquidity and short-term financing
C) To trade long-term securities
D) To issue initial public offerings (IPOs)
Ans: B) To provide liquidity and short-term financing
Q2: Which of the following best describes the difference between a Treasury bill and a Treasury bond?
A) Treasury bills are long-term, while Treasury bonds are short-term
B) Treasury bills have shorter maturities than Treasury bonds
C) Treasury bonds are issued at a discount, while Treasury bills pay periodic interest
D) Treasury bills are riskier than Treasury bonds
Ans: B) Treasury bills have shorter maturities than Treasury bonds
Q3: A company with seasonal cash flow fluctuations is most likely to use which of the following for short-term financing?
A) Common stock issuance
B) Commercial paper
C) Venture capital
D) Preferred stock
Ans: B) Commercial paper
Q4: Which entity regulates money markets in the United States?
A) The Financial Accounting Standards Board (FASB)
B) The Securities and Exchange Commission (SEC)
C) The Federal Reserve
D) The Internal Revenue Service (IRS)
Ans: C) The Federal Reserve
Q5: Which characteristic is typical of money market securities?
A) High liquidity and low credit risk
B) High yield and high default risk
C) Low marketability and long maturity
D) Variable interest rates and long maturityAns: A) High liquidity and low credit risk
