Money markets ó an arena for liquidity management

Nov 16 2012, 03:49 IST
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SummaryThe money market is a market for securities with an original term to maturity of one year or less. Securities with an original term to maturity of greater than a year are referred to as capital market securities.

The money market is a market for securities with an original term to maturity of one year or less. Securities with an original term to maturity of greater than a year are referred to as capital market securities. Quite obviously, money market securities must be debt securities, since equity shares do not have a stated maturity date.

On the other hand, capital market securities may be equity or debt securities. In the context of debt securities, there are two terms used in the context of their tenure, which differ in meaning. The original term to maturity of a security is its term to maturity as of the date of issue. Obviously, it will not change subsequently.

However, the actual term to maturity of a security is its current term to maturity, which will decline with the passage of time. Money market securities will, consequently, have an actual term to maturity of one year or less.

The money market is for managing imbalances between inflows and outflows. For any economic agent, be it a private business or a government entity, the times at which inflows are realised will rarely, if ever, be perfectly synchronised with the times at which expenditure is scheduled. Take the Indian government for instance. It collects income tax once a quarter. Thus, inflows are lumpy. However, expenditure on account of wages, salaries, fuel bills and other items will be incurred on virtually a daily basis.

Consequently, even if the government were to have a budget surplus for the financial year as a whole, which is rare, most of the time, it will have a deficit. Same is true for corporate entities. There will be points in time where their currency accounts will have a healthy surplus. At other times, however, they will have low or nil balances and may even have to take recourse to an overdraft facility.

The money market is the arena where economic agents source cash for bridging their temporary deficits and is also the venue for their short-term investments. Governments borrow by issuing short-term debt securities, termed as treasury bills or T-bills.

Corporations borrow by issuing short-term unsecured promissory notes known as commercial paper (CP). Banks borrow by issuing negotiable certificates of deposit (CDs), which are essentially fixed deposit receipts which can be traded before maturity. Other forms of transactions in the money market include repurchase agreements or repos, which are referred to as ready-forward (RF) transactions in India,

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