Less known investment option.

The Money Market

The money market is a subset of the fixed-income market. In the money market, participants borrow or lend for short period of time, usually up to a period of one year. These instruments are generally traded by the Government, financial institutions and large corporate houses. These securities are of very large denominations, very liquid, very safe but offer relatively low interest rates. The cost of trading in the money market (bid-ask spread) is relatively small due to the high liquidity and large size of the market. Since money market instruments are of high denominations they are generally beyond the reach of individual investors. However, individual investors can invest in the money markets through money-market mutual funds. We take a quick look at the various products available for trading in the money markets.

T-Bills

T-Bills or treasury bills are largely risk-free (guaranteed by the Government and hence carry only sovereign risk - risk that the government of a country or an agency backed by the government, will refuse to comply with the terms of a loan agreement), short-term, very liquid instruments that are issued by the central bank of a country. The maturity period for T-bills ranges from 3-12 months. T-bills are circulated both in primary as well as in secondary markets. T-bills are usually issued at a discount to the face value and the investor gets the face value upon maturity. The issue price (and thus rate of interest) of T-bills is generally decided at an auction, which individuals can also access. Once issued, T-bills are also traded in the secondary markets. In India, T-bills are issued by the Reserve Bank of India for maturities of 91-days, 182 days and 364 days. They are issued weekly (91-days maturity) and fortnightly (182-days and 364- days maturity).

Commercial Paper

Commercial papers (CP) are unsecured money market instruments issued in the form of apromissory note by large corporate houses in order to diversify their sources of short-term borrowings and to provide additional investment avenues to investors. Issuing companies are required to obtain investment-grade credit ratings from approved rating agencies and in some cases, these papers are also backed by a bank line of credit. CPs are also issued at a discount to their face value. In India, CPs can be issued by companies, primary dealers (PDs), satellite dealers (SD) and other large financial institutions, for maturities ranging from 15 days period to 1-year period from the date of issue. CP denominations can be Rs. 500,000 or multiples thereof. Further, CPs can be issued either in the form of a promissory note or in dematerialized form through any of the approved depositories.

Certificates of Deposit

A certificate of deposit (CD), is a term deposit with a bank with a specified interest rate. The duration is also pre-specified and the deposit cannot be withdrawn on demand. Unlike other bank term deposits, CDs are freely negotiable and may be issued in dematerialized form or as a Usance Promissory Note. CDs are rated (sometimes mandatory) by approved credit rating agencies and normally carry a higher return than the normal term deposits in banks (primarily due to a relatively large principal amount and the low cost of raising funds for banks). Normal term deposits are of smaller ticket-sizes and time period, have the flexibility of premature withdrawal and carry a lower interest rate than CDs. In many countries, the central bank provides insurance (e.g. Federal Deposit Insurance Corporation (FDIC) in the U.S., and the Deposit Insurance and Credit Guarantee Corporation (DICGC) in India) to bank depositors up to a certain amount (Rs. 100000 in India). CDs are also treated as bank deposit for this purpose. In India, scheduled banks can issue CDs with maturity ranging from 7 days – 1 year and financial institutions can issue CDs with maturity ranging from 1 year – 3 years. CD are issued for denominations of Rs. 1,00,000 and in multiples thereof.