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FINANCIAL MARKET AND MONEY MARKET | JAIIB IE & IFS IMPORTANT NOTES 2023

FINANCIAL MARKET AND MONEY MARKET

The financial market and Money market constitute a major part of IE & IFS’s syllabus, here we’ll be talking about the structure of the money market, how it’s different from the capital market, the functions of the money market, and other associated topics. 

Financial market

Both the financial market and the money market are essential elements of the world financial system because they give investors a place to purchase and sell financial instruments, control risk, and effectively allocate capital.

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Here financial products are bought and sold. 

A financial market is constituted of a money market, capital market, foreign exchange market, insurance market, credit market and derivative market. 

Financial markets perform the function of price discovery, funds mobilization, liquidity, accessibility, reducing transaction costs, capital formation, and price discovery. 

Price discovery is a method for determining the price of an asset through interactions between buyers and sellers, enabling buyers and sellers to set the market prices of tradable assets. 

It is determined by market forces such as demand and supply in the market. Funds mobilization determines how funds are allocated among entities in need of the funds. Liquidity provides an opportunity for investors to sell their financial instruments at their fair value.

Accessibility brings together potential buyers and sellers, reducing transaction costs, and capital formation help in capital formation. Price discovery is a method for determining the price of an asset through interactions between buyers and sellers.

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Let’s learn more about these. 

Money market Capital market 
Traded Short-term market assets have liquidity  Long-term debt or equity-backed securities
Maturity Up to 1 year 1 year or more or an indefinite period
Risk factor Lower Higher
Instruments traded Call money, certificates of deposit, Treasury bills, commercial paper etc. Bonds, preference shares, debentures, equity shares, etc.
Regulator  RBI  SBI

 

Foreign exchange market

The foreign exchange market is a market where currencies are traded, with the Reserve Bank of India, banks, and customers all participating. It allows for the exchange of one country’s currency for another.

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Credit market 

Companies and governments issue debt to investors through the credit market, including investment-grade bonds, junk bonds, and short-term commercial paper.

Derivative market

Financial products originating from other assets including futures contracts and options are traded.

Types of derivative market

  • Over-the-counter derivatives

Contracts in which the terms of the transaction, such as the amount, maturity, etc., are mutually agreed upon by the parties to the transaction and are transacted directly between two eligible persons without the need for an exchange.

  • Exchange-traded derivatives

Goods with derivatives that are exchange-traded. The Exchange standardises these goods’ size and maturity.

Insurance market

The Insurance Regulation and Development Authority regulates the insurance market, which consists of the buying and selling of insurance (IRDA). The IRDA regulates this industry, which is split into life and non-life insurance enterprises.

Aspects that impact levels of price discovery

  1. Demand and supply affect the price of an asset, resulting in a higher or lower price.
  2. Buyers are willing to pay more for the potential reward of a large rise in price to secure their exposure to a market.
  3. Volatility is a key factor in determining whether a buyer chooses to enter a market.
  4. Buyers and sellers are influenced by the amount of available information.

Money market

Because the money market and the financial market are intertwined and changes in one sector can have an impact on the other, it is crucial for investors to keep educated and current on market trends.

The money market is a type of financial market where short-term financial assets with the liquidity of one year or less are traded. The RBI regulates the money market, and among its duties are ensuring that investors and borrowers can meet their financial obligations, fostering economic expansion, financing trade and industry adequately, enabling the RBI to carry out monetary policy, and acting as a mechanism to balance the supply and demand of short-term funds.

  • Issued by financial institutions

Call money: Borrowing or lending of funds for 1 day by Banks.

Notice money: Borrowing or lending of funds for the period between 2 days and 14 days by Banks.

Term money: Banks may borrow or lend money for a duration longer than 14 days and as long as one year.

  • Certificate of deposit

It is a short-term security with a fixed maturity date issued by a bank that seeks to raise funds from the secondary money market.

  1. Issuers: All scheduled commercial banks excluding RRBs and Local Area Banks (LABs), also selected all Indian financial institutions permitted by RBI are allowed to issue
  2. Investors: individuals, corporations, companies, trusts, funds, associations etc.

NRIs can also invest but on a non-repatriable basis.

Maturity: Min 7 days Max 12 months (for banks) and for FIs Min 7 days Max 3 years

CDs are issued at a discount on the face value

Issue Size: Min 5 Lac and thereafter multiple of Rs 5 lac

No loan or buyback is allowed

Freely transferable

  • Issued by government

Treasury management

These are issued by the Government of India through Reserve Bank for maturities of 91 days, 182 days and 364 days, for pre-determined amounts. 

The interest is allowed as a way of discount. (Implicit Yield)

Prices are determined by way of auctions by RBI.

For bank treasury, investment in T-bills is a convenient way of parking short-term surpluses in risk-free investment, yielding interest generally higher than the overnight call money rates. 

T-bills have a liquid secondary market and the T-bill yields constitute a valid benchmark rate for debt paper.

T-bill is in electronic form and is to be held in an SGL account maintained by banks with the Reserve Bank of India.

  • Issued by companies

Commercial papers

Commercial Paper is an unsecured money market instrument issued in the form of a promissory note and shall be held in a dematerialised form through any of the depositories approved by and registered with SEBI.

(Regulated by RBI and market practices prescribed by FIMMDA [Fixed Income and Money Market and Derivatives Association of India)

CP shall be issued in a minimum denomination of Rs. 5 lakh & multiples thereof. It shall be issued at a discount to face value.

Minimum maturity: 7 days maximum 12 months (not beyond the credit rating validity period)

Eligible issuers

  1. Companies, including NBFCs and All India Financial Institutions, can issue CPs subject to the condition that any fund-based facility availed from banks and/or financial institutions is classified as a standard asset. 
  2. Other organisations may also issue CPs if they have a net value of at least Rs. 100 crore.
  3. Standard WC limit
  4. Loans in the standard category
  5. A rating of at least A3 from two SEBI-approved rating agencies is required for CP amounting to Rs 1,000 cr or more in a calendar year.

Rating requirement

  1. A minimum of two CRAs registered with SEBI must provide credit ratings, and the eligible issuers must take the lesser of the two ratings. 
  2. According to the rating symbol established by SEBI, a CP must have a minimum credit rating of A3.

Secondary market trading & settlement of CP

  1. All over-the-counter (OTC) trades in CP shall be reported within 15 minutes of the trade to the Financial Market Trade Reporting and Confirmation Platform.
  2. Loan against CP not permitted 
  3. If maturity is on holiday, then CP is to be paid on the previous day. 
  4. Buyback is allowed after 30 days of issuance.

Repo 

  1. Repo is used for lending and borrowing money market funds, for terms extending from 1 day to 1 year. 
  2. It refers to the sale of securities with an agreement to repurchase the same securities at a later date. 
  3. The bank sells the securities to the counterparty, with an agreement to repurchase the same securities, at a predetermined price. 
  4. The effective interest rate on repo transactions is marginally less than the corresponding money market rate, as the lending bank has securities in hand until the loan is repaid. 
  5. The advantage to the counterparty bank is earning interest on secured lending and holding securities which will help it to meet any shortfall in its SLR compliance.
  6. The value of securities is higher by a margin, about 5%, to cover price risk in case of a default. All repo settlements are routed through Clearing Corporation of India Ltd. (CCIL).

Repo under liquidity adjustment facility

Repo is an instrument of monetary policy used by the Reserve Bank of India to control liquidity in the interbank market. In case of a shortage of funds, banks and primary dealers can sell government securities to RBI with a commitment to repurchase the securities on a specified date. 

In case of surplus liquidity, banks can buy securities from RBI in exchange for cash deposits, with an agreement to resell the securities after a fixed period. Infusion of liquidity is affected through lending to banks under a Repo transaction, while absorption of liquidity is done through accepting deposits from banks known as a Reverse Repo transaction.

Bill rediscounting scheme (BRDS)

Rediscounting trade invoices that clients have already purchased or reduced through the bank is known as BRDS. These trade bills result from the provision of products and services.

How is trade conducted?

The trades are carried out using the RBI-installed NDS Call system, an electronic screen-based method.

Money market transactions are settled utilising the Real Time Gross Settlement (RTGS) mechanism for electronic funds transfers.

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