Page 37 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Indian Financial System

Notes Another redeeming characteristic of money market is that money market instruments are
generally sold in large denominations. The size of these transactions prevents most individual
investors from participating directly in the money markets. Instead, dealers and brokers operating
in the trading rooms of large banks and brokerage houses, bring customers together. Individuals
generally invest in money market securities indirectly, with the help of financial intermediaries.
Low default risk is another feature of money market securities. The risk of late or non-payment
of principal and/or interest is generally small. As cash lent in money markets must be available
for quick repayment to the lender, money market instruments are usually issued by high-
quality borrowers having low default risk.

Innovation and flexibility are the hallmark of the money market. Despite the wholesale nature
of the money market, innovative securities and trading methods have been developed to provide
opportunity to small savers to access to money market securities.
Money market securities are used to 'warehouse' funds until needed. The returns earned in these
investments are low due to their low risk and high liquidity.

It is important to note that money market does not represent a single physical location. Money
market transactions do not take place in any one particular place or building. Usually, traders
arrange purchases and sales between participants over the phone and complete them
electronically. Dealings may be conducted with or without the help of brokers. In view of this
unique characteristic, money market securities typically have an active secondary market. An
active secondary market makes it easy to find buyers who will purchase the security sold
initially in the future. This provides flexibility to the instruments to use them for meeting short-
term financial needs.

3.3 Functions of Money Market

Primary objective of money market is to facilitate the flow of short-term funds. To achieve these
objectives, money market performs the following functions:
1. The most important function of money market is to establish linkage between supplies of
short-term surplus funds and demanders of funds for meeting their short-term
requirements. It provides convenient access to both providers and borrowers of short-
term funds to satisfy their lending and investment requirements. In this process, money
market provides an equilibrating mechanism to even out short-term liquidity.
2. Money market provides an ideal place for a firm or financial intermediary to 'warehouse'
excessive holdings of cash balances until they are needed. In the real world, the immediate
cash needs of individuals, firms and governments hardly synchronise with cash receipts.
Further, corporations' daily patterns of receipts from sales do not match the pattern of
their day-to-day expenses. Since holding surplus cash involves opportunity cost in terms
of lost interest income, firms and other economic units use the money market as an
interim investment that provides a higher return than holding cash or money in banks.
They invest their excess cash funds in money market instruments that can be quickly
liquidated in cash in times of need with little risk of loss of value. Thus, through the
'warehousing' function, money market provides efficient means to enable large amount
of funds to be funneled from suppliers of funds to users of funds for a short period of time.
Most investment funds and financial institutions held money market securities to meet
investment or deposit outflows.

3. Money market provides an effective low cost source of temporary funds. Banks may issue
certificate of deposits and other short-term securities in the money market to overcome
the problem of reserve requirements shortages. Likewise, the government issues treasury
bills to fund a large portion of its debt.

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