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Unit 3: Financial Markets

investment preferences of the investors, and where financial institutions buy the financial claims Notes
of those who have surplus funds and sell their own claims. In view of a large number of different
types of financial investments of diverse maturity issued by financial institutions and trading of
wide range of securities, there exist different types of financial markets in a developed economy.
Each market deals with a somewhat different type of securities in terms of instruments, maturity
and the assets backing it. Also, different markets serve different parts of the country. A fair
understanding of these financial markets provides insight into conceptual model of the financial
system and intricate interrelationships that exist among various intermediaries. This, in itself,
hones the decision-making skills of the market participants.
Broadly speaking, financial markets can be classified according to maturity structure and kind
of securities traded in the markets.

3.1 Money Market in India

Money market, as noted earlier, is a market for short-term funds and covers money and financial
assets that are close substitutes for money. The money market is concerned with intermediation
of short-term funds from savers to those who need them for meeting their working capital
requirements and allocation of the funds in an efficient manner among competing uses in the
economy, thereby contributing to growth through increased investment and through enhanced
efficiency in resource utilisation. A developed money market is critical for effective economy.
Monetary transmission cannot take place without transmission of monetary policy impulses to
the rest of the efficient price discovery, particularly with respect to interest rates and exchange
rates. Deep and liquid money market contributes significantly to efficient price discovery in
various segments of the financial market.
In recognition of the crucial role of the money market, structural reforms have been initiated in
recent years in several countries of the globe leading to a regime characterised by market-
determined interest and exchange rates, price-based instruments of monetary policy, current
account convertibility, phased capital account liberalisation and an action-based system in the
government securities markets. From the point of view of the economy as a whole, while
developing money market, it is essential to keep in view how such development helps overall
growth and development. The price discovery of interest rates and exchange rates and the
integration of such prices across markets helps in the efficient allocation of resources in the real
sectors of the economy. Financial institutions like banks also gain from better determination of
interest rates in financial markets so that they can price their own products better. Further, their
own risk management can also improve through the availability of different varieties of financial
instruments. The access of real sector entities to finance is also assisted by the appropriate
development of the financial market and availability of transparent information on benchmark
interest rates and prevailing exchanges. All these considerations have influenced the central
banking authority of different countries while taking measures to strengthen money market
and its various constituents.

3.2 Nature of Money Market

Money market is a market where near money assets and not currency are traded. Near money
assets are characterised by their liquidity, high marketability and low risk. Money market is
distinct from other financial markets because of the short-term maturity of money market
instruments, large denomination of transactions, low default risk, innovation and flexibility.
Money market typically trades in short-term securities having an original maturity of one year
or less. Because of short-term maturity, adverse price movements resulting from interest rate
fluctuations are smaller in money market securities which, in turn, lead to low risk.

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