Debt instrument which have a maturity of less than one year at the time of issue are called money market instruments. These instruments are highly liquid and have negligible risk. The major money market instruments are Treasury bills, certificates of deposit, commercial paper, and repos. The money market is dominated by the government, financial institutions, banks, and corporate. Individual investors scarcely participate in the money market directly. A brief description of money market instruments is given below.
Treasury Bills are the most important money market instrument. They represent the obligations of the Government of India which have a primary tenor like 91 days and 364 days. They are sold on an auction basis every week in certain minimum denominations by the Resave Bank of India. They do not carry an explicit interest rate (or coupon rate). Instead, they are sold at a discount and redeemed at par. Hence the implicit yield of a Treasury bills is a function of the size of the discount and the period of maturity.
Though the yield on Treasury bills is somewhat low, yet have an appeal for the following reasons: (1) These can be transacted readily and there is a very active secondary market for them (2) Treasury bills nil credit risk and negligible price risk (thanks to their short tenor).
Certificates of deposits:
Certificates of deposits (CDs) represent short term deposits which are transferable from one party to another. Banks and financial institutions are the major issuers of CDs. The principal investors in CDs are banks, financial institutions, corporates, and mutual funds. CDs are issued in either bearer or registered form. They generally have a maturity of 3 months to 1 year. CDs carry a certain interest rate.
CDs are a popular form of short term investment for companies for the following reasons: (1) banks are normally willing to tailor the denominator and maturities to suit the needs of the investors. (2) CDs are generally risk free, (3)CDs generally offer a higher rate of interest than Treasury bills or term deposits.
A Commercial Paper represents short term unsecured promissory note issued by firms that are generally considered to be financially strong. A commercial paper usually has a maturity period of 90 to 180 days. It is sold at a discount and redeemed at par; hence the implicit rate is a function of the size of discount and the period of maturity.
The term Repos is issued an abbreviation for Repurchase Agreement or Ready Forward. A Repo involves a simultaneous sale and repurchase agreement.
A Repo works as follows: Party A needs short term funds and party B wants to make a short term investment. Party A sells securities to Party B at a certain price and simultaneously agrees to repurchase the same after a specified time at a slightly higher price. The difference between the sale price and the repurchase price represents the interest cost to party A (the party doing the Repo) and conversely the income for Party B (the party doing the Reverse Repo).
Reverse Repos are a safe and convenient form of short term investment.
Bonds or debentures represent long term debt instruments. The issuer of a bond promises to pay a stipulated stream of cash flows. This generally comprise periodic interest payments over the life of the instrument and principal payment at the time of redemption (s).
Debt securities issued by the central government, state government and quasi-government agencies are referred to as government securities or gilt-edged securities. Three types of instruments are issued.