4 Main Constituents of Money Market | Financial Markets

This article throws light upon the four main constituents of money market. The constituents are: 1. Call Money Market 2. Collateral Loan Market 3. Acceptance Market 4. Bill Market.

Constituent # 1. Call Money Market:

Call money market refers to the market for very short period. Bill brokers and dealers in stock exchange usually borrow money at call from the commercial banks. These loans are given for a very short period not exceeding seven days under any circumstances, but more often from day-to-day or for overnight only i.e., 24 hours.

There is no demand of collateral securities against call money. They process high liquidity; the borrowers are required to pay the loan as and when asked for, i.e. at very short notice. It is on account of this reason that these loans are called ‘call money’ or call loans. Thus, call money market is an important component of the money market.

The investment of funds in the call market meets the need of liquidity but not that of profitability because the rate of interest on call loans is very low and changes several times during the course of the day.

Call loans are useful to the commercial banks because these can be converted into cash at any time. They are almost like cash. It is a form of secondary cash reserves for the commercial banks from which they earn some income too.

Constituent # 2. Collateral Loan Market:

It is another specialised sector of the money market. The market for loans secured by stocks and market is geographically most diversified and most loosely organised. The loans are generally advanced by the commercial banks to private parties in the market.

The collateral loans are backed by the securities, stocks and bonds. The collateral securities may be in the form of some valuable, say government bonds which are easily marketable and do not fluctuate much in prices.

The collateral money is returned to the borrower when the loan is repaid. Once the borrower is unable to repay the loan, the collateral becomes the property to the lender. These loans are given for a few months. The borrowers are generally the dealers in stocks and shares. But even smaller commercial banks can borrow collateral loans from the bigger banks.

Constituent # 3. Acceptance Market:

Banker’s acceptances are very old from of commercial credit. Acceptance market refers to the market for banker’s acceptances involved in trade transactions. This market deals with bankers’ acceptances which may be defined as a draft drawn by a business firm upon a bank and accepted by it.

It is required to pay to the order of a particular party or the bearer a certain specific amount at a specific date in the future. These acceptances emerge out of commercial transactions both within the country and abroad. The market where the bankers’ acceptances are easily sold and discounted is known as acceptance market.

Raymond P. Kent, in his book ‘Money and Banking’ has stated that banker’s acceptance is “a draft drawn by an individual or firm upon a bank and accepted by the bank whereby it is ordered to pay to the order of a designated party or to bearer a certain sum of money at a specified time in future.”

We would like to draw a distinction between a banker’s acceptance and a cheque. A banker’ acceptance is payable at a specified future date whereas a cheque is payable on demand. Banker’s acceptances can be easily discounted in the money market because they carry the signature of the bankers.

In case of acceptance houses, no banks are involved. The bank has merely added its guarantee to the draft. But a note-worthy point is that the banker’s acceptances are used primarily in international trade. In the London Money Market there are specialised firms known as accepting houses which accept bills drawn on them by traders instead of drawing on the true debtors.

In the past, the acceptance houses were very important in the London Money Market but now their importance has declined considerably. In the Indian Money Market these have no significance because there is no development of the acceptance market.

Constituent # 4. Bill Market:

It is a market in which short term papers or bills are bought and sold.

The important types of short terms papers are:

(a) Bills of Exchange, and 

(b) Treasury Bills.

(a) Bills of Exchange:

Bills of exchange are commercial papers. A bill of exchange is a written unconditional order which is signed by the drawer requiring the drawee to pay on demand or at a fixed future time, a definite sum of money.

Once the buyer signifies his acceptance on the bill itself, it becomes a legal document. Such bills are discounted or rediscounted by commercial banks to lend credit to the bill-holders or to borrower from the central bank.

(b) Treasury Bills:

The treasury bills are government papers/securities for a short period usually of 91 days’ duration. The treasury bills are the promissory notes of the government to pay a specified sum after a specified period. These are sold by the central bank on behalf of the government.

An important aspect of a treasury bill is that there is no fixing of rate of interest beforehand. The treasury offers the bills on the basis of competitive bidding, so one who is satisfied with minimum interest would be allotted the bills. Since the treasury bills are government papers, they inspire public confidence in the minds of the investors.

As no risk is involved in their purchase, they become good papers for the commercial banks to invest their short term funds. Since discounting is the main process of exchange, so it is called ‘discount market’ also. A pertinent point is that the market for bonds, government long term loan market or treasury bonds, and the stock exchange, etc., deal with a long period; so they cannot be regarded as constituents of money market.

Thus from the above discussion it is clear that different markets from part of money market. The call money market, for example, refers to the borrowing and lending of call loans and advances. The loans backed by securities, stocks and bonds are called collateral loans.

The acceptance market refers to the acceptances of bills which lead to the discounting of bills. The bill market refers to buying and selling of bills. All these four sub-markets form the money market.