Money Market – AHSEC Class 12 Finance Chapter 6

Here is a comprehensive study note for the AHSEC Class 12 Finance textbook, focusing on Chapter 6: Money Market.

Chapter 6: Money Market

Summary Note

This chapter provides a detailed introduction to the money market, its features, composition, and importance in a modern economy.

• Meaning and Definition:
  • The money market is a market for short-term borrowing and lending of funds, typically for a period of less than one year.
  • It deals with “near-money” assets, which are highly liquid and can be quickly converted into cash with minimal risk of loss. Examples include treasury bills, commercial papers, and bills of exchange.
  • According to Crowther, it is a “collective name given to the various firms and institutions that deal with the various grades of near-money.”
• Features of the Money Market:
  1. Constituents: It comprises lenders, borrowers, and the short-term credit instruments they trade.
  2. Dealers: Participants include commercial banks, the central bank (RBI), non-bank financial institutions, corporations, and the government.
  3. Heterogeneous Market: It is not a single market but consists of several specialized sub-markets (e.g., call money market, bill market).
  4. Short-Term Funds: It exclusively deals with funds for periods of less than one year.
  5. No Fixed Location: It is not restricted to a physical place; transactions are often conducted over the phone or electronically.
• Sub-Markets/Composition of the Money Market:
  1. Call Money Market: Deals in extremely short-term loans (1 to 14 days), known as call loans or call money. These are repayable on demand.
  2. Collateral Loan Market: A market where loans are provided against collateral securities like stocks and bonds.
  3. Acceptance Market: A market for banker’s acceptances, which are drafts drawn on and accepted by a bank, primarily used for financing trade.
  4. Bill Market (or Discount Market): Deals in the sale and purchase (discounting) of short-term bills like bills of exchange and treasury bills.
• Institutions of the Money Market:
  • Central Bank (RBI): The apex institution that controls and regulates the money market.
  • Commercial Banks: The principal suppliers of short-term funds.
  • Non-bank Financial Institutions: Investment banks, insurance companies, etc.
  • Acceptance Houses & Discount Houses: Specialized institutions that guarantee (accept) and trade (discount) bills of exchange.
• Functions and Importance of the Money Market:
  1. Financing Trade and Industry: Provides short-term working capital to businesses.
  2. Profitable Investment for Banks: Allows commercial banks to invest their excess reserves in liquid assets to earn returns.
  3. Helps the Government: Enables the government to raise short-term funds at low interest rates by issuing treasury bills.
  4. Helps the Central Bank: A well-developed money market is essential for the effective implementation of the central bank’s monetary policy.
  5. Encourages Saving and Investment: Facilitates the transfer of funds from savers (surplus sector) to investors (deficit sector).
• Characteristics of a Developed Money Market:
  1. Presence of a Strong Central Bank.
  2. A Well-Organised Banking System.
  3. Availability of Proper Credit Instruments (e.g., treasury bills, commercial papers).
  4. Existence of Well-Organised Sub-Markets.
  5. Integrated Structure: Close connection and free flow of funds between sub-markets.
  6. Availability of Adequate Financial Resources.
• Differences between Money Market and Capital Market:
  • Term: Money market deals with short-term funds (< 1 year); Capital market deals with long-term funds (> 1 year).
  • Instruments: Money market uses treasury bills, commercial papers, etc.; Capital market uses shares, debentures, bonds, etc.
  • Risk: Risk is generally lower in the money market compared to the capital market.
  • Institutions: Money market institutions include commercial banks and discount houses; Capital market institutions include stock exchanges and investment banks.
• Similarities between Money Market and Capital Market:
  1. Complementary: They are not competitive but complementary to each other.
  2. Same Institutions: Some institutions, like commercial banks, operate in both markets.
  3. Interdependence: The activities and policies of one market have a significant impact on the other.

Complete Textual Question Answers

Here are the answers to all the questions given at the end of Chapter 6.

A. Very Short Answer Questions (1 Mark each)

1. Write the name of the apex financial institution in the money market of a country.
   Ans: The apex financial institution in the money market of a country is its Central Bank (in India, it is the Reserve Bank of India).

B. Short Answer Questions (2 Marks each)

1. What is money market?
   Ans: The money market is a market for dealing with short-term borrowing and lending of funds, generally for a period of less than one year. It deals with highly liquid and quickly marketable assets known as “near-money”.
2. Write two features of money market.
   Ans: Two features of the money market are:
   i. Short-Term Funds: It deals exclusively with funds and financial assets having a maturity period of less than one year.
   ii. Heterogeneous Market: It is not a single market but consists of several sub-markets, each specializing in a specific short-term instrument like the call money market or the bill market.
3. What is call money market?
   Ans: The call money market is a sub-market of the money market that deals in extremely short-term loans, ranging from one day to 14 days. These loans, known as call money, are repayable on demand at the option of either the lender or the borrower.
4. What is collateral loan market?
   Ans: The collateral loan market is a market where short-term loans are provided against collateral securities like stocks and bonds. If the borrower repays the loan, the collateral is returned; if they default, the collateral becomes the property of the lender.
5. What is acceptance market?
   Ans: The acceptance market is a market for banker’s acceptances. It arises from trade transactions where a bank ‘accepts’ a draft on behalf of a buyer, guaranteeing payment to the seller at a future date.
6. What is bill market?
   Ans: The bill market, also known as the discount market, deals in the sale and purchase (discounting) of short-term bills of exchange and treasury bills. Its main business is the discounting of these bills.
7. Write the names of two institutions of the money market.
   Ans: Two main institutions of the money market are (i) the Central Bank (RBI) and (ii) Commercial Banks.
8. Write two functions of money market.
   Ans: Two functions of the money market are:
   i. Financing Trade: It finances internal and international trade by discounting bills of exchange.
   ii. Helps to Government: It helps the government raise short-term funds by selling treasury bills at a low interest rate.
9. Write two characteristics of a developed money market.
   Ans: Two characteristics of a developed money market are:
   i. Presence of a Central Bank: A strong and effective central bank is essential to guide and regulate the market.
   ii. A Well-Organised Banking System: A network of commercial banks acts as the principal supplier of short-term funds.
10. Write two differences of money market and capital market.
    Ans: Two differences between the money market and the capital market are:
    i. Term of Funds: The money market deals with short-term funds (less than one year), while the capital market deals with long-term funds (more than one year).
    ii. Instruments: Money market instruments include treasury bills and commercial papers, whereas capital market instruments include shares and debentures.
11. Write two similarities of money market and capital market.
    Ans: Two similarities between the money market and the capital market are:
    i. Complementary: They are not competitive but work together to form the complete financial market of a country.
    ii. Interdependence: The policies and interest rate movements in the money market directly impact the capital market, and vice-versa.

C. Long Answer Questions (Type-I) (5 Marks each)

1. Write five features of money market.
   Ans: (Refer to the “Features of the Money Market” section in the summary above and elaborate on five points like Constituents, Dealers, Heterogeneous Market, Near-Money Assets, and Short-Term Funds).
2. Write five function of money market.
   Ans: (Refer to the “Functions and Importance of the Money Market” section in the summary and elaborate on five points like Financing Trade, Financing Industry, Profitable Investment, Helps to Government, and Helps to Central Bank).
3. Write five differences of money market and capital market.
   Ans: (Refer to the “Differences between Money Market and Capital Market” section in the summary and present five points of difference in a table format, covering Term, Nature of loan, Instruments, Institutions, and Risk).
4. Write five characteristics of a developed money market.
   Ans: (Refer to the “Characteristics of a Developed Money Market” section in the summary and elaborate on five points like Presence of a Central Bank, A well-organised banking system, Availability of proper credit instruments, Existence of well-organised sub-markets, and Integrated structure).
5. Write about five institution of money market.
   Ans: (Refer to the “Institutions of the Money Market” section in the summary and elaborate on five institutions like Central bank, Commercial banks, Non-bank Financial Institutions, Acceptance Houses, and Discount Houses, explaining the role of each).

D. Long Answer Questions (Type-2) (8 Marks each)

1. What is money market? State the features of money market.
   Ans: (Combine the answer from B.1 and C.1. First, define the money market clearly. Then, explain its key features in detail, such as its short-term nature, the types of instruments traded, its heterogeneous structure, and the major participants).
2. What is money market? State about the institutions of the money market.
   Ans: (Combine the answer from B.1 and C.5. First, provide a comprehensive definition of the money market. Then, describe the various institutions that operate within it, explaining the specific roles of the Central Bank, Commercial Banks, Non-bank Financial Institutions, Acceptance Houses, and Discount Houses).
3. What is money market? Explain the various sub-market of the money market.
   Ans: (Combine the answer from B.1 with the “Sub-Markets/Composition” section from the summary. First, define the money market. Then, explain each of its four main sub-markets—Call Money Market, Collateral Loan Market, Acceptance Market, and Bill Market—detailing the specific type of transaction that occurs in each).
4. What is money market? State the differences between money market and Capital market.
   Ans: (Combine the answer from B.1 and C.3. Start with a clear definition of the money market. Then, create a table to clearly state the differences between the money market and the capital market based on points like Term, Purpose of loan, Instruments, Institutions, Risk, and Basic Role).
5. Discuss the functions and importance of the money market.
   Ans: (This answer is the same as C.2 but requires more detailed explanation for 8 marks. Elaborate on how the money market is crucial for financing trade and industry, providing investment avenues for banks, helping the government with its short-term fund needs, and enabling the central bank to implement monetary policy effectively).
6. Discuss the characteristics of a developed money market.
   Ans: (This answer is the same as C.4 but requires more depth for 8 marks. Explain in detail why each characteristic, such as a strong central bank, an organized banking system, a variety of credit instruments, and integrated sub-markets, is essential for the efficiency and effectiveness of a money market).

Previous Year AHSEC Question Answers (2015-2025)

Short Questions (1-2 Marks)

• What is Money Market? (AHSEC 2016, 2020)
  Ans: The money market is a market for short-term borrowing and lending of funds, generally for a period of less than one year. It deals with highly liquid financial instruments known as “near-money”.
• Mention two instruments of Money Market. (AHSEC 2017)
  Ans: Two instruments of the Money Market are (i) Treasury Bills and (ii) Commercial Papers.
• What is Call Money Market? (AHSEC 2018)
  Ans: The call money market is a sub-market of the money market that deals in very short-term loans, from one day to 14 days. These loans are repayable on demand.
• State two differences between money market and capital market. (AHSEC 2019, 2022)
  Ans: Two differences are:
  i. Maturity: The money market deals with short-term funds (less than one year), while the capital market deals with long-term funds (more than one year).
  ii. Risk: The money market involves lower risk compared to the capital market, which is generally riskier.

Long Questions (5-8 Marks)

• Discuss the functions of the money market. (AHSEC 2017)
  Ans: (This answer is the same as the textual Long Answer Question C.2. Please refer to that answer above).
• Explain the characteristics of a developed money market. (AHSEC 2018)
  Ans: (This answer is the same as the textual Long Answer Question C.4. Please refer to that answer above).

10 Most Important Questions

1. Why is the money market called a market for “near-money” assets?
   Ans: It is called a market for “near-money” assets because the financial instruments traded in it (like treasury bills) are highly liquid and can be converted into cash very quickly with minimal risk of loss in value.
2. Who are the main participants (lenders and borrowers) in the money market?
   Ans: The main participants include the Central Bank (RBI), commercial banks, non-bank financial institutions, large corporations, and the government.
3. What is the role of the Central Bank in the money market?
   Ans: The Central Bank (RBI) is the apex authority that regulates, controls, and guides the money market to ensure its stability and helps implement the country’s monetary policy.
4. Differentiate between the Bill Market and the Call Money Market.
   Ans: The Bill Market deals with the discounting and trading of short-term bills like treasury bills and bills of exchange, while the Call Money Market deals with extremely short-term, unsecured loans between banks for periods of 1 to 14 days.
5. How does the money market help commercial banks?
   Ans: The money market allows commercial banks to profitably invest their temporary excess cash reserves in liquid assets and also enables them to borrow short-term funds to meet their reserve requirements or sudden cash demands.
6. What is a Treasury Bill (T-Bill)?
   Ans: A Treasury Bill is a short-term debt instrument issued by the government (through the central bank) to raise short-term funds. It is sold at a discount to its face value and redeemed at par on maturity.
7. Why is an integrated structure important for a developed money market?
   Ans: An integrated structure, where funds can move easily between different sub-markets, is important because it ensures that interest rates are uniform and that the central bank’s policy actions are quickly transmitted throughout the entire market.
8. What is the main purpose of the Acceptance Market?
   Ans: The main purpose of the Acceptance Market is to facilitate trade, especially international trade, by having a bank “accept” (guarantee) a trade bill, which makes the bill more secure and easily tradable.
9. Explain the complementary relationship between the money market and the capital market.
   Ans: The money market provides short-term funds for working capital, while the capital market provides long-term funds for fixed investment. Both are essential for a business to function, making them complementary; one cannot thrive without the other.
10. Why is personal contact not necessary in the money market?
    Ans: Personal contact is not necessary because the money market is not a physical place. Transactions are conducted electronically or over the telephone between well-known institutions, making physical meetings redundant.