We have already considered money as commodity in the first article - importance of money.
Here we give more insight of money in more broader terms.
Money and Its Importance
Money is a thing that is usually accepted as payment for goods and services as well as for the repayment of debts.
Money originated as commodity money, but almost all contemporary money systems are based on concept of fiat money. Fiat money is of no value as a physical commodity, and derives its value by being declared by the government to be a legal tender; that is, it must be accepted as a form of payment within the boundaries of the country. This applies for "all debts, public as well as private".
The money supply of a country consists of currency and demand deposits of bank money. Currency consists of banknotes and coins and demand deposits or 'bank money' consist of balance held in checking accounts and savings accounts. These demand deposits usually account for a much larger part of the money supply as compare to currency. Bank money is intangible. It exists in the form of various bank records. Although it is intangible, bank money still carries out the basic functions of money, being generally accepted as a form of payment.
Functions of Money
Money is best defined based on the functions that it performs as "anything that is widely used for making payments and accounting"
Money is considered as -
Store of value
Common measure of value
A means of payment
Medium of exchange
Unit of account
In order to function as a store of value, money should be capable of being reliably saved, stored, as well as retrieved. It should also be predictably usable as a medium of exchange once it is retrieved. The value of money must also remain stable over a period of time.
When money is used for carrying out the exchange of goods and services, it is functioning as a medium of exchange. It thus avoids the inefficiencies of barter system, like the 'double coincidence of wants' problem.
A unit of account is nothing but a standard numerical unit of measurement of the market value of goods, services, and several other transactions. It is also known as a "measure" or "standard" of relative worth and "standard" of deferred payment. A unit of account is a necessary prerequisite for the purpose of formulation of commercial agreements which involve debt. In order to function as a 'unit of account', whatever is being used as money should necessarily be:
Divisible into number of smaller units without any loss of value
Fungible: meaning that one unit or piece should be perceived as equivalent to any other, which is why real estate, diamonds, or works of art cannot be considered as money.
A specific size, weight, or measure to be verifiably countable.
Types of Money
Commodity Money - Commodity money value is derived from the commodity out of which it is made. The commodity itself represents money, and the money is the commodity. For instance, commodities that have been used as mediums of exchange include gold, silver, copper, salt, peppercorns, rice, large stones, etc.
Representative Money - is money that includes token coins, or any other physical tokens like certificates, that can be reliably exchanged for a fixed amount/quantity of a commodity like gold or silver.
Fiat Money - Fiat money, also known as fiat currency is the money whose value is not derived from any intrinsic value or any guarantee that it can be converted into valuable commodity (like gold). Instead, it derives value only based on government order (fiat)
Commercial Bank Money - Commercial bank money or the demand deposits are claims against financial institutions which can be used for purchasing goods and services
Showing posts with label money. Show all posts
Showing posts with label money. Show all posts
Thursday, 8 July 2010
Importance of Money
Trading involves the exchange of goods and services for payment by money. Those wanting to purchase goods/services require money, while those selling expect to receive money.
The business world has developed to the stage where money is not only a medium of exchange, but it is also a commodity. Therefore, money itself is bought and sold.
The evolution and development of the money markets is closely linked to the business world’s requirement of this scarce commodity – money.
Money supply and Demand
Money may be in surplus -- due to large financial profits, completion of lucrative contact, unexpectedly high return on some investment.
Money may be in deficit -- heavy financial loss, insufficient yield in short-term from long term project, buying abroad and falling to cover adverse currency fluctuation.
Transactions
Transactions may be
1. Lending
2. Borrowing
3. Selling
4. Buying
The business world has developed to the stage where money is not only a medium of exchange, but it is also a commodity. Therefore, money itself is bought and sold.
The evolution and development of the money markets is closely linked to the business world’s requirement of this scarce commodity – money.
Money supply and Demand
Money may be in surplus -- due to large financial profits, completion of lucrative contact, unexpectedly high return on some investment.
Money may be in deficit -- heavy financial loss, insufficient yield in short-term from long term project, buying abroad and falling to cover adverse currency fluctuation.
Transactions
Transactions may be
1. Lending
2. Borrowing
3. Selling
4. Buying
Money markets
Definition of the Money Market
The money market is the market where the buying, selling, lending, and borrowing of short-term funds occur.
It is not a physical market; instead, all participants are linked by a sophisticated network of telephones and computers.
The short-term nature of the money market is its major distinguishing feature. Transactions in the money market are for one year or less. This contrasts with the capital market where transactions are long-term in nature, that is, greater than one year.
Main Players :
Mainly it is
1. International Money markets where transaction involves currency other than domestic currency.
2. Interbank markets, where transactions are actually carried out between banks.
In case of India, it is Reserve bank of India (RBI), Discount and Finance House of India (DFHI), mutual funds, banks, corporate investor, non-banking finance companies (NBFCs), state governments, provident funds, Primary dealers. Securities Trading Corporation of India (STCI), public sector undertaking (PSUs), non-resident Indians and overseas corporate bodies.
Characteristics of Money markets
Money markets are
1. global - It doesnt have central trading floor. Instead they form global OTC market, connected by sophisticated networks and telephone lines, that operate on 24 hour basis.
2. Wholesale - These transactions have corporations, banks, brokers, dealers and central authorities.
3. Short term - It has short maturity and hence its instruments are called cash instruments.
Functions of the Money Market:
A money market is generally expected to perform three broad functions:
1. Provide a balancing mechanism to even out the demand for and supply of short term funds
2. Provide a focal point for central bank intervention for influencing liquidity and general level of interest rates in the economy.
3. Provide reasonable access to suppliers and users of short term funds to fulfill their borrowings and investment requirements at an efficient market clearing price.
Besides the above functions, a well functioning money market facilitates the development of a market for longer term securities. The interest rates for extremely short term use of money serve as a benchmark for longer term financial instruments.
Benefits of an Efficient Money Market:
An efficient money market benefits a number of players. It provides a stable source of funds to banks in addition to deposits allowing alternative financing structures and competition. It allows banks to manage risks arising from interest rate fluctuations and to manage the maturity structure of their assets and liabilities.
A developed inter-bank market provides the basis for growth and liquidity in the money including the secondary market for commercial paper and treasury bills.
An efficient money market encourages the development of non-bank intermediaries thus increasing the competition for funds. Savers get a wide array of savings instruments to choose from and invest their savings.
A liquid money market provides an effective source of long term finance to borrowers. Large borrowers can lower the cost of raising funds and manage short term funding or surplus efficiently.
A liquid and vibrant money market is necessary for the development of a capital market, foreign exchange market, and market in derivative instruments. The money market supports the long term debt market by increasing the liquidity of securities. The existence of an efficient money market is a precondition for the development of a government securities market and a forward foreign exchange market.
Trading in forwards, swaps, and futures is also supported by a liquid money market as the certainty of prompt cash settlement is essential for such transactions. The government can achieve better pricing on its debt as it provides access to a wide range of buyers. It facilitates the government market borrowing.
Monetary control through indirect methods (repos and open market operations) is more effective if the money market is liquid. In such a market response to the central bank’s policy actions are both faster and less subject to distortion.
The Indian Money Market:
The average turnover of the money market in India is over Rs 40,000 crore daily. This is more than 3 per cent of the total money supply in the Indian economy and 6 percent of the total funds that commercial banks have let out to the system. This implies that 2 per cent of the annual GDP of India gets traded in the money market in just one day. Even though the money market is many times larger than the capital market, it is not even a fraction of the daily trading in developed markets.
The money market is the market where the buying, selling, lending, and borrowing of short-term funds occur.
It is not a physical market; instead, all participants are linked by a sophisticated network of telephones and computers.
The short-term nature of the money market is its major distinguishing feature. Transactions in the money market are for one year or less. This contrasts with the capital market where transactions are long-term in nature, that is, greater than one year.
Main Players :
Mainly it is
1. International Money markets where transaction involves currency other than domestic currency.
2. Interbank markets, where transactions are actually carried out between banks.
In case of India, it is Reserve bank of India (RBI), Discount and Finance House of India (DFHI), mutual funds, banks, corporate investor, non-banking finance companies (NBFCs), state governments, provident funds, Primary dealers. Securities Trading Corporation of India (STCI), public sector undertaking (PSUs), non-resident Indians and overseas corporate bodies.
Characteristics of Money markets
Money markets are
1. global - It doesnt have central trading floor. Instead they form global OTC market, connected by sophisticated networks and telephone lines, that operate on 24 hour basis.
2. Wholesale - These transactions have corporations, banks, brokers, dealers and central authorities.
3. Short term - It has short maturity and hence its instruments are called cash instruments.
Functions of the Money Market:
A money market is generally expected to perform three broad functions:
1. Provide a balancing mechanism to even out the demand for and supply of short term funds
2. Provide a focal point for central bank intervention for influencing liquidity and general level of interest rates in the economy.
3. Provide reasonable access to suppliers and users of short term funds to fulfill their borrowings and investment requirements at an efficient market clearing price.
Besides the above functions, a well functioning money market facilitates the development of a market for longer term securities. The interest rates for extremely short term use of money serve as a benchmark for longer term financial instruments.
Benefits of an Efficient Money Market:
An efficient money market benefits a number of players. It provides a stable source of funds to banks in addition to deposits allowing alternative financing structures and competition. It allows banks to manage risks arising from interest rate fluctuations and to manage the maturity structure of their assets and liabilities.
A developed inter-bank market provides the basis for growth and liquidity in the money including the secondary market for commercial paper and treasury bills.
An efficient money market encourages the development of non-bank intermediaries thus increasing the competition for funds. Savers get a wide array of savings instruments to choose from and invest their savings.
A liquid money market provides an effective source of long term finance to borrowers. Large borrowers can lower the cost of raising funds and manage short term funding or surplus efficiently.
A liquid and vibrant money market is necessary for the development of a capital market, foreign exchange market, and market in derivative instruments. The money market supports the long term debt market by increasing the liquidity of securities. The existence of an efficient money market is a precondition for the development of a government securities market and a forward foreign exchange market.
Trading in forwards, swaps, and futures is also supported by a liquid money market as the certainty of prompt cash settlement is essential for such transactions. The government can achieve better pricing on its debt as it provides access to a wide range of buyers. It facilitates the government market borrowing.
Monetary control through indirect methods (repos and open market operations) is more effective if the money market is liquid. In such a market response to the central bank’s policy actions are both faster and less subject to distortion.
The Indian Money Market:
The average turnover of the money market in India is over Rs 40,000 crore daily. This is more than 3 per cent of the total money supply in the Indian economy and 6 percent of the total funds that commercial banks have let out to the system. This implies that 2 per cent of the annual GDP of India gets traded in the money market in just one day. Even though the money market is many times larger than the capital market, it is not even a fraction of the daily trading in developed markets.
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