Looking for the answer to the question below related to Financial Management ?
Which of the following are not money market instruments?
|A. Treasury bills
B. Commercial Paper
C. Certificate of deposit
D. Fixed deposit receipt
The Correct Answer Is:
- D. Fixed deposit receipt
The correct answer is D. Fixed deposit receipt. Let’s examine why this is the correct answer and why the other options are considered money market instruments:
D. Fixed Deposit Receipt:
A fixed deposit receipt (FDR) is not typically considered a money market instrument. Fixed deposit receipts are term deposits offered by banks and financial institutions that allow individuals to deposit a lump sum of money for a fixed period at a predetermined interest rate. These deposits have a maturity date, and the principal amount, along with accrued interest, is paid to the depositor upon maturity.
Fixed deposit receipts are categorized as time deposits and are not as liquid as money market instruments. They usually have longer tenures ranging from a few months to several years, which makes them distinct from the short-term nature of money market instruments. Money market instruments are designed for short-term funding and liquidity management.
Now, let’s explore why the other options are considered money market instruments:
A. Treasury Bills:
Treasury bills, often referred to as T-bills, are a prominent example of money market instruments. These are short-term government securities with maturities typically ranging from a few days to one year. Treasury bills are highly liquid and are considered one of the safest investments because they are backed by the government.
Investors purchase T-bills at a discount to their face value, and the difference between the purchase price and the face value represents the interest earned. Treasury bills are actively traded in the money market and are an essential tool for governments to manage their short-term borrowing needs.
B. Commercial Paper:
Commercial paper is another key money market instrument. It represents short-term, unsecured promissory notes issued by corporations, financial institutions, and other large borrowers. These notes have maturities ranging from a few days to one year. Commercial paper is typically issued to raise funds for short-term operational needs, such as financing accounts receivable or managing inventory.
It is considered a low-risk investment because it is usually issued by creditworthy entities, and it offers higher yields than traditional bank deposits. Commercial paper is actively traded in the money market.
C. Certificate of Deposit:
A certificate of deposit (CD) is also classified as a money market instrument. It is a time deposit offered by banks and financial institutions with fixed terms ranging from a few days to several years. CDs offer a fixed interest rate, and the investor agrees not to withdraw the funds until the maturity date.
While some CDs have longer maturities, those with shorter tenures (e.g., 1 month, 3 months) are considered money market instruments because they provide a safe and relatively liquid investment option for short-term funds. Investors can trade short-term CDs in the secondary market, enhancing their liquidity.
In summary, fixed deposit receipts (Option D) are not typically considered money market instruments because they are time deposits with longer tenures, unlike money market instruments, which are designed for short-term funding and liquidity management.
Treasury bills, commercial paper, and certificates of deposit, on the other hand, are recognized money market instruments due to their short-term nature and active participation in the money market. These instruments serve as crucial tools for investors, financial institutions, and governments to manage short-term cash flows, finance operations, and optimize liquidity.