Read the following passage and answer the question.

Mr. Rehan has done a diploma in Financial market and its participants. Recently he got a chance to present his knowledge and train students in a school. He told students about various money market instruments. He mentioned about an instrument which is issued by RBI on behalf of Central Government. He told students that Banks use a system to borrow money (an instrument) to manage their CRR i.e Cash Reserve Ratio. Later. he mentioned a short term self liquidating instrument like Bills of Exchange that can be used for arranging working capital. He also told students about an instrument that helps to mobilise large amounts of money in short period by commercial banks. Lastly, Mr. Rehan spoke about an instrument that works as a replacement towards bank borrowing for large credit-worthy companies, its maturity period is 15 days to one year.

"An instrument that works as a replacement towards bank borrowing for large Credit-worthy companies, its maturity period is 15 days to one year".

Identify the money market instrument stated in the above lines.

Commercial paper

The correct answer is option (2)- Commercial paper.

The money market instrument described in the statement, which acts as a replacement for bank borrowing for large credit-worthy companies with a maturity period of 15 days to one year, is Commercial paper.

Commercial Paper: Commercial paper is a short-term unsecured promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is issued by large and creditworthy companies to raise short-term funds at lower rates of interest than market rates. It usually has a maturity period of 15 days to one year. The issuance of commercial paper is an alternative to bank borrowing for large companies that are generally considered to be financially strong. It is sold at a discount and redeemed at par. The original purpose of commercial paper was to provide short-terms funds for seasonal and working capital needs. For example companies use this instrument for purposes such as bridge financing.
Example: Suppose a company needs long-term finance to buy some machinery. In order to raise the long term funds in the capital market the company will have to incur floatation costs (costs associated with floating of an issue are brokerage, commission, printing of applications and advertising, etc.). Funds raised through commercial paper are used to meet the floatation costs. This is known as Bridge Financing.

OTHER OPTIONS

• Call Money: Call money is short-term finance repayable on demand, with a maturity period of one day to fifteen days, used for inter-bank transactions. Call money is a method by which banks borrow from each other to be able to maintain the cash reserve ratio.

• Certificate of Deposit: Certificates of deposit (CD) are unsecured, negotiable, short-term instruments in bearer form, issued by commercial banks and development financial institutions. They can be issued to individuals, corporations and companies during periods of tight liquidity when the deposit growth of banks is slow but the demand for credit is high. They help to mobilise a large amount of money for short periods.

• Commercial bill is a bill of exchange used to finance the working capital requirements of business firms. It is a short-term, negotiable, self-liquidating instrument which is used to finance the credit sales of firms. When goods are sold on credit, the buyer becomes liable to make payment on a specific date in future. The seller could wait till the specified date or make use of a bill of exchange.