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Difficulty: MediumThe Money Market: Operations and Financial Instruments

A merchant who holds an accepted 90-day credit instrument from a customer needs immediate liquidity to replenish inventory before the payment due date. The merchant approaches a money market institution to obtain cash immediately at a value lower than the face amount. Which money market operation is being demonstrated in this scenario?

  1. Discounting a bill of exchangeAnswer
  2. B
    Subscribing to a corporate debenture
  3. C
    Underwriting an equity share issue
  4. D
    Trading government development stocks

Answer

Discounting a bill of exchange
Discounting a bill of exchange allows the holder of a short-term commercial bill to receive immediate cash from a financial institution (like a commercial bank or discount house) before its maturity date. The institution deducts a small fee (discounting rate) from the face value and collects the full amount from the debtor upon maturity.

Step-by-Step Solution

1
Identify the nature of the transaction described in the scenario.
The scenario involves converting a short-term commercial credit debt (90-day maturity) into immediate liquid cash prior to maturity at a reduced (discounted) value.
The merchant holds a short-term trade instrument and requires funds before the maturity date.
2
Distinguish between money market and capital market instruments and operations.
Converting short-term bills into cash through financial intermediaries at a discount is the core operation known as discounting bills of exchange in the money market.
Options involving debentures, equity shares, and development stocks relate to long-term capital market securities.

Key Concept

Bill Discounting in the Money Market
Estimated Time:1m 0s
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Topics

The Money Market: Operations and Financial Instruments

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