Commercial bills and treasury bills are the two main financial instruments in which the London money market deals. Hence the money market is composed of two sub-markets: (a) Commercial bill market and (b) Treasury bill market. In what follows is discussed the structure, working and the historical changes of the London money market.

1. Commercial Bill Market:

Commercial bills dominated the London money market till the World War I. A bill of exchange is a written order by a seller or an exporter to the buyer or importer to pay a specified sum of money on demand or at a specified future date. Most bills are drawn for three months after date for making payment for goods sold.

The bill thus drawn is sent to the buyer or importer who gets it accepted by either a bank or an acceptance house.


The acceptance house accepts the bill by giving an undertaking to pay the specified amount in the event of default by the drawee of the bill (i.e., buyer or importer). On acceptance, the bill becomes a complete document and is returned to the seller or exporter.

There are now three options open to the seller or exporter who possesses the accepted bill: (a) he can hold it himself for three months when it is due for payment (b) he can endorse it in favour of his creditor in settlement of the debt (c) he can sell it to a discount house and get it discounted, i.e., receive payment minus interest for the outstanding period and some service charges.

Generally, the third option is chosen. In this way, the bill is thrice blessed: (a) it blesses the drawer (seller or exporter) who immediately receives the liquid funds; (b) it blesses the drawee (buyer or importer) who gets his goods and will make the payment on maturity of the bill, and (c) it blesses the holder of the bill (the discount house) who earns a good return in the form of interest.

The discount houses generally sell the bills to the bankers through brokers. The banks then ultimately receive the payment of the bills on their maturity.


2. Decline of Commercial Bills:

After 1914, the volume of commercial bills declined considerably. On the other hand, increased borrowing by the government to finance the war expenditure increased the volume of Treasury bills. Even today, the volume of Treasury bills far exceeds that of commercial bills.

Many factors are responsible for the decline in importance of commercial bills:

(a) Borrowers on the bills of exchange were not willing to have their name in circulation,


(b) Commercial bills were non-flexible as regards maturity period,

(c) Bank credit has become more popular and more convenient means of financing internal trade,

(d) There has been a considerable decline in international trade,

(e) In international trade, alternative methods of payment, such as telegraphic transfer, have been developed.


3. Treasury Bills Market:

Treasury bill is a bill of exchange drawn by the Treasury on itself, usually for three months. They are issued in denominations of £ 5000 or multiple of £ 5000 and carry just over 5% rate of interest. These bills can be purchased only by institutions.

Treasury bills are issued in two forms:

(a) When the Treasury bills are offered by tender to the highest bidder in the money market, they are known as tender bills. Such bills are purchased by British banks, discount houses, foreign banks and governments, and big industrial and commercial firms,


(b) When the Treasury bills are bought by government departments, the Bank of England and some foreign monetary authorities, they are known as tap bills.

4. Emergence of Short Term Bonds:

Although the Treasury bills dominate the London money market, the profit yield on the Treasury bills had been very low. This led the discount market to look for other more profitable sources of investment. Such a source was found in the short-term government bonds.

Short-term government bonds were of two types: (a) short-term bonds of one to five year maturity, and (b) long-term bonds of 15 to 20 years becoming short-term bonds nearing maturity. The short-term bonds were preferred on the considerations of safety and higher return.