Documente Academic
Documente Profesional
Documente Cultură
Project
ON
SECTION-FN2
ROLL NO: 02
By convention, the term ‘Money Market’ refers to the market for short time
requirement & deployment of funds. Money market instruments are those
instruments, which have a maturity time of less than 1 year.The most active part of
the money market is the market for overnight call and term money between the
banks, institutions as well as call money transactions. Call Money or Repo are very
short term Money Market products. The below mentioned instruments are
normally termed as money market instruments:
The slice of the financial market where instruments with high liquid and short
maturities are traded is called money market. It is a generic definition. The
players who indulge in short time from several days to less than one year. It is
generally used for borrow & lend over this short term. Due to the highly liquid
nature of the security and short maturities, money market are perceived as a safe
place to lock in money.
Treasury Bills are highly liquid short-time instruments that yield attractive returns.
Short- term borrowing instruments of the Central Govt, it is a promise to pay a said
sum after expiry of a specified period. It is a zero-risk instrument available in both
primary and secondary markets. Money market instruments are characterised by
high degree of safety of the principal.
The Money market instrument meets the short-term requirements of borrowers and
provides liquidity to lenders. Short-term surplus funds at the disposal of
institutions and individuals are bid by borrowers, who could be in the same
category.
Debt instrument which have a maturity of less than a year at the time of issue are
called money market instruments. Types of debt instruments include notes, bonds,
certificates, mortgages, leases or other agreements between a lender and a
borrower. These instruments are highly liquid and have negligible risk. The major
money market instruments are Treasury bills, certificates of deposit, commercial
paper, and repos. The money market is dominated by the government, financial
institutions, banks, and corporate. Individual investors scarcely participate in the
money market directly. A brief description of money market instruments is given
below.
5) Treasury Bills
6) Bill Rediscounting
Call/Notice money is the money borrowed or lent on demand for a very short
period. When money is borrowed or lent for a day, it is known as Call (Overnight)
Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus
money, borrowed on a day and repaid on the next working day, (irrespective of the
number of intervening holidays) is "Call Money". When money is borrowed or lent
for more than a day and up to 14 days, it is "Notice Money". No collateral security
is required to cover these transactions.
The entry into this field is restricted by RBI. Commercial Banks, Co-operative
Banks and Primary Dealers are allowed to borrow and lend in this market.
Specified All-India Financial Institutions, Mutual Funds, and certain specified
entities are allowed to access to Call/Notice money market only as lenders.
Reserve Bank of India has recently taken steps to make the call/notice money
market completely inter-bank market. Hence the non-bank entities will not be
allowed access to this market beyond December 31, 2000.
From May 1, 1989, the interest rates in the call and the notice money market are
market determined. Interest rates in this market are highly sensitive to the demand
- supply factors. Within one fortnight, rates are known to have moved from a low
of 1 - 2 per cent to dizzy heights of over 140 per cent per annum. Large intra-day
variations are also not uncommon. Hence there is a high degree of interest rate risk
for participants. In view of the short tenure of such transactions, both the borrowers
and the lenders are required to have current accounts with the Reserve Bank of
India. This will facilitate quick and timely debit and credit operations. The call
market enables the banks and institutions to even out their day to day deficits and
surpluses of money. Banks especially access the call market to borrow/lend money
for adjusting their cash reserve requirements (CRR). The lenders having steady
inflow of funds (e.g. LIC, UTI) look at the call market as an outlet for deploying
funds on short term basis.
The market in this segment is presently not very deep. The declining spread in
lending operations, the volatility in the call money market with accompanying
risks in running asset/liability mismatches, the growing desire for fixed interest
rate borrowing by corporates, the move towards fuller integration between forex
and money markets, etc. are all the driving forces for the development of the term
money market. These, coupled with the proposals for rationalisation of reserve
requirements and stringent guidelines by regulators/managements of institutions, in
the asset/liability and interest rate risk management, should stimulate the evolution
of term money market sooner than later. The DFHI (Discount & Finance House of
India), as a major player in the market, is putting in all efforts to activate this
market.
Treasury Bills.
Treasury Bills are money market instruments to finance the short term
requirements of the Government of India. The Treasury bills are short-term money
market instrument that mature in a year or less than that. The purchase price is less
than the face value. At maturity the government pays the Treasury Bill holder the
full face value. The Treasury Bills are marketable, affordable and risk free. The
security attached to the treasury bills comes at the cost of very low returns.
Treasury Bills are short term (up to one year) borrowing instruments of the union
government. It is an IOU of the Government. It is a promise by the Government to
pay a stated sum after expiry of the stated period from the date of issue
(14/91/182/364 days i.e. less than one year). They are issued at a discount to the
face value, and on maturity the face value is paid to the holder. The rate of
discount and the corresponding issue price are determined at each auction.
Types
Amount
Treasury bills are available for a minimum amount of Rs.25,000 and in multiples
of Rs. 25,000. Treasury bills are issued at a discount and are redeemed at par.
Treasury bills are also issued under the Market Stabilization Scheme (MSS).
Auctions
While 91-day T-bills are auctioned every week on Wednesdays, 182-day and 364-
day T-bills are auctioned every alternate week on Wednesdays. The Reserve Bank
of India issues a quarterly calendar of T-bill auctions which is available at the
Banks’ website. It also announces the exact dates of auction, the amount to be
auctioned and payment dates by issuing press releases prior to every auction.
• The bills are generally issued in the form of SGL - entries in the books of
Reserve Bank of India. The SGL holdings can be transferred by issuing a
SGL transfer form. For non-SGL account holders, RBI has been issuing the
bills in scrip form.
This system of auction is exactly identical to that of the French Auction System as
far as the price discovery mechanism part is concerned. The difference is observed
only at the stage of payment obligation. After determination of the market related
cut-off rate, allotment is made to all the bidders at a uniform price. The concept of
premium on account of yield differential does not exist here.
Other Instruments
New money market instruments like Certificates of Deposits (CDs) and
Commercial Paper (CPs) were introduced in 1989-90 to give greater flexibility to
investors in the deployment of their short-term surplus funds
Certificates of Deposit
Certificates of Deposit (CDs) - introduced since June 1989 - are negotiable term
deposit certificates issued by a commercial banks/Financial Institutions at discount
to face value at market rates, with maturity ranging from 15 days to one year.
Certificate of Deposit: The certificates of deposit are basically time deposits that
are issued by the commercial banks with maturity periods ranging from 3 months
to five years. The return on the certificate of deposit is higher than the Treasury
Bills because it assumes a higher level of risk.
DFHI trades in these instruments in the secondary market. The market for these
instruments, is not very deep, but quite often CDs are available in the secondary
market. DFHI is always willing to buy these instruments thereby lending liquidity
to the market.
Salient features :
CDs are issued by Banks, when the deposit growth is sluggish and credit demand is
high and a tightening trend in call rate is evident. CDs are generally considered
high cost liabilities and banks have recourse to them only under tight liquidity
conditions.
CPs enable highly rated corporate borrowers to diversify their sources of short-
term borrowings and raise a part of their requirement at competitive rates from the
market. The introduction of Commercial Paper (CP) in January 1990 as an
additional money market instrument was the first step towards securitisation of
commercial bank's advances into marketable instruments.
Commercial Papers are unsecured debts of corporates. They are issued in the form
of promissory notes, redeemable at par to the holder at maturity. Only corporates
who get an investment grade rating can issue CPs, as per RBI rules. Though CPs
are issued by corporates, they could be good investments, if proper caution is
exercised.
The market is generally segmented into the PSU CPs, i.e. those issued by public
sector unit and the private sector CPs. CPs issued by top rated corporates are
considered as sound investments.
DFHI trades in these certificates. It will buy these certificates, subject to its
perception of the instrument and will also be offering them for sale subject to
availability of stock.
The purpose of introduction of CP was to release the pressure on bank funds for
small and medium sized borrowers and at the same time allowing highly rated
companies to borrow directly from the market.
As in the case of CDs, the secondary market in CP has not developed to a large
extent.
Commercial Bills
Commercial Paper is short-term loan that is issued by a corporation use for
financing accounts receivable and inventories. Commercial Papers have higher
denominations as compared to the Treasury Bills and the Certificate of Deposit.
The maturity period of Commercial Papers are a maximum of 9 months. They are
very safe since the financial situation of the corporation can be anticipated over a
few months.
The concept of raising money through commercial paper was know to the US
markets since 20th century. On our country though it was introduced in 1990, the
RBI constantly watching the growth of the CP market and it is modifying the
guidelines from time to time. For further development of CP market, the stamp
duty on CP should be abolished since there is no stamp duty in US, UK and
France and RBI has to relax the stringent Credit Rating norms from the present
Credit rating P2 of CRISIL to P3, since credit rating is not compulsory in many
countries like US, UK and France.The denominations of CP should be reduced
further for the growth of secondary market for CP.
Jan 1990 July July July June July Sep. Feb. Oct. Oct.
1990 1991 1992 1994 1995 1996 1997 2000 2004
Tangible Net 10 Crore 5 - - 4 Crore - - - - -
Worth Crore
WCFBL* 25 Crore 15 10 5 4 Crore - - - - -
Crore Crore Crore
Minimum Size 1 Crore 50 25 - - - - - 5 Lakh -
Lakh Lakh
Maximum Size 20% of - 30% 75% - 75% of 100% of 100% of Should -
MPBF** of of Cash Cash WCFBL not
MPBF MPBF Credit Credit exceed
Compone Compone WCFBL
nt nt
Denominations 25 Lakh 10 5 Lakh - - - - - 5 Lakh -
Lakh
Maturity 91days - - - - 3 - - - 15 days 7days
Period 6 months months – 1 year - One
– 1year Yr.
Credit Rating P1+ by CRISIL - P2 - - - - -
or Equal grade
by other
agencies
Other
Measures
Bills of exchange are negotiable instruments drawn by the seller (drawer) on the
buyer (drawee) for the value of the goods delivered to him. Such bills are called
trade bills. When trade bills are accepted by commercial banks, they are called
commercial bills. If the seller wishes to give some period for payment, the bill
would be payable at a future date (usance bill). During the currency of the bill, if
the seller is in need of funds, he may approach his bank for discounting the bill.
One of the methods of providing credit to customers by bank is by discounting
commercial bills at a prescribed discount rate. The bank will receive the maturity
proceeds (face value) of discounted bill from the drawee. In the meanwhile, if the
bank is in need of funds, it can rediscount the bill already discounted by it in the
commercial bill rediscount market at the market related rediscount rate. (The RBI
introduced the Bill Market Scheme in 1952 and a new scheme called the Bill
Rediscounting Scheme in November 1970).
The eligibility criteria prescribed by the Reserve Bank of India for rediscounting
commercial bill inter-alia are that the bill should arise out of genuine commercial
transaction evidencing sale of goods and the maturity date of the bill should not be
more than 90 days from the date of rediscounting.
RBI has widened the entry regulation for Bill Market by selectively allowing,
besides banks and PDs, Co-op Banks, mutual funds and financial institutions.
Bill Rediscounting
The RBI introduced the Bills Market Scheme (BMS) in 1952 which was later
modified into the New Bills Market Scheme (NBMS). Under this scheme
commercial banks can rediscount the bills which were originally discounted by
them with approved institutions (viz., Commercial Banks, Dvelopment Financial
Institutions, Mutual Funds, Primary Dealers etc.)
Multiple Rediscounting
The individual bills can be substituted by Derivative Usance Promissory Notes
(DUPN) of the equal aggregate amount and maturity which are drawn by the
issuing bank to eliminate movement of papers and to facilitate multiple
rediscounting. DUPNs are exempt from stamp duty and are negotiable instruments
securities with an agreement to resell the same to the seller on an agreed date in
future at a prefixed price. For the purchaser of the security, it becomes a Reverse
Repo deal. In simple terms, it is recognised as a buy back arrangement. In a
standard ready forward transaction when a bank sells its securities to a buyer it
simultaneously enters into a contract with him (the buyer) to repurchase them on a
predetermined date and price in the future. Both sale and repurchase prices of
securities are determined prior to entering into the deal. In return for the securities,
the bank receives cash from the buyer of the securities. It is a combination of
securities trading (involving a purchase and sale transaction) and money market
operation (lending and borrowing). The repo-rate represents the borrowing/lending
rate for use of the money in the intervening period. As the inflow of cash from the
ready forward transaction is used to meet temporary cash requirement, such a
transaction in essence is a short term cash management technique.
The motivation for the banks and other organizations to enter into a ready forward
transaction is that it can finance the purchase of securities or otherwise fund its
requirements at relatively competitive rates. On account of this reason the ready
forward transaction is purely a money lending operation. Under ready forward deal
the seller of the security is the borrower and the buyer is the lender of funds. Such
a transaction offers benefits both to the seller and the buyer. Seller gets the funds at
a specified interest rate and thus hedges himself against volatile rates without
parting with his security permanently (thereby avoiding any distressed sale) and
the buyer gets the security to meet his SLR requirements. In addition to pure
funding reasons, the ready forward transactions are often also resorted to manage
short term SLR mismatches.
RBI has prescribed that following factors have to be considered while performing
repo:
1. purchase and sale price should be in alignment with the ongoing market
rates
2. no sale of securities should be effected unless the securities are actually held
by the seller in his own investment portfolio.
3. Immediately on sale, the corresponding amount should be reduced from the
investment account of the seller.
4. The securities under repo should be marked to market on the balance sheet
date.
The relaxations over the years made by RBI with regard to repo transactions are:
i. In addition to Treasury Bills, all central and State Government securities are
eligible for repo.
ii. Besides banks, PDs are allowed to undertake both repo/reverse repo
transactions.
iii. RBI has further widened the scope of participation in the repo market to all
the entities having SGL and Current with RBI, Mumbai, thus increasing the
number of eligible non-bank participants to 64.
iv. It was indicated in the 'Mid-Term Review' of October 1998 that in line with
the suggestion of the Narasimham Committe II, the Reserve Bank will move
towards a pure inter-bank (including PDs) call/notice money market. In view
of this non-bank entities will be allowed to borrow and lend only through
Repo and Reverse Repo. Hence permission of such entities to participate in
call/notice money market will be withdrawn from December 2000.
v. In terms of instruments, repos have also been permitted in PSU bonds and
private corporate debt securities provided they are held in dematerialised
from in a depository and the transactions are done in a recognised stock
exchange.
Apart from inter-bank repos RBI has been using this instrument effectively for its
liquidity management, both for absorbing liquidity and also for injecting funds into
the system. Thus, Repos and Reverse Repo are resorted to by the RBI as a tool of
liquidity control in the system. With a view to absorbing surplus liquidity from the
system in a flexible way and to prevent interest rate arbitraging, RBI introduced a
system of daily fixed rate repos from November 29, 1997.
Reserve Bank of India was earlier providing liquidity support to PDs through the
reverse repo route. This procedure was also subsequently dispensed with and
Reserve Bank of India began giving liquidity support to PDs through their holdings
in SGL A/C. The liquidity support is presently given to the Primary Dealers for a
fixed quantum and at the Bank Rate based on their bidding commitment and also
on their past performance. For any additional liquidity requirements Primary
Dealers are allowed to participate in the reverse repo auction under the Liquidity
Adjustment Facility along with Banks, introduced by RBI in June 2000.
The major players in the repo and reverse repurchase market tend to be banks who
have substantially huge portfolios of government securities. Besides these players,
primary dealers who often hold large inventories of tradable government securities
are also active players in the repo and reverse repo market.
Banker's Acceptance:
It is a short-term credit investment. It is guaranteed by a bank to make payments.
The Banker's Acceptance is traded in the Secondary market. The banker's
acceptance is mostly used to finance exports, imports and other transactions in
goods. The banker's acceptance need not be held till the maturity date but the
holder has the option to sell it off in the secondary market whenever he finds it
suitable.
In addition to their value for a borrower who desires protection against inflation,
TIPS can also be a useful information source for policy makers: the interest-rate
differential between TIPS and conventional Treasury bonds is what borrowers are
willing to give up in order to avoid inflation risk. Therefore, changes in this
differential are usually taken to indicate that market expectations about inflation
over the term of the bonds have changed. The interest payments from these
securities are taxed for federal income tax purposes in the year payments are
received (payments are semi-annual, or every six months). The inflation
adjustment credited to the bonds is also taxable each year. This tax treatment
means that even though these bonds are intended to protect the holder from
inflation, the cash flows by the bonds are actually inversely related to inflation
until the bond matures. For example, during a period of no inflation, the cash flows
will be exactly the same as for a normal bond, and the holder will receive the
coupon payment minus the taxes on the coupon payment. During a period of high
inflation, the holder will receive the same equivalent cash flow (in purchasing
power terms), and will then have to pay additional taxes on the inflation adjusted
principal. The details of this tax treatment can have unexpected repercussions.
By comparing a TIPS bond with a standard nominal Treasury bond across the same
maturity dates, investors may calculate the bond market's expected inflation rate by
applying Fisher's equation.
Sometimes appropriate market structures have developed only after central banks
and governments have taken the lead. For example, Reserve bank of India realized
quite early in its existence that a well functioning money market-dealing in
treasury bills, commercial paper, overnight funds, and the like-would assist the
implementation of monetary policy as well as the overall efficiency of the
economy. But although the banking system as such had been well developed for
many decades, an active money market emerged only after a series of RBI
From the viewpoint of monetary control, and therefore inflation control, the
development of the Canadian money market had two particularly desirable
features. In the first place, the money market's developmentprovided an avenue for
increased reliance on price-related methods of monetary management-broadly
speaking, open market operations. And in this process, reliance on jawboning and
on bank liquidity ratios to influence commercial banks' extension of credit
became less and less-to the point that these features now have no role in India
Secondly, the broadening of outlets for the placement of government debt-to
include the money market as well as the bond market-helped to provide a first line
of assurance that government deficit financing would not impinge upon monetary
control.
In general, in the absence of broad and resilient financial markets through which to
absorb financing demands, the central bank would find it very difficult to deflect
direct pressure from government Monetary Policy and the Control of Inflation
deficits on its balance sheet and therefore on inflation of the monetary base.
To deflect the pressure by, for example, imposing higher bankreserve requirements
in cash, or in government securities, is not an adequate solution. At the very least it
causes problems for the efficiency and competitiveness of the deposit-taking part
of the financial system. A better solution would be for the government to pay an
interest rate sufficiently high that it attracts willing lenders, and without pumping
up the money supply. In general, if credit of various kinds really has to be
subsidized or channelled preferentially, the subsidy should be out in the open and
not financed through what is in effect a tax (and therefore fiscal, not monetary,
policy) on the intermediation of savings through the banking system. A related
issue with implications for controlling inflation is the importance of developing at
an early stage a workable system of prudential oversight for financial institutions,
including determining which institutions will have access to the lender-of-last-
resort facility for liquidity purposes. This, too, is a separate topic of discussion in a
later session. Its importance for inflation control is to remove a potential constraint
on the conduct of monetary policy. The presence of distressed institutions may
inhibit monetary discipline, for fear of precipitating a crisis in the financial system
or of disrupting the flow of investment finance to the non-financial sector,
BIBLIOGRAGHY:
BOOKS REFERENCE:
DYNAMICS OF INDIAN FINANCIAL SYSTEM – BY - PREETY
SINGH
INDIAN FINANCIAL SYSTEM –BY BHARATI V. PATHAK
FINANCIAL SERVICE AND MARKET-BY
DR.S.GURUSWAMY
NSE DEBT MARKET (BASIC MODULE) WORK BOOK
BUSINESSW ENVIRONMENT – BY FRANCIS CHERUNILAM
MONEY BANKING TRADE AND PUBLIC FINANCE –BY D.M.
MITTHANI
WEBSITES:
www.rbi.org.in/weekly statistical
supplement/various issues.co.in
www.investopedia.com .
www.bseindia.com
www.nseindia.com
www.economics.indiatimes.com