Q 1. What factors determine the yield on Treasury Bills?

Show how would you

calculate the yield?
Answer
YIEL !" T#EAS$#Y BILL !# T#EAS$#Y BILL

It refers to the rate of discount at which the TBs are sold by the
RBI. The effective yield or return on TBs depends on:
(i) the rate of discount
(ii) difference between the price at which they are sold and their redemption
value.
(iii) The time period of their maturity.

Treasury bill rate on 91day TBs had been an administered rate of discount fi!ed by the
RBI from time to time. Because of hi"h li#uidity and total safety$ treasury bill rate is
"enerally the lowest rate of interest in the entire interest rate structure in the country.
Increase in treasury bill rate over the last many decades has not %ept pace with the
increase in the rest of the interest rate structure$ thou"h of late the yield on auctioned
TBs has improved considerably.

Treasury bill rate was &.'& per cent in 19''. It was increased to (.' per cent in
19)'$ but was lowered to ( per cent in 19)* and was a"ain raised to +.) per cent on 91
days TBs in 19,+. The rate remained pe""ed at that level. The mar%et for TBs
remained narrow and inactive due to low TBs rate. -ha%raborty -ommittee and
.a"hul -ommittee therefore su""ested dere"ulation of discount rate and its suitable
upward revision so as to provide an ade#uate yield to the investors. -ha%raborty
-ommittee recommended that the discount rate on TBs should provide a yield which
is mar"inally positive in real terms. /s a result of these recommendations 1*&day
treasury bills were introduced in 0ovember 19*) with variable discount rate
dependin" on:

(a) the bids for these TBs in tenders and auctions$ and$
(b) the cutoff discount rate and the amount of TB to be auctions.

Both these were determined by the RBI. Issue of 1*&day treasury bill was
discounted in /pril199& and the RBI announced ()+daysTBs to be sold by
auction. The prices at which they are auctioned$ determines the yields on these
TBs


/t present. 91day TBs are issued at fi!ed discount rate. and also throu"h
auctions. ()+day TBs are a fle!ibleyield or variableyield instrument. The discount
rate #uoted by the mar%et participants and accepted by the authorities (called the cut
off rate) determines the rate of return on ()+dayTBs and 91day TBs sold throu"h
auction.

%om&utation of Yield on TBs

1ield on TBs can be calculated with the help of the followin" formula:

1 2 3.4 5 ()+ 5 166
4 7


8R

1 2 7iscount 5 ()+ 5 166
Issue 4rice 9aturity 4eriod in 7ays


:here$

12 1ield tare on TBs
3. 2 3ace value or 0ominal .alue or Redemption value
42 4urchase 4rice or Issue 4rice of TBs
72 9aturity 4eriod TBs on days

0ote: 1ear is assumed to be of ()+ days for 1ield calculation

3or e!ample$ 91 days Treasury bills were issued on tap basis at a fi!ed price of 9*.*' for
Rs 166 face value TB. The yield will be:

1ield 2 1669*.*' ! ()+ ! 166 2 +.)'(' per cent
9*.*' 91




;!ample$ in may 199) ()+day TBs maturin" on 9ay 9 199, $ were issued at a discount
of 11.1* percent.


1ield 2 166(16611.1*) ! ()+ ! 166 2 11.1* ! 166
16611.1* ()+ **.*&


2 1&.'* <
Q'. E(&lain the )olatile nature of call money rates and what forces ma*e the call
rate fluctuates so much
+olatile "ature of %all ,oney #ates?
Answer
%ALL ,!"EY #ATES
-all rates vary in different seasons$ on different days within a fortni"ht from 3riday to the
alternate 3riday(8n reportin" 3ridays the ban%s have to meet -RR and =>R re#uirement
in relation to their 07T>)$and from time to time on the same day. /vera"e monthly call
rates are "enerally hi"her in 9arch$ /pril$ 9ay$ 8ctober and 0ovember. The demand for
temporary li#uid funds is lower in ?anuary$ /u"ust and 7ecember. 7urin" these months
call rates are lower. The rates are moderate in other months.

%A$SES !- +!LATILITY I" %ALL ,!"EY #ATES

1. >ar"e borrowin"s by ban%s on reportin" 3ridays to meet -RR re#uirements raise
demand for li#uid resources and call rates move up. 8nce the ban%s have covered
their -RR re#uirements$ the call rates decline.
2. when ban%s e!tend their credit operations beyond their own resources$ they
approach call money mar%et for meetin" structural dise#uilibrium in their inflows
and outflows of funds. /s a result$ call rates "o up.
3. :hen institutional lenders are short of li#uidity and instead of lendin" they start
sellin" securities for meetin" their loan repayment or maturity of their instruments
or other business needs$ call money rates increase.
4. 7urin" the #uarterends when advance ta! becomes payable by companies and
other institutions$ there is a spurt in call rates.
5. =upply of call loans increases when there is increase in ban% deposits and call
rates "oes down. Reverse is the situation when deposits decline and maturity of
lar"e deposits bunches up durin" a period.
6. :hen stoc% mar%et is buoyant$ call rates "o up and vice versa.
7. 7urin" industrial and commercial boom$ call rates move up$ and decline in a
period of depression.
8. :hen subscription to "overnment loans opens$ the demand for call loans "oes up
and call rates increase. :hen "overnment securities mature and are encashed by
the public and private institutions$ supply of call loans increases and therefore call
rates come down.
9. In case ban%s have liberal access to rediscount or refinance facility from the RBI
at cheaper rates$ there is lesser need to resort to call mar%ets for funds. /s a result$
the call rates remain low and steady.
10. Interest payments on central and state "overnment securities "enerally become
due in /pril@9ay and 8ctober@0ovember. 8n release of interest the li#uidity
position of ban%s improves. This has a soberin" impact on call rates.
11. -ommercial ban%s attempt window dressin" by mobiliAin" more deposits durin"
last fortni"ht of 9arch every year. But they are not able to sustain these deposits
in /pril and 9ay. >i#uidity constraint with ban% increases and call rates tend to
increase.
12. 7espite e!pansion and diversification$ Indian trade continues to have busy and
slac% seasons$ thou"h overall seasonal fluctuations are less s%ewed now. 7urin"
busy season from 8ctober to 9arch$ there is "reater demand for call loans. The
demand is less durin" slac% season from /pril to =eptember.
13. 7urin" the busy season from 8ctober to 9arch$ cash credit limits "ranted by
ban%s are fully utiliAed$ forcin" ban%s to meet their li#uidity re#uirements throu"h
call loans. /s a result call rates "o up. 7urin" slac% season from /pril to
=eptember cash credit limits remain #uite underutiliAed and ban%s have easy
li#uidity condition. They "enerally turn into lenders and call rates ease.
14. -yclical bul% import payments reduce li#uidity in the money mar%et resultin" in
an increase in call rates.
15. -all money mar%et is characteriAed by chronic borrowers e.". commercial ban%s $
and a small number of bi" lenders. /bsence of bi" lenders from the call mar%et
even for a few days is interpreted as li#uidity crunch. Borrowers scramble for
funds in anticipation of a rise in call rates and these rates soar up.
16. =ophisticated statistical techni#ues for forecastin" call rates are not applied by
fund mana"ers in India. /s a result$ both borrowers and lenders overreact to even
small chan"es in call mar%et. 7ue to this demandsupply e#uilibrium is seldom
reached and call rates remain volatile.
17. -all mar%et in India is overthetelephone mar%et. There is onetoone deal
between borrower and lender$ e!cept when 73BI is involved$ because bro%ers are
prohibited since 19,(. In the absence of perfect communication different deals
ta%e place at different rates. :ith induction of 73BI as mar%et ma%er$ this
problem has become less acute.
18. >i#uidity crisis (real or artificially created for a very short period) also results in
soarin" call rates.