Hrishi Final Draft

8/3/2019 Hrishi Final Draft

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IINNTTRROODDUUCCTTIIOONN TTOO MMOONNEEYY MMAARRKKEETT

A market where short-term funds are borrowed and lent is called

money market is a market for short-term financial assets, which arenear substitutes for money. The instruments dealt within the moneymarket are liquid and can be turned over quickly at low transaction costand without loss.

The money market comprises individuals, institutions, and thegovernment. These agencies create demand for money and also ensuresupply of money for a short-term period. The demand for moneyemanates from merchants, traders, brokers, manufacturers, speculatorsand even government institutions, the suppliers include commercial banks, insurance companies, nonbanking financial concerns and the

Central Bank of the country. Thus, the money market represents thecountrys pool of short-term investible funds to meet the short-term

requirements of the economy.

DEFINITION

1. According to the McGraw Hill Dictionary of ModernEconomics, Money market is the term designed to include thefinancial institutions which handle the purchase, sale, and transfers

of short-term credit instruments. The money market includes theentire machinery for the canalizing of borrowing, and governmentshort-term obligations; it differs from the long-term or capitalmarket which devotes its attention to dealings in bonds, corporatestocks and mortgage credit.

2. According to Geoffrey, money market is the collective namegiven to the various firms and institutions that deal in the variousgrades of the near-money.

3. According to the Reserve Bank of India, a money market is thecentre for dealings, mainly of short-term character in money

assets; it meets the short-term requirements of borrowers and provides liquidity or cash to the lenders. It is the place whereshort-term surplus investible funds at the disposal of financial andother institutions and individuals are bid by borrowers agentscomprising institutions and individuals and also the governmentitself.


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HHIISSTTOORRYY OOFF IINNDDIIAANN MMOONNEEYY MMAARRKKEETT

Till 1935, when the RBI was set up, the Indian money

market remained highly disintegrated, unorganized, narrow,

shallow and therefore, very backward. The planned economic

development that commenced in the year 1951 marked an

important beginning in the annals of the Indian money market.

The nationalization of banks in Group (1986), the setting up of

Discount and Finance House of India Ltd (1988), the Vaghulworking of India (1994) and the commencement of

liberalization and globalization process in 1991 gave a further

fillip for the integrated and efficient development of Indian

money market.


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IIMMPPOORRTTAANNCCEE && FFUUNNCCTTIIOONN OOFF MMOONNEEYY

MMAARRKKEETT

GENERAL CHARACTERISTIC

The general characteristics of a money market are outlined below:

1. Short-term funds are borrowed and lent.2. No fixed place for conduct of operations, the transactions being

conducted even over the phone and therefore there is an essential

need for the presence of well developed communications system.

3. Dealings may be conducted with or without the help ofbrokers.4. The short-term financial assets that are dealt in are close

substitutes for money, financial assets being converted into

money with ease, speed, without loss and with minimum

transactions cost.

5. Funds are traded for a maximum period of one year.6. Presence of a large number ofsubmarkets such as inter-bank call

money, bills rediscounting, treasury bills, etc.

OBJECTIVES

A well-developed money market serves the following objectives:

1. Providing an equilibrium mechanism for ironing out short-termsurplus and deficits.

2. Providing a focal point for central bank intervention forinfluencing liquidity in the economy.

3. Providing access to users of short-term money to meet theirrequirements at a reasonable price.


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IMPORTANCE

The functioning of an efficient money market in a country is helpful to its

various segments as detailed below:

SOURCE OF CAPITAL

Money market is an important source of financing for trade and industry.

The short-term finances are made available through bills, commercial

papers, etc. The happenings in the money market influence the

availability of finances both for the national and international trade.

Besides trade and industry, money market offers to the government an

important non-inflationary avenue of raising short-term funds throughbills that are subscribed by commercial banks and the public.

IDEAL INVESTMENT

Money market offers an ideal source of investment for the commercial

banks. The market helps them invest their short-term surplus funds so as

to meet statutory reserve requirements. For instance, the requirements of

Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) vary

every fortnight depending on banks Net Demand and Time Liability

(NDTL).

EFFECTIVE MONETARY MANAGEMENT

An efficient money market being sensitive in nature allows for the

effective implementation of monetary policy of the central bank and thus

paves way for the efficient monetary management of the country. In fact,

the money market events serve as an important guide to the government

in formulation, revising and implementing its monetary policy. This is

rightly so, given the fact that the conditions prevailing in money market

serve as an indicator of monetary state of an economy.


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The monetary authority uses the money market for diffusing the

effects of its actions throughout the banking system and the economy, so

as to promote economic growth with stability.

ECONOMIC DEVELOPMENT

Money market being an integral part of a countrys economy, contributes

substantially to the economic development of a country. A developed

money market is indispensable for the rapid development of the

economy. In fact, the stage of development of the economy will be

reflected in the stage of development of a money market. This is borne

out by the fact that ill-developed nature of a money market is responsiblefor the primitive nature of economic development of a country. The

absence of a well-developed money market would constrain the

economies from making available, on a continuous basis the supply of

adequate funds.

EFFICIENT BANKING SYSTEM

The existence of a developed money market greatly facilitates the smooth

and efficient functioning of the banking and financial system. Such an

advantage contributes to the promotion of trade and industry in the

economy. Further the mediating role played by the commercial bankers

ensures delivery of credit at the most opportune time. Similarly, money

market enables the commercial banks to meet much of their unexpected

needs for funds quickly and cheaply. It is possible for the commercial

banks to utilize their funds profitably and with liquidity.


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FACILITATING TRADE

Money market is of immense help to the business community in the

following ways:

1. Providing an ideal payment mechanism making it possible forexpeditious transfer of large sums of money.

2. Meeting the working capital requirements for carrying out theproduction and marketing activities.

3. Making efficient investment of surplus funds into near-moneyassets which can be quickly converted into money as and when

needed.

HELPFUL TO GOVERNMENT

The government uses the money market as an arena in which short-term

funds are raised by floating treasury bills. It helps the government

manage its monetary position smoothly through the central bank of the

county.


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GENERAL FUNCTIONS

Money market performs diverse functions within the banking system of

an economy, as discussed below:

INVESTMENT FUNCTION

The money market provides an ideal source for investment of the funds

for a short period of time for commercial banks, nonbanking financial

concerns, business corporations and other investors. It enables

businessmen, with temporary surplus funds, to invest them for a short

period.

FINANCING FUNCTION

Money market provides an ideal source for short-term financing for

businessmen, industrialists, traders, etc to meet their day-to-day

requirements of working capital. Funds are available for borrowing by the

government and its agencies also.

FACILITATING FUNCTION

Money market provides an ideal play ground for the central monetary

authority of the country to carry out various regulatory operations relating

to the banking and financial system of the country. The sensitive nature

of the money market helps the central bank to make it an ideal arena for

the execution of various credit control measures.


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TTYYPPEESS OOFF MMOONNEEYY MMAARRKKEETT IINNSSTTRRUUMMEENNTTSS

INSTRUMENTS

Traditionally when a borrower takes a loan from a lender, he enters into

an agreement with the lender specifying when he would repay the loan

and what return (interest) he would provide the lender for providing the

loan. This entire structure can be converted into a form wherein the loan

can be made tradable by converting it into smaller units with pro rata

allocation of interest and principal. This tradable form of the loan is

termed as a debt instrument.

Therefore, debt instruments are basically obligations undertaken by the

issuer of the instrument as regards certain future cash flows representing

interest and principal, which the issuer would pay to the legal owner of

the instrument. Debt instruments are of various types. The key terms that

distinguish one debt instrument from another are as follows:

Issuer of the instrument

Face value of the instrument

Interest rate

Repayment terms (and therefore maturity period/tenor)

Security or collateral provided by the issuer


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MONEY MARKET INSTRUMENTS:

By convention, the term "money market" refers to the market for short-

term requirement and deployment of funds. Money market instruments

are those instruments, which have a maturity period of less than one year.

The most active part of the money market is the market for overnight and

term money between banks and institutions (called call money) and the

market for repo transactions. The former is in the form of loans and the

latter are sale and buy back agreements both are obviously not traded.

The main traded instruments are commercial papers (CPs), certificates of

deposit (CDs) and treasury bills (T-Bills). All of these are discounted

instruments ie they are issued at a discount to their maturity value and the

difference between the issuing price and the maturity/face value is the

implicit interest. These are also completely unsecured instruments. One

of the important features of money market instruments is their high

liquidity and tradability. A key reason for this is that these instruments

are transferred by endorsement and delivery and there is no stamp duty or

any other transfer fee levied when the instrument changes hands. Another

important feature is that there is no tax deducted at source from the

interest component. A brief description of these instruments is as follows:

1. Certificate of Deposits2. Commercial Papers3. Treasury Bills4. Ready Forward Contracts ((Repos)5. Money Market Mutual Funds (MMMFs)


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CERTIFICATE OF DEPOSIT

Meaning of CDs

A marketable document of title to a time deposits for a specified period

may be referred to as a Certificate of Deposit (CD). It takes the form of

a receipt given by a bank or any other institution for funds deposited with

it by the depositor.

Features

Certificates of deposits process the following distinguishing

characteristics:

1. Negotiable instruments CDs are negotiable term-depositcertificates issued by commercial bank/financial institutions at

discount to face value at market rates. The Negotiable Instruments

Act governs CDs.

2. Maturity The maturity period of CDs ranges from 15 days to oneyear.

3.

Nature CDs are in the form of usance promissory notes and henceeasily negotiable by endorsement and delivery.

4. Ideal source CDs constitute a judicious source of investments asthese certificates are the liabilities of commercial banks/financial

institutions.


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PROFILE

A distinguishing profile of Certificate of Deposit as operating in India is

presented below:

THE TAMBE WORKING GROUP

The Tambe working Group set up in 1982 in India, reported that banks

and financial institutions were not willing to support the launch of money

market instruments such as CDs, and therefore advised against the

introduction of these instruments. The Group cited many reasons for the

non-popularity of these instruments including the absence of secondary

market, administered interest rate structure on bank deposits and thedanger of CDs giving rise to a large number of fictitious transactions.

THE VAGHUL WORKING GROUP

The Vaghul Working Group set up in 1987, again reviewed the issue and

expressed itself against the launch of the instrument by the RBI. The

Group reported that the introduction of CDs as a money market

instrument would be meaningful only where the short-term deposit rateswere aligned with other rates in the financial system. The Group instead

recommended, as a prelude, the setting up of a discount house and the

alignment of short-term deposit rates.

Based on the recommendations of the Group, the RBI constituted

the Discount and Finance House of India Ltd. (DFHI) in the year 1988. In

the same manner, RBI rationalized the interest rate structure in March

1989 by abolishing fixed deposits of shortest terms with maturity of 15 to

45 days.


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THE LAUNCH

The RBI launched the scheme of CDs with effect from March 27, 1989.

Following guidelines were laid down in this regard.

ELIGIBLE ISSUERS

The institutions that are eligible to issue CDs are scheduled commercial

banks (excluding RRBs) and specified all-India financial institutions,

namely, IDBI, IFCI, ICICI, SIDBI, IRBI, and EXIM bank.

ELIGIBLE SUBSCRIBERS

The parties who are eligible to buy CDs are individuals, associations,companies, corporations, trust funds, etc. NRI an also subscribe to the

CDs. How ere, this is possible only on a non-repatriation basis. It is not

possible for an NRI to endorse CDs to another NRI in the secondary

market.

NEGOTIATION

CDs are freely transferable by endorsement and delivery after the initial

lock in period of 15 days. The instrument can be purchased by any of

the above subscribers and DFHI in the secondary market.

MATURITY

The maturity period of CDs issued by banks ranges from 3 days to 12

months and that issued by specified financial institutions can have a

maturity period up to 3 years. With the announcement of credit policy on

April27, 2000 the maturity period was reduced from 3 month to 15 days.


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DISCOUNT

CDs are to be issued at a discount to face value, with the maturity period

not having any grace period.

LIMITS OF ISSUE

The maximum amount of issue by a bank, which was originally fixed at 1

percent of its fortnightly aggregate average deposits, was raised to 10

percent in 1992. This was subsequently abolished totally. The minimum

size of issue to a single investor, which was originally fixed at Rs.10

lakhs, was reduced to Rs. 5lakhs with effect from October 21, 1997. Issue

of CDs above Rs.5 lakhs can now be made in multiples of Rs.1 lakhs.CDs can now be CRR on issue price of CDs for which there is no ceiling.

STAMP DUTY

Stamp duty is payable on CDs as applicable to any other negotiable

instrument.

SECURITY PAPER

CDs are transferable by endorsement and delivery, and shall therefore be

issued on a good quality security paper.

OTHER REQUIREMENTS

1.No loans can be granted by banks against CDs.2. Banks cannot have any buyback arrangement of their own CDs

before maturity.

3. Banks are to submit fortnightly report on their CDs to the RBIunder section 42 of the RBI Act, 1935.

4. Banks are to show CDs under the head liabilities in the balancesheet.


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YIELD

CDs are offered at interest rates higher than the time deposits of banks.

However, the rate of interest is dependent upon many factors such as

urgency of requirement for funds, alterative opportunities for investment

of funds mobilized, etc. The rate of discount being deregulated is now

determined by the demand and supply of CDs. CDs are issued at a

discount to their face value and redeemed at par. CDs are issued at a

front-end discount and in such a case; the effective rate of interest is

higher than the quoted discount rate.

Effective rate of interest may be calculated as follows.ERRR= [(1+QDR/100*N/M) N/M-1]*100

Where,

ERR = Effective rate of interest

QDR = Quoted discount rate

N = Total period in a year. Say 12 months or 365 days etc

M = Maturity period in months or days as the case may be

ROLE OF DFHI

The Discount and Finance House of India Ltd. Functions as a market

maker in CDs market. It offers bid rate, the rate of discount at which it is

prepared to buy CDs, and offer rate at which it would be willing to sell

the CDs. The DFHI acts as an ideal conduit for disinvestments of CD

holdings, which is done through their banker in Mumbai. DFHI also

engages in buying CDs from the bank at its bid discount rate. Settlements

are effected through RBI cheque.


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ROLE OF BANKS

Scheduled commercial banks are the active players in the realm of CDs

market segment. CDs are used as an important money market instrument.

CDs provide an ideal avenue of investment money market instrument.

CDs provide ideal avenue of investment for bankers. CDs are considered

safe, liquid, and attractive in returns for both scheduled commercial bank

and investors.

It is not necessary for banks to encash CDs before maturity under

the RBI Act. Banks are under obligation to maintain usual reserve

requirements (SLR and CRR) on issue price of CDs. CDs offer the

opportunity for banks for the bulk mobilization of resources as part ofeffective fund management. Besides, offering an attractive yield help

bankers utilize them eligible assets for determination of Net Demand and

Time Liabilities (NDTL). According to the RBI guidelines, it will not be

possible for banks to enter into buyback arrangement with the subscriber

of CDs. Similarly, they cannot grant loans against CDs issued by them.

It is possible for investors to sell CDs in secondary market before

their maturity. This offers investors the advantage of liquidity through

ready marketability. However, the tendency on the part of holders of

CDs to hold the instruments till maturity date has not made possible for

the creation of an effective secondary market for them, although the

primary market for CDs has shown a considerable improvement.


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COMMERCIAL PAPER

Debt instrument that are issued by corporate houses for raising short-term

financial resources from the money market are called Commercial Papers

(CPs).

FEATURES

Following are the features of commercial papers:

NATURE

These are unsecured debts of corporate. They are issued in the form of

promissory notes. These are redeemable at par to the holder at maturity.

The issuing company should have a minimum tangible net worth to the

extent of Rs.4 crores. Moreover, the working capital (fund-based) limit of

the company should not be less than Rs. 4 crores and this allows

corporate to issue CPs up to 100 per cent of their fund based working

capital limits. CPs are issued at a discount to face value in multiples of

Rs.5 Lakhs. CPs attracts stamp duty. No prior approval of RBI is needed

to issue CP

s and no underwriting is mandatory. The issuing company hasto bear all expense (Such as dealers fees, rating agency fee and charges

for provision of stand-by facilities) relating to the issue of CP. The issue

of CPs serves the purpose of releasing the pressure on bank funds for

small and medium sized borrowers, besides allowing highly rated

companies to borrow directly from the market.


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MARKET

The market for the Cps comprises of issues made by public sector and

private sector enterprises CPs issued by top rated corporate are

considered as sound investments. Conditions attached to the issue are less

stringent than those applicable for raising CPs. Beginning from

September 1996, Primary Dealers (PDs) were also permitted by RBI to

issue CPs for augmenting their resources. This is one of the steps

initiated by the RBI to make the CPs market popular.

RATING

As per the guidelines of the RBI, CPs are required to be graded by the

organization issuing them. Accordingly, a rated CP is considered to be a

quality and sound instrument. With the liberalization of interest rate

structure, the rate of interest is market-determined. This causes wide

variation in the prevailing rates of interest.

INTEREST RATES

The rate of interest applicable to CP

s varies greatly. This variation isinfluenced by a large number of factors such as credit rating of the

instrument, economic phase, the prevailing rate of interest in CPs market,

call rates, the position in foreign exchange market, etc. It is however to be

noted that there is no benchmark for the interest rate.

MARKETABILITY

The marketability of the CPs is influenced by the rates prevailing in thecall money market and the foreign exchange market. Accordingly where

attractive interest rates prevail in these markets, the demand for Cps will

be affected. This is because; investors will divert their investment into

these markets.


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CPS IN LIEU OF WC

The nature of credit policy announced by the RBI to allows highly rated

corporate to have the advantage of banks offering an automatic

restoration of working capital limits on the repayment of CP.

Accordingly, short-term working capital loans were substituted with

cheaper CPs. This was done by the RBI to hasten the growth of the CP

market.

SATELLITE DEALERS (SDs)Dealers who are enlisted with the RBI to deal in the Government

securities market, are called Satellite Dealers. With effect from June 17,

1998, they are allowed to issue CPs, with prior approval from RBI. The

purpose was to enable them to have access to short-term borrowings

through CP route. Following are the conditions to be satisfied in this

regard:

RATING

In order that the satellite dealers are permitted to trade in CPs, it is

essential that the issuing corporate obtain the minimum specified credit

rating from a credit rating agency. Such a rating must have been approved

by the months.

MATURITY

The CPs shall be issued for a maturity period ranging from 15 days to one

year from the dated is issue.


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TARGET MARKET

The issue of CPs may be targeted to such persons as individuals, banks,

companies, other corporate bodies registered or incorporated in India and

unincorporated bodies and non-resident Indian (NRI) on non-repatriation

basis subject to the condition that it shall be transferable.

LIMITS OF ISSUE

Each issue of CPs (including renewal) shall be treated as a fresh issue.

The CPs issue may take place in multiples of Rs. 5 Lakhs. The

investment by any single investor shall be for a minimum amount of Rs.

25 Lakhs (face Value) and the secondary market transactions may be

dealt in for amounts of Rs. 5Lakhs or multiples thereof. The RBI shall fix

the total amount of issue. The issue amount shall be raised within a period

of 2 week from weeks from the date of approval by the Reserve Bank or

ma be issued on a single day or in parts on different days as the case may

be.

NATURE

The CPs shall be in the form of usance promissory note. It shall be

negotiable by endorsement and delivery. It is issued at discount to face

value, discount being determined by the SD issuing the CPs. The SDs

shall bear the expenses of the issue, including dealers fee, rating agency

fee, etc.


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TREASURY BILL

TREASURY BILLS (TBs)

A kind of finance bills, which are in the nature of promissory notes,

issued by the government under discount for a fixed period, not

exceeding one year, containing a promise to pay the amount stated

therein to the bearer of the instrument, are know as treasury bills.

GENERAL FEATURES

Treasury bills incorporate the following general features:

1.

Issuer TBs are issued by the government for raising short-termfunds from institutions or the public for bridging temporary gaps

between receipts (both revenue and capital) and expenditure.

2. Finance bills TBs are in the nature of finance bills because theydo not arise due any genuine commercial transaction in goods.

3. Liquidity TBs are not self-liquidating like genuine trade bills,although they enjoy higher degree of liquidity.

4. Vital source Treasury bills are an important source of raisingshort-term funds by the government.

5. Monetary management TBs serve as an important tool ofmonetary used by the central bank of the county to infuse liquidity

in to the economy.


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FEATURES OF INDIAN TBs

HISTORY

It was in the year 1877 that Treasury Bills (TBs) came to be issued for the

first time in the world. Later, it acquired wide popularity around the

world both in developing and developed countries. TBs were first issued

in India in October1971. The issue aimed at raising resources for

financing the First World War efforts of the government and for mopping

liquidity in the economy due to heavy war expenditure.

TBs that were initially sold by the government had a maturity

period of 3 months, 6 months, 9 months and 12 months. Later on, withthe setting up of the RBI in 1935, the issue profile of TBs underwent a lot

of changes. Accordingly, RBI came to issue two type of TBs such as Tap

Bills that were issued at all times and Intermediate Bill that were sold

between auctions, to nongoverment investors. However, in the year 1965,

a sale of TBs to public through auction was suspended and issue took

place on top basis at a discount. Thus commercial banks began to invest

in them.

ISSUE

TBs, which were first up to 1935 by the Government of India directly,

came to be issued by the RBI since its inception in 1935. Thereafter, TBs

are issued at a discount by the RBI on behalf of the Government of India.

TYPES

There are two types of treasury bills. They are ordinary treasury bills and

ad hoc treasury bills. The freely marketable treasury bills that are issued

by the Government of India to the public, banks and other institution for


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raising resources to meet the short-term finance needs takes the form of

ordinary TBs.

Ad hoc TBs, on the other hand, are issued in favor of the RBI only.

They are used by RBI as reserve against which the issue department issue

currency notes. In addition, they are also issue to serve the purpose of

replenishing cash balance of the central government. Besides, ad hoc TBs

provide an investment avenue to state government, semigoverment

department and foreign central banks for parking their temporary surplus

and for earning income. Since ad hoc TBs are not marketable in India, the

holders of these bills can always sell them back to the RBI.

MATURITY PERIOD

A lot of changes taken place in the realm of the periodicity of treasury

bills, changes having being brought about by the policy announcements

made by RBI from time to time. A brief account of the changes in the

period of maturity of TBs is outlined below:

1. Maturity period of TBs at the close of the First World War was of3, 6, 9, and 12 months duration.

2. Maturity periods of tap bills and Intermediate Bills introduces byRBI immediately after its inception was 91 days which was

continued up to November 1986.

3. Maturity period of 182 days recommended by ChakrabortyCommittee was issued up to April 1992.

4. Maturity period of 365 days beginning from April 1992.5. Maturity period of 14 days introduced in May 1997 and of 28 days

introduced on October21, 1997.

6. Maturity period of 182 days reintroduced with effect from May26,1999.


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PARTICIPANTS

The participants in the TBs market include the Reserve Bank of India, the

State Bank Of India, Commercial Banks, State Governments and other

approved bodies, Discounts and Finance House of India as a market

maker in TBs, the Securities Trading Corporation of India (STCI), other

financial institutions such as, LIC, UTI, GIC, NABRAD, IDBI, IFCI,

ICICI, etc corporate entities and general public and Foreign Institutional

Investors.

Of the above-mentioned participants, RBI and commercial banks

are the most popular players. This essentially arises from the nature of

relationship between them. TBs are least popular among the corporateentities and the general public.

THE ISSUE PROCEDURE

The procedure followed by the RBI for successful issue of treasury bills

is briefly outlined below.

NOTIFICATION The RBI issues notifications for the sale of

91day TBs on tap basis throughout the week and the 14-days,

28-days, 91-days, and 364-days, TBs through fortnightly

auction. The notification mentions the date of auction and the

last date for submission of tenders.

TENDERING Immediately after the issue of notification by

the RBI, investors are permitted to submit bids through separate

tenders. The result of the auction mentioning the price up to

which the bids have been accepted is displayed. The successful

bidders are expected to collect letter of acceptance from the RBI

and deposit the same together with a cheque on RBI.


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SGL SGL is maintained by the RBI for facilitating the

purchases and sales of TBs by the investors like Commercial

Banks, DFHI, STCI and other financial institutions.

DFHI WHERE the SGL facility is not available to certain

investors, purchase and sale takes DFHI. TBs sold to such

investors are held by DFHI on their behalf, which pays the

proceeds of the TBs held, to the investor on the date of

maturity. DFHI takes an active part in the primary auctions of

TBs, besides operating in the secondary market by quoting tow-way rates. In addition, the DFHI also gives buyback and sell-

back commitments for periods up to 14 days at negotiated

interest rates, to commercial banks, financial institutions and

public sector undertakings.


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AUCTIONING METHODS.

UNIFORM PRICE AUCTION

The system of uniform price auction system in respect of 97-days, TBs

was introduced as to broaden market participation. (Winners curse is a

phenomenon whereby those bidding at lower than the cut-off, end up

paying a premium.) The introduction of uniform price auction is expected

to reduce uncertainty associated with the bidding process. This is peculiar

to the underdeveloped nature of Indian money market, which is afflicted

by the lack of reliable information, causing wide differences in the yield

expectations before the auctions. The amounts of issue are notified in

respect of 97-days TBs auctions and the dated securities auctions.

TREASURY BILLS AUCTION

Auction in TBs takes place both on Competitive as well as on

noncompetitive basis. The State Governments, Provident Funds and the

Nepal Rastra Bank are the noncompetitive bidders. Commercial banks

and other financial institutions comprise competitive bidders. It is to be

noted that the merits of enhanced market efficiency and price discovery

take place through the competitive bids.

POLICY MEASURES

With a view to improving the depth and liquidity in the government

securities market, RBI announced the following policy measures relating

to Treasury Bills with effect from October1999:

1. Price based auction of government dated securities.2. Auction of 182-day Treasury Bills.3. A calendar of Treasury Bills Issuance


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TB RATE

The discount rate at which the RBI sells TBs known as Treasury Bills

rate. The effective yield on TBs depends on such factors as the rate of

discount, difference between the issue price and the redemption value,

and time period of their maturity.

The treasury bills rate is computed as follows:

Y= {[(FV-IP)/IP]*[364/MP]}*100.

Where,

FV = Face Value TBs

IP = Issue Price of TBsMP = Maturity Period of TBs in days

D = Discount.

BENEFITS

TBs being an important money market instruments provide the following

benefits:

LIQUIDITY

Treasury bills command high liquidity. A number of institutions such as

RBI, the DFHI, STCI, commercial banks, etc take part in the TB market.

In addition, the Central bank is always prepared to purchased or discount

TBs.

NO DEFAULT RISK

Since there is a guarantee by the central government, TBs are absolutely

free from the risk of default of payment by the issuer. Moreover, the

government itself issues the TBs.


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AVAILABILITY

RBI has the policy of making available on a steady basis, the TBs

especially through the Tap route since July 12, 1965. This greatly helps

banks and other institutions to park their funds temporarily in TBs.

LOW COST

Trading in TBs involves less transaction costs. This is because two-way

quotes with a fine margin are offered by the DFHI on a daily basis.

SAFE RETURN

The biggest advantage of TBs is that they offer a steady and sage returnto investors. There are not many fluctuations in the discount rate. It is

also possible for the investors to earn attractive return by keeping

investment in nonearning cash to the minimum and supplementing it with

TBs.

NO CAPITAL DEPRECIATION

Since TBs command high order of liquidity, safely and yield, there is

very little scope for capital depreciation in them.

SLR ELIGBILITY

TBs are of great attraction to commercial banks as it helps them park

their funds (Net Demand and Time Liabilities) as per the norms or SLR

announced b the RBI from time to time. This reason makes commercial

banks dominate dealers in TBs.


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FUNDS MOBILIZATION

TBs are used as an ideal tool by the government for raising short-term

funds required for meeting temporary budget deficit.

MONETARY MANAGEMENT

It is also possible for the government to mop up excess liquidity in the

economy through the issue of TBs. Since TBs are subscribed by the

investors other than the RBI, the issue would neither lead to inflationary

pressure nor result in monetization.

BETTER SPREAD

TBs facilitate proper spread of asset mix different maturity as they are

available on tap basis as well as in fortnightly auctions.

PERFECT HEDGE

TBs can be used as a hedge against volatility of call loan market and

interest rate fluctuations.

FUND MANAGEMENT

TBs serve as effective tools of fund management because of the

following reasons:

1. Ready market availability, both for sale and purchase at marketdriven prices, thus imparting flexibility.

2. Facility of rediscounting TBs on tap basis.3. Facility of refinancing from the RBI.4. Plethora of options available to fund managers to invest in TBs and

for raising funds against TBs especially through and with the help

of DFHI

5. Ideally suited for investment of temporary surplus


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6. Possibility of building up portfolio of TBs with dates of maturitiesmatching the dates of payment of liabilities, such as certificates of

deposits and deposits of short-term maturities.

7. Possibility of meeting the temporary difficulties of funds byentering into buyback transactions for surplus TBs and reversing

the transactions when the financial need is over

8. Possibility of making enhanced profit by indulging in quick raisingof money against TBs for investing in call money market when call

rates are high and doing the reverse when call rates dip.


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REPOS

The term Repo is used as an abbreviation for Repurchase Agreement or

Ready Forward. A Repo involves a simultaneous sales and repurchase

agreements.

A Repo works as follow as follows. Party A needs short-term funds

and Party B wants to make a short-term investment. Party A sells

securities to Party B at a certain price and simultaneously agrees to

repurchase the same after a specified time at a slightly higher price. The

difference between the sale price and repurchase price represent the

interest cost to Party A (the party doing the repo) and conversely the

interest income forParty B (the party doing the Reverse Repo). Reverse

Repos are a safe and convenient form of short-term investment.

BENEFITS & FEATURES

1. Interest Rate Being collateralized loans, repos help reducecounter party risk & therefore, fetch a low interest rate.

2. Contract The Repo contract provides the seller bank to getmoney by partying with its security and the buyer bank in turn to

get the security by parting with its money. It becomes a Reserve

Repo deal for the purchaser of the security. Securities are sold first

to a buyer bank and simultaneously another contract is entered in to

with buyer to repurchase them at a predetermine date and price in

future. The price of the sale and repurchase of securities is

determined before entering into deal.


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3. Safety Repo is an almost risk free instrument used to even outliquidity changes in the system. Repos offer short-term outlet for

temporary excess cash at close to the market interest rate.

4. Hedge tool As purchaser of the repo requires title to the securitiesfor the term of agreement and as the repurchase price is locked in

at a time of sale itself. It is possible to use repos as an effective

hedge-tool to arrange the others repos or to sell them outright or to

deliver them to another party to fulfill the delivery commitment in

respect of a forward or future contract or a short sale or a maturing

reveres repo.

5. Period The minimum period for Ready Forward Transaction Billwill be 3 day. However, RBI withdraws this restriction for the

minimum period with the effect from October 30, 1998.

6. Liquidity Control The RBI uses Repo as a tool of liquiditycontrol for absorbing surplus liquidity from the banking system in

a flexible way and thereby preventing interest rate arbitraging. All

Repo transaction are to be effected at Mumbai only and the deals

are to be necessary put through the subsidiary General Ledger

(SGL) account with the Reserve Bank of India.

7. Cash Management Tool The Repo arrangement essential servesas a short term cash management tool as the bank receive cash

from the buyer of the securities in return for the securities. This

helps the banker meet temporary cash requirement. This also

makes the repo a pure money lending operation. On the maturity of

the repos the security is purchased back by the seller bank from

the buyer-bank by returning the money to the buyer.


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MONEY MARKET MUTUAL FUNDS (MMMFS)

The Reserve Bank of India introduced the Money Market Mutual Funds

(MMMFs) scheme in April 1972. The schemes aim at providing

additional short-term avenues to individual investor in order to bring

Money Market Instrument within their reach. MMMFs are expected to be

more attractive to banks and financial institutions, ho would find them

providing greater liquidity and depth to the money market.

FEATURES

He Silent features of the MMMFs are as follows.

Eligibility

The MMMFs can be set up by schedule commercial banks and public

financial institution as define under section 4A of the companies Act,

1956, either directly or through their existing Mutual Funds / Subsidiaries

who are engaged in fund management. In addition, private sector Mutual

Funds may also set up MMMFs with the prior approval of RBI, subject to

fulfillment of certain terms and conditions. SEBIs clearance is requiredin the event of MMMFs being set up in the private sector.

Structure

MMMFs can be set up either as Money Market Deposit Accounts

(MMDAs) or Money Market Mutual Funds (MMMFs)

Size

There is no ceiling prescribed for the MMMFs for raising resources.


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Investors

The MMMFs are primary indented to serve as a vehicle for individual

investor to participate in the Money Market, the units / shares of MMMFs

can be issued only to individuals. In addition, individual Non Resident

Indian (NRIs) may also subscribe to the share / units of MMMFs. The

dividend / income on such subscription will be allowed to be repatriated,

through the principle amount of subscription will be allowed to be

repatriated, though the principal amount of subscription will not.

Minimum Size of Investment.

MMMFs would be free to determine the minimum size of the investmentby single investor. The investor cannot be guaranteed of a minimum rate

of return, the minimum lock-in period for the investment would be 46

days.

Investment by MMMFs

The resources mobilized by MMMFs should be invested exclusively in

the various money market instruments as listed below.

1. Treasury Bills and dated Government Securities having anunexpired maturity up to 1 year with no minimum limit

2. call / notice money with no maximum limit3. Commercial Paper with no maximum limit, the exposure to the

commercial paper issue by the individual company being limited to

3% of the resources of the MMMFs as the prudential requirement.

4. Commercial bills arising out of genuine trade / commercialtransactions and accepted / co-accepted by banks with no

maximum limits.

5. Certificate of deposit with no limit.


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Reserve Requirements

In the MMMFs set up by banks, the resources mobilized by them would

not to be considering part of their net demand, and time liabilities, and as

such would be free of any reserve requirement.

Stamp duty

The share / units issued by MMMFs would be subject to Stamp duty.

Regulatory Authority

RBI is the regulatory that gives the approval for the setting of MMMFs.

Beside this, banks their subsidiaries and public financial institution wouldalso be required to comply with the guidelines and directives that may be

issued by RBI from time to time for the setting and operation of MMMFs.

Similarly, the Private Sector MMMFs would need to clearance of SEBI,

as also approval of RBI.


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CCRREEDDIITT RRAATTIINNGG OOFF IINNSSTTRRUUMMEENNTT

Credit rating is the process of assigning standard scores which summarize

the probability of the issuer being able to meet its repayment obligations

for a particular debt instrument in a timely manner. Credit rating is

integral to debt markets as it helps market participants to arrive at quick

estimates and opinions about various instruments. In this manner it

facilitates trading in debt and money market instruments especially in

instruments other than Government of India Securities.

Rating is usually assigned to a specific instrument rather than the

company as a whole. In the Indian context, the rating is done at the

instance of the issuer, which pays rating fees for this service. If it is

unsatisfied with the rating assigned to its proposed instrument, it is at

liberty not to disclose the rating given to it. There are 4 rating agencies in

India. These are as follows:

CRISIL - The oldest rating agency was originally promoted by ICICI.

Standard & Poor, the global leader in ratings, has recently taken a small

10% stake in CRISIL.

ICRA - Promoted by IFCI. Moodys, the other global rating major, has

recently taken a small 11% stake in ICRA.

CARE - Promoted by IDBI.

Duff and Phelps - Co-promoted by Duff and Phelps, the worlds 4th

largest rating agency.


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CRISIL is believed to have about 42% market share followed by ICRA

with about 36%, CARE with 18% and Duff and Phelps with 4%.

Grading system

Eachof the rating agencies has different codes for expressing rating for

different instruments; however, the number of grades and sub-grades is

similar e.g. for long term debentures/bonds and fixed deposits, CRISIL

has 4 main grades and a host of sub grades. In decreasing order of quality,

these are AAA, AA+, AA, AA-, A+, A, A-, BBB-, BBB, BBB+, BB+,

BB, BB-, B+, B, B-, C and D. ICRA, CARE and Duff and Phelps have

similar grading systems. The following table contains a key to the codes

used by CRISIL and ICRA.

Credit rating is a dynamic concept and all the rating companies are

constantly reviewing the companies rated by them with a view to

changing (either upgrading or downgrading) the rating. They also have a

system whereby they keep ratings for particular companies on "rating

watch" in case of major events, which may lead to change in rating in the

near future. Ratings are made public through periodic newsletters issued

by rating companies, which also elucidate briefly the rationale for

particular ratings. In addition, they issue press releases to all major

newspapers and wire services about rating events on a regular basis.

Factors involved in credit rating

Credit rating depends on several factors, some of which are

tangible/numerical and some of which are judgmental and intangible.

Some of these factors are listed below:


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y Overall fundamentals and earnings capacity of the company andvolatility of the same

y Overall macro economic and business/industry environmenty Liquidity position of the company (as distinguished from profits)y Requirement of funds to meet irrevocable commitmentsy Financial flexibility of the company to raise funds from outside

sources to meet temporary financial needs

y Guarantee/support from financially strong external bodiesy Level of existing leverage (borrowings) and financial risk

As mentioned earlier ratings are assigned to instruments and not to

companies and two different ratings may be assigned to two different

instruments of the same company e.g. a company may be in a

fundamentally weak business and may have a poor rating assigned for 5

year debentures while its liquidity position may be good, leading to the

highest possible rating for a 3 month commercial paper. Very few

companies may be assigned the highest rating for a long term 5 or 7 year

instrument e.g. CRISIL has only 20 companies rated as AAA for longterm instruments and these companies include unquestionable blue chips

like Videsh Sanchar Nigam, Bajaj Auto, Bharat Petroleum, Nestle India

apart from institutions like ICICI, IDBI, HDFC and SBI.

Derived ratings and structured obligations

Sometimes, debt instruments are so structured that in case the issuer is

unable to meet repayment obligations, another entity steps in to fulfill

these obligations. Sometimes there is a documented, concrete mechanism

for recourse to the third party, while on other occasions the arrangement

is loose. On such occasions, the debt instrument in question is said to be

"credit enhanced" by a "structured obligation" and the rating assigned to


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the instrument factors in the additional safety mechanism. The extent of

enhancement is a function of the rating of the "enhancer", the nature of

the arrangement etc and usually there is a suffix to the rating which

expresses symbolically that the rating is enhanced e.g. A bond backed by

the guarantee of the Government of India may be rated AAA (SO) with

the SO standing for structured obligation.

Limitations of credit rating - rating downgrades

Rating agencies all across the world have often been accused of not being

able to predict future problems. In part, the problem lies in the rating

process itself, which relies heavily on past numerical data and standard

ratios with relatively lower usage of judgment and understanding of the

underlying business or the country economics. Data does not always

capture all aspects of the situation especially in the complex financial

world of today. An excellent example of the meaningless over reliance on

numbers is the poor country rating given to India. Major rating agencies

site one of the reasons for this as the low ratio Indias exports to foreign

currency indebtedness. This completely ignores two issues firstly, India

gets a very high quantum of foreign currency earnings through

remittances from Indians working abroad and also services exports in the

form of software exports which are not counted as "merchandise"

exports. These two flows along with other "invisible" earnings accounted

for almost US$11bn in FY 99. Secondly, since India has tight control on

foreign currency transactions, there is very little error possible in the

foreign currency borrowing figure. As against this, for a country like

Korea, the figure for foreign currency borrowing increased by US$50bn

after the exchange crisis began. This was on account of hidden forward

liabilities through swaps and other derivative products.


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In general, Indian rating agencies have lost some amount of their

credibility in the last two years due to their inability to predict defaults in

many companies, which they had rated quite highly. Sometimes, some of

the agencies had an investment grade rating in place when the company

in question had already defaulted to some of the fixed deposit holders.

Further, rating agencies resorted to mass downgrading of 50-100

companies as a reaction to public criticism, which further eroded their

credibility. The major reasons for these downgrades are as follows

Corporate earnings fell very sharply due to persistent recessionary

conditions prevailing in the economy. Many of the corporate are in

commodity sectors where fluctuations in selling prices of products can be

very sharp - leading to complete erosion of profitability. This problem

was compounded by the Asian crisis, which led to increased competition

from cheap imports in many product categories.

Rating agencies substantially overestimated financial flexibility of

corporate especially from traditional corporate houses. Much of the

financial flexibility was implicit on raising money from new issues from

the capital market, which has been impossible in the last 3 years.

In the case of finance companies, widespread defaults like CRB and

tightening of regulations made it virtually impossible for them to raise

money in any form. These finance companies had been in the habit of

investing in longer term, illiquid assets by borrowing shorter term fixed

deposits. When the flow of credit stopped, they faced liquidity problems.

These were further compounded by defaults by some of the companies to

which they had on lent money.


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The experience is no different from the international scenario where

reputed and highly experienced rating agencies like Standard & Poor

(S&P) and Moodys were unable to predict the Asian crisis and had to

face the embarrassment of seeing the credit rating of South Korea as a

country go from A+ to BB+ in a short span of 3 months.

By and large, the rating is a very good estimate of the actual

creditworthiness of the company; however, it is not able to predict

extreme situations such as the ones described above, which are unlikely

to have been predicted by most investors in any case. Investors should

realize that a credit rating is not sacrosanct and that one has to do ones

own due diligence and investigation before investing in any instrument.

They should use the rating as a reference and a base point for their own

effort. One good way of doing this is examining the behavior of the stock

price in case the stock is listed. As a collective, the market is far smarter

at predicting problems than any credit rating agency. Witness the sharp

erosion in stock prices of companies much before their credit ratings were

downgraded. Witness also the fact that foreign currency bonds fromIndian issuers trade at yields lower than countries which have been rated

higher by rating agencies.


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SSIIMMIILLAARRIITTIIEESS && DDIIFFFFRREENNCCEE BBEETTWWEEEENN

CCAAPPIITTAALL MMAARRKKEETT IINNSSTTRRUUMMEENNTT && MMOONNEEYY

MMAARRKKEETT IINNSSTTRRUUMMEENNTT

SIMILARITIES OF CAPITAL MARKET

INSTRUMRNT & MONEY MARKET INSRUMENT

In many respects, both money market and capital markets exhibit similar

characteristics as specified below.

1. TRANSFER OF RESOURCES TRANSFER of resources takes placefrom surplus units to deficit units both in money market and capital

market.

2. COMMERCIAL BANKS Commercial banks provide both short-term and long-term finance and therefore, take an active part in the

money market as well as capital market.

3. LIQUIDITY ADJUSTMENT Nonbanking financial institution andspecial financial institutions approach money and capital markets

to a limited degree in order to adjust their liquidity positions.

Besides, financial institutions operate on both sides of the market,

borrowing and lending and participate in both money and capital

market.

4. FLOW OF FUNDS As lenders and borrowers of funds have accessto both capital and money market, there is a substantial flow of

funds between capital and money markets.

5. PREFERENCE FOR INVESTORS Preference is available for mostof the suppliers of funds operate in both the markets, as investors

simultaneously invest in various investment avenues such as

savings bank, units, fixed deposits, national saving certificate


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schemes, life insurance, government and industrial securities, real

estate, bullion, etc

6. INTEREST RATES THERE is an interdependency of short and long-term rates of interest. This is because, rise in interest rate in money

make influence long-term interest rates also.

DIFFRENCE BEWTEEN CAPITAL MARKET

INSTRUMRNT & MONEY MARKET INSRUMENT

Sl

No.

Point of

Difference

Capital market

Instrument

Money Market

Instrument

1. Term of

finance

Provides long-term funds Provides short-term funds

2. Nature of

Capital

Capital used for fixed and

working capital needs

Capital usually used for

working capital needs

3. Main

Function

Mobilization and effective

utilization through lending

Lending and borrowing to

facilitate liquidity

adjustment

4. Main

Constituent

Primary and secondary

markets, with stock

exchange acting as a

bridge for buying and

selling of securities

Call money market,

treasury bills market,

commercial bills market,

market for Certificate of

Deposit & Commercial

Paper, etc

5. Link Acts as a link between

investor & entrepreneur

Act as a link between

depositor and borrower

6. Underwriting It is a primary function Not a primary function

7. Institution Investment house and Commercial banks and


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mortgage banks discount house

8. Development

Assistance

Provided to central and

state governments, public

and local bodies, etc

Provided to government

by discounting treasury

bills etc.9. Negotiation Funds are lent after a

prolonged negotiation

between lending financial

institution and the

borrowing corporate entity

Dealing can take place

without any personal

contact and negotiation

are not formal

10. Market Place Dealings are conducted

through the mechanism of

stock exchanges

Dealing are conducted

through the over-the-

phone-market

11. Claims Bonds & Shares Financial claims, assets,

and securities

12. Risk High credit & market risk Low credit & market risk

13. Price

Fluctuations

High Not much

14. Liquidity Low High

15. Regulator Besides central bank,

Special regulatory

authority like SEBI, etc

Central Bank


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EEXXEECCUUTTIIVVEE SSUUMMMMAARRYY

Debt Instruments which have a maturity of less than one year at the time

of issue are called money market instrument. These instruments are

highly liquid and have negligible risk. The major money market

instruments are Treasury Bills, Certificate of Deposit, Commercial Paper,

Money market Mutual Fund, & 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.

Treasury Bills (TBs)-:

Treasury bills are the most important money market instrument. They

represent the obligation of the Government of India which has a primary

tenor like 91 days and 364 days. They are sold on an auction basis every

week in certain minimum denominations by the Reserve Bank of India.

They do not carry an explicit interest rate. Instead, they are sold at a

discount and redeemed at par. Hence the implicit yield of a Treasury bill

is a function of the size of the discount and the period of maturity.

Though the yield on Treasury bills is somewhat low, yet they have

an appeal for the following reasons: (a) These can be transacted readily

and there is a very active secondary market for them. (b) Treasury bills

have nil credit risk and negligible price risk.


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Certificate of Deposit (CDs) -:

Certificate of Deposits (CDs) represent short-term deposits which are

transferable from one party to another. Banks and financial institution are

the major issuers of CDs. The principal investors in CDs are banks,

financial institutions, corporate, and mutual funds. CDs are issued in

either bearer or registered form. They generally have a maturity of 3

months to one year. CDs carry a certain interest rate.

CDs are a popular form of short-term investment for companies for

the following reasons: (i) Banks are normally willing to tailor the

denominations and maturities to suit the needs of the investors. (ii) CDs

are generally risk-free. (iii) CDs generally offer a higher rate of interest

than Treasury bills or term deposits.

Commercial Paper (CPs) -:

A commercial paper represents short-term unsecured promissory note

issued by firms that are generally considered to be financially strong. A

commercial paper usually has a maturity period of 90 to 180 days. It is

sold at a discount and redeemed at par. Hence the implicit rate is a

function of the size of discount and the period of maturity.

Money Market Mutual Funds (MMMFs) -:

The Reserve Bank of India introduced the Money Market Mutual Funds

(MMMFs) scheme in April 1972. The schemes aim at providing

additional short-term avenues to individual investor in order to bring

Money Market Instrument within their reach. MMMFs are expected to be

more attractive to banks and financial institutions, ho would find them

providing greater liquidity and depth to the money market.


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Repos -:

A Repo works as follow as follows. Party a needs short-term funds and

Party B wants to make a short-term investment. Party A sells securities to

Party B at a certain price and simultaneously agrees to repurchase the

same after a specified time at a slightly higher price. The difference

between the sale price and repurchase price represent the interest cost to

Party A (the party doing the repo) and conversely the interest income for

Party B (the party doing the Reverse Repo). Reverse Repos are a safe and

convenient form of short-term investment.


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BBIIBBLLIIOOGGRRAAPPHHYY

www.google.com

www.rbi.org.in

www.calypso.com

www.yahoo.com

The Economic Times

Financial Services & Markets ( Reference book)

- Dr. Gurusamy

Hrishi Final Draft

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