PRESENTATION ON MONEY MARKET INSTRUMENTS

SUBMITTED By: RAGINI PATEL(34)

Tasneem Sutarwala (55)

Submitted to:-

MRS .RUTVI UMRIGAR

1! What is Money Market?1! What is Money Market?

As per RBI definitions “ A market for short terms As per RBI definitions “ A market for short terms financial assets that are close substitute for financial assets that are close substitute for money, facilitates the exchange of money in money, facilitates the exchange of money in primary and secondary market”.primary and secondary market”.

The money market is a mechanism that deals with The money market is a mechanism that deals with the lending and borrowing of short term funds (less the lending and borrowing of short term funds (less than one year). than one year).

A segment of the financial market in which A segment of the financial market in which financial instruments with high liquidity and very financial instruments with high liquidity and very short maturities are traded.short maturities are traded.

Continued…….Continued…….

It doesn’t actually deal in cash or money It doesn’t actually deal in cash or money but deals with substitute of cash like trade but deals with substitute of cash like trade bills, promissory notes & govt papers bills, promissory notes & govt papers which can converted into cash without any which can converted into cash without any loss at low transaction cost.loss at low transaction cost.

It includes all individual, institution and It includes all individual, institution and intermediaries.intermediaries.

2 ! Features of Money Market?2 ! Features of Money Market?

It is a market purely for short-terms funds or It is a market purely for short-terms funds or financial assets called near money.financial assets called near money.

It deals with financial assets having a maturity It deals with financial assets having a maturity period less than one year only.period less than one year only.

In Money Market transaction can not take place In Money Market transaction can not take place formal like stock exchange, only through oral formal like stock exchange, only through oral communication, relevant document and written communication, relevant document and written communication transaction can be done. communication transaction can be done.

Continued……..Continued……..

Transaction have to be conducted without the Transaction have to be conducted without the help of brokers.help of brokers.

It is not a single homogeneous market, it It is not a single homogeneous market, it comprises of several submarket like call money comprises of several submarket like call money market, acceptance & bill market.market, acceptance & bill market.

The component of Money Market are the The component of Money Market are the commercial banks, acceptance houses & NBFC commercial banks, acceptance houses & NBFC (Non-banking financial companies). (Non-banking financial companies).

3 ! Objective of Money 3 ! Objective of Money Market?Market? To provide a parking place to employ short term To provide a parking place to employ short term

surplus funds.surplus funds.

To provide room for overcoming short term To provide room for overcoming short term deficits.deficits.

To enable the central bank to influence and To enable the central bank to influence and regulate liquidity in the economy through its regulate liquidity in the economy through its intervention in this market.intervention in this market.

To provide a reasonable access to users of short-To provide a reasonable access to users of short-term funds to meet their requirement quickly, term funds to meet their requirement quickly, adequately at reasonable cost.adequately at reasonable cost.

4 ! Importance of Money 4 ! Importance of Money Market?Market?

o Development of trade & industry.Development of trade & industry.o Development of capital market.Development of capital market.o Smooth functioning of commercial banks.Smooth functioning of commercial banks.o Effective central bank control.Effective central bank control.o Formulation of suitable monetary policy.Formulation of suitable monetary policy.o Non inflationary source of finance to Non inflationary source of finance to

government.government.

5 ! Composition of Money 5 ! Composition of Money Market?Market?

Money Market consists of a number of sub-Money Market consists of a number of sub-markets which collectively constitute the markets which collectively constitute the money market. They are,money market. They are,

Call Money MarketCall Money Market Commercial bills market or discount Commercial bills market or discount

marketmarket Acceptance market Acceptance market Treasury bill marketTreasury bill market

6 ! Instrument of Money 6 ! Instrument of Money Market?Market?A variety of instrument are available in a developed A variety of instrument are available in a developed

money market. In India till 1986, only a few money market. In India till 1986, only a few instrument were available.instrument were available.

They wereThey were• Treasury bills Treasury bills • Money at call and short notice in the call loan Money at call and short notice in the call loan

market.market.• Commercial bills, promissory notes in the bill Commercial bills, promissory notes in the bill

market.market.

New instrumentNew instrument

Now, in addition to the above the following new Now, in addition to the above the following new instrument are available:instrument are available:

Commercial papers.Commercial papers. Certificate of deposit.Certificate of deposit. Inter-bank participation certificates.Inter-bank participation certificates. Repo instrumentRepo instrument Banker's AcceptanceBanker's Acceptance Repurchase agreementRepurchase agreement Money Market mutual fundMoney Market mutual fund

Treasury Bills (T-Bills)Treasury Bills (T-Bills)

(T-bills) are the most marketable money market (T-bills) are the most marketable money market security. security.

They are issued with three-month, six-month They are issued with three-month, six-month and one-year maturities. and one-year maturities.

T-bills are purchased for a price that is less than T-bills are purchased for a price that is less than their par(face) value; when they mature, the their par(face) value; when they mature, the government pays the holder the full par value.government pays the holder the full par value.

T-Bills are so popular among money market T-Bills are so popular among money market instruments because of affordability to the instruments because of affordability to the individual investors. individual investors.

Disadvantages of T - bill

Yield from TBs is lowest as long-term government securities fetch more interest and hence subscription for it is declining.

TBs are sold through auction in order to ensure market rates for investors, in actual competitive bids are cons piously absent. Hence adequate return is not available.

Investors hold TBs till maturity and they do not come for circulation. Hence, active trading in TBs is adversely affected.

Advantages of T- bill Safety Liquidity Ideal short-term investment Ideal fund management Statutory liquidity requirement Hedging facility Non inflationary monetary tool Source of short term funds

Estimating T-bill yield No coupon payments Par or face value received at maturity Yield at issue is the difference between the

selling price and par or face value adjusted for time

If sold prior to maturity in secondary market Yield based on the difference between price paid for

T-bill and selling price adjusted for time

Calculating T-Bill Annualized Yield

YT SP – PP

PP

365

n

YT = The annualized yield from investing in a T-bill

SP = Selling price

PP = Purchase price

n = number of days of the investment (holding period)

=

T-bill yield for a newly issued security

Par – PP

PP

360

n

T-bill discount = percent discount of the purchase price from par

Par = Face value of the T-bills at maturity

PP = Purchase price

n = number of days to maturity

T-bill discount =

Certificate of deposit (CD)Certificate of deposit (CD)

A CD is a time deposit with a bank.A CD is a time deposit with a bank. Like most time deposit, funds can not Like most time deposit, funds can not

withdrawn before maturity without paying withdrawn before maturity without paying a penalty.a penalty.

CD’s have specific maturity date, interest CD’s have specific maturity date, interest rate and it can be issued in any rate and it can be issued in any denomination.denomination.

The main advantage of CD is their safety.The main advantage of CD is their safety. Anyone can earn more than a saving Anyone can earn more than a saving

account interest.account interest.

Advantages of Certificate of Deposit as a money market instrument

1. Since one can know the returns from before, the certificates of deposits are considered much safe. 2. One can earn more as compared to depositing money in savings account. 3. The Federal Insurance Corporation guarantees the investments in the certificate of deposit.

Disadvantages of Certificate of deposit as a money market instrument:

1. As compared to other investments the returns is less. 2. The money is tied along with the long maturity period of the Certificate of Deposit. Huge penalties are paid if one gets out of it before maturity.

Commercial paper (CP)Commercial paper (CP)

CP is a short term unsecured loan issued by a CP is a short term unsecured loan issued by a corporation typically financing day to day corporation typically financing day to day operation.operation.

CP is very safe investment because the financial CP is very safe investment because the financial situation of a company can easily be predicted situation of a company can easily be predicted over a few months.over a few months.

Only company with high credit rating issues CP’s.Only company with high credit rating issues CP’s.

Commercial Paper Commercial paper consists of short-term,

unsecured promissory notes issued by well-known and financially strong companies.

Commercial paper is traded mainly in the primary market. Opportunities for resale in the secondary market are more limited.

Commercial paper is rated prime, desirable, or satisfactory, depending on the credit standing of the issuing company.

Estimating commercial paper yields

YCP

Par – PP

PP

360

n

YCP = Commercial paper yield

Par = Face value at maturity

PP = Purchase price

n = number of days to maturity

=

Types of Commercial Paper There are two major types of commercial

paper. Direct paper is issued mainly by large

finance companies and bank holding companies directly to the investor.

Dealer paper, or industrial paper, is issued by security dealers on behalf of their corporate customers (mainly nonfinancial companies and smaller financial companies).

Structure of the Commercial Paper Market

Investors in commercial paper

Money market fundsBanks

Insurance companies

Pension fundsIndustrial companies

Other investors

Demand SideSupply Side

Issuers of commercial paper

Finance companies

Bank holding companies

Nonfinancial firms

Direct or finance paper

Paper dealer housesDealer or

industrial paper

Commercial PaperAdvantages Relatively low interest rates Flexible interest rates - choice of dealer or

direct paper Large amounts may be borrowed

conveniently The ability to issue paper gives

considerable leverage when negotiating with banks

Commercial Paper

Disadvantages Risk of alienating banks whose loans may

be needed when an emergency develops May be difficult to raise funds in the paper

market at times Commercial paper must generally remain

outstanding until maturity - does not permit early retirement without penalty

Repurchase agreement Repurchase agreement (Repos)(Repos)

Repo is a form of borrowing and is used by those Repo is a form of borrowing and is used by those who deal in government securities.who deal in government securities.

They are usually very short term repurchases They are usually very short term repurchases agreement, from overnight to 30 days of more.agreement, from overnight to 30 days of more.

The short term maturity and government backing The short term maturity and government backing usually mean that Repos provide lenders with usually mean that Repos provide lenders with extremely low risk.extremely low risk.

Repos are safe collateral for loans.Repos are safe collateral for loans.

Estimating repurchase agreement yields

Repo RateSP – PP

PP

360

n

Repo Rate = Yield on the repurchase agreement

SP = Selling price

PP = Purchase price

n = number of days to maturity

=

Banker's AcceptanceBanker's Acceptance

A banker’s acceptance (BA) is a short-term credit A banker’s acceptance (BA) is a short-term credit investment created by a non-financial firm.investment created by a non-financial firm.

BA’s are guaranteed by a bank to make payment.BA’s are guaranteed by a bank to make payment. Acceptances are traded at discounts from face Acceptances are traded at discounts from face

value in the secondary market.value in the secondary market. BA acts as a negotiable time draft for financing BA acts as a negotiable time draft for financing

imports, exports or other transactions in goods.imports, exports or other transactions in goods. This is especially useful when the credit This is especially useful when the credit

worthiness of a foreign trade partner is unknown. worthiness of a foreign trade partner is unknown.

Bankers’ Acceptances A bankers’ acceptance is a time draft

drawn on and endorsed by an importer’s bank.

Acceptances are used in international trade because most exporters are uncertain of the credit standing of their importers.

The issuing bank unconditionally guarantees to pay the face value of the acceptance when it matures, thus shielding exporters and investors in international markets from default risk.

Bankers’ Acceptances Acceptances carry maturities ranging from

30 to 270 days, with 90 days being the most common.

They are traded among financial institutions, industrial corporations, and securities dealers as a high-quality investment and source of ready cash.

How Acceptances AriseImporter applies for line of credit

Importer’s bank issues letter of credit in favor of exporter

Letter of credit authorizes the drawing of a time draft

Importer’s bank accepts time draft from exporter’s bank

Importer’s bank pays exporter’s bank discounted value of bankers’ acceptance, and then holds or sells it

Bankers’ acceptance is redeemed at maturity

Acceptance Rates Acceptances do not carry a fixed rate of

interest, but are sold at a discount in the open market like Treasury bills.

The yield on acceptances is usually only slightly higher than the yield on Treasury bills, and close to the negotiable CD rates offered by major banks, because of the high credit quality of the banks that issue the acceptances and CDs.

Money Market Securities

Issued by large commercial banks Minimum denomination of $100,000 but $1

million more common Purchased by nonfinancial corporations or

money market funds Secondary markets supported by dealers in

security

Negotiable Certificates of Deposit (NCD)

NCD placement Direct placement Use a correspondent institution specializing in

placement Sell to securities dealers who resell Sell direct to investors at a higher price

NCD premiums Rate above T-bill rate to compensate for lower

liquidity and safety

11 ! 11 ! SummarySummary The money market specializes in debt securities The money market specializes in debt securities

that mature in less than one year. that mature in less than one year. Money market securities are very liquid, and are Money market securities are very liquid, and are

considered very safe. As a result, they offer a considered very safe. As a result, they offer a lower return than other securities. lower return than other securities.

The easiest way for individuals to gain access to The easiest way for individuals to gain access to the money market is through a money market the money market is through a money market mutual fund. mutual fund.

T-bills are short-term government securities that T-bills are short-term government securities that mature in one year or less from their issue date. mature in one year or less from their issue date.

T-bills are considered to be one of the safest T-bills are considered to be one of the safest investments. investments.

Continued…….Continued……. A certificate of deposit (CD) is a time deposit with a A certificate of deposit (CD) is a time deposit with a

bank. bank. Annual percentage yield (APY) takes into account Annual percentage yield (APY) takes into account

compound interest, annual percentage rate (APR) compound interest, annual percentage rate (APR) does not. does not.

CDs are safe, but the returns aren't great, and your CDs are safe, but the returns aren't great, and your money is tied up for the length of the CD. money is tied up for the length of the CD.

Commercial paper is an unsecured, short-term loan Commercial paper is an unsecured, short-term loan issued by a corporation. Returns are higher than T-issued by a corporation. Returns are higher than T-bills because of the higher default risk. bills because of the higher default risk.

Banker’s acceptance (BA) are negotiable time draft Banker’s acceptance (BA) are negotiable time draft for financing transactions in goods. for financing transactions in goods.

Repurchase agreement (repos) are a form of Repurchase agreement (repos) are a form of overnight borrowing backed by government overnight borrowing backed by government securities. securities.