UNIVERSITY OF MUMBAI
PROJECT ON:-
MONEY MARKET INSTRUMENTS
MASTER OF COMMERCE
(BANKING AND FINANCE)
SEMESTER I2014-2015
In Partial Fulfillment of the Requirement under Semester Based
Credit And Grading System for Post Graduated (PG)
Programme under Faculty of Commerce
SUBMITTED BY:-
PARSHURAM.BABU.OMKAR
ROLL NO: 44
PROJECT GUIDE:-
PROF. SHARADDHA SHUKLEACKNOWLEDGEMENT
With great pleasure I thank Mrs. SHARADDHA SHUKLE Professor of
K.P.B.HINDUJA college of Commerce for being an inspiration in the
completion of this project. I thank for her invaluable help
provided during the completion of this project. I also thank her
for providing me guidance and numerous suggestions throughout
entire duration of the project. I am thankful for invaluable help
without which this project would not have materialized.
I express my deep gratitude to my entire college friend and my
family members whose efforts and creativity helped us in giving the
final structure to the project work.
I am also thankful to all those seen and unseen hands and hands,
which have been of help in the completion of this project work.
CERTIFICATE
This is certify that Mr. Parshuram.Babu.Omkar of M.Com. Banking
& Finance 2nd Semester (2014-2015) has successfully completed
the Project on "MONEY MARKET INSTRUMENTS".
Under the guidance of Mrs. SHARADDHA SHUKLE Project Guide
________________________
Course Coordinator
________________________
Internal Examiner
________________________
External Examiner
________________________
Principal
________________________
Date________________
Place: MumbaiM.Com (Banking and Finance)
2nd SEMESTER
"MONEY MARKET INSTRUMENTS"
SUBMITTED BY
PARSHURAM.BABU.OMKAR
ROLL NO: 44
DECLARATION
I Mr. Parshuram.Babu.Omkar the student of M.com (Banking and
Finance), 2nd Semester (2014-2015), hereby declares that I have
completed the project on "MONEY MARKET INSTRUMENTS"
The information submitted is true and original to the best of my
knowledge.
Parshuram.Babu.Omkar
(Signature)INDEXSR.NOPARTICULARSPAGE NO.
CHP 1INTRODUCTION TO MONEY MARKET INSRUMENTS8-9
1.1INTRODUCTION8
1.2OBJECTIVES OF THE STUDY8
1.3METHODS OF RESEARCH8
1.4CHAPTER SCHEME8-9
1.5LIST OF TABLE9
CHP 2INTRODUCTION OF MONEY MARKET10-12
CHP 3FUNCTIONS OF MONEY MARKET13-14
CHP 4WHAT CONSTITUTES THE MONEY MARKET IN INDIA15-16
CHP 5WHAT ARE MONEY MARKET INSTRUMENTS17-18
CHP 6TYPES OF MONEY MARKET INSTRUMENTS 19-35
CHP 7T-BILL & INFLATION CONTROL36-38
CHP 8CONCLUSION39
CHP 9ANNEXURE40
Chapter 1Introduction to Money Market
Instruments1.1Introduction:
The major purpose of financial markets is to transfer funds from
lenders to borrowers. Financial market participants commonly
distinguish between the "capital market" and the "money market".
The money market refer to borrowing and lending for periods of a
year or less. It is a mechanism to clear short term monetary
transactions in an economy.
Various instruments exist, such as Treasury bills, commercial
paper, bankers' acceptances, deposits, certificates of deposit,
bills of exchange, repurchase agreements, federal funds, and
short-lived mortgage-, and asset-backed securities. It provides
liquidity funding for the global financial system. Money markets
and capital markets are parts of financial markets. The instruments
bear differing maturities, currencies, credit risks, and structure.
Therefore they may be used to distribute the exposure.
1.2 Objectives of the Study:1) To understand the definition and
meaning of money market.
2) To understand the various instruments of money market.
1.3 Methods of Research:
The data is collected only from secondary data source. Such as
Newspapers, Magazines, Books, Journals, E-data, etc.1.4 Chapter
Scheme
Chapter 1: Introduction to money market instruments Chapter 2:
Introduction of money marketChapter 3: Functions of money
marketChapter 4: What constitutes the money market in IndiaChapter
5: What are money market instrumentsChapter 6: Types of money
market instrumentsChapter 7: Treasury bill & Inflation control
Chapter 8: ConclusionChapter 9: AnnexureChapter 10: Annexure
1.5 List of Table
1) T-bill Calendar2) Commercial Paper policy changesChapter 2
Money Market:
Introduction:As money became a commodity, the money market
became a component of the financial markets for assets involved in
short-term borrowing, lending, buying and selling with original
maturities of one year or less. Trading in the money markets is
done over the counter and is wholesale. Various instruments exist,
such as Treasury bills, commercial paper, bankers' acceptances,
deposits, certificates of deposit, bills of exchange, repurchase
agreements, federal funds, and short-lived mortgage-, and
asset-backed securities. It provides liquidity funding for the
global financial system. Money markets and capital markets are
parts of financial markets. The instruments bear differing
maturities, currencies, credit risks, and structure. Therefore they
may be used to distribute the exposure.There are two types of
financial markets viz., the money market and the capital market.
The money market in that part of a financial market which deals in
the borrowing and lending of short term loans generally for a
period of less than or equal to 365 days. It is a mechanism to
clear short term monetary transactions in an economy.
Definitions of Money MarketFollowing definitions will help us to
understand the concept of money market.
According to Crowther, "The money market is a name given to the
various firms and institutions that deal in the various grades of
near money."
According to the RBI, "The money market is the centre for
dealing mainly of short character, in monetary assets; it meets the
short term requirements of borrowers and provides liquidity or cash
to the lenders. It is a place where short term surplus investible
funds at the disposal of financial and other institutions and
individuals are bid by borrowers, again comprising institutions and
individuals and also by the government."
According to Nadler and Shipman, "A money market is a mechanical
device through which short term funds are loaned and borrowed
through which a large part of the financial transactions of a
particular country or world are degraded. A money market is
distinct from but supplementary to the commercial banking
system."
These definitions help us to identify the basic characteristics
of a money market. A money market comprises of a well organized
banking system. Various financial instruments are used for
transactions in a money market. There is perfect mobility of funds
in a money market. The transactions in a money market are of short
term nature.
Market for short-term debt securities, such as banker's
acceptances, commercial paper, repos, negotiable certificates of
deposit, and Treasury Bills with a maturity of one year or less and
often 30 days or less. Money market securities are generally very
safe investments which return a relatively low interest rate that
is most appropriate for temporary cash storage or short-term time
horizons. Bid and ask spreads are relatively small due to the large
size and high liquidity of the market.
Money market is an important part of the economy. It plays very
significant functions. As mentioned above it is basically a market
for short term monetary transactions. Thus it has to provide
facility for adjusting liquidity to the banks, business
corporations, non-banking financial institutions (NBFs) and other
financial institutions along with investors.
Whenever a bear market comes along, investors realize (yet
again!) that the stock market is a risky place for their savings.
It's a fact we tend to forget while enjoying the returns of a bull
market! Unfortunately, this is part of the risk-return tradeoff. To
get higher returns, you have to take on a higher level of risk. For
many investors, a volatile market is too much to stomach - the
money market offers an alternative to these higher-risk
investments.
The money market is better known as a place for large
institutions and government to manage their short-term cash needs.
However, individual investors have access to the market through a
variety of different securities. In this tutorial, we'll cover
various types of money market securities and how they can work in
your portfolio.
he money market is a subsection of the fixed income market. We
generally think of the term fixed income as being synonymous to
bonds. In reality, a bond is just one type of fixed income
security. The difference between the money market and the bond
market is that the money market specializes in very short-term debt
securities (debt that matures in less than one year). Money market
investments are also called cash investments because of their short
maturities.
Money market securities are essentially IOUs issued by
governments, financial institutions and large corporations. These
instruments are very liquid and considered extraordinarily safe.
Because they are extremely conservative, money market securities
offer significantly lower returns than most other securities.
One of the main differences between the money market and the
stock market is that most money market securities trade in very
high denominations. This limits access for the individual investor.
Furthermore, the money market is a dealer market, which means that
firms buy and sell securities in their own accounts, at their own
risk. Compare this to the stock market where a broker receives
commission to acts as an agent, while the investor takes the risk
of holding the stock. Another characteristic of a dealer market is
the lack of a central trading floor or exchange. Deals are
transacted over the phone or through electronic systems.
The easiest way for us to gain access to the money market is
with a money market mutual funds, or sometimes through a money
market bank account. These accounts and funds pool together the
assets of thousands of investors in order to buy the money market
securities on their behalf. However, some money market instruments,
like Treasury bills, may be purchased directly. Failing that, they
can be acquired through other large financial institutions with
direct access to these markets.
There are several different instruments in the money market,
offering different returns and different risks. In the following
sections, we'll take a look at the major money market
instruments.
Chapter 3Functions of Money Market
The major functions of money market are given below:-
1. To maintain monetary equilibrium. It means to keep a balance
between the demand for and supply of money for short term monetary
transactions.
2. To promote economic growth. Money market can do this by
making funds available to various units in the economy such as
agriculture, small scale industries, etc.
3. To provide help to Trade and Industry. Money market provides
adequate finance to trade and industry. Similarly it also provides
facility of discounting bills of exchange for trade and
industry.
4. To help in implementing Monetary Policy. It provides a
mechanism for an effective implementation of the monetary
policy.
5. To help in Capital Formation. Money market makes available
investment avenues for short term period. It helps in generating
savings and investments in the economy.
6. Money market provides non-inflationary sources of finance to
government. It is possible by issuing treasury bills in order to
raise short loans. However this dose not leads to increases in the
prices.
Apart from those, money market is an arrangement which
accommodates banks and financial institutions dealing in short term
monetary activities such as the demand for and supply of money.
The money market functions are:
1. Financing Trade:
Money Market plays crucial role in financing both internal as
well as international trade. Commercial finance is made available
to the traders through bills of exchange, which are discounted by
the bill market. The acceptance houses and discount markets help in
financing foreign trade.
2. Financing Industry:
Money market contributes to the growth of industries in two
ways:
(a) Money market helps the industries in securing short-term
loans to meet their working capital requirements through the system
of finance bills, commercial papers, etc.
(b) Industries generally need long-term loans, which are
provided in the capital market. However, capital market depends
upon the nature of and the conditions in the money market. The
short-term interest rates of the money market influence the
long-term interest rates of the capital market. Thus, money market
indirectly helps the industries through its link with and influence
on long-term capital market.
3. Profitable Investment:
Money market enables the commercial banks to use their excess
reserves in profitable investment. The main objective of the
commercial banks is to earn income from its reserves as well as
maintain liquidity to meet the uncertain cash demand of the
depositors. In the money market, the excess reserves of the
commercial banks are invested in near-money assets (e.g. short-term
bills of exchange) which are highly liquid and can be easily
converted into cash. Thus, the commercial banks earn profits
without losing liquidity.
4. Self-Sufficiency of Commercial Bank:
Developed money market helps the commercial banks to become
self-sufficient. In the situation of emergency, when the commercial
banks have scarcity of funds, they need not approach the central
bank and borrow at a higher interest rate. On the other hand, they
can meet their requirements by recalling their old short-run loans
from the money market.
5. Help to Central Bank:
Though the central bank can function and influence the banking
system in the absence of a money market, the existence of a
developed money market smoothens the functioning and increases the
efficiency of the central bank.
Money market helps the central bank in two ways:
(a) The short-run interest rates of the money market serves as
an indicator of the monetary and banking conditions in the country
and, in this way, guide the central bank to adopt an appropriate
banking policy,
(b) The sensitive and integrated money market helps the central
bank to secure quick and widespread influence on the sub-markets,
and thus achieve effective implementation of its policy.
Chapter 4What Constitutes the Money Market in India?
The money market is a mechanism that deals with the lending and
borrowing of short term funds. Money market refers to the market
for short term assets that are close substitutes of money, usually
with maturities of less than a year. A well functioning money
market provides a relatively safe and steady income-yielding
avenue, for short term investment of funds both for banks and
corporates and allows the investor institutions to optimize the
yield on temporary surplus funds. The RBI is a regular player in
the money market and intervenes to regulate the liquidity and
interest rates in the conduct of monetary policy to achieve the
broad objective of price stability, efficient allocation of credit
and a stable foreign exchange market. As per definition given by
RBI the money market is "the centre for dealings, mainly short-term
character, in money assets. It meets the short-term requirements of
borrower and provides liquidity or cash to the lenders. It is the
place where short-term surplus investible funds at the disposal of
financial and other institutions and individuals are bid by
borrowers, again comprising Institutions, individuals and also the
Government itself" The main segments of the money market are the
call/notice money, term money, commercial bills, treasury bills,
commercial paper and certificate deposits. Mr.G. Crowther in his
treatise "An
Outline of Money defines money market as If the economic
relationships between nations are not, by one means or another,
brought fairly close to balance, then there is no set of financial
arrangements that can rescue the world from the impoverishing
results of chaos. "the collective name given to the various firms
and institutions that deal in the various grades of near-money".
.
Call /Notice-Money MarketThe call/notice money market forms an
important segment of the Indian Money Market. Under call money
market, funds are transacted on overnight basis and under notice
money market, funds are transacted for the period between 2 days
and 14 days.The most active segment of the money market has been
the call money market, where the day to day imbalances in the funds
position of scheduled commercial banks are eased out. The call
notice money market has graduated into a broad and vibrant
institution .
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.
Inter-Bank Term Money
A short-term money market, which allows for large financial
institutions, such as banks, mutual funds and corporations to
borrow and lend money at interbank rates. The loans in the call
money marketare very short, usually lastingno longer than a week
and are often used to help banks meet reserve
requirements.Inter-bank market for deposits of maturity beyond 14
days is referred to as the term money market. The entry
restrictions are the same as those for Call/Notice Money except
that, as per existing regulations, the specified entities are not
allowed to lend beyond 14 days.
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.
Chapter 5What are Money Market Instruments?
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.
The participants in the financial market perceive a thin line,
differentiating between the capital market & the money market.
Capital market refers to stock markets where the common stocks are
traded, and bond markets where bonds are issued and traded. This is
in sharp contrast to money markets which provide short term debt
financing and investment. In money market, there is borrowing and
lending for periods of a year or less.
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.
Commercial paper is a short-term unsecured promissory note
issued by corporates and financial institutions. Commercial Paper
is short-term loan that is issued by a corporation use for
financing accounts receivable and inventories. Issued at discount
to the face value, they yield attractive returns. The Government of
India securities are sovereign coupon bearing instruments that are
issued by the Govt. of India. They are available both for
short-term and long tenures.
A savings certificate entitling the bearer to receive interest.
Certificate of deposit is short-term borrowings that are more like
bank term deposit accounts. They are transferable by endorsement
and are to be stamped. Investors can consider money market funds.
These invest in government securities, certificates of deposits,
commercial paper of companies, and other highly liquid and low-risk
securities. These funds are required by law to invest in low risk
securities. Investors with low risk appetite can opt for money
market funds.
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.
1) Treasury Bills2) Certificate of Deposit (CD)3) Commercial
Paper (C.P)4) Bill Rediscounting5) Repurchase agreement6) Bankers
Acceptance7) Euro Dollars8) BondsChapter 6Types of Money Market
Instruments:
1)Treasury Bills: Treasury bills are short-term securities
issued by the U.S. Treasury. The Treasury sells bills at regularly
scheduled auctions to refinance issues and to help finance current
federal deficits. It also sells bills on an irregular basis to
smooth out the uneven flow of revenues from corporate and
individual tax receipts. Persistent federal deficits have resulted
in rapid growth in Treasury bills in recent years. At the end of
1992 the outstanding volume was $658 billion, the largest for any
money market instrument.(T-bills) are the most marketable money
market security. Their popularity is mainly due to their
simplicity. Essentially, T-bills are a way for the U.S. government
to raise money from the public. In this tutorial, we are referring
to T-bills issued by the U.S. government, but many other
governments issue T-bills in a similar fashion.
T-bills are short-term securities that mature in one year or
less from their issue date. They are issued with three-month,
six-month and one-year maturities. T-bills are purchased for a
price that is less than their par (face) value; when they mature,
the government pays the holder the full par value. Effectively,
your interest is the difference between the purchase price of the
security and what you get at maturity. For example, if you bought a
90-day T-bill at $9,800 and held it until maturity, you would earn
$200 on your investment. This differs from coupon bonds, which pay
interest semi-annually.
Treasury bills (as well as notes and bonds) are issued through a
competitive bidding process at auctions. If you want to buy a
T-bill, you submit a bid that is prepared either non-competitively
or competitively. In non-competitive bidding, you'll receive the
full amount of the security you want at the return determined at
the auction. With competitive bidding, you have to specify the
return that you would like to receive. If the return you specify is
too high, you might not receive any securities, or just a portion
of what you bid for. More information on auctions is available at
the Treasury Direct website.
The biggest reasons that T-Bills are so popular is that they are
one of the few money market instruments that are affordable to the
individual investors. T-bills are usually issued in denominations
of $1,000, $5,000, $10,000, $25,000, $50,000, $100,000 and $1
million. Other positives are that T-bills (and all Treasuries) are
considered to be the safest investments in the world because the
U.S. government backs them. In fact, they are considered risk-free.
Furthermore, they are exempt from state and local taxes. (For more
on this, see Why do commercial bills have higher yields than
T-bills?)
The only downside to T-bills is that you won't get a great
return because Treasuries are exceptionally safe. Corporate bonds,
certificates of deposit and money market funds will often give
higher rates of interest. What's more, you might not get back all
of your investment if you cash out before the maturity date.
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.
Treasury Bill Issues
Treasury bills were first authorized by Congress in 1929. After
experimenting with a number of bill maturities, the Treasury in
1937 settled on the exclusive issue of three-month bills. In
December 1958 these were supplemented with six-month bills in the
regular weekly auctions. In 1959 the Treasury began to auction
one-year bills on a quarterly basis. The quarterly auction of
one-year bills was replaced in August 1963 by an auction occurring
every four weeks. The Treasury in September 1966 added a nine-month
maturity to the auction occurring every four weeks but the sale of
this maturity was discontinued in late 1972. Since then, the only
regular bill offerings have been the offerings of three- and
six-month bills every week and the offerings of one-year bills
every four weeks. The Treasury has increased the size of its
auctions as new money has been needed to meet enlarged federal
borrowing requirements. In 1992 the weekly auctions of three- and
six-month bills both ranged from $10.2 billion to $12.5 billion,
and the four-week auctions of one-year bills ranged from $12.8
billion to $15.0 billion.
In addition to its regularly scheduled sales, the Treasury
raises money on an irregular basis through the sale of cash
management bills, which are usually "reopenings" or sales of bills
that mature on the same date as an outstanding issue of bills. Cash
management bills are designed to bridge low points in the
Prior to 1975, the Treasury raised funds on an irregular basis
through the sale of tax anticipation bills. Nelson (1977) provides
a description of these bills.Treasury's cash balances. Many cash
management bills help finance the Treasury's requirements until tax
payments are received. For this reason they frequently have
maturities that fall after one of the five major federal tax dates.
Sixty issues of cash management bills were sold in the decade from
1983 through 1992. Of these, 29 had maturities of less than one
month, 21 had maturities between one month and three months, and 10
had maturities between three months and one year.
Types
Treasury bills (T-bills) offer short-term investment
opportunities, generally up to one year. They are thus useful in
managing short-term liquidity. At present, the Government of India
issues three types of treasury bills through auctions, namely,
91-day, 182-day and 364-day. There are no treasury bills issued by
State Governments.
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.
Type ofDay ofDay of
T-billsAuctionPayment*
91-dayWednesdayFollowing Friday
182-dayWednesday of non-reporting weekFollowing Friday
364-dayWednesday of reporting weekFollowing Friday
* If the day of payment falls on a holiday, the payment is made
on the day after the holiday.
The salient features of the auction system of T-Bills are : The
14/91/182/364-days bills are issued for a minimum value of
Rs.25,000 and multiples thereof.
They are issued at a discount to face value.
Any person in India including individuals, firms, companies,
corporate bodies, trusts and institutions can purchase the
bills.
The bills are eligible securities for SLR purposes.
All bids above a cut-off price are accepted and bidders are
permitted to place multiple bids quoting different prices at each
auction. Till November 6, 1998, all types of T-Bills auctions were
conducted by means of 'Multiple Price Auction'. However, since
November 6, 1998, auction of 91-days T-Bills are being conducted by
means of 'Uniform Price Auction'. In the case of 'Multiple Price
Auction' method successful bidders pay their own bid prices,
whereas under 'Uniform Price Auction' method, all successful
bidders pay an uniform price, i.e. the cut-off price emerged in the
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.
French Auction or Multiple Price Auction SystemAfter receiving
written bids at various levels of yield expectations, a particular
yield is decided as the cut-off rate of the security in question.
Auction participants (bidders) who bid at yield levels lower than
the yield determined as cut-off get full allotment although at a
premium. The premium is equal to the yield differential expressed
in rupee terms. The yield differential is the difference between
the cut-off yield and the yield at which the bid is made. All bids
made at yield levels higher than that determined as cut-off yield
get entirely rejected.
Dutch Auction or Uniform Price Auction SystemThis 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
2) 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.
A certificate of deposit (CD) is a time deposit with a bank. CDs
are generally issued by commercial banks but they can be bought
through brokerages. They bear a specific maturity date (from three
months to five years), a specified interest rate, and can be issued
in any denomination, much like bonds. Like all time deposits, the
funds may not be withdrawn on demand like those in a checking
account.
CDs offer a slightly higher yield than T-Bills because of the
slightly higher default risk for a bank but, overall, the
likelihood that a large bank will go broke is pretty slim. Of
course, the amount of interest you earn depends on a number of
other factors such as the current interest rate environment, how
much money you invest the length of time and the particular bank
you choose. While nearly every bank offers CDs, the rates are
rarely competitive, so it's important to shop around.
Domestic CDS
A certificate of deposit is a document evidencing a time deposit
placed with a depository institution. The certificate states the
amount of the deposit, the date on which it matures, the interest
rate and the method under which the interest is calculated. Large
negotiable CDs are generally issued in denominations of $1 million
or more.
A CD can be legally negotiable or non-negotiable, depending on
certain legal specifications of the CD. Negotiable CDs can be sold
by depositors to otherparties who can in turn resell them.
Non-negotiable CDs generally must be held by the depositor until
maturity. During the late 1970s and early to mid-1980s, between 60
and 80 percent of large CDs issued by large banks were negotiable
instruments. The Federal Reserve stopped collecting separate data
on negotiable CDs in 1987.
A CD may be payable to the bearer or registered in the name of
the investor. Most large negotiable CDs are issued in bearer form
because investors can resell bearer CDs more easily. Registration
adds complication and costs to the process of transferring
ownership of CDs. CDs with original maturities of more than one
year must be registered under the Tax Equity and Fiscal
Responsibility Act of 1982 (TEFRA).
Federal banking agency regulations limit the minimum maturity of
a time deposit to seven days. Most CDs have original maturities of
1 to 12 months, although some have maturities as long as five years
or more. At the end of December 1992 approximately half of the
large CDs issued domestically by U.S. banks that were still
outstanding, had a maturity of three months or less.
Interest rates on CDs are generally quoted on an
interest-bearing basis with the interest computed on the basis of a
360-day year. A $1 million, 90-day CD with a 3 percent annual
interest rate would after 90 days entitle the holder of the CD to:
$1,000,000 x [1 + (90/360) x 0.03] = $1,007,500.
This method of calculating interest is known as "CD basis,"
"365/360 basis" or "actual/360 basis." At some banks, however,
interest on CDs is computed on the basis of a 365-day year. When
calculated on a 365-day year basis a $1 million, 90-day CD would
have to pay a stated rate of 3.04 percent to offer the holder a
return equivalent to a CD that paid 3 percent on a CD basis:
$1,000,000 x [1 + (90/365) x 0.0304] = $1,007,500.
Although the timing of interest payments is subject to
negotiation,banks usually pay interest semiannually on fixed-rate
CDs with maturities longer than one year.
Variable-Rate CDsVariable-rate CDs (VRCDs), also called
variable-coupon CDs or floating-rate CDs, have been available in
the United States since 1975 from both domestic banks and the
branches of foreign banks. VRCDs have the distinguishing feature
that their total maturity is divided into equally long rollover
periods, also called legs or roll periods, in each of which the
interest rate is set anew. The interest accrued on a leg is paid at
the end of that leg.
The interest rate on each leg is set at some fixed spread to a
certain base rate which is usually either a composite secondary
market CD rate, a Treasury bill rate, LIBOR, or the prime rate. The
maturity of the instrument providing the base rate is equal in
length to that of the leg. For example, the interest rate on a
VRCDwith a one-month roll might be reset every month with a fixed
spread to the composite one-month secondary market CD rate. The
most popular maturities of VRCDs are 18 months and two years, and
the most popular roll periods are one and three months.
VRCDs are used by issuing banks because they improve their
liquidity positions by providing funds for relatively long periods.
Money Market investors purchase VRCDs because they wantt to invest
in instruments with long-term maturities but wish to be protected
from loss if interest rates increase. Money market funds are the
largest investors in VRCDs. Money market funds are allowed by SEC
regulations to treat their holdings of VRCDs as if they had
maturities equal to the length of the roll.
Throughout much of the 1980s VRCDs accounted for 10 percent or
more of outstanding large CDs. The percentage fell rapidly in the
1990s, however, and as of December 1992 VRCDs were only about 2
percent of outstanding large CDs. This decline may have resulted
from a diminished concern of investors with the risk of rising
inflation and therefore rising interest rates.
A fundamental concept to understand when buying a CD is the
difference between annual percentage yield (APY) and annual
percentage rate (APR). APY is the total amount of interest you earn
in one year, taking compound interest into account. APR is simply
the stated interest you earn in one year, without taking
compounding into account. (To learn more, read APR vs. APY: How The
Distinction Affects You.)
The difference results from when interest is paid. The more
frequently interest is calculated, the greater the yield will be.
When an investment pays interest annually, its rate and yield are
the same. But when interest is paid more frequently, the yield gets
higher. For example, say you purchase a one-year, $1,000 CD that
pays 5% semi-annually. After six months, you'll receive an interest
payment of $25 ($1,000 x 5 % x .5 years). Here's where the magic of
compounding starts. The $25 payment starts earning interest of its
own, which over the next six months amounts to $ 0.625 ($25 x 5% x
.5 years). As a result, the rate on the CD is 5%, but its yield is
5.06. It may not sound like a lot, but compounding adds up over
time.
The main advantage of CDs is their relative safety and the
ability to know your return ahead of time. You'll generally earn
more than in a savings account, and you won't be at the mercy of
the stock market. Plus, in the U.S. the Federal Deposit Insurance
Corporation guarantees your investment up to $100,000.
Despite the benefits, there are two main disadvantages to CDs.
First of all, the returns are paltry compared to many other
investment. Furthermore, your money is tied up for the length of
the CD and you won't be able to get it out without paying a harsh
penalty.
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.
Being securities in the form of promissory notes, transfer of
title is easy, by endorsement and delivery. Further, they are
governed by the Negotiable Instruments Act. As these certificates
are the liabilities of commercial banks/financial institutions,
they make sound investments.
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 can be issued to individuals, corporations, companies,
trusts, funds, associates, etc.
NRIs can subscribe to CDs on non-repatriable basis.
CDs attract stamp duty as applicable to negotiable
instruments.
Banks have to maintain SLR and CRR on the issue price of CDs. No
ceiling on the amount to be issued.
The minimum issue size of CDs is Rs.5 lakhs and multiples
thereof.
CDs are transferable by endorsement and delivery.
The minimum lock-in-period for CDs is 15 days.
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.
3) Commercial Papers:Commercial paper is a short-term unsecured
promissory note issued by corporations and foreign governments for
many large, creditworthy issuers. Commercial paper is a low-cost
alternative to bank loans. Issuers are able to efficiently raise
large amounts of funds quickly and without expensive Securities and
Exchange Commission (SEC) registration by selling paper, either
directly or through independent dealers, to a large and varied pool
of institutional buyers. Competitive, market-determined yields in
notes whose maturity and amounts can be tailored to specific needs,
can be earned by investors in commercial paper.
Commercial paper has become one of America's most important debt
markets, because of the advantages of commercial paper for both
investors and issuers. Commercial paper outstanding grew at an
annual rate of 14 percent from 1970 to 1991. Commercial paper
totaled $528 billion at the end of 1991.
This chapter describes some of the important features of the
commercial paper market. The first section reviews the
characteristics of commercial paper. The second section describes
the major participants in the market, including the issuers,
investors, and dealers. The third section discusses the risks faced
by investors in the commercial paper market along with the
mechanisms that are used to control these risks. The fourth section
discusses some recent innovations, including asset-backed
commercial paper, the use of swaps in commercial paper financing
strategies, and the international commercial paper markets.
For many corporations, borrowing short-term money from banks is
often a laborious and annoying task. The desire to avoid banks as
much as possible has led to the widespread popularity of commercial
paper. (See Why do companies issue bonds instead of borrowing from
the bank?)
Commercial paper is an unsecured, short-term loan issued by a
corporation, typically for financing accounts receivable and
inventories. It is usually issued at a discount, reflecting current
market interest rates. Maturities on commercial paper are usually
no longer than nine months, with maturities of between one and two
months being the average.
For the most part, commercial paper is a very safe investment
because the financial situation of a company can easily be
predicted over a few months. Furthermore, typically only companies
with high credit ratings and credit worthiness issue commercial
paper. Over the past 40 years, there have only been a handful of
cases where corporations have defaulted on their commercial paper
repayment.
Commercial paper is usually issued in denominations of $100,000
or more. Therefore, smaller investors can only invest in commercial
paper indirectly through money market funds.
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 securitization 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.
Commercial Papers - Salient Features CPs are issued by companies
in the form of usance promissory note, redeemable at par to the
holder on maturity.
The tangible net worth of the issuing company should be not less
than Rs.4 crores.
Working capital (fund based) limit of the company should not be
less than Rs.4 crores.
Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2
or higher from any approved rating agencies and should be more than
2 months old on the date of issue of CP.
Corporates are allowed to issue CP up to 100% of their fund
based working capital limits.
It is issued at a discount to face value.
CP attracts stamp duty.
CP can be issued for maturities between 15 days and less than
one year from the date of issue.
CP may be issued in the multiples of Rs.5 lakh.
No prior approval of RBI is needed to issue CP and underwriting
the issue is not mandatory.
All expenses (such as dealers' fees, rating agency fee and
charges for provision of stand-by facilities) for issue of CP are
to be borne by the issuing company,
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 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.
Commercial Paper policy changes:
Jan 1990July1990July1991July1992June
1994July1995Sep.1996Feb.1997Oct.2000Oct.2004
Tangible Net Worth10 Crore5 Crore--4 Crore-----
WCFBL*25 Crore15 Crore10 Crore5 Crore4 Crore-----
Minimum Size1 Crore50 Lakh25 Lakh-----5 Lakh-
Maximum Size20% of MPBF**-30% of MPBF75% of MPBF-75% of Cash
Credit Compone nt100% of Cash Credit Compone nt100% of WCFBLShould
not exceed WCFBL-
Denominations25 Lakh10 Lakh5 Lakh-----5 Lakh-
Maturity Period91days - 6 months---3 months 1year---15 days 1
year7days - One Yr.
Credit RatingP1+ by CRISIL or Equal grade by other
agencies-P2-----
Other Measures
4) Bills of Exchange: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).
With a view to eliminating movement of papers and facilitating
multiple rediscounting, the RBI introduced an innovative instrument
known as "Derivative Usance Promissory Notes" backed by such
eligible commercial bills for required amounts and usance period
(up to 90 days). Government has exempted stamp duty on derivative
usance promissory notes. This has indeed simplified and streamlined
the bill rediscounting by Institutions and made commercial bill an
active instrument in the secondary money market. Rediscounting
institutions have also advantages in that the derivative usance
promissory note, being a negotiable instrument issued by a bank, is
good security for investment. It is transferable by endorsement and
delivery and hence is liquid. Thanks to the existence of a
secondary market the rediscounting institution can further discount
the bills anytime it wishes prior to the date of maturity. In the
bill rediscounting market, it is possible to acquire bills having
balance maturity period of different days upto 90 days. Bills thus
provide a smooth glide from call/overnight lending to short term
lending with security, liquidity and competitive return on
investment. As some banks were using the facility of rediscounting
commercial bills and derivative usance promissory notes for as
short a period as one day merely a substitute for call money, RBI
has since restricted such rediscounting for a minimum period of 15
days.
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.
DFHI trades in these instruments by rediscounting Derivative
Usance Promissory Notes (DPNs) drawn by commercial banks. DPNs
which are sold to investors may also be purchased by DFHI.
Derivative Usance Promissory Notes"(DUPN)
IT is an innovative instrument issued by the RBI to eliminate
movement of papers and facilitating easy rediscounting. DUPN is
backed by up to 90 days Usance commercial bills. Government has
exempted stamp duty on DUPN to simplify and steam-line the
instrument and to make it an active instrument in the secondary
market. The minimum rediscounting period is 15 days
Bill RediscountingThe 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 RediscountingThe 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
instruments5) Repurchase agreement (REPOS):Ready Forward Contracts
is short for repurchase agreement. Those who deal in government
securities use repos as a form of overnight borrowing. A dealer or
other holder of government securities (usually T-bills) sells the
securities to a lender and agrees to repurchase them at an agreed
future date at an agreed price. They are usually very short-term,
from overnight to 30 days or more. This short-term maturity and
government backing means repos provide lenders with extremely low
risk.
Repos are popular because they can virtually eliminate credit
problems. Unfortunately, a number of significant losses over the
years from fraudulent dealers suggest that lenders in this market
have not always checked their collateralization closely enough.
There are also variations on standard repos:
Reverse Repo - The reverse repo is the complete opposite of a
repo. In this case, a dealer buys government securities from an
investor and then sells them back at a later date for a higher
price
Term Repo - exactly the same as a repo except the term of the
loan is greater than 30 days.
Ready forward or Repos or Buyback deal is a transaction in which
two parties agree to sell and repurchase the same security. Under
such an arrangement, the seller sells specified securities with an
agreement to repurchase the same at a mutually decided future date
and a price. Similarly, the buyer purchases the 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.
Internationally, Repos are versatile instruments and used
extensively in money market operations. While inter-bank Repos were
being allowed prior to 1992 subject to certain regulations, there
were large scale violation of laid down guidelines leading to the
'securities scam' in 1992; this led Government and RBI to clamp
down severe restrictions on the usage of this facility by the
different market participants. With the plugging of loophole in the
operation, the conditions have been relaxed gradually.
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.
6) Banker's Acceptance: A bankers acceptance, or BA, is a time
draft drawn on and accepted by a bank. Before acceptance, the draft
is not an obligation of the bank; it is merely an order by the
drawer to the bank to pay a specified sum of money on a specified
date to a named person or to the bearer of the draft. Upon
acceptance, which occurs when an authorized bank employee stamps
the draft "accepted" and signs it, the draft becomes a primary and
unconditional liability of the bank. If the bank is well known and
enjoys a good reputation, the accepted draft may be readily sold in
an active market.A bankers' acceptance (BA) is a short-term credit
investment created by a non-financial firm and guaranteed by a bank
to make payment. Acceptances are traded at discounts from face
value in the secondary market.
For corporations, a BA acts as a negotiable time draft for
financing imports, exports or other transactions in goods. This is
especially useful when the creditworthiness of a foreign trade
partner is unknown.
Acceptances sell at a discount from the face value:
Face Value of Banker\'s Acceptance $1,000,000
Minus 2% Per Annum Commission for One Year -$20,000
Amount Received by Exporter in One Year $980,000
One advantage of a banker's acceptance is that it does not need
to be held until maturity, and can be sold off in the secondary
markets where investors and institutions constantly trade BAs.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.7) Euro Dollars:Eurodollars are bank deposit liabilities
denominated in U.S. dollars but not subject to U.S. banking
regulations. Banks that offered Eurodollar deposits were located
outside the United States. However, since late 1981 non-U.S.
residents have been able to conduct business, free of U.S. banking
regulations at International Banking Facilities (IBFs) in the
United States. Eurodollar deposits may be owned by individuals,
corporations, or governments from anywhere in the world, with the
exception that only non-U.S. residents can hold deposits at
IBFs.
Originally, dollar-denominated deposits, not subject to U.S.
banking regulations were held almost exclusively in Europe; hence,
the name Eurodollars. Most of these deposits are still held in
Europe, but they also are held at U.S. IBFs and in such places as
the Bahamas, Bahrain, Canada, the Cayman Islands, Hong Kong, Japan,
the Netherlands Antilles, Panama, and Singapore. Regardless of
where they are held, such deposits are referred to as
Eurodollars.
Banks in the Eurodollar market, including U.S. IBFs, compete
with banks in the United States to attract dollar-denominated
funds. Since the Eurodollar market is relatively free of
regulation, banks in the Eurodollar market are able to operate on
narrower margins or spreads between dollar borrowing and lending
rates than can banks in the United States. This gives Eurodollar
deposits an advantage relative to deposits issued by banks
operating under U.S. regulations. The Eurodollar market has grown
largely as means of avoiding the regulatory costs involved in
dollar-denominated financial intermediation.
Contrary to the name, euro dollars have very little to do with
the euro or European countries. Eurodollars are U.S.-dollar
denominated deposits at banks outside of the United States. This
market evolved in Europe (specifically London), hence the name, but
euro dollars can be held anywhere outside the United States.
The euro dollar market is relatively free of regulation;
therefore, banks can operate on narrower margins than their
counterparts in the United States. As a result, the euro dollar
market has expanded largely as a way of circumventing regulatory
costs.
The average euro dollar deposit is very large (in the millions)
and has a maturity of less than six months. A variation on the euro
dollar time deposit is the euro dollar certificate of deposit. A
euro dollar CD is basically the same as a domestic CD, except that
it's the liability of a non-U.S. bank. Because euro dollar CDs are
typically less liquid, they tend to offer higher yields.
The euro dollar market is obviously out of reach for all but the
largest institutions. The only way for individuals to invest in
this market is indirectly through a money market fund.
8) Bonds:An interest-bearing certificate of debt, being one of a
series constituting a loan made to, and an obligation of, a
government or business corporation; a formal promise by the
borrower to pay to the lender a certain sum of money at a fixed
future day with or without security, and signed and sealed by the
maker (borrower); a promise to pay a principal amount on a stated
future date and a series of interest payments, usually semiannually
until the stated future date; "all subdivided interest-bearing
contracts for the future payment of money that are drawn with
formality whether they are secured or unsecured, whether the
interest is imperative under all conditions, or not, as in the case
of income bonds" (L. Chamberlain, The Principles of Bond
Investment).The difference between a bond and promissory note is
aptly explained by F.A. Cleveland (Funds and Their Uses) as
follows:
The only way that a bond is distinguished from an ordinary
promissory note is by the fact that it is issued as part of a
series of like tenor and amount, and, in most cases, under a common
security. By rule of common law the bond is also more formal in its
execution. The note is a simple promise (in any form, so long as a
definite promise for the payment of money appears upon its face),
signed by the party bound, without any formality as to witnesses or
seal. The bond, on the other hand, in its old common-law form,
required a seal and had to be witnessed in the same manner as a
deed or other formal conveyance of property, and though assignable
was not negotiable. This is still the rule with many
jurisdictions.
A bond differs from an investment note only in the time which it
has to run before maturity. Ordinarily the deviding line is five
years; if the term of the funded debt exceeds this period, the
issue is called bonds; if within this period, notes.
A bond differs from a share of stock in that the former is a
contract to pay a certain sum of money with definite stipulations
as to amount and maturity of interest payments, maturity of
principal, and other recitals as to the rights of the holder in
case of default, sinking fund provisions, etc. A stock contains no
promise to repay the purchase price or any amount whatsoever. The
shareholder is an owner; a bondholder is a creditor. The bondholder
has a claim against the assets and earnings of a corporation prior
to that of the stockholder, and while the bondholder is an
investor, the stockholder speculates on the success of the
enterprise. The former's claim is a definite contractual one;the
latter's claim is contingent upon earnings.Chapter 7TREASURY BILLS
AND INFLATION CONTROL:Treasury Inflation-Protected Securities (or
TIPS) are the inflation-indexed bonds issued by the RBI Treasury.
These securities were first issued in 1997. The principal is
adjusted to the Consumer Price Index, the commonly used measure of
inflation. The coupon rate is constant, but generates a different
amount of interest when multiplied by the inflation-adjusted
principal, thus protecting the holder against inflation. TIPS are
currently offered in 5-year, 7-year, 10-year and 20-year
maturities. 30-year TIPS are no longer offered.
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,
Treasury bills are generally considered to be free of default
risk because they are obligations of the federal government. In
contrast, even the highest grade of other money market instruments,
such as commercial paper or certificates of deposit (CDs), is
perceived to have some degree of default risk. Concern over the
default risk of securities other than Treasury securities typically
increases in times of weak economic conditions, and this tends to
raise the differential between the rates on these securities and
the rates on Treasury bills of comparable maturity (discussed
below).
Because Treasury bills are free of default risk, various
regulations and institutional practices permit them to be used for
purposes that often cannot be served by other money market
instruments. For example, banks use bills to make repurchase
agreements free of reserve requirements with businesses and state
and local governments, and banks use bills to satisfy pledging
requirements on state and local and federal deposits. Treasury
bills are widely accepted as collateral for selling short various
financial securities and can be used instead of cash to satisfy
initial margin requirements against futures market positions. And
Treasury bills are always a permissible investment for state and
local governments, while many other types of money market
instruments frequently are not.
Liquidity
A second characteristic of bills is their high degree of
liquidity, which refers to the ability of investors to convert them
into cash quickly at a low transactions cost. Investors in Treasury
bills have this ability because bills are a homogeneous instrument
and the bill market is highly organized and efficient. A measure of
the liquidity of a financial asset is the spread between the price
at which securities dealers buy it (the bid price) and the price at
which they sell it (the asked price). In recent years the bid-asked
spread on actively traded bills has been 2 basis points or less,
which is lower than for any other money market instrument.
Taxes
Unlike other money market instruments, the income earned on
Treasury bills is exempt from all state and local income taxes. The
relationship between, say, the CD rate (RCD) and the bill rate
(RTB) that leaves an investor with state income tax rate t
indifferent between the two, other considerations aside, is
RCD(1 - t) = RTB.
From this formula it can be seen that the advantage of the
tax-exempt feature for a particular investor depends on (1) the
current level of interest rates and (2) the investor's state and
local tax rate. For an investor to remain indifferent between bills
and CDs, the before-tax yield differential (RCD - RTB) must rise if
the level of interest rates rises or if the investor's tax rate
increases. For example, the interest rate differential at which an
investor subject to a marginal state tax rate of 6 percent is
indifferent between CDs and bills rises from 32 basis points when
the Treasury bill rate is 5 percent to 64 basis points when the
bill rate is 10 percent. And with a 5 percent Treasury bill rate,
the interest rate differential at which an investor is indifferent
between CDs and bills rises from 32 basis points when the
investor's tax rate is 6 percent to 43 basis points when his tax
rate is 8 percent.
This characteristic of bills is relevant only for some
investors. Other investors, such as state and local governments,
are not subject to state income taxes. Still other investors, such
as commercial banks in many states, pay a "franchise" or "excise"
tax that in fact requires them to pay state taxes on interest
income from Treasury bills.
Minimum Denomination
A fourth investment characteristic of Treasury bills is their
relatively low minimum denomination. Prior to 1970, the minimum
denomination of bills was $1,000. In early 1970 the Treasury raised
the minimum denomination from $1,000 to $10,000. The Treasury made
this change in order to discourage noncompetitive bids by small
investors, reduce the costs of processing many small subscriptions
yielding only a small volume of funds, and discourage the exodus of
funds from financial intermediaries and the mortgage market.
Despite the increase in the minimum denomination of bills,
investors continued to shift substantial amounts of funds out of
deposit institutions into the bill market in periods of high
interest rates such as 1973 and 1974.
Chapter 8Conclusion: The money market specializes in debt
securities that mature in less than one year.
Money market securities are very liquid, and are considered very
safe. As a result, they offer a lower return than other
securities.
The easiest way for individuals to gain access to the money
market is through a money market mutual fund.
T-bills are short-term government securities that mature in one
year or less from their issue date.
T-bills are considered to be one of the safest investments -
they don't provide a great return.
A certificate of deposit (CD) is a time deposit with a bank.
Annual percentage yield (APY) takes into account compound
interest, annual percentage rate (APR) does not.
CDs are safe, but the returns aren't great, and your money is
tied up for the length of the CD.
Commercial paper is an unsecured, short-term loan issued by a
corporation. Returns are higher than T-bills because of the higher
default risk.
Banker's acceptances (BA)are negotiable time draft for financing
transactions in goods.
BAs are used frequently in international trade and are generally
only available to individuals through money market funds.
Eurodollars are U.S. dollar-denominated deposit at banks outside
of the United States.
The average eurodollar deposit is very large. The only way for
individuals to invest in this market is indirectly through a money
market fund.
Repurchase agreements (repos) are a form of overnight borrowing
backed by government securities.
Chapter 9AnnexureBIBILOGRAPHY
A) Reference Books:-
TITLE OF BOOK:- DYNAMICS OF INDIAN FINANCIAL SYSTEM
FINANCIAL SERVICE AND MARKET INDIAN FINANCIAL SYSTEM
BUSINESSW ENVIRONMENT
MONEY BANKING TRADE AND PUBLIC FINANCE
AUTHOR'S NAME:- BY - PREETY SINGHBY- BHARATI V. PATHAKBY-
DR.S.GURUSWAMYBY -FRANCIS CHERUNILAM
BY - D.M. MITTHANI
B) JOURNALS:-
E-DATA:-
WEBSITES:
www.rbi.org.in/weekly statistical supplement/various
issues.co.in
www.investopedia.com .
www.bseindia.com
www.nseindia.com
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