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IINNTTRROODDUUCCTTIIOONN TTOO MMOONNEEYY MMAARRKKEETT
A market where short-term funds are borrowed and lent is called
money market is a market for short-term financial assets, which arenear substitutes for money. The instruments dealt within the moneymarket are liquid and can be turned over quickly at low transaction costand without loss.
The money market comprises individuals, institutions, and thegovernment. These agencies create demand for money and also ensuresupply of money for a short-term period. The demand for moneyemanates from merchants, traders, brokers, manufacturers, speculatorsand even government institutions, the suppliers include commercial banks, insurance companies, nonbanking financial concerns and the
Central Bank of the country. Thus, the money market represents thecountrys pool of short-term investible funds to meet the short-term
requirements of the economy.
DEFINITION
1. According to the McGraw Hill Dictionary of ModernEconomics, Money market is the term designed to include thefinancial institutions which handle the purchase, sale, and transfers
of short-term credit instruments. The money market includes theentire machinery for the canalizing of borrowing, and governmentshort-term obligations; it differs from the long-term or capitalmarket which devotes its attention to dealings in bonds, corporatestocks and mortgage credit.
2. According to Geoffrey, money market is the collective namegiven to the various firms and institutions that deal in the variousgrades of the near-money.
3. According to the Reserve Bank of India, a money market is thecentre for dealings, mainly of short-term character in money
assets; it meets the short-term requirements of borrowers and provides liquidity or cash to the lenders. It is the place whereshort-term surplus investible funds at the disposal of financial andother institutions and individuals are bid by borrowers agentscomprising institutions and individuals and also the governmentitself.
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HHIISSTTOORRYY OOFF IINNDDIIAANN MMOONNEEYY MMAARRKKEETT
Till 1935, when the RBI was set up, the Indian money
market remained highly disintegrated, unorganized, narrow,
shallow and therefore, very backward. The planned economic
development that commenced in the year 1951 marked an
important beginning in the annals of the Indian money market.
The nationalization of banks in Group (1986), the setting up of
Discount and Finance House of India Ltd (1988), the Vaghulworking of India (1994) and the commencement of
liberalization and globalization process in 1991 gave a further
fillip for the integrated and efficient development of Indian
money market.
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IIMMPPOORRTTAANNCCEE && FFUUNNCCTTIIOONN OOFF MMOONNEEYY
MMAARRKKEETT
GENERAL CHARACTERISTIC
The general characteristics of a money market are outlined below:
1. Short-term funds are borrowed and lent.2. No fixed place for conduct of operations, the transactions being
conducted even over the phone and therefore there is an essential
need for the presence of well developed communications system.
3. Dealings may be conducted with or without the help ofbrokers.4. The short-term financial assets that are dealt in are close
substitutes for money, financial assets being converted into
money with ease, speed, without loss and with minimum
transactions cost.
5. Funds are traded for a maximum period of one year.6. Presence of a large number ofsubmarkets such as inter-bank call
money, bills rediscounting, treasury bills, etc.
OBJECTIVES
A well-developed money market serves the following objectives:
1. Providing an equilibrium mechanism for ironing out short-termsurplus and deficits.
2. Providing a focal point for central bank intervention forinfluencing liquidity in the economy.
3. Providing access to users of short-term money to meet theirrequirements at a reasonable price.
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IMPORTANCE
The functioning of an efficient money market in a country is helpful to its
various segments as detailed below:
SOURCE OF CAPITAL
Money market is an important source of financing for trade and industry.
The short-term finances are made available through bills, commercial
papers, etc. The happenings in the money market influence the
availability of finances both for the national and international trade.
Besides trade and industry, money market offers to the government an
important non-inflationary avenue of raising short-term funds throughbills that are subscribed by commercial banks and the public.
IDEAL INVESTMENT
Money market offers an ideal source of investment for the commercial
banks. The market helps them invest their short-term surplus funds so as
to meet statutory reserve requirements. For instance, the requirements of
Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) vary
every fortnight depending on banks Net Demand and Time Liability
(NDTL).
EFFECTIVE MONETARY MANAGEMENT
An efficient money market being sensitive in nature allows for the
effective implementation of monetary policy of the central bank and thus
paves way for the efficient monetary management of the country. In fact,
the money market events serve as an important guide to the government
in formulation, revising and implementing its monetary policy. This is
rightly so, given the fact that the conditions prevailing in money market
serve as an indicator of monetary state of an economy.
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The monetary authority uses the money market for diffusing the
effects of its actions throughout the banking system and the economy, so
as to promote economic growth with stability.
ECONOMIC DEVELOPMENT
Money market being an integral part of a countrys economy, contributes
substantially to the economic development of a country. A developed
money market is indispensable for the rapid development of the
economy. In fact, the stage of development of the economy will be
reflected in the stage of development of a money market. This is borne
out by the fact that ill-developed nature of a money market is responsiblefor the primitive nature of economic development of a country. The
absence of a well-developed money market would constrain the
economies from making available, on a continuous basis the supply of
adequate funds.
EFFICIENT BANKING SYSTEM
The existence of a developed money market greatly facilitates the smooth
and efficient functioning of the banking and financial system. Such an
advantage contributes to the promotion of trade and industry in the
economy. Further the mediating role played by the commercial bankers
ensures delivery of credit at the most opportune time. Similarly, money
market enables the commercial banks to meet much of their unexpected
needs for funds quickly and cheaply. It is possible for the commercial
banks to utilize their funds profitably and with liquidity.
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FACILITATING TRADE
Money market is of immense help to the business community in the
following ways:
1. Providing an ideal payment mechanism making it possible forexpeditious transfer of large sums of money.
2. Meeting the working capital requirements for carrying out theproduction and marketing activities.
3. Making efficient investment of surplus funds into near-moneyassets which can be quickly converted into money as and when
needed.
HELPFUL TO GOVERNMENT
The government uses the money market as an arena in which short-term
funds are raised by floating treasury bills. It helps the government
manage its monetary position smoothly through the central bank of the
county.
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GENERAL FUNCTIONS
Money market performs diverse functions within the banking system of
an economy, as discussed below:
INVESTMENT FUNCTION
The money market provides an ideal source for investment of the funds
for a short period of time for commercial banks, nonbanking financial
concerns, business corporations and other investors. It enables
businessmen, with temporary surplus funds, to invest them for a short
period.
FINANCING FUNCTION
Money market provides an ideal source for short-term financing for
businessmen, industrialists, traders, etc to meet their day-to-day
requirements of working capital. Funds are available for borrowing by the
government and its agencies also.
FACILITATING FUNCTION
Money market provides an ideal play ground for the central monetary
authority of the country to carry out various regulatory operations relating
to the banking and financial system of the country. The sensitive nature
of the money market helps the central bank to make it an ideal arena for
the execution of various credit control measures.
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TTYYPPEESS OOFF MMOONNEEYY MMAARRKKEETT IINNSSTTRRUUMMEENNTTSS
INSTRUMENTS
Traditionally when a borrower takes a loan from a lender, he enters into
an agreement with the lender specifying when he would repay the loan
and what return (interest) he would provide the lender for providing the
loan. This entire structure can be converted into a form wherein the loan
can be made tradable by converting it into smaller units with pro rata
allocation of interest and principal. This tradable form of the loan is
termed as a debt instrument.
Therefore, debt instruments are basically obligations undertaken by the
issuer of the instrument as regards certain future cash flows representing
interest and principal, which the issuer would pay to the legal owner of
the instrument. Debt instruments are of various types. The key terms that
distinguish one debt instrument from another are as follows:
Issuer of the instrument
Face value of the instrument
Interest rate
Repayment terms (and therefore maturity period/tenor)
Security or collateral provided by the issuer
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MONEY MARKET INSTRUMENTS:
By convention, the term "money market" refers to the market for short-
term requirement and deployment of funds. Money market instruments
are those instruments, which have a maturity period of less than one year.
The most active part of the money market is the market for overnight and
term money between banks and institutions (called call money) and the
market for repo transactions. The former is in the form of loans and the
latter are sale and buy back agreements both are obviously not traded.
The main traded instruments are commercial papers (CPs), certificates of
deposit (CDs) and treasury bills (T-Bills). All of these are discounted
instruments ie they are issued at a discount to their maturity value and the
difference between the issuing price and the maturity/face value is the
implicit interest. These are also completely unsecured instruments. One
of the important features of money market instruments is their high
liquidity and tradability. A key reason for this is that these instruments
are transferred by endorsement and delivery and there is no stamp duty or
any other transfer fee levied when the instrument changes hands. Another
important feature is that there is no tax deducted at source from the
interest component. A brief description of these instruments is as follows:
1. Certificate of Deposits2. Commercial Papers3. Treasury Bills4. Ready Forward Contracts ((Repos)5. Money Market Mutual Funds (MMMFs)
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CERTIFICATE OF DEPOSIT
Meaning of CDs
A marketable document of title to a time deposits for a specified period
may be referred to as a Certificate of Deposit (CD). It takes the form of
a receipt given by a bank or any other institution for funds deposited with
it by the depositor.
Features
Certificates of deposits process the following distinguishing
characteristics:
1. Negotiable instruments CDs are negotiable term-depositcertificates issued by commercial bank/financial institutions at
discount to face value at market rates. The Negotiable Instruments
Act governs CDs.
2. Maturity The maturity period of CDs ranges from 15 days to oneyear.
3.
Nature CDs are in the form of usance promissory notes and henceeasily negotiable by endorsement and delivery.
4. Ideal source CDs constitute a judicious source of investments asthese certificates are the liabilities of commercial banks/financial
institutions.
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PROFILE
A distinguishing profile of Certificate of Deposit as operating in India is
presented below:
THE TAMBE WORKING GROUP
The Tambe working Group set up in 1982 in India, reported that banks
and financial institutions were not willing to support the launch of money
market instruments such as CDs, and therefore advised against the
introduction of these instruments. The Group cited many reasons for the
non-popularity of these instruments including the absence of secondary
market, administered interest rate structure on bank deposits and thedanger of CDs giving rise to a large number of fictitious transactions.
THE VAGHUL WORKING GROUP
The Vaghul Working Group set up in 1987, again reviewed the issue and
expressed itself against the launch of the instrument by the RBI. The
Group reported that the introduction of CDs as a money market
instrument would be meaningful only where the short-term deposit rateswere aligned with other rates in the financial system. The Group instead
recommended, as a prelude, the setting up of a discount house and the
alignment of short-term deposit rates.
Based on the recommendations of the Group, the RBI constituted
the Discount and Finance House of India Ltd. (DFHI) in the year 1988. In
the same manner, RBI rationalized the interest rate structure in March
1989 by abolishing fixed deposits of shortest terms with maturity of 15 to
45 days.
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THE LAUNCH
The RBI launched the scheme of CDs with effect from March 27, 1989.
Following guidelines were laid down in this regard.
ELIGIBLE ISSUERS
The institutions that are eligible to issue CDs are scheduled commercial
banks (excluding RRBs) and specified all-India financial institutions,
namely, IDBI, IFCI, ICICI, SIDBI, IRBI, and EXIM bank.
ELIGIBLE SUBSCRIBERS
The parties who are eligible to buy CDs are individuals, associations,companies, corporations, trust funds, etc. NRI an also subscribe to the
CDs. How ere, this is possible only on a non-repatriation basis. It is not
possible for an NRI to endorse CDs to another NRI in the secondary
market.
NEGOTIATION
CDs are freely transferable by endorsement and delivery after the initial
lock in period of 15 days. The instrument can be purchased by any of
the above subscribers and DFHI in the secondary market.
MATURITY
The maturity period of CDs issued by banks ranges from 3 days to 12
months and that issued by specified financial institutions can have a
maturity period up to 3 years. With the announcement of credit policy on
April27, 2000 the maturity period was reduced from 3 month to 15 days.
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DISCOUNT
CDs are to be issued at a discount to face value, with the maturity period
not having any grace period.
LIMITS OF ISSUE
The maximum amount of issue by a bank, which was originally fixed at 1
percent of its fortnightly aggregate average deposits, was raised to 10
percent in 1992. This was subsequently abolished totally. The minimum
size of issue to a single investor, which was originally fixed at Rs.10
lakhs, was reduced to Rs. 5lakhs with effect from October 21, 1997. Issue
of CDs above Rs.5 lakhs can now be made in multiples of Rs.1 lakhs.CDs can now be CRR on issue price of CDs for which there is no ceiling.
STAMP DUTY
Stamp duty is payable on CDs as applicable to any other negotiable
instrument.
SECURITY PAPER
CDs are transferable by endorsement and delivery, and shall therefore be
issued on a good quality security paper.
OTHER REQUIREMENTS
1.No loans can be granted by banks against CDs.2. Banks cannot have any buyback arrangement of their own CDs
before maturity.
3. Banks are to submit fortnightly report on their CDs to the RBIunder section 42 of the RBI Act, 1935.
4. Banks are to show CDs under the head liabilities in the balancesheet.
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YIELD
CDs are offered at interest rates higher than the time deposits of banks.
However, the rate of interest is dependent upon many factors such as
urgency of requirement for funds, alterative opportunities for investment
of funds mobilized, etc. The rate of discount being deregulated is now
determined by the demand and supply of CDs. CDs are issued at a
discount to their face value and redeemed at par. CDs are issued at a
front-end discount and in such a case; the effective rate of interest is
higher than the quoted discount rate.
Effective rate of interest may be calculated as follows.ERRR= [(1+QDR/100*N/M) N/M-1]*100
Where,
ERR = Effective rate of interest
QDR = Quoted discount rate
N = Total period in a year. Say 12 months or 365 days etc
M = Maturity period in months or days as the case may be
ROLE OF DFHI
The Discount and Finance House of India Ltd. Functions as a market
maker in CDs market. It offers bid rate, the rate of discount at which it is
prepared to buy CDs, and offer rate at which it would be willing to sell
the CDs. The DFHI acts as an ideal conduit for disinvestments of CD
holdings, which is done through their banker in Mumbai. DFHI also
engages in buying CDs from the bank at its bid discount rate. Settlements
are effected through RBI cheque.
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ROLE OF BANKS
Scheduled commercial banks are the active players in the realm of CDs
market segment. CDs are used as an important money market instrument.
CDs provide an ideal avenue of investment money market instrument.
CDs provide ideal avenue of investment for bankers. CDs are considered
safe, liquid, and attractive in returns for both scheduled commercial bank
and investors.
It is not necessary for banks to encash CDs before maturity under
the RBI Act. Banks are under obligation to maintain usual reserve
requirements (SLR and CRR) on issue price of CDs. CDs offer the
opportunity for banks for the bulk mobilization of resources as part ofeffective fund management. Besides, offering an attractive yield help
bankers utilize them eligible assets for determination of Net Demand and
Time Liabilities (NDTL). According to the RBI guidelines, it will not be
possible for banks to enter into buyback arrangement with the subscriber
of CDs. Similarly, they cannot grant loans against CDs issued by them.
It is possible for investors to sell CDs in secondary market before
their maturity. This offers investors the advantage of liquidity through
ready marketability. However, the tendency on the part of holders of
CDs to hold the instruments till maturity date has not made possible for
the creation of an effective secondary market for them, although the
primary market for CDs has shown a considerable improvement.
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COMMERCIAL PAPER
Debt instrument that are issued by corporate houses for raising short-term
financial resources from the money market are called Commercial Papers
(CPs).
FEATURES
Following are the features of commercial papers:
NATURE
These are unsecured debts of corporate. They are issued in the form of
promissory notes. These are redeemable at par to the holder at maturity.
The issuing company should have a minimum tangible net worth to the
extent of Rs.4 crores. Moreover, the working capital (fund-based) limit of
the company should not be less than Rs. 4 crores and this allows
corporate to issue CPs up to 100 per cent of their fund based working
capital limits. CPs are issued at a discount to face value in multiples of
Rs.5 Lakhs. CPs attracts stamp duty. No prior approval of RBI is needed
to issue CP
s and no underwriting is mandatory. The issuing company hasto bear all expense (Such as dealers fees, rating agency fee and charges
for provision of stand-by facilities) relating to the issue of CP. The issue
of CPs serves the purpose of releasing the pressure on bank funds for
small and medium sized borrowers, besides allowing highly rated
companies to borrow directly from the market.
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MARKET
The market for the Cps comprises of issues made by public sector and
private sector enterprises CPs issued by top rated corporate are
considered as sound investments. Conditions attached to the issue are less
stringent than those applicable for raising CPs. Beginning from
September 1996, Primary Dealers (PDs) were also permitted by RBI to
issue CPs for augmenting their resources. This is one of the steps
initiated by the RBI to make the CPs market popular.
RATING
As per the guidelines of the RBI, CPs are required to be graded by the
organization issuing them. Accordingly, a rated CP is considered to be a
quality and sound instrument. With the liberalization of interest rate
structure, the rate of interest is market-determined. This causes wide
variation in the prevailing rates of interest.
INTEREST RATES
The rate of interest applicable to CP
s varies greatly. This variation isinfluenced by a large number of factors such as credit rating of the
instrument, economic phase, the prevailing rate of interest in CPs market,
call rates, the position in foreign exchange market, etc. It is however to be
noted that there is no benchmark for the interest rate.
MARKETABILITY
The marketability of the CPs is influenced by the rates prevailing in thecall money market and the foreign exchange market. Accordingly where
attractive interest rates prevail in these markets, the demand for Cps will
be affected. This is because; investors will divert their investment into
these markets.
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CPS IN LIEU OF WC
The nature of credit policy announced by the RBI to allows highly rated
corporate to have the advantage of banks offering an automatic
restoration of working capital limits on the repayment of CP.
Accordingly, short-term working capital loans were substituted with
cheaper CPs. This was done by the RBI to hasten the growth of the CP
market.
SATELLITE DEALERS (SDs)Dealers who are enlisted with the RBI to deal in the Government
securities market, are called Satellite Dealers. With effect from June 17,
1998, they are allowed to issue CPs, with prior approval from RBI. The
purpose was to enable them to have access to short-term borrowings
through CP route. Following are the conditions to be satisfied in this
regard:
RATING
In order that the satellite dealers are permitted to trade in CPs, it is
essential that the issuing corporate obtain the minimum specified credit
rating from a credit rating agency. Such a rating must have been approved
by the months.
MATURITY
The CPs shall be issued for a maturity period ranging from 15 days to one
year from the dated is issue.
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TARGET MARKET
The issue of CPs may be targeted to such persons as individuals, banks,
companies, other corporate bodies registered or incorporated in India and
unincorporated bodies and non-resident Indian (NRI) on non-repatriation
basis subject to the condition that it shall be transferable.
LIMITS OF ISSUE
Each issue of CPs (including renewal) shall be treated as a fresh issue.
The CPs issue may take place in multiples of Rs. 5 Lakhs. The
investment by any single investor shall be for a minimum amount of Rs.
25 Lakhs (face Value) and the secondary market transactions may be
dealt in for amounts of Rs. 5Lakhs or multiples thereof. The RBI shall fix
the total amount of issue. The issue amount shall be raised within a period
of 2 week from weeks from the date of approval by the Reserve Bank or
ma be issued on a single day or in parts on different days as the case may
be.
NATURE
The CPs shall be in the form of usance promissory note. It shall be
negotiable by endorsement and delivery. It is issued at discount to face
value, discount being determined by the SD issuing the CPs. The SDs
shall bear the expenses of the issue, including dealers fee, rating agency
fee, etc.
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TREASURY BILL
TREASURY BILLS (TBs)
A kind of finance bills, which are in the nature of promissory notes,
issued by the government under discount for a fixed period, not
exceeding one year, containing a promise to pay the amount stated
therein to the bearer of the instrument, are know as treasury bills.
GENERAL FEATURES
Treasury bills incorporate the following general features:
1.
Issuer TBs are issued by the government for raising short-termfunds from institutions or the public for bridging temporary gaps
between receipts (both revenue and capital) and expenditure.
2. Finance bills TBs are in the nature of finance bills because theydo not arise due any genuine commercial transaction in goods.
3. Liquidity TBs are not self-liquidating like genuine trade bills,although they enjoy higher degree of liquidity.
4. Vital source Treasury bills are an important source of raisingshort-term funds by the government.
5. Monetary management TBs serve as an important tool ofmonetary used by the central bank of the county to infuse liquidity
in to the economy.
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FEATURES OF INDIAN TBs
HISTORY
It was in the year 1877 that Treasury Bills (TBs) came to be issued for the
first time in the world. Later, it acquired wide popularity around the
world both in developing and developed countries. TBs were first issued
in India in October1971. The issue aimed at raising resources for
financing the First World War efforts of the government and for mopping
liquidity in the economy due to heavy war expenditure.
TBs that were initially sold by the government had a maturity
period of 3 months, 6 months, 9 months and 12 months. Later on, withthe setting up of the RBI in 1935, the issue profile of TBs underwent a lot
of changes. Accordingly, RBI came to issue two type of TBs such as Tap
Bills that were issued at all times and Intermediate Bill that were sold
between auctions, to nongoverment investors. However, in the year 1965,
a sale of TBs to public through auction was suspended and issue took
place on top basis at a discount. Thus commercial banks began to invest
in them.
ISSUE
TBs, which were first up to 1935 by the Government of India directly,
came to be issued by the RBI since its inception in 1935. Thereafter, TBs
are issued at a discount by the RBI on behalf of the Government of India.
TYPES
There are two types of treasury bills. They are ordinary treasury bills and
ad hoc treasury bills. The freely marketable treasury bills that are issued
by the Government of India to the public, banks and other institution for
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raising resources to meet the short-term finance needs takes the form of
ordinary TBs.
Ad hoc TBs, on the other hand, are issued in favor of the RBI only.
They are used by RBI as reserve against which the issue department issue
currency notes. In addition, they are also issue to serve the purpose of
replenishing cash balance of the central government. Besides, ad hoc TBs
provide an investment avenue to state government, semigoverment
department and foreign central banks for parking their temporary surplus
and for earning income. Since ad hoc TBs are not marketable in India, the
holders of these bills can always sell them back to the RBI.
MATURITY PERIOD
A lot of changes taken place in the realm of the periodicity of treasury
bills, changes having being brought about by the policy announcements
made by RBI from time to time. A brief account of the changes in the
period of maturity of TBs is outlined below:
1. Maturity period of TBs at the close of the First World War was of3, 6, 9, and 12 months duration.
2. Maturity periods of tap bills and Intermediate Bills introduces byRBI immediately after its inception was 91 days which was
continued up to November 1986.
3. Maturity period of 182 days recommended by ChakrabortyCommittee was issued up to April 1992.
4. Maturity period of 365 days beginning from April 1992.5. Maturity period of 14 days introduced in May 1997 and of 28 days
introduced on October21, 1997.
6. Maturity period of 182 days reintroduced with effect from May26,1999.
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PARTICIPANTS
The participants in the TBs market include the Reserve Bank of India, the
State Bank Of India, Commercial Banks, State Governments and other
approved bodies, Discounts and Finance House of India as a market
maker in TBs, the Securities Trading Corporation of India (STCI), other
financial institutions such as, LIC, UTI, GIC, NABRAD, IDBI, IFCI,
ICICI, etc corporate entities and general public and Foreign Institutional
Investors.
Of the above-mentioned participants, RBI and commercial banks
are the most popular players. This essentially arises from the nature of
relationship between them. TBs are least popular among the corporateentities and the general public.
THE ISSUE PROCEDURE
The procedure followed by the RBI for successful issue of treasury bills
is briefly outlined below.
NOTIFICATION The RBI issues notifications for the sale of
91day TBs on tap basis throughout the week and the 14-days,
28-days, 91-days, and 364-days, TBs through fortnightly
auction. The notification mentions the date of auction and the
last date for submission of tenders.
TENDERING Immediately after the issue of notification by
the RBI, investors are permitted to submit bids through separate
tenders. The result of the auction mentioning the price up to
which the bids have been accepted is displayed. The successful
bidders are expected to collect letter of acceptance from the RBI
and deposit the same together with a cheque on RBI.
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SGL SGL is maintained by the RBI for facilitating the
purchases and sales of TBs by the investors like Commercial
Banks, DFHI, STCI and other financial institutions.
DFHI WHERE the SGL facility is not available to certain
investors, purchase and sale takes DFHI. TBs sold to such
investors are held by DFHI on their behalf, which pays the
proceeds of the TBs held, to the investor on the date of
maturity. DFHI takes an active part in the primary auctions of
TBs, besides operating in the secondary market by quoting tow-way rates. In addition, the DFHI also gives buyback and sell-
back commitments for periods up to 14 days at negotiated
interest rates, to commercial banks, financial institutions and
public sector undertakings.
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AUCTIONING METHODS.
UNIFORM PRICE AUCTION
The system of uniform price auction system in respect of 97-days, TBs
was introduced as to broaden market participation. (Winners curse is a
phenomenon whereby those bidding at lower than the cut-off, end up
paying a premium.) The introduction of uniform price auction is expected
to reduce uncertainty associated with the bidding process. This is peculiar
to the underdeveloped nature of Indian money market, which is afflicted
by the lack of reliable information, causing wide differences in the yield
expectations before the auctions. The amounts of issue are notified in
respect of 97-days TBs auctions and the dated securities auctions.
TREASURY BILLS AUCTION
Auction in TBs takes place both on Competitive as well as on
noncompetitive basis. The State Governments, Provident Funds and the
Nepal Rastra Bank are the noncompetitive bidders. Commercial banks
and other financial institutions comprise competitive bidders. It is to be
noted that the merits of enhanced market efficiency and price discovery
take place through the competitive bids.
POLICY MEASURES
With a view to improving the depth and liquidity in the government
securities market, RBI announced the following policy measures relating
to Treasury Bills with effect from October1999:
1. Price based auction of government dated securities.2. Auction of 182-day Treasury Bills.3. A calendar of Treasury Bills Issuance
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TB RATE
The discount rate at which the RBI sells TBs known as Treasury Bills
rate. The effective yield on TBs depends on such factors as the rate of
discount, difference between the issue price and the redemption value,
and time period of their maturity.
The treasury bills rate is computed as follows:
Y= {[(FV-IP)/IP]*[364/MP]}*100.
Where,
FV = Face Value TBs
IP = Issue Price of TBsMP = Maturity Period of TBs in days
D = Discount.
BENEFITS
TBs being an important money market instruments provide the following
benefits:
LIQUIDITY
Treasury bills command high liquidity. A number of institutions such as
RBI, the DFHI, STCI, commercial banks, etc take part in the TB market.
In addition, the Central bank is always prepared to purchased or discount
TBs.
NO DEFAULT RISK
Since there is a guarantee by the central government, TBs are absolutely
free from the risk of default of payment by the issuer. Moreover, the
government itself issues the TBs.
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AVAILABILITY
RBI has the policy of making available on a steady basis, the TBs
especially through the Tap route since July 12, 1965. This greatly helps
banks and other institutions to park their funds temporarily in TBs.
LOW COST
Trading in TBs involves less transaction costs. This is because two-way
quotes with a fine margin are offered by the DFHI on a daily basis.
SAFE RETURN
The biggest advantage of TBs is that they offer a steady and sage returnto investors. There are not many fluctuations in the discount rate. It is
also possible for the investors to earn attractive return by keeping
investment in nonearning cash to the minimum and supplementing it with
TBs.
NO CAPITAL DEPRECIATION
Since TBs command high order of liquidity, safely and yield, there is
very little scope for capital depreciation in them.
SLR ELIGBILITY
TBs are of great attraction to commercial banks as it helps them park
their funds (Net Demand and Time Liabilities) as per the norms or SLR
announced b the RBI from time to time. This reason makes commercial
banks dominate dealers in TBs.
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FUNDS MOBILIZATION
TBs are used as an ideal tool by the government for raising short-term
funds required for meeting temporary budget deficit.
MONETARY MANAGEMENT
It is also possible for the government to mop up excess liquidity in the
economy through the issue of TBs. Since TBs are subscribed by the
investors other than the RBI, the issue would neither lead to inflationary
pressure nor result in monetization.
BETTER SPREAD
TBs facilitate proper spread of asset mix different maturity as they are
available on tap basis as well as in fortnightly auctions.
PERFECT HEDGE
TBs can be used as a hedge against volatility of call loan market and
interest rate fluctuations.
FUND MANAGEMENT
TBs serve as effective tools of fund management because of the
following reasons:
1. Ready market availability, both for sale and purchase at marketdriven prices, thus imparting flexibility.
2. Facility of rediscounting TBs on tap basis.3. Facility of refinancing from the RBI.4. Plethora of options available to fund managers to invest in TBs and
for raising funds against TBs especially through and with the help
of DFHI
5. Ideally suited for investment of temporary surplus
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6. Possibility of building up portfolio of TBs with dates of maturitiesmatching the dates of payment of liabilities, such as certificates of
deposits and deposits of short-term maturities.
7. Possibility of meeting the temporary difficulties of funds byentering into buyback transactions for surplus TBs and reversing
the transactions when the financial need is over
8. Possibility of making enhanced profit by indulging in quick raisingof money against TBs for investing in call money market when call
rates are high and doing the reverse when call rates dip.
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REPOS
The term Repo is used as an abbreviation for Repurchase Agreement or
Ready Forward. A Repo involves a simultaneous sales and repurchase
agreements.
A Repo works as follow as follows. Party A needs short-term funds
and Party B wants to make a short-term investment. Party A sells
securities to Party B at a certain price and simultaneously agrees to
repurchase the same after a specified time at a slightly higher price. The
difference between the sale price and repurchase price represent the
interest cost to Party A (the party doing the repo) and conversely the
interest income forParty B (the party doing the Reverse Repo). Reverse
Repos are a safe and convenient form of short-term investment.
BENEFITS & FEATURES
1. Interest Rate Being collateralized loans, repos help reducecounter party risk & therefore, fetch a low interest rate.
2. Contract The Repo contract provides the seller bank to getmoney by partying with its security and the buyer bank in turn to
get the security by parting with its money. It becomes a Reserve
Repo deal for the purchaser of the security. Securities are sold first
to a buyer bank and simultaneously another contract is entered in to
with buyer to repurchase them at a predetermine date and price in
future. The price of the sale and repurchase of securities is
determined before entering into deal.
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3. Safety Repo is an almost risk free instrument used to even outliquidity changes in the system. Repos offer short-term outlet for
temporary excess cash at close to the market interest rate.
4. Hedge tool As purchaser of the repo requires title to the securitiesfor the term of agreement and as the repurchase price is locked in
at a time of sale itself. It is possible to use repos as an effective
hedge-tool to arrange the others repos or to sell them outright or to
deliver them to another party to fulfill the delivery commitment in
respect of a forward or future contract or a short sale or a maturing
reveres repo.
5. Period The minimum period for Ready Forward Transaction Billwill be 3 day. However, RBI withdraws this restriction for the
minimum period with the effect from October 30, 1998.
6. Liquidity Control The RBI uses Repo as a tool of liquiditycontrol for absorbing surplus liquidity from the banking system in
a flexible way and thereby preventing interest rate arbitraging. All
Repo transaction are to be effected at Mumbai only and the deals
are to be necessary put through the subsidiary General Ledger
(SGL) account with the Reserve Bank of India.
7. Cash Management Tool The Repo arrangement essential servesas a short term cash management tool as the bank receive cash
from the buyer of the securities in return for the securities. This
helps the banker meet temporary cash requirement. This also
makes the repo a pure money lending operation. On the maturity of
the repos the security is purchased back by the seller bank from
the buyer-bank by returning the money to the buyer.
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MONEY MARKET MUTUAL FUNDS (MMMFS)
The Reserve Bank of India introduced the Money Market Mutual Funds
(MMMFs) scheme in April 1972. The schemes aim at providing
additional short-term avenues to individual investor in order to bring
Money Market Instrument within their reach. MMMFs are expected to be
more attractive to banks and financial institutions, ho would find them
providing greater liquidity and depth to the money market.
FEATURES
He Silent features of the MMMFs are as follows.
Eligibility
The MMMFs can be set up by schedule commercial banks and public
financial institution as define under section 4A of the companies Act,
1956, either directly or through their existing Mutual Funds / Subsidiaries
who are engaged in fund management. In addition, private sector Mutual
Funds may also set up MMMFs with the prior approval of RBI, subject to
fulfillment of certain terms and conditions. SEBIs clearance is requiredin the event of MMMFs being set up in the private sector.
Structure
MMMFs can be set up either as Money Market Deposit Accounts
(MMDAs) or Money Market Mutual Funds (MMMFs)
Size
There is no ceiling prescribed for the MMMFs for raising resources.
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Investors
The MMMFs are primary indented to serve as a vehicle for individual
investor to participate in the Money Market, the units / shares of MMMFs
can be issued only to individuals. In addition, individual Non Resident
Indian (NRIs) may also subscribe to the share / units of MMMFs. The
dividend / income on such subscription will be allowed to be repatriated,
through the principle amount of subscription will be allowed to be
repatriated, though the principal amount of subscription will not.
Minimum Size of Investment.
MMMFs would be free to determine the minimum size of the investmentby single investor. The investor cannot be guaranteed of a minimum rate
of return, the minimum lock-in period for the investment would be 46
days.
Investment by MMMFs
The resources mobilized by MMMFs should be invested exclusively in
the various money market instruments as listed below.
1. Treasury Bills and dated Government Securities having anunexpired maturity up to 1 year with no minimum limit
2. call / notice money with no maximum limit3. Commercial Paper with no maximum limit, the exposure to the
commercial paper issue by the individual company being limited to
3% of the resources of the MMMFs as the prudential requirement.
4. Commercial bills arising out of genuine trade / commercialtransactions and accepted / co-accepted by banks with no
maximum limits.
5. Certificate of deposit with no limit.
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Reserve Requirements
In the MMMFs set up by banks, the resources mobilized by them would
not to be considering part of their net demand, and time liabilities, and as
such would be free of any reserve requirement.
Stamp duty
The share / units issued by MMMFs would be subject to Stamp duty.
Regulatory Authority
RBI is the regulatory that gives the approval for the setting of MMMFs.
Beside this, banks their subsidiaries and public financial institution wouldalso be required to comply with the guidelines and directives that may be
issued by RBI from time to time for the setting and operation of MMMFs.
Similarly, the Private Sector MMMFs would need to clearance of SEBI,
as also approval of RBI.
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CCRREEDDIITT RRAATTIINNGG OOFF IINNSSTTRRUUMMEENNTT
Credit rating is the process of assigning standard scores which summarize
the probability of the issuer being able to meet its repayment obligations
for a particular debt instrument in a timely manner. Credit rating is
integral to debt markets as it helps market participants to arrive at quick
estimates and opinions about various instruments. In this manner it
facilitates trading in debt and money market instruments especially in
instruments other than Government of India Securities.
Rating is usually assigned to a specific instrument rather than the
company as a whole. In the Indian context, the rating is done at the
instance of the issuer, which pays rating fees for this service. If it is
unsatisfied with the rating assigned to its proposed instrument, it is at
liberty not to disclose the rating given to it. There are 4 rating agencies in
India. These are as follows:
CRISIL - The oldest rating agency was originally promoted by ICICI.
Standard & Poor, the global leader in ratings, has recently taken a small
10% stake in CRISIL.
ICRA - Promoted by IFCI. Moodys, the other global rating major, has
recently taken a small 11% stake in ICRA.
CARE - Promoted by IDBI.
Duff and Phelps - Co-promoted by Duff and Phelps, the worlds 4th
largest rating agency.
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CRISIL is believed to have about 42% market share followed by ICRA
with about 36%, CARE with 18% and Duff and Phelps with 4%.
Grading system
Eachof the rating agencies has different codes for expressing rating for
different instruments; however, the number of grades and sub-grades is
similar e.g. for long term debentures/bonds and fixed deposits, CRISIL
has 4 main grades and a host of sub grades. In decreasing order of quality,
these are AAA, AA+, AA, AA-, A+, A, A-, BBB-, BBB, BBB+, BB+,
BB, BB-, B+, B, B-, C and D. ICRA, CARE and Duff and Phelps have
similar grading systems. The following table contains a key to the codes
used by CRISIL and ICRA.
Credit rating is a dynamic concept and all the rating companies are
constantly reviewing the companies rated by them with a view to
changing (either upgrading or downgrading) the rating. They also have a
system whereby they keep ratings for particular companies on "rating
watch" in case of major events, which may lead to change in rating in the
near future. Ratings are made public through periodic newsletters issued
by rating companies, which also elucidate briefly the rationale for
particular ratings. In addition, they issue press releases to all major
newspapers and wire services about rating events on a regular basis.
Factors involved in credit rating
Credit rating depends on several factors, some of which are
tangible/numerical and some of which are judgmental and intangible.
Some of these factors are listed below:
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y Overall fundamentals and earnings capacity of the company andvolatility of the same
y Overall macro economic and business/industry environmenty Liquidity position of the company (as distinguished from profits)y Requirement of funds to meet irrevocable commitmentsy Financial flexibility of the company to raise funds from outside
sources to meet temporary financial needs
y Guarantee/support from financially strong external bodiesy Level of existing leverage (borrowings) and financial risk
As mentioned earlier ratings are assigned to instruments and not to
companies and two different ratings may be assigned to two different
instruments of the same company e.g. a company may be in a
fundamentally weak business and may have a poor rating assigned for 5
year debentures while its liquidity position may be good, leading to the
highest possible rating for a 3 month commercial paper. Very few
companies may be assigned the highest rating for a long term 5 or 7 year
instrument e.g. CRISIL has only 20 companies rated as AAA for longterm instruments and these companies include unquestionable blue chips
like Videsh Sanchar Nigam, Bajaj Auto, Bharat Petroleum, Nestle India
apart from institutions like ICICI, IDBI, HDFC and SBI.
Derived ratings and structured obligations
Sometimes, debt instruments are so structured that in case the issuer is
unable to meet repayment obligations, another entity steps in to fulfill
these obligations. Sometimes there is a documented, concrete mechanism
for recourse to the third party, while on other occasions the arrangement
is loose. On such occasions, the debt instrument in question is said to be
"credit enhanced" by a "structured obligation" and the rating assigned to
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the instrument factors in the additional safety mechanism. The extent of
enhancement is a function of the rating of the "enhancer", the nature of
the arrangement etc and usually there is a suffix to the rating which
expresses symbolically that the rating is enhanced e.g. A bond backed by
the guarantee of the Government of India may be rated AAA (SO) with
the SO standing for structured obligation.
Limitations of credit rating - rating downgrades
Rating agencies all across the world have often been accused of not being
able to predict future problems. In part, the problem lies in the rating
process itself, which relies heavily on past numerical data and standard
ratios with relatively lower usage of judgment and understanding of the
underlying business or the country economics. Data does not always
capture all aspects of the situation especially in the complex financial
world of today. An excellent example of the meaningless over reliance on
numbers is the poor country rating given to India. Major rating agencies
site one of the reasons for this as the low ratio Indias exports to foreign
currency indebtedness. This completely ignores two issues firstly, India
gets a very high quantum of foreign currency earnings through
remittances from Indians working abroad and also services exports in the
form of software exports which are not counted as "merchandise"
exports. These two flows along with other "invisible" earnings accounted
for almost US$11bn in FY 99. Secondly, since India has tight control on
foreign currency transactions, there is very little error possible in the
foreign currency borrowing figure. As against this, for a country like
Korea, the figure for foreign currency borrowing increased by US$50bn
after the exchange crisis began. This was on account of hidden forward
liabilities through swaps and other derivative products.
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In general, Indian rating agencies have lost some amount of their
credibility in the last two years due to their inability to predict defaults in
many companies, which they had rated quite highly. Sometimes, some of
the agencies had an investment grade rating in place when the company
in question had already defaulted to some of the fixed deposit holders.
Further, rating agencies resorted to mass downgrading of 50-100
companies as a reaction to public criticism, which further eroded their
credibility. The major reasons for these downgrades are as follows
Corporate earnings fell very sharply due to persistent recessionary
conditions prevailing in the economy. Many of the corporate are in
commodity sectors where fluctuations in selling prices of products can be
very sharp - leading to complete erosion of profitability. This problem
was compounded by the Asian crisis, which led to increased competition
from cheap imports in many product categories.
Rating agencies substantially overestimated financial flexibility of
corporate especially from traditional corporate houses. Much of the
financial flexibility was implicit on raising money from new issues from
the capital market, which has been impossible in the last 3 years.
In the case of finance companies, widespread defaults like CRB and
tightening of regulations made it virtually impossible for them to raise
money in any form. These finance companies had been in the habit of
investing in longer term, illiquid assets by borrowing shorter term fixed
deposits. When the flow of credit stopped, they faced liquidity problems.
These were further compounded by defaults by some of the companies to
which they had on lent money.
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The experience is no different from the international scenario where
reputed and highly experienced rating agencies like Standard & Poor
(S&P) and Moodys were unable to predict the Asian crisis and had to
face the embarrassment of seeing the credit rating of South Korea as a
country go from A+ to BB+ in a short span of 3 months.
By and large, the rating is a very good estimate of the actual
creditworthiness of the company; however, it is not able to predict
extreme situations such as the ones described above, which are unlikely
to have been predicted by most investors in any case. Investors should
realize that a credit rating is not sacrosanct and that one has to do ones
own due diligence and investigation before investing in any instrument.
They should use the rating as a reference and a base point for their own
effort. One good way of doing this is examining the behavior of the stock
price in case the stock is listed. As a collective, the market is far smarter
at predicting problems than any credit rating agency. Witness the sharp
erosion in stock prices of companies much before their credit ratings were
downgraded. Witness also the fact that foreign currency bonds fromIndian issuers trade at yields lower than countries which have been rated
higher by rating agencies.
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SSIIMMIILLAARRIITTIIEESS && DDIIFFFFRREENNCCEE BBEETTWWEEEENN
CCAAPPIITTAALL MMAARRKKEETT IINNSSTTRRUUMMEENNTT && MMOONNEEYY
MMAARRKKEETT IINNSSTTRRUUMMEENNTT
SIMILARITIES OF CAPITAL MARKET
INSTRUMRNT & MONEY MARKET INSRUMENT
In many respects, both money market and capital markets exhibit similar
characteristics as specified below.
1. TRANSFER OF RESOURCES TRANSFER of resources takes placefrom surplus units to deficit units both in money market and capital
market.
2. COMMERCIAL BANKS Commercial banks provide both short-term and long-term finance and therefore, take an active part in the
money market as well as capital market.
3. LIQUIDITY ADJUSTMENT Nonbanking financial institution andspecial financial institutions approach money and capital markets
to a limited degree in order to adjust their liquidity positions.
Besides, financial institutions operate on both sides of the market,
borrowing and lending and participate in both money and capital
market.
4. FLOW OF FUNDS As lenders and borrowers of funds have accessto both capital and money market, there is a substantial flow of
funds between capital and money markets.
5. PREFERENCE FOR INVESTORS Preference is available for mostof the suppliers of funds operate in both the markets, as investors
simultaneously invest in various investment avenues such as
savings bank, units, fixed deposits, national saving certificate
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schemes, life insurance, government and industrial securities, real
estate, bullion, etc
6. INTEREST RATES THERE is an interdependency of short and long-term rates of interest. This is because, rise in interest rate in money
make influence long-term interest rates also.
DIFFRENCE BEWTEEN CAPITAL MARKET
INSTRUMRNT & MONEY MARKET INSRUMENT
Sl
No.
Point of
Difference
Capital market
Instrument
Money Market
Instrument
1. Term of
finance
Provides long-term funds Provides short-term funds
2. Nature of
Capital
Capital used for fixed and
working capital needs
Capital usually used for
working capital needs
3. Main
Function
Mobilization and effective
utilization through lending
Lending and borrowing to
facilitate liquidity
adjustment
4. Main
Constituent
Primary and secondary
markets, with stock
exchange acting as a
bridge for buying and
selling of securities
Call money market,
treasury bills market,
commercial bills market,
market for Certificate of
Deposit & Commercial
Paper, etc
5. Link Acts as a link between
investor & entrepreneur
Act as a link between
depositor and borrower
6. Underwriting It is a primary function Not a primary function
7. Institution Investment house and Commercial banks and
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mortgage banks discount house
8. Development
Assistance
Provided to central and
state governments, public
and local bodies, etc
Provided to government
by discounting treasury
bills etc.9. Negotiation Funds are lent after a
prolonged negotiation
between lending financial
institution and the
borrowing corporate entity
Dealing can take place
without any personal
contact and negotiation
are not formal
10. Market Place Dealings are conducted
through the mechanism of
stock exchanges
Dealing are conducted
through the over-the-
phone-market
11. Claims Bonds & Shares Financial claims, assets,
and securities
12. Risk High credit & market risk Low credit & market risk
13. Price
Fluctuations
High Not much
14. Liquidity Low High
15. Regulator Besides central bank,
Special regulatory
authority like SEBI, etc
Central Bank
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EEXXEECCUUTTIIVVEE SSUUMMMMAARRYY
Debt Instruments which have a maturity of less than one year at the time
of issue are called money market instrument. These instruments are
highly liquid and have negligible risk. The major money market
instruments are Treasury Bills, Certificate of Deposit, Commercial Paper,
Money market Mutual Fund, & Repos. The money market is dominated
by the Government, financial institutions, banks, and corporate.
Individual investors scarcely participate in the money market directly. A
brief description of money market instruments is given below.
Treasury Bills (TBs)-:
Treasury bills are the most important money market instrument. They
represent the obligation of the Government of India which has a primary
tenor like 91 days and 364 days. They are sold on an auction basis every
week in certain minimum denominations by the Reserve Bank of India.
They do not carry an explicit interest rate. Instead, they are sold at a
discount and redeemed at par. Hence the implicit yield of a Treasury bill
is a function of the size of the discount and the period of maturity.
Though the yield on Treasury bills is somewhat low, yet they have
an appeal for the following reasons: (a) These can be transacted readily
and there is a very active secondary market for them. (b) Treasury bills
have nil credit risk and negligible price risk.
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Certificate of Deposit (CDs) -:
Certificate of Deposits (CDs) represent short-term deposits which are
transferable from one party to another. Banks and financial institution are
the major issuers of CDs. The principal investors in CDs are banks,
financial institutions, corporate, and mutual funds. CDs are issued in
either bearer or registered form. They generally have a maturity of 3
months to one year. CDs carry a certain interest rate.
CDs are a popular form of short-term investment for companies for
the following reasons: (i) Banks are normally willing to tailor the
denominations and maturities to suit the needs of the investors. (ii) CDs
are generally risk-free. (iii) CDs generally offer a higher rate of interest
than Treasury bills or term deposits.
Commercial Paper (CPs) -:
A commercial paper represents short-term unsecured promissory note
issued by firms that are generally considered to be financially strong. A
commercial paper usually has a maturity period of 90 to 180 days. It is
sold at a discount and redeemed at par. Hence the implicit rate is a
function of the size of discount and the period of maturity.
Money Market Mutual Funds (MMMFs) -:
The Reserve Bank of India introduced the Money Market Mutual Funds
(MMMFs) scheme in April 1972. The schemes aim at providing
additional short-term avenues to individual investor in order to bring
Money Market Instrument within their reach. MMMFs are expected to be
more attractive to banks and financial institutions, ho would find them
providing greater liquidity and depth to the money market.
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Repos -:
A Repo works as follow as follows. Party a needs short-term funds and
Party B wants to make a short-term investment. Party A sells securities to
Party B at a certain price and simultaneously agrees to repurchase the
same after a specified time at a slightly higher price. The difference
between the sale price and repurchase price represent the interest cost to
Party A (the party doing the repo) and conversely the interest income for
Party B (the party doing the Reverse Repo). Reverse Repos are a safe and
convenient form of short-term investment.
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BBIIBBLLIIOOGGRRAAPPHHYY
www.google.com
www.rbi.org.in
www.calypso.com
www.yahoo.com
The Economic Times
Financial Services & Markets ( Reference book)
- Dr. Gurusamy
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