Money Market & Money Market Instruments

Money Market The market where money and highly liquid marketable securities are bought and sold having a maturity period of one or less than one year The highly liquid marketable securities are also called as ‘ money market instruments’ like treasury bills, commercial paper etc The major player in the money market -Reserve Bank of India (RBI) - Discount and Finance House of India (DFHI) -Banks -Financial institutions -Government -Big corporate houses The basic aim of dealing in money market instruments is to fill the gap of short-term liquidity problems or to deploy the short-term surplus to gain income on that.

Definition of Money Market According to the Reserve Bank of India, “money market is the centre for dealing, mainly of short term character, in money assets; it meets the short term requirements of borrowings 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’ agents comprising institutions and individuals and also the government itself.”

Objectives of Money Market Providing an equilibrium mechanism for ironing out short-term surplus and deficits Providing a focal point for central bank intervention for the influencing liquidity in the economy Providing access to users of short-term money to meet their requirements at a reasonable price

Characteristics of Money Market Short-term funds are borrowed and lent No fixed place Dealings conducted with or without the help the brokers Financial assets being converted into money with ease, speed, without loss and with minimum transaction cost Trading period - maximum one year Presence of a large number of submarkets such as inter-bank call money, bill rediscounting, and treasury bills, etc

The Role of the Reserve Bank of India in the Money Market The most important constituent of the money market The market comes within the direct preview of the Reserve Bank of India regulations. The aims of the Reserve Bank’s operations in the money market are: - To ensure that liquidity and short term interest rates are maintained at levels consistent with the monetary policy objectives of maintaining price stability. -To ensure an adequate flow of credit to the productive sector of the economy -To bring about order in the foreign exchange market

The Reserve Bank of India influence liquidity and interest rates through a number of operating instruments - Cash reserve requirement (CRR) of banks -Conduct of open market operations (OMOs) -Repos -Change in bank rates and at times - Foreign exchange swap operations

Money Market Instruments Investment in money market is done through money market instruments Money market instrument meets short term requirements of the borrowers and provides liquidity to the lenders

Types of instruments Treasury Bills Commercial Paper Certificate of Deposits Banker's Acceptance Call Money Market

Treasury Bills Short-term instrument Issued by the Reserve Bank on behalf of the government to tide over short-term liquidity shortfalls. Used by the government to raise short-term funds to bridge seasonal or temporary gaps between its receipt (revenue and capital) and expenditure. Form the most important segment of the money In other words, T-Bills are short term (up to one year) borrowing instruments of the Government of India which enable investors to park their short term surplus funds while reducing their market risk

T-bills are repaid at par on maturity Discount Tax deducted at source (TDS) is not applicable

Features of T-bills Negotiable securities Highly liquid as they are of shorter tenure and there is a possibility of an interbank repos on them. Absence of default risk They have an assured yield, low transaction cost, and are eligible for inclusion in the securities for SLR purpose

They are not issued in scrip form. The purchases and sales are affected through the subsidiary general ledger (SGL) account. T-Bills are issued in the form of SGL entries in the books of Reserve Bank of India to hold the securities on behalf of the holder. The SGL holdings can be transferred by issuing a SGL transfer form

Types of Treasury Bills 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, RBI issues T-Bills for three different maturities : -91 days - weekly auction basis -182 days - auction is held on Wednesday preceding non- reporting Friday -364 days - Wednesday preceding the reporting Friday No treasury bills issued by State Governments

Advantages of investing in T-Bills: No Tax Deducted at Source (TDS) Zero default risk as these are the liabilities of GOI Liquid money Market Instrument Active secondary market thereby enabling holder to meet immediate fund requirement

Amount Available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000 Also issued under the Market Stabilization Scheme (MSS) Available in both Primary and Secondary market

Participants in the T-bills market The Reserve Bank of India Mutual funds Financial institutions Primary dealers Satellite dealers Provident funds Corporate Foreign banks Foreign institutional The sale government can invest their surplus funds as non-competitive bidders in T-bills of all maturities.

CUT-OFF YIELDS T- bills are issued at a discount and are redeemed at par The implicit yield in the T- bill is the rate at which the issue price (which is the cut-off price in the auction) has to be compounded, for the number of days to maturity, to equal the maturity value.

Types of auctions of T-bills There are two types of auctions: -Multiple-price auction -Uniform-price auction

Commercial Paper A short term, unsecured promissory notes which are issued at discount to face value by well known companies, banks and corporations that are financially strong and enjoy a high credit rating. Delivery Fixed maturity period Used to meet short term financial needs

Maturity period - maximum of 9 months Introduced into the Indian money market during the year 1990 A popular debt instrument of the corporate world - Very safe instruments cause the financial situation of the corporation can be anticipated over a few months

Features of Commercial Paper Negotiable by endorsement and delivery - Flexible as well as liquid instruments Can be issued with varying maturities as required by the issuing company Unsecured instruments as they are not backed by any assets of the company which is issuing the commercial paper Can be sold either directly by the issuing company to the investors or else issuer can sell it to the dealer who in turn will sell it into the market Helps the highly rated companies to get cheaper funds from commercial paper rather than borrowing from the banks

Advantages of Commercial Paper High credit ratings fetch a lower cost of capital Wide range of maturity provide more flexibility It does not create any lien on asset of the company Tradability of Commercial Paper provides investors with exit options

Amount Commercial Papers can be issued in denominations of Rs.5 lakh or multiples thereof

Participants Commercial paper is issued by a wide variety of domestic and foreign firms Financial companies - biggest issuers Banks Industrial firms

RBI guidelines for issue of Commercial paper A corporate can issue Commercial Paper if: Its tangible net worth is not less than Rs.5 crores as per latest balance sheet Working capital limit is obtained from banks/ all India financial institutions Its borrowal account is classified as standard asset by banks/ all India financial institutions

Credit rating should be obtained by all eligible participants in cp issue from the specified credit rating agencies like CRISIL, ICRA, CARE, and FITCH each commercial paper shall have the same maturity date Commercial paper can be subscribed by individuals, banking companies, corporate, NRIs and FIIs It can be issued either in the form of a promissory note or in a dematerialised form

Certificate of Deposits Certificate of deposit are unsecured, negotiable, short-term instruments in bearer form, issued by commercial banks and development financial institutions. The scheme of certificates of Deposits (CDs) was introduced by RBI as a step towards deregulation of interest rates on deposits. Under this scheme, any scheduled commercial banks, co-operative banks excluding land development banks, can issue certificate of deposits for a period of not less than three months and upto a period of not more than one year. Certificate of deposits, can be issued within the period prescribed for any maturity.

Certificates of Deposits (CDs) are short-term borrowings by banks. Certificates of deposits differ from term deposit because they involve the creation of paper, and hence have the facility for transfer and multiple ownerships before maturity. Certificate of deposits rates are usually higher than the term deposit rates, due to the low transactions costs. Banks use the certificates of deposits for borrowing during a credit pick-up, to the extent of shortage in incremental deposits. Most certificates of deposits are held until maturity, and there is limited secondary market activity.

RBI guidelines for issue of Certificate of Deposit Certificate of deposits can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs) (ii) select all-India Financial Institutions that have been permitted by RBI to raise short -term resources within the umbrella limit fixed by RBI Banks have the freedom to issue certificate of deposits depending on their requirements. An FI may issue certificate of deposits within the overall umbrella limit fixed by RBI, i.e., issue of certificate of deposits together with other instruments, viz., term money, term deposits, commercial papers and inter-corporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

Denomination For Certificate Of Deposits Minimum amount of a certificate of deposits should be Rs.1 lakh, i.e., the minimum deposit that could be accepted from a single subscriber should not be less than Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter.

Participants Certificate of deposits can be issued to Individuals Corporations Companies Trusts Funds Associations, etc Non-Resident Indians (NRIs) may also subscribe to certificate of deposits, but only on non-repatriable basis which should be clearly stated on the Certificate. Such certificate of deposits cannot be endorsed to another NRI in the secondary market.

Maturity The maturity period of certificate of deposit’s issued by banks Should be not less than 7 days Not more than one year The FIs can issue certificate of deposits for a period not less than 1 year and not exceeding 3 years from the date of issue

Discount on Issue of Certificate Of Deposits: Certificate of deposits may be issued at a discount on face value. Banks/FIs are also allowed to issue certificate of deposits on floating rate basis provided the methodology of compiling the floating rate is objective, transparent and market -based. The issuing bank/FI is free to determine the discount/coupon rate.

Reserve Requirement and Transferability Banks have to maintain the appropriate reserve requirements, i.e., cash reserve ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the certificate of deposits. Physical certificate of deposits are freely transferable by endorsement and delivery.

There is no lock-in period for the certificate of deposits Banks/FIs cannot grant loans against certificate of deposits They cannot buy- back their own certificate of deposits before maturity

Banker's Acceptance A short term credit investment created by a non financial firm and guaranteed by a bank to make payment A bill of exchange drawn by a person and accepted by a bank It is a buyer’s promise to pay to the seller a certain specified amount at certain date The same is guaranteed by the banker of the buyer in exchange for a claim on the goods as collateral. The person drawing the bill must have a good credit rating otherwise the Banker’s Acceptance will not be tradable.

The most common term for these instruments is 90 days. However, they can very from 30 days to180 days. For corporations, it acts as a negotiable time draft for financing imports, exports and other transactions in goods and is highly useful when the credit worthiness of the foreign trade party is unknown. The seller need not hold it until maturity and can sell off the same in secondary market at discount from the face value to liquidate its receivables.

Call money Market Call and notice money market refers to the market for short -term funds ranging from overnight funds to funds for a maximum tenor of 14 days. Under Call money market, funds are transacted on overnight basis and under notice money market, funds are transacted for the period of 2 days to 14 days.

This is because, any change in demand and supply of short-term funds in the financial system is quickly reflected in call money rates. The RBI makes use of this market for conducting the open market operations effectively.

Participants Participants in call/notice money market currently include - banks (excluding RRBs) - Primary dealers -both as borrowers and lenders Non Bank institutions are not permitted in the call/notice money market The rate at which funds are borrowed in this market is called `Call Money rate' Non-bank financial institutions like IDBI, LIC, and GIC etc participate only as lenders in this market

Volumes in the Call Money Market Call markets represent the most active segment of the money markets. Though the demand for funds in the call market is mainly governed by the banks' need for resources to meet their statutory reserve requirements, it also offers to some participants a regular funding source for building up short -term assets. However, the demand for funds for reserve requirements dominates any other demand in the market

Participants in the Call Money Market As lenders and borrowers: -Banks -Institutions such as commercial banks, both Indian and foreign - State Bank of India -Cooperative Banks - Discount and Finance House of India ltd. (DFHL) -Securities Trading Corporation of India (STCI). As lenders: -Life Insurance Corporation of India (LIC), Unit Trust of India (UTI) -General Insurance Corporation (GIC) - Industrial Development Bank of India (IDBI) -National Bank for Agriculture and Rural Development (NABARD)

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