PRESENTATION ON MONEY MARKET INSTRUMENTS SUBMITTED By: RAGINI PATEL(34) Tasneem Sutarwala (55) Submitted to:- MRS.RUTVI UMRIGAR

1! What is Money Market? As per RBI definitions “ A market for short terms financial assets that are close substitute for money, facilitates the exchange of money in primary and secondary market”.  The money market is a mechanism that deals with the lending and borrowing of short term funds (less than one year).  A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded.

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

2 ! Features of Money Market?  It is a market purely for short-terms funds or financial assets called near money.  It deals with financial assets having a maturity period less than one year only.  In Money Market transaction can not take place formal like stock exchange, only through oral communication, relevant document and written communication transaction can be done.

Continued……..  Transaction have to be conducted without the help of brokers.  It is not a single homogeneous market, it comprises of several submarket like call money market, acceptance & bill market.  The component of Money Market are the commercial banks, acceptance houses & NBFC (Non-banking financial companies).

3 ! Objective of Money Market?  To provide a parking place to employ short term surplus funds.  To provide room for overcoming short term deficits.  To enable the central bank to influence and regulate liquidity in the economy through its intervention in this market.  To provide a reasonable access to users of short- term funds to meet their requirement quickly, adequately at reasonable cost.

4 ! Importance of Money Market? o Development of trade & industry. o Development of capital market. o Smooth functioning of commercial banks. o Effective central bank control. o Formulation of suitable monetary policy. o Non inflationary source of finance to government.

5 ! Composition of Money Market? Money Market consists of a number of sub- markets which collectively constitute the money market. They are,  Call Money Market  Commercial bills market or discount market  Acceptance market  Treasury bill market

6 ! Instrument of Money Market? A variety of instrument are available in a developed money market. In India till 1986, only a few instrument were available. They were Treasury bills Treasury bills Money at call and short notice in the call loan market. Money at call and short notice in the call loan market. Commercial bills, promissory notes in the bill market. Commercial bills, promissory notes in the bill market.

New instrument Now, in addition to the above the following new instrument are available: Now, in addition to the above the following new instrument are available:  Commercial papers.  Certificate of deposit.  Inter-bank participation certificates.  Repo instrument  Banker's Acceptance  Repurchase agreement  Money Market mutual fund

Treasury Bills (T-Bills)  (T-bills) are the most marketable money market security.  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.  T-Bills are so popular among money market instruments because of affordability to the individual investors.

Disadvantages of T - bill  Yield from TBs is lowest as long-term government securities fetch more interest and hence subscription for it is declining.  TBs are sold through auction in order to ensure market rates for investors, in actual competitive bids are cons piously absent. Hence adequate return is not available.  Investors hold TBs till maturity and they do not come for circulation. Hence, active trading in TBs is adversely affected.

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

 Estimating T-bill yield No coupon payments Par or face value received at maturity Yield at issue is the difference between the selling price and par or face value adjusted for time If sold prior to maturity in secondary market  Yield based on the difference between price paid for T-bill and selling price adjusted for time

 Calculating T-Bill Annualized Yield YTYT  SP – PP PP 365 n Y T = The annualized yield from investing in a T-bill SP = Selling price PP = Purchase price n = number of days of the investment (holding period) =

 T-bill yield for a newly issued security Par – PP PP 360 n T-bill discount = percent discount of the purchase price from par Par = Face value of the T-bills at maturity PP = Purchase price n = number of days to maturity T-bill discount= 

Certificate of deposit (CD)  A CD is a time deposit with a bank.  Like most time deposit, funds can not withdrawn before maturity without paying a penalty.  CD’s have specific maturity date, interest rate and it can be issued in any denomination.  The main advantage of CD is their safety.  Anyone can earn more than a saving account interest.

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

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

Commercial paper (CP)  CP is a short term unsecured loan issued by a corporation typically financing day to day operation.  CP is very safe investment because the financial situation of a company can easily be predicted over a few months.  Only company with high credit rating issues CP’s.

Commercial Paper  Commercial paper consists of short-term, unsecured promissory notes issued by well-known and financially strong companies.  Commercial paper is traded mainly in the primary market. Opportunities for resale in the secondary market are more limited.  Commercial paper is rated prime, desirable, or satisfactory, depending on the credit standing of the issuing company.

 Estimating commercial paper yields Y CP Par – PP PP 360 n Y CP = Commercial paper yield Par = Face value at maturity PP = Purchase price n = number of days to maturity = 

Types of Commercial Paper  There are two major types of commercial paper.  Direct paper is issued mainly by large finance companies and bank holding companies directly to the investor.  Dealer paper, or industrial paper, is issued by security dealers on behalf of their corporate customers (mainly nonfinancial companies and smaller financial companies).

Structure of the Commercial Paper Market Investors in commercial paper Money market funds Banks Insurance companies Pension funds Industrial companies Other investors Demand SideSupply Side Issuers of commercial paper Finance companies Bank holding companies Nonfinancial firms Direct or finance paper Paper dealer houses Dealer or industrial paper

Commercial Paper Advantages  Relatively low interest rates  Flexible interest rates - choice of dealer or direct paper  Large amounts may be borrowed conveniently  The ability to issue paper gives considerable leverage when negotiating with banks

Commercial Paper Disadvantages  Risk of alienating banks whose loans may be needed when an emergency develops  May be difficult to raise funds in the paper market at times  Commercial paper must generally remain outstanding until maturity - does not permit early retirement without penalty

Repurchase agreement (Repos)  Repo is a form of borrowing and is used by those who deal in government securities.  They are usually very short term repurchases agreement, from overnight to 30 days of more.  The short term maturity and government backing usually mean that Repos provide lenders with extremely low risk.  Repos are safe collateral for loans.

 Estimating repurchase agreement yields Repo Rate SP – PP PP 360 n Repo Rate = Yield on the repurchase agreement SP = Selling price PP = Purchase price n = number of days to maturity = 

Banker's Acceptance  A banker’s acceptance (BA) is a short-term credit investment created by a non-financial firm.  BA’s are guaranteed by a bank to make payment.  Acceptances are traded at discounts from face value in the secondary market.  BA acts as a negotiable time draft for financing imports, exports or other transactions in goods.  This is especially useful when the credit worthiness of a foreign trade partner is unknown.

Bankers’ Acceptances  A bankers’ acceptance is a time draft drawn on and endorsed by an importer’s bank.  Acceptances are used in international trade because most exporters are uncertain of the credit standing of their importers.  The issuing bank unconditionally guarantees to pay the face value of the acceptance when it matures, thus shielding exporters and investors in international markets from default risk.

Bankers’ Acceptances  Acceptances carry maturities ranging from 30 to 270 days, with 90 days being the most common.  They are traded among financial institutions, industrial corporations, and securities dealers as a high-quality investment and source of ready cash.

How Acceptances Arise Importer applies for line of credit Importer’s bank issues letter of credit in favor of exporterLetter of credit authorizes the drawing of a time draftImporter’s bank accepts time draft from exporter’s bankImporter’s bank pays exporter’s bank discounted value of bankers’ acceptance, and then holds or sells it Bankers’ acceptance is redeemed at maturity

Acceptance Rates  Acceptances do not carry a fixed rate of interest, but are sold at a discount in the open market like Treasury bills.  The yield on acceptances is usually only slightly higher than the yield on Treasury bills, and close to the negotiable CD rates offered by major banks, because of the high credit quality of the banks that issue the acceptances and CDs.

Money Market Securities Issued by large commercial banks Minimum denomination of $100,000 but $1 million more common Purchased by nonfinancial corporations or money market funds Secondary markets supported by dealers in security Negotiable Certificates of Deposit (NCD)

 NCD placement Direct placement Use a correspondent institution specializing in placement Sell to securities dealers who resell Sell direct to investors at a higher price  NCD premiums Rate above T-bill rate to compensate for lower liquidity and safety

11 ! Summary 11 ! Summary  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.

Continued…….  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 acceptance (BA) are negotiable time draft for financing transactions in goods.  Repurchase agreement (repos) are a form of overnight borrowing backed by government securities.