The Fundamentals Of Money Market Instruments In India

VIDYUT JAIN

RESEARCH METHODOLOGY

Problem statements

Data collection

Secondary Data

Data analysis

Primary Data

Literature reviews

Research methodology

Recommendations and Conclusion

Survey In-depth interviews

Overview Of Financial Markets

FINANCIAL MARKET

Money Mkt.Debt Mkt. FOREX Mkt.

Capital Mkt.

MONEY MARKETIt includes

Call/ Notice

Treasury Bills

Term Money

Certificate Of Deposit

Repo

Commercial Bill

Icd

Commercial Papers

Debt MarketIt includes Government Securities and Bonds.

Government Security includes • Central Govt. Securities

• State Govt. Securities

Bonds includes • Foreign Investment Bonds

• PSU Bonds

• Corporate Securities

The Six Horses:Why,What,Who,Which, How and Where

Why : The Need

What : The Definition

Who : The Players

Which & How : The Products and Process

Where : The Resources

The Need

Need for short term funds by banks

Outlet for deploying funds on short term basis

Need to keep the SLR & CRR as prescribed

Optimize the yield on temporary surplus funds

Regulate the liquidity & interest rates

The Definition

Money Market is “the centre for dealings, mainly short term character, in money assets.It meets the short term requirements of the borrowers & provides liquidity or cash to the lenders.Money Market refers to the market for short term assets that are close substitutes of money, usually with maturities of less than a year.

The Players

RBISBI DFHI Ltd. (Amalgamation of Discount & Finance House in India & SBI Gilts in 2004)Commercial Banks, Cooperative Banks & Primary Dealers are allowed to borrow and lend.Specified All-India Financial Institutions, Mutual Funds and certain specified entities are allowed to access to Call/Notice money market only as lenders.Individuals, Firms, Companies, corporate bodies, trusts & institutions can purchase the treasury bills, commercial papers and certificate of deposits.

The Products & Process

Certificate of Deposit (CD)Commercial Paper (C.P)Inter Bank Participation CertificatesInter Bank Term MoneyTreasury BillsCall MoneyBanker’s AcceptanceREPO

Certificate Of Deposit (June,1989)

Short term borrowings in the form of Usance Promissory Notes having a maturity of not less than 15 days upto a maximum of 1 year.

Subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central Act)

They are like bank term deposit accounts, freely negotiable instruments often referred to as Negotiable CD.

Features Of CD

Can be issued by all scheduled commercial banks except RRB’s

Minimum period 15 days, Maximum period 1 year

NRIs can subscribe to CDs on non-repatriable basis.

Minimum amount Rs.1 lac & in multiples of Rs.1 lac

Transferable by endorsement & delivery.

CRR & SLR are to be maintained.

CDs are to be stamped.

Advantages

Enable high return on short term surpluses.

Enhances liquidity & allows resale.

For raising resources in times of need.

To improve lending capacity of the bank.

Commercial Paper

CP is an unsecured money market instrument (short-term) issued in the form of a promissory note.

Who Can Issue CP?

• Highly rated corporate borrowers, primary dealers (PDs) & satellite dealers (SDs) & all-India financial institutions (FIs)

Features

Cheaper source of funds than limits set by banks.

Optimal combination of liquidity return.

Highly liquid instrument.

Transferable by endorsement & delivery.

Backed by liquidity & earnings of issuer.

Issued for a minimum period of 30 days and a maximum up to one year

Issued at a discount to face value

Issued in demat form. (Compulsory demat from July '01).

Types of CP

Direct Papers :-

Issued directly by company to investors without any intermediary.

Dealer Papers :-

Issued by a dealer or merchant banker on behalf of a client.

Eligibility for issue of CP

The tangible net worth-not less than Rs.4 crore;

the working capital (fund-based) limit-not less than Rs.4 crore

& borrowal account- classified as a Standard Asset by the financing banks.

Rating RequirementAll eligible participants should obtain the credit rating for

issuance of CP through the following--

Credit Rating Information Services Of India Ltd. (CRISIL)

Investment Information & Credit Rating Agency of India Ltd. (ICRA)

Credit Analysis & Research Ltd. (CARE)

DCR India

The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.

Maturity

Issued for maturities between a minimum of 30 days and a maximum upto one year from the date of issue.

If the maturity date is a holiday, the company would be liable to make payment on the immediate preceding working day.

To whom Issued

CP is issued to and held by

individuals,

banking companies,

other corporate bodies registered or incorporated in India, and

unincorporated bodies,

Non-Resident Indians (NRIs) and

Foreign Institutional Investors (FIIs).

Banker's Acceptance

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.

RepoMeaning of Repo

Transaction in which 2 parties agree to sell & repurchase the same security. Under such an agreement, the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price.

The Repo/Reverse repo transaction can only be done at Mumbai between parties approved by RBI & in securities as approved by RBI (Treasury Bills, Central/State Govt. Securities).

Repo

Uses of Repo

• Helps banks to invest surplus cash

• Helps investors achieve money market returns with sovereign risks.

• Raising funds by borrowers

• Adjusting SLR/CRR positions simultaneously.

• For liquidity adjustment in the system.

Recent changes

All Govt. Securities are eligible for repos.

Primary dealers & non-bank participants allowed to undertake such transactions.

Minimum 3 days period, for inter-bank transactions has been removed.

Call Money Market

Integral part of Indian Money Mkt., where the day-to-day surplus funds (mostly of banks) are traded. The loans are of short term duration varying from 1 to 14 days.

The money that is lent for 1 day in this mkt. is known as “Call Money”, & if it exceeds 1 day (but less than 15 days), it is referred to as “Notice Money”.

Call Money MarketFeatures

Deals in loans at call and short notices.

Deals with extreme form of short term loans; 24 hours, 7-15 days maturity.

Recalled on demand or shortest possible notice.

Normally, collaterals are not insisted upon.

In India, CMM provides facilities for inter-bank tending.

Surplus suppliers of funds: UTI, SBI, LIC

Call Money Market

Banks borrow in this market for the following purpose:

• To fill the gaps in funds.

• To meet CRR & SLR mandatory requirements.

• To meet sudden demand for funds

Gilt Edged Securities

The term Government securities encompass all bonds & treasury bills issued by the Central and the State govt. These securities are normally referred to, as “gilt-edged” as repayments of principal as well as interest are totally secured by sovereign guarantee.

FeaturesThese securities have a fixed coupon that is paid on specific dates on half-yearly basis.

Maturity dates, from short dated (less than one year) to long dated (upto twenty years).

Available in primary and secondary market.

High liquidity-securities can be sold in the secondary market at prevailing rates.

Available in physical form or in demat -maintained in Constituents Subsidiary General Ledger (CSGL) a/c with any bank.

Securities held in CSGL a/c will have the convenience of  automatic credit of half yearly interest and the redemption proceeds on due date.

Reasonably good returns

Recent Changes

During last few years, Government of India has issued new instruments such as Zero Coupon Bonds, Floating Rates Bonds, Partly-paid Stocks, Capital Index Bonds, Tap Stock, etc.

Treasury Bills

T-Bills are issued by Govt. of India against their short term borrowing requirements with maturities ranging between 14 to 364 days.

All these are issued at a discount-to-face value. For eg: a T-Bill of Rs.100 face value issued for Rs.91.50 gets redeemed at the end of its tenure at Rs.100.

Features

Issued at a discount to face value.Sovereign zero risk instruments.Available in primary and secondary market.No Tax Deduction at Source (TDS)Highly liquid & attractive returnsEligible securities for SLR purposes.The 14/91/182/364-days bills are issued for a minimum value of Rs.25,000 and multiples thereof.Generally issued in the form of SGL (Subsidiary General Ledger) – entries in the books of RBI & not as securities.

Who can invest in T-Bill?

Banks, Primary dealers, State Governments, Provident Funds, Financial Institutions, Insurance Companies, NBFIs, FIIs (as per prescribed norms), NRIs can invest in T-Bills.

Credit Card

Instrument that enables the cardholder to obtain goods & services without actual payment at the time of purchase – a “Pay Later” card provided to a customer.

Features

Can be availed for a period of 30-45 days.Card carries a pre-determined limit upto which the holder can spend.2-3% interest p.m. charged on outstanding balance.Discounts on purchases on gaining additional points on regular use of card.

Types of Cards

Master card

VISA Card

Affinity Card

Standard Card

Classic Card

Gold/Executive Card

Platinum Card

Titanium Card

Secured Card

Smart Card

Charge Card

Rebate Card

Co-branded Card

Cash Card

Travel Card

Debit Card

Recent Changes

Personal Accident Insurance

Cash withdrawal facility

Increase in credit

“Add-on” facility

Leveraged investment facility

With the ongoing financial liberalization, each country now have a wider source of funds.

The traditional instruments in the international bond market are known as Foreign bonds.Foreign bonds are sold in the foreign countries and are denominated in that country’s currency.

Internationalization of Financial Markets

Internationalization of Financial Markets

Foreign bonds:

German auto maker sales a foreign bond in US denominated in US

dollar.

Euro Bond:

Bonds denominated in a currency other than that of the country in which it is sold.

Euro bond:

A bond denominated in US dollar and sold in London.

Internationalization of Financial Markets

However, A bond denominated in euro is called Euro Bond if it is sold outside the countries that adopted Euro as their currencies.Euro Currencies:

A variant of euro bond is euro currencies. Foreign currencies deposited in banks outside the home country. US dollar deposited in Banks outside US.

Money market mutual funds

Introduced in June,1996

Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors

Municipal notes - (in the U.S.)

Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.

Federal funds - (in the U.S.)

Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate.

Instrument Principal Borrowers

Federal Funds Banks

Discount Window Banks

Negotiable Certificates of Deposit (CDs) Banks

Eurodollar Time Deposits and CDs Banks

Repurchase Agreements Securities dealers, banks, non financial corporations, governments (principal participants)

Treasury Bills government

Municipal Notes State and local governments

Commercial Paper Non financial and financial businesses

Bankers Acceptances Nonfinancial and financial businesses

Government-Sponsored Enterprise Securities

Farm Credit System, Federal Home Loan Bank System, Federal National Mortgage Association

Shares in Money Market Instruments Money market funds, local government investment pools, short-term investment funds

Futures Contracts Dealers, banks (principal users)

Futures Options Dealers, banks (principal users)

Swaps Banks (principal dealers)

Money market and the financial world

The money available to consumers, investors, etc. to spend or invest in products is known as the money supply of the market.

High money supply high → increased demand for products in the products market → inflation (rising prices).

To enable the monetary authorities to guard against this kind of inflation, a few options are available where use is made of the money market, two of which are ---- Selling money market instruments & Increasing interest rates by offering less money

Current Reports

Special repo for 140.3 bn rupees to enable banks to meet liquidity needs of mutual funds: RBI. The repo rate is now 7.5%.

Summary

1. Efficient financial markets are required to channel funds from surplus-spending units (savers) to deficit-spending units. Typically, such securities entitle the holder to a stream of periodic future cash payments.

2. Financial intermediaries allow economies of scale to be realized when matching surplus-spending units with deficit-spending units. Greater opportunities for portfolio diversification and money management can be gained.

Major findings

various segments of the financial market in India have achieved market efficiencythe 91-day Treasury bill rate is the appropriate 'reference rate' of the financial sector in Indiathe financial markets in India are largely integrated at the short-end of the market, andthe long-end of the market is integrated with the short-end of the market.

The above findings suggest that monetary

policy should rely more on interest rate and asset price channels to control inflation.

Conclusion

The money market is a vibrant market, affecting our everyday lives. As the short-term market for money, money changes hands in a short time frame and the players in the market have to be alert to changes, up to date with news and innovative with strategies and products

.

In brief, various policy initiatives by the Reserve Bank have facilitated development of a wider range of instruments such as market repo, interest rate swaps, CDs and CPs. This approach has avoided market segmentation while meeting demand for various products. These developments in money markets have enabled better liquidity management by the Reserve Bank.

The Resources

RBIs site http://rbi.org.in

SBI DFHI’s site http://sbidfhi.com/

Website of R Kannon

http://www.geocities.com/kstability/lea

I.M. Pandey (Book)

Indian Institute Of Banking & Finance

http://www.iibf.org.in