04-09-2019

Capital Markets
Section 4 – Money Market

Objective
• To Understand Money Market
• Difference between Money Market and other
Markets
• Instruments in Money Market

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What is Money Market

• Money markets are markets for debt instruments with a maturity up to
one year.

• Money markets allow banks to manage their liquidity as well as

provide the central bank means to conduct its monetary policy.

• The most active part of the money market is the call money market
(i.e. market for overnight and term money between banks and
institutions) 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.

• Mainly traded money market instruments are commercial papers

(CPs), certificates of deposit (CDs) and treasury bills (T-Bills).

Functions of Money
Market
Due to short term maturity, the instruments of money market are liquid and can
be converted to cash easily and thus are able to address the need of the short
term surplus fund of the lenders and short term borrowing requirements of the
borrowers. Thus, the major function of the money markets is to cater to the short
term financial needs of the economy.

The other functions are as follows:

• Money Markets help in effective implementation of the RBI’s monetary policy
• Money markets help to maintain demand and supply equilibrium with regard
to short term funds
• They cater to the short term fund requirement of the governments
• They help in maintaining liquidity in the economy
• Money market matches the needs of;
o those entities which need to fund transactions in other market and need
to borrow money for short term – Borrowers
o Those entities which have surplus funds for short tenure investments -
Lenders

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Money Market Structure

• Indian money market is divided into organized and unorganized
segments.
• Unorganized market is an old indigenous market mainly made of
indigenous bankers, money lenders etc.
• Organized market is that part which comes under the regulatory
purview of RBI and SEBI.
• The nature of the money market transactions is such that they are
large in amount and high in volume. Thus, the entire market is
dominated by small number of large players.
• At the same time, the money market in India is yet underdeveloped.
• The key players in the organized money market include Governments
(Central and State), Discount and Finance House of India (DFHI),
Mutual Funds, Corporate, Commercial / Cooperative Banks, Public
Sector Undertakings (PSUs), Insurance Companies and Financial
Institutions and Non-Banking Financial Companies (NBFCs).

Money Market Structure

There are two kinds of markets where borrowing and lending of money takes place between fund scarce
and fund surplus individuals and groups. The markets catering the need of short term funds are called Money
Markets while the markets that cater to the need of long term funds are called Capital Markets.
Thus, money markets is that segment of financial markets where borrowing and lending of the short-term
funds takes place. The maturity of the money market instruments is one day to one year. In our country,
Money Markets are regulated by both RBI and SEBI.

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Money Market
participants
• RBI, as banker to and on behalf of the governments
• Banks
• NBFCs
• Primary Dealers (PDs)
• Discount and Finance House of India
• Mutual funds
• Insurance companies
• Pension funds
• Trusts
• Large highly rated companies which are not in the financial
services business
• FIIs

Buyers & Sellers

• Borrowers are sellers of the financial instruments used in
the money market.
o They issue(sell) the instruments and receive funds.
• Lenders are buyers of the financial instruments used in
the money market.
o They buy the instruments and give funds.
• These instruments are designed such that buyers gain a
fixed pre-determined return
• Buyers take credit risk on the sellers
• Medium and small companies
o borrow from banks under cash credit facility
o take asset backed loans from banks and NBFCs
• Individuals
o Take personal loans or asset backed loans from banks and NBFCs

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Names of various financial instruments in money

market used by various types of borrowers

WMA
RBI works as a banker to the State Governments by
agreement. But there is no fixed minimum reserve
balance for the State Governments. All state
Governments are required to maintain a minimum
reserve balance with RBI, but it depends upon the size
of the economy of the state and its budget.
However, there are times, when there is a temporary
mismatch in the cash flow of the receipts and
payments of the State Governments. To handle this
mismatch, there is a WMA scheme / facility which
refer to Ways and Means Advances.

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What are Ways and Means

Advances (WMA) ?
Who borrows ? governments

Who lends ? RBI

What is the tenor less than 90 days

temporary unplanned shortfalls in the governments’ fund

What purpose is served ? requirements are met through this route

What is the rate of interest ? Repo rate (Repo rate is defined in a later slide)

>Normal WMA – no collateral security, they are clean advances

What is collateral security ?
> Special WMA – long dated government securities are used as collateral
Why special WMA ?– when borrowing is beyond the limit for normal WMA

How is the settlement done ? bilaterally between RBI and the governments

CMBs
Cash Management Bills (CMBs) are short term bills issued by central
government to meet its immediate cash needs. The bills are issued by the RBI
on behalf of the government. Hence the CMBs are short-term money market
instruments that help the government to meet its temporary cash flow
mismatches. Following are the features of CMBs.

• CMBs have a maturity of less than 90 days.

• The CMBs have the generic character of Treasury Bills as the CMBs are
issued at a discount and redeemed at face value at maturity.
For example, if the face value of a CMB is Rs 100, we can get the bill at Rs 97
and at the end of the maturity date, say 60 after days, we can get Rs 100.
Here, there is no interest payment as the maturity period is so small. But the
return for buying CMB is obtained in the form of a discount.
• The tenure or maturity, notified amount (how much total CMBs to be
issued) and date of issue of the CMBs depends upon the temporary cash
requirement of the Government.
• CMBs are eligible as SLR securities. Investment in CMBs is also recognized
as an eligible investment in Government securities by banks for SLR
purpose under Section 24 of the Banking Regulation Act, 1949.

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Money Market
Instruments
• Call Money / Notice Money / Term Money Market
o Call Money, Notice Money and Term Money markets are sub-markets of the
Indian Money Market. These refer to the markets for very short term funds.
• Call Money refers to the borrowing or lending of funds for 1 day.
• Notice Money refers to the borrowing and lending of funds for 2-14 days.
• Term money refers to borrowing and lending of funds for a period of more
than 14 days.

• Treasury Bill (T – Bills)

o The bill market is a sub-market of the money market in India.
o There are two types of bills viz. Treasury Bills and commercial bills.
o While Treasury Bills or T-Bills are issued by the Central Government; Commercial
Bills are issued by financial institutions.

• Commercial Bills
o Commercial bills market is basically a market of instruments similar to Bill of
Exchange.
o The participants of commercial bill market in India are banks and financial
institutions but this market is not yet developed.

What is call money

Who borrows ? Banks and PDs

Who lends ? Banks and PDs

What is the tenor 1 working day

What purpose is served ? Temporary requirements of funds

What is the rate of interest ? Market determined, Reference rate called MIBOR ( Mumbai Interbank Offered
Rate) is based on rates pooled from various bank dealers

What is collateral security ? no collateral security

How is the settlement done ? Bilaterally by the banks and the PDs.

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What are Cash Management Bills and Treasury Bills (CMBs

and T bills)?
Who sells ? governments

who buys ? Banks and PDs

What is the tenor less than 90 days for CMBs, 91 days/182 days/364 days for T bills

CMBs are for temporary shortfall, T bills are part of

What purpose is served ?
government borrowing program

What is the rate of interest ? Market determined, RBI conducts auctions

no collateral security
What is collateral security ?

Clearing Corporation of India (CCIL) settles the trades. CCIL is set up by the RBI and plays the role of
How is the settlement done ? an exchange by interposing between the two counterparties to a trade.

Money Market
Instruments
• Certificate Of Deposits (CDs)
o Certificate of Deposit (CD) refers to a money market instrument, which is
negotiable and equivalent to a promissory note.
o All scheduled commercial banks excluding Regional Rural Banks (RRBs)
and Local Area Banks (LABs) and Select All India Financial Institutions
permitted by RBI are eligible to issue certificates of deposits.

• Commercial Papers (CP)

o Commercial Paper (CP) is yet another money market instrument in India,
which was first introduced in 1990 to enable the highly rated corporates to
diversify their resources for short term fund requirements.

• Money Market Mutual Funds (MMMFs)

o Money Market Mutual Funds (MMMFs) were introduced by RBI in 1992 but
since 2000, they are brought under the purview of the SEBI.
o They provide additional short-term avenue to individual investors.

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What is CD
Who borrows ? Banks

Who lends ? All types of money market participants

What is the tenor 7 – 364 days

What purpose is served ? Short term funding for banks

What is the rate of interest ? Market determined, negotiated on phone

What is collateral security ? No collateral security

How is the settlement done ? Bilaterally

What is CP
Who borrows ? NBFCs, PDs and large highly rated corporates

Who lends ? All types of money market participants

What is the tenor 7 – 364 days

What purpose is served ? Short term funding for borrowers

What is the rate of interest ? Market determined, negotiated on phone

What is collateral security ? No collateral security

How is the settlement done ? Bilaterally

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Money Market
Instruments
• The Repo / Reverse Repo
o Repo (repurchase agreement ) was introduced in December 1992. Repo
means selling a security under an agreement to repurchase it at a
predetermined date and rate.
o Repo transactions are affected between banks and financial institutions and
among bank themselves, RBI also undertake Repo.
o IN 1996, Reverse Repo was introduced.
o Reverse Repo transactions are affected with scheduled commercial banks
and primary dealers.

• Discount And Finance House Of India (DFHI)

o It was established in 1988 by RBI and is jointly owned by RBI, public sector banks
and all India financial institutions which have contributed to its paid up capital.
o DFHI plays important role in developing an active secondary market in Money
Market Instruments.
o From 1996, it has been assigned status of a Primary Dealer (PD).
o It deals in treasury bills, commercial bills, CDs, CPs, short term deposits, call
money market and government securities.

What is repo
Who borrows ? Banks and PDs

Who lends ? RBI

What is the tenor 1 – 364 days, usually short durations

What purpose is served ? Temporary requirements of funds

What is the rate of interest ? Repo rate as announced by RBI from time to time

Government securities held by the borrowers, through the process of sale

What is collateral security ? and repurchase

How is the settlement done ? CCIL

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What is reverse repo

Who borrows ? RBI

Who lends ? Banks and PDs

What is the tenor 1 – 364 days, usually short durations

What purpose is served ? Temporary deployment of surplus funds

What is the rate of interest ? Reverse Repo rate as announced by RBI from time to time

What is collateral security ? Government securities held by the borrowers, through the
process of sale and repurchase

How is the settlement done ?

CCIL

What is CBLO
Who borrows ? All types of money market participants

Who lends ? All types of money market participants

What is the tenor 1 – 364 days, usually short durations

What purpose is served ? Temporary requirements of funds

What is the rate of interest ? Market determined, either negotiated on phone or through electronic order
matching

What is collateral security ?

Government securities held by the borrowers

How is the settlement done ? CCIL

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What is the concept of a discount based

instrument in the money market ?
• Buyer ( ie the lender ) buys the instrument at a discount
to the face value.
• On maturity, buyer receives the full face value.
Example –
o Bank “A” purchases CP of company “X” at Rs 98
o “A” pays Rs 98 to “X” at the time of purchase
o Tenor – 91 days
o On maturity , ie on 91st day; “A” would receive Rs 100 from “X”
o Effective yield = (100 – 98)/ 98 * 365/91 * 100
= 8.19 % p.a.
• The calculation conventions are
o Day count taking 365 days
o Simple interest calculation , no compounding up to 365 days
• CMB, T bills, CDs and CPs are discount based instruments

Sale and repurchase in

case of repo
• Buyer (i.e., the lender) buys the long dated
government securities at a price P0 from the seller
(i.e., the borrower)
• Simultaneously, buyer and seller agree on a price
(P1) and date for repurchase of the securities by the
seller
• The difference in price is the gain for the lender
Example –
o Bank “X” sells 7.70GOI2024 at Rs 101.0000 (P0) and agrees to repurchase
at 101.1404 (P1) after 7 days
o Effective cost to the bank = (101.1404 – 101)/ 101 * 365/7 * 100
= 7.25 % p.a. ( which is the repo
rate of RBI)

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Negotiated Dealing
System (NDS)
• CCIL operates through NDS
• NDS is the system platform on which the trades
through CCIL are executed
• A trade can be negotiated as well as executed
through the order matching system on the NDS,
called NDS-OM
• In case a trade is negotiated outside NDS ( say over
phone between two parties), it needs to be
reported on the NDS within a stipulated time period
after it is negotiated.
https://rbi.org.in/scripts/FAQView.aspx?Id=86
https://www.ccilindia.com/OMIT.aspx

How does RBI use money market

to implement monetary policy
• Higher CRR and SLR results in reducing money
supply and higher money market interest rates, and
vice –a-versa
• Announcing repo rate – the rate at which banks
borrow short term funds from RBI. If RBI wants to
signal “tighter” monetary policy ie reduce money
supply then RBI would hike the repo rate, and vice-
a-versa
• Open market operations – RBI may sell government
securities to absorb excess money supply from the
money market, and vice-a-versa

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