Atul Anand

500071462

R. no. 72

1. Differentiate between Repo rate and reverse repo rate in respect of monetary
control tool.

ANSWER:
Difference between Repo Rate and Reverse Repo Rate
The reverse repo rate now stands at 3.35% after a drop of 40 basis points (bps).
The reverse repo rate was decreased by 90 basis points earlier after which it stood at the rate
of 3.75%. The previous repo rate was 4.4% which was revised on 27 March 2020.
On 4 April 2019, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI)
revised the repo rate. This rate was decreased by 25 basis points, from 6.25% to 6%.
Even the reverse repo rate saw revisions with a decrease of 25 basis points, which now stands
at 5.75%. The previous reverse repo rate, which was revised on 1 August 2018, stood at 6%.
The most recent revision witnessed a drop of another 25 basis points and now the repo rate
stands at 5.15%, with effect from 4 October 2019.
To understand how this affects you and your loans, you need to know what’s the difference
between the repo rate and reverse repo rate.
Repo Rate
When commercial banks approach the Reserve Bank of India for funds, they’re charged a
certain amount of interest. The rate at which RBI lends these finances to commercial banks is
called the repo rate.
In this case, a repurchasing agreement is signed by both the parties, stating that the securities
will be repurchased on a given date at a predetermined price. For instance, let’s assume the
repo rate fixed by the RBI is 10% p.a. and the amount borrowed by a bank from RBI is
Rs.10,000. The interest rate to be paid by the bank will be Rs.1,000.
The repo rate in India is fixed and monitored by India’s central banking institution, the
Reserve Bank of India. It allows the central bank to control liquidity, money supply, and
inflation level in the country.
To decrease the money supply in the economy, the RBI will hike up the repo rate to
discourage banks from borrowing funds. Similarly, if the RBI wants to pump funds into the
system, it might reduce the repo rate, thus encouraging banks to go ahead and borrow funds.

Reverse Repo Rate

 Reverse repo rate is the interest offered by the RBI to banks who deposit funds into the
treasury. For instance, when banks generate excess funds, they may deposit the money in the
central bank. This is a much safer approach when compared to lending it to other companies
or account holders.
So, the interest earned on the deposited funds is known as the reverse repo rate. As an
example, let’s assume the reverse repo rate is 5% p.a. A commercial bank has deposited
Rs.10,000 in the central bank. This means, the commercial bank will earn Rs.500 p.a. as
interest.
This is another financial instrument used by the RBI to control the supply of money in the
nation. In case the RBI is falling short on money, they can always ask commercial banks to
pitch in with funds and offer them great reverse repo rates in return. This gives banks and
other financial institutions the opportunity to earn profit on excess funds.
5 Major differences between Repo Rate and Reverse Repo Rate
Besides the way these rates work, there are other differentiators you should know of:
 A high repo rate helps drain excess liquidity from the market, whereas a high reverse
repo rate helps inject liquidity into the economic system.
 The repo rate is always higher than the reverse repo rate.
 Repo rate is used to control inflation and reverse repo rate is used to control the
money supply.
To conclude, the major difference between these two is that an increase in the repo rate will
make commercial banks borrow less. Whereas an increase in the reverse repo rate will allow
commercial banks to transfer more funds to RBI, which contributes to the money supply.

2. What are treasure bills and how they are different from commercial paper?
ANSWER:

Treasury bills

Treasury bills, or T-bills, are the most marketable money market securities. Governments
issue them to borrow money for a short period.

T-bills are issued with maturities that range from 1 month to 1 year. They're sold at a
discount, i.e., the government sells them for less than par value (face value) and, when they
mature, buys them back at par value.

In practice, the interest you receive is the difference between the purchase price and what you
get at maturity. In other words, if you pay $9,800 for a T-bill with a face value of
$10,000 and keep it until maturity, you'll earn $200 in interest.

T-bills are very popular because they're one of the few affordable money
market instruments. They're usually issued in denominations of $1,000, $5,000, $10,000,
$25,000, $50,000, $100,000 and $1 million. Note that brokers generally require a minimum
purchase of $10,000.
T-bills (and other Treasuries) are considered to be the safest investments in the financial
market because governments back them.

However, their exceptional safety means a lower return than provided by corporate bonds,
certificates of deposit and money market funds. Also, you don't automatically get back all of
your investment if you cash out your T-bills before the maturity date

Commercial paper

Many corporations prefer, as much as possible, to avoid borrowing short-term money from
banks. Therefore, they use commercial paper.

Commercial paper is an unsecured short-term debt instrument issued by a corporation. On

average, maturities range from 1 to 2 months and are usually no longer than 9 months.
Commercial paper is issued at a discount, reflecting current market interest rates.

Commercial paper provides a better return than T-bills, as corporations have a higher risk of
default than governments do.

Commercial paper is usually issued in denominations of $100,000 or more. As a result,

smaller investors can only access commercial paper indirectly, through their broker or money
market funds.