Fi&m Chapter 4

Chapter Four: Primary Market and Money Market Market Organization
CHAPTER FOUR: ORGANIZATION AND STRUCTURE OF MARKETS –

PRIMARY MARKETS & MONEY MARKET
4.1 PRIMARY MARKET
About primary market
Primary market: Primary markets are those markets which deal in the new securities. Therefore,
they are also known as new issue markets. These are markets where securities are issued for the
first time. In other words, these are the markets for the securities issued directly by the
companies. The primary markets mobilize savings and supply fresh or additional capital to
business units. In short, primary market is a market for raising fresh capital in the form of shares
and debentures.
4.1.1 Investment Banking and Underwriting
4.1.1.1. Investment Banking
Investment bankers were called “Masters of the Universe” in Tom Wolfe’s The Bonfireb of the
Vanities. They are the elite on Wall Street. They have earned this reputation from the types of
financial services they provide. Investment banks are best known as intermediaries that help
corporations raise funds. However, this definition is far too narrow to accurately explain the
many valuable and sophisticated services these companies provide. (Despite its name, an
investment bank is not a bank in the ordinary sense; that is, it is not a financial intermediary that
takes in deposits and then lends them out.) In addition to underwriting the initial sale of stocks,
bonds, and commercial paper, investment banks also play a pivotal role as deal makers in the
mergers and acquisitions area, as intermediaries in the buying and selling of companies, and as
private brokers to the very wealthy. Some well-known investment banking firms are Morgan
Stanley, Bank of America, Merrill Lynch, Credit Suisse, and Goldman Sachs.
One feature of investment banks that distinguishes them from stockbrokers and dealers is that
they usually earn their income from fees charged to clients rather than from commissions on
stock trades. These fees are often set as a fixed percentage of the dollar size of the deal being
worked. Because the deals frequently involve huge sums of money, the fees can be substantial.
The percentage fee will be smaller for large deals, in the neighborhood of 3%, and much larger
for smaller deals, sometimes exceeding 10%.
4.1.1.2. Underwriting Stocks and Bonds
When a corporation wants to borrow or raise funds, it may decide to issue long-term debt or
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equity instruments. It then usually hires an investment bank to facilitate the issuance and
Compiled by: instructor Tsegazeab T. Accounting and Finance Infolink, Dilla Campus
subsequent sale of the securities. The investment bank may underwrite the issue. The process of
underwriting a stock or bond issue requires that the securities firm purchase the entire issue at a
predetermined price and then resell it in the market. There are a number of services provided in
the process of underwriting.
Giving Advice
Most firms do not issue capital market securities very frequently. Over 80% of all corporate
expansion is financed using profits retained from prior period earnings. As a result, the financial
managers at most firms are not familiar with how to proceed with a new security offering.
Investment bankers, since they participate in this market daily, can provide advice to firms
contemplating a sale. For instance, a firm may not know if it should raise capital by selling
stocks or by selling bonds. The investment bankers may be able to help by pointing out, for
example, that the market is currently paying high prices for stocks in the firm’s industry
(historically high PE ratios), while bonds are currently carrying relatively high interest rates (and
therefore low prices).
Firms may also need advice as to when securities should be offered. If, for example, competitors
have recently released earnings reports that show poor profits, it may be better to wait before
attempting a sale: Firms want to time the market to sell stock when it will obtain the highest
possible price. Again, because of daily interaction with the securities markets, investment
bankers should be able to advise firms on the timing of their offerings.
Possibly the most difficult advice an investment banker must give a customer concerns at what
price the security should be sold. Here the investment banker and the issuing firm have
somewhat differing motives. First, consider that the firm wants to sell the stock for the highest
price possible. Suppose you started a firm and ran it well for 20 years. You now wish to sell it to
the public and retire to Tahiti. If 500,000 shares are to be offered and sold at $10 each, you will
receive $5 million for your company. If you can sell the stock for $12, you will receive $6
million.
Investment bankers, however, do not want to overprice the stock because in most underwriting
agreements, they will buy the entire issue at the agreed price and then resell it through their
brokerage houses. They earn a profit by selling the stock at a slightly higher price than they paid
the issuing firm. If the issue is priced too high, the investment bank will not be able to resell, and
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it will suffer a loss.
Pricing securities is not too hard if the firm has prior issues currently selling in the market, called
seasoned issues. When a firm issues stock for the first time, called an initial public offering
(IPO), it is much more difficult to determine what the correct price should be. All of the skill and
expertise of the investment banking firm will be used to determine the most appropriate price. If
the issuing firm and the investment banking firm can come to agreement on a price, the
investment banker can assist with the next stage, filing the required documents.
Filing Documents
In addition to advising companies, investment bankers will assist with making the required
Securities and Exchange Commission (SEC) filings. The activities of investment banks and
the operation of primary markets are heavily regulated by the SEC, which was created by the
Securities and Exchange Acts of 1933 and 1934 to ensure that adequate information reaches
prospective investors. Issuers of new securities to the general public (for amounts greater than
$1.5 million in a year and with a maturity longer than 270 days) must file a registration
statement with the SEC. This statement contains information about the firm’s financial
condition, management, competition, industry, and experience.
The firm also discloses what the funds will be used for and management’s assessment of the risk
of the securities. The issuer must then wait 20 days after the registration statement is filed with
the SEC before it can sell any of the securities. The SEC will review the registration statement,
and if it does not object during a 20-day waiting period, the securities can then be sold.
The SEC review in no way represents an endorsement of the offering by the SEC. Their approval
merely means that all of the required statements and disclosures are included in the statement.
Nor does SEC approval mean that the information is accurate. Inaccuracies in the registration
statement open the issuing firm’s management up to lawsuits if it incurs losses. In extreme cases,
inaccuracies could result in criminal charges.
A portion of the registration statement is reproduced and made available to investors for review.
This widely circulated document is called a prospectus. By law, investors must be given a
prospectus before they can invest in a new security.
While the registration document is in the process of being approved, the investment banker has
other chores to attend to. For issues of debt, the investment banker must:
 Secure a credit rating from one or more of the credit review companies, such as Standard
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and Poor’s or Moody’s.
 Hire a bond counsel who will issue a statement attesting to the legality of the issue.
 Select a trustee who is responsible for seeing that the issuer fulfills its obligations as
stated in the security’s contract.
 Have the securities printed and prepared for distribution.
For equity issues, the investment banker may arrange for the securities to appear on one of the
stock exchanges. Clearly, the investment banker can be of great assistance to an issuer well
before any securities are actually offered for sale.
Underwriting
Once all of the paperwork has been completed, the investment banker can proceed with the
actual underwriting of the issue. At a pre-specified time and date, the issuer will sell all of the
stock or bond issue to the investment banking firm at the agreed price. The investment banker
must now distribute this issue to the public at a greater price to earn its fee.
By agreeing to underwrite an issue, the investment banking firm is certifying the quality of the
issue to the public. We again see how asymmetric information helps justify the need for an
intermediary. Investors do not want to put in weeks and weeks of hard technical study of a firm
before buying its stock. Nor can they trust the firm’s insiders to accurately report its condition.
Instead, they rely on the ability of the investment bank to collect information about the firm in
order to accurately establish the firm’s value. They trust the investment bank’s assessment, since
it is backing up its opinion by actually purchasing securities in the process of underwriting them.
Investment bankers recognize the responsibility they have to report information accurately and
honestly, since once they lose investors’ confidence, they will no longer be able to market their
deals.
The investment banking firm is clearly taking a huge risk at this point. One way that it can
reduce the risk is by forming a syndicate. A syndicate is a group of investment banking firms,
each of which buys a portion of the security issue. Each firm in the syndicate is then responsible
for reselling its share of the securities. Most securities issues are sold by syndicates because it is
such an effective way to spread the risk among many different firms.
Investment banks advertise upcoming securities offerings with ads in the Wall Street Journal.
The traditional advertisement is a large block ad in the financial section of the paper. These ads
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are called tombstones because of their shape, and they list all of the investment banking firms
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included in the syndicate. Review the tombstone reproduced in the Following the Financial News
box. The ad states that this is neither an offer to sell nor will offers to buy be accepted. The
actual offer to sell can only be made in the prospectus. Also note the different investment
banking firms involved in the syndicate.
The longer the investment banker holds the securities before reselling them to the public, the
greater the risk that a negative price change will cause losses. One way that the investment
banking firm speeds the sale is to solicit offers to buy the securities from investors prior to the
date the investment bankers actually take ownership. Then, when the securities are available, the
orders are filled and the securities are quickly transferred to the final buyers.
Most investment bankers are attached to larger brokerage houses (multifunction securities firms)
that have nationwide sales offices. Each of these offices will be contacted prior to the issue date,
and the sales agents will contact their customers to see if they would like to review a prospectus
on the new security. The goal is to fully subscribe the issue. A fully subscribed issue is one
where all of the securities available for sale have been spoken for before the issue date. Security
issues may also be undersubscribed. In this case, the sales agents have been unable to generate
sufficient interest in the security among their customers to sell all of the securities by the issue
date. An issue may also be oversubscribed, in which case there are more offers to buy than there
are securities available.
It is tempting to assume that the best alternative is for an issue to be oversubscribed, but in fact
this will alienate the investment banker’s customers. Suppose you were issuing a security for the
first time and had negotiated with your investment banker to sell the issue of 500,000 shares of
stock at $20. Now you find out that the issue is oversubscribed. You would feel that the
investment banker had set the price too low and that you had lost money as a result. Maybe the
stock could have sold for $25 and you could have collected an extra $2.5 million [($25 – $20) _
500,000 = $2,500,000]. You, as well as other issuing firms, would be unlikely to use this
investment banker in the future.
It is equally serious for an issue to be undersubscribed, since it may be necessary to lower the
price below what the investment bankers paid to the issuer in order to sell all of the securities to
the public. The investment banking firm stands to lose extremely large amounts of money
because of the volume of securities involved. For example, review the tombstone shown in the
Following the Financial News box once more. There are over 24 million shares being offered for
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sale. If the price must be lowered by even $.25 per share, over $6,000,000 would be lost. The
high risk taken by investment bankers explains why they tend to be the most elite and highest-
paid professionals on Wall Street, many earning millions of dollars per year.
Best Efforts
An alternative to underwriting a securities offering is to offer the securities under a best efforts
agreement. In a best efforts agreement, the investment banker sells the securities on a
commission basis with no guarantee regarding the price the issuing firm will receive. The
advantage to the investment banker of a best efforts transaction is that there is no risk of
mispricing the security. There is also no need for the time-consuming task of establishing the
market value of the security.
The investment banker simply markets the security at the price the customer asks. If the security
fails to sell, the offering can be canceled.
Private Placements
An alternative method of selling securities is called the private placement. In a private
placement, securities are sold to a limited number of investors rather than to the public as a
whole. The advantage of the private placement is that the security does not need to be registered
with the SEC as long as certain restrictive requirements are satisfied. Investment bankers are also
often involved in private placement transactions. While investment bankers are not required for a
private placement, they often facilitate the transaction by advising the issuing firm on the
appropriate terms for the issue and by identifying potential purchasers.
The buyers of private placements must be large enough to purchase large amounts of securities at
one time. This means that the usual buyers are insurance companies, commercial banks, pension
funds, and mutual funds. Private placements are more common for the sale of bonds than for
stocks. Goldman Sachs is the most active investment banking firm in the private placement
market.
Equity Sales
Another service offered by investment banks is to help with the sale of companies or corporate
divisions. For example, in 1984, Mattel was dangerously close to having its bank loans called
when its electronics subsidiary incurred significant losses.
Mattel enlisted the help of the investment banking firm Drexel Burnham Lambert. The first step
in the firm’s restructuring was to sell off all of its non-toy businesses. Mattel returned to health
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until it again ran into problems in 1999 due to the acquisition of a software company. In 2000,
Mattel again used the services of investment bankers to sell this subsidiary.
The first step in any equity sale will be the seller’s determination of the business’s worth. The
investment banker will provide a detailed analysis of the current market for similar companies
and apply various sophisticated models to establish company value. Unlike a box of detergent or
bar of candy, a going concern has no set price. The company value is based on the use the buyer
intends to make of it. If a buyer is only interested in the physical assets, the firm will be worth
one amount.
A buyer who sees the firm as an opportunity to take advantage of synergies between this firm
and another will have a very different price. Despite the elasticity of the yardstick, investment
bankers have developed a number of tools to give business owners a range of values for their
firms.
How much cash flows will have to be discounted depends very much on who will be bidding on
the firm. Again, investment bankers help. They may make discreet inquiries to feel out who in
the market may be interested. Additionally, they will prepare a confidential memorandum that
presents the detailed financial information required by prospective buyers to make an offer for
the company. All prospective buyers must sign a confidentiality agreement stipulating that they
will not use the information to compete or share it with third parties. The investment bank will
screen prospects to ensure that the information goes only to qualified buyers.
The next step in an equity sale will be the letter of intent issued by a prospective buyer. This
document signals a desire to go forward with a purchase and outlines preliminary terms. The
investment banker will negotiate the terms of the sale on the seller’s behalf and will help to
analyze and rank competing offers. The investment banker may even help structure financing in
order to obtain a better offer.
Once the letter of intent has been accepted by the seller, the due diligence period begins. This
20- to 40-day period is used by the buyer to verify the accuracy of the information contained in
the confidential memorandum. The findings shape the terms of the definitive agreement. This
agreement converts information gathered during the due diligence period and the results of
subsequent negotiations into a legally binding contract.
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4.1.2. Regulation of Security Firms

Many financial firms engage in all three securities market activities, acting as brokers, dealers,
and investment bankers. The largest in the United States is Merrill Lynch; other well-known
firms include Morgan Stanley, and Salomon Smith Barney (a division of Citigroup). The SEC
not only regulates the firms’ investment banking operations but also restricts brokers and dealers
from misrepresenting securities and from trading on insider information, unpublicized facts
known only to the management of a corporation.
When discussing regulation, it is important to recognize that the public’s confidence in the
integrity of the financial markets is critical to the growth of our economy and the ability of firms
to continue using the markets to raise new capital. If the public believes that there are other
powerful players with superior information who can take advantage of smaller investors, the
market will be unable to attract funds from these smaller investors. Ultimately, the markets could
fail entirely.
Due to asymmetric information, investors will not know as much about securities being offered
for sale by firms as firm insiders will. If an average price is set for all securities based on this
lack of information, good securities would be withdrawn and only poor and overpriced securities
would remain for sale. With only these securities offered, the average price would fall. Now any
securities worth more than this new average would be withdrawn. Eventually, the market would
fail as the average security offered drops in quality and market prices fall as a result. One
solution to the lemons problem is for the government to regulate full disclosure so that
asymmetric information is reduced.
The securities laws were designed with two goals: to protect the integrity of the markets and to
restrict competition among securities firms so that they would be less likely to fail. Two acts
passed in 1933 and 1934 provide the primary basis for regulation of today’s securities markets.
These acts were passed shortly after the Great Depression and were largely responding to abuses
that many people at the time felt were partly responsible for the economic troubles the country
was suffering. The principal provisions of the 1933 and 1934 acts are as follows:
 To establish the Securities and Exchange Commission (SEC), this is charged with
administering securities laws
 To require that issuers register new securities offerings and those they disclose all
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relevant information to potential investors
 To require that all publicly held corporations file annual and semiannual reports with the
SEC; publicly held corporations must also file a report whenever any event of
“significant interest” to investors occurs
 To require that insiders file reports whenever shares are bought or sold
 To prohibit any form of market manipulation
Prior to the passage of these acts, the market was subject to much abuse. For example, a study
conducted in 1933 showed evidence of 127 “investment pools” operating during 1932 alone. An
investment pool is formed to manipulate the market. A group of investors band together and
spread false but damaging rumors about the health of a firm. These rumors drive the price of the
firm’s stock down. When the price is depressed, the members of the pool buy the stock. Once
they all hold shares purchased at artificially low prices, the members of the pool release good
news about the company so that the price of the stock rises. Obviously, the members of the pool
stand to earn huge profits. Small, uninformed investors lose. Practices such as these were
outlawed by the securities acts of 1933 and 1934.
As noted in our discussion of private placements, not all securities issues are subject to SEC
oversight. SEC registration is not required if less than $1.5 million in securities is issued per
year, if the securities mature in less than 270 days, or if the securities are issued by the U.S.
government or most municipalities.
Other legislation of significance to securities firms include the Glass-Steagall Act of 1933, which
separated commercial and investment banking (mostly repealed by the Gramm-Leach-Bliley
Act); the Investment Advisers Act of 1940, which required investment advisers to register with
the SEC; and the Securities Protection
Corporation Act of 1970, which established the Securities Investor Protection Corporation,
which insures customers of securities firms from losses to their cash accounts up to $100,000 and
from losses of securities documents up to $500,000. 9
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4.2. MONEY MARKET

4.2.1. Definition, characteristics, objective and role of money market
About Money Market
 Money markets are used to facilitate the transfer of short-term funds from individuals,
corporations, or governments with excess funds to those with deficient funds.
 Even investors who focus on long-term securities tend to hold some money market
securities.
 Money markets enable financial market participants to maintain liquidity.
Definition:
 Money market is the term designed to include the financial institutions which handle the
purchase, sale & transfers of short term credit instruments.
 It includes the entire machinery for the channelizing of short term funds.
Characteristics of Money Markets:
The general Characteristics of a money market are given below:
 Short term funds are borrowed & lent
 No fixed place for conduct of operations, the transaction being conducted even over the
prone & therefore there is an essential need for the presence of well developed
communications system.
 Dealings may be conducted with or without the help of brokers.
 Funds are traded for a maximum period of one year.
Objectives of Money Markets:
A well developed money market serves the following objectives
a) Providing an equilibrium mechanism for smoothing out short term surplus & deficit.
b) Providing a focal point for central bank intervention for influencing liquidity in the
economy.
c) Providing access to users of short term money to meet their requirements at a reasonable
price.
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The role and Importance of money markets
A well developed money market is essential for the development of a country. It supplies short
term funds adequately and quickly to trade and industry. A developed money market helps the
smooth functioning of the financial system in any economy in the following ways:
1. Development of trade and industry: Money market is an important source of finance to trade
and industry. Money market finances the working capital requirements of trade and industry
through bills, commercial papers etc. It influences the availability of finance both in the national
and international trade.
2. Development of capital market: Availability funds in the money market and interest rates in
the money market will influence the resource mobilisation and interest rate in the capital market.
Hence, the development of capital market depends upon the existence of a developed money
market. Money market is also necessary for the development of foreign exchange market and
derivatives market.
3. Helpful to commercial banks: Money market helps commercial banks for investing their
surplus funds in easily realisable assets. The banks get back the funds quickly in times of need.
This facility is provided by money market. Further, the money market enables commercial banks
to meet the statutory requirements of CRR (cash reserve ratio) and SLR. In short, money market
provides a stable source of funds in addition to deposits.
4. Helpful to central bank: Money market helps the central bank of a country to effectively
implement its monetary policy. Money market helps the central bank in making the monetary
control effective through indirect methods (repos and open market operations). In short, a well
developed money market helps in the effective functioning of a central bank.
5. Formulation of suitable monetary policy: Conditions prevailing in a money market serve as
a true indicator of the monetary state of an economy. Hence it serves as a guide to the Govt. in
formulating and revising the monetary policy. In short, the Govt. can formulate the monetary
policy after taking into consideration the conditions in the money market.
6. Helpful to Government: A developed money market helps the Government to raise short
term funds through the Treasury bill floated in the market. In the absence of a developed money
market, the Govt. would be forced to issue more currency notes or borrow from the central bank.
This will raise the money supply over and above the needs of the economy. Hence the general
price level will go up (inflationary trend in the economy). In short, money market is a device to
the Govt. to balance its cash inflows and outflows. Thus, a well developed money market is
essential for economic growth and stability.
4.2.2. Money Market Instruments

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Money market is involved in buying and selling of short term instruments. It is through these
instruments, the players or participants borrow and lend money in the money market. There are
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various instruments available in the money market. The important money market instruments
are:
1. Call and short notice money
2. Commercial bills
3. Treasury bills
4. Certificate of deposits
5. Commercial papers
6. Repurchase agreements
7. Money market mutual funds.
8. ADR/GDR
9. Acceptance Market
10. Collataral loan Market
These instruments are issued for short period. These are interest bearing securities.
1. Call and Short Notice Money
 These are short term loans.
 Their maturity varies between one day to fourteen days.
 If money is borrowed or lent for a day it is called call money or overnight money.
 When money is borrowed or lent for more than a day and up to fourteen days, it is called
short notice money.
 Surplus funds of the commercial banks and other institutions are usually given as call
money.
 Banks are the borrowers as well as the lenders for the call money.
 Banks borrow call funds for a short period to meet the cash reserve ratio (CRR)
requirements.
 Banks repay the call fund back once the requirements have been met.
 The interest rate paid on call loans is known as the call rate.
 It is a highly volatile rate.
 It varies from day to day, hour to hour, and sometimes even minute to minute.
Features of Call and Short Notice Money
1. These are highly liquid.
2. The interest (call rate) is highly volatile.
3. These are repayable on demand.
4. Money is borrowed or lent for a very short period.
5. There is no collateral security demanded against these loans. This means they are
unsecured.
6. The risk involved is high.
2. Commercial Bills
 When goods are sold on credit, the seller draws a bill of exchange on the buyer for the
amount due.
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 The buyer accepts it immediately.

 This means he agrees to pay the amount mentioned therein after a certain specified date.
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 After accepting the bill, the buyer returns it to the seller. This bill is called trade bill.
 The seller may either retain the bill till maturity or due date or get it discounted from
some banker and get immediate cash.
 When trade bills are accepted by commercial banks, they are called commercial bills.
 The bank discounts this bill by deducting a certain amount (discount) and balance is paid.
 A bill of exchange contains a written order from the creditor (seller) to the debtor (buyer)
to pay a certain sum, to a certain person after a certain period.
 According to Negotiable instruments Act, 1881, a bill of exchange is ‘an instrument in
writing containing an unconditional order, signed by the maker, directing a certain person
to pay a certain sum of money only to, or to the order of a certain person or to the bearer
of the instrument’.
Features of Commercial Bills
1. These are negotiable instruments.
2. These are generally issued for 30 days to 120 days. Thus these are short term credit
instruments.
3. These are self liquidating instruments with low risk.
4. These can be discounted with a bank. When a bill is discounted with a bank, the holder gets
immediate cash. This means bank provides credit to the customers. The credit is repayable on
maturity of the bill. In case of need for funds, the bank can rediscount the bill in the money
market and get ready money.
5. These are used for settling payments in the domestic as well as foreign trade.
6. The creditor who draws the bill is called drawer and the debtor who accepts the bill is called
drawee.
Types of Bills
Many types of bills are in circulation in a bill market. They may be broadly classified as follows:
1. Demand Bills and Time Bills:
 Demand bill is payable on demand.
 It is payable immediately on presentation or at sight to the drawing.
 Demand bill is also known as sight bill.
 Time bill is payable at a specified future date.
 Time bill is also known as usance bill.
2. Clean Bills and Documentary Bills:
 When bills have to be accompanied by documents of title to goods such as
railway receipts, bill of lading etc. the bills are called documentary bills.
 When bills are drawn without accompanying any document, they are called clean
bills. In such a case, documents will be directly sent to the drawee.
3. Inland and Foreign Bills:
 Inland bills are bills drawn upon a person resident in India and are payable in
India.
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 Foreign bills are bills drawn outside India and they may be payable either in
India or outside India.
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4. Accommodation Bills and Supply Bills :

 In case of accommodation bills, two parties draw bills on each other purely for the
purpose of mutual financial accommodation.
 These bills are then discounted with the bankers and the proceeds are shared
among themselves.
 On the due dates, the parties make payment to the bank.
 Accommodation bills are also known as ‘wind bills’ or ‘kite bills’.
 Supply bills are those drawn by suppliers or contactors on the Govt. departments
for the goods supplied to them.
 These bills are not considered as negotiable instruments.
5. Treasury Bills
 Treasury bills are short term instruments issued by RBI on behalf of Govt.
 These are short term credit instruments for a period ranging from 91 to 364.
 These are negotiable instruments.
 Hence, these are freely transferable.
 These are issued at a discount.
 These are repaid at par on maturity.
 These are considered as safe investment.
 Thus treasury bills are credit instruments used by the Govt. to raise short term funds to
meet the budgetary deficit.
 Treasury bills are popularly called T bills.
 The difference between the amount paid by the tenderer at the time of purchase (which is
less than the face value), and the amount received on maturity represents the interest
amount on T-bills and is known as the discount.
Features of T-Bills
1. They are negotiable securities.
2. They are highly liquid.
3. There is no default risk (risk free). This is because they are issued by the Govt.
4. They have an assured yield.
5. The cost of issue is very low. It does not involve stamp fee.
6. These are available for a minimum amount of Rs. 25000 and in multiples thereof.
Types of T-Bills
There are two categories of T-Bills. They are:
1. Ordinary or Regular T-Bills:
 These are issued to the public, banks and other institutions to raise money for
meeting the short term financial needs of the Govt.
 These are freely marketable.
 These can be bought and sold at any time.
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2. Ad hoc T-Bills:
 These are issued in favour of the RBI only.
 They are not sold through tender or auction.
 They are purchased by the RBI on tap.
 The RBI is authorised to issue currency notes against there.
On the basis of periodicity T-bills may be classified into four. They are as follows:
1. 91-Day T-Bills
2. 14-Day T-Bills
3. 182-Day T-Bills: - These were introduced in November 1986 to provide short term investment
opportunities to financial institutions and others.
4. 364-Day T-Bills
6. Certificate of Deposits (CDs)
With a view to give investor’s greater flexibility in the development of their short term
surplus funds, RBI permitted banks to issue Certificate of Deposit.
CDs were introduced in June 1989.
CD is a certificate in the form of promissory note issued by banks against the short term
deposits of companies and institutions, received by the bank.
Simply stated, it is a time deposit of specific maturity and is easily transferable.
It is a document of title to a time deposit.
It is issued as a bearer instrument and is negotiable in the market.
It is payable on a fixed date.
It has a maturity period ranging from three to twelve months.
It is issued at a discount rate varying from13% to 18%.
The discount rate is determined by the issuing bank and the market.
All scheduled banks except Regional Rural Banks and scheduled co-operative banks are
eligible to issue CDs to the extent of 7% of deposits.
It can be issued to individuals, corporations, companies, trusts, funds and associations.
CDs are issued by banks during period of tight liquidity, at relatively high interest rate.
Banks rely on this source when the deposit growth is low but credit demand is high.
The main difference between fixed deposit and CD is that CDs are easily transferable
from one party to another, whereas FDs are non-transferable.
Features of CDs
1. These are unsecured promissory notes issued by banks or financial institutions.
2. These are short term deposits of specific maturity similar to fixed deposits.
3. These are negotiable (freely transferable by endorsement and delivery)
4. These are generally risk free.
5. The rate of interest is higher than that on T-bill or time deposits
6. These are issued at discount
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7. These are repayable on fixed date.

8. These require stamp duty.
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Guidelines for Issue of CDs

CDs are negotiable money market instruments. These are issued against deposits in banks or
financial institutions for a specified time period. RBI has issued several guidelines regarding the
issue of CDs. The following are the RBI guidelines:
1. CDs can be issued by scheduled commercial banks (excluding RRBs and Local
Area Banks) and select all-India financial institutions.
2. Minimum of a CD 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.
3. CDs can be issued to individuals, corporations, companies, trusts, funds, and associations.
NRIs may also subscribe to CDs, but only on a repatriable basis.
4. The maturity period of CDs issued by banks should not be less than 7 days and not more
than one year. Financial institutions can issue CDs for a period not less than one year and not
exceeding 3 years from the date of issue.
5. CDs may be issued at a discount on face value. Bankers/Fls are also allowed to issue CDs on
a floating rate basis provided that the rate is objective, transparent and market based.
6. Banks have to maintain the appropriate CRR and SLR requirements, on the issue price of
CDs.
7. Physical CDs are freely transferable by endorsement and delivery. Dematted CDs can be
transferred as per the procedure applicable to other demat securities. There is no lock in period
for CDs.
8. Bank/Fls cannot grant loans against CDs. They cannot buy back their own CDs before
maturity.
9. Bankers/Fls should issue CDs only in the dematerialised form. However, according to the
depositories Act, 1996 investors have the option to seek a certificate in physical form.
10. Since CDs are transferable, the physical certificate may be presented for payment by the
last holder.
6. Commercial Papers (CPs)
 Commercial paper was introduced into the market in 1989-90.
 It is a finance paper like Treasury bill.
 It is an unsecured, negotiable promissory note.
 It has a fixed maturity period ranging from three to six months.
 It is generally issued by leading, nationally reputed credit worthy and highly rated
corporations.
 It is quite safe and highly liquid.
 It is issued in bearer form and on discount.
 It is also known as industrial paper or corporate paper.
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 Thus a CP is an unsecured short term promissory note issued by leading, creditworthy and
highly rated corporate to meet their working capital requirements.
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 In short, a CP is a short term unsecured promissory note issued by financially strong

companies.
Advantages of Commercial Paper
1. These are simple to issue.
2. The issuers can issue CPs with maturities according to their cash flow.
3. The image of the issuing company in the capital market will improve. This makes easy
to raise long term capital.
4. The investors get higher returns
5. These facilitate securitisation of loans. This will create a secondary market for CP.
Disadvantages of Commercial Papers
1. It cannot be repaid before maturity.
2. It can be issued only by large, financially strong firms.
6. Repurchase Agreements (REPO)
 REPO is basically a contract entered into by two parties (parties include RBI, a bank or
NBFC).
 In this contract, a holder of Govt. securities sells the securities to a lender and agrees to
repurchase them at an agreed future date at an agreed price.
 At the end of the period the borrower repurchases the securities at the predetermined price.
 The difference between the purchase price and the original price is the cost for the borrower.
 This cost of borrowing is called repo rate.
 A transaction is called a Repo when viewed from the perspective of the seller of the
securities and reverse when described from the point of view of the suppliers of funds.
 Thus whether a given agreement is termed Repo or Reverse Repo depends largely on which
party initiated the transaction.
 Thus Repo is a transaction in which a participant (borrower) acquires immediate funds by
selling securities and simultaneously agrees to repurchase the same or similar securities after
a specified period at a specified price.
 It is also called ready forward contract.
7. Money Market Mutual Funds (MMMFs)
 Money Market Mutual Funds mobilise money from the general public.
 The money collected will be invested in money market instruments.
 The investors get a higher return.
 They are more liquid as compared to other investment alternatives.
 The MMMFs were originated in the US in 1972.
Advantages of MMMFs
1. These enable small investors to participate in the money market.
2. The investors get higher return.
3. These are highly liquid.
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4. These facilitate the development of money market.

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Disadvantage of MMMFs
1. Heavy stamp duty.
2. Higher flotation cost.
3. Lack of investors’ education.
8. American Depository Receipt and Global Depository Receipt
 ADRs are instruments in the nature of depository receipt and certificate.
 These instruments are negotiable and represent publicly traded, local currency equity
shares issued by non - American company.
 For example, an NRI can invest in Indian Company’s shares without bothering dollar
conversion and other exchange formalities.
 If the facilities extended globally, these instruments are called GDR.
 ADR are listed in American Stock exchanges and GDR are listed in other than American
Stock exchanges, say Landon, Luxembourg, Tokyo etc.,
9. Acceptance Market
 Acceptance Market is another component of money market. It is a market for banker’s
acceptance.
 The acceptance arises on account of both home and foreign trade.
 Bankers’ acceptance is a draft drawn by a business firm upon a bank and accepted by that
bank.
 It is required to pay to the order of a particular party or to the bearer, a certain specific
amount at a specific date in future.
 It is commonly used to settle payments in international trade.
 Thus acceptance market is a market where the bankers’ acceptances are easily sold and
discounted.
10. Collateral Loan Market
 Collateral loan market is another important sector of the money market.
 The collateral loan market is a market which deals with collateral loans.
 Collateral means anything pledged as security for repayment of a loan.
 Thus collateral loans are loans backed by collateral securities such as stock, bonds etc.
 The collateral loans are given for a few months.
 The collateral security is returned to the borrower when the loan is repaid.
 When the borrower is not able to repay the loan, the collateral becomes the property of
the lender.
 The borrowers are generally the dealers in stocks and shares.
4.2.3. VALUATION OF MONEY MARKET SECURITIES
The market price of money market securities (Pm) should equal the present value of their future
cash flows. Since money market securities normally do not make periodic interest payments,
their cash flows are in the form of one lump-sum payment of principal. Therefore, the market
18
price of a money market security can be determined as

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This illustrates how the prices of money market securities would change in response a change in
the required rate of return, which is influenced by the risk-free interest rate and the perceived
credit risk over time. The above Exhibit identifies the underlying forces that can affect the short-
term risk-free interest rate (the T-hill rate) and the risk premium, and can therefore affect the
required return and prices of money market securities over time.
In general, the money markets are widely perceived to be efficient, in that the prices reflect all
available public information. Investors closely monitor economic indicators that may signal
future changes in the strength of the economy, which can affect short-term interest rates and
therefore the required return from investing in money market securities.
Investors also closely monitor indicators of inflation, such as the consumer price index and the
producer price index. An increase in these indexes may create expectations of higher interest
rates and places downward pressure on money market prices.
In addition to the indicators, investors also assess the financial condition of the firms that are
issuing commercial paper. Their intent is to ensure that the issuing firm is financially healthy and
19
therefore capable of paying off the debt at maturity.

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4.2.4. International money market securities

 Apart from variety of money market instruments which enable short-term lending and
borrowing to take place in the domestic currency, in recent years some of the fastest
growing markets have been the so-called euro currency markets.
 These are markets in which the borrowing and lending denominated in a currency of
some other country takes place.
Concept
 Eurocurrency instrument is any instrument denominated in a currency which differs
from that of the country in which it is traded.
 The factor contributing to the long-term development of euro currency business was the
ability of euro banks to offer their services at more competitive rates than domestic
institutions.
 ‘Euro banks’ are banks which specialize in euro currency business.
 They channel funds between surplus and deficit units and thus create assets and
liabilities which are more attractive to end-users than if they dealt directly with each
other, also they help to use funds which might otherwise lay idle.
 In the Eurodollar market banks channel the deposited funds to other companies which
need to receive Eurodollar loans.
 The deposit and loan transactions are of large denominations, e.g. exceeding 1 million
USD.
 Therefore only governments and largest corporations can participate in the market.
Eurocurrency liabilities of financial institutions are the following:
 Euro Certificates of deposits
 Inter bank placements
 Time deposits
 Call money
1. Euro certificates of deposits (Euro CDs) are negotiable deposits with a fixed time to
maturity.
2. Inter bank placements are short-term, often overnight, interbank loans of Eurocurrency
time deposits.
3. Time deposits are non negotiable deposits with a fixed time to maturity. Due to
illiquidity their yields tend to be higher than the yields on equivalent maturity of
negotiable Euro certificates of deposits.
4. Call money are non negotiable deposits with a fixed maturity that can be withdrawn at
any time.
Eurocurrency assets of financial institutions are the following:
 Euro Commercial Papers (Euro CPs)
20
 Syndicated Euroloans
 Euronotes
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1. Euro Commercial Papers (Euro CPs)

 Are securitized short-term bearer notes issued by a large well-known corporation.
 They are issued only by private corporations in short maturities with the aim to
provide short-term investments with a broad currency choice for international
investors.
 Most issues are pure discount zero coupon debt securities with maturities from 7 to
365 days.
 Issuance may be conducted through an appointed panel of dealers.
 It can be resold in a highly liquid secondary market.
 The issuers should be highly rated as Euro CPs are unsecured.
Syndicated Euro loans
 Are related to bank lending of Eurocurrency deposits to nonfinancial companies with the
need for funds.
 Since they are non-negotiable, banks used to hold the syndicated loans in their portfolios
until they mature.
 Due to their illiquidity, the loans are often made jointly by a group of lending banks,
which is called a syndicate.
 The role of syndication is to share loan risks among the banks that members of the
syndicate.
Euro notes
 Are un-securitized debt instruments, substitutes for non-negotiable Euro-loans.
 They are short –term, most often up to one year.
 Floating rate notes (FRNs) offer a variable interest rate that is reset periodically, usually semi
annually or quarterly, according to some predetermined market interest rate (e.g. LIBOR).
 For a high rated issuer the interest rate can be set lower than LIBOR.
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Chapter Four: Primary Market and Money Market Market Organization

CHAPTER FOUR: ORGANIZATION AND STRUCTURE OF MARKETS –

it will suffer a loss.

and Poor’s or Moody’s.

4.1.2. Regulation of Security Firms

relevant information to potential investors

4.2. MONEY MARKET

Characteristics of Money Markets:

The general Characteristics of a money market are given below:

 Short term funds are borrowed & lent

A well developed money market serves the following objectives

The role and Importance of money markets

4.2.2. Money Market Instruments

 The buyer accepts it immediately.

4. Accommodation Bills and Supply Bills :

7. These are repayable on fixed date.

Guidelines for Issue of CDs

 In short, a CP is a short term unsecured promissory note issued by financially strong

4. These facilitate the development of money market.

price of a money market security can be determined as

therefore capable of paying off the debt at maturity.

4.2.4. International money market securities

1. Euro Commercial Papers (Euro CPs)

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