National seminar

On

Contemporary issue in Commerce and Management

Organized by

Shree G.K & C.K Bosamia Arts & Commerce college- Jetpur

&

Indian Accounting Association Saurashtra Branch, Rajkot.

Financial markets
Money Market Instruments
A comparative Study with respect to Certificate of Deposits and BSE
SENSEX in India.
Presented by

Bhojani Minal V. (M.Com)

Student of: M.Phil (Commerce)

Department of Commerce & Business Administration

Saurashtra University, Rajkot.

2009-10

Venue

Shree G.K & C.K Bosamia Arts & Commerce College

Junagadh road, Jetpur – 360 370

Money Market Instruments

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 A comparative Study with respect to Certificate of Deposits and BSE
SENSEX in India.

Abstract
Financial markets are a mechanism enabling participants to deal in financial
claims. The markets also provide a facility in which their demands and
requirements interact to set a price for such claims.

The money market forms an important part of the financial system by

providing an avenue for equilibrating the surplus funds of lenders and the
requirements of borrowers for short periods ranging from overnight up to a year.

This paper is being prepared to analyze the return on certificate of deposits

compare to yield on BSE sensex.

Introduction

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 The money market is a market for financial assets that are close substitute
for money. It is a market for overnight to short term funds and instruments
having a maturity period of one or less than one year. It is not a place (like stock
market), but an activity conducted by telephone. The money market constitutes a
very important segment of the Indian financial system.
The money market forms an important part of the financial system by
providing an avenue for equilibrating the surplus funds of lenders and the
requirements of borrowers for short periods ranging from overnight up to a year.
It also provides a focal point for central bank’s intervention for influencing the
liquidity in the financial system and thereby transmitting the monetary policy
impulses.

Indian money market

The Indian money market till mid-1980s was relatively underdeveloped

with few instruments and strict regulations with regard to participants and
interest rates. Another issue of concern was that the distribution of liquidity in
the market was skewed with a few large lenders and some chronic borrowers.
The basic pre-requisite of a deep and liquid market that participants should
alternate between borrowing and lending activity (i.e., providing two-way quotes)
was also absent.
In pursuance of the recommendations of the Committee to Review the
Working of the Monetary System (Chairman: Professor Sukhamoy Chakravarty)
[1985] and the Working Group on the Money Market (Chairman: Shri N. Vaghul)
[1987], a number of measures were taken by RBI to widen and deepen the money
market through institution building and instrument development. Measures were

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 also initiated to increase the number of participants in the money market. The
Discount and Finance House of India Ltd. (DFHI) was set up jointly by the Reserve
Bank, public sector banks and financial institutions to deal in short-term money
market instruments with the primary objective of imparting improved liquidity to
such instruments.
Accordingly, while introduction of new instruments, broadening of
participants' base and strengthening of institutional infrastructure have been
pursued during the 1990s based on the framework provided by the Vaghul
Committee, the Narasimham Committee (1998) recommended rationalisation,
inter alia, of the participation of different classes of entities in various segments
of money market as also underscored the importance of money market in the
context of discretionary liquidity management of RBI. Pursuant to these
recommendations, coupled with the need to keep the credit risk at a minimum in
the financial market, encouraging inter-linkages across various

Definitions.

The RBI defines the money market as, “a market for short term financial
assets that are close substitutes for money, facilitates the exchange of money for
new financial claims in the primary market as also for financial claims, already
issued, in the secondary market.”
According to Geottery Crowther, “The money market is the collective name
given to the various firms and institutions that deal in the various grades of near
money.”

Certificate of Deposits:

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Certificates of deposits are unsecured, negotiable, short-term instruments in
bearer form, issued by commercial banks and development financial institutions.

Certificates of deposit were introduced in June 1989. Only scheduled commercial

banks were allowed to issue them initially. Financial institutions were permitted
to issue certificates of deposits in 1992.

Regulatory Framework for Issue of CDs:

The RBI has modified its original scheme from time to time. The norms/guidelines
which are in force in 1997-98 are broadly as follows:

The minimum denomination of CDs is Rs. Five lakh.

Minimum size of the issue of a single depositor is Rs.10 lakh; additional
amounts can be issued in multiples of Rs. Five lakh.
The maturity period of CDs of banks varies from three months to one year.
CDs are issued at a discount to face value.
Discount rate is determined by the market.
CDs are freely transferable after a lock-in period of 30 days after the issue.
All scheduled banks other than RRBs can issue them.
Term-lending financial institution also can issue them, but with maturity of
one to three years and with an overall umbrella limit equal to NOF of each
FI.
Banks can issue CDs without any ceiling.
CDs are subject to CRR and SLR requirements.
CDs cannot be bought back by issuing institutions, nor can they lend against
CDs.
Anyone can purchase CDs.
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CDs in India:

Since the beginning of 1980s, the possibility of introducing CDs in India was being
seriously assessed. The Tambe Working Group studied, in 1982, its feasibility and
recommended against it for the following reasons: (a) there were no secondary
money market; (b) there was the administered system of interest rates; and (c)
there was the possibility that CDs might give rise to fictitious transactions. The
Vaghul Working Group studied the matter again five years later (1987) and was in
favour of introducing CDs, provided short-term deposit rates were aligned with
other interest rates in the system. Ultimately, following the rationalization of
interest rates on short-term deposits the RBI formulated and launched, in June
1989, a scheme permitting banks to issue CDs “ with a view to further widen the
range of money market instrument and to give investors greater flexibility in the
deployment of their short-term surplus funds.”

According to the original RBI scheme, CDs were issued in the form of usance
promissory notes payable on a fixed date without any grace period. They were
issued in multiples of Rs.25 lakh subject to minimum size of each issue being Rs.
One crore. They had the maturity period of three months to one year, and they
would be issued at a discount to face value like TBs and CPs, and the discount rate
was freely determined by the issuing bank and market. CDs are freely transferable
by endorsement and delivery but only after the lock-in period of 45 days after the
date of issue. All scheduled banks, other than regional rural banks and scheduled
co-operative banks, were eligible to issue CDs but the total outstanding of all CDs
issued by a bank at any point of time were not to exceed one per cent of its
fortnightly average deposits during the financial year, 1988-89. All CDs were

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subject to the usual CRR and SLR requirements on the issue price of CDs, and
banks had to report them (CDs) as deposits to the RBI. Banks were not permitted
to buy-back their CDs prematurely; nor could they grant loans against CDs. CDs
had to bear stamp duty at the rate of 0.25 per cent ad valorem for a maturity of
over three to six months, 0.375 per cent for a maturity of over six months to nine
months, and 0.5 per cent for a maturity of over nine months to 12 months. CDs
can be issued to individuals, corporations, companies, trusts, funds, and
associations. The NRIs also can subscribe to CDs but only on a non-repatriation
basis.

Secondary Market for CDs:

Being a negotiable instrument CDs are traded in the secondary money market.
However, the secondary market for these deposits has remained dormant as
investors; find it profitable to hold the high-interest yielding deposits till maturity.
In order to provide flexibility and depth to the secondary market, the time
restriction on transferability of CDs issued by both banks and financial institutions
was withdrawn effective from October 10, 2000. Two-way quotations on the
deposits are offered by DFHI, but very little trade actually takes place in the
secondary market. CDs are also traded on the NSE-WDM segment but the
proportion in the total trading volume is significant.

Factors inhibiting the growth of CDs:

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CDs of commercial banks for only 2 per cent of their (financial institutions)
aggregate deposits. Hence, there is a largest scope for the development of this
instrument. The following factors, however, limit the growths of CDs.

a) Transactions in the secondary market have not developed because the

numbers of participants are limited, interest rates are quite high, and
certificates of deposit are not listed.
b) The secondary market for certificates of deposit has been slow to develop.
With banks offering higher interest rates on these deposits, investors find it
profitable to hold them till maturity.
c) The reliance of financial institutions on CDs has decreased. It can be
increased if the tenor of the certificates of deposit of the financial
institutions is rationalized.
d) There is no facility of loans against the deposits by banks nor can banks by
them back prematurely.
e) The market is limited to few investors as the minimum level of investment
is still high.
f) The stamp duty on the certificate of deposit has also affected their growth.
g) Certificates of deposits carry a fixed rate discount. To enlarge the market of
these deposits, it is necessary to introduced floating rate of CDs.

Size of the CD Market:

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The size of the CD market is reflected in the total outstanding amount of CDs
issued by commercial banks and financial institutions.

The amount of money mobilized by banks till 1997-98 through certificates of

deposit increased indicating that the primary market for the issuance of the
deposits grew rapidly. Stringent conditions in the money market and firm call
money rates rekindled the interest of banks in CDs in 1994-95 to 1997-98.

Since 1998-99, the bank’ reliance on the relatively high-cost CDs declined due to
downward trend in the rates of other money market instruments and strong
growth in bank deposits coupled with a deceleration in non-food bank credit.
Moreover, interest rate deregulation in term deposits and reduction in the
maturity period to 15 days facilitated better management of liabilities by banks
and reduced their need to issue CDs.

Year Outstanding amount Interest rate (in %)

(Rs. In crores)
2004-05 6,052 5.18
2005-06 27,298 6.09
2006-07 65,021 8.24
2007-08 1,17,186 8.94
2008-09 1,62,574 9.31

Research Methodology:

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 Research methodology includes the Hypotheses and values, which is useful
for interpreting data and reaching to conclusion.

The Advanced Lerner’s Dictionary of Current English lays down the meaning
of research as “a careful investigation or inquiry especially through search for new
facts in any branch of knowledge.”

Identification of problem:

Collection of data:

The present study is a micro-level study since it is not possible to conduct it

on the macro-level. This study is completely based on the secondary data. The
data has been collected from the Annual Report of RBI, report on currency and
finance of 2004-05 to 2008-09 and www.BSEindia.co.in . In addition to other
reference books and the published and unpublished articles of money market
have been considered in this study.

The collected data was classified, tabulated and analyzed in a systematic

manner. For the data analysis, a statistical tool like co-efficient of correlation is
used in the present study.

Sample of the study:

For this purpose only Certificates of Deposits (CDs) have been selected,
from various money market instruments like commercial Paper, Treasury bills,
Call Money etc., for the comparison with the BSE Sensex.

Objective and Hypothesis:

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The main objective of this study is to prove that the performance of CDs compare
to yield on BSE Sensex.

Null Hypothesis:

H0 = There would be no significant correlation between interest on CDs

and dividend yield on BSE Sensex.

Alternative Hypothesis:

H1 = There would be significant correlation between interest on CDs and

dividend yield on BSE Sensex.

Tabular analysis:

Co-efficient of Correlation:

X Y X2 Y2 XY2
1.59 5.18 2.53 26.83 8.24
1.36 6.09 1.85 37.09 8.28
1.10 8.24 1.21 67.90 9.06
1.30 8.94 1.69 79.92 11.62
1.44 9.31 2.07 86.68 13.41
∑x =6.79 ∑y=37.76 ∑x2=9.35 ∑y2=298.42 ∑xy2=50.61

Taking, X = Dividend yield on BSE Sensex & Y = int. rate on certificates of Deposits.

Based on the above data the finding out the Co-efficient of Correlation. The
value of ‘r’ is -0.51 which indicate the negative correlation between the variables.
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So, there is no correlation between Dividend yields on BSE Sensex & int. rate on
certificates of Deposits.

Conclusion and Recommendations:

In order to develop CD market in India RBI took several steps:

 Relaxation in the denomination of CD issue from 25 Lakhs to 5 Lakhs.

 CDs can be freely transferred after a lock-in period of 30 day after the issue.
 Banks can issue CDs without ceiling.
 Reduction in stamp duty charged at issue expenses.

It is suggested that in order to further preserve the integrity of CD market as also

to generate further investment interest in this in this instruments.

1) There should be reduction in minimum denomination of CD issue so that it

can be made attractive to retail investors.
2) There should be development of well connected online trading system in
money market instrument also as in equity market.
3) Minimum maturity period should reduce.

References:

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 BHARATI V. PATHAK “Indian Financial System” , Pearson Education, New
Delhi.
 L M BHOLE, “Financial Institutions and Markets” , TATA McGraw HILL.
 S P GUPTA, “Statistical Method”, Sultan Chand Sons Education Publishers,
New Delhi.
 C R KOTHARI “research Methodology” , New Age International Pvt. Ltd.
Publishers, New Delhi
 The Management Accountant, April 2009, VOL., 44, No. 04.
 www.rbi.org.com.
 www.bseindia.com

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