MONEY MARKET IN INDIA UNIT 5 SEM 6

MONEY MARKET IN INDIA

Money Market is a segment of the financial market in India where borrowing and
lending of short-term funds take place. The maturity of money
market instruments is from one day to one year. In India, this market is regulated
by both RBI (the Reserve bank of India) and SEBI (the Security and Exchange Board
of India). The nature of transactions in this market is such that they are large in
amount and high in volume. Thus, we can say that the entire market is dominated
by a small number of large players.

The money market refers to trading in very short-term debt investments. At the
wholesale level, it involves large-volume trades between institutions and traders.
At the retail level, it includes money market mutual funds bought by individual
investors and money market accounts opened by bank customers.

Objectives of the money market in India

The following are the important objectives of an Indian money market –

 Facilitate a parking place to employ short-term surplus funds.

 Aid room for overcoming short-term deficits.

 To enable the Central Bank to influence and regulate liquidity in the

economy through its intervention in this market.

 Help reasonable access to users of short-term funds to meet their

requirements quickly, adequately and at reasonable costs.

Segments of the Indian money market

The Indian money-market has the following two segments. The existence of the
unorganized market, though illegal, yet operates. However, we that is out of the
scope of the present article. So we will concentrate exclusively on the organized

1
money-markets in India. Wherever, in the blog article or elsewhere in the site we
refer money-markets, it is in organized money-market only.

1. Unorganized money-market

The unorganized money market is an old and ancient market, mainly it made of
indigenous bankers and money lenders, etc.

2. Organized money-market

The organized money market is that part which comes under the regulatory ambit
of RBI & SEBI. Governments (Central and State), Discount and Finance House of
India (DFHI), Mutual Funds, Corporate, Commercial or Cooperative Banks, Public
Sector Undertakings, Insurance Companies, and Financial Institutions and Non-
Banking Financial Companies (NBFCs) are the key players of the organized Indian
money market.

Structure of organized money market of India

The organized money market in India is not a single market. It is a combination of
markets of various instruments. The following are the instruments that are
integral parts of the Indian money market system.

1. Call money or notice money

Call money, notice money, and term money markets are sub-markets of the
Indian money market. These markets provide funds for very short-term. Lending
and borrowing from the call money market for 1 day.

Whereas lending and borrowing of funds from notice money market are for 2 to
14 days. And when there are borrowing and lending of funds for the tenor of
more than 14 days, it refers to “Term Money”.

2. Treasury bills

The Bill market is a sub-market of this market in India. There are two types of the
bill in the money market. They are treasury bills and commercial bill. The treasury

2
bills are also known as T-Bills, T-bills are issued by the Central bank on behalf of
Government, whereas Commercial Bills are issued by Financial Institutions.

Treasury bills do not yield any interest, but it is issued at discount and repaid at
par at the time of maturity. In T-bills there is no risk of default; it is a safe
investment instrument.

3. Commercial bills

Commercial bill is a money market instrument which is similar to the bill of

exchange; it is issued by a Commercial organization to raise money for short-term
needs. In India, the participants of the commercial bill market are banks and
financial institutions.

4. Certificate of deposits

Certificate of Deposits also known as CDs. It is a negotiable money market

instrument. It is like a promissory note. Rates, terms, and amounts vary from
institution to institution. CDs are not supposed to trade publically neither it is
traded on any exchange.

In general institutions issue certificate of deposit at discount on its face value. The
banks and financial institutions can issue CDs on a floating rate basis.

5. Commercial paper

The commercial paper is another money market instrument in India. We also call
commercial paper as CP. CP refers to a short-term unsecured money market
instrument. Big corporations with good credit rating issue commercial paper as a
promissory note. There is no collateral support for CPs. Hence, only large firms
with considerable financial strength can issue the instrument.

6. Money market mutual funds (MMMFs)

The money-market mutual funds were introduced by RBI in 1992 and since 2000
they are brought under the regulation of SEBI. It is an open-ended mutual fund
which invests in short-term debt securities. This kind of mutual fund solely invests
in instruments of the money market.
3
7. Repo and the reverse repo market

Repo means “Repurchase Agreement”. It exists in India since December 1992.

REPO means selling a security under an agreement to repurchase it at a
predetermined date and rate. Those who deal in government securities they use
the repo as an overnight borrowings.

Features of the Indian money market

The following are the important features of the money market in India –

1. The money market is purely for short-term funds or assets called near
money.

2. All the instruments of the money market deal only with financial assets that
are financial in nature. Also, such instruments have maturity period up to
one year.

3. It deals assets that can convert into cash readily without much loss and
with minimum transaction cost.

4. Generally, transactions take place through oral communication (for eg.

phone or mobile). The exchange of relevant documents and written
communications take place subsequently. There is no formal place for the
trading ( like a stock exchange).

5. Brokers free transactions are there.

6. The components of a money market are the Central Bank, Commercial

Banks, Non-banking financial companies, discount houses, and acceptance
house. Commercial banks are dominant player of this market.

Functions of Indian money markets

The instruments of this market are liquid when we compare it with other financial
instruments. We can convert these instruments into cash easily. Thus, they are
able to address the need for the short-term surplus funds of the lenders and
short-term fund requirements of the borrowers.
4
The major functions of such market instrument are to cater to the short-term
financial needs of the economy. Some other functions are as following:

1. It helps in effective implementation of the RBI’s monetary policy.

2. This market helps to maintain demand and supply equilibrium with regard
to short-term funds.

3. It also meets the need for short-term fund requirement of the government.

4. It helps in maintaining liquidity in the economy.

The money market serves the following objectives:

1. It provides an equilibrating mechanism for evening out short-term
surpluses and deficits.

2. It provides a focal point for central bank intervention for influencing

liquidity in the economy.

3. It provides reasonable access to users of short-term money to meet their

requirements at a realistic price.

 To cater to the requirements of borrowers for short term funds at

competitive prices.

 To overcome short term deficits

 Helps central bank to regulate liquidity in the economy

 Helps government to implement monetary policy through open market

operation

 It helps employment of surplus fund, thus provides good investment

opportunity.

Participants in the Money Market:

1. Central Government:

5
The Central Government is an issuer of Government of India Securities (G-Secs)
and Treasury Bills (T-bills). These instruments are issued to finance the
government as well as for managing the Government’s cash flow. G-Secs are
dated (dated securities are those which have specific maturity and coupon
payment dates embedded into the terms of issue) debt obligations of the Central
Government.

2. State Government:

The State Governments issue securities termed as State Development Loans

(SDLs), which are medium to long-term maturity bonds floated to enable State
Governments to fund their budget deficits.

3. Public Sector Undertakings:

Public Sector Undertakings (PSUs) issue bonds which are medium to long-term
coupon bearing debt securities. PSU Bonds can be of two types: taxable and tax-
free bonds. These bonds are issued to finance the working capital requirements
and long-term projects of public sector undertakings. PSUs can also issue
Commercial Paper to finance their working capital requirements.

4. Scheduled Commercial Banks (SCBs):

Banks issue Certificate of Deposit (CDs) which are unsecured, negotiable instru-
ments. These are usually issued at a discount to face value. They are issued in
periods when bank deposits volumes are low and banks perceive that they can
get funds at low interest rates. Their period of issue ranges from 7 days to 1 year.

5. Private Sector Companies:

Private Sector Companies issue commercial papers (CPs) and corporate

debentures. CPs are short-term, negotiable, discounted debt instruments. They
are issued in the form of unsecured promissory notes. They are issued when
corporations want to raise their short-term capital directly from the market
instead of borrowing from banks.

6. Provident Funds:

6
Provident funds have short term and long term surplus funds. They invest their
funds in debt instruments according to their internal guidelines as to how much
they can invest in each instrument category.

The instruments that Provident funds can invest in are:

(i) G-Secs,

(ii) State Development Loans,

(iii) Bonds guaranteed by the Central or State Governments,

(iv)Bonds or obligations of PSUs, SCBs and Financial Institutions (FIs), and

(v) Bonds issued by Private Sector Companies carrying an acceptable level of

rating by at least two rating agencies.

7. General Insurance Companies:

General insurance companies (GICs) have to maintain certain funds which have to
be invested in approved investments. They participate in the G-Sec, Bond and
short term money market as lenders. It is seen that generally they do not access
funds from these markets.

8. Life Insurance Companies:

Life Insurance Companies (LICs) invest their funds in G-Sec, Bond or short term
money markets. They have certain pre-determined thresholds as to how much
they can invest in each category of instruments.

9. Mutual Funds:

Mutual funds invest their funds in money market and debt instruments. The
proportion of the funds which they can invest in any one instrument vary
according to the approved investment pattern declared in each scheme.

10. Non-banking Finance Companies:

7
Non-banking Finance Companies (NBFCs) invest their funds in debt instruments to
fulfill certain regulatory mandates as well as to park their surplus funds. NBFCs
are required to invest 15% of their net worth in bonds which fulfill the SLR
requirement.

11. Primary Dealers (PDs):

he organization of Primary Dealers was conceived and permitted by the Reserve

Bank of India (RBI) in 1995. These are institutional entities registered with the RBI.

The roles of a PD are:

1. To commit participation as Principals in Government of India issues through

bidding in auctions.

2. To provide underwriting services and ensure development of underwriting and

market- making capabilities for government securities outside the RBI.

3. To offer firm buy – sell/bid ask quotes for T-Bills & dated securities and to
improve secondary market trading system, which would contribute to price
discovery, enhance liquidity and turnover and encourage voluntary holding of
government securities amongst a wider investor base.

4. To strengthen the infrastructure in the government securities market in order

to make it vibrant, liquid and broad based.

5. To make PDs an effective conduit for conducting open market operations.

Money Market

Definition: Money Market can be understood as the market for short term funds,
wherein lending and borrowing of funds varies from overnight to a year. It is an
important part of the financial system that helps in fulfilling the short term and
very short term requirements of the companies, banks, financial institution,
government agencies and so forth.

Salient Features of Money Market

8
  It is a wholesale market, as the transaction volume is large.

 Trading takes place over the telephone, after which written confirmation is
done by way of e-mails.

 Participants include banks, mutual funds, investment institutions and

Central Banks.

 There is an impersonal relationship between the participants in the money

market, and so, pure competition exists.

 Money market operations focus on a particular area, which serves a region

or an area. On the basis of the market size and needs, the area may differ.

What is Call Money Market?

The call money market is an essential part of the Indian Money Market, where the
day-to-day surplus funds (mostly of banks) are traded. The money that is lent for
one day in this market is known as "Call Money".

he call money market is an essential part of the Indian Money Market, where the
day-to-day surplus funds (mostly of banks) are traded. The money market is a
market for short-term financial assets that are close substitutes of money. The
most important feature of a money market instrument is that it is liquid and can
be turned into money quickly at low cost and provides an avenue for equilibrating
the short-term surplus funds of lenders and the requirements of borrowers.

The loans are of short-term duration varying from 1 to 14 days, are traded in call
money market. The money that is lent for one day in this market is known as "Call
Money", and if it exceeds one day (but less than 15 days) it is referred to
as "Notice Money". Term Money refers to Money lent for 15 days or more in the
Inter Bank Market.

Banks borrow in this money market for the following purpose:

 To fill the gaps or temporary mismatches in funds

9
  To meet the Cash Reserve Ratio(CRR) & Statutory Liquidity Ratio(SLR)
mandatory requirements as stipulated by the RBI

 To meet sudden demand for funds arising out of large outflows.

Thus call money usually serves the role of equilibrating the short-term liquidity
position of banks

Participants of Call Money Market in India

Banks, Primary Dealers (PDs), Development Finance Institutions, Insurance

companies, and select Mutual Funds are currently participants in the call money
market. PDs and banks can act as both borrowers and lenders in the market. Non-
bank institutions that have been granted specific permission to operate in the call
money market, on the other hand, can only act as lenders.

Borrowing

1. Scheduled Commercial Banks

2. Co-operative Banks

3. Primary Dealers (PDs)

Lending

1. Scheduled Commercial Banks

2. Co-operative Banks
3. Primary Dealers (PDs)
4. Select all-India Financial Institutions
5. Select Insurance Companies
6. Select Mutual Funds

What are Money Market Instruments?

Money market instruments are those instruments, which have a maturity period
of less than one year. The most active part of the money market is the market for
overnight call and term money between banks and institutions and repo

10
transactions. Call Money / Repo are very short-term Money Market products. The
below mentioned instruments are normally termed as money market
instruments:

 Certificate of Deposit (CD)

 Commercial Paper (CP)

 Inter Bank Participation Certificates

 Inter Bank term Money

 Treasury Bills

 Bill Rediscounting

 Call/ Notice/ Term Money

Call Money Market in India

Call money market deals with day-to-day requirements of funds. The purpose
of call loans is to deal in the bullion market and stock exchanges.

 Money lent for one day is called call money.

 Money lent for more than one day and less than 15 days is called Notice
Money.

 Money lent for more than 15 days is called term money.

Why do Banks Need Call Money?

 For managing temporary funding mismatches

 To comply with the cash reserve ratio (CSR) and the statutory liquidity ratio
(SLR)

 For meeting excess demand caused by a net outflow of funds from

disinvestment or imports

Call Money Market Features

11
 1. High Liquidity: One of the most important characteristics of the call money
market is the high liquidity it provides. They provide fixed income to the
investor and have a short-term maturity. Because of this feature, call money
market instruments are regarded as close substitutes for money.

2. Secure Investment: These financial instruments are among the most secure
investment avenues available in the market. Since issuers and borrowers of
call money market instruments have high credit ratings and the returns are
fixed beforehand, the risk of losing invested capital is minuscule.

3. Competitive Interest Rates: The interest rate charged on a call loan

between financial institutions is known as the call loan rate. Call money is used
by brokers as a short-term source of funding to keep margin accounts open for
customers who want to leverage their investments. The interest rate charged
on loans used to purchase securities varies based on the call money rate set by
the RBI.

4. Easy Transfers: The funds can be transferred between lenders and

brokerage firms quickly. As a result, call money is the second most accessible
asset in a balance sheet, trailing only cash. If the lender calls the funds, the
broker can issue a margin call, which typically results in the automatic sale of
securities in a client’s account (to convert the securities to cash) to repay the
lender.

Advantages of Call Money Market

i. It provides facility of high liquidity because money lent in this type of

market can be called back at any time.

ii. Sudden payments and remittances are possible.

iii. It offers a profitable parking place for employing the surplus funds.

iv. It helps the Government to raise short-term funds.

v. Call loans are safe since the participants have a strong financial standing.

vi. It is helpful to central bank operations.

12
 Disadvantages of Call Money Market

Following are the drawbacks of call money market in India:

i. It is confined to only big industrial and commercial centres.

ii. Call money markets are not fully integrated.

iii. There is the volatile nature of the call money rates.

Repo Rate

The repo rate is the interest rate at which the Reserve Bank of India (RBI) loans
money to commercial banks. Repo is an abbreviation for Repurchase Agreement
or Repurchasing Option. Banks obtain loans from the Reserve Bank of India (RBI)
by selling qualifying securities.

The central bank or RBI and the commercial bank would reach an agreement to
repurchase the securities at a set price. When banks are short on funds or need to
maintain liquidity under volatile market conditions, this is done. The repo rate is
utilized by the RBI to manage inflation.

The repo transaction comprises two phases –

Phase 1 – Transaction for a nearer date – In this phase, the selling of the security
and its repurchasing take place. The sale price is based on the available market
price for outright deals.

Phase 2 – Transaction for a future date – The price is determined based on the
fund’s flow of interest and tax elements of funds exchanged.

How Does Repo Rate Work?

As previously stated, the repo rate is utilized by the Indian central bank to restrict
the flow of money in the market. When the market is impacted by inflation, the
RBI raises the repo rate.

An increased repo rate means that banks borrowing money from the central bank
during this period will have to pay more interest. This inhibits banks from

13
borrowing money, reducing the amount of money in the market and helping to
negate inflation. In the event of a recession, repo rates are also reduced.

Current Repo Rate in India

In September 2022, the Monetary Policy Committee (MPC) stated that the repo
rate had been raised by 50 basis points to 5.90%. During its meeting, the MPC
agreed to maintain the reverse repo rate at 3.35%. The Bank Rate and also the
marginal standing facility rate have been changed to 5.15%.

Reserve Bank of India Repo Rate

Repo Rate - 5.90%

Reverse Repo Rate - 3.35%

Bank Rate - 5.15%

Marginal Standing Facility Rate - 5.15%

Calculation of Repo Rate by the Reserve Bank of India

The banks need to secure a standard repo rate. The interest rates paid by the
commercial banks to the RBI or the interest rates they get when they deposit
money in the RBI must be agreed upon and standardized.

The repo rate formula is as follows –

Repo Rate = (Repurchase Price – Original Selling Price / Original Selling Price) *
(360 / n)

Where:

 Repurchase Cost = Original Selling Price + Interest

 Original Selling Cost = Sales Cost of Security

 n = Number of Days to Maturity

Increase in Repo Rate

14
 1. When there is a high inflation rate in the economy, and as per RBI, the
condition may further surge.

2. When there is a risk of depreciation of the currency

3. When it wants to reduce any speculations that arise in areas of foreign

exchange

4. The possibility of the formation of asset bubbles as a result of an excessive

amount of capital formation

Decrease in Repo Rate

1. That situation in which RBI assumes that both inflation and the fiscal deficit
are well controlled and there is no unlikely possibility that a demand-led price
surge will be observed.

2. When the economy is showing signs of slow down and RBI looks to
accelerate the economy by facilitating a more friendly monetary policy.

3. If the balance of payments situation is deemed to be normal by the RBI.

Importance of Repo Rate

 Safer investment since security acts as collateral in this type of agreement.

 Maintains liquidity in the market

 Checks inflation in the economy

 Lower interest rate as compared to an unsecured loan

What is Reverse Repo Rate?

As the name implies, reverse repo is the inverse contract to the repo rate. The
reverse repo rate is the rate at which the RBI borrows funds from the country's
commercial banks. It is the rate where the commercial banks in India park excess
funds with the Reserve Bank of India, typically for a short period of time.

15
Impact on economy
Increasing the reverse repo rate: It is a contractionary monetary policy that aims
to reduce inflation in the economy. When the central bank offers a higher reverse
rate on funds, commercial banks find it profitable and provide surplus funds—for
a short period.

In doing so, commercial banks are left with little funds—cannot extend loans to
the public. The impact is more visible with home loans. Naturally, this reduces
people’s purchasing power—demand for goods and services falls. Ultimately,
there is a gradual decline in inflation and market liquidity.

Decreasing the reverse repo rate: When there is an economic slowdown

(recession or depression), the central bank resorts to expansionary monetary
policies. Curtailing the reverse repo rate is one option—It discourages commercial
banks from parking their excess funds with the central bank.

Thus, commercial banks extend more loans to the public—from this surplus fund.
When customers find sufficient money at their disposal, their purchasing power
increases. Consequentially, the demand for goods and services in the market
increases. The rise in demand ultimately accelerates the economy, improves
liquidity, and controls recession.

Repo Rate Reverse Repo Rate

The lender is the RBI, and the borrower is The lender is the commercial banks, and the
the commercial bank. borrower is the Reserve Bank of India.

The objective of the repo rate is to manage It is to reduce the overall supply flow of
short deficiency of the funds. money in the economy.

The rate of interest for repo rates is higher The rate of interest is lesser than the repo

16
than that of reverse repo rates. rate.

The interest charge that is applicable to The applicable interest charge is through a
the repo rate is through a repurchase reverse repurchase agreement.
agreement.

The mechanism of operation in the case of In reverse repo rate, the commercial banks
repo rate for commercial banks gets funds deposit their excess funds with the Reserve
from RBI utilizing government bonds as Bank of India and get interested from the
collateral. deposit.

Higher the rate, the cost of the funds in When the rate is high, the money supply in
repo rate increases for commercial banks; the economy gets lower as commercial
hence the loans become more expensive. banks park more excess funds with the
Reserve Bank of India.

Lowering the rate makes the cost of the When the rate is low, the money supply in
funds lower for commercial banks and the economy gets higher as banks lend more
leads to lower interest rates on loans. and lessen the deposits with RBI.

What are Treasury Bills in India?

Treasury bills, also known as T-bills, are short term money market instruments.
The RBI on behalf of the government to curb liquidity shortfalls. It is a promissory
note with a guarantee of payment at a later date. The funds collected are usually
used for short term requirements of the government. It is also used to reduce the
overall fiscal deficit of the country.

Treasury bills or T-bills have zero-coupon rates, i.e. no interest is earned on them.
Individuals can purchase T-bills at a discount to the face/value. Later, they are
redeemed at a nominal value, thereby allowing the investors to earn the

17
difference. For example, an individual purchase a 91-day T-bill which has a face
value of Rs.100, which is discounted at Rs.95. At the time of maturity, the T-bill
holder gets Rs.100, thus resulting in a profit of Rs.5 for the individual.

Therefore, it is an essential monetary instrument that the Reserve Bank of India

uses. It helps RBI to regulate the total money supply in the economy as well as
raising funds.

Types of Treasury Bills

Four types of treasury bills are auctioned. The primary distinction for these
treasury bills tbills is their holding period.

14-day Treasury bill

These bills complete their maturity on 14 days from the date of issue. They are
auctioned on Wednesday, and the payment is made on the following Friday. The
auction occurs every week. These bills are sold in the multiples of Rs.1lakh and
the minimum amount to invest is also Rs.1 lakh.

91-day Treasury bill

These bills complete their maturity on 91 days from the date of issue. They are
auctioned on Wednesday, and the payment is made on the following Friday. They
are auctioned every week. These bills are sold in the multiples of Rs.25000 and
the minimum amount to invest is also Rs.25000.

182-day Treasury bill

These bills complete their maturity on 182 days from the date of issue. They are
auctioned on Wednesday, and the payment is made on the following Friday when
the term expires. They are auctioned every alternate week. These bills are sold in
the multiples of Rs.25000 and the minimum amount to invest is also Rs.25000.

364-day Treasury bill

These bills complete their maturity 364 days from the date of issue. They are
auctioned on Wednesday, and the payment is made on the following Friday when

18
the term expires. They are auctioned every alternate week. These bills are sold in
the multiples of Rs.25000 and the minimum amount to invest is also Rs.25000.

How to Buy Treasury Bills in India?

T-bills are issued in the primary market through RBI auctions. A qualified investor
may participate in a competitive or non-competitive bidding auction.

 Competitive Bidding: Institutional investors, such as financial institutions,

banks, mutual funds, primary dealers, and insurance companies, are eligible
to make competitive bids.

 Non-Competitive Bidding: Non-competitive bidders can be individuals,

HUF/ trust, firm, corporate body, institution, provident funds and any other
parties. Non-competitive bidders can participate in the auctions without
having to quote the price/ yield. Hence, one doesn’t have to worry about
whether the bid is on or off the mark. The bidder will be allotted partially or
fully in accordance with the plan.

RBI issues an indicative auction calendar that contains information about the
borrowing, tenor range and auction duration. During the auction duration, bids
can be placed on the electronic platform of

RBI called E-Kuber. E-Kuber is the Core Banking Solution (CBS) platform of RBI.

Competitive bidders who maintain funds or current account and securities

account (Subsidiary General Ledger (SGL) account) with RBI are members of the E-
Kuber Platform.

Through this electronic platform, all E-Kuber members can submit bids in the
auction. RBI publishes the auction results within a stipulated time period for
Treasury bills at 1:30 PM.

Non-Competitive bidders can place their bids to purchase T-bills through trading
members of the NSE or NSE goBID app. The allotted bonds will directly reflect in
the bidder’s demat account. Therefore, non-competitive bidders must have a

19
demat account. The following steps will help you place non-competitive bids for
T-bills:

1. Login to your demat account.

2. Under the IPO section, select the T-bill that you wish to bid for.

3. Click on Apply.

4. Place your bids.

5. Upon successful application, you will be notified by the trading platform.

6. The allotted bonds will reflect in your account in T+1 days.

Features of Treasury Bills

Form

Treasury bills can be issued in a physical form as a promissory note or

dematerialized form by crediting to SGL account (Subsidiary General Ledger
Account).

Minimum Bid Amount

Treasury bills are issued at a minimum price of Rs.25000 and in the same
multiples thereof.

Issue Price

Treasury bills are issued at a discounted price. However, they are redeemed at
par value at the time of maturity.

Eligibility

Individuals, companies, firms, banks, trust, insurance companies, provident fund,

state government and financial institutions are eligible to purchase T-bills.

Highly Liquid

20
Treasury bills are highly liquid negotiable instruments. They are available in both
financial markets, i.e. primary and secondary market.

Auction Method

The 91 day T-bill follows a uniform auction method, whereas, 364 day T-bill
follows a multiple auction method.

Zero Risk

The yields are assured. Hence, they have zero risks of default.

Day Count

For treasury bills, the day count is 364 days in a year.

Besides this, it also have other characteristics like market-driven discount rate,
selling through auction, issued to meet short term cash flow mismatch, assured
yield, low transaction cost, etc.

How to calculate the yield on Treasury bills?

To calculate the yield, the comparison of par value to its face value is the first
step. Additionally, investment returns are more useful when expressed on an
annualized basis. The next step is to use the maturity period to convert the return
to an annual percentage.

You can calculate the yield of treasury bills through the following formula –

Y= (100-P)/P * [(365/D)*100], where

Y – Yield/ return percentage of T-bill

P – The discounted price of the T-bill purchased

D – Tenure of T-bill

Let’s understand this with an illustration. If RBI issues a 91- Day treasury bill at the
discounted price of Rs.97 while the face value of the bill is Rs.100, the yield of the
security can be determined as follows –

21
Yield = [(100-97)/97] *(365/91*100)

= 12.40%

By annualizing the returns, a shorter Treasury bill can be compared with the
following:

 Long-dated Treasury bill

 Government bond

 Corporate bond

 Treasury bond

 Any other type of fixed income investment instrument.

Advantages and limitations of treasury bills

Treasury bills investments come with many advantages as it provides safety and
security to its investors.

Risk-Free

Treasury bills is a popular short term government security. The Central

government backs them. They act as a liability to the Indian government as they
need to be paid within a stipulated time.

Therefore, investors have total security on their funds invested as they are backed
by the government of India, I.e. the highest authority in the country. The amount
has to be paid to the investors even during the crisis.

Highly Liquid

Treasury bill has a highest maturity period of 364 days. They help in raising money
for short term requirements for the economy. Individuals who are looking for
short term investments can park their funds here. Also, T-bills can be sold in the
secondary market. This allows investors to convert their holding into cash during
any emergency.

22
Bidding

Treasury bills are usually auctioned by RBI every week. This allows the retail
investors to place their noncompetitive bids. This increases the exposure of
investors to the government bond market, which creates higher cash flows to
the capital market.

Limitations of Treasury Bills

Compared to other stock market investment tools, treasury bills yield lower
returns as they are government-backed debt securities. Treasury bills are zero-
coupon bonds, i.e. no interest is paid on them to investors. They are issued at a
discount and redeemed at face value. Therefore, the returns earned by investors
in T-bills remains fixed throughout the bond tenure irrespective of the economic
condition of the country.

Stock market variations influence the returns generated by equity, equity fund,
debt fund and debt instruments. Subsequently, when the stock market moves
upwards, the yield generated by equity, equity fund, debt fund or debt
instruments is also higher. However, the returns generated by T-bills remain fixed
irrespective of the financial market movements.

Meaning of Commercial Paper

Commercial paper is an unsecured, short period debt tool issued by a company,
usually for the finance and inventories and temporary liabilities. The maturities in
this paper do not last longer than 270 days. These papers are like a promissory
note allotted at a huge cost and exchangeable between the All-India Financial
Institutions (FIs) and Primary Dealers (PDs).

Most of the commercial paper investors are from the banking sector, individuals,
corporate and incorporated companies, Non-Resident Indians (NRIs) and Foreign
Institutional Investors (FIIs), etc. However, FII can only invest according to the
limit outlined by the Securities and Exchange Board of India (SEBI)

23
In India, commercial paper is a short-term unsecured promissory note issued by
the Primary Dealers (PDs) and the All-India Financial Institutions (FIs) for a short
period of 90 days to 364 days.

Commercial Paper in India

On 27th March 1989, commercial paper in India was introduced by RBI in the
Indian money market. It was initially recommended by Vaghul working Group on
the basis of the following points.

 The registration of commercial papers should only be granted to companies

having Rs. 5 cores and above net worth with excellent dividend payment
record.

 The market should follow the CAS discipline. The RBI should manage the
paper amount, entry of the market, and total quantum which can be
upgraded in a year.

 No limitation on the commercial paper market apart from the least size of
the note. However, the size of one issue and each lot should not be less
than Rs. 1 crore and Rs. 5 lakhs respectively.

 It should be eliminated from the provision of insecure advances in the state

of banks.

 The company using commercial paper should have minimum 5 cores as net
worth, a debt ratio maximum of 105, a debt servicing ratio closer to 2,
current ratio minimum 1033, and should be recorded on the stock
exchange.

 The paper can be made in terms of interest or at a discount rate to face

value.

 It should not be compelled to stamp duty while issuing and transferring.

Features of Commercial Paper

Few distinct features are:
24
  It is a short-term money market tool, including a promissory note and a set
maturity.

 It acts as an evidence certificate of unsecured debt.

 It is subscribed at a discount rate and can be issued in an interest-bearing

application.

 The issuer guarantees the buyer to pay a fixed amount in future in terms of
liquid cash and no assets.

 A company can directly issue the paper to investors, or it can be done

through banks/dealer banks.

Types of Commercial Paper

According to the Uniform Commercial Code (UCC), commercial papers are divided
into four different types.

 Draft – It is written guidance by an individual to another and to pay a

stipulated sum to a third party.

 Check – It is a unique draft where the drawee is a bank.

 Note – Here, an individual is promised to pay another individual or bank a

particular amount.

 Certificates of Deposit – In this type, a bank confirms the receipt of deposit.

According to security, there are two types of commercial papers

 Unsecured Commercial Papers – These are traditional papers and allotted

without any security.

 Secured Commercial Papers – It is also known as Asset-Backed Commercial

Papers (ABCP) and assured by other financial assets.

Advantages of Commercial Paper

25
  Contributes Funds – It contributes extra funds as the cost of the paper to
the issuing company is cheaper than the loans of the commercial bank.

 Flexible – It has a high liquidity value and flexible maturity range giving it
extra flexibility.

 Reliable – It is highly reliable and does not have any limiting condition.

 Save Money – On commercial paper, companies can save extra cash and
earn a good return.

 Lasting Source of Funds– Maturity range can be customised according to

the firm’s requirement, and matured papers can be paid by selling the new
commercial paper.

Commercial Paper Formula

The formula for estimation discounted price of a commercial paper.

Price = Face Value/ [1 + yield x (no. of days to maturity/365)]

Yield = (Face value – Price)/ (price x no of days to maturity) X 365 X 100

What is a Certificate of Deposit?

Certificate of Deposit or CD is a fixed-income financial instrument governed under
the Reserve Bank and India (RBI) issued in a dematerialized form. The amount at
payout is assured from the beginning. A CD can be issued by any All-India
Financial Institution or Scheduled Commercial Bank. They are issued at a discount
provided on face value. Like a fixed deposit (FD), a CD’s purpose is to denote in
writing that you have deposited money in a bank for a fixed period and that bank
will pay you interest on it based on the amount and duration of your deposit.

Features of CD

Here are some salient features of CD’s and how they compare to other financial
instruments.

26
  CDs can be issued in India for a minimum deposit of ₹1 lakh and in
subsequent multiples of it.

 Scheduled Commercial Banks (SCBs) and All-India Financial Institutions are

eligible to issue a CD. Cooperative Banks and RRBs cannot issue a CD.

 CDs issued by SCBs have in term period anywhere between 3 months to a

year.

 CDs issued by financial institutions have a term period ranging from 1–3
years.

 Similar to dematerialized securities, CDs in dematerialized forms are

transferable through means of endorsement or delivery.

 There is no lock-in required for a CD.

 One cannot issue a loan against a CD.

 A certificate of deposit is fully taxable under the Income Tax Act.

 A CD cannot be publicly traded.

 Banks are not permitted to buy back a CD before its maturity.

When Do Banks Issue a CD in India?

CDs can be high-risk liabilities for any scheduled commercial bank. There are
certain times where some banks are more likely to issue a CD compared to others.
There can be boiled down to two factors:

 In case of both low deposit growth and high demand for credit.

 When there are stiff or tight liquidity conditions in the market signifying
that cash is tied up in non-liquid assets.

*NRIs that have invested in a CD are not permitted to repatriate to their home
country after the amount has matured.

Advantages of Issuing CD in India

27
CD There are benefits to issuing a CD which makes it such a popular choice among
investors. They are:

 Security:

A certificate of deposit or FD is not going to eat up your capital due to market

volatility. It is a completely secure financial instrument with an assured sum at
maturity, similar to traditional insurance. The money you put into your CD will
continue to predictably increase and there is no risk of any loss. It is a very secure
short to mid-term investment.

 High-Interest Rate:

This benefit is what attracts most investors towards a CD. They offer larger rates
of interest which can go as high as 7.8% on the lump sum deposited than
traditional savings accounts whose interest rates average around 4%.

 Flexibility:

You can opt for monthly payouts, annual payouts, or a lump sum withdrawal of
your CD at maturity. You can pick the duration and price you want to invest,
although it has to fit certain parameters set by the bank. Tailoring the CD to your
needs helps you get the most from it.

 Low to Minimum Maintenance Costs:

When it comes to the market there are always brokerage costs for the delivery,
buying and selling of shares. There are usually no additional costs associated with
a CD. You only pay what you invest with some banks.

Disadvantages of CD

Early withdrawal penalties: Credit unions and banks often impose a specific
amount from you if you take out funds from a CD before its maturity date.

Lower Returns: CD may provide stable security and returns, but the consequence
will be lower returns. You may see the fastest growth of your money by investing
in mutual funds or stocks.

28
Difference between Commercial Paper and Certificate of Deposit

Criteria of
Commercial Paper Certificate of Deposit
differentiation

It is a short-term, negotiable,
CD is also short-term,
unsecured, promissory note, and
unsecured, negotiable
Meaning interchangeable by acceptance
instruments in short-term
and delivery with a major fixed
tradable time deposits.
maturity period.

The commercial paper could be

issued as a dematerialized form
and a promissory note. FI or banking sectors must
Subscribers and issuers are issue the certificate of
De-Mat
inspired to opt for self-reliance in deposit in the
this De-Mat form. So, FI, banks, dematerialized form.
and other primary dealers can
invest solely in De-Mat.

Corporations, funds,
The scheduled commercial banks,
individuals, associates,
Investors individuals, NRI, corporate, and
companies, trust, and
FII.
others.

Minimum 7 days and

7 days of minimum maturity and
Maturity maximum range is up to 1 year
from the date of issue.
maximum range shouldn’t
exceed 1 year. In the case
of FIs, the minimum
maturity rate is 1 year and
the maximum is not more

29
 than 3 years.

Superior credit-worthy corporates,

Financial institutions and
Issuer all Indian financial institutions,
banks.
and primary dealers.

The minimum credit rating will be It doesn’t need to abide by

Rating
P2 of CRISIL. such requirements.

The minimum range

The range should be a minimum
Denomination should be 1 lakh and
of 5 lakhs and could go higher.
multiples thereafter.

Market for government/debt securities in India

A government bond is a debt instrument issued by the Central and State
Governments of India. Issuance of such bonds occur when the issuing body
(Central or State governments) faces a liquidity crisis and requires funds for the
purpose of infrastructure development.

Government bond in India is essentially a contract between the issuer and the
investor, wherein the issuer guarantees interest earnings on the face value of
bonds held by investors along with repayment of the principal value on a
stipulated date.

Government Bonds India, fall under the broad category of government securities
(G-Sec) and are primarily long term investment tools issued for periods ranging
from 5 to 40 years. It can be issued by both Central and State governments of
India. Government bonds issued by State Governments are also called State
Development Loans (SDLs).

30
Initially, most G-Secs were issued for the purpose of large investors, such as
companies and commercial banks. However, eventually, GOI made government
securities available to smaller investors such as individual investors, co-operative
banks, etc.

There are multiple variants of bonds issued by GOI and State Governments which
cater to the various investment objectives of investors. The Government Bond
interest rates, also called a coupon, can either be fixed or floating and disbursed
on a semi-annual basis. In most cases, GOI issues bonds at a fixed coupon rate in
the market.

Types of Government Securities in India?

Government securities are investment products issued by the both central and
state government of India in the form of bonds, treasury bills, or notes.
They are generally issued for the purpose of refunding maturity securities for
advance refunding of securities that have not yet matured and raising fresh cash
resources.
However, they carry minimal risk and are called risk-free gilt-edged instruments.
So let’s look at the different types of government securities in India:

 Treasury Bills

Treasury bills, also called T-bills, are short term government securities with a
maturity period of less than one year issued by the central government of India.
Treasury bills are short term instruments and issued three different types:
1) 91 days
2) 182 days
3) 364 days
Several financial instruments pay interest to you on your investment; treasury
bills do not pay interest because they are also called zero-coupon securities.
These securities do not pay any interest; instead, they are issued at a discount
rate and redeemed at face value on the date of the maturity.
For example a 91 day T-bill with a face value of Rs. 200 may be issued at Rs.196,

31
with a discount of RS. 4 and redeemed at face value of Rs. 200.
However, RBI performs weekly auctions to issue treasury bills.

 Cash Management Bills (CMBs)

Cash management bills are new securities introduced in the Indian financial
market. The government of India and the Reserve Bank of India introduced this
security in the year 2010.
Cash management bills are similar to treasury bills because they are short term
securities issued when required.
However, one primary difference between both of these is its maturity period.
CMBs are issued for less than 91 days of a maturity period which makes these
securities an ultra-short investment option.
Generally, the government of India use these securities to fulfil temporary cash
flow requirements.

 Dated Government Securities

Dated Government securities are a unique type of securities because they either
have fixed or a floating rate of interest also called the coupon rate.
They are issued at face value at the time of issuance and remains constant till
redemption.
Unlike treasury and cash management bills, government securities are recognized
as long-term market instruments because they provide a wide range of tenure
starting from 5 years up to 40 years.
The investors investing in dated government securities are called primary dealers.
There are nine different types of dated government securities issued by the
Government of India given below:
1) Capital Indexed Bonds
2) Special Securities
3) 75% Savings (Taxable) Bonds, 2018
4) Bonds with Call/Put Options
5) Floating Rate Bonds
6) Fixed Rate Bonds
7) Special Securities
32
8) Inflation Indexed Bonds
9) STRIPS

 State Development Loans

State development loans are dated government securities issued by the State
government to meet their budget requirements.
The issue is auctioned once every two weeks with the help of the Negotiated
Dealing System.
SDL support the same repayment method and features a variety of investment
tenures. But when it comes to rates, SDL is a little higher compared to dated
government securities.
The major difference between dated government securities and state
development loans is that G-Securities are issued by the central government
while SDL is issued by the state government of India.

 Treasury Inflation-Protected Securities (TIPS)

Treasury Inflation-Protected Securities (TIPS) are available based on five, 10 or 30

year term periods. These securities deliver interest payments to all users every six
months.
TIPS are similar to conventional treasury bonds, but it comes with one major
difference. The same principle is issued during the entire term of the bond in a
standard treasury bond.
However, the par value of TIPS will increase gradually to match up with the
Consumer Price Index (CPI) to keep the bond’s principle on track with inflation.
If inflation increases during the year, there will be an increase in the security value
during that year. It means you will have a bond that maintains its value
throughout life instead of a bond that’s worthless after maturity.

 Zero-Coupon Bonds

Zero-coupon bonds are generally issued at a discount to face value and redeemed
at par. These bonds were issued on January 19th 1994.
The securities do not carry any coupon or interest rate as the tenure is fixed for

33
the security. In the end, the security is redeemed at face value on its maturity
date.

 Capital Indexed Bonds

In these securities, the interest comes in a fixed percentage over the wholesale
price index, which offers investors an effective hedge against inflation.
The capital indexed bonds were floated on a tap basis on December 29th 1997.

 Floating Rate Bonds

Floating rate bonds does not come with a fixed coupon rate. They were first
issued in September 1995 as floating rate bonds are issued by the government.

Types of Government Bonds in India?

The multiple variants of Government bonds are discussed below –

1. Fixed-rate bonds

Government bonds of this nature come with a fixed rate of interest which
remains constant throughout the tenure of investment irrespective of fluctuating
market rates.

2. Floating Rate Bonds (FRBs)

As the name suggests, FRBs are subject to periodic changes in rate of returns. The
change in rates is undertaken at intervals which are declared beforehand during
the issuance of such bonds. For instance, an FRB could have a pre-announced
interval of 6 months; which means interest rates on it would be re-set every six
months throughout the tenure.

3. Sovereign Gold Bonds (SGBs)

The Central Government issues sovereign Gold Bonds, wherein entities can invest
in gold for an extended period through such bonds, without the burden of
investing in physical gold. The interest earned on such bonds is exempted from
tax.

34
4. Inflation-Indexed Bonds

It is a unique financial instrument, wherein the principal, as well as the interest

earned on such bond, is accorded with inflation. Mainly issued for retail investors,
these bonds are indexed as per the Consumer Price Index (CPI) or Wholesale Price
Index (WPI). Such IIBs ensure real returns accrued with such investments remain
constant, thereby allowing investors to safeguard their portfolio against inflation
rates.

5. 7.75% GOI Savings Bond

This G-Sec was introduced as a replacement to the 8% Savings Bond in 2018. As

noted from its nomenclature, the interest rate of such bonds is set at 7.75%. As
per RBI regulations, these bonds can only be held by –

 An individual or individuals who are/are not NRI(s) in any capacity

 A minor with a legal guardian representative

 A Hindu Undivided Family

6. Bonds with Call or Put Option

The distinguishing feature of this type of bonds is the issuer enjoys the right to
buy-back such bonds (call option) or the investor can exercise its right to sell (put
option) them to such issuer. This transaction shall only take place on a date of
interest disbursal.

7. Zero-Coupon Bonds

As the name suggests, Zero-Coupon Bonds do not earn any interest. Earnings
from Zero-Coupon Bonds arise from the difference in issuance price (at a
discount) and redemption value (at par). This type of bonds are not issued
through auction but rather created from existing securities.

Advantages of Investing in Government Bonds?

Sovereign Guarantee

35
Government Bonds enjoy a premium status with respect to the stability of funds
and promise of assured returns. As G-Secs are a form of a formal declaration of
Government’s debt obligation, it implies the issuing governmental body’s liability
to repay as per the stipulated terms.

Inflation-adjusted

Balances held in Inflation-Indexed Bonds are adjusted against increasing average

price level. Other than that, the principal amount invested in Capital Indexed
Bonds is also adjusted against inflation. This feature provides an edge to investors
as they are less susceptible to be financially undermined as investing in such
funds increase the real value of the deposited funds.

Regular source of income

As per RBI regulations, interest earnings accrued on Government Bonds are

supposed to be disbursed every six months to such debt holders. It provides
investors with an opportunity to earn regular income by investing their idle funds.

Disadvantages of Investing in Government Bonds?

Low Income

Other than 7.75% GOI Savings Bond, interest earnings on other types of bonds are
relatively lower.

Loss of relevancy

As Government Bonds are long-term investment options with maturity tenure

ranging from 5 – 40 years, it can lose relevancy over time. It means such bonds
value loses relevance in the face of inflation, barring IIBs and Capital Indexed
Bonds.

Secondary market for government / debt securities:

The development of secondary markets adds new attributes to government
securities and broadens the role and importance of government securities in the
financial system. Government securities can have near-money like properties
36
when secondary markets facilitate rapid and low-cost conversion into cash. Bonds
can become a medium of exchange for the borrowing and lending of funds.
Secondary markets also open avenues for risk management through various types
of transactions whose pricing can be derived from government securities markets.
These unique features of government securities markets help deepen the number
and type of transactors in government securities which, in turn, help achieve the
aim of establishing liquid and efficient secondary markets. The design of
secondary market transactions and structures—discussed in more detail below—
should seek to maximize such attributes and incentives to trade, thereby
encouraging the development of secondary markets.

Types of Transactions in Secondary Markets

1 Spot Transactions

Scope for fast liquidation of securities and deployment of cash makes government
securities attractive as cash-like investments.110 To effectively compete with
money, secondary government securities markets must provide for the
immediate purchase and sale of government securities. Such on-the-spot
transactions should have the following features: (i) low transaction costs, (ii)
widely available and continuous pricing, (iii) wide access to trading systems and
intermediaries that provide immediate execution, (iv) safe and rapid settlement
of transactions, and (v) efficient custodial and safekeeping services.

2 Repurchase Agreements

In fostering secondary markets, the authorities may wish to develop the use of
repurchase agreements (repos), as they serve unique functions for both the
private sector and the monetary authority. Borrowing and lending among a range
of market participants, including banks, financial institutions, and corporates, can
be fostered on a safe and secure basis through the use of repos that reduce both
credit risk and transaction costs. Securities dealers use repos to finance their
inventories of government instruments that are needed to make markets and
provide two-way quotes. For this purpose, dealers lend out (or repo) securities
that are in their inventory but are not expected to be immediately sold. Thus,

37
dealers are able to leverage their capital and hold a larger inventory. A central
bank can temporarily inject liquidity into the system by buying securities under
repo. Because of the many uses of repos, the demand for government securities
increases, while the underlying conditions for liquid secondary markets are put in
place.

In developing repo markets, the authorities will want to ensure that a framework
is established that governs the following elements of the transaction and
addresses the risks that arise (Box 7.1):

Payment and transfer: The seller is required to deliver against payment the
security to the buyer on the purchase date, and the buyer is required to
deliver the security to the seller on the repurchase date. Payment must be
in immediately available funds, and the securities must be transferred on
the official book-entry system.113

Default and netting: In settling a default, the net value, or closeout

balance, is defined as the difference between the current market value of
the collateral security plus margin amounts and the cash borrowed plus
interest. This is the amount owed to the lender (or borrower if less than
zero).

Margins: Margin payments are transfers of cash or securities made during

the repo contract to reflect changes in the market price of the underlying
security, which can reduce potential losses associated with credit risk in the
face of a drop in prices.

Substitution: The parties in a repo transaction may agree to allow the

borrower to substitute replacement securities for a repoed security during
the life of a repo contract. There is little disadvantage to the cash lender
because he receives another security of equal or higher value as
replacement collateral.

Interest payments: If interest (or coupon) payments are made on a

collateral security during the repo, the buyer is required to transfer the
payment to the seller.
38
3 Derivatives and Risk Management Instruments

Secondary markets can be further developed to provide opportunities for risk

management through the development of various instruments whose pricing can
be derived from government securities markets. In turn, the use of these
instruments by participants further adds to the liquidity in secondary government
securities markets.

7.3.3.1 Short Selling

Short selling, the sale of borrowed securities, can promote market liquidity and
price efficiency. Short selling allows for sophisticated trading strategies, including
arbitrage and hedging, which contribute to efficient price discovery.

7.3.3.2 Strips

The depth of secondary markets can be enhanced with the development of zero-
coupon Treasury derivative securities known as strips. This practice involves
separating future coupon payments and principal payment at maturity from a
Treasury bond.

7.3.3.3 Forward Transactions

Forward transactions are commitments made today to make or take delivery of

an asset at a future date. Usually such transactions are tailor-made to the needs
of the parties involved in the trade.

7.3.3.4 Swap Transactions

Swap transactions provide risk management opportunities by altering cash flows

and allow flexible risk strategies tailored to the type of flow.

7.3.3.5 Futures and Options

Futures and options have become indispensable risk management tools in

developed markets. In emerging markets, they can contribute to broadening risk
management opportunities and promoting more liquid markets.

39
7.3 Features of Market Structures
There are a number of choices to be considered in developing a government
securities market structure. The features of different market structures, including
trading mechanism, information systems, and scope for competition, can
influence the outcome of price discovery and liquidity.

7.3.1 Periodic Versus Continuous Markets

As the name suggests, periodic markets involve trading at periodic (or discrete)
intervals. A periodic market may also feature execution at a single price—that is,
at a price determined by all orders coming to the market at the trading interval.

7.3.2 Dealer Versus Auction-Agency Markets

In dealer markets, the random arrival of orders to the market is bridged by

intermediaries—dealers—that maintain continuous market conditions. Dealers
provide two-way (bid and offer) quotations, supplying a high degree of immediacy
to traders that may either buy or sell against those quotations.

7.3.3 Automation and Electronic Market Structures

Electronic technology (computers, telecommunications, and so forth) is rapidly

changing all market structures.

7.4 Efficiency and Liquidity Issues in Market Structures

In assessing the choice of market structure with the goals of liquidity and
efficiency in mind, authorities should consider frequency of trading, transparency,
and competition, all of which have an impact on liquidity and efficiency.

7.4.1 Trading Frequency

Frequency of trading means the choice between a periodic market and a

continuous market. The concentration of orders in a periodic market develops
liquidity and market depth at the trading interval and reduces price volatility.

7.4.2 Consolidated Versus Multiple Markets

40
In developing markets, consideration might be given to the benefits and possible
costs of competing marketplaces.

7.4.3 Degree of Security Fragmentation

The degree of security fragmentation may also influence the suitability of market
structure for the type of government security.

7.4.4 Wholesale Versus Retail

In countries where typical investors are small or “retail,” the authorities may wish
to promote auction-agency markets because trading is typically in large volume
but low value.

7.4.5 Competition Among Market Intermediaries

Competition in the government securities market between market intermediaries

improves liquidity and efficiency.

7.4.6 Execution Risk and Secondary Market Liquidity

In nascent markets, there is a high liquidity risk to dealers accommodating

customer trades to and from securities inventories, since two-way markets are
not yet fully developed.

7.4.7 Liquidity Risk

To foster a competing dealer market structure in the absence of well-developed

funding markets (repo or call money markets), central banks often establish lines
of credit with primary dealers.

7.4.8 Transparency : Transparency promotes an efficient and fair markets

7.4.9 Development Strategies

As discussed above, caution should be exercised in undertaking direct

involvement in market structure that would shift undue risk to the central bank or
debt management office.

41