University of Mumbai

PROJECT WORK ON
INDIAN MONEY MARKET

A project submitted to
University of Mumbai for Partial completion of the degree of Bachelors of
commerce in banking and insurance
By
PRIYA VIJAY JAISWAL
ROLL NO. 301

Under the Guidance of PROF. MRS. CHANDANI SINGH

Smt. Parmeshwaridevi Durgadutt Tibrewala Lions Juhu College & Science

J.B. Nagar, Andheri (East), Mumbai – 400059.

2022-2023

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 Certificate

This is to certify that Miss. PRIYA VIJAY JAISWAL has worked and duly completed her
Project Work for the degree of Master in Commerce under the Faculty of Commerce in the
subject of banking & insurance and her project is entitled, “INDIAN MONEY MARKET”
under my supervision.

I further certify that the entire work has been done by the learner under my guidance and that
no part of it has been submitted previously for any Degree or Diploma of any University.
It is her/ his own work and facts reported by her/his personal findings and investigations.

Name and Signature of Guiding Teacher

Date of submission:

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 Declaration by learner

I the undersigned Miss PRIYA VIJAY JAISWAL here by declare that the work
embodied in this project work titled “INDIAN MONEY MARKET”, forms my own
contribution to the research work carried out under the guidance of PROF. CHANDANI
SINGH is a result of my own research work and has not been previously submitted to any
other University for any other Degree/ Diploma to this or any other University. Wherever
reference has been made to previous works of others, it has been clearly indicated as such
and included in the bibliography.
I, here by further declare that all information of this document has been obtained and
presented in accordance with academic rules and ethical conduct.

Name and Signature of the learner

Certified by

Name and signature of the Guiding Teacher

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 Acknowledgment

To list who all have helped me is difficult because they are so numerous and the depth is so
enormous.
I would like to acknowledge the following as being idealistic channels and fresh dimensions
in the completion of this project.
I take this opportunity to thank the University of Mumbai for giving me chance to do this
project.
I would like to thank my Principal, DR. TRISHLA MEHTA for providing the necessary
facilities required for completion of this project.
I take this opportunity to thank our Coordinator PROF. RAJESH YADAV, for her moral
support and guidance.
I would also like to express my sincere gratitude towards my project guide PROF. MRS.
CHANDANI SINGH whose guidance and care made the project successful.
I would like to thank my College Library, for having provided various reference books and
magazines related to my project.
Lastly, I would like to thank each and every person who directly or indirectly helped me in
the completion of the project especially my Parents and Peers who supported me throughout
my project.

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 INDEX

CHAPTER CONTENTS PAGE

NO. NO.
1 1.1 INTRODUCTION TO MONEY MARKET 6-66
1.2 MONEY MARKET INSTRUMENTS
1.3 EVOLUTION OF MONEY MARKET IN INDIA
1.4 RECOMMENDATION OF VARIOUS COMMITTEES
1.5 NEEDS FOR IMBIBING DEPTH TO THE MARKET
1.6 INTRODUCTION TO DERIVATIVES
1.7 Introduction of Forward Rate Agreements and Interest Rate Swaps
1.8 HISTORY AND EVOLUTION
1.9 A BRIEF LOOK AT THE GLOBAL MARKETS
1.10 OBSTACLES TO DEVELOPMENT OF IRS IN INDIA

2 RESEARCH METHODOLOGY 67-70

3 REVIEW OF LITERATURE 71-75

4 DATA ANALYSIS & INTERPRETATION AND PRESENTATION 76-86

5 SUGGESTION, CONCLUSION & BIBLIOGRAPHY 87-90

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 CHAPTER NO.1
1.1 INTRODUCTION TO MONEY MARKET

The financial system of any country is the backbone of the economy of that country. The financial
systems of all economies are broadly sub-divided into money market, capital market, gilt-edged securities
market and foreign exchange market. The money market, capital market and the gilt securities market
provides avenues to the surplus sector such as household institutions in the economy to deploy their funds
to the deficit sector such as corporate and government sectors to mobilize funds for their requirements.

The operations in the money market are generally short-term (upto 1 year) in nature, in capital market
short-term to long term and in gilt securities market generally long-term. However, in an integrated
financial system, the occurrence of an event in one market of the financial system will have an impact on
the other market system.

The Indian money market is a market for short-term money and financial asset that are close substitutes for
money, which are close substitute for money, with the short-term in the Indian context being for 1 year. The
important feature of the money market instruments is that it is liquid and can be turned quickly at low cost.
The money market is not a well-defined place where the business is transacted as in the case of capital
markets where all business is transacted at a formal place, i.e. stock exchange.

The money market is basically a telephone market and all the transactions are done through oral
communication and are subsequently confirmed by written communication and exchange of relative
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instruments.

As short-term securities became a commodity, the money market became a component of the financial
market for assets involved in short-term borrowing, lending, buying and selling with original maturities of
one year or less. Trading in money markets is done over the counter and is wholesale.

There are several money market instruments in most Western countries, including treasury bills, commercial
paper, banker's acceptances, deposits, certificates of deposit, bills of exchange, repurchase agreements,
federal funds, and short-lived mortgage- and asset-backed securities.
[1] The instruments bear differing maturities, currencies, credit risks, and structures.
[2] A market can be described as a money market if it is composed of highly liquid, short-term assets.
Money market funds typically invest in government securities, certificates of deposit, commercial paper of
companies, and other highly liquid, low-risk securities. The four most relevant types of money are
commodity money, fiat money, fiduciary money (cheques, banknotes), and commercial bank money.
[3] Commodity money relies on intrinsically valuable commodities that act as a medium of exchange. Fiat
money, on the other hand, gets its value from a government order.

Money markets, which provide liquidity for the global financial system including for capital markets, are
part of the broader system of financial markets.

The money market consists of many sub-markets such as the inter-bank call money, bill discounting,
treasury bills, Certificate of deposits (CDs), Commercial paper (CPs), Repurchase Options/Ready Forward
(REPO or RF), Inter-Bank participation certificates (IBPCs), Securitized Debts, Options, Financial Futures,
Forward Rate Agreement (FRAs), etc. which collectively constitute the money market.

By convention the term 'Money market' refers to the market for short term requirement and deployment of
funds. Money market is the instrument which have less than one year as a maturity period. The most active
part of money market is the overnight call money and term money between the Banks, Financial Institutions,
as well as Call Money market transaction. Call money or Repo are the two short term money market
products. The below mentions instruments are the money market instruments: The financial markets where
instruments are highly liquidating and are of shot maturity period which are traded in the market is called as
money market. It is a generic definition.

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Money Market is a financial market where short-term financial assets having liquidity of one year or less are
traded on stock exchanges. The securities or trading bills are highly liquid. Also, these facilitate the
participant’s short-term borrowing needs through trading bills. The participants in this financial market are
usually banks, large institutional investors, and individual investors.

There are a variety of instruments traded in the money market in both the stock exchanges, NSE and BSE.
These include treasury bills, certificates of deposit, commercial paper, repurchase agreements, etc. Since the
securities being traded are highly liquid in nature, the money market is considered as a safe place for
investment.

The Reserve Bank controls the interest rate of various instruments in the money market. The degree of risk is
smaller in the money market. This is because most of the instruments have a maturity of one year or less.

Hence, this gives minimal time for any default to occur. The money market thus can be defined as a market
for financial assets that are near substitutes for money.
The player who indulge or who trade for short term for several days to less than a year. It is generally use for
borrowing and lending for a short period. Due to high liquidate nature of security and short maturities,
money market is placing to are recognized as a safe place to lock in money i.e. to invest in money market.

The participants in financial market are of thin line, differentiating between capital market and money
market.
Capital market refers to stock market where the stock is being traded in market and bond markets where the
bonds are being issued and traded. This is the sharp contrast to money market which provide the short-term
debt financing and investment. In money market, there is borrowing and lending for periods of a year or less.

There are seven type of money market instruments: -

1) Certificate of deposit (CD)
2) commercial paper (C.P)
3) Treasury Bills
4) Inter Bank Participation certificates
5) Bill Rediscounting
6) Inter Bank Term Mone

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MEANING AND DEFINITION

Money market refers to the market where money and highly liquid marketable securities are bought and sold
having a maturity period of one or less than a year. It is not like stock Market, but an activity conducted by
telephone. The market constitutes a very important segment of the Indian financial system. The highly liquid
marketable Securities are also called as 'money market instruments' like treasury bills, government
securities, commercial paper, certificate of deposit, call money and repurchase agreement etc. The players in
the money market are Reserve Bank of India (RBI), Discount and Finance House of India (DFHI), banks,
financial institutions, mutual funds, government, big corporate houses. The basic aim of dealing in money
market instruments is to fill the gap between the short-term liquidity problems or to use the Short-term
surplus to gain income on that.

DEFINITION OF MONEY MARKET

According to the Reserve Bank of India, “money market is the center for dealing, mainly of short-term
character, in money assets; it meets the short-term requirements of borrowings and provides liquidity or cash
to the lenders. It is the place where short term surplus investible funds at the disposal of financial and other
institutions and individuals are bid by borrowers’ agents comprising institutions and individuals and the
government itself.”

According to the Geoffrey, “money market is the collective name given to the various firms and institutions
that deal in the various grades of the near money.

LENDERS
These are the entities with surplus lendable funds like-
Banks (Commercial, Co-operative & Private)
Mutual Funds
Corporate Entities with bulk lendable resources of minimum of Rs. 3 crores per transaction
Financial Institutions

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FEATURES OF MONEY MARKET

1. It is a collection of market for following instruments- Call money, notice money, repos, term money,
treasury bills, commercial bills, certificate of deposits, commercial papers inter-bank participation
certificates, inter-corporate deposits, swaps, etc.
2. The sub markets have close inter- relationship & free movement of funds from one sub-market to
another.
3. A network of large number of participants exists which will add greater depth to the market.
4. Activities in the money market tend to concentrate in some Centre, which serves a region or an area.
The width of such area may vary depending upon the size and needs of the market itself.
5. The relationship that characterizes a money market is impersonal in character so that competition is
relatively pure.

6. Price differentials for assets of similar type will tend to be eliminated by the interplay of demand &
supply.
7. A certain degree of flexibility in the regulatory framework exists and there are constant endeavors for
introducing a new instruments / innovative dealing technique.
8. It is a wholesale market & the volume of funds or financial assets traded are very large i.e., in crores
of rupees.

THE FUNCTIONS OF MONEY MARKET ARE AS FOLLOWS:

(a) Providing an equilibrating mechanism for leveling out the short-term surpluses and deficits.
(b) Offering a focal point for the central bank intervention for influencing liquidity in the economy.
(c) Creating an access to the user of short-term money to meet their requirements at a realistic price

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OBJECTIVE OF MONEY MARKET:

The following are the important objectives of a money market:

To provide a parking place to employ short-term surplus funds.
To provide 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.
To provide a reasonable access to users of Short-term funds to meet their requirements
quickly, adequately and at reasonable costs.
Providing borrowers such as individual investors, government, etc. with short-term funds at a reasonable
price. Lenders will also have the advantage of liquidity as the securities in the money market are short-term.
It also enables lenders to turn their idle funds into an effective investment. In this way, both the lender and
borrower are at a benefit.
RBI regulates the money market. Therefore, in turn, helps to regulate the level of liquidity in the economy.
Since most organizations are short on their working capital requirements.
The money market helps such organizations to have the necessary funds to meet their working capital
requirements.
It is an important source of finance for the government sector for both national and international trade. And
hence, provides an opportunity for the banks to park their surplus funds.

GENERAL CHARACTERISTICS OF MONEY MARKET:

Money market is the short-term money market where financial assets that are the close
substitute of money. Money market can exist anywhere were borrowers and lenders
desires to enter into short term credit transaction as in any other market. Money market
also has three constituents like any other market —
(I) Money market has buyers and sellers in the form of borrowers and lenders.
(2) It has a commodity in the form of instruments like Treasury Bill and Commercial
Paper etc.

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(3) It has a price in the form of rate of interest.
The term “Money Market” refers to the various firms and institutions dealing with
several types of “near money”. Near money consists of assets which can be converted
into cash without any loss.
One of the features of money market is that it is not a one market but the collection of
markets such as call and notice money market and bill market etc. All these markets
have close inter-relationships.
An ideal money market is one where there are enormous number of participants.
Larger is the number of participants greater is the depth of the market.
It’s only the money market which solves the problem.
If the problem is that of cash out flow more than cash receipts, they go to the money
market looking for funds. If the problem is that of excess cash inflow, then the problem is
again set off by money market for temporary fund deployment. Thus, it is the money
market which meets short-term requirements of borrowers and provides profitable
avenues to the lenders.
The term money market is also known as a wholesale market. The volume of funds,
traded in the market, are very large. There are skilled personnel to undertake the
transactions. Trading in the market is attend beyond the telephone followed by written
confirmation from both the borrowers and lenders.

Depending on supply of funds, Indian Money Market is divided into two markets:
(a) The organized money markets
(b) The unorganized money markets.

The participants in the organized money market are the Reserve Bank of India (RBI), Commercial Banks,
Co-operative Banks, Unit Trust of India (UTI), Life Insurance Corporation of India (LIC), General Insurance
Company (GIC). Discount and Finance House of India (DF HI), Industrial Development Bank of India
(IDBI), National Bank of Agriculture and Rural Development (NABARD), Industrial Credit Investment
Corporation of India (ICICI), Corporate bodies.

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The RBI has close links with money market and it can justly be regarded as an important constituent of
money market as it plays the vital role of controlling the flow of currency and credit in the market.
The unorganized sector consists of indigenous bankers who engage the banking business
on traditional lines. Indigenous bankers follow their own rules of banking and finance.
Attempts have been made by RBI to bring them under the organized market. But
indigenous bankers as an aggregate not accepted the conditions prescribed by RBI.
The instruments in the money market are call money’, Treasury Bills, Commercial Bills,
Commercial Paper, Certificate of Deposits, Interbank Participation.

Money market has two strata:

(a) the primary market and
(b) the secondary market.
Where the lenders and borrowers directly deal with money or through brokers it is known
as primary market. To make the instruments more liquid, the secondary market has been
built up. Discount and Finance House of India Ltd. has been set up by the Reserve Bank
of India to provide an active secondary market for money market.

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IMPORTANCE OF THE MONEY MARKET

The money market is a market for short term transactions. Hence it is responsible for the liquidity in the
market. Following are the reasons why the money market is essential:

It maintains a balance between the supply of and demand for the monetary transactions done in the market
within a period of 6 months to one year..
It enables funds for businesses to grow and hence is responsible for the growth and development of the
economy.
It aids in the implementation of monetary policies.
It helps develop trade and industry in the country. Through various money market instruments, it finances
working capital requirements. It helps develop the trade in and out of the country.
The short term interest rates influence long term interest rates. The money market mobilises the resources to
the capital markets by way of interest rate control.
It helps in the functioning of the banks. It sets the cash reserve ratio and statutory liquid ratio for the banks.
It also engages their surplus funds towards short term assets to maintain money supply in the market.
The current money market conditions are the result of previous monetary policies. Hence it acts as a guide
for devising new policies regarding short term money supply.
Instruments like T-bills, help the government raise short term funds. Otherwise, to fund projects, the
government will have to print more currency or take loans leading to inflation in the economy. Hence the it
is also responsible for controlling inflation.

What are the Advantages and Disadvantages of Money Market Instruments?

Advantages of Investing in Money Market Instruments

Money market instruments offer higher liquidity in comparison to other fixed income instruments. With no
lock-in period, an investor can sell their investments at any time. Furthermore, the rate of return on a money

14
market instrument is marginally higher in comparison to interest on savings accounts.

Disadvantages of Investing in Money Market Instruments

No doubt the interest rate is higher in comparison to savings bank accounts. However, the rate of interest
does not account for the increasing inflation in the economy. While other investment instruments like mutual
funds offer a higher return on investment over the long term. Hence, if the investment objective is to seek
capital appreciation with inflation-beating returns then money market instruments are not an ideal choice.

CHARACTERISTICS OF MONEY MARKET INSTRUMENTS

It is a financial market and has no fixed geographical location.

It is a market for short term financial needs, for example, working capital needs.
It’s primary players are the Reserve Bank of India (RBI), commercial banks and financial institutions like
LIC, etc.,
The main money market instruments are Treasury bills, commercial papers, certificate of deposits, and call
money.
It is highly liquid as it has instruments that have a maturity below one year.
Most of the money market instruments provide fixed returns.

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 1.2 MONEY MARKET INSTRUMENTS

1.Call Money

Call/Notice money is an amount borrowed or lent on demand for a very short period. If the period is
more than one day and upto 14 days it is called 'Notice money' otherwise the amount is known as
Call money'. Intervening holidays and/or Sundays are excluded for this purpose. No collateral
security is required to cover these transactions

Features

 The call market enables the banks and institutions to even out their day-to-day deficits and surpluses
of money.
 Commercial banks, Co-operative Banks and primary dealers are allowed to borrow and lend in this
market for adjusting their cash reserve requirements.
 Specified All-India Financial Institutions, Mutual Funds and certain specified entities are allowed to
access Call/Notice money only as lenders.
 It is a completely inter-bank market hence non-bank entities are not allowed access to this market.
 Interest rates in the call and notice money market are market determined.
 In view of the short tenure of such transactions, both the borrowers and the lenders are required to
have current accounts with the Reserve Bank of India.
 It serves as an outlet for deploying funds on short term basis to the lenders having steady inflow of
funds

2. TREASURY BILLS MARKET

In the short term, the lowest risk category instruments are the treasury bills.
RBI issues these at a prefixed day and a fixed amount.
These are four types of treasury bills.

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  14-day Tbill- maturity is in 14 days. Its auction is on every Friday of every week. The
notified amount for this auction is Rs. 100 crores.

 91-day T-bill- maturity is in 91 days. Its auction is on every Friday of every week. The
notified amount for this auction is Rs. 100 crores.

 182-day Tbill- maturity is in 182 days. Its auction is on every alternate Wednesday (which is
not a reporting week). The notified amount for this auction is Rs. 100 crores.

 364-Day Tbill- maturity is in 364 days. Its auction is on every alternate Wednesday (which is
a reporting week). The notified amount for this auction is Rs. 500 crores.

A considerable part of the government's borrowings happen through Tbills of various

maturities. Based on the bids received at the auctions, RBI decides the cut off yield and
accepts all bids below this yield.

These T-bills, which are issued at a discount, can be traded in the market. Most of the time, unless the
investor requests specifically, they are issued not as securities but as entries in the Subsidiary General
Ledger (SGL), which is maintained by RBI. The transactions cost on Tbill are non-existent and trading is
considerably high in each bill, immediately after its issue and immediately before its redemption.
The returns on T-bills are dependent on the rates prevalent on other investment avenues open for investors.
Low yield on T-bills, generally a result of high liquidity in banking system as indicated by low call rates,
would divert the funds from this market to other markets. This would be particularly so, if banks already
hold the minimum stipulated amount (SLR) in government paper.

3. INTER-BANK TERM MONEY

Interbank market for deposits of maturity beyond 14 days and up to three months is referred to as the term
money market. The specified entities are not allowed to lend beyond 14 days. The development of the term
money market is inevitable due to the following reasons
• Declining spread in lending operations
• Volatility in the call money market
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• Growing desire for fixed interest rates borrowing by corporate

• Move towards fuller integration between forex and money market

• Stringent guidelines by regulators/management of the institutions

4. CERTIFICATE OF DEPOSITS MARKET

After treasury bills, the next lowest risk category investment option is the certificate of deposit (CD) issued
by banks and FIs.

Allowed in 1989, CDs were one of RBI's measures to deregulate the cost of funds for banks and FIs. A CD
is a negotiable promissory note, secure and short term (upto a year) in nature. A CD is issued at a discount to
the face value, the discount rate being negotiated between the issuer and the investor. Though RBI allows
CDs upto one-year maturity, the maturity most quoted in the market is for 90 days.

CDs are issued by banks and FIs mainly to augment funds by attracting deposits from corporates, high net
worth individuals, trusts, etc. the issue of CDs reached a high in the last two years as banks faced with
reducing deposit base secured funds by these means. The foreign and private banks, especially, which do not
have large branch networks and hence lower deposit base use this instrument to raise funds.

The rates on these deposits are determined by various factors. Low call rates would mean higher liquidity in
the market. Also, the interest rate on one-year bank deposits acts as a lower barrier for the rates in the
market.

5. INTER-CORPORATE DEPOSITS MARKET

Apart from CPs, corporates also have access to another market called the inter- corporate deposits (ICD)
market. An ICD is an unsecured loan extended by one corporate to another. Existing mainly as a refuge for
low rated corporates, this market allows funds surplus corporates to lend to other corporates. Also the better-
rated corporates can borrow from the banking system and lend in this market. As the cost of funds for a
corporate in much higher than a bank, the rates in this market are higher than those in the other markets.
ICDs are unsecured, and hence the risk inherent in high. The ICD market is not well organised with very

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little information available publicly about transaction details.

6. COMMERCIAL PAPER MARKET

CPs are negotiable short-term unsecured promissory notes with fixed maturities, issued by well rated
companies generally sold on discount basis. Companies can issue CPs either directly to the investors or
through banks / merchant banks (called dealers). These are basically instruments evidencing the liability of
the issuer to pay the holder in due course a fixed amount (face value of the instrument) on the specified due
date.

These are issued for a fixed period of time at a discount to the face value and mature at par.
Ideally, the discount rates on CPs ought to be determined by the demand and supply factors in the money
market and the interest rates on the other hand competing money market instruments such as certificate of
deposits (CDs), commercial bills and treasury bills. It has been noticed that in a comparatively stable and
low rate conditions in the money market, the discount rates in the CP markets do somewhat soften whereas
in the tight money market situation it may not be possible even for a best rated company to issue CPs at
lower rates than the lending rates on it's banks lines of credit. This is partly for the reason that banks could
also firm up the lending rates during such periods. The maturity management of CPs should also affect the
CP rates. It has been observed that in a period of prolong low and steady money market rates there is no
significant different between the discount rates if CPs for 90 and 180 days.

ADVANYAGES OF CP’s

The advantage of CP lies in its simplicity involving less paper work as large amounts can be raised without
having any underlying transaction. It gives flexibility to the company by providing an additional option of
raising funds particularly when the conditions prevailing in the money market are favorable. In a regime
where there is a prescription of a minimum lending rate for banks advances, the raising of funds by a
company upto 75% of its working capital limit through issue of CPs at somewhat lower interest rates,
enables it to reduce the overall cost of short-term funds. It is, however, to be recognized that under the cash
credit system of lending, the borrowers' effective interest cost is lower than the prescribed lending rate as
this system affords flexibility to borrowers to reduce the outstanding as and when surplus funds accrue to

19
them. Hence, a company proposing to issue CPs should have a clear perception as to its cash flow during the
period for which CPs are proposed to be issued and accordingly fix the discount rates at which the
instrument is to be issued.

From the investor's point of view, the investment in CPs gives comparatively higher yields than those
obtained on bank deposits of similar maturities. Although CP is an unsecured promissory note, the
availability of stand-by facility by banks to the issuing companies makes it's holders confident of getting the
payment on due dates.
This agreement also facilitated quicker payment as a company's banker and make the payment to the holders
on their behalf and as the companies permissible working capital limit gets reinstated to the extent of
maturing CPs provided, however, at the time of maturity of CPs, the companies maximum permissible bank
finance has not been revised downwards.

7. READY FORWARD CONTRACT

It is a transaction in which two parties agree to sell and repurchase the same security. Under such an
agreement the seller sells specified securities with an agreement to repurchase the same at a mutually
decided future date and a price. Similarly, the buyer purchases the securities with an agreement to resell the
same to the seller on an agreed date in future at a predetermined price. Such a transaction is called a Repo
when viewed from the prospective of the seller of securities (the party acquiring fund) and Reverse Repo
when described from the point of view of the supplier of funds. Thus, whether a given agreement is termed
as Repo or a Reverse Repo depends on which party initiated the transaction.

The lender or buyer in a Repo is entitled to receive compensation for use of funds provided to the
counterparty. Effectively the seller of the security borrows money for a period of time (Repo period) at a
particular rate of interest mutually agreed with the buyer of the security who has lent the funds to the seller.
The rate of interest agreed upon is called the Repo rate. The Repo rate is negotiated by the counterparties
independently of the coupon rate or rates of the underlying securities and is influenced by overall money
market.

The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was later modified into New

20
Bills Market scheme (NBMS) in 1970. Under the scheme, commercial banks can rediscount the bills, which
were originally discounted by them, with approved institutions (viz., Commercial Banks, Development
Financial Institutions, Mutual Funds, Primary Dealer, etc.).

With the intention of reducing paper movements and facilitate multiple rediscounting, the RBI introduced an
instrument called Derivative Usance Promissory Notes (DUPN). So the need for physical transfer of bills
has been waived and the bank that originally discounts the bills only draws DUPN. These DUPNs are sold to
investors in convenient lots of maturities (from 15 days up to 90 days) on the basis of genuine trade bills,
discounted by the discounting bank.

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 1.3 EVOLUTION OF MONEY MARKET IN INDIA

The existence of money market could be traced back to hundis or indigenous bills of exchange. These were
in use from the 12th century and it appears from the writings of few Muslim historians, European travelers,
state records and the Ain-I-Akbari that indigenous bankers played a prominent part in lending money both
under the early Muslim and mogul rulers in India. The indigenous bankers financed internal and foreign
trade with cash or bill and gave financial assistance to rulers during period of stress.

The money market in India is not a single homogeneous entity and may be divided into two parts: (a) the
central part- consisting of the Reserve Bank of India, State Bank of India, the Public Sector Bank, the Private
Sector Bank, the Exchange Banks, and the other development financial institution; and (b) the bazaar part-
consisting of the money –lenders, indigenous bankers, loan office, chit funds, niches, etc., and the co-
operative banks occupying the intermediate position. The connection between these parts is incomplete as
the Indian financial system was somewhat loosely organized and without much cohesion until 1935 and
lacked a central coordinating agency. Till then, the central part was largely dominated by government, which
controlled currency and through it influenced the bank rate decisively.

Owing to the absence of a central bank until 1935, the Imperial Bank of India performed some of the
functions of the banker’s bank. The other Bank are not bound to keep balances with it, but in practice the
exchange Banks and larger India joint-stock banks kept a substantial part of their cash balances with it. The
Imperial bank’s grant of loans to joint-stock banks against government securities at the bank rate proved
very useful to them, but the high bank rate frequently reduced to a considerable extent the benefits of such
loan. On account of the special banks concessions that the Imperial bank received from the government and
later from the Reserve Bank also, the joint-stock banks have regarded it more as an unfair competitor than as

22
a friendly supporter. Their feeling towards the State Bank was not much better.

The exchange banks were also considered as powerful competitors owing to their large resources and
encroachment upto the field of the finance of internal trade at ports as well as in the interior. The state co-
operative banks used to maintain current accounts with the state bank and also used to get credit and
overdraft facilities from it. The co-operative banks have no connection with the indigenous bankers and the
moneylenders beyond the fact that a few of them were depositors or directors of central cooperative banks.

There is also not much contact between the indigenous bankers and the moneylenders and both of them
usually did not maintain account with the State Bank of India and not at all with the Reserve bank of India
(RBI). Till the mid- 1970s, during the busy season (October-April), when the supply of hundis was greater
than the resource of the indigenous bankers, a temporary connection was established between a number of
them who were selected And placed on the approval list and the State Bank and the joint stock banks
rediscounted the hundis drawn and endorsed by the by the approved indigenous bankers up to a certain
maximum limits determined according to the financial standing off the financial standing of the banker or
gave them advances against demand promissory notes signed by to of them.

(a) Operation of the central or organized part of the money market

These may be considered under the three heads:

(i) The call money market,

(ii) The bill market, and
(iii) Other sub-markets (CPs and CDs)

(i) The call money market

Call money market is the core of the central part of the money market, in which banks lend money to each
other. To begin with call money operated from Mumbai and later Calcutta, Delhi and Madras joined. The
call money is most sensitive part of the money market and indicates the current condition of the market. The
major participants are the public sector banks. Over the period pf time, the RBI has permitted other
institutions, flush with funds, such as LIC, GIC, UTI, IDBI, NABARD to participate in money market as
lenders.

23
The call money transaction is unsecured, enabling the borrowing banks to replenish their funds without
touching their other assets. In this market, banks operate with their own surplus funds and usually without
any help from outside. Thus, banks with surplus funds lend to those that are in need. This helps in spreading
the liquid funds evenly among the various banks and thus enables a more economic use of resources in the
banking system. The role of banks, as a borrowers or lenders, change according to liquidity position.

Up to 1956, the exchange banks were the chief borrower on account of nature of their business. Their
advances were generally very liquid and they held large proportion of bills. As a consequence, they
functioned with a fine cash ratio and turned to the call market to make up any deficiency of funds for day or
two. Prior to 1956, some of the Indian banks also resorted to the call money market occasionally as a
borrower in order to maintain their cash ratio at the level required by law.

However, since 1956, the India Bank have been resorting to the call money market mare frequently
whenever the demand upon them for credit owing to increasing investment activity press upon their
resources. Hence, the funds now flow more easily and to a large extent, not among Indian banks center like
Mumbai or Calcutta, but also among various centers.

(ii) The Bill Market

The bill market can be divided into two viz., the commercial bills market and the treasury bills market.

Commercial Bills Market

Bill financing is an important mode of meeting the credit needs of trade and industry in developed
economies because it facilitates an efficient payment system being self-liquidating in nature. In India bill
financing has been popular since long in ancient “Hundi” form.
The existence of an approved bills market enables rediscounting of bills which is a traditional instrument of
credit control. As such, the Indian central Banking Enquiry Committee (1931) had strongly recommended
the establishment of a market in commercial bills. But nothing could be done by the Reserve Bank till 1952,
on account of the war, the indifference of British Government and the partition of the country.

24
Banks of India, especially the Exchange Banks, used to discount bills of approved parties fulfilling certain
conditions, but there was no discount in the discount market in India, except the limited bills market
provided by the Reserve Bank for further dealings in these bills and banks had either to keep them until they
matured or rediscount them in London discount market, if they were export bills.

The RBI pioneered effort on developing bill culture in India. It introduced Bill Market Scheme (BMS) in
1952 to provide demand loan against bank’s promissory notes supported by their constituent’s 90 days
usance bills or promissory notes.

The bank could also cover part of their advances, loans, etc., into usance promissory notes for lodging with
the RBI collateral. The 1952 Bill Market Scheme was however, basically a scheme of accommodation for
banks. The scheme was designed to ease the problem of providing temporary finance to commercial banks
by the Reserve Bank as a lender of last resort. But, it did not succeed in developing a genuine bill market.

Promotion of bill culture, however, remained one of the major concerns of the RBI. Finally in November
1970, based on the recommendations of Narasimha committee, RBI introduced Bill Rediscounting Scheme
(BRS) also known as New Bill Market Scheme (NBMS) which continues till date in modified form. Under
this scheme, all scheduled commercial banks are eligible to rediscount genuine trade bills arising out of
sale/purchase of goods with the RBI and other approved institutions.

To promote the bills culture, RBI in March 198 educed the discount rate for bills for borrowers from 16.5%
to 15.5%. Thereafter, the bills finance has always been subject to one percentage point lower rate of interest
than prime lending rate fixed for corporate borrowers. Further, interest rate on rediscounting of bills was
deregulated in May 1989.

Treasury Bills Market

In addition to internal and foreign trade bills, banks deal in Treasury Bills. As they are issued at a discount
by the Government of India or State Government and are repayable usually after three months, banks regard
them as a very suitable form of investment for their own surplus fund. Most of them have been issued by
Government of India. During the First World War, they were issued to meet government’s disbursements on
behalf of British War Office. During the post-war period, they were issued to meet budget deficits and to
repay old bills. Later, they have been issued to provide ways and means of current and capital expenditure,
repayment of old bills and conversion of loans. During the Second World War, they were issued to provide

25
in large amounts for the same purpose as the First World War.

Tenders for them are invited by government notification and are received by the office of Reserve Bank. The
tenders quoting the lowest discount are accepted and the bills are issued and paid by the offices of the
Reserve Bank. In addition, intermediate Treasury Bills are sold sometime at a particular rate. At least 90% of
the tenders and purchases are made by few big banks and nearly half of these by the State Bank alone.

This makes government in India dependent upon a few banks, whereas in London, large funds which do not
belong to banks are invested in Treasury Bills and enable Government there to secure more favorable rates.
Consequently, the Reserve Bank sometimes had to intervene and purchase Bills on its own account. The
Reserve Bank has tried to organize and widen the Treasury bill market, in order to secure better control of
the money market, with the rediscounting of the bills with itself and to enable the market to carry a large
floating debt and thereby reduce the cost of Government borrowing.

The efforts of the Reserve Bank in widening the Treasury bill market have not succeeded fully until the late
1980s, owing to the absence of a discount market in these bills. Banks were reluctant to discount Treasury
bill with the Reserve Bank because the money market regarded such discount as a sign of weakness. This
lead to funds being locked in and market elasticity was not there in case of Treasury bill. Sales of treasury
bills were suspended from 20th April 1954 to 2nd November 1954 and form 6th April 1956 to 1st August
1958. However, since 1970s, the treasury bills were issued at a fixed rate of 4.6% and were for tenure of 91
days. However, with the setting up of the Discount and Finance House of India (DFHI) in 1988, the
secondary market for the treasury bills began to develop.

(iii) Other Sub-markets

The other important sub-markets that have come into existence in the money market are the Certificate of
deposits (CDs) market and the Commercial Papers (CPs) market.
These sub-markets are of recent origin. While the CDs market becomes operational during 1989-1990, the
CPs market emerged in 1990-91.

Certificate of Deposit (CDs)

26
The CDs are basically deposit receipts issued by a bank to the depositor. In India the Tambe Working group
in 1982 was the first one to evaluate the introduction of CDs in the money market. The group, however, did
not recommend introduction of CDs on the ground of inherent weakness viz. (i) absence of secondary
market, (ii) administered interest rate on bank deposits, and (iii) danger of giving rise to fictitious
transaction. The Vaghela Working Group in 1987 also discussed at large the desirability of launching this
instrument. The working group was of the view that developing CDs as money market instrument would not
be meaningful unless the short-term deposit rate are aligned with other rates in the system. As such, it did
not recommend introduction of CDs. The group, however, noted the importance of CDs and recommended
feasibility of introduction of CDs after appropriate changes at a later date.

Commercial Papers (CPs)

The CPs as an instrument are unsecured usance promissory notes issued by the corporate borrowers with
fixed maturity evidencing their short-term debt obligation. In India, Vaghela Working Group 1987 was the
first to recommend introduction of CPs in Indian money market. It noted that CP market has a advantage of
giving highly rated corporate borrowers cheaper funds while providing investors higher interest earnings.
Though the banks would loose some of their first rated borrowing clientele and consequently interest income
they can supplement their earning by acting as issuers and dealers of commercial papers. Accordingly, the
working group recommended the launch of CPs and suggested a scheme for issue of CPs.

(b) The Bazaar Part

Important cogs in the evolution of the Indian money market evolution of the Indian Money Market are the
indigenous institutions. Although, niches and chit funds exist, they are not important or money market as
such they absorb funds that might otherwise fed into banking system. A more obvious money market
institution was the Multani shroff. Formerly, and indeed into 1960s and the early 1970s, the Multani shroff
lent money to customer by discounting a hundi (which was originally in promissory note form) and then,
after endorsement and by arrangement through a hundi broker, rediscounted with a schedule bank up to
limits agreed upon. Although Multani shroffs have survived as a part of the indigenous sector, their clan is
readily declining and expected to become extinct.

Discount and Finance House of India (DHFI) AND Securities Trading Corporation of India (STCI)
A very significant step in evolution of the Indian money market has been setting up of the DHFI and the
STCI. As a sequel to the recommendations of the Working Group of the money market, the Discount and
Finance House of India was set up by the RBI jointly with the Public Sector Banks and all-India financial
institutions to deal in money market instruments. DHFI was incorporated on March 8, 1988 under the

27
Companies Act, 1956 with an autorised share capital of Rs. 100 crores subscribed by the RBI (Rs. 33 crores)
and all-India financial institutions (Rs 16 crores).

DHFI quotes regular bid and offer rates for treasury bills and commercial bills rediscounting. However only
bid prices for CDs and CPs are normally quoted. DHFI is also autorised to undertake “REPO” transaction
against treasury bills and it provides daily buy back and sell back rates for treasury bills to suit their
requirements of commercial banks.
The STCI is of recent orign. Basically, set-up for dealing in government securities market to broaden and
deepen this market, the STCI also has been allowed to deal in call money market and the treasury bills
market.

1.4 RECOMMENDATION OF VARIOUS COMMITTEES

The Indian money market has undergone metamorphosis during the last few years owing to a series of
measure which increased the number of participants, introduced newer instrument and deregulated interest
rate. The Reserve Bank of India (RBI) set up a committee to review the functioning of monetary system,
viz., SUKHMOY CHAKRAVARTY COMMITTEE in 1982, a working group to review the functioning of
money market, viz., VAGHUL WORKING GROUP in 1986 and the NARASIHMHAM COMMITTEE to
review the functioning of the financial system in India. While the Chakravarthy Committee recommended
measures for improvement in the monetary system, the Vaghela Working Group recommended measures to
activate and vitalize the money market and the Narasimhan Committee recommended measures to
streamline the functioning of the financial system.

RBI appointed a working group on Money market under the Chairmanship of N Vaghela, which suggested a
number of measures to deepen the money market. As a follow up the RBI took the following initiatives
· Formation of DFHI, an institution established in March 1988, to provide liquidity to money market
instruments.
· Increasing the range of money market instruments; CP, CD and Inter-bank participation Certificates
are some of the instruments introduced in 1988-89.

Freeing of call money rates in stages from interest rate regulation to price discovery based on market forces.
Today the Bank Rate has emerged as a reference rate and the call money rates generally operate in a corridor
with the Repo rate acting as a floor and the Bank Rate as a ceiling.
At present the overnight money market rate is the only floating rate benchmark. The methodology used for

28
calculating the overnight index is transparent.
Reuters MIBOR is the weighted average of call money transactions of 22 banks and other players.
NSE-MIBOR (Mumbai Inter-bank Offer Rate) is the rates polled from a representative panel of 32-banks/
institutions/ PDs.
The other benchmark instruments are 14-, 91-, 182- & 364-day T-bills. Also, we have the SBI-PLR rate.
Recommendation of Narasimhan Committee (April 1998)
The various recommendations in respect of the money market in the subject report are as under:

• The banks should put in place proper Asset-Liability Management policies, which should prescribe
tolerance levels for mismatches in various time bands.
• The inter-bank call and money market and inter-bank term money market should be strictly restricted
to banks. The only exception should be primary dealer (PDs), who in a sense, perform a key function of
equilibrating the call money market and are formally treated as banks for the purpose of them of their inter-
bank transactions. All the other present non-bank participants in the inter-bank call money market should not
be provided access to the inter-bank call money market. This institution could be providing access to the
money market through different other segments of the money market.
• Structural changes would result in the development of a strong and stable money market with
liquidity and depth.
• The foreign institutional investor should be given access to the Treasury bill market. Broadening the
market by increasing the participant would provide depth to the market.
• With the progressive expansion of the forward exchange market there should be endeavor to
integrate the forward exchange market with the spot market by allowing the participant in the spot forex
market to participate in the forward market by their exposure. Furthermore, the forex market, the money
market and the securities market should be allowed to integrate and their forward premia should reflect the
interest rate differential. As instruments move in tandem in these markets the desiderative of a seamless and
a vibrant financial market would hopefully emerge.

5. Major Reforms in Indian Money Market

Deregulation of Interest Rates

Some of the important policies in the deregulation of interest rates have been:

29
1. The lending and deposit rates that have, over time, been considerably freed. Lending rates are now
linked to the PLR, and the banks depending on their risk perceptions freely determine the spreads. Deposit
rates beyond one year have been freed, and deposit rates less than one year linked or pegged to the Bank
Rate. All re-finance; the OMO operations and liquidity to the Primary Dealers (PDs) have been linked to the
Bank Rate. To that extent the Bank Rate has been emerging as a kind of reference rate in the interest rate
scenario.
2. The second interesting aspect has been that the borrowings by the government (since 1992) have been
at market rates.

3. The PSUs and FIs, who had been largely depending on budgetary support for their resources, have been
forced to go to the market to raise their resource requirements.
Integration of Markets

The other important aspect of the fixed income market is the close inter-linkage between the money and
debt segments. The Call, Notice & Term money markets are to be made purely inter-bank markets. The non-
bank participants are being shifted to the Repo market. However, the existing players have been allowed to
park their short-term investments till they find other avenues. The corporates have the facility of routing
their call transactions through the PDs.

Primary Dealers
In order to make the government securities market more vibrant, liquid and to ensure market making
capabilities outside RBI a system of PD’s was established. The PDs have been allowed to operate a current
account and along with a SGL account. They also have been allowed to open constituent SGL accounts. RBI
has provided them liquidity support facility. In order to facilitate their continued presence in auctions the
RBI invites bids for underwriting in respect of all auctions. Routing of operations in the call money market is
allowed through PD’s. They are allowed the facility of funds from one Centre to another under RBI’s
Remittance facility scheme. The number of PDs has been increased from 7 to 13. Infect the introduction of
PDs has added to the liquidity in the market.

Valuation of securities
Banks have been required to mark 70% of their portfolio to market from the year 1998-99 and 75% from

30
1999-2000.
Foreign Institutional Investors (FIIs)
FIIs have been allowed to trade in T. Bills within the overall debt ceiling. They now have access to all types
debt instruments.
Developments in the Money Markets
Call/Notice Money Market
As per the suggestions of the Narasimhan Committee II, the RBI in the Mid-Term Review of October 1998
that it would move towards a pure inter-bank call/notice/term money market, including the PDs. Towards
this end the non-bank participants can invest their short-term resources in the Repo market and other money
market instruments.

Taking into consideration the transitional problems, it has also been decided to continue with the present
system of permitting FIs and MFs to lend in the call/notice money market. The corporates can route their
call/notice money transactions through the PDs.

Term Rate
Inter-bank CRR, other than minimum 3% has been done away with. In this direction the Interest Rate Swaps
(IRS) have been introduced for the participants to hedge their interest risks. For benchmarking we have the
14, 91& 364 T-bill. Also, we have the CPs. Now it is to the participants to use this opportunity.

Money Market Mutual Funds (MMMFs)

Many Mutual Funds have started funds which specifically focus on money market. They have also been
permitted to invest in rated corporate bonds and debentures with a residual maturity of up to only one year,
within the ceiling existing for CP.
Repos and Reverse Repos

Non-bank entities, which are currently permitted to take Repos, have been permitted to borrow money
through reverse Repos at par with banks and PDs. There is no restriction for the duration of a Repo. All
government securities have been made available for Repo. The Repos have also been permitted in PSU
bonds and private corporate debt securities provided they are held in demat form in a depository and the
transactions are done in recognized stock exchanges.

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 1.5 NEEDS FOR IMBIBING DEPTH TO THE MARKET

Diversifying investor base

Active participation by a number of investor segments, with diverse views and profiles, would make the
market more liquid. In order to attract retail investors there is need to exempt the interest income from
income tax. The mutual funds are expected to take the markets in a big way.

Settlement system reforms

In the settlement and transfer of wholesale trades, though DVP settlement has been introduced, inter-city
settlement continues to be a problem. It is not possible to buy and sell a security on the same day as
transactions are settled on a gross basis and short selling is not allowed. The RBI plans to introduce the Real
Time Gross Settlement (RTGS), which will add efficiency.

Transparency

Development of technology is an integral part of reforming the debt market, especially in the context of
providing a technologically superior dealing and settlement system. Hence the RBI has embarked upon the
technological upgradation of the debt market. This includes screen-based trade reporting system with the use
of VSAT communication network complimented by a centralized SGL accounting system. It shall also
facilitate logging bids in auctions of dated securities and T-bill. This will broaden the participation in the

32
auction system.

The participants would be required to provide two-way quotes. It is also believed that the screen would have
a chat line mode. The system will be integrated with the regional current account system. Nothing seems to
have been finalized as of now.
Anyway this system may not really be effective enough to substitute the telephonic mode of operation. The
system as has been planned does not provide for a participant to withhold his identity. Now this factor alone
could lead to inefficiencies in Price discovery, as in the case of a major participant having to reveal his
buy/sell interest.

In fact, the market participants seem to be divided over this issue. Some believe that the system as planned
is proper while many others believe that there would be no significant improvement. Anyway the RBI seems
to have decided to eliminate the brokers from the system. This would remain an interesting debate as the
NSE members/brokers not willing to believe that they would be out of the system after having paid the NSE
fees. About this system the market seems to be divided.
RBI would like the market to be free of intermediaries (brokers). The banks feel that the brokers would
remain. The brokers maintain that this system would not lead to the best price discovery. It is not very wise
for the participants to release their identity and interest.

Short selling
The participants feel that this would add to the depth of the market and also help in providing two-way
quotes. However it is not evident whether the RBI will be allowing this.
Primary dealers
The banks maintain that with all the benefits provided to them they should be providing fine two-way quotes
at market rates. For this the PDs feel that it is essential to allow the short selling of securities and that every
participant provides a two-way quote.
Awareness
The government along with the RBI has decided to do some publicity work.

Retailing of government securities

Since the beginning of the reforms, it has been recognized that a strong retail segment for government
segment needs to be developed. The basic objective of setting up of primary and Satellite Dealers was to
33
enhance distribution channels and encourage voluntary holding of government securities among a wider
investor base. To give a fillip to this scheme for availing of liquidity support from RBI has been made
available to them. Now banks are allowed to buy or sell freely government securities on an outright basis
and retail government securities to non-bank clients without any restriction on the period between sale and
purchase. The big question is whether the banks would actually take interest in the task, as this will affect
their deposits. Towards this end there is the need for introducing STRIPS.

Further to enable dematerialization of securities of retail holders, institutions such as NSDL, SHCIL, and
NSCCL have been allowed to open SGL accounts with RBI. SD’s have also been extended the facility of
Repo transactions since March 1998.

Market Microstructure
To develop the primary and the secondary markets the following points need careful evaluation
1. At present the PDs underwrite a sizeable portion of the market loans and quote an underwriting
commission. It has been suggested that it be made compulsory for them to bid for a minimum
percent for a minimum percent of the notified amount. By increasing the number of PDs, the
total bids should be brought up to 100% of the notified amount.

2. The RBI should try and move out of the primary auctions but in transition could take up to 20% of the
notified amount. In case of the issue being not fully subscribed the RBI should have the option of canceling
the entire issue.
3. Gradually the RBI should move out of the 14- and 91-day T. Bill auction and then the 364-day auction
and then finally from the dated of securities.

The RBI should have a strong presence in the secondary market by means of providing two-way quotes.

Standardization of Practices

Standard practices in the market need to be evolved with regard to the manner of quotes, conclusion of deals,
etc. It has been proposed that the Primary Dealers Association and FIMMDSI quickly setup a timeframe for
CP. The minimum the documentation and market practices, minimum the lock in period. If needed RBI will
come forward and indicate a time frame. Most importantly the code of conduct will have to be compatible
with the contemplated dealing screen and the technological upgradation.

Risk Management
34
Investors in debt instrument face three major types of risks namely credit risk, interest rate risk and foreign
currency risk. In case of the government securities the credit risk is zero. For the domestic investors the
foreign exchange risk is none. Investment in all debt instruments is exposed to interest rate risk. Introduction
of rupee derivatives will go a long way in providing investors an opportunity to hedge their exposures. IRS
and FRA have already been introduced. Also, there is a need for the dealers (especially in PSU banks) to be
provided with more freedom to make decisions. Finally, it remains on the willingness of the participants to
trade. This indeed would provide the needed fillip to the market.

1.6 INTRODUCTION TO DERIVATIVES

As their name implies, are contracts that are based on or derived from some underlying asset, reference rate,
or index. Most common financial derivatives can be classified as one, or a combination, of four types:
forwards, futures, options and swaps that are based on interest rates or currencies.
Derivatives help to improve market efficiencies because risks can be isolated and sold to those who are
willing to accept them at the least cost. Using derivatives breaks risk into pieces that can be managed
independently. Corporations can keep the risks they are most comfortable managing and transfer those they
do not want to other companies that are more willing to accept them. From a market-oriented perspective,
derivatives offer the free trading of financial risks.
A swap is another forward-based derivative that obligates two counterparties to exchange a series of cash
flows at specified settlement dates in the future. Swaps are entered into through private negotiations to meet
each firm's specific risk-management objectives. There are two principal types of swaps: interest-rate swaps
and currency swaps. The first recorded swaps were negotiated in 1981. Since then, the markets have grown
very rapidly.
Interest Rate Swaps (IRS)
An interest rate swap is a transaction involving an exchange of one stream of interest obligations for another.
Typically, it results in an exchange of fixed rate of interest payments. Occasionally, it involves an exchange
of one stream of floating rate interest payments for another.

The principle features of an interest rate swap are:

 It effectively translates a floating rate borrowing into a fixed rate borrowing and vice versa. The net
interest differential is paid or received, as the case may be.
35
 There is no exchange of principle repayment obligations.
 It is structured as a separate contract distinct from the underlying loan agreement.
 It is applicable to new as well as existing borrowings.
 It is treated as an off-the-balance-sheet transaction

To illustrate the nature of interest rate swaps, let us consider an example.

X has a borrowing of $ 50 million on which a floating interest of LIBOR (London Inter Bank Offer Rate)
plus 0.25 percent is payable and Y has a borrowing of $ 50 million on which a fixed interest rate of 10.5
percent is payable.

X and Y enter into an IRS transaction under which X agrees to pay Y a fixed interest rate of 10.5 percent and
Y agrees to pay X a floating rate of interest rate of LIBOR plus 0.25 percent. This transaction may be
represented diagrammatically as follows.

An interesting Indian example of an IRS is one entered into by Maruti Udyog Limited (MUL). On 16TH
March, 1984, MUL took a syndicate foreign loan of US $ 75 million. The terms of the loan agreement
specified that MUL would draw $30 million by 16TH March, 1985, $40 million by 16TH March, 1986, and
$50 million by 16TH March, 1987. The loan was repayable from March 1988 through March 1991. The rate
of interest on the loan was stipulated to be 3/8 percent over LIBOR till March 1988 and 1/ 2 percent over
LIBOR thereafter.

Concerned about the dollar LIBOR fluctuation, MUL in consultation with the government, the Reserve Bank
of India, and the State Bank of India, decided to go in for a IRS. On 30th July, 1985, MUL entered into a
transaction with Bank of America for an IRS. Under the deal, Bank of America agreed to pay Bank of Tokyo
an interest of 3/8 percent over LIBOR on 20 million while MUL agreed to pay a fixed rate of interest of 10.5
percent to Bank of America.
It must be noted that IRS are different from Forward Rate Agreements (FRA). While in FRA, a certain
interest rate applies for a certain period of time in the future; an IRS is a portfolio of FRA’s. All IRS can be
decomposed into separate FRA’s.

36
 1.7 Introduction of Forward Rate Agreements and Interest Rate Swaps

The Indian scene (Source: RBI Guidelines)

Objective

 To further deepen the money markets

 To enable banks, primary dealers and all India financial institutions to hedge interest rate risks.

These guidelines are intended to form the basis for development of Rupee derivative products such as
FRAs/IRS in the country. They have been formulated in consultation with market participants. The
guidelines are subject to review, on the basis of development of FRAs/IRS market.

Accordingly, it has been decided to allow scheduled commercial banks (excluding Regional Rural Banks),
primary dealers and all -India financial institutions to undertake FRAs/IRS as a product for their own
balance sheet management and for market making purposes.

Prerequisites

Participants are to ensure that appropriate infrastructure and risk management systems are put in place.
Further, participants should also set up sound internal control system whereby a clear functional separation
of trading, settlement, monitoring and control and accounting activities is provided.

Description of the product

37
A Forward Rate Agreement (FRA) is a financial contract between two parties exchanging or swapping a
stream of interest payments for a notional principal amount on settlement date, for a specified period from
start date to maturity date. Accordingly, on the settlement date, cash payments based on contract (fixed) and
the settlement rate, are made by the parties to one another. The settlement rate is the agreed
benchmark/reference rate prevailing on the settlement date.

An Interest Rate Swap (IRS) is a financial contract between two parties exchanging or swapping a stream
of interest payments for a notional principal amount of multiple occasions on specified periods. Accordingly,
on each payment date that occurs during the swap period-Cash payments based on fixed/floating and floating
rates are made by the parties to one another.

Participants
Schedule commercial banks.

Primary dealers

All India financial institutions

Benchmark rate

The benchmark rate should necessarily evolve in the market and require market acceptance. The parties are
therefore; free to use any domestic money or debt market rate for entering into FRAs/IRS, provided
methodology of computing the rate is the objective, transparent and mutually acceptable to counter parties.

Size
There will be no restriction on the minimum or maximum size of notional or principal amounts of
FRAs/IRS. Norms with regard to size are expected to emerge in the market with the development of the
product.

Tenure
No restrictions
Capital adequacy

Banks, FIs as per the stipulations contained

PDs as per the stipulations contained

38
Exposure limits
Banks, FIs and PDs have to arrive at the credit equivalent amount for the purposes of reckoning exposure to
a counter party. For this purpose, participants may apply the conversion factors to notional principal amounts
as per the original exposure method prescribed in Annexure I and II. The exposure should be within sub
limit to be fixed for FRAs/IRS to corporates/ banks/ FIs/ PDs by the participants concerned. In case of banks
and FIs, the exposure on account of FRAs/IRS together with other credit exposures should be within single/
group borrower limits as prescribed by RBI.

Further while dealing with corporates, banks, FIs and PDs should exercise due diligence to ensure that they
(corporates) are undertaking FRAs/ IRS only for hedging their own rupee balance sheet exposures. Banks,
FIs and PDs are advised to also obtain a certificate from the authorized signatory/ signatories of corporate/s
to such an effect.

Swap Position

Ideally, participants should undertake FRAs/ IRS only for hedging underlying genuine exposures. However,
recognizing the crucial role-played by the market maker in development of the product and creating of the
market itself, participants have been allowed to deal in the market without underlying exposure. However, to
ensure that the market makers do nor over extend themselves, market makers are required to place prudential
limits on swap positions, which may arise on account of market making activity.

Scheduled commercial banks, should place various components of assets, liabilities and off-balance sheet
positions (including FRAs, IRS) in different time buckets and fix prudential limits on individual gaps (as per
the procedure laid down in the procedure laid down in the RBI Circular on ALM system).The prudential
limits for different time buckets approved by boards of participants will require vetting by the RBI as
mentioned below:

Institution RBI’s department

PDs Internal Debt Management Cell (IDMC)

FIs Financial Institution Division, Department of Banking

Supervision

39
The above procedures for setting up of limits on swap positions and exposure limits may form the bottom-
line for the risk management, participants who can employ more sophisticated methods such as Value at
Risk (VaR) and Potential Credit Exposure (PCE) may do so.

Why do firms enter into interest rate swaps?

Swaps for a comparative advantage

Comparative advantages between two firms arise out of differences in credit rating, market preferences and
exposure.

Firm A with high credit rating can borrow fixed at 80 bps over PLR and floating at 50 bps over MIBOR.
Another firm B with a lower rating can borrow fixed at 150 bps over PLR and floating at 80 bps over
MIBOR.

The firm A has absolute advantage over firm B in both fixed and floating rates. Firm B pays 70 bps more
than firm A in the fixed rate borrowing and only 30 bps more than A in the floating rate borrowing. So firm
B has comparative advantage in borrowing floating rate funds. Hence B borrows funds at MIBOR plus 80
bps.

The gain because firm A borrows in the fixed rate segment is:

(PLR + 150 bps) - (PLR + 80 bps) i.e., 70 bps.

The loss because firm B borrows in the floating rate segment is:

(MIBOR + 80 bps) - (MIBOR + 50 bps) i.e., 30 bps.

The net gain in the swap = 70 - 30 = 40 bps.

The firms can divide this gain equally. Firm B can pay fixed at (PLR + 130 bps) to firm A and receive a
floating rate of (MIBOR + 80 bps).

40
 PLR+30bps
A B
MIBOR + 130bps

PLR+80bps Mibor+80bps

Effective cost for firm A = ((PLR + 80) + (MIBOR + 80) - (PLR + 130))

= MIBOR + 30 bps

This results into a gain of ((MIBOR + 50) - (MIBOR + 30)) i.e., a gain of 20 bps.

Effective cost for firm B = ((MIBOR + 80) + (PLR + 130) - (MIBOR + 80))

= PLR + 130 bps

This results into a gain of ((PLR + 150) - (PLR + 130)) i.e., a gain of 20 bps.

Swaps for reducing the cost of borrowing

With the introduction of rupee derivatives, the Indian corporates can attempt to reduce their cost of
borrowing and thereby add value. A typical Indian case would be a corporate with a high fixed rate
obligation.

Pawan-Priya Ltd. an AAA rated corporate; 3 years back had raised 4-year funds at a fixed rate of 18.5%.
Today a 364-day T. bill is yielding 10.25%, as the interest rates have come down. The 3-month MIBOR is
quoting at 10%.

Fixed to floating 1-year swaps are trading at 50 bps over the 364-day T. bill vs 6-month MIBOR.

41
The treasurer is of the view that the average MIBOR shall remain below 18.5% for the next one year.

The firm can thus benefit by entering into an interest rate fixed for floating swap, whereby it makes floating
payments at MIBOR and receives fixed payments at 50 bps over a 364 day treasury yield i.e. 10.25 + 0.50 =
10.75 %.

3 months MIBOR
Counter- Pawan-
party
Fixed 10.75 Priya

Mibor 18.5%

The effective cost for Pawan- Priya Ltd. = 18.5 + MIBOR - 10.75

= 7.75 + MIBOR

At the present 3m MIBOR at 10%, the effective cost is = 10 + 7.75 = 17.75%

The gain for the firm is (18.5 - 17.75) = 0.75 %

The risks involved for the firm are

42
- Default/ credit risk of counterparty. This may be ignored, as the counterparty is a bank. This risk
involves losses to the extent of the interest rate differential between fixed and floating rate payments.

- The firm is faced with the risk that the MIBOR goes beyond 10.75%. Any rise beyond 10.75% will
raise the cost of funds for the firm. Therefore, it is very essential that the firm hold a strong view that
MIBOR shall remain below 10.75%. This will require continuous monitoring on the path of the firm.

1.8 HISTORY AND EVOLUTION

After the fall of the Bretton Woods System, the government of the Great Britain undertook various steps to
prevent the downslide of the Pound and instituted new internal controls. One of the control measures was the
creation of the Dollar premium market to discourage the direct foreign investment. However, this created
opportunities for financial ingenuity by the British merchant bankers.

To avoid Dollar premium, Parallel Loans were introduced. Here, the parties were required to exchange the
principal on the value date. During the life of the contract, each party was to pay the interests on the
currency it had received. The next crucial step was the introduction of the Back-to-back Loans, in which the
loan was directly arranged between two parent companies in different countries and structured under one
agreement. Parallel Loans were strictly designed to satisfy the letter of the law.

That is why four entities – the parent and the subsidiary in each of the two different countries – had to be
involved in structuring each loan. In Back-to-back loans, the intermediary level of the subsidiary was
eliminated. Back-to-back loans tested the legal waters and did not face any problems. IN Back-to-back
Loans, only one documentation covered the transaction. These two instruments played an important role in
paving the way for the emergence of the Swaps.

Currency Swaps

The breakdown of the Bretton Woods System had opened up a whole new area of the foreign exchange
trading. In a deregulated market, banks could offer products to the clients, collect a fee, and improve their

43
profit margins. Gaining entry into the Parallel and the Back-to-back Loans was easy for the banks. But two
problems began to emerge.

One was the old issue of the paperwork, except that increased volume of the loans gave a new urgency to its
resolution. The other problem was related to accounting. Both of the above-mentioned loans were recorded
as two separate transactions. This ignored the contingent nature of the loans, inflated the balance sheets and
distorted the accounting ratios that were used in analyzing the financial health of the banks. The answer,
drawing heavily on the experience of the swap network, came in the form of the Currency Swaps.

In a Currency Swap, the notional amount of the trade was designated as off-balance-sheet, and payment of
interest by each party was made contingent upon the other party’s performance. With the principal amount
of the Currency Swap no longer subject to the counterparty default risk, it was possible to classify swaps as
off-balance-sheet instruments.

Incorporating the cash-flow structure of the Back-to-back Loans into the legal notion of the contingency
took the Currency Swap one step further from being a concept and made it a financial instrument as well.

The early Currency Swap deals were not disclosed to the public because of the proprietary nature. In 1981,
the World Bank and IBM announced a Currency Swap deal which was well publicized and gave an impetus
to the swap market.

Interest Rate Swaps

Building on the two important features of the Currency Swaps - contingency of the payments and the off-
balance-sheet nature of the transaction - international banks created and then expanded the idea of the IRS
market. Although IRS were created based on the concept of the Currency Swaps, a different set of
circumstances brought about their explosion. The Euromarket, where the Eurodollars are traded, is the
birthplace of the IRS.

Euromarket

Beginning in the '50s, the Socialist governments began to deposit their hard currency holdings in European
banks because they were concerned that, in the Cold War environment of the '50s, the US would freeze their
assets. However, these deposits were not enough to create and sustain a large market. It was the Dollar
holdings of the US corporations that created the Euromarket, as it was against the outflow of the US funds
that the Interest Equalisation Tax Act (IETA) was passed (IETA created a strong incentive for the US
investors to keep their Dollars in Europe).
44
The Euromarkets was created because of the higher rates of return in Europe and it was sustained due to the
tax differentials that could not be arbitraged because of the sovereignty. Euromarket was a concept of the
laissez-faire. Transactions in this market are mostly wholesale in the nature and the interest rates are heavily
influenced by the availability of, and demand for the funds.

Loans in this market are basically variable in nature and if necessary, on a roll over basis with fixed
maturities and non-prepayment clauses. As the '80s began, interest rates in the US market reached
unprecedented high levels and this trend split into the rate-sensitive Euromarket. So, the corporations sought
hedging vehicles against interest rate fluctuations. This was the starting point of the IRS. Here, the parties
agree to the exchange of the interest payments calculated on a notional amount.

However, interest payments in the IRS are based on the different modes of the same currency.

Thus, we can see that IRS or more precisely the swap market was born as insurance market directly related
to the Euromarket loans. This insurance market fueled and sustained the swap market. Swaps became
insurance vehicle of the borrowers because their premiums were borrowed.

Secondary Factors in the Development of the Swap Market

As international barriers to financial markets began to disappear, swap dealers were able to switch between
different indexes and different markets. By arbitraging capital and credit markets, they were able to borrow
at the best index available and then swap to the desired index.

Heavy borrowing by the US government and government agencies in the '80s played a major role in the
development of the swap market. Borrowing at the floating rates and swapping to the fixed rates met the
needs of the corporations and in effect added to the depth and the liquidity of the swap market.

Taking a view on the future direction of the interest rates, swaps can be proved to very attractive instrument,
and under a variety of yield curve conditions, they are among the cheapest to transact. Speculative trading of
the swaps added enormously to the depth and liquidity of the market.

45
 1.9 A BRIEF LOOK AT THE GLOBAL MARKETS

After the first swap in 1981, the interest rate swap market has exploded. In 1998, the annual turnover, in
terms of notional principal, is around $32 trillion. The market is regulated by the local level exchanges,
which together form the International Swap and Derivatives Association (ISDA). ISDA has set for the
guidelines and the regulatory framework, and most of the local regulations are based on these. ISDA has
about 104 members, and it publishes regular statistics about the markets. It also holds conferences and
spreads awareness of the instruments. ISDA has contributed significantly to the standardization and
documentation of swaps and consequently, their acceptance in financial markets. The ISDA Master
Document is used to record swaps.

Most of the IRS deals are pegged to the six-month LIBOR. The quotations for the fixed rate are normally in
terms of basis points over the US T-bill rates. Most swaps are of duration of 2 to 6 years, with swaps as long
as 15 years also having been recorded. IRS are mature products, and there are widely accepted theories and
research on their pricing and various varieties. Most players have adequate systems and exposure limits to
internally control their risk management. New forms of swaps keep on emerging, and then, theories for
pricing them also follow. Gradually small banks and corporates have also realized the usefulness of swaps as
hedging instruments, and their use is still increasing. For the last 5 years, the turnover for IRS has been
increasing by about 25-30% annually.
It must also be noted that more than 80% of the deals are speculative in nature, and this will continue to be
the case in the future in world markets. Swaps in currencies other than USD have gradually come of age, and
46
now, form substantial part of the total swap market.

PRESENT SCENARIO OF THE INDIAN MARKET

9.1 Genesis of the Interest Rate Swaps in India

Interest rates in India have been RBI determined for decades now. In the past five years, we have seen this
situation changing. Gradually, India is moving towards a market determined interest rate regime. RBI is
gradually freeing interest rates, and this has forced banks to manage risks on their own. Moreover, the Indian
companies were used to the earlier easy go approach and surety in interest rates that they can borrow on. But
now, corporates have a plethora of rates at which they can borrow.

They have the option of loans linked to fixed or floating rates. Thus, Indian companies have to be self-
sufficient with regards to management of financial uncertainties, like firms are elsewhere in the world. With
all this deregulation and integration with global practices, there was a felt need for instruments to hedge
against various risks. Derivatives for the money market were the next logical step in the process. This is
exactly what RBI has done.

The RBI Governor’s Statement on ‘Mid-Term Review of Monetary and Credit Policy for 1998-99’
announced on October 30, 1998, indicated that to further deepening the money market and to enable banks,
primary dealers (PDs) and all-India financial institutions (FIs) to hedge interest risks, the RBI had decided to
create an environment that would favour the introduction of Interest Rate Swaps.
Accordingly, on July 7, 1999 RBI issued final guidelines to introduce IRS and Forward Rate Agreements
(FRAs). The players are allowed to practice IRS/FRAs as a product for their own balance sheet management
and for market making purposes.

The RBI has been criticized for being hasty in introducing such interest rate derivatives. It was said that our
debt market is not mature enough to incorporate and deal with such products. Though the Indian debt market
has not been properly developed, blaming the RBI move does not seem to be proper because these products
will have to be introduced sooner or later and the present time appears to be as good a time as any other.
Moreover, this move may also help in quickening the development of a mature debt and money market.

9.2 The Legal Framework: RBI Guidelines (Summary)

A brief summary of RBI guidelines regarding IRS issued on July 7, 1999 follows:

47
Interest rate swap refers to a financial contract between two parties exchanging a stream of interest
payments for a notional principal amount on multiple occasions during a specified period.
Forward rate agreement (FRA) is being defined as the same on settlement date for a specified period from
start date to maturity date.

The players: Scheduled commercial banks excluding regional rural banks, primary dealers (PDs) and all-
India financial institutions have been allowed to undertake IRS as a product of their own asset liability
management and market-making purposes.

Types: Banks/PDs/FIs undertake different types of plain vanilla FRAs/IRS for interest rate risks arising on
account of lending’s or borrowings made at fixed or variable interest rates. However, swaps having
explicit/implicit option features like caps, floors or collars are not permitted.

Benchmark rate: The players can use any domestic money or debt market rates as reference rate for
entering into FRA/IRS, provided methodology of computing the rate is objective, transparent and mutually
acceptable to counter-parties. The reason stated for the same is that the benchmark rate is expected to evolve
on its own in the market.

Size of the notional principal amount: There will be no limit on the maximum or minimum size of the
notional principal amounts of FRAs/IRS or the tenor of the IRS/FRAs. Regarding the exposure limits the
banks, FIs and PDs have to arrive at the credit equivalent amount for the purpose of reckoning exposure to a
counter-party.
Exposure: The exposure should be within the sub limits and this should be fixed for the FRAs/IRS to
corporates/FIs, banks/PDs by the participants concerned. In case of the banks and the FIs, the credit
exposure should be within the single/group borrower limits as prescribed by the RBI.

9.3 Trends in Indian Markets

Before coming to the actual trends in the market, let us look at the players. Most of the active participation is
by foreign banks, followed by Indian banks, corporates and finally, FI’s. The absence of nationalised banks
from the IRS scene is noteworthy.
48
IRS today can be used by corporates only for an actual hedging exercise, and it has to have board
permission. Moreover, the deal would be within the exposure limits of that firm for the bank with which it is
dealing. These measures are to ensure that corporates do not undertake speculative activities, and start
dealing only after they have proper risk-management systems in place.

On the first day of trading, more than 30 deals were recorded, worth over Rs, 600 crores in notional principal
terms. Rs. 500 crores of this were accounted for by corporate deals. The rush was because the European and
private banks wanted to be a part of the history, dealing on first day, rather than actual hedging.

It has also been reported that some deals were circular between three players, with no real effect in any
players’ position. No deal was stuck for more than a year’s tenor.
Since the first day, there have been almost no deals, and the markets are cold. The reasons for this are many.
At the short-term level, almost all the players expect the interest rates to go down in the next few months.

This means that there are no conflicting views among players about interest rates, and so IRS deals are not
very tempting. Again, there are very few floating rate loans around. These and other fundamental reasons
have been discussed in the next section.
Exposure: The exposure should be within the sub limits and this should be fixed for the FRAs/IRS to
corporates/FIs, banks/PDs by the participants concerned. In case of the banks and the FIs, the credit
exposure should be within the single/group borrower limits as prescribed by the RBI.

9.4 Trends in Indian Markets

Before coming to the actual trends in the market, let us look at the players. Most of the active participation is
by foreign banks, followed by Indian banks, corporates and finally, FI’s. The absence of nationalised banks
from the IRS scene is noteworthy.

IRS today can be used by corporates only for an actual hedging exercise, and it has to have board
permission. Moreover, the deal would be within the exposure limits of that firm for the bank with which it is
dealing. These measures are to ensure that corporates do not undertake speculative activities, and start
dealing only after they have proper risk-management systems in place.
49
On the first day of trading, more than 30 deals were recorded, worth over Rs, 600 crores in notional principal
terms. Rs. 500 crores of this were accounted for by corporate deals. The rush was because the European and
private banks wanted to be a part of the history, dealing on first day, rather than actual hedging. It has also
been reported that some deals were circular between three players, with no real effect in any players’
position. No deal was stuck for more than a year’s tenor.

Since the first day, there have been almost no deals, and the markets are cold. The reasons for this are many.
At the short-term level, almost all the players expect the interest rates to go down in the next few months.

This means that there are no conflicting views among players about interest rates, and so IRS deals are not
very tempting. Again, there are very few floating rate loans around. These and other fundamental reasons
have been discussed in the next section.
The market is only about 2 months old now, and is yet to evolve. The likely problems in its evolution and the
future are discussed in the following sections.

50
 1.10 OBSTACLES TO DEVELOPMENT OF IRS IN INDIA

When we talk of IRS, we are actually referring to derivatives based on underlying instruments, which are
linked to interest rates. Now, for a good derivatives market for any underlying instrument, the market for
that instrument should be well developed, mature and competitive. However, in India, we do not have a very
mature and competitive money market, especially the term money market and the floating rate loan market.
Thus, the derivatives based on these instruments are bound to be far and few. Moreover, India does not even
have a very good inter-bank rate measure for different parties, which are acceptable to all parties. Then, risk
management systems are almost non-existent in most corporate. These and other obstacles in development of
the IRS market have been discussed in greater detail below.

 Non-availability of an acceptable Benchmark rate

 Lack of A Developed Term-Money Market

 Lack Of Active Market for Floating Rate Loans

 Non-availability of a variety of acceptable Yield Curves

 Participants’ Inertia

 Lack Of Awareness

 Reluctance on Part of Small Corporates and Small Banks

51
 1.11 FUNCTIONS

Money markets serve five functions—to finance trade, finance industry, invest profitably, enhance
commercial banks' self-sufficiency, and lubricate central bank policies.

Financing trade

The money market plays a crucial role in financing domestic and international trade. Commercial finance is
made available to the traders through bills of exchange, which are discounted by the bill market. The
acceptance houses and discount markets help in financing foreign trade.

Financing industry

The money market contributes to the growth of industries in two ways:

They help industries secure short-term loans to meet their working capital requirements through the system
of finance bills, commercial papers, etc.
Industries generally need long-term loans, which are provided in the capital market. However, the capital
market depends upon the nature of and the conditions in the money market. The short-term interest rates of
the money market influence the long-term interest rates of the capital market. Thus, money market indirectly
helps the industries through its link with and influence on long-term capital market.
52
Profitable investments
The money market enables commercial banks to use their excess reserves in profitable investments. The
main objective of commercial banks is to earn income from its reserves as well as maintain liquidity to meet
the uncertain cash demand of its depositors. In the money market, the excess reserves of commercial banks
are invested in near money assets (e.g., short-term bills of exchange), which are easily converted into cash.
Thus, commercial banks earn profits without sacrificing liquidity.

Self-sufficiency of commercial banks

Developed money markets help commercial banks to become self-sufficient. In an emergency, when
commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher
interest rate. They can instead meet their requirements by recalling their old short-run loans[clarify] from the
money market.

Help to central bank

Though the central bank can function and influence the banking system in the absence of a money market,
the existence of a developed money market smooths the functioning and increases the efficiency of the
central bank.

Money markets help central banks in two ways:

Short-run interest rates serve as an indicator of the monetary and banking conditions in the country and, in
this way, guide the central bank to adopt an appropriate banking policy,
Sensitive and integrated money markets help the central bank secure quick and widespread influence on the
sub-markets, thus facilitating effective policy implementation

53
 1.12 AUTHORISED SHORT TERM MONEY MARKET DEALERS

Authorized short term money market dealers are securities dealers which have a special contractual
relationship with the Reserve Bank. They play a pivotal role in the money market as they are the
entities through which the Bank primarily conducts its open market operations. They provide
facilities for the investment of overnight and short-term funds and are obliged to act as market
makers in short term Commonwealth Government securities. Their operations also extend into other
markets.

In recognition of their key role and to assist their operations the Bank provides dealers with some
special facilities. These include liquidity support and clearing accounts at the Bank which give
same-day value to dealers' transactions. In return, in addition to their market-making obligations,
dealers are required to observe guidelines set by the Bank for capital adequacy, ownership and asset
composition.

The origins of the dealers date back to the 1950s. At that time the Australian financial system was
relatively unsophisticated. Facilities for investing funds at interest for short periods were limited.
The main outlets were to deposit funds with banks for fixed periods, with a minimum maturity of
three months, or to purchase short-dated private or Commonwealth Government securities. To cater
for this demand, a number of stock and share brokers began to offer an interest-bearing short-term

54
investment secured by ‘buy-back’ arrangements on Commonwealth Government securities [1].
These facilities proved popular.

The Bank took a close interest in these activities, particularly since they were based on
Commonwealth stock. In the late 1950s, it decided to formalize and nurture the embryonic market
by accrediting certain dealers to conduct these operations under its guidance, in return for liquidity
support and other facilities. Thus, were born the authorized dealers or official short term money
market as it became known. Seven dealers were accredited in 1959, and a further two in 1960.

The number of authorized dealers remained unchanged until 1989. In recent years the Bank has
withdrawn accreditation from one company, two new dealer companies have been authorized, two
companies have merged, and one has withdrawn from the market. The eight dealers currently
accredited are listed in Appendix A.

The authorized dealers have three key functions. They provide a facility for the investment of short-
term funds with minimal risk, they make a market in short term Commonwealth paper; and they are
the prime counterparties for the Reserve Bank in its open market operations.

(a) Repository facility for short term funds

The core activity of authorized dealers is the acceptance of short-term wholesale funds and the
investment of these funds in short term securities. On the surface, such activities might seem
unremarkable. The clue to the special role of the official dealers lies in the composition of their
liabilities; they are the only entities which can provide the commercial banks with an alternative to
the Reserve Bank as a repository for banks' cash reserves or exchange settlement funds.

Exchange settlement funds are used by the banks to settle obligations between themselves and with
the Reserve Bank. The unique characteristic of these funds is that they give ‘same-day’ good value,
i.e. they are as good as cash. Transfer of value is affected instantaneously through debits/credits to
the relevant accounts. Exchange settlement accounts must always be in credit but do not accrue
interest, so banks aim to minimize balances in them.

55
To enhance earnings banks, keep a substantial amount of their liquid funds at interest with the
authorized dealers in the form of secured loans. Most of these funds are ‘at call’ and can be
withdrawn on any day if needed.

Dealers also accept loans from personal clients and non-bank institutions such as life offices,
superannuation funds and industrial companies. Loans from these clients are made by bank cheque
and are referred to as ‘next-day funds. While the authorized dealers get immediate credit for the
cheques deposited, the Bank does not obtain good value for these cheques until inter-bank
settlements for cheque exchanges are made on the next business day. It does, however, receive
interest overnight from the owing banks. Personal clients represent a very small part of the non-
bank funds lent to dealers.

All loans accepted by authorized dealers are fully secured by Commonwealth Government
securities or defined private sector securities. Evidence of ownership of securities by dealers is
delivered to clients or lodged with independent third parties.

(b) Market-makers
The authorized dealers make a market in short term Commonwealth Government securities and in
repurchase agreements based on Commonwealth Government securities. To this end, they trade
actively and consistently in these securities. Some data on turnover are provided later in this article.

They are also permitted to hold and trade a restricted range of bank and public authority securities,
as well as longer-term Commonwealth stock.

(c) Counterparties for Reserve Bank open market operations

The Reserve Bank conducts the bulk of its domestic open market operations with the authorized
dealers. It deals with them in the same securities in which they make markets, i.e., short term
Commonwealth Government securities (less than 1 year) and repurchase agreements based on
Commonwealth Government securities. The dealers' capacity to deal in both the exchange
settlement and bank cheque markets for cash gives them a pivotal role in the transmission of
Reserve Bank actions to the wider financial community.

The Bank trades with the dealers for two separate but related purposes. The first is to smooth ebbs

56
and flows in the supply of banks' cash balances and, as a consequence, to dampen fluctuations in
short term interest rates. These smoothing actions are often referred to as liquidity management.
The second is to alter the supply of such balances in order to bring about changes in the prevailing
level of interest rates in the markets for short term (overnight) funds. This then influences other
interest rates in the economy and, ultimately, saving and spending decisions, economic activity and
inflation. These are called monetary policy actions.

4. Reserve Bank Facilities

To enable full effect to be given to their role in the system, the Reserve Bank provides dealers with
a number of facilities.

The central pillar of any short-term money market is liquidity. Those who lend their own liquid
funds must be confident they can retrieve them at short notice. Those who invest in securities want
to be able to unwind quickly their investments without incurring additional loss due to market
illiquidity.

From the inception of the official market, the Bank has underpinned liquidity through the provision
of a line of credit to the authorized dealers. Until recently this took the form of a ‘lender-of-last-
resort’ facility, where dealers were able to borrow from the Bank pledging Commonwealth
Government securities as collateral.

In May 1989, the line of credit was changed to an end-of-day repurchase facility. Dealers are
expected to use the facility only after all reasonable efforts have been made to obtain funds in the
market. The interest rate and term applying to repurchase agreements are set by the Bank. The term
is normally seven days, though the Bank may offer other terms. Yields vary with market conditions
but normally contain a penalty element.

Dealers also have access to the Treasury note rediscount facility which is available from the Bank to
any holder of Treasury notes within 90 days of maturity.

Each dealer conducts a clearing account at the Reserve Bank, through which pass transactions with
clients, with other dealers, and with the Bank itself. Funds deposited to this account receive

57
immediate (same day) value which puts the dealers in a unique position to provide an interest-
bearing repository for banks' cash reserves. When funds on loan are repaid to a bank, the proceeds
again receive immediate value in the bank's exchange settlement account with the Reserve Bank.

Dealers are required to secure loans by placing with the lender (or with a third party acting on the
lender's behalf) collateral in the form of selected money market instruments to at least the market
value of the loan. Commonwealth Government securities form the majority of such collateral. To
facilitate this process, dealers' Commonwealth Government securities are held in a special account
at the Bank. The Bank then issues Acknowledgement Forms which dealers deliver to clients as
collateral. The relevant Commonwealth Government securities are ‘reserved’ by the Bank while the
Acknowledgement Forms are on issue.

To help bridge differences in timing between the movement of funds and securities, the Bank
allows dealers to overdraw their money and securities accounts for short periods during the day.
Limits are placed on the extent of these daylight overdrafts.

The Bank also acts as participating bank for dealers' Australia transactions.

5. Supervision of Dealers
As part of their contractual relationship with the Bank, dealers agree to meet certain guidelines.
These are designed to ensure that the dealers are managed prudently and have adequate capital and
liquidity; and that the facilities of the authorized market are available widely for the benefit of the
financial system generally, rather than solely for the benefit of a particular shareholding group.

(a) Ownership
The ownership of a dealer must be acceptable to the Reserve Bank. Owners must have the capacity
and willingness to commit resources to preserve the position of creditors and to maintain the capital
of the company. They should be of good repute and market standing and be able to contribute to the
direction and management of the company. It is important that dealers should operate independently
from each other to ensure genuine market competition. To this end, owners may not have a
substantial interest in more than one official dealer company. For similar reasons, and to see that the
effects of the Bank's market operations spread quickly to the financial markets as a whole, a

58
separation is maintained between banks and authorized dealers. A bank may not be a direct
shareholder in a dealer company and may only hold, indirectly, up to 12.5 per cent. A party with a
substantial shareholding in a bank authorized to operate in Australia may not also be a substantial
shareholder in a dealer company.

Chart 1 shows the ownership structure of the dealers as a group as at end May 1991. At their
inception, dealers were owned mainly by individuals and partnerships. Over time, ownership has
largely passed to institutions and now only one ownership structure is in the early form.

59
Over the years there has been an increase in foreign ownership, with many dealers now having
substantial foreign equity. This reflects the relaxation and final removal of quantitative restrictions
on participation by foreigners. The final step occurred in early 1990 with the removal of the 50 per
cent limit on foreign ownership. This change brought the rules on foreign ownership of dealers into
line with those applying more generally to the non-bank finance industry in Australia.

(b) Capitalization
In May 1989, the Bank increased the required minimum capital level of individual dealer companies
from $5 million to $10 million. Capital is defined as paid-up capital, share premium reserves and
retained earnings. Subordinated loans from shareholders are not counted as permanent capital but
may be approved as a temporary means of supplementing the capital base for gearing purposes (see
below).

The total capital base of the eight authorized dealers at end May 1991 was $113 million.

(c) Asset Structure

Dealers are subject to a ‘gearing limit’, i.e., the total assets they may hold is determined by the risk
attached to the assets and the size of their capital base. Aggregate risk weighted assets may not
exceed 33 times shareholders' funds (including any subordinated loans approved for inclusion by
the Bank for gearing purposes). Assets are weighted by period to maturity, with shortest maturities
having the lowest weights. Adjustments are made for some commitments not reflected on the
balance sheet, including those in respect of repurchase agreements, forward commitments and
derivative products (futures contracts, options, etc). Basing risk weights on maturity reflects the
sensitivity of the value of securities to changes in interest rates. The longer the period to maturity,
the larger the capital loss occasioned by a rise in interest rates.

The main assets which dealers may hold are limited to highly liquid, low credit risk securities.
These include Commonwealth Government securities, bank bills and certificates of deposit, and
marketable securities issued by major public authorities. A dealer's aggregate holdings of non-
Commonwealth Government securities are limited to 50 per cent of its gearing limit.

(d) Reporting requirements

The Reserve Bank monitors closely the activities of authorized dealers. They provide the Bank with

60
a wide range of information on their operations. Much of this is supplied through regular statistical
returns, some on a less formal basis.
Contacts between the Bank and the individual dealer companies are close and frequent. Formal
meetings also occur at least twice a year with the Chief Executives of the dealers as a group.

6. Recent Trends
(a) Assets
In terms of assets, authorized dealers are small relative to other financial groups. Table 1 shows
that, at 30 March 1991, their assets totaled $4.3 billion, around one per cent of the total assets of
financial institutions in Australia. Their balance sheets also tend to be much more variable than
those of other institutions, contracting and expanding in response to the ebbs and flows of liquidity
in the money markets and the banks' desire to hold cash balances.

b) Sources of Funds
Dealers borrow funds at call, or for fixed periods, in minimum amounts of $50,000.

Until 1984, they typically raised 75–85 per cent of their funds from non-bank clients. However,
many of these clients were lost to the banks following the decision in August 1984 to permit banks
to pay interest on overnight and short-term deposits. Nowadays, loans from non-banks form less
61
than one third of the dealers' liabilities (see Graph 1). The bulk is overnight loans of exchange
settlement funds by banks.

Turnover
Dealers are active traders, some more active than others. On average, around two thirds of the value
of assets is turned over every day, but four dealers between them account for about two thirds of the
total turnover.

62
Graph 2 shows that dealers' transaction volumes quadrupled between 1985 and 1988, from $700
million a day to around (3.2 billion. Turnover has subsequently stabilized around this higher level.
The main factor in the higher turnover has been the trade in repurchase agreements (RPs). In August
1986, the Reserve Bank allowed dealers to buy and sell securities under RP with banks and other
clients; this had not previously been possible.

Under a repurchase agreement, a trader buys (or sells) a certain number of securities and agrees to a
reverse transaction for equivalent value at a specified future date at an agreed price. It can also be
called a spot/ forward swap.

63
RPs are different from a loan of securities or the type of buy-back common in the 1950s, since
ownership of the securities legally changes hands. RPs increase the effective stock of
Commonwealth Government securities available for trading in the money market by enabling
longer-term bonds to be used for short term trading without purchasers having to carry the full risk
of large swings in capital values as yields change.

RPs now account for about 60 per cent of dealers' transactions. Recently there has also been some
growth in RP transactions based on securities of public authorities.

‘Single-leg’ trading of Commonwealth Government securities now accounts for only a little over
one tenth of total trading activity. For non-Commonwealth Government securities -mainly bank
64
bills and securities of public authorities – outright trades account for around one quarter of turnover.
Chart 3 shows the composition of dealers' trading activity for 1990.

1.13 WHO SHOULD INVEST IN MONEY MARKET MUTUAL FUNDS?

Money market mutual funds help with portfolio diversification. The primary objective is to generate
low-risk short-term returns from investing in highly-rated money market instruments. The corpus
gets invested in a well-diversified portfolio to produce the highest short-term gain. Investors with a
short-term investment horizon of one year and with high liquidity may invest in these funds.

Further, low-risk appetite investors seeking higher returns than traditional investment options like
fixed deposits can park their investable corpus in money market fund schemes that generate
predictable returns in the short term.

However, if you have a long-term investment horizon, money market mutual funds may not suit
your purposes. Instead, you should invest in dynamic bond funds or balanced funds, which are still
low-risk investments capable of generating more returns than money market mutual funds.

Since these schemes invest in money market instruments, they are ideal for investors with lower
risk tolerance and an investment horizon of up to one year. Typically, investors with idle cash lying
in their savings account can earn better returns by investing in these funds. It is important to note

65
 that these funds are recommended to investors having short-term cash surplus which they won’t
need urgently.

1.14 FACTORS TO CONSIDER BEFORE INVESTING IN MONEY MARKET FUNDS IN INDIA

Here are some important aspects that you must consider before investing in money market funds in India:
– Risks and Returns
Money Market Funds are debt funds and hence carry all the risks applicable to debt funds like interest rate
risk and credit risk. Additionally, the fund manager might invest in instruments with a slightly higher risk
component to increase returns. Usually, money market funds tend to offer better returns than a regular
savings account. The Net Asset Value or NAV of these funds changes with a change in the interest rate
regime.

– Expense Ratio
Since the returns are not very high, the expense ratio plays an important role in determining your earnings
from a money market fund.
‘Expense Ratio is a small percentage of the total assets of the fund charged by the fund house towards fund
management services.’

Ideally, you should look for funds with a lower expense ratio to maximize your returns.
– Invest according to your Investment Plan
Usually, money market funds are recommended to investors with an investment horizon of 90-365 days.
These schemes can help you diversify your portfolio and help invest surplus cash while maintaining

66
liquidity. Ensure that you invest according to your investment plan.
Looking to invest? Open an account with Groww and start investing in direct mutual funds for free

Taxation
In the case of Money Market Funds, the taxation rules are as follows:
Capital Gains Tax
If you hold the units of the scheme for a period of up to three years, then the capital gains earned by you are
called short-term capital gains or STCG. STCG is added to your taxable income and taxed as per the
applicable income tax slab.

If you hold the units of the scheme for more than three years, then the capital gains earned by you are called
long-term capital gains or LTCG. LTCG is taxed at 20% with indexation benefits.

CHAPTER NO.-2

RESEARCH METHODOLOGY

Methodology is an essential part of research to find answer to the research objective

that initiate the same. Therefore, it figures as an important part of the study. This
chapter focuses on the design and research method utilized in the study. In addition, the
procedure followed to collect, capture, process and analyzed data is presented. The
research approach used in the study is presented below: -

Sample Unit: -
Sample size determination is the process of choosing the number of
respondents/observations to include in a statistical sample. It is an important feature of a
research study because on the basis of sample size data is collected and interpreted to give
accurate and appropriate results.
The correct and appropriate sample size is said to give more accurate results. For
example, in a census, data is collected from the entire population. Therefore, the sample
size is equal to population of the country. Keeping in mind the rate of non-response and
non-availability of respondents, the sample size was taken between 25 – 50 sciences

67
students of Mumbai University. It was Random sampling method that was considered to
decide the sample size.
Due to the sample size being small there may be slight inaccuracy of data that can be
rectified by further study.

Type of research: -
my research is based on descriptive research. It helps to know qualitative and
quantitative aspects of study. It studies the characteristics of Indian Money Market and
see to it that how we can bring more agencies in India. It is used because this topic is
being studies only to understand the concept and the problem it faces. However, my
research also studies Review of Literature which acts as a base for Descriptive study.

Sampling Objective: -
The objectives are designed to have a particular direction to the study like what aspect
of the topic is going to be studied. A topic can be studied from various parameter, the
objectives designed for a project gives an idea that in what manner the topic is studied,
what is the flow of project, what are the variables selected for the project, etc.
-To find out individual investors for the age group of 18-55 years.

Sampled size: -
Sample size determination is the process of choosing the number of
respondents/observations to include in a statistical sample. It is an important feature of a
research study because on the basis of sample size data is collected and interpreted to give
accurate and appropriate results.
The correct and appropriate sample size is said to give more accurate results. For
example, in a census, data is collected from the entire population. Therefore, the sample
size is equal to population of the country. Keeping in mind the rate of non-response and
non-availability of respondents, the sample size was taken between 25 – 50 science
students of Mumbai University. It was Random sampling method that was considered to
decide the sample size.

68
Due to the sample size being small there may be slight inaccuracy of data that can be
rectified by further study. (100 respondents)

SAMPLE DESIGN: -
The sample design used to represent the survey data sin the form of Pie-Charts andBarCharts based on the
80 respondents of the survey. Probability sampling was used to
collect responses.

Data Collection: -
Data for the study was collected from the primary as well as secondary sources.

PRIMARY SOURCE OF DATA COLLECTION: -

Primary source of data collection consisted of survey method. The survey was collected
through a Structured Questionnaire. The questionnaire was prepared keeping in mind
the objectives of the study and factors that were to be considered for the study.
Questionnaire was prepared in such a manner that it could be easily understood by the
respondents. The questionnaire being structured was in a single format to save time of the
respondents.

SECONDARY SOURCE OF DATA COLLECTION: -

The secondary source of data collection is assessed to gain information and knowledge
about our research problem that may be previously discussed by some other researcher.
The secondary is referred to know what has already been discussed and what more
scope can be there for research.
The secondary data is taken from selective websites and from online publication of
some researchers. The secondary data was useful for the study of Review of Literature.
We could study various aspects of different researchers which gave us an idea about the
factors being previously discussed and also the conclusions drawn from them. It also
gave us an insight on what more could be studied to solve the research problem.

Data Analysis; -

69
The application of statistical tools and techniques for the data collected by means of
questionnaires is been classified tabulated analyzed and summarized with the help of
statistical tool percentage method.

LIMITATION OF THE STUDY: -

The study is based on limited scope of area.
Whole market cannot be collected.

Objective of Study: -
The objective of the project are as follows: -
To study about INDIAN MONEY MARKET AND its related aspects like its types and
the instruments.

To study about the history, participant, organizational structure of INDIAN MONEY

(MONETORY) MARKET.
To find out the investors saving preferences.
To study about overcoming the short-term deficit.
To enable liquidity in the market.

70
CHAPTER NO-3

REVIEW OF LITERATURE

Reuters (2009) Article: India call money ends near reverse repo rate, cash abundant. India overnight money rates
brought down to the reverse repo rate of 3.25% on Wednesday these cash surplus in the system will help the banks
meet their reserve needs comfortably. Cheaper money usable at the security borrowing and lending agreement (CBLO)
also reduce the pressure on the inter-bank cash rates. On that day banks were guided to report their position to RBI
once in two weeks. This alteration created an expectation on liquidity resistance. And some analysts said that the
central bank may start rolling back the liquidity as early as on December 2009, as they already pressured the consumer
prices could pose significant inflationary threat to the economy, in the thick of easy cash conditions Overnight rates
are supported around the reverse repo rate because banks holding the surplus funds could also break up with the same
central bank at that rate in its daily liquidity adjustment auctions.

Rastogi Nikhil (2008) Article: Money Market Integration in India: A Time Series Study Says that Indian financial
markets have achieved much from the highly controlled pre-liberalization era. He denotes that the main focus is on
achieving efficiency, which is the trade mark of any developed financial market. This research paper tests the
efficiency and extent of integration between financial markets observed at the short end of the market. The rates are
mainly taken for the purpose of the study of, the compound call market rate, CD (Certificate of Deposit) rate, CP
(Commercial Paper) rate, 91-day T-bill (Treasury bill) rate and 3-month forward premium.
71
The results, though promising, are mixed. In his research he concluded that although markets have achieved
integration in some of its branches, but they still have to attain full integration. It has absolute implications on the
monetary policy of the Reserve Bank of India. (RBI) since the changes in one market (gilt market) can be used to
coordinate the other market (forex market).

Rusty Sadananda (2007) Article: Market efficiency and financial markets integration in India in their work
examined the impact of economic reforms on the integration of various segments of the financial market in India over
the time series tools during the period from March 2006 to March 2012. The major findings were: (I) various sector of
the financial market in India have achieved market efficiency, (ii) the 91-day Treasury bill rate is the suitable 'base
rate' of the financial sector in India, (iii) the financial markets in India are broadly integrated at the short-end of the
market, and (iv) the long- end of the market is amalgamate with the short-end of the market. From the above monetary
policy should rely more on interest rate and asset price channels to control inflation.

Recommendations of Three Committees: - The issue of whether non-bank participants should constitute part of
call/notice/term money market could be traced first in the Report of the Committee to Review the Working of the
Monetary System (Chairman: S. Chakravarty) in 1985. Since then, the Report of the Working Group on the Money
Market (Chairman: N. Vague) in 1987 and the Report of the Committee on Banking Sector Reforms (Chairman: M.
Narasimha) in 1998 had also deliberated on this issue. It needs to be appreciated that the particular set of
recommendations from these three Committees have to be assessed against the specific objectives for which these
Committees had been constituted as well as the differing initial conditions reflecting the state of Indian financial
market which were prevailing at that particular point of time.

Sukhmoy Chakravarty Committee (1982) Articles: - Recommended for call money market. Examined the study of
call money market for India was first recommended by the Sukhoi Chakravarty. Committee was set up in 1982 to
review the working of the monetary system. They felt that allowing additional nonbank participants into the call
market would not dilute the strength of monetary regulation by the RBI, as resources from non-bank participants do
not represent any additional resource for the system as a whole, and their participation in call money market would
only imply a redistribution of existing resources from one participant to another. In view of this, the Chakravarty
Committee recommended that additional nonbank participants may be allowed to participate in call money market.

The Vaghul Committee (1990) Articles: - Introduction of money market instruments. The Vaghul Committee (1990),
while recommending the introduction of a number of money market instruments to broaden and deepen the money
market, recommended that the call markets should be restricted to banks. The other participants could choose from the
72
new money market instruments, for their short - term requirements. One of the reasons the committee ascribed to
keeping the call markets as pure inter-bank markets was the distortions that would arise in an environment where
deposit rates were regulated, while call rates were market determined.

Narasimham Committee (1998) Articles: - observation on call/money/term money market examined the
Narasimham Committee II (1998) concurred with the Vaghul Committee as it also observed that call/notice/term
money market in India, like in most other developed markets, should be strictly restricted to banks. It, however, felt
that exception should be made for Primary Dealers (PDs) who have been acting as market makers in the call money
market and are formally treated as banks for the purpose of their inter-bank transactions and, therefore, they should
remain as part of call money market. With regard to non-banks, it expressed concern that these participants "are not
subjected to reserve requirements and the market is characterized by chronic lenders and chronic borrowers and there
are heavy gyrations in the market".

It felt that allowing non-bank participants in the call market "has not led to the development of a stable market with
liquidity and depth and the time has come to undertake a basic restructuring of call money market". Like the Vaghul
Committee, it had also suggested that the non-bank participants should be given full access to bill rediscounting,
Commercial Paper (CP), Certificates of Deposit (CDs), Treasury Bills (TBs) and Money Market Mutual Funds
(MMMFs) for deploying their short-term surpluses

Kotter and Mosser (2002) Articles: - The Monetary Transmission Mechanism: Some Answers and Further
Questions, examined the Monetary policy’s effect appears to be somewhat weaker than they were in past decades.
Financial Innovation is one possible cause of this change but not the only one improved inventory management and
the conduct of monetary policy itself are others. Thank to financial innovation and institutional changes in housing
finance the housing sector is no longer on the leading edge of the transmission mechanism. However, judging from the
evidence presented for the United. Kingdom, the role of housing assets on households’ balance sheets warrants further
study. Neither financial consolidation nor the shrinking reserve volume appears to be a major factor affecting
monetary transmission—at least not yet. Some loose ends and lacunae remain, however. First, although monetary
policy seems to have retained its effectiveness, the economy’s sensitivity to interest rates remains an open question.

Dr. Y.V. Reddy (2002) Article: - Parameters of Monetary Policy in India attempted to focus on the conduct of
monetary policy and highlighted some of the immediate tasks. In case, there is interest in an overview of theory and
analytics, especially in the context of role of monetary policy in revitalizing growth in India. The conduct of monetary
policy in India would continue to involve the constant rebalancing of objectives in terms of the relative importance
assigned, the selection of instruments and operating frameworks, and a search for an improved understanding of the
73
working of the economy and the channels through which monetary policy operates. Among the unrealized medium-
term objectives of reforms in monetary policy, the most important is reduction in the prescribed CRR for banks to its
statutory minimum of 3.0 per cent. The movement to 3.0 per cent can be designed in three possible ways, viz., the
traditional way of pre-announcing a time-table for reduction in the CRR; reducing CRR as and when opportunities
arise as is being done in recent years; and as a one-time reduction from the existing level to 3.0 per cent under a
package of measures. The Reserve Bank influences liquidity on a day-to-day basis through LAF and is using this
facility as an effective flexible instrument for smoothening interest rates. The operations of non-bank participants
including FIs, mutual funds and insurance companies that were participating in the call/notice money market are in the
process of being gradually reduced according to pre-set norms. Such an ultimate goal of making a pure inter-bank call
money market is linked to the operationalization of the CCIL and attracting non-banks also into an active repo market.
The effectiveness of LAF thus will be strengthened with a pure inter-bank call/notice money market in place coupled
with growth of repo market for non-bank participants.

Reserve Bank of India (2010) in his discussion paper “Deregulation of Savings bank Interest rates: A Discussion
paper” try to put the pros and cons of deregulation of savings deposits interest rates in India. Regulation of interest
rates imparts rigidity to the instrument/product as rates are either not changed in response to changing market
conditions or changed slowly. This adversely affects the attractiveness of a product/instrument. In the case of savings
bank deposits, its interest rate has remained unchanged at 3.5 per cent since March 1, 2003 even as the Reserve Bank’s
policy rates and call rates (representing a proxy for operative policy rate as at a time, only one rate – either the repo
rate or the reverse
repo rate – is operative depending on liquidity conditions) moved significantly in either direction. Regulation of
savings deposits interest rate has not only reduced its relative attractiveness but has also adversely affected the
transmission of monetary policy. For transmission of monetary policy to be effective, it is necessary that all rates move
in tandem with the policy rates.
This suggests that regulation of the interest rate on savings deposits has impeded the monetary transmission and that
deregulation of interest rate will help improve the transmission of monetary policy. In sum, deregulation of savings
deposit interest rates has both pros and cons. Savings deposit interest rate cannot be regulated for all times to come
when all other interest rates have already been deregulated as it creates distortions in the system. International
experience suggests that in most of the countries, interest rates on savings bank accounts are set by the commercial
banks based on market interest rates.

Deepak Mohanty (2011) Article: - Monetary Policy Response to Recent Inflation in India trying to prove the relation
between the Policy framed by the reserve bank of India and the Inflation situation in the country. India, though
initially somewhat insulated from the global developments, was eventually impacted significantly by the global shocks
74
through all the channels – trade, finance and expectations channels. In response, the Reserve Bank swiftly introduced a
comprehensive range of measures to limit the impact of the adverse global developments on the domestic financial
system and the economy. The Reserve Bank, like most central banks, took a number of conventional and
unconventional measures to augment domestic and foreign currency liquidity, and sharply reduced the policy rates. In
a span of seven months between October 2008 and April 2009, there was unprecedented policy activism. For example:
(I) the repo rate was reduced by 425 basis points to 4.75 per cent, (ii) the reverse repo rate was reduced by 275 basis
points to 3.25 per cent, (iii) the cash reserve ratio (CRR) of banks was reduced by a cumulative 400 basis points of
their net demand and time liabilities (NDTL) to 5.0 per cent, and (iv) the total amount of primary liquidity potentially
made available to the financial system was over 5.6 trillion or over 10 per cent of GDP. As growth took hold and
inflation became more generalized, monetary policy response was strengthened. Initially, monetary transmission was
weak as systemic liquidity was in surplus. But once liquidity turned into deficit in July 2010, monetary transmission
improved.

Rastogi Nikhil (2008) Article: Money Market Integration in India: A Time Series Study Says that
Indian financial markets have achieved much from the highly controlled pre-liberalization era. He
denotes that the main focus is on achieving efficiency, which is the trade mark of any developed
financial market. This research paper tests the efficiency and extent of integration between financial
markets observed at the short end of the market.

Rusty Sadananda (2007) Article: Market efficiency and financial markets integration in India in their
work examined the impact of economic reforms on the integration of various segments of the financial
market in India over the time series tools during the period from March 2006 to March 2012.

Sukhmoy Chakravarty Committee (1982) Articles: - Recommended for call money market.
Examined the study of call money market for India was first recommended by the Sukhmoy
Chakravarty. Committee was set up in 1982 to review the working of the monetary system.

Narasimham Committee (1998) Articles: - observation on call/money/term money market examined the
Narasimham Committee II (1998) concurred with the Vaghul Committee as it also observed that
call/notice/term

75
money market in India, like in most other developed markets, should be strictly restricted to banks.
Reserve Bank of India (2010) in his discussion paper “Deregulation of Savings bank Interest rates: A
Discussion paper” try to put the pros and cons of deregulation of savings deposits interest rates in India.
Regulation of interest rates imparts rigidity to the instrument/product as rates are either not
changed in response to changing market conditions or changed slowly.

CHAPTER NO. 4
DATA ANALYSIS & INTERPRETATION AND PRESENTATION

1. What is your annual income?

SR. NO. PARTICULARS FREQUENCY PERCENTAGE

1 Below 1 lakh 7 7%
2 Between 1 lakh to 3 lakhs 10 10%
3 Between 3 lakhs to 5lakhs 15 15%
4 Above 5 lakhs 38 38%
5 No income 30 30%

76
 Percentage

Below 1 lakh Between 1 lakh to 3 lakhs Between 3 lakhs to 5lakhs

Above 5 lakhs No income

Interpretation: - There were total 100 responses out of which 7% respondents have annual income of below 1
lakh. 10% respondents have an annual income between 1 lakh to 3 lakhs, between 3 lakhs to 5 lakhs were of
15%, above five lakhs were 38% and for no income there are 30%

2. How do you invest in your saving?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 Invest in capital market 49 49%

2 Invest in money market 54 54%

mutual fund

3 Invest in bank 60 60%

4 Invest in real estate 20 20%

77
 Chart Title

Invest in real estate

Invest in bank

Invest in money market mutual fund

Invest in capital market

0 10 20 30 40 50 60 70

PERCENTAGE FREQUENCY

Interpretation: - From the above data we can see that 49% of the respondents invest in capital market, 54%
of respondents invest in money market mutual fund, 60% invest in banks and 20 % invest in real estate.

3) Do you have any knowledge about money market instruments?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 YES 75 75%

2 NO 8 8%

3 MAYBE 6 6%

4 HEARD BUT DON’T 11 11%

KNOW

78
 PERCENTAGE

HEARD BUT DON’T

KNOW
MAYBE 11%
6% YES
NO
8% NO
MAYBE
HEARD BUT DON’T KNOW
YES
75%

Interpretation: - From the above analysis we can see that 75% have heard about money market and knows
about that, while there are 6% people who aren't sure about this, 11% people have heard about the term
money market but have no knowledge about that and then about 8% of the respondents don't know anything
about money market

4) How long would you like to hold your money market instruments?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 LONG TERM METOD 78 78%

2 SHORT-TERM 22 22%
METHOD

79
 PERCENTAGE

22%
LONG TERM METOD
SHORT-TERM METHOD

78%

Interpretation: - From the above data 78% of the people like to keep money market instruments for long term
method while other people which are about 22 % keep it for the short-term method. We can see that most of
them are willing to keep their investment for long term.

5) How much risk will you be willing to take?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 LOW 13 13%

2 AVERAGE 19 19%

3 MEDIUM 51 51%

4 HIGH 17 17%

80
 PER CENTA GE
LOW AVERAGE MEDIUM HIGH

Interpretation: - From the above data we can see that 13% respondents will take low level of risk, while 17%
of respondents will take high amount of risk. 19% of respondents will take risk at average level. Most of the
respondents are willing to take average number of risks.

6) In your opinion what is your expected rate of return?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 BELOW 10% 17 17%

2 BETWEEN 10 TO 20% 32 32%

3 BETWEEN 20 TO 30% 42 42%

4 ABOVE 30% 8 8%

81
 FREQUENCY
ABOVE 30%
BELOW 10%

BETWEEN 20 TO 30%

BETWEEN 10 TO 20%

Interpretation: - From the above data we can see that 17% respondents expect returns below 10%. 32%
respondents expect Returns between 10%-20%. 43% respondents expect returns between 20%-30%. 8%
respondents expect returns above 30%.

7) How would you rate your experience with Indian money market?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 AVERAGE 18 18%
2 POOR 10 10%

3 GOOD 58 58%

82
 4 EXCELLENT 14 14%

PERCENTAGE

AVERAGE POOR GOOD EXCELLENT

Interpretation: - From the above analysis we can see that 10% respondents didn't have a good experience
with Indian market while 14% respondents had excellent experience with Indian Market.

8) Is recession had affected your investment decision?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 YES 86 86%

2 NO 14 14%

83
 PERCENTAGE

NO
14%

YES
86%

Interpretation: - From the above data we can see that 86% respondents experienced that recession has
affected their investment decision while 14% respondents were not affected by recession.

9) For fixed income what type of instrument would prefer?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 Corporate Bond 51 51%

2 Treasury Bills 57 57%

3 Government Securities 53 53%

84
 4 Commercial Papers 47 47

Interpretation: - From the above data we can see that 51% of respondent invest in corporate bonds, 57% in treasury
bills, 53% in government securities and 47% of respondents invest in commercial paper.

10) What will be your course of action during recession?

SR NO. PARTICULARS FREQUENCY PERCENTAGE

1 BUY 39.2 39.2%

2 SELL 23.7 23.7%

3 HOLD 37.1 37.1%

85
 PERCENTAGE

BUY SELL HOLD

Interpretation; - From the above analysis we can see that 39.2% of the respondents buy the instruments at the time of
recession, 37.1% of the respondents sells the instruments, and 23.7% of the respondents hold the instruments.

FINDINGS

1) Is past price affect the present price?

o There may be change in the price because of change in demand or change in the
economic condition due to this price can increase or decrease as the demand
changes or there can be no change in price even the demand changes.

2) Is there any change in economic growth?

o Yes, there can be change in the economic condition as in the above itself say that
change in the economic condition tends to change the price, therefore there can be
86
positive, negative, or no change in the economic growth.
o Recession may have positive or negative impact on economy

3) How can one manage the short-term deficit?

o One can overcome the short-term deficit by managing the funds
o Managing the funds means there can be issue of money market securities or,
o One can do nothing i.e. (under come of short-term deficit).

4) Does recession tend to liquidate the money market instruments?

o from the above question at the time of recession, the investor may liquidate them
investment from the market, purchase the instrument or do nothing (hold).
o Recession have an impact on the liquidity.

5) Is there a risk in money market instruments?

o Money market instruments is a minimal risk or no risk instruments in the market as they
are for shorter period i.e. (a year or less than one year).it has low risk or no risk
instrument in the market.
o the instrument is divided in various risk categories elevated risk, minimal risk, or no risk
instruments.

SUGGESTION

 Few suggestions relevant to the development of money market in India are enumerated below.
 There should be a mechanism to make the call range bound which may reduce uncertainty and
provide confidence to the bankers for lending/borrowing.
 In the context, it is emphasized that Repos and Reverse Repos conducted by RBI has the potential to
set the floor and ceiling in the call money market. Besides, Repo mechanism, call money market,
needs to be supplemented by Open Market Operation (OMO). OMO can influence interest rate as
well as volumes in the market.
 Non-bank segment should be brought under the same regulation on par with the banks early as

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 possible so that level playing field is created.
 Transparency should be ensured in money market transaction.
 There should be screen based trading with two-way quotes for each money market instruments.
 The lock-in period of CDs and CPs should be completely removed in a phase manner. Retailing of
government papers should be encouraged.
 The primary dealers can play a role in this context. Currently FIIs are allowed in government dated
securities in primary as well as secondary market.
 More FII participation could be encouraged.
 Money Market Mutual Funds should be set up by various banks and institutions.
 This would increase the retail participation in the market.

CONCLUSION

 The money market is a vibrant market, affecting our everyday lives. As the short-term market for
money, money changes hands in a short time frame and the players in the market have to be alert to
changes, up to date with news and innovative with strategies and products.
 The withdrawal of non-bank entities from the inter-bank call-money market is
 linked to the improvement of settlement systems.
 Any time-bound plan for the evolution of a pure inter-bank call/notice money
market would be ineffective till the basic issue of settlements is addressed.

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 In brief, various policy initiatives by the Reserve Bank have facilitated
 development of a wider range of instruments such as market repo, interest rate
swaps, CDs and CPs.
 This approach has avoided market segmentation while meeting demand for
various products.
 These developments in money markets have enabled better liquidity management
by the Reserve Bank.
 The money market specializes in debt securities that mature in less than one year
 Money market securities are very liquid, and are considered very safe. As a result,
they offer a lower return than other securities.
 The easiest way for individuals to gain access to the money market is through
a money market mutual fund.
 The call money market decreases the repo rate, but the bank manages the cheaper money of their
surplus breakdown through reverse repo rate.
 The bank has to report this issue to RBI within to week.
 Rastogisays that the Indian money market has achieved more from the preliberalization era.
 In his research he concluded that although markets have achieved integration in some of its branches,
but they still have to attain full integration.
 He said that the main objective or focus is on creating efficiency or growth of money market.
 The monetary policy should rely more on interest rate and asset price channels to control inflation.

 The Chakravarty Committee recommended the additional nonbank participants may be allowed to
participate in call money market.
 The Vaghul Committee introduce the money market and broaden the instrument of money market.

 The money market is usually for short-term period i.e., less than one year.
 THE Narasimham Committee study the observation of call and term money.
 Interest is collected periodically by the depositor by depositing.
 Because of change in RBI regulation there is change the rate of interest
 Because of inflation there is change in the rate of interest it affects the rate of interest

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 BIBLIOGRAPHY

AUTHOR SOURCE
R.S. Aggarwal Emerging money market
M.S. GOPALAN Indian money market structure, operation and development
Prasanna Chandra Financial management
P.K. Bandgar Securities management and portfolio management
RBI SITE http://rbi.org.in/

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SBI DHFI SITE http://sbidhfi.com/

INDIAN INSTITUTE OF
BANKING AND FINANCE http://www.iibf.org.in

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