Money Market in India

FIS Assignment - I Shiva Velshan Arumugam A K Jeneef Joshua Prince Richard 215111039 215111066 215111077 215111086

Table of Contents
Important players in the Indian Money market ___________________________________ 4
Reserve Bank of India: ___________________________________________________________ 4 Government: __________________________________________________________________ 4 Banks: ________________________________________________________________________ 4 Discount Houses: _______________________________________________________________ 4 Financial Institutions: ____________________________________________________________ 5 Corporate Firms:________________________________________________________________ 5 Institutional Players: ____________________________________________________________ 5 Dealers: _______________________________________________________________________ 5

Instruments floated in these markets during the 2001-2011 _________________________ 5

Treasury Bills: __________________________________________________________________ 5 Commercial Paper: ______________________________________________________________ 7
Advantage of commercial paper: __________________________________________________________ 7 Disadvantages of commercial paper: _______________________________________________________ 8 Issuance Process of Commercial Paper: _____________________________________________________ 8 RBI Guidelines on Issue of Commercial Paper: ________________________________________________ 8 Growth in the Commercial Paper Market: __________________________________________________ 10

Certificate of Deposits:__________________________________________________________ 11
Eligibility for Issue of Certificate of Deposits: ________________________________________________ 12 Denomination for Certificate of Deposits: __________________________________________________ 12 Maturity: _____________________________________________________________________________ 12 Discount on Issue of Certificate Of Deposits: ________________________________________________ 13 How Certificate Of Deposits Work: ________________________________________________________ 13 RBI Guidelines on issue of Certificate of Deposits: ____________________________________________ 13

Call Money Market: ____________________________________________________________ 14

Call Money Rates: ______________________________________________________________________ 16

Repurchase Agreement (Repo): ___________________________________________________ 16

Reserve Repos: ________________________________________________________________________ 17 Importance of Repos: ___________________________________________________________________ 18 Repo Rate: ___________________________________________________________________________ 18

Commercial bill market: _________________________________________________________ 19

Types of Commercial Bills: _______________________________________________________________ 20 Measures to Develop the Bills Market: _____________________________________________________ 21 Size of the Commercial Bills Market: _______________________________________________________ 22

Money Market mutual fund (MMMFS): ____________________________________________ 23

INVESTORS IN MUTUAL FUNDS: __________________________________________________________ 24

Government Securities Market (GSM): _____________________________________________ 25

Importance of the Government Securities:__________________________________________ 26

Types of Government Securities: __________________________________________________________ 27

Inter-Corporate Deposits (ICD): ___________________________________________________ 28 Banker's Acceptance: ___________________________________________________________ 28

Important players in the Indian Money market

The transactions in the money market are of high volume involving large amount. So, money market is dominated by a small number of large players. Some of the important players in the money market are:
Player RBI Government Banks Discount Houses Financial Institutions Corporate Institutional Players Dealers Role Intermediary Borrowers/Issuers Borrowers/Issuers Intermediary Borrowers/Issuers Issuers Investors Intermediaries

Reserve Bank of India:

The Reserve Bank of India is the most important player in the Indian Money Market. The Organized money market comes under the direct regulation of the RBI. The RBI operates in the money market is to ensure that the levels of liquidity and short-term interest rates are maintained at an optimum level so as to facilitate economic growth and price stability. RBI also plays the role of a merchant banker to the government. It issues Treasury Bills and other Government Securities to raise funds for the government. The RBI thus plays the role of an intermediary and regulator of the money market.

Government:
The Government is the most active player and the largest borrower in the money market. It raises funds to make up the budget deficit. The funds may be raised through the issue of Treasury Bills and government securities. o With a maturity period of 91day o With a maturity period of 182day o With a maturity period of 364 days

Banks:
Commercial Banks play an important role in the money market. They undertake lending and borrowing of short term funds. The collective operations of the banks on a day to day basis are very predominant and hence have a major impact and influence on the interest rate structure and the liquidity position.

Discount Houses:
They are the intermediaries in the money market. Discount Houses discount and rediscount commercial bill and Treasury Bills. They also underwrite Government Securities.

Financial Institutions:
Financial institutions also deal in the money market. They undertake lending and borrowing of short-term funds. They also lend money to banks by rediscounting Bills of Exchange. Since, they transact in large volumes, they have a significant impact on the money market.

Corporate Firms:
Corporate firms operate in the money market to raise short-term funds to meet their working capital requirements. They issue commercial papers with a maturity period of 7 days to 1 year. These papers are issued at a discount and redeemed at face value on maturity. These corporate firms use both organized and unorganized sectors of money market.

Institutional Players:
They Consist of Mutual Funds, Foreign Institutional Players, Insurance Firms, etc. Their level of Participation depends on the regulations. For instance the level of participation of the FIIs in the Indian money market is restricted to investment in Government Securities.

Dealers:
They are the intermediaries in the money market. Primary Dealers were introduced by RBI for developing an active secondary market for Government securities. They also underwrite Government Securities.

Instruments floated in these markets during the 2001-2011 Treasury Bills:

Treasury bills are short-term instruments issued by the Reserve Bank on behalf of the government to tide over short-term liquidity shortfalls. This instrument is used by the government to raise short-term funds to bridge seasonal or temporary gaps between its receipt (revenue and capital) and expenditure. They form the most important segment of the money market not only in India but all over the world as well. In other words, T-Bills are short term (up to one year) borrowing instruments of the Government of India which enable investors to park their short term surplus funds while reducing their market risk T-bills are repaid at par on maturity. The difference between the amount paid by the tenderer at the time of purchase (which is less than the face value) and the amount received on maturity represents the interest amount on T-bills and is known as the discount. Tax deducted at source (TDS) is not applicable on T-bills.

Features of T-bills are:

They are negotiable securities. They are highly liquid as they are of shorter tenure and there is a possibility of an interbank repos on them. There is absence of default risk. They have an assured yield, low transaction cost, and are eligible for inclusion in the securities for SLR purpose. They are not issued in scrip form. The purchases and sales are affected through the subsidiary general ledger (SGL) account. T-Bills are issued in the form of SGL entries in the books of Reserve Bank of India to hold the securities on behalf of the holder. The SGL holdings can be transferred by issuing a SGL transfer form Recently T-Bills are also being issued frequently under the Market Stabilization Scheme (MSS).

Types of Treasury Bills:

Treasury bills (T-bills) offer short-term investment opportunities, generally up to one year. They are thus useful in managing short-term liquidity. At present, RBI issues T-Bills for three different maturities : 91 days, 182 days and 364 days. The 91 day T-Bills are issued on weekly auction basis while 182 day T-Bill auction is held on Wednesday preceding nonreporting Friday and 364 day T-Bill auction on Wednesday preceding the reporting Friday. There are no treasury bills issued by State Governments.

Advantages of investing in T-Bills:

No Tax Deducted at Source (TDS) Zero default risk as these are the liabilities of GOI Liquid money Market Instrument

Active secondary market thereby enabling holder to meet immediate fund requirement.

Commercial Paper:
Commercial paper was introduced into the Indian money market during the year 1990, on the recommendation of Vaghul Committee. Now it has become a popular debt instrument of the corporate world. A commercial paper is an unsecured short-term instrument issued by the large banks and corporations in the form of promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period to meet the short-term financial requirement. There are four basic kinds of commercial paper: promissory notes, drafts, checks, and certificates of deposit. It is generally issued at a discount by the leading creditworthy and highly rated corporates. Depending upon the issuing company, a commercial paper is also known as Financial paper, industrial paper or corporate paper. Commercial paper was initially meant to be used by the corporates borrowers having good ranking in the market as established by a credit rating agency to diversify their sources of short term borrowings at a rate which was usually lower than the banks working capital lending rate. Commercial papers can now be issued by primary dealers, satellite dealers, and allIndia financial institutions, apart from corporatist, to access short-term funds. Effective from 6th September 1996 and 17th June 1998, primary dealers and satellite dealers were also permitted to issue commercial paper to access greater volume of funds to help increase their activities in the secondary market. It can be issued to individuals, banks, companies and other registered Indian corporate bodies and unincorporated bodies. It is issued at a discount determined by the issuer company. The discount varies with the credit rating of the issuer company and the demand and the supply position in the money market. In India, the emergence of commercial paper has added a new dimension to the money market.

Advantage of commercial paper:

High credit ratings fetch a lower cost of capital. Wide range of maturity provide more flexibility.

It does not create any lien on asset of the company. Tradability of Commercial Paper provides investors with exit options.

Disadvantages of commercial paper:

Its usage is limited to only blue chip companies. Issuances of Commercial Paper bring down the bank credit limits. A high degree of control is exercised on issue of Commercial Paper. Stand-by-credit may become necessary.

Issuance Process of Commercial Paper:

In the developed economies, a substantial portion of working capital requirement especially those that are short-term, is promptly met through flotation of commercial paper. Directly accessing market by issuing short-term promissory notes, backed by stand-by or underwriting facilities, enables the corporate to leverage its rating to save on interest costs. Typically commercial paper is sold at a discount to its face value and is redeemed at face value. Hence, the implict interest rate is function of the size of discount and the period of maturity. Scheduled commercial banks are major investors in commercial paper and their investment is determined by bank liquidity conditions. Banks prefer commercial paper as an investment avenue rather than sanctioning bank loan. These loans involve high transaction costs and money is locked for a longer time period whereas a commercial paper is an attractive short-term instrument for banks to park funds during times of high liquidity. Some banks fund commercial papers by borrowing from the call money market. Usually, the call money market rates are lower than the commercial paper rates. Hence, banks book profits through arbitraged between the two money markets. Moreover, the issuance of commercial papers has been generally observed to be invested related to the money market rates.

RBI Guidelines on Issue of Commercial Paper:

The summary of RBI guidelines for issue of Commercial paper is given below:

Corporate, primary dealers, satellite dealers and all India financial institutions are permitted to raise short term finance through issue of commercial paper, which should be within the umbrella limit fixed by RBI. A corporate can issue Commercial Paper if: 1. Its tangible net worth is not less than Rs.5 crores as per latest balance sheet. 2. Working capital limit is obtained from banks/ all India financial institutions, and 3. Its borrowal account is classified as standard asset by banks/ all India financial institutions. Credit rating should be obtained by all eligible participants in cp issue from the specified credit rating agencies like CRISIL, ICRA, CARE, and FITCH. The minimum rating shall be equivalent to P-2 of CRISIL. Commercial paper can be issued for maturities between a minimum of 15 days and a maximum of upto one year from the date of issue. The maturity date of commercial paper should not exceed the date beyond the date upto which credit rating is valid. It can be issued in denomination of Rs. 5 lakhs or in multiples thereof. Amount invested by a single investor should not be less than Rs. 5 lakhs (face value). A company can issue commercial paper to an aggregate amount within the limit approved by board of directors or limit specified by credit rating agency, whichever is lower. Banks and financial institutions have the flexibility to fix working capital limits duly taking into account the resource pattern of companys financing including commercial papers. The total amount of commercial paper proposed to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription. Commercial paper may be issued on a single date or in parts on different dated provided that in the latter case, each commercial paper shall have the same maturity date. Every commercial paper should be reported to RBI through issuing and paying agent (IPA). Only a scheduled bank can act as an IPA.

Commercial paper can be subscribed by individuals, banking companies, corporate, NRIs and FIIs. It can be issued either in the form of a promissory note or in a dematerialised form. It will be issued at a discount to face value as may be determined by the issuer. Issue of commercial paper should not be underwritten or co-accepted. The initial investor in commercial paper shall pay the discounted value of the commercial paper by means of a crossed account payee cheque to the account of the issuer through IPA. On maturity, if commercial paper is held in physical form, the holder of commercial paper shall present the investment for payment to the issuer through IPA. When the commercial paper is held in demat form, the holder of commercial paper will have to get it redeemed through depository and received payment from the IPA. Commercial paper is issued as a stand alone product. It would not be obligatory for banks and financial institutions to provide stand-by facility to issuers of commercial paper. Every issue of commercial paper, including renewal, should be treated as a fresh issue. Growth in the Commercial Paper Market: Commercial paper was introduced in India in January 1990, in pursuance of the Vaghul Committees recommendations, in order to enable highly rated non-bank corporate borrowers to diversify their sources of short term borrowings and also provide an additional instrument to investors. commercial paper could carry on an interest rate coupon but is generally sold at a discount. Since commercial paper is freely transferable, banks, financial institutions, insurance companies and others are able to invest their short-term surplus funds in a highly liquid instrument at attractive rates of return. A major reform to impart a measure of independence to the commercial paper market took place when the stand by facility* of the restoration of the cash credit limit and guaranteeing funds to the issuer on maturity of the paper was withdrawn in October 1994. As the reduction in cash credit portion of the MPBF impeded the development of the commercial paper market, the issuance of commercial paper was delinked from the cash credit limit in October 1997. It was converted into a stand alone product from October 2000 so as to enable the issuers of the service sector to meet short-term working capital requirements.

Banks are allowed to fix working capital limits after taking into account the resource pattern of the companies finances, including commercial papers. Corporates, PDs and allIndia financial institutions (FIs) under specified stipulations have permitted to raise shortterm resources by the Reserve Bank through the issue of commercial papers. There is no lock in period for commercial papers. Furthermore, guidelines were issued permitting investments in commercial papers which has enabled a reduction in transaction cost. In order to rationalize the and standardize wherever possible, various aspects of processing, settlement and documentation of commercial paper issuance, several measures were undertaken with a view to achieving the settlement on T+1 basis. For further deepening the market, the Reserve Bank of India issued draft guidelines on securitisation of standard assets on April 4, 2005.
Accordingly the reporting of commercial papers issuance by issuing and paying agents (IPAs) on NDS platform commenced effective on April 16, 2005. Activity in the commercial paper market reflects the state of market liquidity as its issuances tend to rise amidst ample liquidity conditions when companies can raise funds through commercial papers at an effective rate of discount lower than the lending rate of bonds. Banks also prefer investing in commercial papers during credit downswing as the commercial paper rate works out higher than the call rate. Table 2.2 shows the trends in commercial papers rates and amounts outstanding.

Certificate of Deposits:
Certicate of deposit are unsecured, negotiable, short-term instruments in bearer form, issued by commercial banks and development financial institutions. The scheme of certificates of Deposits (CDs) was introduced by RBI as a step towards deregulation of interest rates on deposits. Under this scheme, any scheduled commercial banks, co-operative banks excluding land development banks, can issue certificate of deposits for a period of not less than three months and upto a period of not more than one year. The financial institutions specifically authorised by the RBI can issue certificate of deposits for a period not below one year and not above 3 years duration. Certificate of deposits, can be issued within the period prescribed for any maturity. Certificates of Deposits (CDs) are short-term borrowings by banks. Certificates of deposits differ from term deposit because they involve the creation of paper, and hence have the facility for transfer and multiple ownerships before maturity. Certificate of deposits rates are usually higher than the term deposit rates, due to the low transactions costs. Banks use the

certificates of deposits for borrowing during a credit pick-up, to the extent of shortage in incremental deposits. Most certificates of deposits are held until maturity, and there is limited secondary market activity. Certificates of Deposit (CDs) is a negotiable money market instrument and issued in dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of certificate of deposits are presently governed by various directives issued by the Reserve Bank of India.

Eligibility for Issue of Certificate of Deposits:

Certificate of deposits can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short -term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue certificate of deposits depending on their requirements. An FI may issue certificate of deposits within the overall umbrella limit fixed by RBI, i.e., issue of certificate of deposits together with other instruments, viz., term money, term deposits, commercial papers and inter-corporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

Denomination for Certificate of Deposits:

Minimum amount of a certificate of deposits should be Rs.1 lakh, i.e., the minimum deposit that could be accepted from a single subscriber should not be less than Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter. Certificate of deposits can be issued to individuals, corporations, companies, trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also subscribe to certificate of deposits, but only on non-repatriable basis which should be clearly stated on the Certificate. Such certificate of deposits cannot be endorsed to another NRI in the secondary market.

Maturity:
The maturity period of certificate of deposits issued by banks should be not less than 7 days and not more than one year. The FIs can issue certificate of deposits for a period not less than 1 year and not exceeding 3 years from the date of issue.

Discount on Issue of Certificate Of Deposits:

Certificate of deposits may be issued at a discount on face value. Banks/FIs are also allowed to issue certificate of deposits on floating rate basis provided the methodology of compiling the floating rate is objective, transparent and market -based. The issuing bank/FI is free to determine the discount/coupon rate. The interest rate on floating rate certificate of deposits would have to be reset periodically in accordance with a pre -determined formula that indicates the spread over a transparent benchmark.

How Certificate Of Deposits Work:

The consumer who opens a certificate of deposits may receive a passbook or paper certificate, but it now is common for a certificate of deposits to consist simply of a book entry and an item shown in the consumer's periodic bank statements; that is, there is usually no "certificate" as such. At most institutions, the certificate of deposits purchaser can arrange to have the interest periodically mailed as a check or transferred into a checking or savings account. This reduces total yield because there is no compounding. Some institutions allow the customer to select this option only at the time the certificate of deposits is opened. Commonly, institutions mail a notice to the certificate of deposits holder shortly before the certificate of deposits matures requesting directions. The notice usually offers the choice of withdrawing the principal and accumulated interest or "rolling it over" (depositing it into a new certificate of deposits). Generally, a "window" is allowed after maturity where the certificate of deposits holder can cash in the certificate of deposits without penalty. In the absence of such directions, it is common for the institution to "roll over" the certificate of deposits automatically, once again tying up the money for a period of time (though the certificate of deposits holder may be able to specify at the time the certificate of deposits is opened that it is not to be automatically rolled over).

RBI Guidelines on issue of Certificate of Deposits:

The salient features of scheme devised by RBI in issue of certificates of deposit (CDs) by banks are as follows:

Certificate of deposits can be issued only by scheduled commercial banks. Regional rural banks are not eligible for issue of certificate of deposits. The minimum deposit that cab be accepted from a single subscriber should be Rs. 5 lakhs. Above that, it should be in multiples of Rs. 1 lakhs. Certificate of deposits can be issued to individuals, corporations, companies, trusts, funds, associations etc. NRIs can subscribe to certificate of deposits only on nonrepatriable basis. The minimum maturity period of certificate of depositss is 15 days. Certificate of depositss should be issued at a discount on face value. The issuing bank is free to determine the discount rate. As the certificates of depositss are usance promissory notes, stamp duty would be attracted as per provisions if Indian Stamp Act. The issuing banks have to maintain CRR and SLR on the issue price of certificate of deposits. certificate of deposits are freely transferable by endorsement and delivery. Banks cannot grant loan against security of certificate of deposits. Banks cannot buyback their own certificate of deposits before maturity. certificate of deposits should be issued only in demat form. Rating of the certificate of deposit is not mandatory/ compulsory.

Call Money Market:

Call and notice money market refers to the market for short -term funds ranging from overnight funds to funds for a maximum tenor of 14 days. Under Call money market, funds are transacted on overnight basis and under notice money market, funds are transacted for the period of 2 days to 14 days. The call/notice money market is an important segment of the Indian Money Market. This is because, any change in demand and supply of short-term funds in the financial

system is quickly reflected in call money rates. The RBI makes use of this market for conducting the open market operations effectively. Participants in call/notice money market currently include banks (excluding RRBs) and Primary dealers both as borrowers and lenders. Non Bank institutions are not permitted in the call/notice money market with effect from August 6, 2005. The regulator has

prescribed limits on the banks and primary dealers operation in the call/notice money market. Call money market is for very short term funds, known as money on call. The rate at which funds are borrowed in this market is called `Call Money rate'. The size of the market for these funds in India is between Rs 60,000 million to Rs 70,000 million, of which public sector banks account for 80% of borrowings and foreign banks/private sector banks account for the balance 20%. Non-bank financial institutions like IDBI, LIC, and GIC etc participate only as lenders in this market. 80% of the requirement of call money funds is met by the nonbank participants and 20% from the banking system. In pursuance of the announcement made in the Annual Policy Statement of April 2006, an electronic screen-based negotiated quote-driven system for all dealings in call/notice and term money market was operationalised with effect from September 18, 2006. This system has been developed by Clearing Corporation of India Ltd. on behalf of the Reserve Bank of India. The NDS -CALL system provides an electronic dealing platform with features like Direct one to one negotiation, real time quote and trade information, preferred counterparty setup, online exposure limit monitoring, online regulatory limit monitoring, dealing in call, notice and term money, dealing facilitated for T+0 settlement type for Call Money and dealing facilitated for T+0 and T+1 settlement type for Notice and Term Money. Information on previous dealt rates, ongoing bids/offers on re al time basis imparts greater transparency and facilitates better rate discovery in the call money market. The system has also helped to improve the ease of transactions, increased operational efficiency and resolve problems associated with asymmetry of information. However, participation on this platform is optional and currently both the electronic platform and the telephonic market are co-existing. After the introduction of NDS-CALL, market participants have increasingly started using this new system more so during times of high volatility in call rates.

Call Money Rates:

The rate of interest on call funds is called money rate. Call money rates are characteristics in that they are found to be having seasonal and daily variations requiring intervention by RBI and other institutions. The concentration in the borrowing and lending side of the call markets impacts liquidity in the call markets. The presence or absence of important players is a significant influence on quantity as well as price. This leads to a lack of depth and high levels of volatility in call rates, when the participant structure on the lending or borrowing side alters. Short-term liquidity conditions impact the call rates the most. On the supply side the call rates are influenced by factors such as: deposit mobilization of banks, capital flows, and banks reserve requirements; and on the demand side, call rates are influenced by tax outflows, government borrowing programme, seasonal fluctuations in credit off take. The external situation and the behaviour of exchange rates also have an influence on call rates, as most players in this market run integrated treasuries that hold short term positions in both rupee and forex markets, deploying and borrowing funds through call markets. During normal times, call rates hover in a range between the repo rate and the reverse repo rate. The repo rate represents an avenue for parking short -term funds, and during periods of easy liquidity, call rates are only slightly above the repo rates. During periods of tight liquidity, call rates move towards the reverse repo rate. Table 4.3 provides data on the behaviour of call rates. Figure 4.3displays the trend of average monthly call rates. The behaviour of call rates has historically been influenced by liquidity conditions in the market. Call rates touched a peak of about 35% in May 1992, reflecting tight liquidity on account of high levels of statutory pre-emptions and withdrawal of all refinance facilities, barring export credit refinance. Call rates again came under pressure in November 1995 when the rates were 35% par.

Repurchase Agreement (Repo):

The major function of the money market is to provide liquidity. To achieve this function and to even out liquidity changes, the Reserve Bank uses repos. Repo is a useful money market instrument enabling the smooth adjustment of short-term liquidity among varied market participants such as banks, financial institutions and so on.

Repo is a money market instrument, which enables collateralized short term borrowing and lending through sale/purchase operations in debt instruments. Under a repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a predetermined date and rate. It is a temporary sale of debt involving full transfer of ownership of the securities, that is, the assignment of voting and financial rights. Repo is also referred to as a ready forward transaction as it is a means of funding by selling a security held on a spot basis and repurchasing the same on a forward basis. Though there is no restriction on the maximum period for which repos can be undertaken, generally, repos are done for a period not exceeding 14 days. Different instruments can be considered as collateral security for undertaking the ready forward deals and they include Government dated securities, treasury bills. In a typical repo transaction, the counter-parties agree to exchange securities and cash, with a simultaneous agreement to reverse the transactions after a given period. To the lender of cash, the securities lent by the borrower serves as the collateral; to the lender of securities, the cash borrowed by the lender serves as the collateral. Repo thus represents a collateralized short term lending. The lender of securities (who is also the borrower of cash) is said to be doing the repo; the same transaction is a reverse repo in the books of lender of cash (who is also the borrower of securities).

Reserve Repos:
A reverse repo is the mirror image of a repo. For, in a reverse repo, securities are acquired with a simultaneous commitment to resell. Hence whether a transaction is a repo or a reverse repo is determined only in terms of who initiated the first leg of the transaction. When the reverse repurchase transaction matures, the counter- party returns the security to the entity concerned and receives its cash along with a profit spread. One factor which encourages an organization to enter into reverse repo is that it earns some extra income on its otherwise idle cash. The difference between the price at which the securities are bought and sold is the lenders profit or interest earned for lending the money. The transaction combines elements of both a securities purchased/sale operation and also a money market borrowing/lending operation.

Importance of Repos:
Interest Rate: being collateralized loans, repos help reduce counter-party risk and therefore, fetch a low interest rate especially in a volatile market. Safety: repo is an almost risk-free instrument used to even-out liquidity changes in the system. Repos offer safe short-term outlet for temporary excess cash at close to market interest rates. Uses: As low-risk and flexible short-term instruments, repos are used to finance securities held in trading and investment account of security dealers, to establish short positions, to implement arbitrage activities besides meeting specific customer needs. They offer low-cost investment opportunities with combination of yield and liquidity. In India, repo transactions are basically fund management/statutory liquidity reserve (SLR) management devices used by banks. Cash Management Tool: the repo arrangement essentially serves as a short-term cash management tool as the bank receives cash from the buyer in return for the securities. This helps the banks to meet temporary cash requirements. This also makes the repos a pure money lending operation. On maturity of repos, the security is purchased back by the seller of the securities. Liquidity Control: The RBI uses repos as a tool of liquidity control for absorbing surplus liquidity from the banking system in a flexible way and there preventing interest rate arbitraging. All repo transactions are to be affected at Mumbai only and the deals are to be necessarily put through the subsidiary general ledger (SGL) account with the Reserve Bank of India.

Repo Rate:
Repo rate is nothing but the annualised interest rate for the funds transferred by the lender to the borrower. Generally, the rate at which it is possible to borrow through a repo is lower than the same offered on unsecured (or clean) inter-bank loan for the reason that it is a collateralized transaction and the credit worthiness of the issuer of the security is often higher than the seller. Other factors affecting the repo rate include the credit worthiness of the borrower, liquidity of the collateral and comparable rates of other money market instruments.

In a repo transaction, there are two legs of transactions viz. selling of the security and repurchasing of the same. In the first leg of the transaction which is for a nearer date, sale price is usually based on the prevailing market price for outright deals. In the second leg, which is for a future date, the price is structured based on the funds flow of interest and tax elements of funds exchanged. This is on account of two factors. First, as the ownership of securities passes on from seller to buyer for the repo period, legally the coupon interest accrued for the period has to be passed on to the buyer. Thus, at the sale leg, while the buyer of security is required to pay the accrued coupon interest for the broken period, at the repurchase leg, the initial seller is required to pay the accrued interest for the broken period to the initial buyer. Generally, norms are laid down for accounting of repos and valuation of collateral are concerned. While there are standard accounting norms, generally the securities used as collateral in repo transactions are valued at current market price plus accrued interest (on coupon bearing securities) calculated to the maturity date of the agreement less "margin" or "haircut". The haircut is to take care of market risk and it protects either the borrower or lender depending upon how the transaction is priced. The size of the haircut will depend on the repo period, risky ness of the securities involved and the coupon rate of the underlying securities. Since fluctuations in market prices of securities would be a concern for both the lender as well as the borrower it is a common practice to reflect the changes in market price by resorting to marking to market. Thus, if the market value of the repo securities decline beyond a point the borrower may be asked to provide additional collateral to cover the loan. On the other hand, if the market value of collateral rises substantially, the lender may be required to return the excess collateral to the borrower.

Commercial bill market:

Commercial bill is a short term, negotiable, and self-liquidating instrument with low risk. It enhances he liability to make payment in a fixed date when goods are bought on credit. According to the Indian Negotiable Instruments Act, 1881, bill or exchange is a written instrument containing an unconditional order, signed by the maker, directing to pay a certain amount of money only to a particular person, or to the bearer of the instrument. Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or the value of the goods delivered to him. Such bills are called trade bills. When trade bills are

accepted by commercial banks, they are called commercial bills. The bank discount this bill by keeping a certain margin and credits the proceeds. Banks, when in need of money, can also get such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days, depending on the credit extended in the industry.

Types of Commercial Bills:

Commercial bill is an important tool finance credit sales. It may be a demand bill. A demand bill is payable on demand, that is immediately at sight or on presentation by the drawee. If the seller wishes to give sometime for payment, the bill would be payable at a future date. These bills can either be clean bills or documentary bills. In a clean bill, documents are enclosed and delivered against acceptance by drawee, after which it becomes clear. In the case of a documentary bill, documents are delivered against payment accepted by the drawee and documents of bill are filed by bankers till the bill is paid. Commercial bills can be inland bills or foreign bills. Inland bills must (1) be drawn or made in India and must be payable in India: or (2) drawn upon any person resident in India. Foreign bills, on the other hand, are (1) drawn outside India and may be payable and by a party outside India, or may be payable in India or drawn on a party in India or (2) it may be drawn in India and made payable outside India. A related classification of bills is export bills and import bills. While export bills are drawn by exporters in any country outside India, import bills are drawn on importers in India by exporters abroad. The indigenous variety of bill of exchange for financing the movement of agricultural produce, called a hundi has a long tradition of use in India. It is vogue among indigenous bankers for raising money or remitting funds or to finance inland trade. A hundi is an important instrument in India; so indigenous bankers dominate the bill market. However, with reforms in the financial system and lack of availability of funds from private sources, the role of indigenous bankers is declining. With a view to eliminating movement of papers and facilitating multiple rediscounting, RBI introduced an innovation instruments known as Derivative Usance Promissory Notes, backed by such eligible commercial bills for required amounts and usance period (up to 90 days). Government has exempted stamp duty on derivative usance

promissory notes. This has simplified and streamlined bill rediscounting by institutions and made the commercial bill an active instrument in the secondary money market. This instrument, being a negotiable instrument issued by banks, is a sound investment for rediscounting institutions. Moreover rediscounting institutions can further discount the bills anytime prior to the date of maturity. Since some banks were using the facility of rediscounting commercial bills and derivative usance promissory notes of as short a period as one day, the Reserve Bank restricted such rediscounting to a minimum period of 15 days. The eligibility criteria prescribed by the Reserve Bank for rediscounting commercial bills are that the bill should arise out of a genuine commercial transaction showing evidence of sale of goods and the maturity date of the bill should to exceed 90 days from the date of rediscounting. Commercial bills can be traded by offering the bills for rediscounting. Banks provide credit to their customers by discounting commercial bills. This credit is repayable on maturity of the bill. In case of need for funds, and can rediscount the bills in the money market and get ready money. Commercial bills ensure improved quality of lending, liquidity and efficiency in money management. It is fully secured for investment since it is transferable by endorsement and delivery and it has high degree of liquidity. The bills market is highly developed in industrial countries but it is very limited in India. Commercial bills rediscounted by commercial banks with financial institutions amount to less than Rs 1,000 crore. In India, the bill market did not develop due to (1) the cash credit system of credit delivery where the onus of cash management rest with banks and (2) an absence of an active secondary market.

Measures to Develop the Bills Market:

One of the objectives of the Reserve Bank in setting up the Discount and finance House of India was to develop commercial bills market. The bank sanctioned a refinance limit for the DFHI against collateral of treasury bills and against the holdings of eligible commercial bills. With a view to developing the bills market, the interest rate ceiling of 12.5 per cent on rediscounting of commercial bills was withdrawn from May 1, 1989.

To develop the bills market, the Securities and Exchange Board of India (SEBI) allowed, in 1995-96, 14 mutual funds to participate as lenders in the bills rediscounting market. During 1996-97, seven more mutual funds were permitted to participate in this market as lenders while another four primary dealers were allowed to participate as both lenders and borrowers. In order to encourage the bills culture, the Reserve Bank advised banks in October 1997 to ensure that at least 25 percent of inland credit purchases of borrowers be through bills.

Size of the Commercial Bills Market:

The size of the commercial market is reflected in the outstanding amount of commercial bills discounted by banks with various financial institutions. The share of bill finance in the total bank credit increased from 1993-94 to 1995-96 but declined subsequently. This reflects the underdevelopment state of the bills market. The reasons for the underdevelopment are as follows: The Reserve Bank made an attempt to promote the development of the bill market by rediscounting facilities with it self till 1974. Then, in the beginning of the 1980s, the availability of funds from the Reserve Bank under the bill rediscounting scheme was put on a discretionary basis. It was altogether stopped in 1981. The popularity of the bill of exchange as a credit instrument depends upon the availability of acceptance sources of the central bank as it is the ultimate source of cash in times of a shortage of funds. However, it is not so in India. The Reserve Bank set up the DFHI to deal in this instrument and extends refinance facility to it. Even then, the business in commercial bills has declined drastically as DFHI concentrates more on other money market instruments such as call money and treasury bills. It is mostly foreign trade that is financed through the bills market. The size of this market is small because the share of foreign trade in national income is small. Moreover, export and import bills are still drawn in foreign currency which has restricted their scope of negotiation. A large part of the bills discounted by banks are not genuine. They are bills created by converting the cash-credit/overdraft accounts of their customers.

The system of cash-credit and overdraft from banks is cheaper and more convenient than bill financing as the procedures for discounting and rediscounting are complex and time consuming. This market was highly misused in the early 1990s by banks and finance companies which refinanced it at times when it could to be refinanced. This led to channeling of money into undesirable uses. The development of bills discounting as a financial service depends upon the existence of a full fledged bill market. The Reserve Bank of India (RBI) has constantly endeavored to develop the commercial bills market. Several committees set up to examine the system of bank financing, and the money market had strongly recommended a gradual shift to bills finance and phase out of the cash credit system. The most notable of these were: (1) Dehejia Committee, 1969, (2) Tandon Committee, 1974, (3) Chore Committee, 1980 and (4) Vaghul Committee, 1985.This section briefly outlines the efforts made by the RBI in the direction of the development of a full fledged bill market.

Money Market mutual fund (MMMFS):

A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short- term money market instruments and other securities. Mutual funds have a fund manager who invests the money on behalf of the investors by buying / selling stocks, bonds etc. Money market mutual funds (mmmfs) were introduced in April 1991 to provide an additional short-term avenue for investment and bring money market investment within the reach of individuals. These mutual funds would invest exclusively in money market instruments. Money market mutual funds bridge the gap between small investors and the money market. It mobilizes saving from small investors and invests them in short-term debt instruments or money market instruments. There are various investment avenues available to an investor such as real estate, bank deposits, post office deposits, shares, debentures, bonds etc. A mutual fund is one more type of Investment avenue available to investors. There are many reasons why investors prefer mutual funds. An investors money is invested by the mutual fund in a variety of shares, bonds and other securities thus diversifying the investors portfolio across different

companies and

sectors. This diversification helps in reducing the overall

risk of the

portfolio. It is also less expensive to invest in a mutual fund since the minimum investment amount in mutual fund units is fairly low (Rs. 500 or so). With Rs. 500 an investor may be able to buy only a few stocks and not get the desired diversification. These are some of the reasons why mutual funds have gained in popularity over the years Currently, the worldwide value of all mutual funds totals more than $US 26 trillion. The United States leads with the number of mutual fund schemes. There are more than 8000 mutual fund schemes in the U.S.A. Comparatively, India has around 1000 mutual fund schemes, but this number has grown exponentially in the last few years. The Total Assets under Management in India of all Mutual funds put together touched a peak of Rs. 5, 44,535 crs. at the end of August 2008. . As of today there are 41 Mutual Funds in the country. Together they offer over 1000 schemes to the investor. Many more mutual funds are expected to enter India in the next few years. Indians have been traditionally savers and invested money in traditional savings instruments such as bank deposits. Against this background, if we look at approximately Rs. 5 lakh crores which Indian Mutual Funds are managing, then it is no mean an achievement. A country traditionally putting money in safe, risk-free investments like Bank FDs, Post Office and Life Insurance, has started to invest in stocks, bonds and shares thanks to the mutual fund industry.

INVESTORS IN MUTUAL FUNDS:

Mutual funds in India are open to investment by following investors: 1. Residents including: a) Resident Indian Individual b) Indian Companies c) Indian trust/charitable trusts d) Banks e) Non Banking Finance companies f) Insurance companies g) Provident funds 2. Non Residents Including: a) Non residents Indians b) Overseas corporate bodies

3. Foreign entities: a) Foreign Institutional Investors registered with SEBI. Foreign citizens/entities are however now allowed to invest in India.

Government Securities Market (GSM):

One of the important sources of borrowing funds is the government securities market (GSM). The government raises short term and long term funds by issuing securities. These securities do not carry risk and are as good as gold as the government guarantees the payment of interest and the repayment of principal. They are, therefore, referred to as gilt-edged securities. The government securities market is the largest market in any economic system and therefore, is the benchmark for other markets. The Government securities market consists of securities issued by the State government and the Central government. Government securities include Central Government securities, Treasury bills and State Development Loans. They are issued in order to finance the fiscal deficit and managing the temporary cash mismatches of the Government. All entities registered in India like banks, financial institutions, Primary Dealers, firms, companies, corporate bodies, partnership firms, institutions, mutual funds, Foreign Institutional Investors, State Governments, Provident Funds, trusts, research organisations, Nepal Rashtra bank and even individuals are eligible to purchase Government Securities. They are generally by banks and institutions with the Reserve Bank of India in Subsidiary General Ledger accounts. They can be held in special accounts known as Constituent Subsidiary General Ledger (CSGL) accounts which can be opened with banks and Primary Dealers or in dematerialized form in demat accounts maintained with the Depository Participants of NSDL.

The securities are issued at par value (Rs 100) and have a coupon rate which is decided at the time of issue by auction technique. These securities pay interest at the coupon rate on a half yearly basis and are redeemed at par value on maturity. These are called dated securities because these are identified by their date of maturity and the coupon, e.g., 7.99% GOI 2017 is a Central Government security maturing in 2017, which carries a coupon of 7.99% payable half yearly.

Government securities are highly liquid instruments available both in the primary and secondary market. In the primary market Government securities are issued through auctions (yield based or price based auctions) which are conducted by the Reserve Bank of India. There is a scheme of non-competitive bidding in these auctions wherein retail investors can participate for small amounts ranging from Rs 10,000 to Rs 2 cr face value. The tenor of these securities ranges from 1 year to 30 years.

State Development Loans are securities issued by the State Governments to finance their expenditures. These securities are generally issued by auction technique which is carried out by the Reserve Bank of India. They also pay half-yearly interest at the coupon rate.

The secondary market consists of both a telephonic market wherein brokers provide quotes to market participants and the electronic trading system operated by the Reserve Bank of India known as Negotiated Dealing System Order Matching (NDS-OM). The instruments traded on the NDS OM include G-secs, T-Bills and SDLs. The membership of this electronic system is open to most institutional players including banks, primary dealers, insurance companies and financial institutions. The settlement of all such trades takes place through the Clearing Corporation of India which guarantees the settlements. The market trades from 9 a.m. to 5.30 p.m. from Monday to Friday

Importance of the Government Securities:

GSM constitutes the principal segment of the debt market. It not only provides resources to the government for meeting its short term and long term needs but also acts as a benchmark for pricing corporate papers of varying maturities. The government securities issues are helpful in implements the fiscal policy of the government. It is critical in bringing about an effective and reliable transmission channels for the use of indirect instruments of monetary control. The working of the two of the major techniques of monetary control Open Market Operations (OMOs) and Statutory Liquidity Ratio are closely connected with the dynamics of this market. Government securities provide the highest type of collateral for borrowing against their pledge. They have the highest degree of security of capital and the return on each security depends on the coupon rate and period of maturity. They are traded for both long and

short term periods depending on the investment and liquidity preference of the investors. Switches between the short dated and long dated securities take place on the basis of difference in redemption yields.

Types of Government Securities:

Government securities are of two types: treasury bills and government dated securities. The latter carry varying coupons rates and are of different maturities. Sometimes, the Reserve Bank converts maturing treasury bills into bonds thereby rolling over the governments debt. Discount and Finance House of India Ltd. (DFHI), a unique institution of its kind, was set up in April 1988. The share capital of DFHI is Rs 200 crores, which has been subscribed by Reserve Bank of India (10.5%), Public sector banks (62%) and Financial Institutions (26.6%). The discount has been established to deal in money market instruments in order to provide liquidity in the money market. Thus the task assigned to DFHI is to develop a secondary market in the existing money market instruments. The establishment of a discount House was recommended by a Working Group on Money market. The main objective of DFHI is to facilitate the smoothening of the short term liquidity imbalances by developing an active money market and integrating the various segments of the money market. At preset DFHIs activities are restricted to: 1. Dealing in 91 days and 364 days Treasury Bills 2. Re-discounting short term commercial bills. 3. Participating in the inert bank call money, notice money and term deposits and 4. Dealing in Commercial Paper and Certificate of deposits. 5. Government dated Securities Treasury bills are issued by Reserve bank of India on behalf of the Government of India. Such bills are sold at fortnightly auctions. The Discount House regularly participates in such auctions. Moreover, it provides a ready market to other institutions/individuals to buy or sell the Treasury Bills. It purchases the same either as outright purchase or on repos basis. Repos mean the right to re-purchase the same bills again. For this purpose the DFHI quotes

two way prices with fine spread. Such operations in Treasury Bills impart greater flexibility to banks in their funds management. Moreover, with the creation of a secondary market for treasury Bills, corporate bodies and other institutions could also invest their short term surplus funds in such bills.

Inter-Corporate Deposits (ICD):

An Inter-Corporate Deposit (ICD) is an unsecured borrowing by corporates and FIs from other corporate entities registered under the Companies Act 1956. The corporate having surplus funds would lend to another corporate in need of funds. This lending would be an uncollateralized basis and hence a higher rate of interest would be demanded by the lender. The short term credit rating of the corporate would determine the rate at which the corporate would be able to borrow funds. Further the credit spreads demanded even for the top rated corporates would be higher than similar rated banks and the rates on ICDs would higher than those in the Certificate of Deposit (CD) market. The tenor of ICD may range from 1 day to 1 year, but the most common tenor of borrowing is for 90 days.

Primary Dealers are only permitted to borrow in the ICD market. The borrowing under ICD is restricted to 50% of the Net Owned Funds and the minimum tenor of borrowing is for 7 days.

Banker's Acceptance:
It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the Secondary market. The banker's acceptance is mostly used to finance exports, imports and other transactions in goods. The banker's acceptance need not be held till the maturity date but the holder has the option to sell it off in the secondary market whenever he finds it suitable.