Financial markets & Intermediaries

Module 6 - Money Market

Contents

Money market
Sub markets / Instruments
Participants
Regulatory Authority
 Money Market
Market for short-term loanable funds for a
period of not exceeding one year.

Supplies fund for financing working capital

requirements of industries and short financial
deficits of the government.

Instruments dealt in the market are Bills of

exchange, treasury bills, commercial papers,
certificate of deposit etc.
Each single money market instrument is of a
large amount.

The central bank and commercial banks are the

major institutions in the money market.

Instruments generally do not have a secondary

market.

Transactions mostly take place over-the-phone

and there is no formal place.
Transactions have to conducted without the help
of brokers.
 Money market participants
Unorganized banking sector – indigenous bankers,
money lenders, Nidhi’s, Chit funds
Organized banking sector –RBI, Public sector
banks (Scheduled – foreign and Indian, Non –
scheduled) Private sector banks, Development
banks and other financial institutions ( LIC, UTI,
IFC, IDBI), DFHI Ltd.
Co-operative Sector
Sub markets – call money market, short term bill
market, market for certificates of deposits &
commercial papers.
RBI

RBI as the central bank and monetary

authority in the country, is the leader of
the Indian monetary market.

RBI controls the flows of money and

credit in the country.
 Indigenous banker
Individual or private form which receives
deposits and deals in hundis or lends
money.
A substantial portion of financial
requirements of traders are met by them.
Operations free from much formalities sand
delay.
Easily accessible
They lend against even inferior securities
for short term and long term.
 Money lenders
Those who lend their own money for
consumption or other domestic purposes.
On personal security of borrowers, against
promissory note or even collateral
securities, such as ornaments or standing
crops.
Charge exorbitant rate of interest on their
advances.
Role declined at present
Functions of money market
Provides financial assistance to commercial
bank, foreign banks and factoring companies.
It makes finance available to government under
non-inflationary conditions.

Effective implementation of monetary policies

is possible due to the existence of money
market.
Helps in equilibrating short term deficits and
surpluses of various institutions.
Instruments traded in money market

Treasury bills
Commercial bills
Certificate of deposits
Inter-bank participation certificates
Commercial papers
Money at call or call money
What to Understand?
 What? Features?
 Who benefits?
 Who can Issue?
 Who can buy and sell? How?
 Issue size
 Ceiling on issue and purchase
 Lock-in-period
 Interest rate
 Match inflow outflow based on maturity
 Interest high on short term; when liquidity is tight, even
on long term.
Call money market
Banks borrow in this money market

Under call money market, funds are

transacted on overnight basis
Under notice money market, funds are
transacted for a period between 2 days and
14 days.
Payable on demand at the option of the
lender or borrower.
Participants – Banks, primary dealers,
development finance institutions,
insurance companies, mutual funds.

Banks and PDs can operate both as

borrowers and lenders in the market.
Why banks borrow in call money
market?

To fill the gaps or temporary mismatches

in funds.
To meet the CRR & SLR mandatory
requirements as stipulated by the central
bank.
To meet sudden demand for funds arising
out of large outflows.
Lending of scheduled commercial Banks,
on a fortnightly average basis, should not
exceed 25 percent of their capital fund.
However, banks are allowed to lend a
maximum of 50% on any day, during a
fortnight.
Borrowing by scheduled commercial
banks should not exceed 100 percent of
their capital fund or 2 percent of
aggregate deposits, whichever is higher.

However, banks are allowed to borrow a

maximum of 125 percent of their capital
fund on any day, during a fortnight.
Treasury Bills
Instruments to finance the short
requirements of the Government of India.
Issued by RBI on behalf of Government.
Discounted securities- issued at a
discount to face value.
The return to the investor is the difference
between the maturity value and issue
price.
Benefits of investment in treasury
bills
No tax deducted at source.
Zero default risk being sovereign paper.
Highly liquid money market instrument.
Better returns especially in the short term.
Transparency
Simplified settlement
High degree of tradability and active secondary
market facilities meeting unplanned fund
requirements.
Features of treasury bills
Issued in the form of promissory note in
physical form or by credit to subsidiary
general ledger (SGL) account or Gilt
account in dematerialized form.

Minimum bid amount of Rs. 25000 only

and in multiples thereof.
 Who can buy treasury bills
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 organizations, Nepal rashtra bank
And even individuals are eligible to bid and
purchase.
Repaid at par on the expiry of their tenor at
the office of RBI, Mumbai.
Highly liquid instruments available both in
the primary and secondary market.
Day count is taken as 365 days for a year.
Even funds kept in current account can be
deployed in treasury bills to maximize
returns, as banks do not pay interest on fixed
deposits less than 15 days, or balances
maintained in current accounts.
Yield calculation
Y = {(100 –P)*365*100} / (P *D)

Y= Discounted yield
P = Price
D= Days to maturity
Commercial Bills
There are situations of credit sale,

The seller draws a bill on behalf of the

buyer,

The buyer accepts the bill by promising

him to pay the bill amount later.
Usually these bills are drawn for 3 months
to 6 months.
Types of Commercial Bills

Clean and Documentary Bills

Import Bills and Export Bills

Clean and Documentary bills
Documentary bills – bills which
accompany documents of title of goods
like Railway receipt, lorry receipt etc.

Cleanbills – Bills not accompanied with

documents of title of goods.
Import and export bills

Export bills are drawn by Indian

exporters on the importers outside India.

Import bills are drawn on Indian

importers in India by exporters outside
India.
Discount market
An arena where discounting and
rediscounting of certain financial market
instruments like commercial bills or
treasury bills take place.

Discounting means lending against bills

of exchange and other instruments as well
as direct loans and advances generally by
the Central bank of a country.
Commercial papers
Promissory notes issued by companies
approved by RBI.
Unsecured debts of corporate.

Issue with fixed maturity and at a

discount usually determined by the
company issuing it.
Features of Commercial paper
Maturity period 90 to 180 days.
Sold at discount from face value and redeemed
at face value. Implicit interest is a function of
the size of discount and the period of maturity.

Either directly placed with investors or sold

through dealers.
Usually bought by investors who intend holidng
till maturity. Hence no well-developed market
for CP
Conditions to be fulfilled by a company
before issuing Commercial paper.

 A net worth of at least Rs. 50 million.

 A maximum permissible bank finance of at least Rs. 100 million.
 The face value of commercial paper issued by it does not exceed 30
percent of its working capital limit.
 Its equity is listed on a stock exchange.
 Its Commercial Paper receives a minimum rating of P1 from
CRISIL.
 It has a minimum current ratio of 1.33
 It enjoys health code No.1 Status
 The minimum size of the commercial paper issue is Rs. 2.5 million
and the denomination of each commercial paper note is half a
million rupees or multiples thereof.
Certificate of deposits
Issued by banks, financial institutions to
raise large sums of money.
Issued for period of 3 months to one-year.
Issued in the form of promissory notes
payable on a particular fixed date without
days of grace.
Principal and interest repayable to the
bearer at a specified future date.
Features of Commercial Deposit
 CDs can be issued to individuals, corporations,
Companies, Trusts, Funds, Associates, etc.
 NRIs can subscribe to CDs on non-repatriable basis.
 CDs attract stamp duty as applicable to negotiable
instruments.
 Banks have to maintain SLR and CRR on the issue price
of CDs. No ceiling on the amount to be issued.
 The minimum issue size of CDs is Rs. 5 lakhs and
multiples thereof.
 CDs are transferable by endorsement and Delivery.
 The minimum Lock-in-period for CDs is 45 days.
Inter bank participation
With the permission of RBI, the banks re
authorized to raise short term finance by issuing
inter bank participation certificate.

This scheme of inter banks participation is

restricted to scheduled commercial banks only
and the participation is for a minimum period
ranging from 91 days to 180 days.
Participation is permitted in two types (a.) with
risk participation (b) without risk participation
Features or deficiencies of Indian
money market
Existence of unorganized sector
Absence of integration
Diversity in money rates of interest
Seasonal stringency of funds
Absence of bill market
No contact with foreign money markets
Limited instruments
Limited secondary market
Limited participants
Recent developments in money
market
 Integration of unorganized sector with organized sector
 Widening of call money market
 Introduction of innovative instruments
 Offerings of market rates of interest
 Promotion of bill culture
 Entry of MMMF
 Setting up of credit rating agencies
 Adoption of suitable monetary policy
 Establishment of DFHI
 Setting up of STCI Ltd.
 Case Study
 Zeta Bank Ltd., has a surplus cash base of Rs. 10 million,
which it can use for a short term investment.

 The bank officials are considering a portfolio of investing

in Treasury Bills, Government Bonds, Commercial Papers
issued by other financial institutional and investing in the
call money market.

 Keeping the current money markets trends as the basis

which quantum of allocation of investment you
recommend for this portfolio.
 Illustrate your recommendations.