FS in Nepal, Unit II

III Semester , MBM

THE MONEY MARKET
Nischal Risal, MBS, TU;
MPhil (Finance) KUSOM
Doctoral Summer School, IIM Ahmedabad, India
MBM Faculty
 Course Outline
• Nepalese money market,
• Role of NRB in Money Market
• Money Market Instruments in Nepal
– T Bill Features/types, importance
– Participants in the T Bill market
– Sale of T bills
– Implicit yield
• Commercial bills
• Certificate of deposits
• Call money market
• Money market derivatives
 Concept on Money Market
• It is a market for financial assets that are close substitutes
for money.
• Less than 1 year maturity period
• Market for borrowing and lending for shorter period
• Major participants
– Government, corporations , financial inst. and individuals
• Government issue T Bill
• Corporation could issue Commercial paper
• Actively traded in both primary and secondary market
• Market for money market instruments are more liquid.
• Their price fluctuate very less when market interest rates
changes.
 Features of Money Market

• It is not a single market but a collection of

markets for several instruments.
• i,.e wholesale market for short term debt
instruments.
• Honor- Creditworthiness of the participants is
important.
• Main players are: NRB, Banks, Corporate
investors etc
• It is need based market wherein the demand
and supply of money shape the market.
 Money Market Instruments
• T Bill
• Commercial Paper
• Bankers acceptance
• Certificate of deposits
• Promissory notes
• Bills of exchange
• Eurodollars
• Federal Funds
• Repurchase agreements
• And any other securities of maturity less than a year
 Major Features of Money Market Instruments

• Short term instruments market

• Low default risk
• High marketability
• Repos and reverse repos
• Low transaction costs
• Cash equivalents debt securities
• Channel of exchange
 Functions/Roles of Money Market
• Financial instrument
• Function is to find out variety of money market
instruments that attract savers and users.
• Raising funds
• Investing surplus (supply of funds)
• Investing idle cash balances (opportunity cost)
• Synchronization of cash (lending and borrowing)
• Adequate to protection to risk averse investors
• Play central role in country’s financial system
 T-Bill Features

• Negotiable security
• High liquidity security
• Short maturity
• Absence of default risk
• Assured yield, low transaction cost
• Available at min amount of Rs 50000 or
multiple thereof.
• 91days, 182days, 270days, 364day T bill
 Types of T bill
• On Tap bills
– can be bought from central bank of nation at any time.
– In India, an interest yield was 4.66 percent fixed but these bills were
discontinued from 1st April, 1997 as they had lost much of their relevance.
• Ad hoc Bills
– Introduced in 1955 in case of India
– Decided between RBI and Indian Government
– Government account in RBI not less than Rs 50 crore on Friday and Rs 4 crore
on other days
– Replenish the account by creating 91 days T bill when balance fell below the
minimum. (ad hoc bill)
• Auctioned T-Bills
– The most money market instrument.
– Yield is determined by market
– These bills are neither rated nor can they be rediscounted with NRB.
 SALE OF T BILL

• AUCTION
 Treasury Auction( Role of NRB in T Bill)
• Auctioning of the T bills
• Government actions to meet short term needs
• made often each week that includes sale of T notes,
T bonds as well.
• Issue in Nepal in accordance with Public Debt Act
2059
• NRB can assist government in mobilizing resources
by issuing 28, 91, 182 or 364 days T bills
• T bill auction varies from min Rs 200 million to max
Rs 800 million at a time.
• It helps to meet government budget deficits.
 Practice of T Bill in Nepal
• Bidding process
– Competitive and non competitive bidding
• Purchasers bid through branches of NRB or Public
Debt Management Department of NRB
• Competitive Bid
– Bidder specifies the amount of bills desired (2.5 % of bid
price) and the yield at which it is willing to accept them.
• Non Competitive Bid
– The securities are awarded at a yield that equals the
average of the competitive bids. ( Eg Individual investors
can invest)
• Treasury bills are awarded to competitive
bidders offering the lowest yield (highest
price).
• T bill is issued at discount price by NRB on
monthly or bi-monthly basis
• Auction called on every Monday and sold the
issue on every Tuesday ( 1 week prior notice in
newspaper and nrb.org.np)
• Payment period, terms and conditions,
amount every information are disclosed in
notice.
• Out of total issue, 15% is differentiated for non-competitive
bidders.
• Highest bid price gets the first priority and remaining amount is
distributed to lower bid price in pro-rata basis.
• Notice the bid to be opened on every Thursday.
– Accepted bidders deposits remaining amount in bank, if not earnest
money amount is captured.
– Rejected bidders earnest money amount is refunded on same day.
– T bill certificates are issued on the same week
– 5 percent tax is deducted at the time of maturity.
– Min. amount needed is Rs 50000 or divisible of it.
• If the investor require money before the maturity period then they
can sale their T bill in secondary market by informing NRB public
debt management department.
• The expired T bill can be submitted to NRB or its branch office
outside the KTM in order to receive the specified amount of the T
Bill.
 Some Practical Scene
(Class Room Activities)
• www.nrb.org.np (T –Bill)
• 28 days tbill form.pdf
• information about government issuing debt se
curities.pdf
• Public+Debt+Act,+2059.pdf
• www.lawcommission.gov.np
 Treasury Bills and Implicit Yields

• Non interest bearing security

• Pure discount bond
• The T bill in any economy during a given time
period is used as the nominal risk free rate of
interest for the period. i.e T bill yield do not
remain constant over periods
• Subjected to change with the change in
inflation and demand & supply conditions of T
bills in money market.
• Discount yield and Bond equivalent yield
Annualized Yields on T Bill
Yield on 91 days and 364 days T bills
 Conclusion on Table and Figure
• The yield on 91 days T bills are lower than on
364 days T bills during any observed period.
• The difference in yield represents the maturity
risk premium associated with longer term
securities.
• Here, yield means the amount of discount i.e.
difference between face value and issue price
of T bills.
 Money Market in Nepal

• There is no denying the fact that money market

is slowly growing in Nepal.
• It is because money market has been able to
meet the temporary short term credit needs of
the government although companies and firms
have not yet been able to capture the
importance of money market due to failure to
infuse credit worthiness of short term market
instruments in the country.
• Government is playing decisive role in mobilizing
funds through issue of T bills with the help of NRB.
• Institutions that deal completely on money market
instruments are absent.
• Well developed country are using commercial
papers, bankers acceptances, Eurodollars etc.,
have not been issued yet in Nepal.
• NRB and Commercial banks basically involved in
Nepalese money market.
• Dealt only with T bills with REPO, commercial bills,
short term bank loan.
• T bill is major component of money market in
Nepal.
– Started in 1961-62
• The yield on T bill was more fluctuating and
commercial banks were major holder of T bill
in 2000 -2006 period.
• Commercial banks are found major borrowers
and lenders.
• Although, commercial banks have been
dealing with commercial bills.
 Commercial Bill
• A short term, negotiable and self liquidating
instrument with low risk.
• It enhances the liability to make payment on a fixed
date when goods are bought on credit.
• According to negotiable instrument act 2034, chapter
1 section 2 sub section g ‘a bill of exchange is a
written instrument containing an unconditional order,
signed by the maker, directing a certain person to pay
a certain sum of money to, or to the order of certain
person or to the bearer of the instrument in a certain
date or after certain period of time of at the demand.
• Bills of exchange are negotiable instruments
drawn by the seller on the buyer for the value
of the good delivered to him.

• Such bills are called trade bills.

• Trade bills accepted by commercial banks,

they are called as commercial bills.

• Commercial bill is an important tool to finance

credit sales.
• According to NRB act 2002 chapter 5 sec 48
commercial banks and financial institutions
may conduct discount transaction on given
instruments a bill of exchange, debt issued by
government of Nepal.
• Only a small amount of commercial bank’s
lending is against exports and domestic bills
and larger amount is invested in import bills
and LCs and purchase of export bills.
• There was high increment in bills financing.
The increment was 18.2 percent in 2006/2007.
• The development of genuine bill market is beneficial
both to borrowers and to lenders.
• Bills are normally self liquidating and offer greater
liquidity to holders and throughout the financial
system.
• It provides higher return than in T bills, and for
borrowers it costs less than under cash-credit system.
• Lack of discount houses, acceptance houses is the
problem
• Short term credit by commercial banks is another
important part of money market in Nepal.
– Monopoly of commercial banks in past
– Nowadays development banks are also providing
 Call/Notice Money Market
• It is a market for very short term funds repayable on
demand and with a maturity period varying between
one day to a fortnight.
• When money is borrowed or lent for a day, it is known
as call (overnight) money.
• Intervening holidays and/or Sunday are excluded for
this purpose.
• When money is borrowed or lent for more than a day
and up to 14 days, it is known as notice money.
• No collateral security is required to cover these
transactions.
• It is highly risky as well as extremely volatile.
 Call Money

• The inter-bank borrowing has led to the development

of the call money market.
• To maintain CRR (cash reserve requirement),
commercial banks borrow money from other banks.
• CRR refers to the portion of total deposits that
financial institutions have to keep at central bank as
deposit.
• Statutory liquidity ration (SLR) is the portion of total
deposits that financial institutions have to maintain as
liquid assets such as cash, government securities and
precious metals.
• Reduction in CRR and SLR freed some funds of banks
and financial institutions for lending and investment.
CRR/SLR during 5 years period (updating is your job)
CRR CB CRR DB CRR FC
2014-15 6% 5 4.
2013-14 5 4.5 4
2012-13 6 5.5 5
2011-12 5 5 5
2010-11 5.5 5.5 5.5
SLR CB SLR DB SLR FC
2014-15 12 9 8
2013-14 12 9 8
2012-13 15 11 10
2011-12 15 11 10
2010-11 15 11 10
 Conclusion from the table
• CRR is not expected to have much impact on
commercial banks which have to maintain a
liquidity ratio of 20 percent.
• New provisions on CRR will affect development
banks which do not have to maintain 20
percent liquidity ratio.
• NRB has tightened the monetary policy for the
fiscal year 2014-15 as excess liquidity has
started pulling down short term rates.
• In Nepal, the banking sector has been facing
the problem of excess liquidity for 2013-14
due to continuous hike in flow of remittance
income.
• Currently, the banking sector has excess
liquidity of around Rs 100 billion money which
is sitting idle in coffers of banking institutions.
• To address this problem, open market policy
has been followed by NRB, where repo and
reverse repo will be launched so that it can
mop up or inject liquidity whenever needed.
• Money market is a market in which banks
trade positions to maintain cash reserves.
• It is basically an over the counter market
without the intermediation of brokers.
• The participants in the call money market are
those who take on roles as both lender and
borrowers.
• Eg. commercial banks, foreign banks, state,
district and urban cooperative banks,
sometimes individual of high financial status.
• The call money market and the foreign exchange
market are also closely linked as there exist
arbitrage opportunities between two markets.
• When call rates rise, banks borrow dollars from
their overseas branches, swap them for rupees,
and lend them in the call money market.
• The interest rate paid on call loans is known as
call rate.
• Calls rate is highly volatile rate. (changes on
demand and supply of call loans)
 BANK RATE OF LAST THREE YEARS
(UPDATING IS YOUR JOB)
2011/ 2012/ 2014/
12 13 15
Bank 7 8 8
rate

For inter bank rate, you all have to go through

monetary policy. www.nrb.org.np
 Money Market Derivatives
• A financial contract where the value is created
through value of underlying security such as stocks,
currencies, interest rates, indexes etc.
• Off balance sheet instruments
• Helps in managing various types of risks through
hedging, arbitraging and acquiring insurance against
them.
• The deregulation of interest rates led to an interest
rate risk.
• This interest rates risk can be managed with the help
of derivative instruments.
 Two Money Market Derivatives
(Reserve Bank of India)
• Interest Rate swap (IRS)
– a financial contract between two parties,
exchanging or swapping a stream of interest
payments for a notional principal amount during a
specified period.
– Fixed to floating and floating to fixed
– First IRS was negotiated in London (1981)
– USA (1982)
 Forward Rate Agreements (FRA)

• Introduced- British banks – 1983

• A financial contract between two parties
where the interest at a predetermined rate for
a notional principal amount and for a specified
period is exchanged at the market interest
rate prevailing at the time of settlement.
 More about IRS and FRAs
• No benchmark rate, size and tenor specified
• No specific permission is needed by central bank in
the context of India, however, when undertaking
such transactions participants are required to inform
the monetary policy department of central bank.
• Lack of awareness and perception of derivative
instruments as risky keeps away the participants
• Money market itself is in trouble in Nepali context,
which is major problem of money market derivatives
devleopment.
 Individual Assignment I (SQ)
1. An efficient money market benefits a
number of players of Nepali Financial
System. Comment.
2. T bills are an important short term source
of finance for the government, Discuss.
3. Certificate of deposit as money market
instrument in Nepal Explain.
4. The market for interest rate swaps and
forward rate agreements has not grown at
the anticipated pace. Discuss.
 Assignment II

• Presentation on
– Money market instruments, its types, features, importance,
market, maturity etc.
( except commercial bill, certificate of deposit and treasury
bill)
• Article critiquing
• Problem solving questions