The Money Market

Market for financial assets

Close substitutes for money

Market for overnight short term funds

Instruments having maturity periods of 1 year or less than 1 year Demand and supply of money shape the market

Characteristics

Whole sale market for short-term debt instruments

Collection of markets for several instruments

Demand and supply of money shape the market

Credit worthiness of the participants are paramount

Functions

Balances the demand and supply of short-term funds

Focal point for the central bank to intervene for influencing liquidity and interest rates Satisfies the borrowing and investment needs for shortterm funds Facilitates the development of a market for long-term securities

Instruments traded

Treasury bills (T- bills) Call (overnight) and short notice deposits Commercial papers (CPs) Certificate of Deposits (CDs) Commercial bills Collateralized borrowing and lending obligations (CBLO)

Participants

Reserve Bank Of India Discount and Finance house of India (DFHI) Commercial banks Non-banking finance companies (NBFC) Securities Trading Corporation Of India (STCI) Primary dealers

Participants

Public sector undertakings (PSUs) Mutual funds Insurance companies Corporates State Governments

Provident funds
Non-residents

Treasury Bills

Short-term debt instruments issued by RBI

Used by the Government to bridge the gap between receipts and expenditure Negotiable securities Highly liquid Absence of default risk

Treasury Bills

Assured yield
Low transaction cost

SLR security
Maturity - 91-day, 182 day and 364-day T-bills Minimum investment Rs.25000.00

Types of T-Bills

On-tap bills

could be bought at any time from RBI

discontinued from 1997

Ad hoc bills 91-day ad hoc T-bill were created to replenish the Government's cash balance with RBI

Types of T-Bills

Auctioned T-Bills

Most active money market instrument Yield is market determined Bills are not rated Cannot be rediscounted with RBI Three maturities

91-days 182 days 364 -days

Commercial Paper

An unsecured short-term promissory note

Negotiable ,with a fixed maturity period

Issued by creditworthy and highly rated (p2 of CRISIL) corporates to meet their working capital needs Primary /satellite dealers and all-India financial institutions can also issue commercial paper

Commercial Paper

Corporates can issue CPs upto 100% of the fund-based working capital limits
Minimum tangible net worth of the corporate should be Rs.4 crores Minimum period 7 days and maximum period upto one year Denomination: minimum Rs.5 lakhs and multiples thereof

Constraints

Complex administrative procedures

Restriction on investments by RBI on LIC, UTI,GIC on treasury bills No active secondary market No underwriting or roll-over facility Levy of stamp duty

Commercial Bills

Important instrument to finance credit sales

Unsecured short-term Negotiable Self-liquidating Low risk Liable to make payment on a fixed date

Commercial Bills

Can be drawn as Demand bills Usance bills Inland bills Foreign bills
Banks rediscount the bills in money market

Commercial Bills/Guidelines

Banks are required to discount/negotiate bills drawn under confirmed trade contracts or against letters of credit Financing against accommodation bills should not be done

Drawing bills of exchange/Letters of credit claused without recourse should be discouraged

Bills discounted/rediscounted should not be used as collateral for repo transactions

Certificates of Deposit

Short-term instruments Unsecured

Negotiable Bearer security Issued by commercial banks & Development financial institutions

Certificates of Deposit

Banks issue CDs

during tight liquidity periods At high interest rates At a discount to face value In dematerialized form As Usance promissory note Minimum amount Rs.1 lakh or in multiples of Rs. 1 lakh Maturity for banks - not less than 7 days, but not more than 1 year For FIs not less than 1 year and not exceeding 3 years

What hinders the CD market?

Undeveloped secondary market Limited participants Instruments not listed No borrowing or buyback facility Stamp duty on CDs No floating rate of interest

Call /Notice money Market

Market for very short-term funds

Repayable on demand maturity 1 day to 14 days Highly risky and extremely volatile market Inter-bank borrowing without collateral CRR requirement of banks developed call market

Call /Notice money Market

Pure inter-bank money market Participants banks and primary dealers

RBI intervenes through repo/ reverse repo auctions when call rates peak, banks raise funds thro CDs When rates are lower, bank do arbitrage by investing in other securities

Call /Notice money Market

Arbitrage opportunity between call market and foreign exchange market

Banks borrow dollars when call rates are highswap into rupees lend in the local market Buy dollar forward to meet repayment liability Forward dollar premium goes up

Call /Notice money Market

Call rate Interest rates paid on call loans Highly volatile rate Market determined Reference rate through NSE and Reuters NSE MIBID/ MIBOR (Mumbai inter-bank bid/offer rate) MIBOR is transparent, market- determined and mutually acceptable to counter-parties as reference

Collateralized Borrowing and Lending Obligation (CBLO)

Launched by Clearing corporation of India Ltd (CCIL)

Provides liquidity to non-bank institutions

Corporates, NBFCs, FIs, Insurance companies, pension/provident funds participate Discounted instrument with maturity period of 1 to 19 days

Money market & monetary Policy

Both are intrinsically linked

Monetary policy effects the economy through financial prices Interest rates Exchange rates Yields on bonds Asset prices Equity prices

Money market & monetary Policy

It effects through financial quantities Money supply

Credit expansion Government bonds Foreign bonds Euro bonds

Monetary Control Tools

Reserves with central bank

Cash reserve ratio (CRR)

Statutory requirement ratio (SLR)

Interest rates Bank rate Bench mark prime lending rate Base rate

Monetary Control Tools

Refinance from RBI Overcome liquidity crisis Control monetary and credit conditions Direct credit to select sectors Linked to bank rate Export credit refinance General refinance

Liquidity adjustment facility (LAF)

Recommendation of Narasimhan committee on Banking sector reforms Tool for day to day liquidity management Absorbs or injects liquidity by sale/purchase of securities, under repo/reverse repo operations Mechanism for banks to overcome mismatches in demand and supply Principal operating instrument for modulating liquidity conditions

Repos

The borrower gets funds against the collateral of securities placed with the lender
Maturity period 1 to 14 days At maturity, the securities are reverted back to the borrower, on his repayment of the dues Counter party risks are minimum since repos are fully collateralized

Repos

Repo injection of liquidity Reverse repo absorption of liquidity Permitted in

Central and state government dated securities T-bills of all maturities Banks Primary dealers Only in Mumbai To be routed through SGL accounts maintained by RBI

Participants

Money Market Derivatives

A financial contract value derived from the value of the underlying

Stocks Currencies Interest rates Indexes commodities

Interest rate swap

Exchanges a stream of interest payments for a notional principal amount

In a falling market, swap buyer

Receive fixed

Pay floating rates

Interest rate swap

In a rising market, swap buyer Receive floating Pay fixed rates Series of forward contracts
Reduces costs Manage interest rate risks

Forward Rate Agreement (FRA)

Important hedging tool of International banks

A type of forward contract

Financial contract between two parties Interest rate at predetermined rate For notional principal amount For a specific period Exchanged at market interest rates(MIBOR) on the settlement date

Interest Rate Futures

Standardized forward contracts on a bench mark interest rates traded on a stock exchange
Helps in price discovery Widen the underlying cash market

Banks use interest rate futures to hedge their underlying government securities portfolio