Types of Money market instruments in India and Money market in India

Project made by: - Shaikh Shakeeb Ayub. Seat no: - 91 semester: - 5th ATKT College: - Rizvi college

Types of Money market instruments in India and Money market in India

The Indian money market is "a market for short-term and Long term funds with maturity ranging from overnight to one year and includes financial instruments that are deemed to be close substitutes of money." It is diversified and has evolved through many stages, from the conventional platform of treasury bills and call money to commercial paper, certificates of deposit, repos, FRAs and IRS more recently. The Indian money market consists of diverse sub-markets, each dealing in a particular type of short-term credit. The money market fulfills the borrowing and investment requirements of providers and users of shortterm funds, and balances the demand for and supply of short-term funds by providing an equilibrium mechanism. It also serves as a focal point for the Central Bank's intervention in the market.

Structure
The Indian money market consists of the unorganized sector: moneylenders, indigenous bankers, chit funds; organised sector: Reserve Bank of India, private banks, public sector banks, development banks and other Non Banking Financial Companies(NBFCs) such as Life Insurance Corporation of India(LIC),Unit Trust of India(UTI), the International Finance Corporation, IDBI, and the co-operative sector.

Instruments Call money market

The call money market deals in short term finance repayable on demand, with a maturity period varying from one day to 14 days. S.K. Muranjan commented that call loans in India are provided to the bill market, rendered between banks, and given for the purpose of dealing in the bullion market and stock exchanges.[2] Commercial banks, both Indian and foreign, cooperative banks, Discount and Finance House of India Ltd.(DFHI), Securities trading corporation of India (STCI) participate as both lenders and borrowers and Life Insurance Corporation of India (LIC), Unit Trust of India(UTI), National Bank for Agriculture and Rural Development (NABARD)can participate only as lenders. The interest rate paid on call money loans, known as the call rate, is highly volatile. It is the

most sensitive section of the money market and the changes in the demand for and supply of call loans are promptly reflected in call rates. There are now two call rates in India: the Interbank call rate and the lending rate of DFHI. The ceilings on the call rate and inter-bank term money rate were dropped, with effect from May 1, 1989. The Indian call money market has been transformed into a pure inter-bank market during 200607. The major call money markets are in Mumbai, Kolkata, Delhi, Chennai, Ahmedabad.

Treasury bill market

Treasury bills are instrument of short-term borrowing by the Government of India, issued as promissory notes under discount. The interest received on them is the discount which is the difference between the price at which they are issued and their redemption value. They have assured yield and negligible risk of default. Under one classification, treasury bills are categorised as ad hoc, tap and auction bills and under another classification it is classified on the maturity period like 91-days TBs, 182days TBs, 364-days TBs and two types of 14-days TBs. In the recent times (200203, 200304), the Reserve Bank of India has been issuing only 91day and 364-day treasury bills. the auction format of 91-day treasury bill has changed from uniform price to multiple price to encourage more responsible bidding from the market players. The bills are two kinds- Adhoc and regular. the adhoc bills are issued for investment by the state governments, semi government departments and foreign central banks for temporary investment. they are not sold to banks and general public. The treasury bills sold to the public and banks are called regular treasury bills. they are freely marketable. commercial bank buy entire quantity of such bills issued on tender . they are bought and sold on discount basis.

Ready forward contract (Repos)

Repo is an abbreviation for Repurchase agreement, which involves a simultaneous "sale and purchase" agreement. When banks have any shortage of funds, they can borrow it from Reserve Bank of India or from other banks. The rate at which the RBI lends money to commercial banks is called repo rate, a short term for repurchase agreement. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.

Money market mutual funds

Money market mutual funds invest money in specifically, high-quality and very short maturity-based money market instruments. The RBI has approved the establishment of very few such funds in India. In 1997, only one MMMF was in operation, and that too with very small amount of capital.

Reserve Bank of India

The influence of the Reserve Bank of India's power over the Indian money market is confined almost exclusively to the organized banking structure. It is also considered to be the biggest regulator in the markets. There are certain rates and data which are released at regular intervals which have a huge impact on all the financial markets in INDIA. The unorganized sector, which consists mostly of indigenous bankers and non-banking financial companies, although occupying an important position in the money market have not been properly integrated with the rest of the money market.

Reforms
The recommendations of the Sukhmoy Chakravarty Committee on the Review of the Working of the Monetary system, and the Narasimham Committee Report on the Working of the Financial System in India, 1991, The Reserve Bank of India has initiated a series of money market reforms basically directed towards the efficient discharge of its objectives. The bank reduced the ceiling rate on bank advances and on inter-bank call and shortnotice money. There has been a significant lowering of the minimum lending rate of commercial banks and public sector development financial institutions from 18% in 199091 to 10.5% in 200506.

Commercial paper
Commercial Paper in India is a new addition to short-term instruments in Indian Money market since 1990 onward. The introduction of Commercial paper as the short-term monetary instrument was the beginning of a reform in Indian Money market on the background of trend of Liberalization which began in the world economy during 1985 to 1990. A commercial paper in India is the monetary instrument issued in the form of promissory note. It acts as the debt instrument to be used by large corporate companies for borrowing short-term monetary funds in the money market. An introduction

of Commercial Paper in Indian money market is an innovation in the financial system of India. Prior to injection of Commercial Paper in Indian money market i.e. before 1990, the corporate companies had to depend upon the crude and traditional method of borrowing working capital from the commercial banks by pledging the inventory of raw materials as Collateral security. It involved more loss of time for the borrowing companies in availing the short-term funds for day-to-day production activities. The commercial paper has become effective instrument for these corporate companies to avail the short-term funds from the money market within shortest possible time limit by avoiding the hassles of direct negotiation with the commercial banks for availing the short-term loans.

Commercial Paper market

The introduction of commercial paper as debt instrument has promoted commercial paper market as one of the components of Indian money market. In this commercial paper market, the issuers of commercial paper create supply while the subscribers to commercial paper create demand for these papers. The interaction between supply and demand for commercial papers promotes the commercial paper market. The main issuers of Commercial paper in this market are corporate and the main subscribers to the Commercial papers are the banking companies. Commercial Paper is issued by the issuers at a discount to face value of Commercial paper. The face value of Commercial Paper is in the denomination of Rs. 0.5 million and multiples thereof. The maturity period of Commercial paper in the Commercial Paper market ranges between minimum of 7 days and maximum of 1 year from the date of issue. The subscriber to the commercial paper is the investor, and a single investor in the Commercial paper market is not allowed to invest less than Rs. 0.5 million. The other issuers of Commercial paper in this market are Primary dealers and All India Financial Institutions. The other investors or subscribers to Commercial paper in this market are individuals, Non-Resident Indians and Foreign Institutional Investors.

Commercial Paper and Credit Rating agencies

Since Commercial paper is unsecured debt instrument in Indian money market, the issuers of Commercial paper are required to maintain relatively higher Credit rating. According to Reserve Bank of India norms, the issuers of Commercial Paper are eligible to issue Commercial Papers only if they have P2 or equivalent credit rating from any of the credit rating agencies in India. The main agencies are Credit Rating Information Services of India Limited (CRISIL), Credit Analysis and Research Limited (CARE), Investment Information and Credit Rating Agency of India Limited (ICRA). This credit rating is essential for the issue of Commercial papers because a Commercial paper is not backed by any collateral and so only corporate with high-quality credit ratings will easily find buyers without having to offer a substantial discount (higher cost) for the issue of Commercial paper.

Issuers of Commercial Paper

The issuers of Commercial papers in Indian money market are broadly classified into: Leasing and Finance Companies Manufacturing companies Financial Institutions During the decade of 2000-01 to 2010-11, Leasing and finance companies had the average share of 70% of total issue of Commercial papers; while Manufacturing companies and Financial institutions had the average share of 15% each.

Growth of Commercial Paper market in India

Commercial Paper market had relatively higher growth from 1997-98 onward. On October 15 1997, total outstanding amount on Commercial paper transaction in Indian money market was Rs. 3377 crore. This outstanding amount increased substantially to Rs. 1,28,347 crore on July 15, 2011. This growth of Commercial paper market may be attributed to the rapid expansion of corporate manufacturing and financial companies in

liberalized and Globalized Indian economy during the last decade of 20th century and the first decade of 21st century. The growth of Commercial Paper market in India was more conspicuous after the financial year 200708. On 15 July, 2007, total outstanding amount on Commercial paper transaction was Rs. 28,129 crore. This amount increased to Rs. 48,342 crore on 15 July, 2008.Since then, there was substantial increase in the outstanding amount on Commercial paper transactions to the highest level of Rs. 1,28,347 until 15 July, 2011. This period was largely dominated by the Late-2000s financial crisis. In this period, RBI reduced Repo rate drastically from 9% to 4%. However, Prime rate of commercial banks in India remained rigid at 12%. The discounting rate on Commercial papers was in the range of 6.5% to 10% in October 2010. It is explicit from these statistics that the cost of borrowing working capital through Commercial paper transaction became relatively lower for the corporate companies in India in comparison to the cost of borrowing the same working capital through cash credit facility from the commercial banks. The obvious result was an absolute growth of the Commercial paper market in India, particularly, after 2007-08 onward.

Certificate of deposit
A certificate of deposit (CD) is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions. CDs are similar to savings accounts in that they are insured and thus virtually riskfree; they are "money in the bank". CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for banks and by the National Credit Union Administration (NCUA) for credit unions. They are different from savings accounts in that the CD has a specific, fixed term (often monthly, three months, six months, or one to five years), and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest. In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation. Fixed rates are common, but

some institutions offer CDs with various forms of variable rates. For example, in mid-2004, interest rates were expected to rise, many banks and credit unions began to offer CDs with a "bump-up" feature. These allow for a single readjustment of the interest rate, at a time of the consumer's choosing, during the term of the CD. Sometimes, CDs that are indexed to the stock market, the bond market, or other indices are introduced. A few general guidelines for interest rates are:

A larger principal should receive a higher interest rate, but may not. A longer term will usually receive a higher interest rate, except in the case of an inverted yield curve (i.e. preceding a recession) Smaller institutions tend to offer higher interest rates than larger ones. Personal CD accounts generally receive higher interest rates than business CD accounts. Banks and credit unions that are not insured by the FDIC or NCUA generally offer higher interest rates.

How CDs work

CDs typically require a minimum deposit, and may offer higher rates for larger deposits. The best rates are generally offered on "Jumbo CDs" with minimum deposits of $100,000. The consumer who opens a CD may receive a paper certificate, but it is now common for a CD to consist simply of a book entry and an item shown in the consumer's periodic bank statements; that is, there is often no "certificate" as such. Consumers who wish to have a hard copy verifying their CD purchase may request a paper statement from the bank or print out their own from the financial institution's online banking service.

Closing a CD
Withdrawals before maturity are usually subject to a substantial penalty. For a five-year CD, this is often the loss of six months' interest. These penalties ensure that it is generally not in a holder's best interest to withdraw the money before maturityunless the holder has another investment with significantly higher return or has a serious need for the money. Commonly, institutions mail a notice to the CD holder shortly before the CD 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 CD). Generally, a "window" is allowed after maturity where the CD holder can cash in the CD without penalty. In the absence of such directions, it is common for the institution to roll over the CD automatically, once again tying up the money for a period of time (though the CD holder may be able to specify at the time the CD is opened not to roll over the CD).

CD refinance
Insured CDs are required by the Truth in Savings Regulation DD to state at the time of account opening the penalty for early withdrawal. It has been generally accepted that these penalties cannot be revised by the depository prior to maturity. However, there have been cases in which a credit union modified its early withdrawal penalty and made it retroactive on existing accounts. The second occurrence happened when Main Street Bank of Texas closed a group of CDs early without full payment of interest. The bank claimed the disclosures allowed them to do so. The penalty for early withdrawal is the deterrent to allowing depositors to take advantage of subsequent enhanced investment opportunities during the term of the CD. In rising interest rate environments the penalty may be insufficient to discourage depositors from redeeming their deposit and reinvesting the proceeds after paying the applicable early withdrawal penalty. The added interest from the new higher yielding CD may more than offset the cost of the early withdrawal penalty.

Ladders
While The responsibility for maintaining the ladder falls on the depositor, not the financial institution. Because the ladder does not depend on the financial institution, depositors are free to distribute a ladder strategy across more than one bank, which can be advantageous as smaller banks may not offer the longer terms found at some larger banks. Although laddering is most common with CDs, this strategy may be employed on any time deposit account with similar terms. longer investment terms yield higher interest rates, longer terms also may result in a loss of opportunity to lock in higher interest rates in a rising-rate economy. A common mitigation strategy for this opportunity cost is the "CD ladder" strategy. In the ladder strategies, the investor distributes the deposits over a period of several years with the goal of having all one's money deposited at the longest term (and therefore the higher rate), but in

a way that part of it matures annually. In this way, the depositor reaps the benefits of the longest-term rates while retaining the option to re-invest or withdraw the money in shorter-term intervals. For example, an investor beginning a three-year ladder strategy would start by depositing equal amounts of money each into a 3-year CD, 2-year CD, and 1-year CD. From this point on, a CD will reach maturity every year, at which time the investor would re-invest at a 3-year term. After two years of this cycle, the investor would have all money deposited at a three-year rate, yet have one-third of the deposits mature every year (which can then be reinvested, augmented, or withdrawn).

Deposit insurance
The amount of insurance coverage varies depending on how accounts for an individual or family are structured at the institution. The level of insurance is governed by complex FDIC and NCUA rules, available in FDIC and NCUA booklets or online. The standard insurance coverage is currently $250,000 per owner or depositor for single accounts or $250,000 per co-owner for joint accounts. Some institutions use a private insurance company instead of, or in addition to, the federally backed FDIC or NCUA deposit insurance. Institutions often stop using private supplemental insurance when they find that few customers have a high enough balance level to justify the additional cost. The Certificate of Deposit Account Registry Service program allows investors to keep up to $50 million invested in CDs managed through one bank with full FDIC insurance. However rates will likely not be the highest available.

Terms and conditions

There are many variations in the terms and conditions for CDs. The federally required "Truth in Savings" booklet, or other disclosure document that gives the terms of the CD, must be made available before the purchase. Employees of the institution are generally not familiar with this information; only the written document carries legal weight. If the original issuing institution has merged with another institution, or if the CD is closed early by the purchaser, or there is some other issue, the purchaser will need to refer to the terms and conditions document to

ensure that the withdrawal is processed following the original terms of the contract.

The terms and conditions may be changeable. They may contain language such as "We can add to, delete or make any other changes ("Changes") we want to these Terms at any time." The CD may be callable. The terms may state that the bank or credit union can close the CD before the term ends. Payment of interest. Interest may be paid out as it is accrued or it may accumulate in the CD. Interest calculation. The CD may start earning interest from the date of deposit or from the start of the next month or quarter. Right to delay withdrawals. Institutions generally have the right to delay withdrawals for a specified period to stop a bank run. Withdrawal of principal. May be at the discretion of the financial institution. Withdrawal of principal below a certain minimumor any withdrawal of principal at allmay require closure of the entire CD. A US Individual Retirement Account CD may allow withdrawal of IRA Required Minimum Distributions without a withdrawal penalty. Withdrawal of interest. May be limited to the most recent interest payment or allow for withdrawal of accumulated total interest since the CD was opened. Interest may be calculated to date of withdrawal or through the end of the last month or last quarter. Penalty for early withdrawal. May be measured in months of interest, may be calculated to be equal to the institution's current cost of replacing the money, or may use another formula. May or may not reduce the principalfor example, if principal is withdrawn three months after opening a CD with a six-month penalty. Fees. A fee may be specified for withdrawal or closure or for providing a certified check. Automatic renewal. The institution may or may not commit to sending a notice before automatic rollover at CD maturity. The institution may specify a grace period before automatically rolling over the CD to a new CD at maturity. Be careful as some otherwise respectable banks have been known to renew at scandalously low rates.

Criticism
CD interest rates closely track inflation.For example, in one situation interest rates may be 15% and inflation may be 15%, and in another situation interest rates may be 2% and inflation may be 2%. Of course, these factors cancel out, so the real interest rate is the same in both cases. In this situation, it is a misinterpretation that the interest is an increase in value. However, to keep the same value the rate of withdrawal must be the same as the real rate of return, in this case, zero. People may also think that the higher-rate situation is "better," when the real rate of return is actually the same. Also, the above does not include taxes. When taxes are considered, the higher-rate situation above is worse, with a lower (more negative) real return, although the before-tax real rates of return are identical. The afterinflation, after-tax return is what's important. It is a common belief that, "You don't make any money in bank accounts (in real economic terms), simply because you're not supposed to."; on the other hand, bank accounts and CDs are fine for holding cash for a short amount of time. However this applies only to "average" CD interest rates. In reality, some banks pay much lower than average rates while others pay much higher rates (differences of 100% are not unusual, e.g., 2.50% vs 5.00%). In the United States, depositors can take advantage of the best FDIC-insured rates without increasing their risk. Furthermore, a long-term CD might have a high nominal interest rate with a relatively low real interest rate due to high inflation at the time of purchase (as indicated above); however inflation rates often change rapidly and the final real interest rate could be significantly higher than riskier investments. Investors should be suspicious of an unusually high interest rate on a CD. Allen Stanford used fraudulent CDs with high rates to lure people into his Ponzi scheme. Finally, the statement that "CD interest rates closely track inflation" is not necessarily true. For example, during a credit crunch banks are in dire need of funds and CD interest rate increases may not track inflation.