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Money Market:
Money market means market where money or its equivalent can be traded.
Money is synonym of liquidity. Money market consists of financial institutions
and dealers in money or credit who wish to generate liquidity. It is better
known as a place where large institutions and government manage their
short term cash needs. For generation of liquidity, short term borrowing and
lending is done by these financial institutions and dealers. Money Market is
part of financial market where instruments with high liquidity and very short
term maturities are traded. Due to highly liquid nature of securities and their
short term maturities, money market is treated as a safe place. Hence,
money market is a market where short term obligations such as treasury
bills, commercial papers and bankers acceptances are bought and sold.
One of the primary functions of money market is to provide focal point for
RBI’s intervention for influencing liquidity and general levels of interest rates
in the economy. RBI being the main constituent in the money market aims at
ensuring that liquidity and short term interest rates are consistent with the
monetary policy objectives.
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1. Treasury Bills
2. Repurchase Agreements (Repo/Reverse Repo)
3. Commercial paper
4. Certificate of Deposits
5. Bankers Acceptance
6. Eurodollar
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short-term securities that mature in one year or less from their issue
date. They are issued with three-month, six-month and one-year
maturity periods. The Central Government issues T- Bills at a price less
than their face value (par value). They are issued with a promise to
pay full face value on maturity. So, when the T-Bills mature, the
government pays the holder its face value. The difference between the
purchase price and the maturity value is the interest income earned by
the purchaser of the instrument. T-Bills are issued through a bidding
process at auctions. The bid can be prepared either competitively or
non-competitively. In the second type of bidding, return required is not
specified and the one determined at the auction is received on
maturity. Whereas, in case of competitive bidding, the return required
on maturity is specified in the bid. In case the return specified is too
high then the T-Bill might not be issued to the bidder. At present, the
Government of India issues three types of treasury bills through
auctions, namely, 91-day, 182-day and 364-day. There are no treasury
bills issued by State Governments. Treasury bills are available for a
minimum amount of Rs.25K and in its multiples. While 91-day T-bills
are auctioned every week on Wednesdays, 182-day and 364-day T-
bills are auctioned every alternate week on Wednesdays. The Reserve
Bank of India issues a quarterly calendar of T-bill auctions which is
available at the Banks’ website. It also announces the exact dates of
auction, the amount to be auctioned and payment dates by issuing
press releases prior to every auction. Payment by allottees at the
auction is required to be made by debit to their/ custodian’s current
account. T-bills auctions are held on the Negotiated Dealing System
(NDS) and the members electronically submit their bids on the system.
NDS is an electronic platform for facilitating dealing in Government
Securities and Money Market Instruments. RBI issues these
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Securities offered to the public must be registered with the Securities and
Exchange Commission according to the Securities Act of 1933. Registration
requires extensive public disclosure, including issuing a prospectus on the
offering. It is a time-consuming and expensive process. Most commercial
paper is issued under Section 3(a)(3) of the 1933 Act which exempts from
registration requirements short-term securities as long as they have certain
characteristics.
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the continuous rollover of notes, as long as the rollover is not automatic but
is at the discretion of the issuer and the dealer.
Until the 1980s, most commercial paper was issued in physical form in which
the obligation of the issuer to pay the face amount at maturity is recorded
by printed certificates that are issued to the investor in exchange for funds.
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The advantages of a paperless system are significant. In the long run the
fees and costs associated with the book-entry system will, be significantly
less than under the physical delivery system. The expense of delivering and
verifying certificates and the risks of messengers failing to deliver certificates
on time will be eliminated. As all transactions between an issuing agent and
a paying agent will be settled with a single end-of-day wire transaction, the
problem of daylight overdrafts, which arise from non-synchronous issuing
and redeeming of commercial paper will be reduced.
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• Broker’s Loans and Call Loans: Broker’s loans are loans from
commercial banks to brokers so that the broker’s customers can
finance stock purchases. The broker uses the stocks, held in street
name, for collateral for the loans.
Time notes are loans that must be paid by a specific date for a
specified interest rate, with terms of 6 months or less. A demand note
(aka call loan) is a loan that is payable on demand the next day at 1
day’s interest. If the note is not demanded, then the term is extended
by another day, and so on, up to 90 days. The interest rate for each
day varies with the prevailing interest rate.
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money market fund is an investment fund that invests in low risk and low
return bucket of securities viz money market instruments. It is like a mutual
fund, except the fact mutual funds cater to capital market and money
market funds cater to money market. Money Market funds can be
categorized as taxable funds or non taxable funds.
Money Market Index: To decide how much and where to invest in money
market an investor will refer to the Money Market Index. It provides
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information about the prevailing market rates. There are various methods of
identifying Money Market Index like:
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Fixed income security originally referred to instruments that pay a fixed rate
of interest, usually fixed coupon rate.
These days the definition of fixed income securities includes many debts
instruments whose promised cash flows are far from fixed.
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When the bond matures or is refinanced, the person will have their money
returned to them.
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Since the fixed income market is driven by interest rates (prices are
inversely related to yields), those things which impact on rates directly
influence prices. The biggest driver of these rates, from a macro
perspective, is monetary policy, the decisions central banks make in regards
to the level of domestic interest rates. Since the central banks directly
control interest rates (at least short-term rates), they have a heavy influence
over their level and direction. Other, less direct, influencers include:
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• Employment
• Inflation
• Currency exchange rates and trade
Yield Curve
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The yield curve is the graphic portrayal of yields over the array of maturities,
from shortest to longest. An example is shown on the following chart.
Notice that the plot above depicts two lines. The blue line is the more
standard, upwardly sloping yield curve in which the longer-maturities feature
higher yields. The spread between the long maturity issues over the short
maturity ones is positive. The pink line, shows an inverted, or negatively
sloped curve. A negatively sloped curve is often considered an indication of
a pending downturn in the economy as the higher return on short term
money will tend to prevent longer-term investment.
Most fixed income securities have a par value that pays a specific rate of
interest on that value, or otherwise has a knowable rate of return; hence the
term fixed income security.
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less than his investment or his expected return, or that he will get less than
he could have had if he had invested his money elsewhere—what economists
call opportunity costs. These risks associated with fixed income securities,
however, are usually small compared to stocks, options, and other
derivatives, which is why many people invest in them. It is not possible to
lose more than your investment in fixed income securities, as you can
buying stocks on margin, for instance, because it makes no sense to borrow
money to pay for fixed income securities, since the interest rate that you
would be paying would almost certainly be more than you could earn. And it
is not likely that you will lose your initial investment because bondholders
have priority over owners if the company goes bankrupt and usually receive
periodic payments of interest, and many issuers of bonds are governments
or their agencies, which have taxing power. And because the United States
government not only has taxing power, but can print money, investments
such as U.S. Treasuries, are virtually risk-free, at least in regards to principal
and interest payments.
Generally, the most important risk for fixed income securities is market risk
or interest rate risk, because interest rates change continually, and this risk
affects virtually every security.
Fixed Income Yields and security prices generally change much more slowly
than Stock Market prices and it can actually takes years for interest rates to
move in either direction by a few points. At the same time, a trend in
interest movements is likely to last longer than a trend in stock prices. There
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Income Investing should be much easier than it is, and should rarely
produce an anxious moment. If you are thinking long term, as you should be
in this area, the rules become simple and few:
All Interest Rate Sensitive Securities are Created Equal. This means that if
your bonds are up or down in price, so are everyone else's. If your fund is
down, Johnny's fund couldn't do better unless there are significant Quality or
Duration differences involved. Therefore, don't ever switch from one Fixed
Income Security to another for emotional (fear or greed) or other similarly
superficial reasons.
• Investors should almost never switch from one fixed income fund to
another, OR even worse, take losses on fixed income to move into
something else entirely, typically a peaking Equity Market.
• Another basic rule is to avoid yields that are a great deal higher than
normal. Caveat Emptor! In one sense, Fixed Income Investing and
Equity Investing are identical...Junk is Junk.
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To be a successful Fixed Income Investor you must get to the point where
you understand that:
Fixed income refers to any type of investment that yields a regular (or fixed)
return.
For example, if you lend money to a borrower and the borrower has to pay
interest once a month, you have been issued a fixed-income security. When
a company does this, it is often called a bond or corporate bank debt
(although “preferred stock” is also sometimes considered to be fixed
income). Sometimes people misspeak when they talk about fixed income.
Bonds actually have higher risk, while notes and bills have less risk because
these are issued by government agencies.
The term fixed income is also applied to a person's income that does not
vary with each period. This can include income derived from fixed-income
investments such as bonds and preferred stock or pension that guarantee a
fixed income. When pensioners or retirees are dependent on their pension as
their dominant source of income, the term "fixed income" can also carry the
implication that they have relatively limited discretionary income or have
little financial freedom to make large expenditures.
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company will have to offer a high rate of interest (coupon) to get people to
buy their bond. If there are a lot of people in the market trying to get a
return on their money, the company can offer a lower coupon.
There are also index-linked, fixed-income securities. The most common and
an example of the highest rated variety of this kind could include Treasury
Inflation Protected Securities (TIPS). This type of fixed income is adjusted to
the Consumer Price Index for all urban consumers (CPI-U), and then a real
yield is applied to the adjusted principal. This means that the US Treasury
issues fixed income that is backed by the full faith and credit of the US
government to outperform the CPI (e.g. to outperform the inflation rate).
This allows investors of all sizes to not lose the purchasing power of their
money due to inflation, which can be very uncertain at times. For example,
assuming 3.88% inflation over the course of 1 year (just about the 56 year
average inflation rate, through most of 2006), and a real yield of 2.61% (the
fixed US Treasury real yield on October 19, 2006, for a 5 yr TIPS), the
adjusted principal of the fixed income would rise from 100 to 103.88 and
then the real yield would be applied to the adjusted principal, meaning
103.88 x 1.0261, which equals 106.5913; giving a total return of 6.5913%.
TIPS moderately outperform conventional US Treasuries, which yield just
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5.05% for a 1 yr bill on October 19, 2006. By investing in such fixed income,
index linked fixed income securities; consumers can exceed the pace of
inflation, and gain value in real terms.
All fixed income securities from any entity have risks including but not
limited to:
• inflationary risk
• interest rate risk
• currency risk
• default risk
• repayment of principal risk
• reinvestment risk
• liquidity risk
• maturity risk
• streaming income payment risk
• duration risk
• convexity risk
• credit quality risk
• political risk
• tax adjustment risk
• market risk
• climate risk
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