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What are Money Market Instruments?

By convention, the term ‘Money Market’ refers to the market for short time
requirement & deployment of funds. Money market instruments are those
instruments, which have a maturity time of less than 1 year.The most active part of
the money market is the market for overnight call and term money between the
banks, institutions as well as call money transactions. Call Money or Repo are very
short term Money Market products. The below mentioned instruments are
normally termed as money market instruments:

The slice of the financial market where instruments with high liquid and short
maturities are traded is called money market. It is a generic definition. The
players who indulge in short time from several days to less than one year. It is
generally used for borrow & lend over this short term. Due to the highly liquid
nature of the security and short maturities, money market are perceived as a safe
place to lock in money.

The participants in the financial market perceive a thin line, differentiating

between the capital market & the money market. Capital market refers to stock
markets where the common stocks are traded, and bond markets where bonds are
issued and traded. This is in sharp contrast to money markets which provide short
term debt financing and investment. In money market, there is borrowing and
lending for periods of a year or less.

Treasury Bills are highly liquid short-time instruments that yield attractive returns.
Short- term borrowing instruments of the Central Govt, it is a promise to pay a said
sum after expiry of a specified period. It is a zero-risk instrument available in both
primary and secondary markets. Money market instruments are characterised by
high degree of safety of the principal.

Commercial paper is a short-term unsecured promissory note issued by corporates

and financial institutions. Commercial Paper is short-term loan that is issued by a
corporation use for financing accounts receivable and inventories. Issued at
discount to the face value, they yield attractive returns. The Government of India
securities are sovereign coupon bearing instruments that are issued by the Govt. of
India. They are available both for short-term and long tenures.



A savings certificate entitling the bearer to receive interest. Certificate of deposit is

short-term borrowings that are more like bank term deposit accounts. They are
transferable by endorsement and are to be stamped. Investors can consider money
market funds. These invest in government securities, certificates of deposits,
commercial paper of companies, and other highly liquid and low-risk securities.
These funds are required by law to invest in low risk securities. Investors with low
risk appetite can opt for money market funds.

The Money market instrument meets the short-term requirements of borrowers and
provides liquidity to lenders. Short-term surplus funds at the disposal of
institutions and individuals are bid by borrowers, who could be in the same

Debt instrument which have a maturity of less than a year at the time of issue are
called money market instruments. Types of debt instruments include notes, bonds,
certificates, mortgages, leases or other agreements between a lender and a
borrower. These instruments are highly liquid and have negligible risk. The major
money market instruments are Treasury bills, certificates of deposit, commercial
paper, and repos. The money market is dominated by the government, financial
institutions, banks, and corporate. Individual investors scarcely participate in the
money market directly. A brief description of money market instruments is given

1) Certificate of Deposit (CD)

2) Commercial Paper (C.P)

3) Inter Bank Participation Certificates

4) Inter Bank term Money

5) Treasury Bills

7) Call/ Notice/ Term Money

6) Bill Rediscounting



What Constitutes the Money Market in India?

The money market is a mechanism that deals with the lending and borrowing of
short term funds. Money market refers to the market for short term assets that are
close substitutes of money, usually with maturities of less than a year. A well
functioning money market provides a relatively safe and steady income-yielding
avenue, for short term investment of funds both for banks and corporates and
allows the investor institutions to optimize the yield on temporary surplus funds.
The RBI is a regular player in the money market and intervenes to regulate the
liquidity and interest rates in the conduct of monetary policy to achieve the broad
objective of price stability, efficient allocation of credit and a stable foreign
exchange market. As per definition given by RBI the money market is "the centre
for dealings, mainly short-term character, in money assets. It meets the short-term
requirements of borrower and provides liquidity or cash to the lenders. It is the
place where short-term surplus investible funds at the disposal of financial and
other institutions and individuals are bid by borrowers, again comprising
Institutions, individuals and also the Government itself" The main segments of the
money market are the call/notice money, term money, commercial bills, treasury
bills, commercial paper and certificate deposits. Mr.G. Crowther in his treatise "An

Outline of Money defines money market as If the economic relationships between

nations are not, by one means or another, brought fairly close to balance, then there
is no set of financial arrangements that can rescue the world from the
impoverishing results of chaos. "the collective name given to the various firms and
institutions that deal in the various grades of near-money". .

Call /Notice-Money Market

The call/notice money market forms an important segment of the Indian Money
Market. Under call money market, funds are transacted on overnight basis and
under notice money market, funds are transacted for the period between 2 days and
14 days.The most active segment of the money market has been the call money
market, where the day to day imbalances in the funds position of scheduled
commercial banks are eased out. The call notice money market has graduated into
a broad and vibrant institution .



Call/Notice money is the money borrowed or lent on demand for a very short
period. 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. Thus
money, borrowed on a day and repaid on the next working day, (irrespective of the
number of intervening holidays) is "Call Money". When money is borrowed or lent
for more than a day and up to 14 days, it is "Notice Money". No collateral security
is required to cover these transactions.

The entry into this field is restricted by RBI. Commercial Banks, Co-operative
Banks and Primary Dealers are allowed to borrow and lend in this market.
Specified All-India Financial Institutions, Mutual Funds, and certain specified
entities are allowed to access to Call/Notice money market only as lenders.
Reserve Bank of India has recently taken steps to make the call/notice money
market completely inter-bank market. Hence the non-bank entities will not be
allowed access to this market beyond December 31, 2000.

From May 1, 1989, the interest rates in the call and the notice money market are
market determined. Interest rates in this market are highly sensitive to the demand
- supply factors. Within one fortnight, rates are known to have moved from a low
of 1 - 2 per cent to dizzy heights of over 140 per cent per annum. Large intra-day
variations are also not uncommon. Hence there is a high degree of interest rate risk
for participants. In view of the short tenure of such transactions, both the borrowers
and the lenders are required to have current accounts with the Reserve Bank of
India. This will facilitate quick and timely debit and credit operations. The call
market enables the banks and institutions to even out their day to day deficits and
surpluses of money. Banks especially access the call market to borrow/lend money
for adjusting their cash reserve requirements (CRR). The lenders having steady
inflow of funds (e.g. LIC, UTI) look at the call market as an outlet for deploying
funds on short term basis.

Inter-Bank Term Money

A short-term money market, which allows for large financial institutions, such as
banks, mutual funds and corporations to borrow and lend money at interbank rates.
The loans in the call money market are very short, usually lasting no longer than a
week and are often used to help banks meet reserve requirements.Inter-bank
market for deposits of maturity beyond 14 days is referred to as the term money
market. The entry restrictions are the same as those for Call/Notice Money except
that, as per existing regulations, the specified entities are not allowed to lend
beyond 14 days.



The market in this segment is presently not very deep. The declining spread in
lending operations, the volatility in the call money market with accompanying
risks in running asset/liability mismatches, the growing desire for fixed interest
rate borrowing by corporates, the move towards fuller integration between forex
and money markets, etc. are all the driving forces for the development of the term
money market. These, coupled with the proposals for rationalisation of reserve
requirements and stringent guidelines by regulators/managements of institutions, in
the asset/liability and interest rate risk management, should stimulate the evolution
of term money market sooner than later. The DFHI (Discount & Finance House of
India), as a major player in the market, is putting in all efforts to activate this

Treasury Bills.

Treasury Bills are money market instruments to finance the short term
requirements of the Government of India. The Treasury bills are short-term money
market instrument that mature in a year or less than that. The purchase price is less
than the face value. At maturity the government pays the Treasury Bill holder the
full face value. The Treasury Bills are marketable, affordable and risk free. The
security attached to the treasury bills comes at the cost of very low returns.

Treasury Bills are short term (up to one year) borrowing instruments of the union
government. It is an IOU of the Government. It is a promise by the Government to
pay a stated sum after expiry of the stated period from the date of issue
(14/91/182/364 days i.e. less than one year). They are issued at a discount to the
face value, and on maturity the face value is paid to the holder. The rate of
discount and the corresponding issue price are determined at each auction.


Treasury bills (T-bills) offer short-term investment opportunities, generally up to

one year. They are thus useful in managing short-term liquidity. 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


Treasury bills are available for a minimum amount of Rs.25,000 and in multiples
of Rs. 25,000. Treasury bills are issued at a discount and are redeemed at par.
Treasury bills are also issued under the Market Stabilization Scheme (MSS).




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.

Type of Day of Day of

T-bills Auction Payment*
91-day Wednesday Following Friday
182-day Wednesday of non-reporting week Following Friday
364-day Wednesday of reporting week Following Friday
* If the day of payment falls on a holiday, the payment is made on the
day after the holiday.

The salient features of the auction system of T-Bills are :

• The 14/91/182/364-days bills are issued for a minimum value of Rs.25,000

and multiples thereof.
• They are issued at a discount to face value.
• Any person in India including individuals, firms, companies, corporate
bodies, trusts and institutions can purchase the bills.
• The bills are eligible securities for SLR purposes.
• All bids above a cut-off price are accepted and bidders are permitted to place
multiple bids quoting different prices at each auction. Till November 6,
1998, all types of T-Bills auctions were conducted by means of 'Multiple
Price Auction'. However, since November 6, 1998, auction of 91-days T-
Bills are being conducted by means of 'Uniform Price Auction'. In the case
of 'Multiple Price Auction' method successful bidders pay their own bid
prices, whereas under 'Uniform Price Auction' method, all successful bidders
pay an uniform price, i.e. the cut-off price emerged in the auction.



• The bills are generally issued in the form of SGL - entries in the books of
Reserve Bank of India. The SGL holdings can be transferred by issuing a
SGL transfer form. For non-SGL account holders, RBI has been issuing the
bills in scrip form.

French Auction or Multiple Price Auction System

After receiving written bids at various levels of yield expectations, a particular

yield is decided as the cut-off rate of the security in question. Auction participants
(bidders) who bid at yield levels lower than the yield determined as cut-off get full
allotment although at a premium. The premium is equal to the yield differential
expressed in rupee terms. The yield differential is the difference between the cut-
off yield and the yield at which the bid is made. All bids made at yield levels
higher than that determined as cut-off yield get entirely rejected.

Dutch Auction or Uniform Price Auction System

This system of auction is exactly identical to that of the French Auction System as
far as the price discovery mechanism part is concerned. The difference is observed
only at the stage of payment obligation. After determination of the market related
cut-off rate, allotment is made to all the bidders at a uniform price. The concept of
premium on account of yield differential does not exist here.

Other Instruments
New money market instruments like Certificates of Deposits (CDs) and
Commercial Paper (CPs) were introduced in 1989-90 to give greater flexibility to
investors in the deployment of their short-term surplus funds

Certificates of Deposit
Certificates of Deposit (CDs) - introduced since June 1989 - are negotiable term
deposit certificates issued by a commercial banks/Financial Institutions at discount
to face value at market rates, with maturity ranging from 15 days to one year.

Certificate of Deposit: The certificates of deposit are basically time deposits that
are issued by the commercial banks with maturity periods ranging from 3 months



to five years. The return on the certificate of deposit is higher than the Treasury
Bills because it assumes a higher level of risk.

Advantages of Certificate of Deposit as a money market instrument

1. Since one can know the returns from before, the certificates of deposits are
considered much safe.
2. One can earn more as compared to depositing money in savings account.
3. The Federal Insurance Corporation guarantees the investments in the certificate
of deposit.

Disadvantages of Certificate of deposit as a money market instrument:

1. As compared to other investments the returns is less.
2. The money is tied along with the long maturity period of the Certificate of
Deposit. Huge penalties are paid if one gets out of it before maturity.

Being securities in the form of promissory notes, transfer of title is easy, by

endorsement and delivery. Further, they are governed by the Negotiable
Instruments Act. As these certificates are the liabilities of commercial
banks/financial institutions, they make sound investments.

DFHI trades in these instruments in the secondary market. The market for these
instruments, is not very deep, but quite often CDs are available in the secondary
market. DFHI is always willing to buy these instruments thereby lending liquidity
to the market.

Salient features :

• 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 15 days.



CDs are issued by Banks, when the deposit growth is sluggish and credit demand is
high and a tightening trend in call rate is evident. CDs are generally considered
high cost liabilities and banks have recourse to them only under tight liquidity

CPs enable highly rated corporate borrowers to diversify their sources of short-
term borrowings and raise a part of their requirement at competitive rates from the
market. The introduction of Commercial Paper (CP) in January 1990 as an
additional money market instrument was the first step towards securitisation of
commercial bank's advances into marketable instruments.

Commercial Papers are unsecured debts of corporates. They are issued in the form
of promissory notes, redeemable at par to the holder at maturity. Only corporates
who get an investment grade rating can issue CPs, as per RBI rules. Though CPs
are issued by corporates, they could be good investments, if proper caution is

The market is generally segmented into the PSU CPs, i.e. those issued by public
sector unit and the private sector CPs. CPs issued by top rated corporates are
considered as sound investments.

DFHI trades in these certificates. It will buy these certificates, subject to its
perception of the instrument and will also be offering them for sale subject to
availability of stock.

Commercial Papers - Salient Features

• CPs are issued by companies in the form of usance promissory note,

redeemable at par to the holder on maturity.
• The tangible net worth of the issuing company should be not less than Rs.4
• Working capital (fund based) limit of the company should not be less than
Rs.4 crores.
• Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2 or higher
from any approved rating agencies and should be more than 2 months old on
the date of issue of CP.
• Corporates are allowed to issue CP up to 100% of their fund based working
capital limits.
• It is issued at a discount to face value.



• CP attracts stamp duty.

• CP can be issued for maturities between 15 days and less than one year from
the date of issue.
• CP may be issued in the multiples of Rs.5 lakh.
• No prior approval of RBI is needed to issue CP and underwriting the issue is
not mandatory.
• All expenses (such as dealers' fees, rating agency fee and charges for
provision of stand-by facilities) for issue of CP are to be borne by the issuing

The purpose of introduction of CP was to release the pressure on bank funds for
small and medium sized borrowers and at the same time allowing highly rated
companies to borrow directly from the market.

As in the case of CDs, the secondary market in CP has not developed to a large

Commercial Bills
Commercial Paper is short-term loan that is issued by a corporation use for
financing accounts receivable and inventories. Commercial Papers have higher
denominations as compared to the Treasury Bills and the Certificate of Deposit.
The maturity period of Commercial Papers are a maximum of 9 months. They are
very safe since the financial situation of the corporation can be anticipated over a
few months.

The concept of raising money through commercial paper was know to the US
markets since 20th century. On our country though it was introduced in 1990, the
RBI constantly watching the growth of the CP market and it is modifying the
guidelines from time to time. For further development of CP market, the stamp
duty on CP should be abolished since there is no stamp duty in US, UK and
France and RBI has to relax the stringent Credit Rating norms from the present
Credit rating P2 of CRISIL to P3, since credit rating is not compulsory in many
countries like US, UK and France.The denominations of CP should be reduced
further for the growth of secondary market for CP.



Commercial Paper policy changes:

Jan 1990 July July July June July Sep. Feb. Oct. Oct.
1990 1991 1992 1994 1995 1996 1997 2000 2004
Tangible Net 10 Crore 5 - - 4 Crore - - - - -
Worth Crore
WCFBL* 25 Crore 15 10 5 4 Crore - - - - -
Crore Crore Crore
Minimum Size 1 Crore 50 25 - - - - - 5 Lakh -
Lakh Lakh
Maximum Size 20% of - 30% 75% - 75% of 100% of 100% of Should -
MPBF** of of Cash Cash WCFBL not
MPBF MPBF Credit Credit exceed
Compone Compone WCFBL
nt nt
Denominations 25 Lakh 10 5 Lakh - - - - - 5 Lakh -
Maturity 91days - - - - 3 - - - 15 days 7days
Period 6 months months – 1 year - One
– 1year Yr.
Credit Rating P1+ by CRISIL - P2 - - - - -
or Equal grade
by other



Bills of exchange are negotiable instruments drawn by the seller (drawer) on the
buyer (drawee) for the value of the goods delivered to him. Such bills are called
trade bills. When trade bills are accepted by commercial banks, they are called
commercial bills. If the seller wishes to give some period for payment, the bill
would be payable at a future date (usance bill). During the currency of the bill, if
the seller is in need of funds, he may approach his bank for discounting the bill.
One of the methods of providing credit to customers by bank is by discounting
commercial bills at a prescribed discount rate. The bank will receive the maturity
proceeds (face value) of discounted bill from the drawee. In the meanwhile, if the
bank is in need of funds, it can rediscount the bill already discounted by it in the
commercial bill rediscount market at the market related rediscount rate. (The RBI
introduced the Bill Market Scheme in 1952 and a new scheme called the Bill
Rediscounting Scheme in November 1970).

With a view to eliminating movement of papers and facilitating multiple

rediscounting, the RBI introduced an innovative instrument known as "Derivative
Usance Promissory Notes" backed by such eligible commercial bills for required
amounts and usance period (up to 90 days). Government has exempted stamp duty
on derivative usance promissory notes. This has indeed simplified and streamlined
the bill rediscounting by Institutions and made commercial bill an active
instrument in the secondary money market. Rediscounting institutions have also
advantages in that the derivative usance promissory note, being a negotiable
instrument issued by a bank, is good security for investment. It is transferable by
endorsement and delivery and hence is liquid. Thanks to the existence of a
secondary market the rediscounting institution can further discount the bills
anytime it wishes prior to the date of maturity. In the bill rediscounting market, it is
possible to acquire bills having balance maturity period of different days upto 90
days. Bills thus provide a smooth glide from call/overnight lending to short term
lending with security, liquidity and competitive return on investment. As some
banks were using the facility of rediscounting commercial bills and derivative
usance promissory notes for as short a period as one day merely a substitute for
call money, RBI has since restricted such rediscounting for a minimum period of
15 days.

The eligibility criteria prescribed by the Reserve Bank of India for rediscounting
commercial bill inter-alia are that the bill should arise out of genuine commercial
transaction evidencing sale of goods and the maturity date of the bill should not be
more than 90 days from the date of rediscounting.



RBI has widened the entry regulation for Bill Market by selectively allowing,
besides banks and PDs, Co-op Banks, mutual funds and financial institutions.

DFHI trades in these instruments by rediscounting Derivative Usance Promissory

Notes (DPNs) drawn by commercial banks. DPNs which are sold to investors may
also be purchased by DFHI.

Derivative Usance Promissory Notes"(DUPN)

IT is an innovative instrument issued by the RBI to eliminate movement of papers
and facilitating easy rediscounting. DUPN is backed by up to 90 days Usance
commercial bills. Government has exempted stamp duty on DUPN to simplify and
steam-line the instrument and to make it an active instrument in the secondary
market. The minimum rediscounting period is 15 days

Bill Rediscounting
The RBI introduced the Bills Market Scheme (BMS) in 1952 which was later
modified into the New Bills Market Scheme (NBMS). Under this scheme
commercial banks can rediscount the bills which were originally discounted by
them with approved institutions (viz., Commercial Banks, Dvelopment Financial
Institutions, Mutual Funds, Primary Dealers etc.)

Multiple Rediscounting
The individual bills can be substituted by Derivative Usance Promissory Notes
(DUPN) of the equal aggregate amount and maturity which are drawn by the
issuing bank to eliminate movement of papers and to facilitate multiple
rediscounting. DUPNs are exempt from stamp duty and are negotiable instruments

Ready Forward Contracts (REPOS)

Ready forward or Repos or Buyback deal is a transaction in which two parties

agree to sell and repurchase the same security. Under such an arrangement, the
seller sells specified securities with an agreement to repurchase the same at a
mutually decided future date and a price. Similarly, the buyer purchases the



securities with an agreement to resell the same to the seller on an agreed date in
future at a prefixed price. For the purchaser of the security, it becomes a Reverse
Repo deal. In simple terms, it is recognised as a buy back arrangement. In a
standard ready forward transaction when a bank sells its securities to a buyer it
simultaneously enters into a contract with him (the buyer) to repurchase them on a
predetermined date and price in the future. Both sale and repurchase prices of
securities are determined prior to entering into the deal. In return for the securities,
the bank receives cash from the buyer of the securities. It is a combination of
securities trading (involving a purchase and sale transaction) and money market
operation (lending and borrowing). The repo-rate represents the borrowing/lending
rate for use of the money in the intervening period. As the inflow of cash from the
ready forward transaction is used to meet temporary cash requirement, such a
transaction in essence is a short term cash management technique.

The motivation for the banks and other organizations to enter into a ready forward
transaction is that it can finance the purchase of securities or otherwise fund its
requirements at relatively competitive rates. On account of this reason the ready
forward transaction is purely a money lending operation. Under ready forward deal
the seller of the security is the borrower and the buyer is the lender of funds. Such
a transaction offers benefits both to the seller and the buyer. Seller gets the funds at
a specified interest rate and thus hedges himself against volatile rates without
parting with his security permanently (thereby avoiding any distressed sale) and
the buyer gets the security to meet his SLR requirements. In addition to pure
funding reasons, the ready forward transactions are often also resorted to manage
short term SLR mismatches.

Internationally, Repos are versatile instruments and used extensively in money

market operations. While inter-bank Repos were being allowed prior to 1992
subject to certain regulations, there were large scale violation of laid down
guidelines leading to the 'securities scam' in 1992; this led Government and RBI to
clamp down severe restrictions on the usage of this facility by the different market
participants. With the plugging of loophole in the operation, the conditions have
been relaxed gradually.

RBI has prescribed that following factors have to be considered while performing

1. purchase and sale price should be in alignment with the ongoing market



2. no sale of securities should be effected unless the securities are actually held
by the seller in his own investment portfolio.
3. Immediately on sale, the corresponding amount should be reduced from the
investment account of the seller.
4. The securities under repo should be marked to market on the balance sheet

The relaxations over the years made by RBI with regard to repo transactions are:

i. In addition to Treasury Bills, all central and State Government securities are
eligible for repo.
ii. Besides banks, PDs are allowed to undertake both repo/reverse repo
iii. RBI has further widened the scope of participation in the repo market to all
the entities having SGL and Current with RBI, Mumbai, thus increasing the
number of eligible non-bank participants to 64.
iv. It was indicated in the 'Mid-Term Review' of October 1998 that in line with
the suggestion of the Narasimham Committe II, the Reserve Bank will move
towards a pure inter-bank (including PDs) call/notice money market. In view
of this non-bank entities will be allowed to borrow and lend only through
Repo and Reverse Repo. Hence permission of such entities to participate in
call/notice money market will be withdrawn from December 2000.
v. In terms of instruments, repos have also been permitted in PSU bonds and
private corporate debt securities provided they are held in dematerialised
from in a depository and the transactions are done in a recognised stock

Apart from inter-bank repos RBI has been using this instrument effectively for its
liquidity management, both for absorbing liquidity and also for injecting funds into
the system. Thus, Repos and Reverse Repo are resorted to by the RBI as a tool of
liquidity control in the system. With a view to absorbing surplus liquidity from the
system in a flexible way and to prevent interest rate arbitraging, RBI introduced a
system of daily fixed rate repos from November 29, 1997.



Reserve Bank of India was earlier providing liquidity support to PDs through the
reverse repo route. This procedure was also subsequently dispensed with and
Reserve Bank of India began giving liquidity support to PDs through their holdings
in SGL A/C. The liquidity support is presently given to the Primary Dealers for a
fixed quantum and at the Bank Rate based on their bidding commitment and also
on their past performance. For any additional liquidity requirements Primary
Dealers are allowed to participate in the reverse repo auction under the Liquidity
Adjustment Facility along with Banks, introduced by RBI in June 2000.

The major players in the repo and reverse repurchase market tend to be banks who
have substantially huge portfolios of government securities. Besides these players,
primary dealers who often hold large inventories of tradable government securities
are also active players in the repo and reverse repo market.

Banker's Acceptance:
It is a short-term credit investment. It is guaranteed by a bank to make payments.
The Banker's Acceptance is traded in the Secondary market. The banker's
acceptance is mostly used to finance exports, imports and other transactions in
goods. The banker's acceptance need not be held till the maturity date but the
holder has the option to sell it off in the secondary market whenever he finds it


Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed

bonds issued by the RBI Treasury. These securities were first issued in 1997. The
principal is adjusted to the Consumer Price Index, the commonly used measure of
inflation. The coupon rate is constant, but generates a different amount of interest
when multiplied by the inflation-adjusted principal, thus protecting the holder
against inflation. TIPS are currently offered in 5-year, 7-year, 10-year and 20-year
maturities. 30-year TIPS are no longer offered.



In addition to their value for a borrower who desires protection against inflation,
TIPS can also be a useful information source for policy makers: the interest-rate
differential between TIPS and conventional Treasury bonds is what borrowers are
willing to give up in order to avoid inflation risk. Therefore, changes in this
differential are usually taken to indicate that market expectations about inflation
over the term of the bonds have changed. The interest payments from these
securities are taxed for federal income tax purposes in the year payments are
received (payments are semi-annual, or every six months). The inflation
adjustment credited to the bonds is also taxable each year. This tax treatment
means that even though these bonds are intended to protect the holder from
inflation, the cash flows by the bonds are actually inversely related to inflation
until the bond matures. For example, during a period of no inflation, the cash flows
will be exactly the same as for a normal bond, and the holder will receive the
coupon payment minus the taxes on the coupon payment. During a period of high
inflation, the holder will receive the same equivalent cash flow (in purchasing
power terms), and will then have to pay additional taxes on the inflation adjusted
principal. The details of this tax treatment can have unexpected repercussions.

By comparing a TIPS bond with a standard nominal Treasury bond across the same
maturity dates, investors may calculate the bond market's expected inflation rate by
applying Fisher's equation.

Sometimes appropriate market structures have developed only after central banks
and governments have taken the lead. For example, Reserve bank of India realized
quite early in its existence that a well functioning money market-dealing in
treasury bills, commercial paper, overnight funds, and the like-would assist the
implementation of monetary policy as well as the overall efficiency of the
economy. But although the banking system as such had been well developed for
many decades, an active money market emerged only after a series of RBI
From the viewpoint of monetary control, and therefore inflation control, the
development of the Canadian money market had two particularly desirable
features. In the first place, the money market's developmentprovided an avenue for
increased reliance on price-related methods of monetary management-broadly
speaking, open market operations. And in this process, reliance on jawboning and
on bank liquidity ratios to influence commercial banks' extension of credit
became less and less-to the point that these features now have no role in India
Secondly, the broadening of outlets for the placement of government debt-to
include the money market as well as the bond market-helped to provide a first line
of assurance that government deficit financing would not impinge upon monetary



In general, in the absence of broad and resilient financial markets through which to
absorb financing demands, the central bank would find it very difficult to deflect
direct pressure from government Monetary Policy and the Control of Inflation
deficits on its balance sheet and therefore on inflation of the monetary base.
To deflect the pressure by, for example, imposing higher bankreserve requirements
in cash, or in government securities, is not an adequate solution. At the very least it
causes problems for the efficiency and competitiveness of the deposit-taking part
of the financial system. A better solution would be for the government to pay an
interest rate sufficiently high that it attracts willing lenders, and without pumping
up the money supply. In general, if credit of various kinds really has to be
subsidized or channelled preferentially, the subsidy should be out in the open and
not financed through what is in effect a tax (and therefore fiscal, not monetary,
policy) on the intermediation of savings through the banking system. A related
issue with implications for controlling inflation is the importance of developing at
an early stage a workable system of prudential oversight for financial institutions,
including determining which institutions will have access to the lender-of-last-
resort facility for liquidity purposes. This, too, is a separate topic of discussion in a
later session. Its importance for inflation control is to remove a potential constraint
on the conduct of monetary policy. The presence of distressed institutions may
inhibit monetary discipline, for fear of precipitating a crisis in the financial system
or of disrupting the flow of investment finance to the non-financial sector,







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