Money Market

The money market is a

mechanism that deals with
DEFINITION: the lending and borrowing of
short term funds

MONEY MARKET IS THE MARKET FOR FINANCIAL

ASSETS THAT ARE CLOSE SUBSTITUTES OF MONEY.
IT IS A MARKET FOR SHORT TERM FUNDS AND
INSTRUMENTS HAVING A MATURITY PERIOD OF ONE
OR LESS THAN ONE YEAR.

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 Characteristics of Money Market
 It is not a single market but a collection of
markets for several instruments
 It is a wholesale market of short term debt
instruments
 Its principal feature is honour where the credit
Functions of money market

Provides a balancing mechanism to even

out demand and supply for short term
funds
Provides a focal point for central bank
intervention for influencing liquidity and
general level of interest rates in the
economy
Provides reasonable access to suppliers
and users of short term funds to fulfill their
borrowing and investment requirements.
Benefits of an efficient
money market
Provides a stable source of funds to banks
Encourage development of non banking
entities
Facilitates Government market borrowing
Makes effective monetary policy actions
Helps in pricing different floating interest
products.
The Indian Money Market:

The average turnover of the money

market in India is over 40,000 crore daily.
2% of the annual GDP of India gets traded
in the money market in just 1 day
Rolethough
Even of RBI in Money
the money market is many
times larger than the capital market, it is
Market:
not even a fraction of the daily trading in
 To ensure liquidity and short term interest rates are

developed
maintained atmarkets.
levels consistent with monetary policy
 To ensure adequate flow of credit to the productive sectors
of the economy
 To bring about order in the forex market
Money Market instruments

Treasury Bills (T-Bills)

Call/Notice money market
CPs
CDs
CBs
Collateralized Borrowing and Lending
Operations
(CBLOs)
 instruments to

Treasury
finance the short
1 term requirements
of the Government

A
Bills
T-bill is a particular
of India. These were
first issued in 1917

These are
kind of Finance Bill or
Ø

discounted
promissory note put out securities and thus
are issued at a
by the Govt. (A finance
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bill is a bill which does value. The return to
the investor is the
not arise from any difference between
the maturity value
genuine transaction in and issue price.
goods…) ØIt is issued by the
Central Govt.
Though it were
earlier issued by the
T Bills are short term state Govts. too
Features
● They are negotiable instruments
● They are highly liquid
● There is no risk of default
● They have an assured yield, low transaction cost
● There are 92, 182 and 364 day t bills
●

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They are not issued in scrip form (are issued in
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the form of promissory note in physical form or
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by credit to Subsidiary General Ledger (SGL)
account or Gilt account in dematerialised form.)
● They are repaid at par on maturity and sold
through fortnightly or monthly auctions at
varying discount rate depending upon the bids.
● T Bills are available for a minimum amount of
Rs. 25000 and in multiples there off.
Featu
 Form
res
The treasury bills are issued in the form of promissory note in
physical form or by credit to Subsidiary General Ledger (SGL)
account or Gilt account in dematerialised form.
Minimum Amount Of Bids

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Bids for treasury bills are to be made for a minimum amount of
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Rs 25000/- only and in multiples thereof.
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 Eligibility:
All entities registered in India like banks, financial institutions,
Primary Dealers, firms, companies, corporate bodies, partnership
firms, institutions, mutual funds, Foreign Institutional Investors,
State Governments, Provident Funds, trusts, research
organisations, Nepal Rashtra bank and even individuals are
eligible to bid and purchase Treasury bills.
  
Repayment
The treasury bills are repaid at par on the
expiry of their tenor at the office of the
Reserve Bank of India, Mumbai.
 Availability
All the treasury Bills are highly liquid
instruments available both in the primary
and secondary market.
 Day Count
For treasury bills the day count is taken as
Calculation of Yield at
Maturity
The yield of a Treasury Bill is calculated as per the
following formula:
(100-P)*365*100
Y= ---------------------
       P*D
Wherein 
Y = discounted yield ; P= Price; D= Days to
maturity
    
Example
A cooperative bank wishes to buy 91 Days Treasury Bill
Maturing on Dec. 6, 2002 on Oct. 12, 2002. The rate quoted by
seller is Rs. 99.1489 per Rs. 100 face values. The YTM can be
calculated as following:
The days to maturity of Treasury bill
are 55 (October – 20 days, November
– 30 days and December – 5 days)
=5.70
YTM = (100-99.1489) x 365 x 100
%
(99.1489*55)
Similarly if the YTM is quoted by the
seller price can be calculated by
inputting the price in above formula.
Types Of Treasury Bills There are different types
of Treasury bills based on the maturity period and
utility of the issuance like, ad-hoc Treasury bills, 3
months, 12months Treasury bills etc. In India, at
present, the Treasury Bills are the 91-days and
364-days Treasury bills. T-Bills

Types:
Ordinar
Ad-hoc
y

● On Tap Bills
● Ad hoc Bills
● Auctioned T Bills
 Have been discontinued since 1997. Was first used
Ad-hocs
in 1937

Ad hoc Bills: these were introduced afresh in1955, It was decided between the
RBI and the Govt. of India that the Govt. could maintain with the RBI a cash
balance of not less than 50 crores on Fridays and 4 crores on other days, free of
obligation to pay interest thereon. And whenever the balance fell below a
minimum the Govt. a/c would be replenished by creation of ad hoc bills in
favour of RBI.

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Adhoc 91d TBs were widely used for replenishment of Govt’s cash balance with

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the RBI, which is nothing but an Accounting Measure in RBI’s books, resulting in
automatic monetisation of Govt’s budget deficit.
They were issued at an unduly low market rate … remained at 4.6% for many
years and became vehicles for automatic monetisation of budget deficit.
Moreover, In 70 and 80s a large proportion of these bills were converted into:
1)long term dated and 2)undated securities. They put a constraint in RBI’s
credit policy Somehow, this wasn’t desirable and therefore:
The Govt. of India entered into an agreement with the RBI
on Sep 9, 1994 to phase out the system of adhocs
The agreement provided:
That at the end of the year 94-95 the net issues should not exceed
6000 crores
That the net issues should not exceed 9000 cr for more than 10
continuous working days during 94-95
If it exceeds the RBI will reduce the excess by auctioning Tbills or
floating Gsecs
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S97-98
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Has to be totally discontinued from

Fresh agreement on March 26, 1997 which provided :

System of adhocs will be discontinued from April 1, 1997
That the outstanding Adhocs & Taps will be converted into special
securities without any specific maturity date at an interest rate of
4.6% pa.
That a system of “ways and means advance” (WMA) by the RBI to
the GOI will be introduced from April 1, 1997 to accommodate
temporary mismatch in GOI’s receipts and payments.
Auctioned TBills: They were first introduced
in April 1992. The RBI receives bids from
various participants and issues the bills
subject to some cut-off limits. Thus the
yields are market determined. These bills
are neither rated nor can they be
rediscounted with the RBI. At present RBI
issues T Bills of 3 maturities: 91, 182 and
Types Of Treasury Bills There are different types of
364 days.
Treasury bills based on the maturity period and utility of the
issuance like, ad-hoc Treasury bills, 3 months, 12months
Treasury bills etc. In India, at present, the Treasury Bills are
the 91-days and 364-days Treasury bills.
Importance of T-Bills:

It is central to the growth of money market.

They play a vital role in the cash management
of the Govt.
act as a benchmark and helps in pricing different
floating rate products in the market
It is the preferred central bank tool for market
intervention to influence liquidity and short term
interest rates.
Benefits Of Investment In
Treasury Bills
No tax deducted at source
Zero default risk being sovereign paper
Highly liquid money market instrument
Better returns especially in the short term
Transparency
Simplified settlement
High degree of tradability and active
secondary market facilitates meeting
unplanned fund requirements.
 Primary Market

In the primary market, treasury bills are

issued by auction technique.
CALENDAR OF AUCTION AS ANNOUNCED
BY RESERVE BANK OF INDIA FOR 2002-03
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Treasury Bill Notified amount (Rs
crore) XI
Day of auction Day of payment

91 day 500 Every Wednesday Following Friday

364 day 1000 Wednesday to coincide with Following Friday

reporting Friday
Salient Features Of The Auction
Technique

The auction of treasury bills is done only

at Reserve Bank of India, Mumbai.
Bids are to be submitted on NDS by 2:30
PM on Wednesday. If Wednesday happens
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to be a holiday then bids
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on Tuesday.
Bids are submitted in terms of price per Rs
100.  For example, a bid for 91-day
Treasury bill auction could be for Rs
97.50. 
Auction committee of Reserve Bank of
Difference between Govt.
Dated Securities and T Bills
Both are credit instruments or Securities and are used to
finance the Government’s deficit
T-bills are short-term securities that mature in one year or
less from their issue date.
Government Bonds are long-term (1 year and above) debt

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instruments. They are generally issued for a period of five to
thirty years.
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Bonds are issued in the name of each holder, while Treasury
Bills are bearer documents
TBill Rates:

It is the rate of interest at which TBills are

sold by the RBI.
The effective return on the TBills is the
discount at which they are sold and is
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based on the difference
at which they Xare sold and their
redemption value.
It used to be administered as well as the
lowest till 1993 .
It increased from 2.52% in 55-56 to 4.60%
in 74 but as per the recommendation of
2 Call/Notice Money
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.
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Intervening holidays Sand/or Sunday are
excluded for this X I
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
Facts & Characteristics of
C/N MM
It is a key segment of the Indian money
market and accounts for the major part of
the total turnover of the money market.
It is a highly liquid market and highly risky
as well
It is required mostly by banks - because
Commercial banks need to maintain a
minimum cash balance called CRR and for
this they need inter bank borrowings. In
fact this is what has led to the
development of the call money market.
 Hence, once every fortnight on a
reporting Friday banks have to satisfy
What is CRR? reserve requirements which often
involves borrowing in the call/notice
money market.

CRR is a technique for monetary control effected by RBI for achieving specific macro-economic
objective/s like maintaining desired level of inflation, growth exchange rates etc.
CRR refers to the cash that banks have to maintain with the RBI as a certain % of their total
demand and time liabilities (DTL). It is about 9% July-Aug 08
Prior to May2000, banks were required to maintain 85% of their fortnightly reserve requirements on
a daily basis. But because of low branch networking it wasn’t possible to report the NDTL in time.

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To bring in more flexibility in the system, a lagged reserve maintenance system was introduced in

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Nov 99 whereby, banks were allowed to maintain reserve requirements on the basis of the last

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Friday of the 2nd (instead of 1st) preceding fortnight.
From May 6, 2000 this requirement of 85% balance on the first 13 days was brought down to 65%.
From Aug 11, 2000 it was brought down to 50% for the first 7 days of the reporting fortnight while
maintaining 65% for the remaining 7 days including the reporting Friday.
The daily minimum CRR was reduced to enable the smooth adjustment of liquidity between surplus
and deficit segments and better cash management to avoid sudden increase in overnight call rates.
 Participants in the call
money
Was predominantly an inter-bank market till 1971
LEN
when UTI & LIC were allowed to operate as lenders DE
RS
Until 1978 brokers were also allowed
90s the participation was gradually widened to
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include DFHI (Disc & fin hs of India ltd.), STCI, GIC,
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NABARD, IDBI, MMFs. Corporates, Pvt. Sector
Mutual Funds etc as lenders in this market.
LEN
DER
Who plays the role of both lenders and borrowers S&
are scheduled and non-scheduled commercial BOR
ROW
banks, foreign banks, state, district and urban ERS

cooperative banks, DFHIs

From August 6, 2005 call money market is now a pure
1996-97 even Primary dealers
inter-bank have been allowed
money market
Reporting of call/Notice Money Transaction: In order
to improve transparency reporting of call or notice
money market transactions on the NDS(Negotiated
Dealing System) was made compulsory w.e.f May
3rd, 2003 -> Any transaction whether executed on
the NDS or outside it or whether the counter
member is a member of NDS or not is to be
reported on the NDS.

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Role of RBI in the Call Money Market: In 2 ways:
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●

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By providing lines of finance (additional funding) to the DFHIs and
other call money dealers &
● By conducting REPO auctions (This increases liquidity in the market
and brings down call money rates) Reverse Repo absorbs excess
liquidity

Link between call money market and other

Financial Markets:
CALL rates and Short term money market instruments
●
MIBOR

The NSE (National Stock Exchange)

developed and launched the:
● NSE Mumbai Inter-bank Bid Rate (MIBID) &
NSE Mumbai Inter-bank Offer Rate (MIBOR) for
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●

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overnight money markets on June 15, 1998
X pooled by the NSE
Both are based on rates
from a representative panel of
31banks/institutions or PDs (Reuters
MIBOR [Mumbai Inter-bank Overnight
Average] is arrived at by obtaining a
weighted average of call money
More on MIBOR (How is it
done?)
1. On a typical day, 20 dealers are
polled at random from a panel of 30.
2. Each dealer is asked to report the
best borrow/lend rates at Rs.10 crore.
Some dealers, e.g. UTI, only report
best lend rates.
3. The bootstrap is used to obtain
inference for trimming zero to
Bootstrappingfour
is the practice
of estimating properties of an
extreme observations. This is used
estimator (such to as its
variance) by measuring those
choose a “best” k. The properties
bootstrap when sampling from
Factors influencing call
money market rate:
Liquidity conditions (d/s > dep mob, rsv
rqmts/ taxation, govt borrw)
Reserve requirement stipulations (cut in crr
increases call rates)
Measures for( govt
Structural Factors curbing high
legislations, cond
volatility:
of stock mkt)
 Increasing the number of participants
Investment policies of NB participants
 Through Repo options by RBI
Liquidity changes and gaps in FOREX
 Freeing the inter-bank liabilities by
markets (call rates inc during volatile forex
easing reserve requirements
conds.)t

3 Commercial Paper
A commercial paper is an unsecured short
term promissory note issued at a discount
by credit worthy corporates, primary
dealers and all India financial institutions.
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(Was introduced in India in Jan 1990)
Characteristics: XI
It is an unsecured short term promissory note.
It is negotiable and transferable by
endorsement and delivery with a fixed maturity
period
CPs are normally issued in multiples of five
A company issues CPs to save on interest costs i.e. it issues CPs only when the situation is such
that CP rates are lower than the rate at which it borrows money from its banking association.

Corporates are allowed to issue CPs up to 100% of their fund based working capital limits
The paper attracts stamp duty
No prior approval of the RBI is required to issue a CP and underwriting the issue is also not
mandatory.
A CP is issued as an unsecured promissory note or in a dematerialized form at a discount which
is freely determined by market forces. The paper is usually priced between the lending rate of
SCBs and a representative money market rate. (as represented by CDs and TBs)
A CP can be issued to individuals, banks, companies and other registered Indian corporate &

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unincorporated bodies. NRIs can be issued a CP only on a non-transferable and non-repatriable

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basis. Banks are not allowed to underwrite or co-accept the issues of a CPs
Banks are the main lenders of this market, call markets affect CP rate; lower call rates mean
cash surplus, banks scrutinize CPs as an alternate investment route. Higher call rates also
discourage corporates form issuing CPs as it leads to higher cost of funds.
FIs are eligible to invest in CPs but within limits prescribed by SEBI
The process of issuing a CP

A resolution is passed by the BOD approving the CP issue as per the RBI norms
The issue then has to be rated by a credit rating agency (is completed within 2-3
weeks
The company has to select an issuing and paying agent (IPA) which has to be a
scheduled bank.
The IPA verifies all the documents and minimum credit rating stipulations

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Then the company has to arrange for dealers such as merchant bankers, brokers and

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banks for placement which has to be completed within 2 weeks of opening.
Every CP issue has to be reported to the RBI through the IPA
SCBs are major investors in CPs as banks prefers investing in CPs because
sanctioning loans block up the funds for a longer time period.
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As per the annual report 2008 published by RBI, the total outstanding
amount of commercial papers issued by Corporates increased from INR
17,863 Crores (March 2007) to INR 50,062 Crores (January 2008) – a
180% increase in a period spanning 10 months. Although, seasonal
year-end redemptions led to a decline in the figures in March 2008
with outstanding amount at INR 32,592 Crores (a y-o-y increase of
82.45%). July 2008 saw the issuance of CPs reaching INR 51,569
Crores. The report also observes that the fortnightly average issuance
of CPs during 2007-08 was INR 4,153 Crores as compared to INR 2,322
Crores during 2006-07.
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The Weighted Average Discount Rate (WADR) on CPs declined from

11.33% on March 31, 2007 to 7.65% at end-October 2007 but
hardened to 10.38% as on March 31, 2008 and further to 10.95% as on
July 31, 2008. The most preferred tenor of CP issuance was for period
180 days and above.
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In terms of non-SLR Investments made by Scheduled Banks, observing

figures for the year 2007 indicate that Commercial Papers constituted 9.4%
(at INR 8,978 Crores) of the total non-SLR investments made, as compared
to its preceding year at 5.4% (INR 4,821 Crores). Bonds/Debentures still
remain the biggest avenue although their share has been a reasonable
decline over the past four years. Shares and Mutual Funds are the other two
destinations where the banks are routing their non-SLR investments.
Some Examples of CP
issuers:
In the recent past, prominent corporates
like:
● Power Finance Corporation
● Rural Electrification Corporation
● Tata Power, Tata Motors
● Simplex Infrastructure
● IDFC etc.
have been observed raising short-term
funds through commercial papers (CPs)
and debentures.
4
Commercial Trade bills are
called
Commercial
Bills Bills

A commercial bill is a short term, negotiable and self liquidating

instrument with low risk.
It is a negotiable instrument drawn by the seller on the buyer
for the value of goods delivered to him (and are called Trade
Bills.) These are, in turn, accepted and discounted by

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commercial banks and when such bills are accepted by the
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The banks discounts this bill
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commercial banks they are called Commercial Bills.
by keeping a certain margin and
credits the proceeds.
The Commercial banks in turn, if they need money, gets these
bills rediscounted by financial institutions like LIC, UTI, GIC, ICICI
and IRBI.
The maturity period of the bills varies from 30ds – 60ds – 90ds.
Types of Commercial Bills

Demand Bill / Usance Bill

Clean Bill / Documentary Bill
Inland Bill/ Foreign Bill - Export Bill/Import
Bill
Hundi
Derivative usance promissory notes
Demand Bill / Usance Bill: A demand bill is
payable on demand, i.e., immediately at sight
or on presentation to the drawee. A usance
bill is payable after a specified period of time.

Clean Bill / Documentary Bill: In a Clean Bill

documents are enclosed and delivered
against acceptance by the drawee after which
it becomes clear. & in case of Documentary
Bill documents are delivered against payment
accepted by the drawee and documents of
the file is held by the banker till the bill is
paid.
Inland / Foreign Bills: Inland bills must be (a)
A bill of lading is a document issued  A documentary bill Is
and signed by a transportation
company to show receipt of goods for used when the seller of
transportation from and to the point of goods to a customer abroad
destination. wishes to obtain payment or
A clean bill of lading, simply put, is some form of security
when the goods received by the carrier before the goods are
(transportation company) are in actually delivered.
appropriate condition with no defects or
damage to goods and/or packaging. If,  When drafts are
for example, the container received by
the carrier was damaged, the carrier
deliverable only upon
makes a notation that expressly
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declares the defective condition of the

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container. Ultimately, it is the exporter
who will be responsible financially
known
documentary
as a
because of the damaged container and acceptance bill; when
or package to be shipped.
deliverable only upon
payment, the draft is
called a documentary
payment bill.
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.

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Import / Export Bills: Export bills are drawn by
exporters in any country outside India and
Import bills are drawn on importers in India
by exporters abroad.

Hundi: It is an indigenous variety of BOE for

financing the movement of agricultural
produce. It has a long tradition of use in India
and is in vogue among indigenous bankers
for raising money or remitting funds or to
finance inland trade. Indigenous bankers
have so far dominated the bill market but
with the reforms in the financial system and
lack of private funds, their role is on a
Features of CBs in India

CBs ensure improved quality of lending,

liquidity and efficiency in money
management.
It is fully secured for investment since it is
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transferable by endorsement and delivery
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and it has a high degree
The bill market is highly developed in
industrial countries but it is very limited in
India.
CB rediscounted by commercial banks
with Fis amount to less than 1000 cr.
Certificates of Deposits

CDs are unsecured, negotiable, short term

instruments in bearer form issued by
Commercial Banks and DFIs.
CDs were introduced from June 89. Only
SCB excluding RRBs IS
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and local area banks
were allowed to issueX them initially. FIs
were permitted to issue CDs within the
limits fixed by RBI in 1992.
CDs are time deposits of specific maturity
similar to FDs. The biggest difference is
CDs are in bearer form and are