Money Market

Financial Market

Money Market / Financial market is the market that facilitates the transfer of funds between investors/ lenders and borrowers/ users. The financial market may be defined as  ‘a transmission mechanism between investors (or lenders) and the borrowers (or users) through which transfer of funds is facilitated’. It consists of individual investors, financial institutions, and other intermediaries who are linked by a formal trading rule and communication network for trading the various financial assets and credit instruments. It deals in financial instruments (like bills of exchange, shares, debentures, bonds, etc).

Classification of financial markets

1. Money market / Markets for short term funds: Financial instruments traded in them mature in less than a year
2. Capital markets / Markets for long term funds: Financial instruments traded in them mature in more than a year.

Instruments of Money market Or Sub Markets of Money market

Cash Management Bills (CMBs) —

These are short term bills issued by central government to meet its immediate cash needs. The bills are issued by the RBI on behalf of the government. Hence the CMBs are short-term money market instruments that help the government to meet its temporary cash flow mismatches.

Following are the features of CMBs.

CMBs have a maturity of less than 91 days.

• The CMBs have the generic character of Treasury Bills as the CMBs are issued at a discount   and redeemed at face value at maturity. For example, if the face value of a CMB is Rs 100, we can get the bill at Rs 97 and at the end of the maturity date, say 60 after days, we can get Rs 100.   Here, there is no interest payment as the maturity period is so small. But the return for buying  CMB is obtained in the form of a discount.

• The tenure or maturity, notified amount (how much total CMBs to be issued) and date of issue of the CMBs depends upon the temporary cash requirement of the Government.

• CMBs are eligible as SLR securities. Investment in CMBs is also recognized as an eligible investment in Government securities by banks for SLR purpose under Section 24 of the Banking Regulation Act, 1949.

CMBs are issued first on May 12, 2010. The purpose of the mechanism is to enable the government to get short term money.

Ways and Means Advances (WMA).

Under WMA, the RBI gives temporary loan facilities to the centre and state governments as a banker to government for upto 90 days.

Call money market (CMM) —

The market where overnight (one day) loans can be availed by banks to meet liquidity. Banks  who seeks to avail liquidity approaches the call market as borrowers and the ones who have excess liquidity participate there as lenders. The CMM is functional from Monday to Friday.  Banks can access CMM to meet their reserve requirements (CRR and SLR) or to cover a sudden shortfall in cash on any particular day.

Effectively, the Call Money Market is the main market oriented mechanism to meet the liquidity requirements of banks.

Notice money market

The call money is usually availed for one day. If the bank needs funds for more days, it can avail money through notice market. Here, the loan is provided from two days to fourteen days.

Participants

Participants in the call money market are

• Scheduled commercial banks (excluding RRBs),
• co-operative banks (other than Land Development Banks) and
• Primary Dealers (PDs) [ i.e A primary dealer is a bank or other financial institution that has been approved to trade securities with a national government ] are permitted to participate in call/ notice money market both as borrowers and lenders.

• As per the new regulations, Payment Banks are also allowed to participate in CMM as both lenders and borrowers.

Banks are the dominant participants in the CMM and hence it is often known as interbank call money market.

• Surplus banks will give loans to other banks.
• Deficit banks that need funds will purchase it.

* Functioning of the Call Money Market

• Loans are availed through auction/negotiation.
• The auction is made on interest rate.
• Highest bidder (who is ready to give higher interest rate) can avail the loan.
• Average interest rate in the call market is called call rate.
• This call money rate is an important variable for the RBI to assess the liquidity situation in the economy. The CMM is known as the most sensitive segment of the financial system.

Treasury Bill ( TB ) —

When the government is going to the financial market to raise money, it can do it by issuing two types of debt instruments – treasury bills and government bonds. Treasury bills are issued when the government need money for a shorter period while bonds are issued when it need debt for more than say five years.

Treasury bills; generally shortened as T-bills, have a maximum maturity of a 364 days. Hence, they are categorized as money market instruments (money market deals with funds with a maturity of less than one year).

Treasury bills are presently issued in three maturities, namely, 91 days, 182 days, and 364 days.

Treasury bills pay no interest

Moreover, treasury bills are zero-coupon securities and pay no interest. Rather, they are issued at a   discount (at a reduced amount) and redeemed (given back money) at the face value at maturity.

For example, a 91 day Treasury bill of Rs.100/- (face value) may be issued at say Rs. 98.20,   that is, at a discount of say, Rs.1.80  and  would  be redeemed  at  the face value of Rs.100/-. This means that you can get a hundred-rupee treasury bill at a lower price and can get Rupees hundred at maturity.

The return to the investors is the difference between the maturity value or the face value (that is Rs.100) and the issue price. The Reserve Bank of India conducts auctions usually every

Wednesday to issue T-bills. The rational is that since their maturity is lower, it is more convenient to avoid intra period interest payments.

Treasury bills are usually held by financial institutions including banks. They have a very important role in the financial market beyond investment instruments. Banks give treasury bills to the RBI to get money under repo. Similarly, they can keep it as part of SLR.

Commercial Paper (CP)

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. ( A signed document containing a written promise to pay a stated sum to a specified person or the bearer at a specified date or on-demand).

• It was introduced in India in 1990.
• It was introduced  in India in 1990 with a view to enabling  highly rated  corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and all-India financial institutions were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations.

Issue of CP

Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP.

A corporate would be eligible to issue CP provided –

1. the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore

• company has been sanctioned working capital limit  by bank/s or all-India financial institution/ s; and

• Moreover, the borrower account of the company is classified as a Standard Asset by the financing bank/ s/ institution/s.

** All eligible participants shall obtain the credit rating for issuance of Commercial Paper either from —

• Credit Rating Information Services of India Ltd. (CRISIL) or
• the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or
• the Credit Analysis and Research Ltd. (CARE) or
• the FITCH Ratings India Pvt. Ltd. or
• such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose.

The minimum credit rating shall be A-2 Period of maturity for CP —

CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue. However, the maturity date of the CP should not go beyond the date up    to which the credit rating of the issuer is valid.

The limit up to which a CP issued —

The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors. Or subsequently, the quantum indicated by the Credit Rating Agency for the specified rating,

whichever is lower.

As regards FIs, they can issue CP within the overall umbrella limit prescribed in the Master Circular on Resource Raising Norms for FIs, issued by DBOD and updated from time-to-time.

Denominations a CP —

CP can be issued in denominations of Rs.5 lakh or multiples thereof. CP can be issued on different dates by the same issuer —

Yes. CP may be issued on a single date or in parts on different dates provided that in the latter case, each CP shall have the same maturity date. Further, every issue of CP, including renewal, shall be treated as a fresh issue.

Who can invest in CP —

• Individuals,
• banking companies,
• other corporate bodies (registered or incorporated in India) and
• unincorporated bodies,
• Non-Resident Indians (NRIs) and
• Foreign Institutional Investors (FIIs) etc. can invest in CPs.
• However, investment by FIIs would be within the limits set for them by Securities and Exchange Board of India (SEBI) from time-to-time.

CP can be held in dematerilaised form

CP is always issued at a discount —

Moreover, CP will be issued at a discount to face value as may be determined by the issuer.

Certificate of Deposit (CD) —

It is a negotiable money market instrument and issued in dematerialized form or as a Usance Promissory Note against funds deposited at a bank. Or other eligible financial institution for a specified time period.

Eligibility

Moreover, CDs can be issued by (i) scheduled commercial banks {excluding  Regional Rural Banks and Local Area Banks}; and (ii) select All-India Financial Institutions (FIs) that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI.

Minimum Size of Issue and Denominations

Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum deposit that could be accepted

from a single subscriber should not be less than Rs.1 lakh, and in multiples of Rs. 1 lakh thereafter.

Investors

CDs can be issued to individuals, corporations, companies (including banks and PDs), trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also subscribe to CDs, but only on non-repatriable basis, which should be clearly stated on the Certificate. Such CDs cannot be endorsed to another NRI in the secondary market.

Maturity

• The maturity period of CDs issued by banks should not be less than 7 days and not more than one year, from the date of issue.

• FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue.

Discount / Coupon Rate

CDs may be issued at a discount on face value. Banks / FIs are also allowed to issue CDs  on floating rate basis provided the methodology of compiling the floating rate is objective,

Transparent and market-based. The issuing bank / FI is free to determine the discount/coupon rate. Moreover, the interest rate on floating rate CDs would have to be reset periodically in accordance. With a pre-determined formula that indicates the spread over a transparent benchmark. Therefore, the investor should be clearly informed of the same.

Reserve Requirements

Banks have to maintain appropriate reserve requirements, i.e., Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), on the issue price of the CDs.

Transferability

CDs in physical form are freely transferable by endorsement and delivery. Moreover, CDs in the Demat form can be transferred as per the procedure applicable to other Demat securities. There is no lock-in period for the CDs

By Mr. Santanu Chandra

Mr. Santanu Chandra is associated with MIES Institute for the last 8 years as a guest faculty. He has hugely experienced in teaching WBCS, SSC, Bank, etc exams. He is very grateful to MIES Management for giving him a chance as a guest faculty to MIES Institute. Moreover, which is one of the best competitive tutorials in West Bengal. In His opinion, MIES Institute is one of the top competitive exam institutes in West Bengal.
Thousands of students appeared in Govt. service exam from MIES every year. And therefore, got Govt. service maximum of them. As per the student’s version, MIES is the best coaching for Govt. Service exam in west Bengal.