Money Market in India

Money Market in India: 

Definition: Money market basically refers to a section of the financial market where

financial instruments with high liquidity and short-term maturities are traded. Money
market has become a component of the financial market for buying and selling of
securities of short-term maturities, of one year or less, such as treasury bills and
commercial papers. Over-the-counter trading is done in the money market and it is a
wholesale process. It is used by the participants as a way of borrowing and lending for
the short term. 

Description: Money market consists of negotiable instruments such as treasury bills,

commercial papers and certificates of deposit. It is used by many participants, including
companies, to raise funds by selling commercial papers in the market. Money market is
considered a safe place to invest due to the high liquidity of securities.

The money market is an unregulated and informal market and not structured like the
capital markets, where things are organized in a formal way. Money market gives lesser
return to investors who invest in it but provides a variety of products. Withdrawing
money from the money market is easier. Money markets are different from capital
markets as they are for a shorter period of time while capital markets are used for longer
time periods. Money Market Vs. Capital Market:

Money Market is a place for short term lending and Borrowing normally within a year. It
deals in short term debt financing and investments. On the other hand Capital Market
refers to stock market which refers to trading in shares and bonds of companies on stock
exchanges. Individual investor cannot invest in money market as the value of
investments is huge on the other hand in capital market, anybody can make investments
through a broker. Stock Market is connected with high risk and high return as against
money market which is more protected. Further in case of money market deals are
transacted on phone or through electronic systems as against capital market where
trading is through recognized stock exchanges.

Money Market Instruments:

Investment in money market is done throughout money market instruments. Money

market instrument meets short term necessities of the borrowers and provides liquidity
to the lenders. Money Market Instruments are as follows:

 Treasury Bills (T-Bills)

 Repurchase Agreements

 Commercial Papers
 Certificate of Deposit

 Banker’s Acceptance

Treasury Bills (T-Bills)

Treasury Bills are one of the safest money market instruments are short term borrowing
instruments of the Central Government of the nation issued through the Central Bank
(RBI in India). They are risk free instruments and therefore the returns are not so
attractive. It is available both in primary market as well as secondary market. It is a
promise to pay a said sum after a particular period. T-bills are short-term securities that
mature in less than a year from their issue date. They are as 91 days, 182 days and 364
days 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
customer of the instrument. T-Bills are issued through a bidding process at auctions.

At present the Indian government 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 as this issuance are not permitted by GOI. Treasury bills are accessible for a
minimum amount of Rs.25,000 and in its multiples. Though 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 accessible at the bank’s website.

It also announces the correct dates of auction the amount to be auctioned and payment
dates by issuing press releases prior to every auction. Payment by allotters at the auction
is essential 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 stage for facilitate dealing in Government
Securities and Money Market Instruments. The level of discount is determined during
these Treasury auctions. RBI issues these instruments to absorb liquidity from the market
by contracting the money supply.

Secondary Market: From any other seller in the market holding the said security at
market. The most convenient mode of transacting in GOI Securities / Treasury Bills is by
opening Constituent SGL account with a Bank / NSDL. A Constituent SGL account is very
much like a depository account by means of which a person can engage in paperless
transaction in GOI Securities and Treasury Bills.

Repurchase Agreements
Repurchase transactions called Repo or Reverse Repo are transactions or short term
loans in which two parties agree to sell and repurchase the same safety. They are usually
used for overnight borrowing. Repo/Reverse Repo dealings can be done only between
the parties approved by RBI and in RBI approved securities viz. GOI and State Govt.
Securities, T-Bills, PSU Bonds, FI Bonds, Corporate Bonds etc. Under repurchase contract
the seller sells particular securities with an agreement to repurchase the same at an
equally determined future date and price. Likewise the buyer purchases the securities
with an agreement to resell the same to the seller on a decided date at a prearranged
price. Such a transaction is called a Repo when viewed from the perspective of the seller
of the securities and Reverse Repo when viewed from the viewpoint of the buyer of the
securities. Thus whether a given contract is termed as a Repo or Reverse Repo depends
on which party initiated the transaction.

The lender or buyer in a Repo is allowed to receive compensation for use of funds
provided to the counter-party. Successfully the seller of the security borrows money for a
period of time (Repo period) at an exacting rate of interest mutually agreed with the
buyer of the security who has lent the funds to the seller. The rate of interest agreed
upon is called the Repo rate. The Repo rate is negotiated by the counterparties
separately of the coupon rate or rates of the underlying securities and is influenced by
overall money market conditions.

Commercial Papers:

Commercial paper is a low-cost choice to bank loans. It is a short term unsecured

promissory note issued by corporates and financial institutions at a discounted value on
face value. They are generally issued with fixed maturity between one to 270 days and
for financing of accounts receivables, inventories and meeting short term liabilities. For
example a company has receivables of Rs 1 lac with credit period of 6 months, it will not
be able to liquidate its receivables before 6 months. If the company is in need of funds, it
can issue commercial papers in form of unsecured promissory notes at discount of 10%
on face value of Rs 1 lac to be matured after 6 months. The company has strong credit
rating and finds buyers effortlessly. The company is able to liquidate its receivables
instantly and the buyer is able to earn interest of Rs. 10,000 over a period of 6 months.
They yield higher returns as compared to T-Bills as they are less protected in comparison
to these bills; though chances of default are almost negligible but are not considered to
be zero risk instruments. Commercial paper being an instrument not backed by any
collateral, only firms with high quality credit ratings will find buyers easily without
offering any considerable discounts. They are issued by corporates to impart flexibility in
raising working capital resources at market determined rates. Commercial Papers are
actively traded in the secondary market since they are issued in the form of promissory
notes and are freely moveable in DMAT form.

Certificate of Deposit:
A Certificate of Deposit is a receipt for a deposit of money with a bank or a financial
institution. It differs from a fixed Deposit Receipt in two respects. First, it is issued for a
big amount and second, it is freely negotiable. The Reserve Bank of India announced the
scheme of Certificates of Deposit in March 1989. Certificate of Deposits are a popular
avenue for companies to invest their short-term surpluses because Certificate of
Deposits offer risk-free investment opportunity at rates of interest higher than Treasury
bills and term deposits, besides being fairly liquid. For the Issuing Banks, Certificate of
Deposits provides another source of mobilizing funds in bulk. CDs are discounted
instruments and are issued at a discounted price and redeemed at par value. The tenor
of issue can range from 7 days to 1 year, however most CDs are issued by banks for 3, 6
and 12 months. CDs can be issued to individuals (other than minors), corporations,
companies, trusts, funds, associations, etc. Non Resident Indians may also subscribe to
CDs. However they are mainly subscribed to by banks, mutual funds, provident and
pension funds and insurance companies. The minimum amount of a CD should be Rs. 1
lakh i.e., the minimum deposit that can be accepted from a single subscriber should not
be less than Rs 1 lakh and in multiples of Rs 1 lakh thereafter.

Differences between FD and CD:

Banker’s Acceptance

It is a small term credit investment created by a non-financial firm and guaranteed by a

bank to make payment. It is simply a bill of exchange drawn by a person and accepted
by a bank. It is a buyer’s assure to pay to the seller a certain particular amount at certain
date. The same is certain by the banker of the buyer in exchange for a claim on the
goods as security. The person drawing the bill must have a good credit rating otherwise
the Banker’s Acceptance will not be tradable. The most common term for these
instruments is 90 days. However they can vary from 30 days to180 days. For corporations
it acts as a negotiable time draft for financing imports, exports and other transactions in
goods and is highly useful when the credit worthiness of the foreign trade party is
unknown. The seller need not hold it until maturity and can sell off the same in
secondary market at discount from the face value to liquidate its receivables.

An individual player cannot invest in majority of the Money Market Instruments

therefore for retail market, money market instruments are repackaged into Money
Market Funds. A 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. Two modes of investment in money market viz Direct Investment in Money
Market Instruments & Investment in Money Market Funds.

Inter Corporate Deposits (ICDs):

An ICD is an unsecured loan extended by one corporate to another. This market allows
corporates with surplus funds to lend to other corporates. Also the better-rated
corporates can borrow from the banking system and lend in this market. As the cost of
funds for a corporate is much higher than that for a bank, the rates in this market are
higher than those in the other markets. Also, as ICDs are unsecured, the risk inherent is
high and the risk premium is also built into the rates. The tenor of ICD may range from 1
day to 1 year, but the most common tenor of borrowing is for 90 days. The market of
inter-corporate deposits maintains secrecy. The brokers in this market never reveal their
lists of lenders and borrowers, because they believe that if proper secrecy is not
maintained the rate of interest can fall abruptly.

The market of inter-corporate deposits depends crucially on personal contacts. The

decisions of lending in this market are largely governed by personal contacts.

Call/Notice/Term Money:

The call/notice/term money market is a market for trading very short term liquid
financial assets that are readily convertible into cash at low cost. The period of lending
may be for a period of 1 day which is known as call money and between 2 days and 14
days which is known as notice money. Term money refers to borrowing/lending of funds
for a period exceeding 14 days. The interest rates on such funds depends on the surplus
funds available with lenders and the demand for the same which remains volatile. The
trades are conducted both on telephone as well as on the NDS Call system, which is an
electronic screen based system set up by the RBI for negotiating money market deals
between entities permitted to operate in the money market. The settlement of money
market deals is by electronic funds transfer on the Real Time Gross Settlement (RTGS)
system operated by the RBI. The repayment of the borrowed money also takes place
through the RTGS system on the due date of repayment.

Sources:
• http://indianmoney.com/how/money-market-and-its-instruments
• http://www.investopedia.com/university/20_investments/10.asp
• http://www.investopedia.com/ask/answers/012815/how-are-treasury-bill-interest-
rates-determined.asp ;
• https://kbsonigara.wordpress.com/tag/money-market-instruments
• If you are interested in knowing what are the guidelines for the issuing of CPs and
CDs: http://www.fimmda.org/modules/content/?p=1033
• https://www.paisabazaar.com/mutual-funds/certificates-of-deposit-vs-fixed-deposits