Chapter 3

Money Market & Instruments

Dr. Krishna Murari
Introduction to Financial Markets
Financial market is a place or mechanism of enabling the meeting of
buyers and sellers with a view to transfer the funds in most economic
manner.

Financial markets mainly help in mobilizing the funds, provide liquidity,

help in price discovery and make investment related information available
to all the concerned people.

Broadly Financial market are classified in Three categories i.e. capital

Market, Money market and Foreign Exchange Market.
 Financial Markets & Instruments

Capital Market/ Securities market Foreign Exchange Money Market

Market

Secondary
Primary Market
Market

Instruments are:
Derivatives Commodities
Equity Market Debt Market Call Money/ Notice
Market Market
Methods of Money
Floating New Treasury Bills
Issue are:
Instruments are: Commercial Papers
Public Issue Instruments are: Instruments are:
Instruments are: all major Certificates of
Offer for sale Equity Shares Forwards
Debentures categories of Deposits
Private Preference Futures
Bonds goods Commercilal Bills
placement Shares
Options /commodities Repurchase
GDR/ADR Warrants such as Cotton,
Right Issue Swaps agreements
Warrants rice, Pulses etc.
Other Methods
Money Market
Money market is that part of financial market where instruments like securities, bonds having
short term maturities usually less than one year, are traded.

Money market does not indicate to any specific market place, rather it is the whole network
of financial institutions that deal in short-term funds.

Business organisations or financial institutions access money market to meet their short-
term fund requirements for buying inventories, raw material, paying loans and suppliers etc.

It is regulated by RBI
 Monetary Equilibrium

Promotes economic growth

Functions of Facilitates the growth of Trade and Industry

Money
Implementation of Monetary Policy
Market
Capital Formation

Source of Finance to Government

Structure of
Money
Market
 Call Money/ Notice Money

Commercial Bills

Instruments in Treasury Bills

Organised Commercial Papers

Sector of Certificates of Deposits

Money Repurchase Agreements

Market CBLO

Bankers’ Acceptance

MMMFs
 • Call money market is the market for very short
period loans i.e. maturity of loans varies from 1 day
to 14 days.
• If money is lent for one day, it is called call money
and

Call Money/ • if money is lent for a period of more than one day
and up to 14 days is called short notice money.
Notice Money • surplus funds of financial institutions and banks are
traded.
• There is no requirement for collateral security
against call money.
• Call money is required mostly by banks to meet
their statutory reserve requirements such as CRR
 • when goods are sold on credit, the buyer must pay the due amount after
certain period.
• During this period, the seller draws a bill of exchange on the buyer for the
amount due.
• The buyer accepts this bill of exchange immediately.
• After accepting and signing the bill, the buyer returns it to the seller. This bill
Commercial is called as trade bill.
• However, the seller may either retain the bill till maturity/ due date of
Bills payment or can get it discounted from some banker to get immediate cash.
• When such trade bills are accepted by commercial banks for discounting,
they are called as commercial bills.
• The bankers discount this commercial bill by deducting a certain amount
(called as discount and income to the banker) and balance is paid.
• As bankers discount the bills of exchange, this market is also called as
discount market.
 • These are negotiable instruments.
• These are generally issued for 30 days
to 120 days.
• These are self-liquidating instruments
with low risk.
Features of • These can be discounted with a bank.
Commercial • in case of need for funds to the bank, it
can get the bill re-discounted in the
Bills money market and get ready money.
• These are used for settling payments in
the domestic as well as foreign trade.
• The creditor who draws the bill is
called drawer and the debtor who
accepts the bill is called drawee.
 Demand Bills and Time Bills

Types of Clean Bills and Documentary Bills

Commercial
Bills Inland and Foreign Bills

Accommodation Bills and Supply

Bills
 • Treasury Bills were first issued in India in 1917.
• This is one of safest instrument to invest but it gives less
return as compared to other instruments.
• T-bills are issued by RBI backed with government security.
Generally, RBI issues the treasury bills on behalf of central
government to meet the short-term liquidity
Treasury Bills requirements of the central government.
• T-bills are issued at a discount and repaid at par on
(T-Bills) maturity.
• These are negotiable instruments and hence are freely
transferable.
• Treasury bills are available for a minimum amount of ₹
25,000 and in multiples of ₹ 25,000.
 Based on periodicity or maturity profile, currently, the
Government of India issues three types of treasury bills
through auctions, namely, 91-day, 182-day and 364-day
(most popular).
While 91-days T-bills are auctioned every week on
Wednesdays, 182-day and 364-day T-bills are auctioned
every alternate week on Wednesdays.
Types of T-
Bills T-bills auctions are held on the Negotiated Dealing System
(NDS) and the members electronically submit their bids on
the system.

Negotiated Dealing System (NDS) is an electronic platform for

facilitating dealing in Government Securities and Money
Market Instruments.
 • Commercial papers are issued by private
organisations having strong credit rating to meet
short term liquidity requirements.
• a commercial paper is an unsecured monetary
instrument issued by the private organizations, in
the form of promissory note to meet their short
Commercial working capital requirement.
• It acts as the debt instrument and is not backed by
Papers any collateral of the corporate organisations.
• The return on commercial papers is usually higher
than T-bills.
• The organisation that wishes to issue commercial
paper must satisfy minimum eligibility criteria as laid
down by RBI.
Minimum Eligibility guidelines to Issue
Commercial Papers
• Eligibility condition-Commercial Paper can be issued by a company whose-
• Tangible net worth (paid-up capital plus free reserves) is not less than ₹ 4 crores.
• Fund based working capital limits are not less than ₹ 4 crores.
• Specified Credit Rating of P2 is obtained from CRISIL, A2 from ICRA and PR2 from CARE.
• Borrowable health is classified under health code No. 1 and
• Current ratio is 1.33: 1.
• Period- Commercial Paper should be issued for a minimum period of 30 days and maximum of
one year.
• Denomination-Commercial Paper is issued in denominations of ₹ 5 lakhs. But the minimum lot or
investment is ₹ 25 lakhs (face value) per investor. The secondary market transactions can be for ₹
5 lakhs or multiples thereof.
 Ceiling- The aggregate amount that can be raised by commercial paper is 100
percent of the company's working capital limit as announced in November
1996.

Mode of Issue and Discount Rate- Commercial Paper should be in the form
of usance promissory note that are negotiable by endorsement and delivery.
These can be issued at discount as decided by the issuing company.

Issue Expenses- all issue related expenses such as dealers’ fees, rating

Contd.. agency fees and other relevant expenses as well as the charges of the bank
for providing stand-by facilities should be borne by the company.

Investors- Commercial Papers can be issued to any individual, bank, company

or other corporate body and incorporated body registered in India.

Procedure for Issue- Commercial Paper is issued only through the bankers
who have sanctioned working capital limits to the company.
 • CDs were introduced in June 1989.
• It is issued as a bearer instrument and is negotiable in the market.
• The face value is payable on maturity by the issuing bank.
• It has a maturity period ranging from 7 days to 365 days.
• Certificate of Deposit (CD) is a negotiable money market instrument
and issued in dematerialised form against funds deposited at a
Certificate of bank or other eligible financial institution for a specified time at a
market determined discount rate.

Deposit • All scheduled commercial banks (except Regional Rural Banks and
local area banks) and selected all India level financial institutions
are eligible to issue CDs.
• CDs are issued by banks during period of tight liquidity, at relatively
high interest rate.
• Banks rely on this source when the deposit growth is low, but credit
demand is high.
• Generally, minimum amount of CDs is ₹ 1 lakhs.
 • Repo was introduced in December 1992.
Repurchase agreement is also known as Repo.
• Repo is a contract between the seller and a
buyer of debt securities wherein the seller will
repurchase the securities after certain period.
Repurchase • Here the seller pays a higher price to
repurchase the securities, than what he sold
Agreements them.
(Repo) • This difference in the repurchase price and the
original selling price is called as repo rate.
• In simple words, repo means selling a security
under an agreement to repurchase it at a
predetermined date and rate.
 Policy Rates:
• Bank Rate: Bank rate is rate at which central bank (RBI) lends money to
other banks or financial institutions. In case bank rate is hiked, all
commercial banks will hike their own lending rates to ensure that they
continue to make profit.
• Repo Rate: Repo (Repurchase) rate is the rate at which the RBI lends
shot-term money to the banks against securities. When the repo rate
increases borrowing from RBI becomes more expensive. Similarly, if RBI
wants to make borrowings cheaper for banks, it reduces the repo rate.
• Reverse Repo Rate: Reverse Repo rate is the rate at which the
Policy Rates commercial banks park their short-term excess liquidity with the RBI. The
commercial banks use this tool when they feel that they have excess
and Reserve funds and are not able to invest anywhere for reasonable returns. An
increase in the reverse repo rate means that the RBI is ready to borrow
Ratios money from the banks at a higher rate of interest. As a result, banks
would prefer to keep more and more surplus funds with RBI.
• Thus, we can conclude that Repo Rate signifies the rate at which liquidity
is injected in the banking system by RBI, whereas Reverse repo rate
signifies the rate at which the RBI absorbs liquidity from the banks
• Marginal Standing Facility Rate: Marginal Standing Facility (MSF) rate
refers to the rate at which the scheduled banks can borrow funds
overnight from RBI against government securities. MSF is a very short-
term borrowing scheme for scheduled commercial banks.
Reserve Ratios:
• Statutory Liquidity Ratio: every bank must maintain a minimum proportion of
their Net Demand and Time Liabilities (NDTL) as liquid assets in the form of cash,
gold and other approved securities, at the close of business every day. This ratio
of liquid assets to NDTL is known as Statutory Liquidity Ratio (SLR). RBI is
empowered to increase this ratio up to 40%.
• What is current SLR?
• Cash Reserve Ratio: it is that proportion of the total deposits of commercial
banks which they must deposit with RBI in the form of cash. Thus, when a bank’s
deposits increase by ₹ 100, 000 and if the cash reserve ratio is 6%, the banks will
have to hold additional ₹ 6000 with RBI and Bank will be able to use only ₹ 94,000
for investments and lending purpose.
• This power of RBI to reduce the lendable amount by increasing the CRR, makes it
an instrument in the hands of a central bank through which it can control the
amount that banks lend.
• What is current CRR?
 • CBLO is a money market instrument that represents
an obligation between a borrower and a lender as to
the terms and conditions of the loan.
Collateralised • CBLOs are used by those who have been restricted
in the interbank call money market.
Borrowing and • Under CBLO operations, an organisation with
surplus funds lend out its money in the market to
Lending other organisations in need of funds with collateral
in place.
Obligations • Whereas call money market caters to the need of
(CBLO) banks and primary dealers, CBLO mostly lends out
to mutual funds, insurance & financial companies
etc. besides to primary dealers and banks.
• The only difference is that CBLO involves collateral.
 • A bankers’ acceptance is a commercial bank draft
necessitating the bank to pay the holder of the
instrument a specified amount on a specified date.
• The duration of maturity of bankers’ acceptance is
typically 90 days from the date of issue but can
Bankers’ range from 1 to 180 days.
• It is issued at a discount, and paid in full at maturity,
Acceptance and the difference between the value at maturity
and the value when it was issued, is known as the
interest.
• A bankers’ acceptance is generally used for
international trade as means of guaranteeing
payment.
 • A Scheme of MMMFs was introduced by RBI in
1992 with a goal to provide an additional short-
term avenue to individual investors.
• A money market mutual fund is a mutual fund
Money Market that invests exclusively in money market
instruments that mature in less than one year
Mutual Funds and are very liquid.
(MMMFs) • Usually, Treasury bills comprise of majority of
investment proportion among the other money
market instruments in MMMFs.
• The operation of MMMFs in money market is
regulated and monitored by SEBI.
 Lack of integration

Disparities in interest rates

Seasonal diversity of money market

Problems of
Indian Money Absence of bill market
Market Limited instruments & Participants

Restricted secondary market

No Linkage with foreign money markets