Crack Grade B 1

Money market

The money market is a market for financial assets that are close substitutes for money. It is a market for
overnight to short-term funds and instruments having a maturity period of one or less than one year.

The Money Market functions as a wholesale debt market for low-risk, highly liquid, short term instruments.
Funds are available in this market for periods ranging from a single day upto a year.

Mostly Government, banks and financial institutions dominate this market.

The ‘repo rate’ of the time (announced by the RBI) works as the guiding rate for the current ‘discount rate.
The short-term period is defined as upto 364 days.

Government is an active player in the Money Market and in most of the economies; it constitutes the
biggest borrower in this market.

Both, Government securities (G-secs) and Treasury bill (T-bill) is a security issued by RBI on behalf of the
Government of India to meet the latter’s borrowing for financing fiscal deficit.

Apart from functioning as a banker to the government, the central bank (RBI) also regulates the Money
Market and issues guidelines to govern the Money Market operations.

The Reserve Bank influences liquidity and interest rates through a number of operating instruments— cash
reserve requirement (CRR) of banks, conduct of open market operations (OMOs), repos, change in bank
rates, and, at times, foreign exchange swap operations.

The characteristics of the money market are as follows:

• 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 creditworthiness of the participants is important.
• The main players are: the Reserve Bank of India (RBI), the Discount and Finance House of India (DFHI),
mutual funds, insurance companies, banks, corporate investors, non-banking finance companies (NBFCs),
state governments, provident funds, primary dealers, the Securities Trading Corporation of India (STCI),
public sector undertakings (PSUs), and non-resident Indians.
• It is a need-based market wherein the demand and supply of money shape the market.

Money Market in India: The organised form of money market in India is just close to three decades old.
However, its presence has been there, but restricted to the government only. It was the Chakravarthy
Committee (1985) which, for the first time, underlined the need of an organised money market in the
country and the Vahul Committee (1987) laid the blue print for its development. Today, money market in
India is not an integrated unit and has two segments—Unorganised Money Market and Organised Money
Market.

Unorganised Money Market: Unregulated Non-Banking Financial Intermediaries are functioning in the
form of chit funds, nidhis, Indigenous Bankers, Money Lenders, which lend to only their members) and loan
companies. They charge very high interest rates (i.e., 36 to 48 per cent per annum), thus, are exploitative
in nature and have selective reach in the economy. Earlier NBFCs were part of unorganized Money Market
and were put under the regulatory control of the RBI in 1997.

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The chit funds are governed by Chit Funds Act, 1982 which is a Central Act administered by state
governments. RBI has prohibited chit fund companies from accepting deposits from the public in 2009. In
case any Chit Fund is accepting public deposits, RBI can prosecute such chit funds. Chit funds are included
in the definition of Non- Banking Financial Companies by RBI under the sub-head miscellaneous non-
banking company (MNBC).

Indigenous bankers receive deposits and lend money in the capacity of an individual or a private firms.
Example: Gujarati Shroffs: They operate in Mumbai, Kolkata as well as in industrial, trading and port cities
in the region.

Money Lenders: They constitute the most localised form of money market in India and operate in the most
exploitative way. They have their two forms:
(a) The professional money lenders who lend their own money as an profession to earn income through
interest.
(b) The non-professional money lenders who might be businessmen and lend their money to earn interest
income as a subsidiary business.

Nidhi company notified under section 620-A of the Companies Act is classified at present as "Mutual
Benefit Financial Company" by RBI and regulated by the Bank for its deposit taking activities and by
Department of Corporate Affairs, Ministry of Corporate Affairs for its operational matters as also the
deployment of funds. Nidhis are also included in the definition of Non- Banking Financial companies or
(NBFCs) which operate mainly in the unorganized money market. Mutual benefit company (MBC), i.e.
potential nidhi company; i.e., A company which is working on the lines of a Nidhi company but has not yet
been so declared by the Central Government; has minimum net owned fund(NOF) of Rs.10 lakh, has
applied to the RBI for certificate of registration and also to Department of Company Affairs (DCA) for being
notified as Nidhi company and has not contravened directions/ regulations of RBI/DCA.

Ponzi Schemes or Money circulation/multi-level marketing/Chain schemes are schemes promising easy or
quick money upon enrollment of members. Income under Multi-level marketing or pyramid structured
schemes do not come from the sale of products they offer as much as from enrolling more and more
members from whom hefty subscription fees are taken. It compels members to enroll more members, as a
portion of the subscription amounts so collected are distributed among the members.

Organised money market: The organized segment consists of the Reserve Bank of India, State Bank of
India with its associate Banks, Public Sector Banks, Private Sector Commercial Banks including Foreign
Banks, Regional Rural Banks, Non- Scheduled Commercial Banks, apart from Non-banking Financial
Intermediaries such as LIC, GIC etc. Since the government started developing the organised money market
in India (mid-1980s), we have seen the arrival of a total of eight instruments designed to be used by
different categories of business and industrial firms. A brief description of these instruments follows:

(i) Call Money is a Money Market instrument wherein funds are borrowed / lent for a tenor of one day
overnight (excluding Sundays/holidays).

Notice Money is a Money Market instrument, where the tenor is more than 1 day but less than 15 days.
The borrower/lender must convey his intention to repay/recall the amount borrowed/lent with at least 24
hours notice.

Term Money: Money lent for a fixed tenor of 15 days to 364 days is called Term Money.

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Borrowing in this market may take place against securities or without securities. Rate of interest in this
market ‘glides’ with the ‘repo rate’ of the time the principle remains very simple longer the period, higher
the interest rate. Depending upon the availability and demand of fund in this market the real call rate
revolves nearby the current repo rate.

The scheduled commercial banks, co-operative banks operate in this market as both the borrowers and
lenders while LIC, GIC, Mutual Funds, IDBI and NABARD are allowed to operate as only lenders in this
market.

The interest rate paid on call money loans is known as the ‘call rate.’ It is a highly volatile rate. It varies
from day-to-day, hour-to-hour, and sometimes even minute-to-minute

The Call/Notice Money transactions can be executed either on NDS-Call(Negotiated dealing system call), a
screen–based, negotiated, quote-driven electronic trading system managed by the Clearing Corporation of
India (CCIL), or over the counter (OTC) through bilateral communication.

Interest on the amount borrowed/lent =

[Amount borrowed or lent *No. of days * Rate of Interest]/ 365 * 100

Why Call Money: Call money is required mostly by banks. Commercial banks borrow money without
collateral from other banks to maintain a minimum cash balance known as the cash reserve requirement
(CRR). This interbank borrowing has led to the development of the call money market.

The Mumbai Inter Bank Bid (MIBID) is the weighted average interest rate at which certain banks in
Mumbai are ready to borrow from the call money market, MIBID is not the rate at which banks attract
deposits from other banks.

The Mumbai Inter Bank offer Rate (MIBOR) is the weighted average interest rate at which certain
banks/institutions in Mumbai are ready to lend in the call money market. MIBOR is the Indian version
of London Interbank Offer Rate (LIBOR). MIBOR is fixed for overnight to 3 month long funds and these
rates are published every day at a designated time. Of the above tenors, the overnight MIBOR is the most
widely used one which is used for pricing and settlement of Overnight interest rate Swaps (OIS).
Corporates use the OIS for hedging their interest rate risks.

Overnight interest rate swaps are currently prevalent to the largest extent. They are swaps where the
floating rate is an overnight rate (such as NSE MIBOR) and the fixed rate is paid in exchange of the
compounded floating rate over a certain period.

The MIBID/MIBOR rate is also used as a bench mark rate for majority of deals struck for Interest Rate
Swaps (IRS), Forward Rate Agreements (FRA), Floating Rate Debentures and Term Deposits.

London Interbank Offered Rate (LIBOR) is the interest rate on dollar and other foreign currency deposits
at which larger banks are prepared to borrow and lend these currencies in the Euro-currency market. The
rate reflects market conditions for international funds and are widely used by the banks as a basis for
determining the interest rates charged on the US dollar and foreign currency loans to the business
customers.

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LIBOR was first published in 1986 for three currencies - USD, GBP (Great Britain Pound) and JPY (Japanese
Yen). Later on several other currencies were added in the list (currently 10 currencies). It is
published daily at 11:30 A.M (London time) by Thomson Reuters. Formerly the Libor was maintained
by British Bankers' Association (BBA).
The responsibility of LIBOR was handed over to Inter-Continental Exchange on February 01, 2014
administered by ICE Benchmark Administration (IBA). (This was done after detection of scandal in the
calculations of LIBOR).

Since then it is also called by the name of ICE-LIBOR. Currently it constitutes of five major currencies i.e.
CHF (Swiss Franc), EUR (Euro), GBP (Pound Sterling), JPY (Japanese Yen), and USD (US Dollar). The rates are
now quoted for overnight, one week, and 1, 2, 3, 6 and 12 months.

Fixed Income Money Market and Derivatives Association of India (FIMMDA), an association of Scheduled
Commercial Banks, Public Financial Institutions, Primary Dealers and Insurance Companies was
incorporated as a Company under section 25 of the Companies Act,1956 on May 4th, 1998.

FIMMDA is a voluntary market body for the bond, money and derivatives markets.

FIMMDA has members representing all major institutional segments of the market. The membership
includes Nationalized Banks such as State Bank of India, its associate banks and other nationalized banks;
Private sector banks such as ICICI Bank, HDFC Bank, IDBI Bank; Foreign Banks such as Bank of America, ABN
Amro, Citibank, Financial institutions such as IDFC, EXIM Bank, NABARD, Insurance Companies like Life
Insurance Corporation of India (LIC), ICICI Prudential Life Insurance Company and all Primary Dealers.

The FIMMDA represents market participants and aids the development of the bond, money and
derivatives markets.

It acts as an interface with the regulators on various issues that impact the functioning of these markets. It
also undertakes developmental activities, such as, introduction of benchmark rates and new derivatives
instruments, etc.

FBIL takes over from FIMMDA for valuation of govt. securities Reserve Bank of India has appointed
the Financial Benchmark India (FBIL) for valuation of portfolios of government securities, which earlier
used to be done by FIMMDA.

As per RBI directive, FIMMDA has ceased to publish prices/yield of government securities from March 31,
2018.

Financial Benchmark India (FBIL): Financial Benchmark India Private Ltd (FBIL) was jointly promoted by
Fixed Income Money Market & Derivative Association of India (FIMMDA), Foreign Exchange Dealers’
Association of India (FEDAI) and Indian Banks’ ‘Association (IBA). It was incorporated on 9th December
2014 under the Companies Act 2013.

It was recognised by Reserve bank of India as an independent Benchmark administrator on 2nd July 2015.
The main object of the company is to act as the administrators of the Indian interest rate and foreign
exchange benchmarks and to introduce and implement policies and procedures to handle the benchmarks. Its
headquarter is located at Mumbai.

FBIL has been publishing the benchmarks for Overnight MIBOR, Term MIBOR, FC-Rupee Option
Volatility Rate, CD Rates, TBills Rate and Market Repo Overnight Rate (MROR). While the FBIL MIBOR,
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CD Rate, TBills Rate and MROR are based on actual trades in the market, the FBIL - Term MIBOR and
FC-Rupee Option Volatility Rates are based on polled rates.

The FBIL is committed to providing financial benchmarks that are (i) free from bias, (ii) backed by robust
data driven research and (iii) compliant with global best practices.

Mumbai Interbank Outright Rate (MIBOR): FBIL announces the benchmark rate for Overnight Mumbai
Interbank Outright Rate (MIBOR) on a daily basis, except Saturdays, Sundays and local holidays. The
benchmark rate is calculated based on the actual call money transactions data obtained from the NDS-call
platform of Clearing Corporation of India Ltd (CCIL). The CCIL acts as the Calculating Agent. The rate is
announced at 10.45 AM every day.

Market Repo Overnight Rates (FBIL- MROR): FBIL announces the benchmark for Market Repo Overnight
Rates (FBIL- MROR) on a daily basis, except Saturdays, Sundays and local holidays.

The benchmark rate is calculated based on the Basket Repo trades executed on the Basket Repo segment
on the CROMS Platform of Clearing Corporation of India (CCIL) in the first hour of trading between 9.00 AM
to 10 AM. The CCIL acts as the Calculating Agent.

The rate is announced by 10.45 AM every day. However, if the time is extended due to non-fulfillment of
threshold criteria, the dissemination time may get suitably extended.

Term MIBOR: FBIL announces the benchmark rates for Term MIBOR for three tenors of 14-day, 1-month
and 3-month on a daily basis except Saturdays, Sundays and public holidays.

MIFOR (Mumbai Interbank Forward Outright Rate): The Mumbai Interbank Forward Offer Rate (MIFOR) is
the rate that Indian banks use as a benchmark for setting prices on forward-rate agreements and
derivatives. It is a mix of the London Interbank Offered Rate (LIBOR) and a forward premium derived from
Indian forex markets.

The Negotiated Dealing System, or NDS, is an electronic trading platform operated by the Reserve Bank of
India to facilitate the issuing and exchange of government securities and other types of money market
instruments and the Negotiated Dealing System (NDS) was introduced in February 2002. The Negotiated
Dealing System (NDS) has two modules – one for the primary market and the other for the secondary
market.

Government Security (G-Sec): A Government Security (G-Sec) is a tradeable instrument issued by the
Central Government or the State Governments. It acknowledges the Government’s debt obligation.

Such securities are short term (usually called treasury bills, with original maturities of less than one year) or
long term (usually called Government bonds or dated securities with original maturity of one year or more).

In India, the Central Government issues both, treasury bills and bonds or dated securities while the State
Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs).
G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.

State Development Loans (SDLs): State Governments also raise loans from the market which are called
SDLs. SDLs are dated securities issued through normal auction similar to the auctions conducted for dated
securities issued by the Central Government. Interest is serviced at half-yearly intervals and the principal is
repaid on the maturity date.

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Like dated securities issued by the Central Government, SDLs issued by the State Governments also
qualify for SLR.

They are also eligible as collaterals for borrowing through market repo as well as borrowing by eligible
entities from the RBI under the Liquidity Adjustment Facility (LAF).

State Governments have also issued special securities under “Ujjwal Discom Assurance Yojna (UDAY)
Scheme for Operational and Financial Turnaround of Power Distribution Companies (DISCOMs)” notified
by Ministry of Power.

(ii) Treasury Bills (TBs):. They are used by the Central Government to fulfill its short-term liquidity
requirement up to the period of 364 days. There developed five types of the TBs in due course of time:
(a) 14-day (Intermediate TBs)
(b) 14-day (Auctionable TBs)
(c) 91-day TBs
(d) 182-day TBs
(e) 364-day TBs

Treasury bills are zero coupon securities and pay no interest. They are issued at a discount and redeemed
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/-.
The return to the investors is the difference between the maturity value or the face value (that is Rs.100)
and the issue price.

Treasury bills are available for a minimum amount of Rs. 25,000 and in multiples thereof. Out of the above
five variants of the TBs, at present only the 91-day TBs, 182-day TBs and the 364-day TBs are issued by the
government.

Treasury bills have an assured yield, low transaction cost, and are eligible for inclusion in the securities for
SLR purposes.

The auction of treasury bills is done only at Reserve Bank of India, Mumbai. Auction committee of Reserve
Bank of India decides the cut-off price and results are announced on the same day.

Types of T-Bills:

There are three categories of T-bills.

On-tap Bills: On-tap bills, as the name suggests, could be bought from the Reserve Bank at any time at an
interest yield of 4.66 per cent. They were discontinued from April 1, 1997, as they had lost much of their
relevance.
Ad hoc Bills: Ad hoc bills were introduced in 1955. It was decided between the Reserve Bank and the
Government of India that the government could maintain with the Reserve Bank a cash balance of not less
than Rs. 50 crore on Fridays and Rs. 4 crore on other days, free of obligation to pay interest thereon, and
whenever the balance fell below the minimum, the government account would be replenished by the
creation of ad hoc bills in favour of the Reserve Bank. Ad hoc 91-day T-bills were created to replenish the
government’s cash balances with the Reserve Bank. System of Ways and Means Advances from April 1,
1997 was introduced to replace ad hoc bills and to accommodate temporary mismatches in the
government of India receipts and payments.

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Auctioned T-Bills: Auctioned T-bills, the most active money market instrument, were first introduced in
April 1992. The Reserve Bank receives bids in an auction from various participants and issues the bills
subject to some cut-off limits. Thus, the yield of this instrument is market determined. These bills are
neither rated nor can they be rediscounted with the Reserve Bank. At present, the Reserve Bank issues T-
bills of three maturities—91-days, 182-days, and 364-days.

The yield/return of a Treasury Bill is calculated as per the following formula:

Y = [(100 – P) X 365 X 100] / (P X D)

Wherein Y = Discounted yield
P = Price
D = Days to maturity

Example
A co-operative bank wishes to buy 91 Days Treasury Bill on Oct. 12, 2013 which is maturing on Dec. 6,
2013. The rate quoted by seller is ` 99.1489 per ` 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)
Yield to Maturity (YTM) = (100-99.1489) x 365 x 100/(99.1489*55) = 5.70%

Certificate of Deposit (CD): Certificate of Deposits (CDs) is a negotiable Money Market instrument and
issued in dematerialised form as well as physical certificate or as Usance Promissory Note, for funds
deposited at a bank or other eligible financial institution for a specified time period. CDs are short-term
borrowings by banks in the form of Usance Promissory Notes having a maturity of not less than 7 days up
to a maximum of one year. CD is subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central
Act).

They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable
instruments and are often referred to as Negotiable Certificate of Deposits.

Features of CD

 All scheduled banks (except RRBs and Co-operative banks) are eligible to issue CDs
 Issued to individuals, corporations, trusts, funds and associations
 They are issued at a discount rate freely determined by the issuer and the market/investors.
 Freely transferable by endorsement and delivery. At present CDs are issued in physical form.

CDs can be issued by:

(i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and

(ii) selected all-India Financial Institutions that have been permitted by RBI to raise short-term resources
within the umbrella limit fixed by RBI.

These are issued in denominations of Rs. 1 Lac and multiples of Rs. 1 Lac thereafter. Bank CDs have
maturity up to one year. Minimum period for a bank CD is Seven days. Financial Institutions are allowed to
issue CDs for a period between 1 year and up to 3 years. CDs issued by All India Financial Institution’ (AIFI)
are also issued in physical form (in the form of Usance promissory note) and is issued at a discount to the
face value.

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CDs may be issued at a discount on face value. There is no lock-in period for the CDs. Banks / FIs cannot
grant loans against CDs. Furthermore, they cannot buy-back their own CDs before maturity. CDs can be
traded over OTC.

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.
CP can be issued for maturities between a minimum of 7 days and a maximum of up to 1 year from the
date of issue. CP can be issued in denominations of `5 lakh and multiples thereof.

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.

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 –

a. the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4
crore
b. company has been sanctioned working capital limit by bank/s or all-India financial institution/s; and
c. the borrowal account of the company is classified as a Standard Asset by the financing bank/s/
institution/s.

d.Credit Rating not lower than A2 or its equivalent - by Credit Rating Agency approved by Reserve Bank of
India.

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.

Commercial Papers can be issued in both physical and demat form. When issued in the physical form
Commercial Papers are issued in the form of Usance Promissory Note. Commercial Papers are issued in the
form of discount to the face value. Further, CPs are traded in the OTC markets.

Money Market Mutual Funds: A mutual fund that invests only in money markets such as commercial
papers, commercial bills, and treasury bills certificate of deposit and other instruments specified by RBI.
These funds have a minimum lock-in period of 15 days. Till recently, the RBI regulated money market funds
but they now come under SEBI. The limit for raising resources under the MMMF scheme should not exceed
2% of the sponsoring bank’s fortnightly average aggregate deposits.

COMMERCIAL BILLS / Bill of Exchange: Commercial bill is a short-term, negotiable, and self-liquidating
instrument with low risk. It enhances the liability to make payment on a fi xed date when goods are bought
on credit.

According to the Indian Negotiable Instruments Act, 1881, a bill of exchange is a written instrument
containing an unconditional order, signed by the maker, directing to pay a certain amount of money only
to a particular person, or to the bearer of the instrument.

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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.

The bank discounts this bill by keeping a certain margin and credits the proceeds. Banks, when in need of
money, can also get such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI, and IRBI.
The maturity period of the bills varies from 30 days, 60 days, or 90 days, depending on the credit extended
in the industry.

There are three entities that may be involved with a bill of exchange transaction. They are:
Drawee: This party pays the amount stated on the bill of exchange to the payee.
Drawer: This party requires the drawee to pay a third party (or the drawer can be paid by the drawee).
Payee: This party is paid the amount specified on the bill of exchange by the drawee.

Cash Management Bill (CMB): The Government of India, in consultation with the Reserve Bank of India,
has decided to issue a new short-term instrument, known as Cash Management Bills (CMBs), to meet the
temporary mismatches in the cash flow of the Government.

The CMBs have the generic character of T-bills but are issued for maturities less than 91 days.

Like T-bills, they are also issued at a discount and redeemed at face value at maturity. The tenure, notified
amount and date of issue of the CMBs depend upon the temporary cash requirement of the Government.
The announcement of their auction is made by Reserve Bank of India through a Press Release which will be
issued one day prior to the date of auction.

The settlement of the auction is on T+1 basis.

It should be noted here that the existing Treasury Bills serve the same purpose, but as they were put under
the WMAs (Ways & Means Advances) provisions by the Government of India in 1997.

Dated Government Securities: Dated Government securities are long term securities and carry a fixed or
floating coupon (interest rate) which is paid on the face value, payable at fixed time periods (usually half-
yearly). The tenor of dated securities can be up to 30 years.

The Public Debt Office (PDO) of the Reserve Bank of India acts as the registry / depository of Government
securities and deals with the issue, interest payment and repayment of principal at maturity. Most of the
dated securities are fixed coupon securities.

Instruments:
Fixed Rate Bonds – These are bonds on which the coupon rate is fixed for the entire life of the
bond. Most Government bonds are issued as fixed rate bonds.

Floating Rate Bonds – Floating Rate Bonds are securities which do not have a fixed coupon rate. The
coupon is re-set at pre-announced intervals (say, every six months or one year) by adding a spread over a
base rate. In the case of most floating rate bonds issued by the Government of India so far, the base rate is
the weighted average cut-off yield of the last 364- day .

Zero Coupon Bonds – Zero coupon bonds are bonds with no coupon payments. Like Treasury Bills, they are
issued at a discount to the face value. The Government of India issued such securities in the nineties; it has
not issued zero coupon bonds after that.
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Capital Indexed Bonds – These are bonds, the principal of which is linked to an accepted index of inflation
with a view to protecting the holder from inflation. A capital indexed bond, with the principal hedged
against inflation, was issued in December 1997. These bonds matured in 2002. The government is currently
working on a fresh issuance of Inflation Indexed Bonds wherein payment of both, the coupon and the
principal on the bonds, will be linked to an Inflation Index. (Consumer Price Index)

Bonds with Call/ Put Options – Bonds can also be issued with features of optionality wherein the issuer
can have the option to buy-back (call option) or the investor can have the option to sell the bond (put
option) to the issuer during the currency of the bond. The optionality on the bond could be exercised after
completion of five years tenure from the date of issuance on any coupon date falling thereafter. The
Government has the right to buy back the bond (call option) at par value (equal to the face value) while the
investor has the right to sell the bond (put option) to the Government at par value.

Repos and Reverse Repos: In the era of economic reforms there developed two new instruments of
money market—repo and reverse repo. Considered the most dynamic instruments of the Indian money
market they have emerged the most favoured route to raise short-term funds in India. ‘Repo’ is basically
an acronym of the rate of repurchase.

The RBI in a span of four years, introduced these instruments—repo in December 1992 and reverse repo in
November 1996. Repo allows the banks and other financial institutions to borrow money from the RBI for
short-term (by selling government securities to the RBI).

In reverse repo, the banks and financial institutions purchase government securities from the RBI (basically
here the RBI is borrowing from the banks and the financial institutions).

All government securities are dated and the interest for the repo or reverse repo transactions are
announced by the RBI from time to time.

The provision of repo and the reverse repo have been able to serve the liquidity evenness in the economy
as the banks are able to get the required amount of funds out of it, and they can park surplus idle funds
through it.

These instruments have emerged as important tools in the management of the monetary and credit policy
in recent years.

Accepting the recommendations of the Urjit Patel Committee, the RBI in April 2014 (while announcing the
first Bi-monthly Credit & Monetary Policy-2014–15) announced to introduce term repo and term reverse
repo. This is believed to bring in higher stability and better signaling of interest rates across different loan
markets in the economy.

Gilt-edged (Government) Securities: Government securities are instruments issued by the government to
borrow money from the market as per Government Securities Act, 2006. They are also known as gilts or
gilt edged securities.

These have great demand by the banks to maintain the Net Demand and Time Liquidities (NDTL) position
of the bank through its buying and selling. These securities are issued by Governments such as Central and
State Governments, Semi-Government Authorities, Municipalities etc.

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They are long dated securities and held by the RBI. These issues are notified a few days before opening for
subscription and offer is kept open for two to three days. The rate of interest is lower but it is payable half
yearly.
Following features of government securities earned them the name of gilt edged securities.
 They have zero income default.
 Interest payments are regular.
 There is cent per cent liquidity.

Auction system:
What is Dutch auction?
When all the bids accepted are equal to or above the cut off price it is known as Dutch Auction.
What is French Auction?
When all the bids accepted at the cut off level it is known as French Auction.

Municipal bonds are bonds issued by urban local bodies- municipal bodies and municipal corporates
(entities owned by municipal bodies) to raise money for financing specific projects specifically
infrastructure projects.

These bonds are attracting attention as the ULBs urgently need money to finance infrastructural
expenditure. Especially, smart cities and other urban development projects necessitates them to create
finance.

Municipal bonds are there in India from 1997 onwards. Bangalore Municipal Corporation was the first ULB
to issue Municipal Bond in India in 1997.

Municipal bonds in India has tax-free status if they conform to certain rules and their interest rates will be
market-linked. Both pubic issue and private issue can be adopted for municipal bonds.

As per the SEBI Regulations, 2015, a municipality or a Corporate Municipal Entity (CME) should meet
certain conditions:
 The ULB should not have negative net worth in any of three immediately preceding financial years.
 Non-default: The municipality should not have defaulted in repayment of debt securities or loans
obtained from banks or financial institutions during the last 365 days.

Electoral bonds:
Electoral bonds will allow donors to pay political parties using banks as an intermediary.

Key features: Although called a bond, the banking instrument resembling promissory notes will not carry
any interest. The electoral bond, which will be a bearer instrument, will not carry the name of the payee
and can be bought for any value, in multiples of Rs 1,000, Rs 10,000, Rs 1 lakh, Rs 10 lakh or Rs 1 crore.

Eligibility: As per provisions of the Scheme, electoral bonds may be purchased by a citizen of India, or
entities incorporated or established in India. A person being an individual can buy electoral bonds, either
singly or jointly with other individuals. Only the registered Political Parties which have secured not less
than one per cent of the votes polled in the last Lok Sabha elections or the State Legislative Assembly are
eligible to receive the Electoral Bonds.

Need: The electoral bonds are aimed at rooting out the current system of largely anonymous cash
donations made to political parties which lead to the generation of black money in the economy.

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The electoral accounts are issued by the State Bank of India (SBI). The electoral bonds can be purchased
in the months of January, April, July and October.

The bonds remain valid for 15 days and can be encashed by an eligible political party only through a
bank account with the authorized bank within that period only.

Letter of credit (L/C): It is a document issued by a bank or financial institution at the request of a buyer
whereby the bank or financial institution gives assurance of payment to a seller if the terms and conditions
specified in the document are fulfilled. This means that Letter of Credit is a promise made by Bank to pay
to exporter / seller on behalf of importer / buyer. The seller receives the payment only when all the
requirements specified in the L/C are met including the documents, delivery dates, product specification,
etc.

Thus, a Letter of Credit has three parties:

 Applicant (importer) requests the bank to issue the LC
 Issuing bank (importer’s bank which issues the LC
 Beneficiary (exporter)

Letter of Undertaking is a contract of promise, to pay a liability (loan), of a third person (the importer) in
case of his default. The LoU is between two banks (the issuing Indian bank and the buyer’s credit providing
overseas bank). On the other hand, there is Letter of Comfort if the guarantee is provided by a bank to its
foreign branch.

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