INVESTMENT ALTERNATIVES

MONEY MARKET INSTRUMENTS

GROUP 1
INTRODUCTION TO FINANCIAL MARKETS:

Financial markets are the markets where the financial assets/products are created or
transferred. The markets are broadly classified as money market or fixed income market and
capital market.

The financial markets facilitate

 The raising of capital (in the capital markets).

 The transfer of risk (in the derivatives markets).
 International trade (in the currency markets).

The area of focus in the investment alternative is exclusively given to money market and the
instruments that facilitate investment in these markets.

INTRODUCTION TO MONEY MARKET:

 Money market is the centre for dealings, mainly short term character in money
assets.
 RBI defines money market as “a market for short term financial assets that are
close substitute for money, facilitates the exchange of money in primary and
secondary market”.
 It provides liquidity funding for the global financial system.
 It trades in short term financial instruments commonly called “paper”.
 Due to the highly liquid nature of the securities and their short term maturities,
money market is treated to be a safe investment avenue.
 The money market is the global financial market for short term borrowing and
lending. It provides short term liquid funding of the Global Financial System
(GFS).
CHARACTERISTICS OF MONEY MARKET:

 It is not a single market but a collection of markets for several instruments.

 It is a need based market wherein the demand and supply of money shape the
market. It is also called over – the – phone market.
 Dealing in money market can be accomplished with or without the help of
brokers.
 Financial assets which can be converted into money with ease, speed, without
loss and with minimum transaction costs are regarded as close substitutes for
money.

PLAYERS OF MONEY MARKET:

 Reserve Bank of India.

 SBI DFHI Ltd (Amalgamation of Discount and Finance House in India and SBI in
2004).
 Acceptance houses, Commercial banks, cooperative banks and primary dealers
are allowed to borrow and lend.
 Individuals, firms, companies, corporate bodies, trusts and institutions.

MONEY MARKET INSTRUMENTS:

 Call money market.

 Treasury Bills (T – Bills).
 Commercial Papers (CPs).
 Certificate of Deposits (CDs).
 Repurchase agreement.
 Bills Rediscounting (BRDs).
 Inter – bank participation certificates.
 Bankers Acceptance.
 Euro dollar.
 Money market mutual funds.
CALL MONEY MARKET:

 Call money are overnight funds in the banking system, which are borrowed or
advanced for not more than one day.
 For markets which need short term money to adjust their liquidity needs or have
surplus funds, call money market provides an avenue to borrow or lend funds.
 The transactions are not collateralized.
 If the borrowing is longer, it is termed as notice money or term money.
 The call market enables the banks and institutions to even out their day to day
deficits and surpluses of funds.
 Non – bank entities such as Corporate are not allowed to operate in the call
market.
 Interest rates are negotiated by the parties concerned.
 No brokers are permitted to deal in the call market.
 The transactions in call market are routed through current account of the parties
with RBI.

TREASURY BILLS (T – BILLS):

 T – Bills are short term money market instruments with a maturity of generally
14/91/182/364 days. Now, RBI issues T – Bills of maturity of 91 and 364 days.
 They are issued through the process of auction at discounted value.
 They are issued not in physical form but through Subsidiaries General Ledger
(SGL) account maintained by RBI for each participant.
 The transactions involved are huge, so the small investors stay away from this
investment.
 Investment in T – Bills are considered part of SLR securities for banks and
therefore, they are encouraged to invest in this instrument in spite of low returns.
 Banks, financial institutes, insurance companies, mutual funds, primary dealers
and large corporate who have short term funds generally invest in T – Bills.
 Yield of T – Bills = [(Face value – Issue price) * 365 / (Price * no: of days to
maturity)] * 100.
COMMERCIAL PAPERS (CPs):

 CPs is issued for the purpose of raising short term resources for the issuers at
very low rates.
 CPs is short – term, unsecured, negotiable usance promissory notes with
maturity issued by corporate, financial institutes and primary dealers.
 Maturity of CPs varies between 15 to 360 days.
 CPs is issued at discount rate and the difference between issue price and face
value is the yield for the investor.
 They can be issued in denomination of Rs 5, 00,000 or in multiples of it.
 Individuals (having large net worth), corporate, financial institutions, insurance
companies, banks can invest since they have large fund of investment.
 Company must have working capital limits with a bank which must have been
classified as “standard asset” by the bank.
 Company must obtain a rating for the issue of CP from a specified rating agency
such as CRISIL, ICRA or CARE.
 CPs attracts stamp duty as specified by Indian Stamp Act.

CERTIFICATE OF DEPOSITS (CDs):

 It is negotiable, short term instrument issued by banks and development financial

institutions.
 CDs are issued by banks and DFIs to augment their resources by paying
attractive rate of interest on large deposit on money by companies and wealthy
individuals.
 Deposit rates depend on funds position of banks and liquidity available in the
system. Higher the liquidity, the rates would drop, since bank would not be
interested in mobilizing deposits when they are flushed with funds.
 Stamp duty is payable at prescribed rates.
 Maturity period is from 15 days to 1 year. However, DFIs are allowed to issue
CDs for more than 3 years.
REPURCHASE AGREEMENTS:

 Repo or repurchase option is a transaction in which two parties agree to sell and
repurchase the same security after a predetermined period in exchange of funds
borrowed or lent at a negotiated rate of interest.
 The buyer purchases the securities with an agreement to resell the same to the
seller on an agreed date in a future at a predetermined price.
 Such a transaction is called a REPO when viewed from the perspective from
seller of securities and it is REVERSE REPO when seen from the perspective of
buyer of securities.
 REPO is also called Ready forward or Buy Back transaction.
 The user of funds pays interest on the funds borrowed as compensation to the
buyer of securities which is called a REPO rate.

BILLS REDISCOUNTING (BDRs):

 In order to make commercial bill an active instrument in the secondary money

market, RBI introduced bill rediscounting scheme in November 1970 and the
same was revised from time to time.
 The bank, which originally discounts the usance bill, will have to issue an
instrument known as “Derivative Usance Promissory Note” in favour of banker or
other approved financial institution with which it is rediscounting bills. Such
usance promissory note should be payable not more than 90 days from the date
of rediscounting.
 The usance promissory note should be backed by unencumbered usance bills of
exchange arising out of genuine commercial transactions evidencing sale of
goods.
 The negotiation of the usance promissory note shall be restricted to the
participants in the BDRs as approved by the RBI.
 Rediscounting of bills must be for a minimum period of 15 days.
INTER BANK PARTICIPATION CERTIFICATES (IBP):

 With a view to providing an additional instrument for evening out short-term

liquidity within the banking system, two types of Inter-Bank Participations (IBPs)
were introduced, one on risk sharing basis and the other without risk sharing.
 These are strictly inter-bank instruments confined to scheduled commercial
banks excluding regional rural banks. The IBP with risk sharing can be issued for
91-180 days and only in respect of advances classified under Health Code No. 1
Status.
 Under the uniform grading system introduced by Reserve Bank for application by
banks to measure the health of bank advances portfolio, a borrower account
considered satisfactory or assigned Health Code No. 1 is the one in which the
conduct of account is satisfactory, the safety of advance is not in doubt, all the
terms and conditions are complied with, and all the accounts of the borrower are
in order.
 The IBP risk sharing provides flexibility in the credit portfolio of banks. The rate of
interest is left free to be determined between the issuing bank and the
participating bank subject to a minimum 14.0 per cent per annum.
 The aggregate amount of such IBPs under any loan account at the time of issue
is not to exceed 40 per cent of the outstanding in the account.

BANKERS ACCEPTANCE (BA):

 Banker’s acceptance, or BA, is a negotiable instrument or time draft drawn on

and accepted by a bank. Before acceptance, the draft is not an obligation of the
bank; it is merely an order by the drawer to the bank to pay a specified sum of
money on a specified date to a named person or to the bearer of the draft.

 Upon acceptance, which occurs when an authorized bank accepts and signs it,
the draft becomes a primary and unconditional liability of the bank. If the bank is
well known and enjoys a good reputation, the accepted draft may be readily sold
in an active market.
  Bankers’ acceptance starts as an order to a bank by a bank's customer to pay a
sum of money at a future date, typically within six months. At this stage, it is like
a postdated check. When the bank endorses the order for payment as
"accepted", it assumes responsibility for ultimate payment to the holder of the
acceptance. At this point, the acceptance may be traded in secondary markets
much like any other claim on the bank. 

 Bankers' acceptances are considered very safe assets, as they allow traders to

substitute the banks' credit standing for their own. They are used widely in
international trade where the creditworthiness of one trader is unknown to the
trading partner.

 Acceptances sell at a discount from face value of the payment order, just as US
Treasury bills are issued and trade at a discount from par value. Bankers'
acceptances trade at a spread over T-bills. The rates at which they trade are
called bankers' acceptance rates. The Fed publishes BA rates in its weekly H.15
bulletin. Those rates are a standard index used as an underlier in various interest
rate swaps and other derivatives.

EURO DOLLAR:

 Eurodollars are deposits denominated in U.S. dollars at banks outside the United

States, and thus are not under the jurisdiction of the Federal Reserve.
 Consequently, such deposits are subject to much less regulation than similar
deposits within the U.S., allowing for higher margins.
 There is nothing "European" about Eurodollar deposits; a U.S. dollar-
denominated deposit in Tokyo or Caracas would likewise be deemed a
Eurodollar deposit. Neither is there any connection with the euro currency.
 The term was originally coined for U.S. dollars in European banks, but it
expanded over the years to its present definition.
MONEY MARKET MUTUAL FUNDS:

 An open – market mutual fund which invests money only in money markets.
These funds invest in short term (one day to one year) debt obligations such as T
– Bills, CDs and CPs.
 The main goal is the preservation of principal, accompanied by modest
dividends.
 The fund’s NAV remains a constant $1 per share to simplify accounting, but the
interest rate fluctuates.
 They are liquid investments and they are often used by financial institutions to
store money that is not currently invested.
 The return and risk factor is very low and there is also a remote possibility for the
fund to fail.
 The biggest risk involved in investing in money market fund is the risk that
inflation will out space the fund’s return, thereby eroding the purchasing power of
the investor’s money.

RECENT DEVELOPMENTS IN MONEY MARKETS:

 Integration of unorganized sector with the organized sector.

 Widening of call money market.
 Introduction to innovative money market instrument.
 Offering of market rates of interest.
 Promotion of bill culture.
 Entry of money market mutual funds.
 Setting up of credit rating agencies.
 Adoption of suitable monetary policy.
 Establishment of DFHI.
 Setting up of Security Trading Corporation of India Ltd (STCI).