LETTER OF TRANSMITTAL

April 23, 2014

To
Md. Masud Chowdhury
Lecturer
Department of Finance & Banking
Jatiya Kabi Kazi Nazrul Islam University
Mymensingh.

Subject: Assignment on Money market and its Instruments.

Dear Sir,
I have submitted my assignment on Money market and its Instruments of course
Financial Markets and Institutions. I obviously ensure you that this assignment is
prepared by me and I do not make any copy from anyone. I ensure that this assignment
has enhanced both my knowledge and experience about Money market Instruments.

Thanking you for your valuable advice and co-operation.

Yours faithfully

Pankaze Pada Bhoumik

ID: 11132603
Session: 2010-11

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 Table of Contents

Introduction…………………………………………………………..02-02

Money Market & Capital Market………………………………..…02-02

Money Market Instruments…………………………………………02-02

Characteristics Money Market Instruments……………………….03-03

Commonly Used Money Market Instruments………………..…….03-07

Broadly discussion about the Instruments of Money

Market………………………………………………..……………….08-18

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 Introduction
Money market means market where money or its equivalent can be traded. Money is
synonym of liquidity. Money market consists of financial institutions and dealers in
money or credit who wish to generate liquidity. It is better known as a place where
large institutions and government manage their short term cash needs. For generation
of liquidity, short term borrowing and lending is done by these financial institutions
and dealers. Money Market is part of financial market where instruments with high
liquidity and very short term maturities are traded. Due to highly liquid nature of
securities and their short term maturities, money market is treated as a safe place.
Hence, money market is a market where short term obligations such as treasury bills,
commercial papers and bankers acceptances are bought and sold.

Money Market & Capital Market

Money Market is a place for short term lending and borrowing, typically 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 recognized stock exchanges. Individual players cannot invest in money
market as the value of investments is large, on the other hand, in capital market,
anybody can make investments through a broker. Stock Market is associated with high
risk and high return as against money market which is more secure. 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 through money market instruments. Money

market instrument meets short term requirements of the borrowers and provides
liquidity to the lenders.

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 Characteristics Money Market Instruments

Money market instruments give businesses, financial institutions and governments a

means to finance their short-term cash requirements. Three important characteristics
are:

 Liquidity - Since they are fixed-income securities with short-term maturities of

a year or less, money market instruments are extremely liquid.

 Safety - They also provide a relatively high degree of safety because their
issuers have the highest credit ratings.

 Discount Pricing- A third characteristic they have in common is that they are
issued at a discount to their face value.

Commonly Used Money Market Instruments

1. MONEY MARKET AT CALL AND SHORT NOTICE

Next in liquidity after cash, money at call is a loan that is repayable on demand, and
money at short notice is repayable within 14 days of serving a notice. The participants
are banks & all other Indian Financial Institutions as permitted by RBI. The market is
over the telephone market, non bank participants act as lender only. Banks borrow for
a variety of reasons to maintain their CRR, to meet their heavy payments, to adjust
their maturity mismatch etc.

2. MONEY MARKET MUTUAL FUNDS (MMMFS)

A money market fund is a mutual fund that invests solely in money market
instruments. Money market instruments are forms of debt that mature in less than one
year and are very liquid.
Treasury bills make up the bulk of the money market instruments. Securities in the
money market are relatively risk-free. Money market funds are generally the safest
and most secure of mutual fund investments. The goal of a money-market fund is to
preserve principal while yielding a modest return by investing in safe and stable
instruments issued by governments, banks and corporations etc.

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3. TREASURY BILLS

Treasury Bills are short term (up to one year) borrowing instruments of the
Government which enable investors to park their short term surplus funds while
reducing their market risk. These are discounted securities and thus are issued at a
discount to face value. The return to the investor is the difference between the maturity
value and issue price. They are available in both Primary and Secondary market.
Treasury Bills are eligible securities for SLR purposes. Treasury bills are an effective
cash management product since short term surpluses or idle funds can be conveniently
deployed in treasury bills depending upon the availability and requirement. Even
funds in current accounts with Banks can be deployed for short term periods. One can
purchase treasury bills of different maturities as per requirements so as to match the
respective outflow of funds.

4. CERTIFICATE OF DEPOSITS

A CD is a time deposit, financial product commonly offered to consumers by banks.

In case of CDs the banks issue a certificate for a deposit made, such certificate is
transferable, i.e. holder of CD is holder of deposit. CDs are negotiable instrument
issued either in physical form transferable by endorsement and delivery or in demat
form or as a Usance Promissory Notes. CDs issued by banks should not have the
maturity less than seven days and not more than one year. Financial Institutions are
allowed to issue CDs for a period between 1 year and up to 3 years.

5. INTER CORPORATE DEPOSITS

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.

6. COMMERCIAL BILLS

Commercial bill is a short term, negotiable, and self-liquidating instrument with low
risk. It enhances the liability to make payment within a fixed date when goods are
bought on credit. Bills of exchange are negotiable instruments drawn by the seller
(drawer) on the buyer (drawee) or 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. The
maturity period of the bills varies from 30 days, 60 days or 90 days, depending on the
credit extended in the industry. Commercial bill is an important tool finance credit
sales.

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7. COMMERCIAL PAPER

Commercial Paper is a money-market security issued (sold) by large banks and

corporations to get money to meet short term debt obligations , and is only backed by
an issuing bank or corporation's promise to pay the face amount on the maturity date
specified on the note. Since it is not backed by collateral, only firms with excellent
credit ratings from a recognized rating agency will be able to sell their commercial
paper at a reasonable price.
Commercial paper is usually sold at a discount from face value, and carries shorter
repayment dates than bonds. The longer the maturity on a note, the higher the interest
rate the issuing institution must pay. Interest rates fluctuate with market conditions,
but are typically lower than banks' rates. Corporate Borrowers, especially the large and
financially sound, can diversify their short term borrowing by the issue of Commercial
Paper. Commercial Paper is especially attractive for companies with cyclical cash
flows and for cash rich companies during periods of greater cash inflows than
overdraft or cash credit since monitoring is more convenient.
Maturity: 7days -1 year.

8. CALL MONEY MARKET AND SHORT TERM DEPOSIT MARKET

The borrowers are essentially the banks. DFHI plays a vital role in stabilizing the call
and short term deposit rates through larger turnover and smaller spread. It ascertains
the prospective lenders and borrowers, the money available and needed and exchanges
a deal settlement advice with them indicating the negotiated interest rates applicable to
them. When DFHI borrows, a call deposit receipt is issued to the lender against a
cheque drawn on RBI for the amount lent. If DFHI lends it issues to the RBI a cheque
representing the amount lent to the borrower against the call deposit receipt.

9. INTER BANK PARTICIPATION CERTIFICATES

With a view for 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.

10. BILLS REDISCOUNTING

It is an important segment of money market and the bill as an instrument provides

short term liquidity to the suppliers in need of funds. Bill financing seller drawing a
bill of exchange & the buyer accepting it, thereafter the seller discounting it, say with
a bank. Hundies, an indigenous form of bill of exchange, have been popular in India,
but there has been a general reluctance on the part of the buyers to commit themselves
to payments on maturity. Hence the Bills have been not so popular.

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11. GILT EDGED GOVERNMENT SECURITIES

These are issued by governments such as Central Government, State Government,

Semi Government authorities, City Corporations, Municipalities, Port trust, State
Electricity Board, Housing boards etc. The gilt-edged market refers to the market for
Government and semi-government securities. Government securities are tradable debt
instruments issued by the Government for meeting its financial requirements. The
term gilt-edged means 'of the best quality'. This is because the Government securities
do not suffer from risk of default and are highly liquid (as they can be easily sold in
the market at their current price). The open market operations of the RBI are also
conducted in such securities.

12. BANKERS ACCEPTANCE

It is a short-term credit investment. It is guaranteed by a bank to make payments. The

Banker's Acceptance is traded in the Secondary market. The banker's acceptance is
mostly used to finance exports, imports and other transactions in goods. The banker's
acceptance need not be held till the maturity date but the holder has the option to sell it
off in the secondary market whenever he finds it suitable

13. REPOS
The Repo or the repurchase agreement is used by the government security holder
when he sells the security to a lender and promises to repurchase from him at a
specified time. Hence the
Repos have terms ranging from 1 night to 30 days. They are very safe due to
government backing.

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 Broadly discussion about the Instruments of Money Markets

Treasury Bills

Treasury bills (T-bills) are short-term notes issued by the U.S. government. They
come in three different lengths to maturity: 90, 180, and 360 days. The two shorter
types are auctioned on a weekly basis, while the annual types are auctioned monthly.
T-bills can be purchased directly through the auctions or indirectly through the
secondary market. Purchasers of T-bills at auction can enter a competitive bid
(although this method entails a risk that the bills may not be made available at the bid
price) or a noncompetitive bid. T-bills for noncompetitive bids are supplied at the
average price of all successful competitive bids.

Characteristics of T-Bills

Characteristics of T-Bills are...

 Highly liquid
 There is no interest rate.
 It is default risk free short term instrument.
 It is a form of discount instrument.

Advantages of T-Bills

 Extreme Security

Treasury bills are some of the safest investments you can buy. Since they're issued for
four, 13, 26 or 52 weeks, you probably aren't going to own them long enough for
inflation to have a chance to significantly erode their value. At the same time, the law
requires the Treasury to pay them back. Furthermore, since the Treasury can print its
own money, there's essentially no chance that you won't be paid back.

 Low Interest Payments

Treasury bills, also known as T-bills, are issued by the federal government with
maturity periods of four weeks, three months, six months and one year. With maturity
periods being so short and the risk of a U.S. government default being so low, you will
earn less interest investing in T-bills than almost any other bond or bank CD you buy.

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  Favorable Tax Treatment

Unfortunately, the interest you earn on T-bills is subject to Federal income tax, unless
you buy them in a tax-advantaged account such as a Roth IRA. However, they're
exempt from state and local income tax. If you live in a state with relatively high
taxes, this can help to increase the effective return you earn from your T-bills, making
them a superior investment to, for instance, certificates of deposit.

 Low Transaction Cost

Although you can buy T-bills from a broker or dealer, you may have to pay a
commission. Alternately, you can purchase T-bills directly from the Treasury through
their Treasury Direct program. Buying from the Treasury is fee- and commission-free.
When your T-bills mature, you can turn them in and get your initial investment and
your return back, also without incurring fees or commissions.

Disadvantages of T-Bills

 Low Rates of Return

Given their safety, T-bills offer relatively low yields. Between 1976 and 2012, the
average rate of return on a one-year T-bill was 5.83 percent and 5.17 percent on a
three-month T-bill. For comparison, a three-month CD's return averaged 5.82 percent
while AAA-rated corporate bonds paid an average annual rate of return of 8.07
percent. From 2008 through 2012, three-month and one-year Treasuries paid 0.36 and
0.54 percent, compared to 0.88 and 4.84 percent for three-month CDs and corporate
bonds.

 Short-Term Nature

One of the T-Bill's biggest advantages is also one of its biggest drawbacks. You
constantly have to turn them over into new investments since they mature so quickly.
This means that if you have a T-Bill paying a good rate of interest and rates drop,
you'll end up reinvesting and making less money. At the same time, every time the
bond matures, you realize a gain from the interest being paid, and have to pay federal
income tax on it.

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 Calculation of T-Bills:(Annualized yield)
Problem:-01

An investor purchased a T-Bill with a six -month (182-day) maturity and $10,000 par
value for $9,600 if this T-Bill is held to maturity,( 360 day year is to be considered)
what would be yield?

Solution:

We know that,
𝑆𝑝−𝑝𝑝 360
¥T = ×
𝑝𝑝 𝑛
Here,

Selling price=$10,000

Purchase price=$9600

n=182
$10,000−$9,600 360
¥T = × 182
$9,600

=8.24%
If the T-Bill is sold prior to maturity, the selling price and therefore the yield are
dependent on market conditions at the time of the sale.

Problem:-02
Suppose the investor plans to sell the T-Bill after 120 days and forecasts a selling price
of $9,820 at that time. The expected annualized yield based on this forecast is…

¥T=$9,820−$9,600
$9,600
×
360
120

=6.88%
(c) Using the information from the previous example, the T-Bill Discount is
$10,000−$9,600 360
T-bill discount= ×182
$10000

= 7.91%

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Bankers' Acceptances

A banker's acceptance is an instruments produced by a nonfinancial corporation but in

the name of a bank. It is document indicating that such-and-such bank shall pay the
face amount of the instrument at some future time. The bank accepts this instrument,
in effect acting as a guarantor. To be sure the bank does so because it considers the
writer to be credit-worthy. Bankers' acceptances are generally used to finance foreign
trade, although they also arise when companies purchase goods on credit or need to
finance inventory. The maturity of acceptances ranges from one to six months.

Characteristics of Bankers Acceptances

 It is a short term discount money market instrunment.

 Usually it arises in the course of international trade.
 It involves three party (drawer, drawee, payee).
 A banker acceptance is an obligation of the accepting bank.

Advantages of Banker's Acceptance

 The advantage of investment banker is they can earn a high salary, top earners
in the country.
 The exporter is paid immediately. This is important when delivery times are
long after shipment.
 The exporter is shielded from foreign exchange risk because the local bank pays
in domestic funds.
 The exporter does not have to assess the credit worthiness of the importer
because the importer's bank guarantees payment.

Disadvantages of Banker's Acceptance

1).There may errors (Producer's and Consumer's risk) associated with the sampling

2).The sample does not provide 100% accurate information of the condition of the
bacth.

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Repurchase Agreements

Repurchase agreements—also known as repos or buybacks—are Treasury securities

that are purchased from a dealer with the agreement that they will be sold back at a
future date for a higher price. These agreements are the most liquid of all money
market investments, ranging from 24 hours to several months. In fact, they are very
similar to bank deposit accounts, and many corporations arrange for their banks to
transfer excess cash to such funds automatically.

Characteristics of Repurchase Agreement

 A repurchase agreement provides banks with short- term cash.

 The securities are sold with a promise to repurchase.
 The principal is guaranteed and the return is fixed.
 Specified price.
 Short Duration
 Minimum amount
 Fixed or open repurchase

Problem: - 01

An investor initially purchased securities at a price (pp) of $9,852,217 with an

agreement to sell them back at a price (sp) of 10,000,000 at the end of a 60-day period.
What will be the yield (or repo rate) on this repurchase agreement?

Solution:

We know that,

𝑆𝑝−𝑝𝑝 360
Repo Rate= ×
𝑝𝑝 𝑛

Where,

Selling price=$10,000,000

Purchase price=$9,852,217

n=60

$10,000,000−$9,852,217 360
Repo Rate= × =9%
$9,852,217 60

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Problem:-02

An investor initially purchased securities at a price (pp) of $9, 00,500 with an

agreement to sell them back at a price (sp) of 10, 20,000 at the end of a 30-day period.
What will be the yield (or repo rate) on this repurchase agreement?

Solution:

We know that,

𝑆𝑝−𝑝𝑝 360
Repo Rate= ×
𝑝𝑝 𝑛

Where,

Selling price=$10,20,000

Purchase price=$9,00,500

n=30

$10,20,000−$9,00,500 360
Repo Rate= × =1.59%
$9,00,500 30

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Commercial Paper

Commercial paper is an unsecured short-term debt instrument which is issued by

creditworthiness financial institutions. Commercial paper refers to unsecured short-
term promissory notes issued by financial and nonfinancial corporations. Commercial
paper has maturities of up to 270 days (the maximum allowed without SEC
registration requirement). Dollar volume for commercial paper exceeds the amount of
any money market instrument other than T-bills. It is typically issued by large, credit-
worthy corporations with unused lines of bank credit and therefore carries low default
risk.

Unlike some other types of money-market instruments, in which banks act as

intermediaries between buyers and sellers, commercial paper is issued directly by
well-established companies, as well as by financial institutions. Banks may act as
agents in the transaction, but they assume no principal position and are in no way
obligated with respect to repayment of the commercial paper. Companies may also sell
commercial paper through dealers who charge a fee and arrange for the transfer of the
funds from the lender to the borrower.

Characteristics of Commercial Paper

The main characteristics of commercial papers are....

 CPs is essentially short term instruments.

 CPs is negotiable instruments.
 CPs is an unsecured form of borrowing.
 CPs is issued by a creditworthiness financial institution.
 CPs is issued as a discounting instrument.

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Advantages of commercial papers

1) It is quick and cost effective way of raising working capital.

2) Best way to the company to take the advantage of short term interest fluctuations in
the market.

3) It provides the exit option to the investors to quit the investment.

4) They are cheaper than a bank loan.

5) As commercial papers are required to be rated, good rating reduces the cost of
capital for the company.

6) It is unsecured and thus does not create any liens on assets of the company.
7) It has a wide range of maturity
8) It is exempt from federal SEC and State securities registration requirements.

Disadvantages of commercial papers

1) It is available only to a few selected blue chip and profitable companies.

2) By issuing commercial paper, the credit available from the banks may get reduced.
3) Issue of commercial paper is very closely regulated by the RBI guidelines.

Calculation of commercial paper yield

Problem:-01
If an investor purchases 30 day commercial paper with a par value of $10,00,000 for
price of $9,90,000 (360 day year basis), what would be yield?

Solution:
We know that,
𝑆𝑝−𝑝𝑝 360
¥T = ×
𝑝𝑝 𝑛
Here,
Selling price=$10,00,000
Purchase price=$9,90,000
n=30

$10,00,000−$9,90,000 360
¥CP = × 30
$9,90,000
= 12.12%

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Problem:-02

When a firm plans to issue commercial paper, the price (and therefore yield) to
investors is uncertain. Thus, the cost of borrowing funds is uncertain until the paper is
issued. Consider the case of a firm that plans to issue 90 day commercial paper with a
par value of $5,000,000. It expects to sell the commercial paper for $ 4,850,000. The
yield it expects to pay investors (its cost of borrowing) is estimated to be...

Solution:
We know that,
𝑆𝑃−𝑃𝑃 360
¥cp= × 90
𝑝𝑝

Here,

Selling price=$50, 00,000

Purchase price=$48, 50,000

n=90

¥cp =$50,00,000−$48,50,000
$48,50,000
×
360
90

=12.37%

Certificates of Deposit

Certificates of deposit (CDs) are certificates issued by a federally chartered bank

against deposited funds that earn a specified return for a definite period of time. They
are one of several types of interest-bearing "time deposits" offered by banks. An
individual or company lends the bank a certain amount of money for a fixed period of
time, and in exchange the bank agrees to repay the money with specified interest at the
end of the time period. The certificate constitutes the bank's agreement to repay the
loan. The maturity rates on CDs range from 30 days to six months or longer, and the
amount of the face value can vary greatly as well. There is usually a penalty for early
withdrawal of funds, but some types of CDs can be sold to another investor if the
original purchaser needs access to the money before the maturity date.

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 Characteristics of Certificates of Deposits

Certificates of Deposit are...

 Unsecured negotiable instruments.

 Issued at a discount to face value and the discount is market determined.
 CDs are discounted bills.
 Freely transferable.
 Banks are not allowed to grant loans against CDs or to buy back their own CDs.

Advantages of Certificates of Deposits

Lets starts with CDs primary advantage: they are typically considered very safe. The
Federal Deposit Insurance Corp. (FDIC) currently insures customer's certificates of
deposit at member banks like Ally Bank, to the maximum allowed by the law.

Certificates of deposit also offer you fixed or variable interest rates. You will be able
to anticipate the rate at which you balance grows, so making plans for the future id
that much easier.

Another advantage to CDs is that they earn steady interest at a higher rate than mist
regular savings accounts. They can be a great way to diversify beyond the savings
account you may already have, or an excellent alternative to such an account,
depending on your needs.

Disadvantages of Certificates of Deposits

You should know that CDs require that you keep your money on deposit for a set time
frame before withdrawing it in order to avoid early withdrawal penalties. If you think
you may need this money for a possible financial emergency, consider a no penalty
CD, which allows you to withdraw your money, and the interest earned , at any time
without paying an early withdrawal penalty any time after the first 6 days of funding
your CD.

CDs pros often outweigh their downsides and allow you to grow your savings hassle
free. It's easy to compare CDs online, and some of the best CD rates can be found with
online banks. Find out which CDs from Ally Bank can meet your financial needs.

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Problem:-01
An investor purchased an NCDs a year ago in the secondary market for $9,70,000. He
redeems it today upon maturity and receives $10,00,000. He also receives interest of
$40,000. What will be the annualized yield on this investment?

Solution
We know that,
𝑆𝑝−𝑝𝑝+𝑖𝑛𝑡𝑒𝑟𝑠𝑡
¥NCDs = 𝑝𝑝
Where,
Selling price=$10, 00,000
Purchase price=$9, 70,000
Interest=$40,000

$10,00,000−$9,70,000+$40,000
¥NCDs = $9,70,000
=7.22%

Problem:-02
An investor purchased an NCDs a year ago in the secondary market for $9,50, 000. He
redeems it today upon maturity and receives $10,00,000. He also receives interest of
$48,000. What will be the annualized yield on this investment?
Solution:
We know that,
𝑆𝑝−𝑝𝑝+𝑖𝑛𝑡𝑒𝑟𝑠𝑡
¥NCDs = 𝑝𝑝

Where,
Selling price=$10, 00,000
Purchase price=$9, 50,000
Interest=$48,000

$10,00,000−$9,50,000+$48,000
¥NCDs = $9,50,000
=10.32%

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