MONEY MARKET INSTRUMENTS

MONEY MARKET – AN INTRODUCTION

Money market is a very important segment of the Indian financial system. It is the market for dealing
in monetary assets of short term- nature. Short term funds up to one year and financial assets that are
close substitutes for money are dealt in the money market. Money market instruments have the
characteristics of liquidity (quick conversion into money), minimum transaction cost and no loss in
value. Money market provides access to providers and users of short term funds to fulfill their
borrowings and investment requirements at an efficient market clearing price.

The money market is 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 up to a year. Mostly
government banks and financial institution dominate this market.

Government is an active player in the money market and in the most economies; it constitutes the
biggest borrower of this market. Both government securities or G-Secs and treasury –bills or T-bills
are securities issued by RBI on behalf of the Government of India to meet the latter’s borrowing for
financial fiscal deficit. Apart from functioning as a merchant banker to the government, the central
bank also regulates the money market and issues guidelines to govern the money market operations.

Another dominant player in the money market is the banking industry. Banks mobilize deposits and
utilize the same for credit accommodation.

Financial institutions also undertake lending and borrowing of short term funds. Other institutional
players like mutual funds (MFs), foreign institutional investors (FIIs) etc. also transact in money
market. However, the level of participation of these players varies largely depending on the
regulations. For instance, the level of participation of the FIIs in the Indian money market is restricted
to investment in government securities only.

Examples of Money Market Instrument are: -

• T- Bill or Treasury bill

• Capital Indexed Bond

• Floating rate Bond

• Zero coupon Bond

• Money at call and short notice

• Commercial Papers

• Inter-bank Participation

• Certificate of Deposits
 FEATURES OF MONEY MARKET
1. The money market is a wholesale market. The volumes are very large and generally
transactions are settled on a daily basis.

2. Trading in the money market is conducted over the telephone, followed by written
confirmation from both the borrowers and lenders.

3. There are a large number of participants in the money market: commercial banks, mutual
funds, investment institutions, financial institutions and finally the Reserve Bank of India.

GROWTH OF MONEY MARKET

The organization and structure of the money market has undergone a sea change in the last decade of
India. Up to 1987 the money market consisted of 6 facets:

1. Call money market

2. Interbank term deposit/ loan deposit

3. The participation certificate market

4. Commercial bills market

5. Treasury bills market

6. Inter corporate market

The market had 3 main deficiencies:

1. It had a very narrow base with RBI, Banks and UTI as the only participants lending funds
while the borrowers were large in number

2. There were few money market instruments. The participation certificate became extinct
during 1980s.

3. The interest rates were not market determined but were controlled by either RBI or by a
voluntary agreement between the participants through the Indian Banks Association (IBA).

To set right these deficiencies the Chakravarthy Committee (1985) and the Vaghul Committee (1987)
offered many useful suggestions and their implementation has widened and deepened the market
considerably by increasing the number of participants and instruments and introducing market
determined rates as compared to the then existing administered interest rates.
 MONEY MARKET VS. CAPITAL MARKET

BASIS OF CAPITAL MARKET MONEY MARKET

DIFFERENCE
1. Nature of fund The fund raised in capital The fund raised in money
market is long term and market is short term
medium term in nature.

2. Regulator It is regulated by SEBI. It is regulated by RBI.

3. Default risk In capital market there is higher There is no default risk because
default risk in comparison to the market players are either
money market. government itself or highly
rated companies.

4. Maturity Period Generally for more than one Generally for one year; i.e.
year; i.e. long duration. short duration.

5. Example of Instruments Shares, debentures Treasury bill, commercial

paper, Certificate of deposits.

INSTRUMENTS OF MONEY MARKET

The instruments used in money market represent short- term claims. It is important to note that the
money market instruments do not include any equities. Money market instruments mainly include
government securities, securities issued by Banking sector and securities issued by private sector.
These instruments are: -

1. GOVERNMENT SECURITIES

All funds raised by the government from the money market are through the issue of securities by
the RBI. Thus, T-bills and government dated securities are all issued by the RBI on behalf of the
government. The term government securities includes: Central government securities, State
government securities and treasury bills. The Central government borrows funds to finance its
‘fiscal deficit’.

TYPES OF GOVERNMENT SECURITIES

Government securities are of following types:

DATED SECURITIES

Dated securities are generally fixed maturity and fixed coupon securities usually carrying semi-
annual coupon. These are called dated securities because these are identified by their date of maturity
and the coupon, e.g. 11.03% GOI 2012 is a central government security maturing in 2012, which
carries a coupon of 11.03% payable half yearly. The key features of these securities are:

• They are issued at face value.

• Coupon or interest rate is fixed at the time of issuance, and remains constant till redemption
of the security.

• The tenor of the security is also fixed.

• Interest/ coupon payment is made on a half yearly basis on its face value.

• The security is redeemed at par (face value) on its maturity date.

ZERO COUPON BONDS

Zero coupon bonds are bonds issued at discount to face value and redeemed at par. The key features
of these securities are:

• They are issued at a discount to the face value.

• The tenor of the security is fixed.

• The securities do not carry any coupon or interest rate. The difference between the issue price
(discounted price) and face value is the return on this security.

• The security is redeemed at par (face value) on its maturity date.

PARTLY PAID STOCK

Partly paid stock is stock where payment of principal amount is made in installments over a given
time frame. It meets the needs of investors with regular flow of funds and the need of government
when it does not needs funds immediately. The first issue of such stock of eight year maturity was
made on November 15, 1994 for Rs. 2000 crore. The key features of these securities are:

• They are issued at face value, but this amount is paid in installments over a specified period.

• Coupon or interest rate is fixed at the time of issuance, and remains constant till redemption
of the security.

• The tenor of the security is fixed.

• Interest/Coupon payment is made on a half yearly basis on its face value.

• The security is redeemed at par on its maturity date.

FLOATING RATE BONDS

Floating rate bonds are bonds with variable interest rate with a fixed percentage over a benchmark
rate. There may be a cap and a floor rate attached thereby fixing a maximum and minimum interest
rate payable on it. Floating rate bonds of four year maturity were first issued on September 29, 1995.
The key features of these securities are:

• They are issued at face value.

• Coupon or interest rate is fixed as a percentage over a predefined benchmark rate at the time
of issuance. The benchmark rate may be Treasury bill rate, bank rate etc.

• Though the benchmark does not change, the rate of interest may vary according to the change
in the benchmark rate till redemption of the security.

• The tenor of the security is fixed.

• Interest/coupon payment is made on a half yearly basis on its face value.

• The security is redeemed at par (face value) on its maturity date.

BONDS WITH CALL/PUT OPTION

First time in the history of government securities market RBI issued a bond with call and put option
this year. This bond is due for redemption in 2012 and carries a coupon of 6.72%.

CAPITAL INDEXED BONDS

Capital Indexed bonds are bonds where interest rate is a fixed percentage over the wholesale price
index. These provide investors with an effective hedge against inflation. These bonds were floated on
December 29, 1997 on tap basis. They were of five year maturity with a coupon rate of 6% over the
wholesale price index. The principal redemption is linked to the wholesale price index. The key
features of these securities are:

• They are issued at face value.

 • Coupon or interest rate is fixed as a percentage over the wholesale price index at the time of
issuance. Therefore the actual amount on interest paid varies according to the change in the
wholesale price index.

• The tenor of the security is fixed.

• Interest/ coupon payment is made on a half yearly basis on its face value.

• The principal redemption is linked to the wholesale price index.

BENEFITS OF INVESTING IN GOVERNMENT SECURITIES

• No tax deducted at source

• Additional income tax benefits under section 80L of the income tax for individuals

• Qualifies for SLR purpose

• Zero default risk being sovereign paper

• Highly liquid

• Transparency in transactions and simplified settlement procedures through CSGL/NSDL

2. MONEY AT CALL AND SHORT NOTICE

Money at call is outright money. Money at short notice is for a maturity of or up to 14 days. Money
for higher maturity is known as inter-bank deposits. The key features are:

• The participants are banks and all India financial institutions as permitted by RBI.

• With effect from 1991, non-bank participants are allowed to lend only.

• This type of lending and borrowing allowed only at Mumbai, Kolkata, Delhi, Chennai,
Ahmadabad, and Bangalore.

• The borrower i.e. banks, borrow it for a variety of reasons like maintenance of CRR, meeting
of heavy payments.

• It is not available for a general person as an additional source of investment.

3. INTERBANK PARTICIPATION
As per guidelines, banks can issue two types of Interbank Participation (IBPs) instruments;

i) On risk sharing basis

ii) Without risk sharing.

These instruments are used by the scheduled commercial banks other than Regional Rural Banks. The
IBPs with risk sharing issued for 91 to 180 days in respect to certain advances. The rate of interest is
mutually determined by the issuing bank and the participating bank. The maturity period is 90 in case
of IBP without risk sharing. There is no provision for pre-matured redemption/ advance payment of
the certificate after a minimum lock-in period.

4. TREASURY BILLS

Treasury Bills, one of the safest money market instruments, are short term borrowing instruments of
the Central Government of the Country issued through the Central Bank (RBI in India). The
guidelines and key features of Treasury bills are:-

• The treasury bills are issued in the form of promissory note in physical form or by credit to
Subsidiary General Ledger (SGL) account or gilt account in dematerialized form.

• All entities registered in India like Banks, Financial institutions, primary dealers, Firms,
Companies, Corporate bodies, Partnership firms, Mutual funds, Foreign institutional
investors, State governments, Provident funds trusts, Research organizations, Nepal rashtra
bank, and even individuals are eligible to bid and purchase treasury bills.

• They are zero risk instruments, and hence the returns are not so attractive.

• It is available both in primary market as well as secondary market.

• T-bills are short-term securities that mature in one year or less from their issue date. They are
issued with three-month, six-month and one-year 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 purchaser of the instrument.

• T-Bills are issued through a bidding process at auctions. The bid can be prepared either
competitively or non-competitively. In the second type of bidding, return required is not
specified and the one determined at the auction is received on maturity. Whereas, in case of
competitive bidding, the return required on maturity is specified in the bid. In case the return
specified is too high then the T-Bill might not be issued to the bidder.

• At present, the Government of India 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.
 • Treasury bills are available for a minimum amount of Rs.25, 000 and in its multiples thereof.

• While 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 available at the Banks’ website.

• The yield of a treasury bill is calculated as per the following formula:

Y= [(100-P) X 365 X 100] / P X D

The advantages of Treasury bills are: -

• No Tax Deducted at Source (TDS).

• Highly liquid

• Better returns especially in short term

• Availability of two way quotes by primary dealers for purchase and sale of treasury bill.

• Ideal matching of funds for short periods.

5. CERTIFICATE OF DEPOSITS

Certificate of deposits is a negotiable money market instrument and issued in dematerialized form or
as a “usance Promissory note”’ for funds deposited at a bank or other eligible financial institution for
a specified time period. Guidelines for issue of CDs are presently governed by various directives
issued by the Reserve Bank of India.

These guidelines are:-

• Eligibility: - 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.

• Aggregate amount: - Banks have the freedom to issue CDs depending on their requirements.
A FI may issue CDs within the overall limit fixed by RBI, i.e. issue of CD together with other
instruments viz., term money, term deposits, commercial papers and inter corporate deposits
should not exceed 100 percent of its net owned funds, as per the latest audited balance sheet.

• Minimum size of issue: - Minimum amount of a CD should be Rs. 1 lakh i.e., the minimum
deposit that could be accepted from a singe subscriber should not be less than Rs. 1 lakh and
in the multiples of Rs. 1 lakh thereafter.

• Maturity: - The maturity period of CDs issued by banks should not be less than 15 days and
not more than one year. The FIs can issue CDs for a period not less than 1 year and not
exceeding 3 years from the date of issue.
 • Discount/Coupon rate: - CDs may be issued at discount on face value. Banks/FIs are also
allowed to issue CDs on floating rate basis provided the methodology of compiling the
floating rate is objective, transparent and market based.

• Reserve requirements: - Banks have to maintain the appropriate reserve requirements, i.e.
cash reserve ration (CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.

• Transferability: - Physical CDs are freely transferable by endorsement and delivery. Demat
CDs can be transferred as per the procedure applicable to other demat securities. There is no
lock in period for the CDs. Banks/ FI cannot grant loans against CDs. Furthermore, they
cannot buy- back their own CDs before maturity.

6. INTER-CORPORATE DEPOSITS

Apart from CPs, corporate also have access to another market called the Inter Corporate Deposits
(ICD) market. An ICD is an unsecured loan extended by one corporate to another. Existing mainly as
a refuge for low rated corporate, this market allows funds surplus corporate to lend to other corporate.
Also the better –rated corporate can borrow from the banking system and lend in this market. As the
cost of funds of a corporate is much higher than a bank, the rates in this market are higher than those
in the other markets. ICDs are unsecured, and hence the risk inherent is high. The ICD market is not
well organized with very little information available publicly about transaction details.

7. COMMERCIAL BILLS

Commercial Bills are basically negotiable instruments accepted by buyers for goods or services
obtained by them on credit. Such bills being bills of exchange can be kept up to the due date and
encashed by the seller or may be endorsed to a third party in payment of dues owing to the latter. But
the most common method is that the seller who gets the accepted bills of exchange discounts it with
the bank or financial institution or a bill discounting house and collects the money (less the interest
charged for the discounting).

The volume of bills both inland and foreign, which are discounted accounted for about 20% of the
total scheduled commercial bank credit. Over the years this percentage is coming down. The Reserve
Bank has been attempting to develop a market for commercial bills.

The difficulties which stand in the way of bill market development are, the incidence of stamp duty,
shortage of stamp paper, reluctance of buyers to accept bills, predominance of cash credit system of
lending and the administrative work involved in handling documents of title to goods. To be freely
negotiable and marketable, the bills should be first class bills i.e. those accepted by companies having
good reputation. Alternatively, the bills accepted by companies should be co-accepted By banks as a
kind of guarantee. In the absence of these criteria, bill market has not developed in India as the
volume of first class bills is very small.
 8. COMMERCIAL PAPER

Commercial paper (CP) is an unsecured money market instrument issued in the form of a promissory
note. CP as a privately placed instrument 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, satellite 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. Guidelines for issuing CP are presently governed by various
directives issued by the Reserve Bank of India, as amended from time to time. The guidelines for
issue of CP incorporating all the amendments issued till date is given below:

• Issue of commercial paper: - Corporates and primary dealers (PDs), and all-India financial
institutions (FIs) that have been permitted to raise short- term resources under the umbrella
limit fixed by Reserve Bank of India 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
institutions

(c) The borrowed account of the company is classified as a Standard asset by financing
bank/s/ institutions.

• Rating requirement: - All eligible participants shall obtain the credit rating for issuance of
commercial paper from either the Credit Rating Information Services of India Ltd. (CRISIL)
or the Investment Information and Credit Rating Agency of India Ltd. (CARE) or the FITCH
ratings India Pvt. Ltd. Or such other credit rating agencies as may be specified by the Reserve
Bank of India from time to time, for the purpose. The minimum credit rating shall be P – 2 Of
CRISIL or such equivalent rating by other agencies.

• Maturity: - CP can be issued for maturities between a minimum of 7 days and a maximum up
to one year from the date of issue. The maturity date of the CP should not go beyond the date
up to which the credit rating of the issuer is valid.

• Issuing & paying Agent: - Only a scheduled bank can act as an IPA for issuance of CP.

• Investment in CP: - CP may be issued to and held by individuals, banking companies, other
corporate bodies registered or incorporated in India and unincorporated bodies, Non-resident
Indians (NRIs) and foreign Institutional Investors (FIIs). However, investment by FIIs would
be within the limits set for their investments by Securities and Exchange Board of India
(SEBI).

• Mode of issuance: - CP can be issued either in the form of a promissory note or in a

dematerialized form through any of the depositories approved by and registered with SEBI.
 CP will be issued at a discount to face value as may be determined by the issuer. No issuer
shall have the issue of CP underwritten or co- accepted.

9. GILT-EDGED (GOVERNMENT) SECURITIES

Gilt- edged securities are issued by the government such as central government, State government,
Semi- government, Municipalities, and other approved financial institutions.

The key features of Gilt- edged securities are: -

• These are issued by Government or its agency.

• These are held by Reserve Bank of India.

• These are reckoned for the purpose of Statutory Liquidity Ratio (SLR) of Bank.

• These are most secured instrument, which is risk- free, but gives lesser rate of return.

• These are sold by RBI, on behalf of Government by notifying a particular date and kept open
for sale for 2 to 3 days.