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 constitutes a very important segment of the Indian financial system.
 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.
 It is a need-based market wherein the demand and supply of money shape the market.
 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.
MONEY MARKET FUNCTIONS:

 A money market is generally expected to perform three broad functions.

 Provide a balancing mechanism to even out the demand for and supply of short-term funds.
 Provide a focal point for central bank intervention for influencing liquidity and general level of interest rates in the
economy.
 Provide reasonable access to suppliers and users of short-term funds to fulfill their borrowings and investment
requirements at an efficient market clearing price.
 Besides the above functions, a well-functioning money market facilitates the development of a market
for longer-term securities.
 The interest rates for extremely short-term use of money serve as a benchmark for longer-term
financial instruments.
MONEY MARKET INSTRUMENTS

 The instruments traded in the Indian money market are:

 Treasury Bills (T-bills)
 Cash Management Bills (CMBs)
 Call/notice money market—Call (overnight) and short notice (up to 14 days)
 Commercial Papers (CPs)
 Certificates of Deposits (CDs)
 Commercial Bills (CBs)
 Collateralized Borrowing and Lending Obligation (CBLO)
TREASURY BILLS

 Treasury bills are short-term instruments issued by the Reserve Bank on behalf of the government
to tide over short-term liquidity shortfalls.
 This instrument is used by the government to raise short-term funds to bridge seasonal or
temporary gaps between its receipts (revenue and capital) and expenditure.
 They form the most important segment of the money market not only in India but all over the world as well.
 T-bills are repaid at par on maturity.
 The difference between the amount paid by the tenderer at the time of purchase (which is less than the face
value) and the amount received on maturity represents the interest amount on T-bills and is known as the
discount.
FEATURES OF TREASURY BILLS

 They are negotiable securities.

 They are highly liquid as they are of shorter tenure
 There is an absence of default risk.
 They have an assured yield, low transaction cost, and are eligible for inclusion in the securities for SLR
purposes.
 At present, there are 91-day, 182-day, and 364-day T-bills
CASH MANAGEMENT BILLS (CMBS)

 The Reserve Bank of India on behalf of the Government of India issues 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 depends 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 is issued one
day prior to the date of auction.
 The settlement of the auction is on T+1 basis.
COMMERCIAL PAPER

 A commercial paper is an unsecured short-term promissory note, negotiable and transferable by

endorsement and delivery with a fixed maturity period.
 It is generally issued at a discount by the leading creditworthy and highly rated corporates to meet
their working capital requirements.
 The credit risk involved in commercial paper depends on the issuer's credit rating and credibility.
 Companies with high credit ratings can issue commercial paper at favorable rates.
 Commercial paper is a cost-efficient way for companies to meet their immediate cash flow needs.
CALL / NOTICE MONEY

 The call money market is a market for very short-term funds repayable on demand and with a
maturity period varying between one day to a fortnight.
 When money is borrowed or lent for a day, it is known as call (overnight) money.
 Intervening holidays and/or Sundays are excluded for this purpose.
 When money is borrowed or lent for more than a day and upto 14 days, it is known as notice money.
 No collateral security is required to cover these transactions.
 The call money market is a highly liquid market.
 It is highly risky as well as extremely volatile.
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 inter bank borrowing has led to the development of the call money market.
CERTIFICATES OF DEPOSIT:

 Certificates of deposit are short-term tradable time deposits issued by commercial banks and
financial institutions.
 Certificates of deposit are time deposits of specific maturity similar to fixed deposits (FDs).
 The biggest difference between the two is that CDs, being in bearer form, are transferable and
tradable while FDs are not.
 Like other time deposits, CDs are subject to SLR and CRR requirements.
 CDs are issued by commercial banks on a discount to face value basis
 Minimum amount of a CD should be `1 lakh, i.e., the minimum deposit that could be accepted from a single
subscriber should not be less than `1 lakh, and in multiples of `1 lakh thereafter.
CERTIFICATES OF DEPOSIT:

 Discount/coupon rate CDs may be issued at a 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.
 The issuing bank/FI is free to determine the discount/coupon rate.
 The interest rate on floating rate CDs would have to be reset periodically in accordance with a pre-
determined formula that indicates the spread over a transparent benchmark.
 The investor should be clearly informed of the same.
KEY DATES IN THE CASE OF CASH MARKET INSTRUMENTS:

 There are three key dates in the case of instruments

 Transaction date
 Value date
 Maturity date
TRANSACTION DATE

 The transaction date is the date on which the terms and conditions of a financial instrument such as the term to
maturity, transaction amount, and price are agreed upon.
 In other words, it is the date on which the counterparties enter into a contract with each other.

date on which the counterparties enter into a contract with each other
VALUE DATE:

 The value date is the date on which the instrument starts to earn or accrue a return.
 The value date may or may not be the same as the transaction date.
 If the two dates are the same, then the transaction is said to be for same day value or value today.
 In other cases, the value date will be the following business day.
 Transactions with such a feature are said to be for next-day value or value tomorrow.
 Finally, there are markets and transactions where the value date will be two business days after the transaction
date.
 A transaction with such a feature is referred to as a spot transaction and is said to be for spot value.

starts to earn or accrue a return

MATURITY DATE

 The maturity date is the date on which the instrument ceases to accrue a return.
 The maturities of money market instruments are often fixed not by agreeing to a specific date of maturity, but by
agreeing to a term to maturity, which will be a number of weeks or months after the value date. For instance,
assume that today is 24 Jan 20XX.

date on which the instrument ceases to accrue a return

INTEREST COMPUTATION METHODS

 For interbank loans and some money market instruments, interest is payable on the principal value of the
instrument.
 On the other hand, securities like Treasury bills and commercial paper are what we term as discount securities
 That is, they are issued at a discount to their principal value and repay the principal at maturity.

In money market instruments, Interest is payable on the principal

value at the end of the loan period
INTEREST COMPUTATION METHODS

 For interbank loans, interest is computed and paid along with the principal.

 The method of calculating the interest differs according to the currency under consideration. Interest
on
most currencies including the US dollar and the euro is calculated on the
assumption that the year has 360 days and is based on the ACT/360 day-
count convention.
 This means that the interest payable on a loan for T days with a principal of P and carrying an interest rate of r is:
INTEREST COMPUTATION METHODS

 For certain currencies, however, like the sterling, interest is calculated on the assumption of a 365-day year and is
said to be based on an ACT/365 day-count convention.
 Consequently, the formula for computing interest is:
EXAMPLE:

 A bank makes a loan of €10 MM from 15 July till 15 October at an interest rate of 5.75% per annum
 Notice that although the loan is for three months we consider the actual number of days in the period, and do
not automatically take the period as consisting of 90 days.
EXAMPLE:
EXAMPLE:

 A bank makes a loan of $7.5 MM for a period of one year (365 days) at an interest rate of 5.25% per annum. The
interest is given by:
EXAMPLE:
EXAMPLE:

 A bank makes a loan of £7.5 MM for a period of 180 days at an interest rate of 4.95%
per annum. The interest is given by:
EXAMPLE:
MONEY MARKET FORWARD RATES

 Let s1 be the quoted spot rate for an A-day loan and s2 the spot rate for a B-day loan where B > A. If rates are
quoted on an add-on basis,
where f is the forward rate for a B − A day loan, as fixed at the outset
MONEY MARKET FORWARD RATES

 If the rates are quoted on a discount basis, however, the forward rate is the solution to the following equation.
EXAMPLE:

 Assume that the spot rate for a 90-day loan is 2.4% per annum, while that for a 198-day loan is 3.2% per annum.
The forward rate for a 108-day loan after 90 days is given by
EXAMPLE:
EXAMPLE: (DISCOUNT BASIS)

 Assume that the spot rate for a 90-day loan is 2.4% per annum, while that for a 198-day loan is 3.2% per annum.
The forward rate for a 108-day loan after 90 days is given by
 If we were to assume, however, that rates are quoted on a discount basis,
EXAMPLE:

 Assume that the spot rate for a 90-day loan is 2.4% per annum, while that for a 198-day loan is 3.2% per annum.
The forward rate for a 108-day loan after 90 days is given by
 If we were to assume, however, that rates are quoted on a discount basis,