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Money Market and Money Market Instruments

Call Money Market: Call money are overnight funds in the banking system, which are
generally borrowed or advanced for not more than one day. For banks 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,
meaning, no security is offered or taken for borrowing or lending respectively. If the
period of borrowing is longer then it is called notice money or term money.
Call money rates are negotiated between the parties and are ruled by purely demand and
supply of funds in the system on a given date. Call rates are barometer of short term
liquidity in the economy and hence watched very closely by the Central Bank of a
country. Too much volatility in call rates is indicative of liquidity mismatches in the
banking system and improper fund management which is not advisable from the point of
stability of economy. In our Indian market, Reserve Bank of India keeps a tight control
over call money operations and has placed mechanism in place to ensure curbs and
controls over the rates by creating several avenues for the banks so that they resort to call
money borrowings only in the emergent circumstances. Features of call markets are:
• The call market enables the banks and institutions to even out their day to day
deficits and surpluses of funds,
• Commercial banks and co-operative banks are allowed to borrow as well as lend
money in call market.
• Specified All India Financial Institutions, Mutual Funds and certain specified
entities such as insurance companies are allowed access to
call money market only as lenders,
• Non-bank entities such as Corporates are not allowed to operate in call market.
• Interest rates in call money are negotiated by the parties concerned and on any
given date several transactions may take place at different
• No brokers are permitted to deal in call market.
• The transactions in call market are routed through current account of the parties
with RBI.

RBI is gradually moving towards a system where only banks would be allowed to operate
in call market, phasing out the other entities from the market.

Money market instruments:

Whereas call money market facilitates very short term liquidity adjustment, need was
also felt to introduce more instruments having longer maturity of up to one year which
would help the banks and other entities to invest their short term funds and earn a decent
return without losing the liquidity need in emergent circumstances. With a view to giving
more depth to the money market, a committee was appointed under Mr. N. Vaghul, the
Chairman of ICICI which made a number of recommendations for,
i. Institutional developments
ii. Reactivate the available instruments in money market and
iii. Introducing new innovative financial instruments such as commercial papers,
certificate of deposits, money market mutual funds (MMMFs) etc.

Apart from call money, following instruments are available in the Indian financial
system, which fall in the category of money market instruments.
• Treasury Bills (T. Bills) of 91/364 days
• Commercial Papers (C.Ps.)
• Bills Rediscounting (BRDs) or Commercial Bills Market
• Certificate of Deposits (C.Ds.)
• Participation Certificates P.Cs.)
• REPOs/Ready Forward(R/F) / Buy Back
Participants in money market instruments:
• Commercial Banks
• Financial Institutes (IDBI, NABARD etc.), Primary Dealers
• UTI / other mutual funds.
• Insurance Companies (LIC/GIC etc.)
• Regional Rural Banks/Co-op banks/Urban banks
• Discount and Finance House of India (DFHI), and Securities Trading Corporation
of India (STCI)

Treasury Bills: The essential features of Treasury Bills are,

i. Treasury Bills are short term money market instruments with a

maturity of generally 14 / 91 / 182 / 364 days. Currently, RBI
issues T. Bills of maturity of 91 and 364 days.
ii. They are issued at discounted value. The difference between issue
price and face value (maturity value) is the earning or return for the
iii. They are issued through the process of auction.
iv. They are issued not in physical form but through Subsidiaries
General Ledger (SGL) account maintained by RBI for each
participant. Subsequent transactions in T. Bills are also settled
through this account.
v. The transactions are by way of auction and volumes are involved
are quite large. Small investors, therefore, stay away from these
investments. Also returns are traditionally low on account of the
fact that they amount to government borrowings and therefore
have absolute safety.
vi. Banks, Financial Institutes, Insurance companies, mutual funds,
primary dealers and large corporates who have large short term
funds generally invest in T. Bills.
vii. Investments 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. Also, they are highly liquid on
account of secondary market transactions between banks.

viii. DFHI acts as market makers for T. Bills by giving “two way”
quotes i.e. they offer to sale and buy T. Bills in secondary market

Response to auction of Treasury Bills is indicative of liquidity in the system and yields
on Treasury Bills serve as bench mark for the market since the rates on this instrument
are market related. Key factors influencing yields on T Bills are:
In a situation where banks are flushed with funds, demand for T. Bills will be very high
which will drive down the rates of return (yield).
In case liquidity in the system is low, the returns will be high since response for the
auction would be low for want of funds and therefore, returns will be comparatively high.
Formula for calculation of yield on T. Bills is as follows:
Yield = [(Face value – Issue price) X 365 / (Price x no. of days to maturity)] X 100.

Commercial Papers: The essential features of Commercial Papers are,

i. Commercial papers are issued for the purpose of raising short term resources
for the issuers at very low rates.
ii. CPs are short term, unsecured, negotiable usance promissory notes with fixed
maturity issued by corporates, financial institutes, primary dealers etc.
iii. Maturity of CPs varies between 15 days to 360 days.
iv. CPs are issued at discounted rate and the difference between issue price and
the face value is yield for the investor.
v. They can be issued in denomination of Rs 5 lacs and in multiple of Rs 5 lacs.
vi. Individuals (having large net worth), corporates, financial institutions,
insurance companies, banks etc can invest in this instrument since they have
large fund for investments.
vii. Company, to be eligible to issue CPs should have a tangible net worth (paid-
up capital + free reserves) of at least Rs 4 cr.
viii. Company must have working capital limits with a bank which must have been
classified as ‘standard asset’ by the bank.
ix. Company must obtain a rating for the issue of commercial papers from a
specified rating agency such as CRISIL, ICRA or CARE. The rating must be
current and not lapsed. Higher the rating of the company, company would be
in a better position to negotiate favourable rate of interest with the investor.
x. Commercial papers attract stamp duty as in case of bills of exchange at the
rate specified in Indian Stamp Act.
xi. Commercial papers are traded in secondary market and therefore a liquid

Formula for calculation of discounted price of a commercial paper is,

Price = Face Value/ [1 + yield x (no. of days to maturity/365)]
Yield = (Face value – Price)/ (price x no of days to maturity) X 365 X 100

Certificate of Deposits: Whereas CPs are issued by companies to raise short term
resources, for investment of short term surplus funds, companies and high net worth

individuals (HNIs) use CDs issued by banks as an instrument of investment. Special
features of CDs are,
i. It is a negotiable, short term instrument issued by banks and development
financial institutions.
ii. CDs are issued by banks and DFIs to augment their resources by paying
attractive rate of interest on large deposits of money by companies and
wealthy individuals. The rates may vary from depositor to depositor as
different from retail depositors who do not have freedom of demanding higher
rates on their normal deposits.
iii. Deposit rates depend on funds position of banks and liquidity available in the
system. Higher the liquidity, the rates would drop, since banks would not be
interested in mobilizing deposits when they are flushed with funds.
iv. Although they can be traded in secondary market, currently there is not much
depth to the secondary market for CDs.
v. Although CDs were permitted to be issued only at discounted price, RBI has
now allowed banks to issue CDs at par with a coupon (interest).
vi. As in case of CPs stamp duty is payable on CDs at prescribed rates.
vii. Period of issue is 15 days to one year. However, DFIs are allowed to issue
CDs for longer period up to 3 years.
Formula for calculation of discounted value and yield for CD is same as in case of CP

Repo/Ready Forward/Buy Back:

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, if between two banks or at fixed rate, if with RBI.
The buyer purchases the securities with an agreement to resell the same to the seller on an
agreed date in future at a predetermined price. Such a transaction is called a Repo when
viewed from the perspective from seller of securities (or party borrowing funds) and
Reverse Repo when seen from the perspective of buyer of securities (or party lending
Repo is also called Ready Forward or Buy Back transaction. Essentially, there are always
two legs of transaction in Repo deals, i.e. parting of securities in exchange of funds by
seller followed by return of funds in exchange of same securities after a predetermined
period. The user of funds pays interest on the funds borrowed as a compensation to the
buyer of securities which is called a Repo rate; a rate negotiated between two parties.
Repo transactions help banks to meet their short term liquidity needs without
permanently parting with securities, since the securities come back after a specified
period. For lender, the securities are available for a short period for meeting his
temporary statutory liquidity ratio obligations.
RBI undertakes Repos at a fixed rate of interest which is changed periodically. They have
different rates for Repo transaction i.e. when funds are borrowed from banks against
securities and Reverse Repo transaction where funds are lent to banks. Reverse Repo rate
is obviously higher than Repo rate since RBI would earn return from this operation.
Essentially RBI conducts Repo and Reverse Repo operations to facilitate the banks to
adjust their liquidity needs.

In recent years, RBI’s Reverse Repo rate has emerged as a benchmark rate for short term
transactions in the market since RBI uses this rate for adjusting liquidity in the banking
system. When liquidity is excess, they raise the Reverse Repo rate to discourage the
banks from borrowing from RBI. However, when they desire to release more funds in the
market, they reduce the Reverse Repo rate which enables the banks to borrow at a
cheaper rate from RBI and lend to trade and industries to give boost to industrial
Repo can be undertaken only in a) dated Government Securities and b) Treasury Bills as
per current regulations.

Bills Rediscounting: Banks discount for their customers, bills of exchange which arise
out of genuine trade transactions. When a trader buys goods from the supplier, he
demands credit. Supplier in such circumstances draws a bill of exchange on the trader for
the cost of goods so supplied. After bill is formally “accepted” by the drawee (trader) for
payment after specified period, the drawer of the bill (supplier) presents the bill to his
banker for discounting and receives discounted value so that he can continue his
operations unhindered. On due dates banker presents these bills to the drawee and
receives payment on behalf of his customer.
On any day, bankers hold large number of such bills which are yet to become due for
payment. They utilize these bills in times of need to raise funds either from RBI or inter-
bank market by rediscounting them. The rate at which RBI rediscounts these bills is
called “Bank Rate”.

Participation Certificates: Participation Certificates are used by banks to enable them to

acquire or transfer their realizable debts to each other and raise funds through this
process. This transfer may be “with recourse” or “without recourse”. If the agreement to
transfer is “with recourse”, then the acquiring bank also gets the right to recover the dues
from the borrowers through legal process. In “ without recourse” transfer only debt is
passed on to the buyer without a right to recover through legal means. Banks generally
resort to PCs to fulfill their mandatory requirement of advances level in specific sectors
to comply with RBI regulations.

Intermediaries in Money Market:

Apart from RBI, Discount and Finance House of India (DFHI) and Securities Trading
Corporation of India (STCI) play an important role in strengthening the secondary market
for money market instruments. RBI took lead in setting up of these institutions as a part
of their developmental function, with the help of banks and other financial institutions for
giving more liquidity and depth to the secondary market transactions which has a positive
effect on the country’s economy. While DFHI operates mostly in short term instruments,
STCI has been playing more dominant role in instruments of longer maturity. These
institutions give “Two Way” quotes for the securities i.e. offer to buy as well sell the
same security with a spread (difference in rates) which enables them to earn a small profit
in each transaction. After contributing initial capital with the help of banks and financial
institutions and also providing initial credit support, RBI has now mostly diluted their
stake in these profit making companies by selling their share holding to the willing banks
and institutions.

Primary Dealers:
System of Primary Dealers was set up by RBI in 1994 for,
a. Strengthening the trading in government securities to make the securities market
vibrant, liquid and broad based.
b. Ensuring development of underwriting and market making capabilities for
government securities outside RBI so that it can concentrate on their own
c. Improving secondary market trading system which would contribute to price
discovery, enhance liquidity and turnover and encourage voluntary holding of
government securities amongst wider investor base.
d. Making PDs an effective conduit for conducting Open Market Operations
RBI grants licences to the subsidiaries of commercial banks and FIs, formed specifically
for this purpose and to companies incorporated under Companies Act, 1956 and engaged
in securities business and in particular, the government securities market, provided they
fulfill specific conditions as to the net worth, infrastructure, qualification of key officials,
the annual turn over, success rate in the auctions etc. These players have contributed
significantly to the money market and government securities market since inception.