Money Market

Session 13

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Money Markets
The money market encompasses a wide range of instruments with maturities ranging from one day to a year, issued by the government and by banks and corporates that are traded in the markets.

Money Markets

There are fundamental differences between Money and Capital markets. The same borrower may tap both markets to fulfill different needs.

For instance, a corporate borrower may issue long term bonds in the capital market to raise funds to build a factory.

The same borrower may issue commercial paper in the money market to finance his inventories.

Why money markets ?

Take the case of a government. It will collect revenues primarily by way of taxes.

Such revenues tend to arrive in lumps during certain months of the year.

However the government has to incur expenses throughout the year, both on account of developmental works as well as on account of wages and salaries.

Why money markets ?

Consequently during most of the year the government will be a borrower, and will issue T-bills to meet its short-term needs.

Why money markets ?

The same it true for a business. The balance in a current account will constantly fluctuate. If surplus funds are available a business may temporarily park its funds in money market securities. Else if there is a deficit it will issue instruments like commercial paper to raise short-term funds.

Participants of Money Market

Government Agencies Industrial Houses Commercial Companies Intermediaries e.g. Money Brokers, Financial Institutions Banks

Features of Money Market

It is a wholesale market. Not for small investors. However they can participate indirectly through MMMFs.
The money market facilitates large scale transfer of funds. For most banks except the Bank of America, fund requirements usually exceed deposits. For smaller state and local banks, deposits usually exceed fund requirements.

Types of Instruments
The most transactions in the global money markets take the form of:

T-bills Call Money Repurchase agreements Certificate of deposit Commercial paper Certificate of deposit Eurocurrency deposits Bankers Acceptance

Call money market

Call Money Market

It refers to either secured or unsecured callable loans made by banks to money market dealers. The maturity period varies from 1-14 days. Call Money Market is basically an overnight market in which all banks participate. A market that consists of the borrowing of money by brokers and dealers for the purpose of meeting their credit needs.

A fall in the call money rates indicates a rise in the liquidity in the financial system and vice versa. The other key feature of this market is that the borrowings are unsecured; that is, they are not backed by any collateral. The daily turnover in the Call Money Market runs into billions of rupees. The market is operational between 9.30 am to 12.30 pm on Saturdays and between 9.30 am to 2.30 pm on every other working day.

Purpose

Mainly to even out the short term mismatches of assets and liabilities Meet CRR requirements of banks (6%) Discounting commercial bills

Participants
Commercial banks Private sector, public sector and cooperative banks Lenders (only lend cannot borrow) Financial institutions and mutual funds Intermediaries (borrow lend both) DFHI, STCI and primary dealers (SBI Gilts, Punjab Gilts, ICICI securities and Finance Corporation Ltd.)

Call rates

They are the interest paid on call loans High rates indicate tightness of liquidity position Low rates indicate easy liquidity position in the market It reflects the market scarcities and lack of funds Current call rate is 7% -8.5%

Influencing Factors
Demand side Tax outflows Government borrowing programme Seasonal fluctuations in credit off take

Supply side Deposit mobilization of banks Capital flows Money lender Brokers

Role of RBI

Does not lend or borrow funds Intervenes when market overheated

Treasury Bills

Treasury Bills

When government need to borrow fund, govt issues short term security known as T-bills They are free from the credit risk. Investors: Depository institutions, Financial Institutions, Individuals, Corporations banks Size of the issue:

Types of T-Bills

14-day T-bills 91-day T-bills 182-day T-bills

364-day T-bills

Pricing Treasury Bills

The price that an investor will pay for a T bill with a particular maturity is dependent on the investors required rate of return on that T bill. T bills do not offer coupon payment but are sold at a discount from par value. Price is determined on present value of the par value.

Example
If investor requires 7% annual return on one year T bill, willing price to pay: P = 100 = Rs 93.45 1.07 To price a T bill with shorter maturity, return will reduce. If investor requires 6% annual return on six month T bill, willing price to pay: P = 100 = Rs 97.08 1.03

Yield

Yield is influenced by the difference between the selling and purchase price. (primary & secondary) Yields on T-bills are less Yields on T-Bills are considered as benchmark yields
(100 Price ) * 365 (Price * No. of days to Maturity)

Yield =

Illustration

Face value of a 364-day T-bill = Rs. 100 Purchase Price = Rs. 88.24 Yield =
(100 88.24 )* 365 (88.24)* 364

= 13.36%

Suppose the investor plans to sell the T bill after 120 days and forecast selling price as Rs 94 The expected yield will be: Y = 94 88.24 x 365 88.24 120 =???

Estimating Treasury Bill Discount

T bill discount = Par PP x 360 Par n

100-88.24 x 360 100 364 = 11.63%

Issuing Procedure

Auctions Competitive and Non- competitive bids Determination of Cut-off price

Allotment of T-bills
T-bill Periodicity Notified Amount (Rs. Cr) 1000 Day of auction Day of Payment

91-day

Weekly

Every Wednesday Every Alternate Wednesday

Following Friday Following Friday

364-day

Fortnightly

500

Payment

Certificates of Deposits (CDs)

Certificates of Deposits (CDs)

CDs are promissory note, negotiable and in marketable form bearing a specified face value and number. Scheduled commercial banks and the major financial institutions can issue CDs. These are also known as Negotiable Certificates of Deposits These are short term borrowing by banks They are freely transferable after lock in period of 30 days

Features of CDs

It is freely transferable by endorsement and delivery. these are also usually issued at a discount to face value and are redeemable at par on maturity.

The RBI allows CDs to be issued up to one -year maturity. However the maturity most quoted in the market is 90 days.
It does attract stamp duty.

Issuers

Banks and financial institutions are the largest issuers of CDs, and are also subscribers to the CDs of one another. Subscribers
CDs are available for subscription for individuals, corporations, companies, trust, funds, associations etc.

Benefits

CDs benefit both issuers and investors. It is a better way of deploying short-term funds as higher yield is offered secondary market liquidity is available and repayment of interest and principal is assured.

Minimum Size and Maturity

Minimum Size and Maturity

CDs are issued for a period of 7 days to one year( normally one to three years by the financial institutions) at a minimum amount of Rs. 1 lakh.

Discount

CDs are issued at a discount to face value. Bank CDs are always discount bills.

Commercial Paper

Commercial Paper

Commercial paper is a short term, unsecured promissory note. Issued by well known credit worthy firms. Issued to provide liquidity or finance a firms investment in inventory and accounts receivables. Major issuer are finance cos, banks. Min maturity 15 days to 1 year. Company should have a min credit rating of P2 from crisil and A2 from ICRA. Individual investors can invest directly because minimum denomination is less.

Features

Commercial paper is unlike the commercial bill. Commercial paper are Unsecured CP market provides a cheaper source of funds & less paper work formalities Higher liquidity. Maturity Period. Denomination & Size

Participants

Issuers

Investors

Yield
Yield are higher than the T bills because of credit risk. Cps are sold at a discount from par value. If investor purchase 30 days CP with a par value of 10,000 for a price of 9900 yield: = 10,000-9900 x 360 9900 30 =12.12% CPs are issued for periods of 30/45/60/90/120/270/360 days.

Advantage of commercial paper: High credit ratings fetch a lower cost of capital. Wide range of maturity provide more flexibility. Tradability of Commercial Paper provides investors with exit options. Disadvantages of commercial paper: Its usage is limited to only blue chip companies. Issuances of Commercial Paper bring down the bank credit limits. A high degree of control is exercised on issue of Commercial Paper.

Factors Affecting the pricing

Inter Bank Call Rates. Competing Money Market Investment Products. Liquidity. Credit Rating.

Issuing Procedure

Eligibility criteria prescribed by RBI Selection of Merchant Banker and IPA Obtaining a resolution of company Board CP credit rating Approach principal banker

Repo Market

Repo Market

Repo

With repurchase agreement (repo), one party sells securities to another with an agreement to repurchase the securities at a specified date and price. A Repo or a repurchase agreement is an arrangement that facilitates the borrowing of funds by a dealer.
It refers to the purchase of securities by one party from another with an agreement to sell them. Thus both are same but different perspective.

Reverse Repo

Participants: Financial institutions such as banks, savings and loan association, Non financial participants. No secondry market for repo.

Features

Maturity Overnight Open Term Collateralized lending Haircut

Haircut

The lender has to protect himself against the risk that the market value of the collateral may decline. Hence he will not lend the full value of the collateral but will apply a discount. This discount is called a haircut.

The size of the haircut would depend on:

The maturity of the collateral. Its liquidity. Its price volatility. The term to maturity of the repo, Creditworthiness of the borrower.

Advantages

Liquidity & Depth Volumes Source of Finance

Supply of Money

Bankers Acceptance

Bankers acceptance

A banker's acceptance, or BA, is a promised future payment, or time draft, which is accepted and guaranteed by a bank and drawn on a deposit at the bank.

Money Market Price Movement

International eco condition Fiscal policy

Monetary policy

Country Eco condition

Issuers Industry condition

Issuers Unique condition

Short term Risk free IR (Tbill rate) Required rate on MM security Price of the MM security

Risk Premium of Issuer

9/11 effect on Money Market????

Repo Market in India

Tool by RBI LAF Auctions

Widen markets