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Chapter 4

Chapter Objectives
To understand

Characteristics, Functions And Benefits Of

Money Market
Development Of Money Market In India
Different Money Market Instruments
Money Market Intermediaries
Link Between Money Market And Monetary
Tools For Managing Liquidity In The Money
Money Market is a market for
overnight to short-term funds (i.e., upto 1
year) &
for short-term money and financial assets
that are close substitutes for money,
that is, financial assets that can be quickly
converted into cash (money)
with minimum transaction cost and

without loss in value.

Importance of Money
1. Development of Trade and Industry
2. Development of Capital Market
3. Smooth Functioning of Commercial
4. Effective Central Bank Control
5. Formulation of Suitable Monetary
6. Non-inflationary source of Finance to
Characteristics of
Money Market
A collection of markets for several
short-term debt instruments

Wholesale market

Principal feature is honour

Need-based market
Features of a Money
The following are the general features of a money

1. It is a market purely for short-term funds or

financial assets called near money.

2. It deals with financial assets having a maturity

period upto one year only.

3. It deals with only those assets which can be

converted into cash readily without loss and with
minimum transaction cost.
Features of a Money
Market (cont.)
4. Generally transactions take place through
phone i.e., oral communication. Relevant
document and written communications
can be exchanged subsequently. There is
no formal place like stock exchange as in
the case of a capital market.

5. Transactions have to be conducted

without the help of brokers.
Features of a Money
Market (cont.)
6. It is not a single homogeneous market. It
comprises of several sub-markets, each
specializing in a particular type of financing
e.g., Call money market, Acceptance market,
Bill market and so on.

7. The components of a money market are the

Central Bank, Commercial Banks, Non-
banking financial companies, discount houses
and acceptance houses. Commercial banks
generally play a dominant role in this market.
Other features of the Money
Market are:
1. It is a market for short-term loanable funds
for a period of not exceeding one year.

2. This market supplies funds for financing

current business operations, working capital
requirements of industries and short period
requirements of the Government.

3. The instruments that are dealt in a money

market are bills of exchange, treasury bills,
commercial papers, certificate of deposit etc.
Other features of the Money
Market: (cont.)

4. Each single money market instrument is of

large amount. A TB is of minimum for one
lakh. Each CD or CP is for a minimum of
Rs. 25 lakhs.

5. The Central bank and Commercial banks

are the major institutions in the money

6. Money market instruments generally do

not have secondary markets.
Other features of the Money
Market: (cont.)

7. Transactions mostly take place over-the-

phone and there is no formal place.

8. Transactions have to be conducted

without the help of brokers.
Objectives of Money
The following are the important objectives of a
money market:

i. To provide a parking place to employ short-term

surplus funds.
ii. To provide room for overcoming short-term
iii. To enable the Central Bank to influence and
regulate liquidity in the economy through its
intervention in this market.
iv. To provide a reasonable access to user of short-
term funds to meet their requirements quickly,
adequately and at reasonable costs.
Functions of Money
1. By providing various kinds of credit
instruments suitable and attractive for
different sections, a money market augments
the supply of funds.

2. Efficient working of a money market helps to

minimize the gluts and stringencies in the
money market due to the seasonal variations
in the flow of and demand for funds.

3. A money market helps to avoid wide seasonal

fluctuations in the interest rates.
Functions of Money
Market (cont.)
4. A money market, by augmenting the
supply of funds and making them readily
available to the legitimate borrowers, help
in making funds available at cheaper rates.

5. A well organized money market, through

quick transfer of funds from one place to
another, helps to avoid the regional gluts
and stringencies of funds.
Functions of Money
Market (cont.)

6. It enhances the amount of liquidity

available to the entire country.

7. A money market, by providing profitable

investment opportunities for short-term
surplus funds, helps to enhance the
profit of financial institutions and
Objectives/ Functions of
Money Market
These broad objectives/ functions of the
money market are three-fold:

(i) It acts as an equilibrating mechanism for

evening out short-term surpluses and
deficiencies of funds

(ii)It is the focal point of RBI intervention for

influencing liquidity in the economy and
Objectives/Functions of Money
Market (cont.)

(iii) It provides reasonable access to the

users of short-term funds to meet their
requirements at realistic/reasonable
cost or to temporarily deploy their
excess funds for earning returns.
Functions of Money
To provide

A balancing mechanism

The focal point for central bank

An intervention

Reasonable access to short-term funds

Benefits of an Efficient Money

Provides a stable source of funds to banks

Encourage development of non-bank


Facilitates government market borrowing

Makes effective monetary policy actions

Helps in pricing different floating-interest

Role of the Reserve Bank in the
Money Market

Ensure liquidity

Ensure an adequate flow of credit to

the productive sectors of the economy

Bring about order in the foreign

exchange market
Money Market Instruments/
1. Treasury Bills (T-Bills)

2. Commercial Papers (CPs)

3. Commercial Bills (CBs)

4. Certificates Of Deposit (CDs)

5. Call/Notice Money Market

6. Collateralised Borrowing And Lending

Obligation (CBLO)

7. Money Market Mutual Funds (MMMFs)

1. Treasury Bills (T-bills)
A T-bill is an instrument of short-term
borrowing by the Government of India
to bridge seasonal/ temporary gaps
between receipts and expenditures.

It is issued by the RBI on behalf of the

1. Treasury Bills (T-bills) (cont.)

The features of T-bills are:


Issued at discount and redemption at par

on maturity,
High liquidity,

Low transaction cost,

Absence of default risk,

Eligibility for inclusion in the SLR and

transaction through SGL account.
1. Treasury Bills (T-bills) (cont.)

Features of T-bills

Short-term instruments issued by RBI on

behalf of the government
Negotiable and highly liquid securities
Absence of default risk
Assured yield, low transaction cost
Security for SLR purposes
Not issued in scrip form
1. Treasury Bills (T-bills) (cont.)
Being a risk-free instrument, the yields
on T-bills at various maturities serve as
a benchmark and help in pricing
different floating rate instruments in the

The T-bill market is the RBI's preferred

tool for intervention, to influence short-
term interest rates.
Types of T-bills
On tap bills

Ad hoc bills

Auctioned T-bills
91-day, 182-day, and 364-day T-Bills
Sale of T-bills

Conducted through an auction

Non-competitive bids also accepted

Types of auctions

Multiple Price Auction

Uniform Price Auction

T-Bills Zero Coupon
T-bills are zero coupon bonds issued by
the RBI on behalf of the Government, in
the form of a promissory note.
It presently issues T-bills in two
maturities: 91 days and 364 days.
They are issued through auction.
The RBI declares the auction calendar at
the starting of the financial year, men
tioning the amount of issue, the day of
auction and the day of payment.
Types of Auctions
The 91 days T-bills are auctioned every

The multiple price based auction technique

is used. Under this method (also known
as French Auction), all bids equal
to/above the cut-off price are accepted.

However, the bidder has to obtain the T-

bills at the price quoted by him.
Types of Auctions (cont.)

The 364 days T-bills are auctioned on the second

and fourth Wednesdays of the month, using the
uniform price based auction (also known as
Dutch Auction).

Under this system, all the bids equal to/above

the cut-off prices are accepted at the cut-off

The bidder obtains the T-bills at the cut-off

(uniform) price and not at the price quoted by
Size of T-Bills Market (Rs in
O/S 2002-03 2003-04 2004-05 2005-
91-day 10,672 7139 27792 16318
364-day 26126 26136 47132 45018

Implicit yield at cut-off prices (Average)

91-day 5.24%
364-day 5.63%
2. Commercial Paper
A CP is a short-term, unsecured,
negotiated instrument consisting of a
usance promissory note with a fixed

It is not tied to any specific self-liquidating

trade transaction.

Depending on whether it is issued by the

company concerned directly or through a
dealer, the CP is called a direct paper or a
dealer paper respectively.
2. Commercial Paper
An unsecured short-term promissory
note issued at a discount

Creditworthy Corporates
Primary Dealers
All India Financial Institutions
2. Commercial Paper

Largest issuers of CPsLeasing and

Finance companies

Usually privately placed with investors

Attracts stamp duty

Underwriting not mandatory

Benefits of Commercial
Papers (CPs)
As a short-term instrument, a CP offers
several advantages to the issuers as
well as the investors, such as

Flexible Maturities,

Lower Cost,
Higher Credit Standing,

No Restriction On End-use Of Funds,

High Liquidity,

Higher Return And So On.

Process for Issuing CP
A resolution to be passed by the Board
of Directors

CP issue to be rated

Select an Issuing and Paying Agent for

verification of documents

Arrange for dealers for placement of

Guidelines Relating to CPs
Corporates, primary dealers and all India
financial institutions eligible to issue a CP

Minimum credit rating P2 of Crisil

Maturity period of minimum of 7 days and

maximum up to one year from the date of issue

Minimum of Rs 5 lakh and multiples

To be issued in demat form

Banks can provide credit enhancement facility

Size of CP Market (Rs in
2002-03 2003-04 2004-05 2005-06

O/S 5749 9131 14235 12693

Indian CP Market
The framework of the Indian CP market has
to conform to the RBI guidelines.

The main elements of the framework relate

to the

(i) Eligible issuers in terms of minimum

tangible networth, sanction of working
capital limits by banks/FIs and
classification of borrowal account as
standard asset,
Indian CP Market (cont.)

(ii) Instrument in terms of minimum

rating, denomination and stand-alone
(iii) Renewal of a CP
(iv) Eligible investors and
(v) Form of issue and so on.
3. Commercial Bills
A commercial bill is a short-term negotiable
and self-liquidating instrument.

It is a written instrument containing an

unconditional order signed by the maker
(seller of goods), directing the buyer to
pay a certain amount of money only to a
particular person or to the bearer of the

The bills can be discounted in the bill

discount market.
3. Commercial Bills (cont.)

A short-term, negotiable and self liquidating

instrument with low risk.
1. Demand bill
2. Usance bill
3. Clean bill
4. Documentary bill
5. Inland bill
6. Foreign bill
7. Hundi
8. Derivative Usance Promissory Note
Bills Rediscounting
Bill rediscounting, as a money market product,
has not become popular in India inspite of
several measures, including abolition of
stamp duty, taken by the RBI to develop bill

The main factors hindering the development

of the bill finance/culture are: system of cash
credit, small size of foreign trade, absence of
specialised discounting institutions, lack of
an active secondary market and so on.
4. Certificate of Deposits
A CD is a negotiable money market product,
issued in a demat form or as a usance
promissory note for funds deposited at a
bank/other eligible FIs for a specified time

In other words, a CD is a marketable receipt

of funds deposited in a bank/FII, for a fixed
period, at a specified rate of interest.
4. Certificate of Deposits
(CDs) (cont.)
It is attractive both to the bank/FII and the
investors as the former does not have to
encash the deposit prematurely, while
the latter can sell it in the secondary
market before its maturity.

So, Certificate of Deposit (CD) is a short-

term tradable time deposit issued by
commercial banks and financial institutions
with following features:
Features of Certificate of
Deposits (cont.)
Issued at a discount to face value.
Minimum amount Rs 1 lakh and in multiples
Maturity period
7 days to one year for banks
1 to 3 years for FIs
No lock-in period
Transferable by endorsement
Banks to maintain appropriate reserve
requirement on issue of CDs.
Issued in demat form
Key investors--Mutual Funds
Cost attractive vis--vis time deposits
Size of CD Market

2002-03 2003-04 2004-05 2005-06

O/S 908 4764 12078 36931

Constitutes 4.3% of aggregate deposits

Certificate of Deposits (CDs)
in India
The framework of the issue of CDs in India is prescribed
by the RBI.

The main elements of the RBI guidelines relate to

Eligibility of issuers,
Aggregate amount of issue,
Minimum issue size and denomination,
Eligible subscribers,
Discount/ coupon rate,
Reserve requirements,
Loans/buy back and so on.
5. Call/Notice Money
(Short-term Deposits/Term Money)

The call/notice money deals with

overnight/one-day (call) money and notice
money for upto 14 days.

Call money is required by banks to meet

their CRR requirements on a reporting

The call market is a pure inter-bank market

5. Call/Notice Money Market

There are also prudential limits on lending

and borrowing by banks.

The lending limit on a fortnightly average

basis is 25 per cent of owned funds.

The borrowing limits are the higher of 100

per cent of owned funds or 2 %of the
aggregate deposits of a bank.
Call/Notice Money Market (cont.)
Banks borrow/lend money for a period
ranging between 1 and 14 days.

No collateral security required

Highly liquid, risky, and volatile market

Banks trade money to adhere to CRR


Average daily turnover in March 2005

Rs15294 cr and in March 2006 Rs 18290 cr.
Call Rate
The interest rate paid on call loans is
known as the call rate.
The call rates are affected by a number of
factors such as easy/tight liquidity
conditions, reserve requirements, volatile
forex market conditions and so on.
The RBI moderates liquidity and volatility in
the call market through LAF, repo and
reverse repo and changes in CRR.
Factors Influencing Call Rate
Liquidity conditions

Reserve requirement prescriptions

Structural factors

Investment policy of non-bank participants.

Liquidity changes and gaps in the foreign

exchange market
Measures for Curbing High
Increasing the number of participants

Through repos

Freeing of inter-bank liabilities from

reserve requirements
6. Collateralized Borrowing and
Lending Obligations (CBLO)
Launched by CCIL

To provide liquidity to non-bank entities

No lock-in period
Original tenure varies between one day and
one year
Trading volumes have grown
Average daily turnover during March 2005 was
Rs 9625 crore which increased to Rs 35775
crore in March 2006
CBLO segment of CCIL increased from 110 as
7. Money Market Mutual
Funds (MMFs)
An MMMF is a conduit through which
small investors can participate in the
money market to earn the market-
related yield.

They are, however, a marginal product in

the Indian money market.
Money Market
The Intermediaries
Discount and Finance House of
India--set up in 1988 by RBI.
Role is to stimulate activity in money
DFHI is an accredited primary dealer.
Money Market Mutual Funds:
Introduced in April 1991. Mobilize
savings from small investors.
Link Between Money Market and
Monetary Policy in India

Objectives of the monetary policy

Price stability
Instruments used to
influence monetary
Direct instruments Indirect
such as instruments such
Reserve Requirements,
Open Market
Limits On Refinance, Operation
Administrative Interest Repos
Qualitative And
Restrictions On Credit
Tools for Managing Liquidity in
the Money Market

Reserve requirements: CRR (5%) &


Interest rates
Prime lending rate:10 .25% -10 .75%
Bank rate :6%(Long-term rate)

Refinance from RBI

Tools for Managing Liquidity in
the Money Market (cont.)
Liquidity Adjustment Facility: operates

Repo and Reverse Repo Auctions;

Coupled with OMOs and MSS

provides RBI greater flexibility in

managing liquidity
Tools for Managing Liquidity in
the Money Market (cont.)
Types of Repos:

Interbank repos,

RBI repos:
Reverse Repo (Borrowing of overnight
funds by RBI)- rate 6% and

Repo (Lending to banks)- rate 7%

(Short-term rates)
Tools for Managing Liquidity in
the Money Market (cont.)

Market Stabilization Scheme (MSS):

deals with enduring capital inflows

without affecting short-term liquidity
management role of LAF.
Money Market Derivatives

Interest Rate Swap

Forward Rate Swap

Interest Rate Futures

Money Market
A ceiling of 10 per cent on call money rates
imposed by the Indian Banks Association was
withdrawn in 1989.

Initially, the participation in the call market was

gradually widened by including non-banks, such
as, financial institutions, non-banking finance
companies, primary/satellite dealers, mutual
funds, corporates (through primary dealers),
etc. The process of transformation of call money
market to a pure inter-bank market commenced
effective May 2001.
Money Market Reforms

The 182-day treasury bills were introduced

effective November 1986, followed
subsequently by phasing out of on-tap
treasury bills, introduction of auctioning
system in 91 day treasury bills since January
1993, and introduction of 14-day and 364-day
treasury bills. The system of ad hoc treasury
bills (with a fixed 4.6 per cent interest rate
since July 1974), which were issued by the
Central Government to the Reserve Bank, was
abolished effective April 1997. Currently only
the 91-day and 364-day treasury bills exist.
Money Market Reforms

Several new financial instruments were

introduced, such as inter-bank participation
certificates (1988), certificates of deposit
(June 1989), commercial paper (January
1990) and repos (December 1992).

Derivative products like forward rate

agreements and interest rate swaps were
introduced in July 1999 to enable banks, FIs
and PDs to hedge interest rate risks.
Money Market Reforms

A full-fledged Liquidity Adjustment Facility was

introduced on June 5,2000 with a view to modulating
short-term liquidity under diverse market conditions.

With a view to adopting the sound risk management

procedures and eliminating counter-party risk, the
Clearing Corporation of India Ltd. was set up on
February 15, 2002. The CCIL acts as a central
counter-party to all trades involving foreign
exchange, government securities and other debt
instruments routed through it and guarantees their
Money Market Reforms

The Discount and Finance House of India (DFHI)

was set up in April 1988, and was allowed to
participate in the call/notice money market both
as a borrower and lender commencing from July

The segment refinance facility for banks is

gradually being phased out. Collateralized
Borrowing and Lending Obligations (CBLO) was
launched by CCIL in January, 2003.
Money Market Reforms

Institutionalization of the Clearing Corporation of

India Limited (CCIL) as a central counter party.

Issuance norms have been modified to

encourage wider participation while
strengthening the transmission of policy signals.

Upgradation of payment system technologies.