S.

K SOMAIYA COLLEGE OF ARTS, SCIENCE &

COMMERCE
VIDYAVIHAR (EAST), MUMBAI - 400077

PROJECT ON:
MONEY MARKET INSTRUMENT

MASTERS OF COMMERCE
(BANKING & FINANCE)

PART 2 (SEM-3)
(2016-2017)

Submitted:
In Partial Fulfillment of the requirements
For the Award of the Degree of
MASTERS OF COMMERCE
(BANKING & FINANCE)
BY
JIGNA M. BHANUSHALI
ROLL NO : 05

CERTIFICATE
This is to certify that MS. JIGNA M. BHANUSHALI of M.Com (BANKING
AND FINANCE) Semester- 3(2016-17) has successfully completed the project
on Money Market Instrument under the guidance of Mr. Ravikant B.S.

________________

________________

Course Coordinator

Principal

________________
Project Guide/Internal Examiner
_______________
External Examiner
Date:

DECLARATION

I JIGNA M. BHANUSHALI student of class in M.com (BANKING

& FINANCE) PART 2 (SEM-3), ROLL NO.05 , academic year
2016-2017 Studying at S.K. SOMAIYA COLLEGE OF ARTS,
SCIENCE AND COMMERCE, hereby declare that the work done
on the project Entitled Money Market Instrument is true and
original and any Reference used in this project is duly acknowledged.

Date:
Place:
_________________
Student Signature
JIGNA BHANUSHALI
Roll No. 05

ACKNOWLEDGEMENT

Talent and capabilities are of course necessary but opportunities and good
guidance is very important things without which no person can climb those
infant ladders towards progress.
With regard to my project I would like to thank each and every one who offered
help, guidance and support whenever required.
I take immense pleasure in thanking Mr. Ravikant B.S. and other staff for their
support and guidance in the project work.
I am extremely grateful to my Mr. Ravikant B.S. for his valuable guidance and
kind suggestions.
Finally and yet importantly I would like to express my heartfelt thanks to my
beloved parents and friends for their blessings, my classmates for their help and
wishes for the successful completion of this project.

_______________
JIGNA M. BHANUSHALI

INDEX

Sr.No
1.
2.
3.
4.

Particulars
Introduction
Structure and functions of Money market
in India
Characteristics of Money Market in India

Page
no.
6
7
13-30

Collateralized borrowing and lending

obligation(CBLO)
Local Government Investment pools
Brokers loans and call loans

31-32

37-42
43

9.

Credit rating of instrument

Similarities of capital market instruments
& money market instrument
Conclusion

10.

Bibliography

5.
6.
7.
8.

33-35
36

44-45
46

INTRODUCTION
Money Market is the centre for dealings, mainly short term character, in money
assets. It meets the short term requirements of the borrowers & provides
liquidity or cash to the lenders. Money Market refers to the market for short
term assets that are close substitutes of money, usually with maturities of less
than a year.
Money market means market where money or its equivalent can be traded.
Money Market is a wholesale market of short term debt instrument and is
synonym of liquidity
As per RBI definitions A market for short terms financial assets that are close
substitute for money, facilitates the exchange of money in primary and
secondary market.
Money Market is part of financial market where instruments with high liquidity
and very short term maturities i.e. one or less than one year are traded. Due to
highly liquid nature of securities and their short term maturities, money market
is treated as a safe place.
Hence, money market is a market where short term obligations such as treasury
Money Market Instruments
bills, call/notice money, certificate of deposits, commercial papers and repos are
bought and sold.
The money market is the global financial market for short-term borrowing and
lending. It provides short-term liquid funding for the Global Financial System
(GFS).
In finance, the money market is the global financial market for short-term
borrowing and lending. It provides short-term liquidity funding for the global
financial system. The money market is where short-term obligations such as
Treasury bills, commercial paper and bankers' acceptances are bought and sold.

Money market
market wherein the demand & supply of money shape the market.
Money market is basically over-the-phone market.
Dealing in money market may be conductive with or without the help of
brokers.
It is a market for short-term financial assets that are close substitutes for
money.
Financial assets which can be The money market is the global financial market
for short-term borrowing and lending. It provides short-term liquid funding for
the Global Financial System (GFS).

Characteristics Of Money Market

It is not a single market but a collection of markets for several
instruments.
It is a need-based converted into money with ease, speed, without loss &
with minimum transaction cost are regarded as close substitutes for
money.
Prerequisites For An Efficient Money Market

Money market should be wide & deep. There should be large number of
participants.
There should be well diversified mix of money market instruments, suited
to different requirement of borrowers and lenders.
A strong central bank for regulation, direction and facilitation is essential
for a well organized and developed money market.
A well organized commercial banking system.
There should be a number of inter-related and integrated sub-markets.

Money market should have adequate amount of liquidity.

Money market should have large demand and supply of funds.

Structure and functions of Money market in India

There are two kinds of markets where borrowing and lending of money takes
place between fund scarce and fund surplus individuals and groups. The
markets catering the need of short term funds are called Money Markets while
the markets that cater to the need of long term funds are called Capital Markets
Thus, money markets is that segment of financial markets where borrowing and
lending of the short-term funds takes place. The maturity of the money market
instruments is one day to one year. In our country, Money Markets are
regulated by both RBI and SEBI. Indian money market is divided into organized
and unorganized segments. Unorganized market is old Indigenous market
mainly made of indigenous bankers, money lenders etc. Organized market is
that part which comes under the regulatory purview of RBI and SEBI. The
nature of the money market transactions is such that they are large in amount
and high in volume. Thus, the entire market is dominated by small number of
large players. At the same time, the money market in India is yet
underdeveloped. The key players in the organized money market include
Governments (Central and State), Discount and Finance House of India (DFHI),
Mutual Funds, Corporate, Commercial / Cooperative Banks, Public Sector
Undertakings (PSUs), Insurance Companies and Financial Institutions and NonBanking
Financial
Companies
(NBFCs).

Structure of Organised Money Market in India

The organized money market in India is not a single market but is a
conglomeration of markets of various instruments. They have been discussed
below:
Call Money / Notice Money / Term Money Market
Call Money, Notice Money and Term Money markets are sub-markets of the
Indian Money Market. These refer to the markets for very short term funds. Call
Money refers to the borrowing or lending of funds for 1 day. Notice Money
refers to the borrowing and lending of funds for 2-14 days. Term money refers
to borrowing and lending of funds for a period of more than 14 days. More
information is available here.

Treasury Bill (T Bills)

The bill market is a sub-market of the money market in India. There are two
types of bills viz. Treasury Bills and commercial bills. While Treasury Bills or
T-Bills are issued by the Central Government; Commercial Bills are issued by
financial institutions. Click here for more information on Treasury Bills.
Commercial Bills
Commercial bills market is basically a market of instruments similar to Bill of
Exchange. The participants of commercial bill market in India are banks and
financial institutions but this market is not yet developed.
Certificate Of Deposits (CDs)
Certificate of Deposit (CD) refers to a money market instrument, which is
negotiable and equivalent to a promissory note. All scheduled commercial
banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs)
and Select All India Financial Institutions permitted by RBI are eligible to issue
certificates of deposits. More information is here.
Commercial Papers (CP)
Commercial Paper (CP) is yet another money market instrument in India,
which was first introduced in 1990 to enable the highly rated corporates to
diversify their resources for short term fund requirements. More Information
about Commercial Papers is here.
Money Market Mutual Funds (MMMFs)
Money Market Mutual Funds (MMMFs) were introduced by RBI in 1992 but
since 2000, they are brought under the purview of the SEBI. They provide
additional short-term avenue to individual investors.
The Repo / Reverse Repo Market
Repo (repurchase agreement ) was introduced in December 1992. Repo means
selling a security under an agreement to repurchase it at a predetermined date
and rate. Repo transactions are affected between banks and financial institutions
and among bank themselves, RBI also undertake Repo. IN 1996, Reverse Repo
was introduced. Reverse Repo means buying a security on a spot basis with a

10

commitment to resell on a forward basis. Reverse Repo transactions are affected

with scheduled commercial banks and primary dealers.
Discount And Finance House Of India (DFHI)
It was established in 1988 by RBI and is jointly owned by RBI, public sector
banks and all India financial institutions which have contributed to its paid up
capital. DFHI plays important role in developing an active secondary market in
Money Market Instruments. From 1996, it has been assigned status of a Primary
Dealer (PD). It deals in treasury bills, commercial bills, CDs, CPs, short term
deposits, call money market and government securities.
Functions of Money Markets
Due to short maturity term, the instruments of money market are liquid and can
be converted to cash easily and thus are able to address the need of the short
term surplus fund of the lenders and short term borrowing requirements of the
borrowers. Thus, the major function of the money markets is to cater to the
short term financial needs of the economy.
The other functions are as follows:
1. Money Markets help in effective implementation of the RBIs monetary
policy
2. Money markets help to maintain demand and supply equilibrium with
regard to short term funds
3. They cater to the short term fund requirement of the governments

Benefits of Money Market

11

Money markets exist to facilitate efficient transfer of short-term funds between

holders and borrowers of cash assets. o For the lender/investor, it provides a
good return on their funds.
Money Market Instruments
o For the borrower, it enables rapid and relatively inexpensive acquisition of
cash to cover short-term liabilities.
One of the primary functions of money market is to provide focal point for
RBIs intervention for influencing liquidity and general levels of interest rates in
the economy. RBI being the main constituent in the money market aims at
ensuring that liquidity and short term interest rates are consistent with the
monetary policy objectives.
Players of Money market
Reserve Bank of India
SBI DFHI Ltd (Amalgamation of Discount & Finance House in India and SBI
in 2004)
Acceptance Houses
Commercial Banks, Co-operative Banks and Primary Dealers are allowed to
borrow and lend.
Specified All-India Financial Institutions, Mutual Funds, and certain specified
entities are allowed to access to Call/Notice money market only as lenders
Individuals, firms, companies, corporate bodies, trusts and institutions can
purchase the treasury bills, CPs and CDs.

CHARACTERISTICS OF MONEY MARKET INSTRUMENTS

12

 Short-term borrowing and lending.

Low credit risk.
High liquidity.
High volume of lending and borrowing.

When the loan is repaid, the borrower retrieves the securities and returns funds
to the lender. Closer examination of financial institutions reveals, however, that
beyond the simple act of exchanging securities for funds, there are major
differences between one financial transaction and another.
The purposes for which money is borrowed within the financial system vary
greatly from person to person, institution to institution, and transaction to
transaction. And the different purposes for which money is borrowed result in
the creation of different kinds of financial assets, having different maturities,
yields, default risks, and other features.
In the nations money market, loans have an original maturity of one year or
less. Money market loans are used to help corporations and governments pay
the wages and salaries of their workers, make repairs, purchase inventories, pay
13

dividends and taxes, and satisfy other short-term working-capital needs. In this
respect the money market stands in sharp contrast to the capital market.
The capital market deals in long-term credit that has over a year to maturity and
is usually used to finance capital investment projects whereas the money market
deals with the market for short-term credit.
The broad objectives of the money market are threefold: First, it should provide
an equilibrating mechanism for evening out short- term surpluses and deficits.
Secondly, the money market should provide a focal point for central bank
intervention for influencing liquidity in the economy. Thirdly, it should provide
reasonable access to users of short-term money to meet their requirements at a
realistic price.
To achieve these objectives, the Reserve Bank has accorded prime attention to
the development of the money market as it is the key link in the transmission
mechanism of monetary policy to financial markets and finally, to the real
economy.
In the past, development of the money market was hindered by a system of
administered interest rates and lack of proper accounting and risk management
systems.
With the initiation of reforms and the transition to indirect, market-based
instruments of monetary policy, the Reserve funk made conscious efforts to
develop an efficient, stable and liquid money market by creating a favourable
policy environment through appropriate institutional changes, instruments,
technologies and market practices.
Furthermore, issuance norms and maturity profiles of other money market
instruments such as commercial Accordingly, the call money market was
14

developed into primarily an inter-bank market, while encouraging other market

participants to migrate towards collateralised segments of the market, thereby
increasing overall market integrity.
In line with the objective of widening and deepening of the money market and
imparting greater liquidity to the market for facilitating efficient price discovery,
new instruments, such as collateralised lending and borrowing obligations
(CBLO), have been introduced.
Money market instruments such as market repo and CBLO have provided
avenues for non- banks to manage their short-term liquidity mismatches and
facilitated the transformation of the call money market into a pure inter-bank
market.
paper (CP) and certificates of deposit (CDS) have been modified over time to
encourage wider participation while strengthening the transmission of policy
signals across the various market segments.
The abolition of ad hoc Treasury Bills and introduction of regular auctions of
Treasury Bills paved the way for the emergence of a risk free rate, which has
become a benchmark for pricing the other money market instruments.
Concomitantly, with the increased market orientation of monetary policy along
with greater global integration of domestic markets, the Reserve Banks
emphasis has been on setting prudential limits on borrowing and lending in the
call money market, encouraging migration towards the collateralised segments
and developing derivative instruments for hedging market risks.
This has been complemented by the institutionalization of the Clearing
Corporation of India Limited (CCIL) as a central counterparty. The up gradation

15

of payment system technologies has also enabled market participants to improve

their asset liability management.
All these measures have widened and deepened the money market in terms of
instruments and participants, enhanced transparency and improved the signaling
mechanism of monetary policy while ensuring financial stability.

Money market Instruments

Money Market Instruments provide the tools by which one can operate in the
money market.
Instrument of Money Market
A variety of instruments are available in a developed money market. In India till
1986, only a few instruments were available. They were
Treasury bills
Money at call and short notice in the call loan market.
Commercial bills, promissory notes in the bill market.
Now, in addition to the above the following new instruments are available:
Commercial papers.
Certificate of deposit.
Inter-bank participation certificates.
Repo instrument
Banker's Acceptance
Repurchase agreement
Money Market mutual fund
Eurodollar
Money Market Instruments
16

Eurodollar
Contrary to the name, Eurodollars have very little to do with the euro or
European countries. Eurodollars are U.S.-dollar denominated deposits at banks
outside of the United States. This market evolved in Europe (specifically
London), hence the name, but Eurodollars can be held anywhere outside the
United States.
The Eurodollar market is relatively free of regulation; therefore, banks can
operate on narrower margins than their counterparts in the United States. As a
result, the Eurodollar market has expanded largely as a way of circumventing
regulatory costs.
The average Eurodollar deposit is very large (in the millions) and has a maturity
of less than six months. A variation on the Eurodollar time deposit is the
Eurodollar certificate of deposit. A Eurodollar CD is basically the same as a
domestic CD, except that it's the liability of a non-U.S. bank. Because
Eurodollar CDs are typically less liquid, they tend to offer higher yields.
The Eurodollar market is obviously out of reach for all but the largest
institutions. The only way for individuals to invest in this market is indirectly
through a money market fund.
Risk
They are not subject to reserve requirements
Nor are they eligible for FDIC depositor insurance (U.S. government is not
interested in protecting foreign depositors)
The resulting rates paid on Euro dollars are higher (higher risk)

Trading
Over night trading as in the Federal Funds market
Eurodollars are traded in London, and the rates offered are referred to as
LIBOR (London Interbank Offered Rate)
Rates are tied closely to the Fed Funds rate

17

 Should the LIBOR rate drop relative to the Fed Funds rate, U.S. banks can
balance their reserves in the Eurodollar market (arbitrage)

Federal Funds
Short-term funds transferred (loaned or borrowed) between financial
institutions, usually for a period of one day.
Used by banks to meet short-term needs to meet reserve requirements (over
night).
Banks loan because they would not make any interest at all on excess reserves
held with the Fed.
Banks may borrow the funds to meet the reserves required to back their
deposits.
Participants in federal funds market include commercial banks, savings and
loan associations, government sponsored enterprises, branches of foreign banks
in the US, federal agencies and securities firms.

Municipal Bonds
Bond issues by a state, city, or other local govt. or their agencies.
The method and practices of issuing debt are governed by an extensive system
of laws and regulations, which vary by state.
The issuer of the municipal bond receives a cash payment at the time of
issuance in exchange for a promise to repay the investor over time.
Repayment period can be as short as few months to few years.
Bond bears interest at either fixed or variable rate of interest. Interest income
received by bond holders is often exempt from the federal income tax and
income tax of state.
Investors usually accept lower interest payments than other types of
borrowing.

18

 Municipal bond holders may purchase bonds either directly from the issuer at
the time of issuance or from other bond holders after issuance.
Municipal bonds typically pay interest semi-annually.
Interest earnings on bonds that fund projects that are constructed for the public
good are generally exempt from federal income tax.
But, not all municipal bonds are tax-exempt.
Municipal bonds may be general obligations of issuer or secured by specified
revenues.

Treasury bill (T-bill)

History of Treasury bills
Treasury Bills (T-bills) are the most marketable money market security. Their
popularity is mainly due to their simplicity. Essentially, T-bills are a way for the
U.S. government to raise money from the public. In this tutorial, we are
referring to T-bills issued by the U.S. government, but many other governments
issue T-bills in a similar fashion.
In the United States, the history of the Treasury bill dates back to December
1929. To tackle the unforeseen financial demands that occurred during, and
after, World War I, the US Treasury issued bills, notes, and bonds. After World
War II, along with their popularity over other short-term government securities,
and there has been a gradual rise of acceptance of treasury bills as marketable
treasury securities. This is because they:
Have a very short maturity period
Are easier to issue and hence less expensive for the Treasury
There is no pre-determined interest rate
Definitions:

19

A short-term debt obligation issued by the government to finance government

activities. These are commonly referred to as T-Bills. They are usually issued
in maturities of one, three, or six months.
T-bills are zero-coupon bonds, which mean that they don't pay out interest.
Instead, an investor buys them at a discount to their par value and earns the
difference
Treasury bills are a short-term marketable securities issued on discount basis
rather than at par, the price of which is determined by competitive bidding.
Purchase can be done primarily through these auctions, however, at the
secondary level; the bills can be bought and sold from traders.
Treasury bills, commonly referred to as T-Bills are issued by Government of
India against their short term borrowing requirements with maturities ranging
between 14 to 364 days. All these are issued at a discount-to-face value. For
example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50 gets
redeemed at the end of it's tenure at Rs. 100.00.
Who can invest in T-Bill?
Banks, Primary Dealers, State Governments, Provident Funds, Financial
Institutions, Insurance Companies, NBFCs, FIIs (as per prescribed norms),
NRIs & OCBs can invest in T-Bills.
The characteristics of Treasury Bills
No coupon and trade at a discount, meaning that the investor is not paid
interest in increments over the life of the investment, but instead the security is
sold for an amount less than the face or par value of the security. When the
security reaches maturity, the investor is paid face value.
Interest = par value minus cost
3- and 6-month treasury bills are auctioned every Monday
One year treasury bills are auctioned every four weeks
Treasury Bills mature on Thursdays unless its a holiday, then they mature on
the next business day
Treasury Bills are quoted and traded on a discount yield that is converted to a
bond equivalent yield.
20

Types of Treasury Bills

At present, the Government of India issues three types of treasury bills through
auctions, namely,
ONTAP : Through the help of this funds can available at any time. It
can be bought from RBI at anytime.
AD HOC : These T-bills issued in favor of RBI only and it serves two
surplus and income. purposes which are :1. They replenish cash balances of the central govt.
2. They provide an investment outlet to state govt., semi-govt. departments and
foreign central bank for parking their temporary
AUCTIONED : RBI receives bids in an auction and issued with
certain cut off limits. It includes 91 days T-bills, 182 days T-bills and 364
days T-bills.

There are no treasury bills issued by State Governments.

Amount
Treasury bills are available for a minimum amount of Rs.25,000 and in
multiples of Rs. 25,000. Treasury bills are issued at a discount and are redeemed
at par.
Types of Bills: on tap bills, ad hoc bills, auctioned T- bills
The Treasury bills are short-term money market instrument that mature in a year
or less than that. The purchase price is less than the face value. At maturity the
government pays the Treasury bill holder the full face value. The Treasury Bills
are marketable, affordable and risk free. The security attached to the treasury
bills comes at the cost of very low returns.
Credit Risk : Low. Treasury bills are backed by the full faith and credit of the
U.S. Treasury.
Liquidity Risk
the market.

: Low. Treasury bills are one of the most liquid securities in

21

Market Risk

: Low. The short duration allows for less price volatility.

Money Market Instruments

Merits of Treasury Bills

T-bills remain one of the safest investments for investors.
The advantage of purchasing these short terms, liquid instruments, is access to
your funds at any time, with the peace of mind knowing that your funds will not
be tied up in long term investments, should an emergency arise.
T-bills can be held to maturity, with constant roll over into other T-bill
purchases, or can be sold at any time an investor chooses.
Compared with commercial banks and other financial institutions rates, the
Treasury Bills sometimes offer the highest interest rate available.
Treasury Bills provide a regular income or cash flow which can be used to
supplement your existing income or provide an income if you are retired.
Treasury Bills can easily be converted to cash on maturity, or they may be
sold if you need the money before the maturity dates.
As Treasury Bills are an income generating asset, they can be used as
collateral for loans from banks and other financial institutions.
Treasury Bills offer a simple mode of preserving & protecting your investment

Demerits of Treasury Bills

The main disadvantage of Treasury Bills is that income from Treasury Bills is
fixed for the term of the investment. In times of high inflation, the purchasing
power of your money will be reduced.
The only downside to T-bills is that you won't get a great return because
Treasuries are exceptionally safe. Corporate bonds, certificates of deposit and
money market funds will often give higher rates of interest. What's more, you
might not get back all of your investment if you cash out before.

22

Participants in T-Bill Market

The Reserve Bank of India, Banks, Mutual Funds, Financial Institutions,
Primary Dealers, Satellite Dealers, Provident Funds, Corporates, Foreign Banks,
& Foreign Institutional Investors are all participants in the T-Bills market The
state governments can invest their surplus funds as non-competitive bidders in
T-Bills of all maturities.

Certificate of Deposit:
A certificate of deposit (CD) is a time deposit with a bank. CDs are generally
issued by commercial banks but they can be bought through brokerages. They
bear a specific maturity date (from three months to five years), a specified
interest rate, and can be issued in any denomination, much like bonds. Like all
time deposits, the funds may not be withdrawn on demand like those in a
checking account.
CDs offer a slightly higher yield than T-Bills because of the slightly higher
default risk for a bank but, overall, the likelihood that a large bank will go broke
is pretty slim. Of course, the amount of interest you earn depends on a number
of other factors such as the current interest rate environment, how much money
you invest, the length of time and the particular bank you choose. While nearly
every bank offers CDs, the rates are rarely competitive, so it's important to shop
around.
A fundamental concept to understand when buying a CD is the difference
between annual percentage yield (APY) and annual percentage rate (APR). APY
is the total amount of interest you earn in one year, taking compound interest
into account. APR is simply the stated interest you earn in one year, without
taking compounding into account
The difference results from when interest is paid. The more frequently interest is
calculated, the greater the yield will be. When an investment pays interest
annually, its rate and yield are the same. But when interest is paid more
frequently, the yield gets higher. For example, say you purchase a one-year,
1,000 CD that pays 5% semi-annually. After six months, you'll receive an
interest payment of 25 (1,000 x 5 % x .5 years). Here's where the magic of
compounding starts. The 25 payment starts earning interest of its own, which
over the next six months amounts to 0.625 (25 x 5% x .5 years). As a result, the
23

rate on the CD is 5%, but its yield is 5.06. It may not sound like a lot, but
compounding adds up over time.
A certificate of deposit is a promissory note issued by a bank. It is a time
deposit that restricts holders from withdrawing funds on demand. Although it is
still possible to withdraw the money, this action will often incur a penalty.

The characteristics of CD
CDs can be issued by all scheduled commercial banks except RRBs (ii)
selected all India financial institutions, permitted by RBI
Minimum period 15 days
Maximum period 1 year
Minimum Amount Rs 1 lac and in multiples of Rs. 1 lac
CDs are transferable by endorsement
CRR & SLR are to be maintained
CDs are to be stamped
CDs may be issued at discount on face value
Interest calculations are mostly based upon a standard 360 days in a year
called actual/360 but some are actual/365
Investment is dependent solely upon the credit worthiness of the bank deposits
Credit Risk
bank.

: High. The investor should monitor the financial condition of the

Liquidity Risk: High. CDs cannot be liquidated without paying penalty.

Market Risk
margins.

: Moderate. Monitor collateral value and require adequate

Advantages of Certificate of Deposit as a money market instrument

1. Since one can know the returns from before, the certificates of deposits
are considered much safe. 2. One can earn more as compared to
24

depositing money in savings account. 3. The Federal Insurance

Corporation guarantees the investments in the certificate of deposit.
Disadvantages of Certificate of deposit as a money market instrument:
1. As compared to other investments the returns is less. 2. The money is
tied along with the long maturity period of the Certificate of Deposit.
Huge penalties are paid if one gets out of it before maturity.
3. Investors can redeem bank-issued CDs prior to maturity. However, you
will typically be charged an early withdrawal penalty. These penalties are
set by each bank and differ nationwide. 4. Unlike Treasury notes, the
interest on CDs is not exempt from state and local taxes. CDs are fully
taxable at the state, local and federal levels. 5. The investment is locked
in at a specific rate, even if interest rates increase
Market of Certificate of Deposits
Being a negotiable instrument CDs are traded in the secondary money
market. However, the secondary market for these deposits has remained
dormant as investors find it profitable to hold the high-interest yielding
deposits till maturity. In order to provide flexibility and depth to the
secondary market, the time restriction on transferability of CDs issued by
both banks and financial institutions was withdrawn effective from
October 10, 2000. Two-way quotations on the deposits are offered by
DFHI, but very little trade actually take place in the secondary market.
CDs are also traded on the NSE-WDM segment but the proportion in the
total trading volume is insignificant.
Commercial Paper
History
Commercial paper, in the form of promissory notes issued by
corporations, has existed since at least the 19th century. For instance,
Marcus Goldman, founder of Goldman Sachs, got his start trading
commercial paper in New York in 1869.
Definition
An unsecured obligation issued by a corporation or bank to finance its
short-term credit needs, such as accounts receivable and inventory.
Maturities typically range from 2 to 270 days. Commercial paper is
available in a wide range of denominations, can be either discounted or
25

interest-bearing, and usually have a limited or nonexistent secondary

market. Commercial paper is usually issued by companies with high
credit ratings, meaning that the investment is almost always relatively
low risk.
Commercial paper is an unsecured and discounted promissory note
issued to finance the short-term credit needs of large institutional buyers.
Banks, corporations and foreign governments commonly use this type of
funding.
An unsecured, short-term debt instrument issued by a corporation,
typically for the financing of accounts receivable, inventories and
meeting short-term liabilities. Maturities on commercial paper rarely
range any longer than 270 days. The debt is usually issued at a discount,
reflecting prevailing market interest rates. Commercial Paper is shortterm loan that is issued by a corporation use for financing accounts
receivable and inventories. Commercial Papers have higher
denominations as compared to the Treasury Bills and the Certificate of
Deposit. The maturity period of Commercial Papers is a maximum of 9
months. They are very safe since the financial situation of the corporation
can be anticipated over a few months.

The characteristics of commercial paper

Unsecured debt
Bearer or depository trust company eligible. A depository trust company
is a firm through which the members can use a computer to arrange for
investment securities to be delivered to other members via computer, thus
there is no physical delivery of the securities. A depository trust company
uses computerized debit and credit entries.
Discount (most common). A discount is the difference between the
purchase price of a security and its par (face) value. This discount
represents the income to be earned on the security, and will be accreted
over the life of the security.
Purchased direct or through dealers.
Eligibility for issue of CP
Highly rated corporate borrowers, primary dealers (PDs) and satellite
dealers (SDs) and all-India financial institutions (FIs)
The tangible net worth-not less than Rs.4 crore;
26

 The working capital (fund-based) limit-not less than Rs.4 crore

& borrower account- classified as a Standard Asset by the financing
banks.
Types of CP
Direct Papers :Issued directly by company to investors without any intermediary.
Dealer Papers :Issued by a dealer or merchant banker on behalf of a client.
Money Market Instruments
Rating Requirement
All eligible participants should obtain the credit rating for issuance of CP
through the following- Credit Rating Information Services Of India Ltd. (CRISIL)
Investment Information & Credit Rating Agency of India Ltd. (ICRA)
Credit Analysis & Research Ltd. (CARE)
DCR India
The minimum credit rating shall be P-2 of CRISIL or such equivalent
rating by other agencies
To whom issued
CP is 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). Denomination: min. of 5 lakhs and multiple thereof. Maturity:
min. of 7 days and a maximum of up to one year from the date of issue
Maturity
Issued for maturities between a minimum of 30 days and a maximum
upto one year from the date of issue. If the maturity date is a holiday,
the company would be liable to make payment on the immediate
preceding working day.
Banker's Acceptance :
It is a short-term credit investment. It is guaranteed by a bank to make
payments. The Banker's Acceptance is traded in the Secondary market.
It is a short-term credit investment. It is guaranteed by a bank to make
payments. The Banker's Acceptance is traded in the Secondary market.
The banker's acceptance is mostly used to finance exports, imports and
other transactions in goods. The banker's acceptance need not be held till
27

the maturity date but the holder has the option to sell it off in the
secondary market whenever he finds it suitable.
A bankers acceptance is a money market instrument which is used to
finance import or export transactions. They represent a banks promise
and ability to pay the face or principal amount on the bankers acceptance
on the stipulated maturity date.
The characteristics of bankers acceptances
Trades at a discount
Prime bankers acceptances are shorter maturities
Credit Risk: Moderate to high. Ratings banks issuing the bankers
acceptance should be monitored. The short term obligations of the bank
must be rated not less than A1/P1.
Liquidity Risk: Moderate. Monitor credit and stability of bank. A
bankers acceptance may be somewhat difficult to sell.
Market Risk: Low to moderate, due to the short-term nature of this
security.
Advantages of Bankers acceptances
Higher yield, specific maturity dates are chosen by the purchaser within
a range of 180 days.
Disadvantages of bankers acceptance
Reduced liquidity
The lack of active secondary market reduces the liquidity of commercial
paper, there also may be other associated market pricing difficulties.
Repurchase Agreement
Meaning
Transaction in which 2 parties agree to sell & repurchase the same
security. Under such an agreement, the seller sells specified securities
with an agreement to repurchase the same at a mutually decided future
date and a price. The Repo/Reverse repo transaction can only be done at
Mumbai between parties approved by RBI & in securities as approved by
RBI (Treasury Bills, Central/State Govt. Securities).
Definition
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Repo is a transaction in which two parties agree to sell and repurchase

the same security. Under such an agreement the seller sells specified
securities with an agreement to repurchase the same at a mutually decided
future date and a price
The security to a lender and promises to repurchase from him overnight.
Hence the Repos have terms ranging from 1 night to 30 days.
They are very safe due government backing.
A repurchase agreement is an agreement between a seller and a buyer in
which the seller agrees to repurchase the securities at an agreed upon rate.
A holder of securities sells repurchase agreements to an investor with an
agreement to repurchase them at a fixed price on a fixed date. The
security buyer, in effect, lends the seller money for the period of the
agreement. The terms of the agreement are structured to compensate the
security buyer. Large amounts of money are needed for this type of
investment.
The Repo/Reverse Repo transaction can only be done at Mumbai between
parties
approved by RBI and in securities as approved by RBI (Treasury Bills,
Central/State Govt securities). The Repo or the repurchase agreement is
used by the government security holder when he sells
Types of Repurchase Agreements
Overnight repurchase agreements, which mature the next day
Open repurchase agreements, which have undefined maturities. The
rates are variable or set daily; they roll or terminate at the request of
either party
Term repurchase agreements have a defined maturity date, a fixed rate,
and are liquid
Uses of Repo
Helps banks to invest surplus cash
Helps investors achieve money market returns with sovereign risks.
Raising funds by borrowers
Adjusting SLR/CRR positions simultaneously.
For liquidity adjustment in the system.

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Collateralized Borrowing and Lending Obligation

(CBLO)
It is a money market instrument as approved by RBI, is a product
developed by CCIL. CBLO is a discounted instrument available in
electronic book entry form for the maturity period ranging from one day
to ninety Days (can be made available up to one year as per RBI
guidelines). In order to enable the market participants to borrow and lend
funds, CCIL provides the Dealing System through:
- Indian Financial Network (INFINET), a closed user group to the
Members of the Negotiated Dealing System (NDS) who maintain Current
account with RBI.
- Internet gateway for other entities who do not maintain Current account
with RBI.
What is CBLO?
CBLO is explained as under:
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 An obligation by the borrower to return the money borrowed, at a

specified future date;
An authority to the lender to receive money lent, at a specified future
date with an option/privilege to transfer the authority to another person
for value received;
An underlying charge on securities held in custody (with CCIL) for the
amount borrowed/lent.
Banks, financial institutions, primary dealers, mutual funds and cooperative banks, who are members of NDS, are allowed to participate in
CBLO transactions. Non-NDS members like corporate, co-operative
banks, NBFCs, Pension/Provident Funds, Trusts etc. are allowed to
participate by obtaining Associate Membership to CBLO Segment.
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

31

Participation Certificates to fulfil their mandatory requirement of

advances level in specific sectors to comply with RBI regulations.

Local Government Investment Pools

Local government investment pools are integrated investment
instruments, formed as a money market fund equivalent, sometimes
governed by a board of participants. Investment pools can include
mandatory participation. Some pools have non-mandatory participation.
Investment pools are calculated based on an actual/360 day basis.
Investment pools are created under the Interlocal Cooperation Act.
Backed by the securities in the fund, the investor owns a pro-rated share
of the portfolio. There is always 1-day liquidity. The investment pool is
quoted on a yield basis, accrues daily and pays monthly. Purchases can be
made directly from the local government investment pool. No minimum
size is required for investing in the pool.
Credit Risk: Low. There is no credit risk on securities, some credit risk
exists on pool ratings.
Liquidity Risk: Moderate to high. There is nominal risk on the constant
dollar pools. There is more risk on fluctuating net asset value pools.
Market Risk: High. Risk on fluctuating net asset value pools only.

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Advantages :
Total liquidity, professional management, convenience, and safety. Some
investment pools are rated by a nationally recognized credit rating
agency. They are "dollar in dollar out", which means that the dollar value
of the original deposit is expected to be maintained through conservative
management practices. They are able to maintain several accounts and
produce separate reports.
Disadvantages :
There is credit risk potential, possible loss if the net asset value falls
below one dollar. Investors should require timely reporting of managed
funds.

Derivative Securities
A derivative security is an instrument whose value is based on and
determined by another security or benchmark. The most common
derivative securities are listed below.
Mortgage-backed securities: These securities are issued by the Federal
Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage
Association (FNMA), and other institutions, which are guaranteed by the
Government National Mortgage Association (GNMA). Investors receive
payments out of the interest and principal on the underlying mortgages.
Sometimes banks issue certificates backed by conventional mortgages,
selling them to large institutional investors. The growth of mortgagebacked certificates and the secondary mortgage market in which they are
traded has helped keep mortgage money available for home financing.
Certificates are held in trust by a third party custodial bank. Most are
rated AAA because of high quality collateral. Payments can be monthly,
quarterly or semi-annual.
Interest Only (IO) and Principal Only (PO):
The cash flow elements are stripped from mortgage backed securities
and traded separately. These have high volatility and market risk.

33

 Inverse Floaters: An inverse floater is a type of security with a coupon

that periodically resets at a higher rate when market interest rates fall and
resets at a lower rate when market interest rates rise. Inverse floaters have
high price volatility.
Callable Bonds: The issuers have the option to redeem these bonds
early if they can lower the finance costs. Most have a call protection
period; there may be a discreet call, whereby the investor has sold the
issuer the right to repurchase the bond back from the investor, but only on
specified interest payment dates or other predetermined dates as per a
formal call schedule, or a continuous call, where the issuer of the security
maintains the right to repurchase it from the buyer at any time after the
initial call date has passed.
Floating Rate Notes: The coupon rate periodically moves up or down
in step with a specified market rate of interest. Floating rate notes are
issued by instrumentalities, mortgage-backed securities, municipalities,
and corporations. They have a reset period, an interest payment period
and low price volatility.
Step up callable: A set coupon or interest rate is set for a stated period
such as six months or a year. After that time if the coupon or interest rate
does not increase to a specified level, the security will be called. There
are many structures and many maturities. There can also be multi-stepups, in which there is an initial coupon then several known coupon
increases and call options.
Credit Risk: Moderate, due to agency issuance.
Liquidity Risk: High. Certain securities types may have the maturity date
extended and may significantly lose value.
Money Market Instruments
Market Risk: High security extension, and volatility risk is high, longer
security means more market risk.
Advantages : Higher yields.
Disadvantages : Higher volatility

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Brokers Loans and Call Loans

Brokers loans are loans from commercial banks to brokers so that the
brokers customers can finance stock purchases. The broker uses the
stocks, held in street name, for collateral for the loans.
Time notes are loans that must be paid by a specific date for a specified
interest rate, with terms of 6 months or less. A demand note (call loan) is
a loan that is payable on demand the next day at 1 days interest. If the
note is not demanded, then the term is extended by another day, and so
on, up to 90 days. The interest rate for each day varies with the prevailing
interest rate.

35

CREDIT RATING OF INSTRUMENT

Credit rating is the process of assigning standard scores which summarize the
probability of the issuer being able to meet its repayment obligations for a
particular debt instrument in a timely manner. Credit rating is integral to debt
markets as it helps market participants to arrive at quick estimates and opinions
about various instruments. In this manner it facilitates trading in debt and
money market instruments especially in instruments other than Government of
India Securities.
Rating is usually assigned to a specific instrument rather than the company as a
whole. In the Indian context, the rating is done at the instance of the issuer,
which pays rating fees for this service. If it is unsatisfied with the rating
assigned to its proposed instrument, it is at liberty not to disclose the rating
given to it. There are 4 rating agencies in India. These are as follows:
CRISIL - The oldest rating agency was originally promoted by ICICI. Standard
& Poor, the global leader in ratings, has recently taken a small 10% stake in
CRISIL.
ICRA - Promoted by IFCI. Moodys, the other global rating major, has recently
taken a small 11% stake in ICRA.
CARE - Promoted by IDBI.

36

Duff and Phelps - Co-promoted by Duff and Phelps, the worlds 4th largest
rating agency.
CRISIL is believed to have about 42% market share followed by ICRA with
about 36%, CARE with 18% and Duff and Phelps with 4%.
Grading system
Each of the rating agencies has different codes for expressing rating for different
instruments; however, the number of grades and sub-grades is similar e.g. for
long term debentures/bonds and fixed deposits, CRISIL has 4 main grades and a
host of sub grades. In decreasing order of quality, these are AAA, AA+, AA,
AA-, A+, A, A-, BBB-, BBB, BBB+, BB+, BB, BB-, B+, B, B-, C and D.
ICRA, CARE and Duff and Phelps have similar grading systems. The following
table contains a key to the codes used by CRISIL and ICRA.
Credit rating is a dynamic concept and all the rating companies are constantly
reviewing the companies rated by them with a view to changing (either
upgrading or downgrading) the rating. They also have a system whereby they
keep ratings for particular companies on "rating watch" in case of major events,
which may lead to change in rating in the near future. Ratings are made public
through periodic newsletters issued by rating companies, which also elucidate
briefly the rationale for particular ratings. In addition, they issue press releases
to all major newspapers and wire services about rating events on a regular basis.
Factors involved in credit rating

Credit rating depends on several factors,

some of which are tangible/numerical and some of which are judgmental and
intangible. Some of these factors are listed below:
Overall

fundamentals

and

earnings

company and volatility of the same

37

capacity

of

the

 Overall

macro

economic

and

business/industry

environment
Liquidity position of the company (as distinguished from
profits)
Requirement of funds to meet irrevocable commitments
Financial flexibility of the company to raise funds from
outside sources to meet temporary financial needs
Guarantee/support from financially strong external bodies
Level of existing leverage (borrowings) and financial risk
As mentioned earlier ratings are assigned to instruments and not to companies
and two different ratings may be assigned to two different instruments of the
same company e.g. a company may be in a fundamentally weak business and
may have a poor rating assigned for 5 year debentures while its liquidity
position may be good, leading to the highest possible rating for a 3 month
commercial paper. Very few companies may be assigned the highest rating for a
long term 5 or 7 year instrument e.g. CRISIL has only 20 companies rated as
AAA for long term instruments and these companies include unquestionable
blue chips like Videsh Sanchar.
Nigam, Bajaj Auto, Bharat Petroleum, Nestle India apart from institutions like
ICICI, IDBI, HDFC and SBI.
Derived ratings and structured obligations
Sometimes, debt instruments are so structured that in case the issuer is unable to
meet repayment obligations, another entity steps in to fulfill these obligations.
38

Sometimes there is a documented, concrete mechanism for recourse to the third

party, while on other occasions the arrangement is loose. On such occasions, the
debt instrument in question is said to be "credit enhanced" by a "structured
obligation" and the rating assigned to the instrument factors in the additional
safety mechanism. The extent of enhancement is a function of the rating of the
"enhancer", the nature of the arrangement etc and usually there is a suffix to the
rating which expresses symbolically that the rating is enhanced e.g. A bond
backed by the guarantee of the Government of India may be rated AAA (SO)
with the SO standing for structured obligation.
Limitations of credit rating - rating downgrades
Rating agencies all across the world have often been accused of not being able
to predict future problems. In part, the problem lies in the rating process itself,
which relies heavily on past numerical data and standard ratios with relatively
lower usage of judgment and understanding of the underlying business or the
country economics. Data does not always capture all aspects of the situation
especially in the complex financial world of today. An excellent example of the
meaningless over reliance on numbers is the poor country rating given to India.
Major rating agencies site one of the reasons for this as the low ratio Indias
exports to foreign currency indebtedness. This completely ignores two issues
firstly, India gets a very high quantum of foreign currency earnings through
remittances from Indians working abroad and also services exports in the form
of software exports which are not counted as "merchandise" exports. These two
flows along with other "invisible" earnings accounted for almost US$11bn in
FY 99. Secondly, since India has tight control on foreign currency transactions,
there is very little error possible in the foreign currency borrowing figure. As
against this, for a country like Korea, the figure for foreign currency borrowing
increased by US$50bn after the exchange crisis began. This was on account of
hidden forward liabilities through swaps and other derivative products.
39

In general, Indian rating agencies have lost some amount of their credibility in
the last two years due to their inability to predict defaults in many companies,
which they had rated quite highly. Sometimes, some of the agencies had an
investment grade rating in place when the company in question had already
defaulted to some of the fixed deposit holders. Further, rating agencies resorted
to mass downgrading of 50-100 companies as a reaction to public criticism,
which further eroded their credibility. The major reasons for these downgrades
are as follows
Corporate earnings fell very sharply due to persistent recessionary conditions
prevailing in the economy. Many of the corporate are in commodity sectors
where fluctuations in selling prices of products can be agencies like Standard &
Poor (S&P) and Moodys were unable to predict the Asian crisis and had to face
the embarrassment of seeing the credit rating of South Korea as a country go
from A+ to BB+ in a short span of 3 very sharp - leading to complete erosion of
profitability. This problem was compounded by the Asian crisis, which led to
increased competition from cheap imports in many product categories.
Rating agencies substantially overestimated financial flexibility of corporate
especially from traditional corporate houses. Much of the financial flexibility
was implicit on raising money from new issues from the capital market, which
has been impossible in the last 3 years.
In the case of finance companies, widespread defaults like CRB and tightening
of regulations made it virtually impossible for them to raise money in any form.
These finance companies had been in the habit of investing in longer term,
illiquid assets by borrowing shorter term fixed deposits. When the flow of credit
stopped, they faced liquidity problems. These were further compounded by
defaults by some of the companies to which they had on lent money.

40

The experience is no different from the international scenario where reputed and
highly experienced rating months.
By and large, the rating is a very good estimate of the actual creditworthiness of
the company; however, it is not able to predict extreme situations such as the
ones described above, which are unlikely to have been predicted by most
investors in any case. Investors should realize that a credit rating is not
sacrosanct and that one has to do ones own due diligence and investigation
before investing in any instrument. They should use the rating as a reference
and a base point for their own effort. One good way of doing this is examining
the behavior of the stock price in case the stock is listed. As a collective, the
market is far smarter at predicting problems than any credit rating agency.
Witness the sharp erosion in stock prices of companies much before their credit
ratings were downgraded. Witness also the fact that foreign currency bonds
from Indian issuers trade at yields lower than countries which have been rated
higher by rating agencies.

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SIMILARITIES OF CAPITAL MARKET

INSTRUMRNT & MONEY MARKET INSRUMENT
INVESTORS Preference is available for most of the suppliers of In many
respects, both money market and capital markets exhibit similar characteristics
as specified below.
1. TRANSFER OF RESOURCES TRANSFER of resources takes place
from surplus units to deficit units both in money market and capital
market.
2. COMMERCIAL BANKS Commercial banks provide both short-term
and long-term finance and therefore, take an active part in the money
market as well as capital market.
3. LIQUIDITY ADJUSTMENT Nonbanking financial institution and
special financial institutions approach money and capital markets to a
limited degree in order to adjust their liquidity positions.

42

Besides,

financial institutions operate on both sides of the market, borrowing and

lending and participate in both money and capital market.
4. FLOW OF FUNDS As lenders and borrowers of funds have access to
both capital and money market, there is a substantial flow of funds
between capital and money markets.
5. PREFERENCE FOR funds operate in both the markets, as investors
simultaneously invest in various investment avenues such as savings
bank, units, fixed deposits, national saving certificate schemes, life
insurance, government and industrial securities, real estate, bullion, etc
6. INTEREST RATES There is an interdependency of short and long-term
rates of interest. This is because, rise in interest rate in money make
influence long-term interest rates also.

CONCLUSION
An individual player cannot invest in majority of the Money Market
Instruments, hence for retail market, money market instruments are repackaged
into Money Market Funds.
A money market fund is an investment fund that invests in low risk and low
return bucket of securities viz money market instruments. It is like a mutual
fund, except the fact mutual funds cater to capital market and money market
funds cater to money market. Money Market funds can be categorized as
taxable funds or non taxable funds.
Having understood, two modes of investment in money market viz Direct
Investment in Money Market Instruments & Investment in Money Market
Funds, lets move forward to understand functioning of money market account.

43

Money Market Account: It can be opened at any bank in the similar fashion as a
savings account. However, it is less liquid as compared to regular savings
account. It is a low risk account where the money parked by the investor is used
by the bank for investing in money market instruments and interest is earned by
the account holder for allowing bank to make such investment. Interest is
usually compounded daily and paid monthly. There are two types of money
market accounts:
Money Market Transactional Account: By opening such type of account, the
account holder can enter into transactions also besides investments, although the
numbers of transactions are limited.
Money Market Investor Account: By opening such type of account, the
account holder can only do the investments with no transactions.
Money Market Index: To decide how much and where to invest in money
market an investor will refer to the Money Market Index. It provides
information about the prevailing market rates. There are various methods of
identifying Money Market Index like:
Smart Money Market Index- It is a composite index based on intraday price
pattern of the money market instruments.
Salomon Smith Barneys World Money Market Index- Money market
instruments are evaluated in various world currencies and a weighted average is
calculated. This helps in determining the index.
Bankers Acceptance Rate- As discussed above, Bankers Acceptance is a
money market instrument. The prevailing market rate of this instrument i.e. the
rate at which the bankers acceptance is traded in secondary market, is also used
as a money market index.

44

 LIBOR/MIBOR- London Inter Bank Offered Rate/ Mumbai Inter Bank

Offered Rate also serves as good money market index. This is the interest rate at
which banks borrow funds from other banks.

BIBLOGRAPHY
www.google.com
www.rbi.org.in
www.calypso.com
www.yahoo.com
The Economic Times
Financial Services & Markets ( Reference book)
- Dr. Gurusamy

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