UNIVERSITY OF MUMBAI

PROJECT ON:-

MONEY MARKET INSTRUMENTS

MASTER OF COMMERCE

(BANKING AND FINANCE)

SEMESTER I2014-2015

In Partial Fulfillment of the Requirement under Semester Based Credit And Grading System for Post Graduated (PG)

Programme under Faculty of Commerce

SUBMITTED BY:-

PARSHURAM.BABU.OMKAR

ROLL NO: 44

PROJECT GUIDE:-

PROF. SHARADDHA SHUKLEACKNOWLEDGEMENT

With great pleasure I thank Mrs. SHARADDHA SHUKLE Professor of K.P.B.HINDUJA college of Commerce for being an inspiration in the completion of this project. I thank for her invaluable help provided during the completion of this project. I also thank her for providing me guidance and numerous suggestions throughout entire duration of the project. I am thankful for invaluable help without which this project would not have materialized.

I express my deep gratitude to my entire college friend and my family members whose efforts and creativity helped us in giving the final structure to the project work.

I am also thankful to all those seen and unseen hands and hands, which have been of help in the completion of this project work.

CERTIFICATE

This is certify that Mr. Parshuram.Babu.Omkar of M.Com. Banking & Finance 2nd Semester (2014-2015) has successfully completed the Project on "MONEY MARKET INSTRUMENTS".

Under the guidance of Mrs. SHARADDHA SHUKLE Project Guide

________________________

Course Coordinator

________________________

Internal Examiner

________________________

External Examiner

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Principal

________________________

Date________________

Place: MumbaiM.Com (Banking and Finance)

2nd SEMESTER

"MONEY MARKET INSTRUMENTS"

SUBMITTED BY

PARSHURAM.BABU.OMKAR

ROLL NO: 44

DECLARATION

I Mr. Parshuram.Babu.Omkar the student of M.com (Banking and Finance), 2nd Semester (2014-2015), hereby declares that I have completed the project on "MONEY MARKET INSTRUMENTS"

The information submitted is true and original to the best of my knowledge.

Parshuram.Babu.Omkar

(Signature)INDEXSR.NOPARTICULARSPAGE NO.

CHP 1INTRODUCTION TO MONEY MARKET INSRUMENTS8-9

1.1INTRODUCTION8

1.2OBJECTIVES OF THE STUDY8

1.3METHODS OF RESEARCH8

1.4CHAPTER SCHEME8-9

1.5LIST OF TABLE9

CHP 2INTRODUCTION OF MONEY MARKET10-12

CHP 3FUNCTIONS OF MONEY MARKET13-14

CHP 4WHAT CONSTITUTES THE MONEY MARKET IN INDIA15-16

CHP 5WHAT ARE MONEY MARKET INSTRUMENTS17-18

CHP 6TYPES OF MONEY MARKET INSTRUMENTS 19-35

CHP 7T-BILL & INFLATION CONTROL36-38

CHP 8CONCLUSION39

CHP 9ANNEXURE40

Chapter 1Introduction to Money Market Instruments1.1Introduction:

The major purpose of financial markets is to transfer funds from lenders to borrowers. Financial market participants commonly distinguish between the "capital market" and the "money market". The money market refer to borrowing and lending for periods of a year or less. It is a mechanism to clear short term monetary transactions in an economy.

Various instruments exist, such as Treasury bills, commercial paper, bankers' acceptances, deposits, certificates of deposit, bills of exchange, repurchase agreements, federal funds, and short-lived mortgage-, and asset-backed securities. It provides liquidity funding for the global financial system. Money markets and capital markets are parts of financial markets. The instruments bear differing maturities, currencies, credit risks, and structure. Therefore they may be used to distribute the exposure.

1.2 Objectives of the Study:1) To understand the definition and meaning of money market.

2) To understand the various instruments of money market.

1.3 Methods of Research:

The data is collected only from secondary data source. Such as Newspapers, Magazines, Books, Journals, E-data, etc.1.4 Chapter Scheme

Chapter 1: Introduction to money market instruments Chapter 2: Introduction of money marketChapter 3: Functions of money marketChapter 4: What constitutes the money market in IndiaChapter 5: What are money market instrumentsChapter 6: Types of money market instrumentsChapter 7: Treasury bill & Inflation control Chapter 8: ConclusionChapter 9: AnnexureChapter 10: Annexure

1.5 List of Table

1) T-bill Calendar2) Commercial Paper policy changesChapter 2 Money Market:

Introduction:As money became a commodity, the money market became a component of the financial markets for assets involved in short-term borrowing, lending, buying and selling with original maturities of one year or less. Trading in the money markets is done over the counter and is wholesale. Various instruments exist, such as Treasury bills, commercial paper, bankers' acceptances, deposits, certificates of deposit, bills of exchange, repurchase agreements, federal funds, and short-lived mortgage-, and asset-backed securities. It provides liquidity funding for the global financial system. Money markets and capital markets are parts of financial markets. The instruments bear differing maturities, currencies, credit risks, and structure. Therefore they may be used to distribute the exposure.There are two types of financial markets viz., the money market and the capital market. The money market in that part of a financial market which deals in the borrowing and lending of short term loans generally for a period of less than or equal to 365 days. It is a mechanism to clear short term monetary transactions in an economy.

Definitions of Money MarketFollowing definitions will help us to understand the concept of money market.

According to Crowther, "The money market is a name given to the various firms and institutions that deal in the various grades of near money."

According to the RBI, "The money market is the centre for dealing mainly of short character, in monetary assets; it meets the short term requirements of borrowers and provides liquidity or cash to the lenders. It is a place where short term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers, again comprising institutions and individuals and also by the government."

According to Nadler and Shipman, "A money market is a mechanical device through which short term funds are loaned and borrowed through which a large part of the financial transactions of a particular country or world are degraded. A money market is distinct from but supplementary to the commercial banking system."

These definitions help us to identify the basic characteristics of a money market. A money market comprises of a well organized banking system. Various financial instruments are used for transactions in a money market. There is perfect mobility of funds in a money market. The transactions in a money market are of short term nature.

Market for short-term debt securities, such as banker's acceptances, commercial paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or less and often 30 days or less. Money market securities are generally very safe investments which return a relatively low interest rate that is most appropriate for temporary cash storage or short-term time horizons. Bid and ask spreads are relatively small due to the large size and high liquidity of the market.

Money market is an important part of the economy. It plays very significant functions. As mentioned above it is basically a market for short term monetary transactions. Thus it has to provide facility for adjusting liquidity to the banks, business corporations, non-banking financial institutions (NBFs) and other financial institutions along with investors.

Whenever a bear market comes along, investors realize (yet again!) that the stock market is a risky place for their savings. It's a fact we tend to forget while enjoying the returns of a bull market! Unfortunately, this is part of the risk-return tradeoff. To get higher returns, you have to take on a higher level of risk. For many investors, a volatile market is too much to stomach - the money market offers an alternative to these higher-risk investments.

The money market is better known as a place for large institutions and government to manage their short-term cash needs. However, individual investors have access to the market through a variety of different securities. In this tutorial, we'll cover various types of money market securities and how they can work in your portfolio.

he money market is a subsection of the fixed income market. We generally think of the term fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short-term debt securities (debt that matures in less than one year). Money market investments are also called cash investments because of their short maturities.

Money market securities are essentially IOUs issued by governments, financial institutions and large corporations. These instruments are very liquid and considered extraordinarily safe. Because they are extremely conservative, money market securities offer significantly lower returns than most other securities.

One of the main differences between the money market and the stock market is that most money market securities trade in very high denominations. This limits access for the individual investor. Furthermore, the money market is a dealer market, which means that firms buy and sell securities in their own accounts, at their own risk. Compare this to the stock market where a broker receives commission to acts as an agent, while the investor takes the risk of holding the stock. Another characteristic of a dealer market is the lack of a central trading floor or exchange. Deals are transacted over the phone or through electronic systems.

The easiest way for us to gain access to the money market is with a money market mutual funds, or sometimes through a money market bank account. These accounts and funds pool together the assets of thousands of investors in order to buy the money market securities on their behalf. However, some money market instruments, like Treasury bills, may be purchased directly. Failing that, they can be acquired through other large financial institutions with direct access to these markets.

There are several different instruments in the money market, offering different returns and different risks. In the following sections, we'll take a look at the major money market instruments.

Chapter 3Functions of Money Market

The major functions of money market are given below:-

1. To maintain monetary equilibrium. It means to keep a balance between the demand for and supply of money for short term monetary transactions.

2. To promote economic growth. Money market can do this by making funds available to various units in the economy such as agriculture, small scale industries, etc.

3. To provide help to Trade and Industry. Money market provides adequate finance to trade and industry. Similarly it also provides facility of discounting bills of exchange for trade and industry.

4. To help in implementing Monetary Policy. It provides a mechanism for an effective implementation of the monetary policy.

5. To help in Capital Formation. Money market makes available investment avenues for short term period. It helps in generating savings and investments in the economy.

6. Money market provides non-inflationary sources of finance to government. It is possible by issuing treasury bills in order to raise short loans. However this dose not leads to increases in the prices.

Apart from those, money market is an arrangement which accommodates banks and financial institutions dealing in short term monetary activities such as the demand for and supply of money.

The money market functions are:

1. Financing Trade:

Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.

2. Financing Industry:

Money market contributes to the growth of industries in two ways:

(a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc.

(b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.

3. Profitable Investment:

Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity.

4. Self-Sufficiency of Commercial Bank:

Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market.

5. Help to Central Bank:

Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank.

Money market helps the central bank in two ways:

(a) The short-run interest rates of the money market serves as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy,

(b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy.

Chapter 4What Constitutes the Money Market in India?

The money market is a mechanism that deals with the lending and borrowing of short term funds. Money market refers to the market for short term assets that are close substitutes of money, usually with maturities of less than a year. A well functioning money market provides a relatively safe and steady income-yielding avenue, for short term investment of funds both for banks and corporates and allows the investor institutions to optimize the yield on temporary surplus funds. The RBI is a regular player in the money market and intervenes to regulate the liquidity and interest rates in the conduct of monetary policy to achieve the broad objective of price stability, efficient allocation of credit and a stable foreign exchange market. As per definition given by RBI the money market is "the centre for dealings, mainly short-term character, in money assets. It meets the short-term requirements of borrower and provides liquidity or cash to the lenders. It is the place where short-term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers, again comprising Institutions, individuals and also the Government itself" The main segments of the money market are the call/notice money, term money, commercial bills, treasury bills, commercial paper and certificate deposits. Mr.G. Crowther in his treatise "An

Outline of Money defines money market as If the economic relationships between nations are not, by one means or another, brought fairly close to balance, then there is no set of financial arrangements that can rescue the world from the impoverishing results of chaos. "the collective name given to the various firms and institutions that deal in the various grades of near-money". .

Call /Notice-Money MarketThe call/notice money market forms an important segment of the Indian Money Market. Under call money market, funds are transacted on overnight basis and under notice money market, funds are transacted for the period between 2 days and 14 days.The most active segment of the money market has been the call money market, where the day to day imbalances in the funds position of scheduled commercial banks are eased out. The call notice money market has graduated into a broad and vibrant institution .

Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions.

The entry into this field is restricted by RBI. Commercial Banks, Co-operative Banks and Primary Dealers are allowed to borrow and lend in this market. Specified All-India Financial Institutions, Mutual Funds, and certain specified entities are allowed to access to Call/Notice money market only as lenders. Reserve Bank of India has recently taken steps to make the call/notice money market completely inter-bank market. Hence the non-bank entities will not be allowed access to this market beyond December 31, 2000.

From May 1, 1989, the interest rates in the call and the notice money market are market determined. Interest rates in this market are highly sensitive to the demand - supply factors. Within one fortnight, rates are known to have moved from a low of 1 - 2 per cent to dizzy heights of over 140 per cent per annum. Large intra-day variations are also not uncommon. Hence there is a high degree of interest rate risk for participants. In view of the short tenure of such transactions, both the borrowers and the lenders are required to have current accounts with the Reserve Bank of India. This will facilitate quick and timely debit and credit operations. The call market enables the banks and institutions to even out their day to day deficits and surpluses of money. Banks especially access the call market to borrow/lend money for adjusting their cash reserve requirements (CRR). The lenders having steady inflow of funds (e.g. LIC, UTI) look at the call market as an outlet for deploying funds on short term basis.

Inter-Bank Term Money

A short-term money market, which allows for large financial institutions, such as banks, mutual funds and corporations to borrow and lend money at interbank rates. The loans in the call money marketare very short, usually lastingno longer than a week and are often used to help banks meet reserve requirements.Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

The market in this segment is presently not very deep. The declining spread in lending operations, the volatility in the call money market with accompanying risks in running asset/liability mismatches, the growing desire for fixed interest rate borrowing by corporates, the move towards fuller integration between forex and money markets, etc. are all the driving forces for the development of the term money market. These, coupled with the proposals for rationalisation of reserve requirements and stringent guidelines by regulators/managements of institutions, in the asset/liability and interest rate risk management, should stimulate the evolution of term money market sooner than later. The DFHI (Discount & Finance House of India), as a major player in the market, is putting in all efforts to activate this market.

Chapter 5What are Money Market Instruments?

By convention, the term Money Market refers to the market for short time requirement & deployment of funds. Money market instruments are those instruments, which have a maturity time of less than 1 year.The most active part of the money market is the market for overnight call and term money between the banks, institutions as well as call money transactions. Call Money or Repo are very short term Money Market products. The below mentioned instruments are normally termed as money market instruments:

The slice of the financial market where instruments with high liquid and short maturities are traded is called money market. It is a generic definition. The players who indulge in short time from several days to less than one year. It is generally used for borrow & lend over this short term. Due to the highly liquid nature of the security and short maturities, money market are perceived as a safe place to lock in money.

The participants in the financial market perceive a thin line, differentiating between the capital market & the money market. Capital market refers to stock markets where the common stocks are traded, and bond markets where bonds are issued and traded. This is in sharp contrast to money markets which provide short term debt financing and investment. In money market, there is borrowing and lending for periods of a year or less.

Treasury Bills are highly liquid short-time instruments that yield attractive returns. Short- term borrowing instruments of the Central Govt, it is a promise to pay a said sum after expiry of a specified period. It is a zero-risk instrument available in both primary and secondary markets. Money market instruments are characterised by high degree of safety of the principal.

Commercial paper is a short-term unsecured promissory note issued by corporates and financial institutions. Commercial Paper is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. Issued at discount to the face value, they yield attractive returns. The Government of India securities are sovereign coupon bearing instruments that are issued by the Govt. of India. They are available both for short-term and long tenures.

A savings certificate entitling the bearer to receive interest. Certificate of deposit is short-term borrowings that are more like bank term deposit accounts. They are transferable by endorsement and are to be stamped. Investors can consider money market funds. These invest in government securities, certificates of deposits, commercial paper of companies, and other highly liquid and low-risk securities. These funds are required by law to invest in low risk securities. Investors with low risk appetite can opt for money market funds.

The Money market instrument meets the short-term requirements of borrowers and provides liquidity to lenders. Short-term surplus funds at the disposal of institutions and individuals are bid by borrowers, who could be in the same category.

Debt instrument which have a maturity of less than a year at the time of issue are called money market instruments. Types of debt instruments include notes, bonds, certificates, mortgages, leases or other agreements between a lender and a borrower. These instruments are highly liquid and have negligible risk. The major money market instruments are Treasury bills, certificates of deposit, commercial paper, and repos. The money market is dominated by the government, financial institutions, banks, and corporate. Individual investors scarcely participate in the money market directly. A brief description of money market instruments is given below.

1) Treasury Bills2) Certificate of Deposit (CD)3) Commercial Paper (C.P)4) Bill Rediscounting5) Repurchase agreement6) Bankers Acceptance7) Euro Dollars8) BondsChapter 6Types of Money Market Instruments:

1)Treasury Bills: Treasury bills are short-term securities issued by the U.S. Treasury. The Treasury sells bills at regularly scheduled auctions to refinance issues and to help finance current federal deficits. It also sells bills on an irregular basis to smooth out the uneven flow of revenues from corporate and individual tax receipts. Persistent federal deficits have resulted in rapid growth in Treasury bills in recent years. At the end of 1992 the outstanding volume was $658 billion, the largest for any money market instrument.(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.

T-bills are short-term securities that mature in one year or less from their issue date. They are issued with three-month, six-month and one-year maturities. T-bills are purchased for a price that is less than their par (face) value; when they mature, the government pays the holder the full par value. Effectively, your interest is the difference between the purchase price of the security and what you get at maturity. For example, if you bought a 90-day T-bill at $9,800 and held it until maturity, you would earn $200 on your investment. This differs from coupon bonds, which pay interest semi-annually.

Treasury bills (as well as notes and bonds) are issued through a competitive bidding process at auctions. If you want to buy a T-bill, you submit a bid that is prepared either non-competitively or competitively. In non-competitive bidding, you'll receive the full amount of the security you want at the return determined at the auction. With competitive bidding, you have to specify the return that you would like to receive. If the return you specify is too high, you might not receive any securities, or just a portion of what you bid for. More information on auctions is available at the Treasury Direct website.

The biggest reasons that T-Bills are so popular is that they are one of the few money market instruments that are affordable to the individual investors. T-bills are usually issued in denominations of $1,000, $5,000, $10,000, $25,000, $50,000, $100,000 and $1 million. Other positives are that T-bills (and all Treasuries) are considered to be the safest investments in the world because the U.S. government backs them. In fact, they are considered risk-free. Furthermore, they are exempt from state and local taxes. (For more on this, see Why do commercial bills have higher yields than T-bills?)

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 the maturity date.

Treasury Bills are money market instruments to finance the short term requirements of the Government of India. 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.Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

Treasury Bill Issues

Treasury bills were first authorized by Congress in 1929. After experimenting with a number of bill maturities, the Treasury in 1937 settled on the exclusive issue of three-month bills. In December 1958 these were supplemented with six-month bills in the regular weekly auctions. In 1959 the Treasury began to auction one-year bills on a quarterly basis. The quarterly auction of one-year bills was replaced in August 1963 by an auction occurring every four weeks. The Treasury in September 1966 added a nine-month maturity to the auction occurring every four weeks but the sale of this maturity was discontinued in late 1972. Since then, the only regular bill offerings have been the offerings of three- and six-month bills every week and the offerings of one-year bills every four weeks. The Treasury has increased the size of its auctions as new money has been needed to meet enlarged federal borrowing requirements. In 1992 the weekly auctions of three- and six-month bills both ranged from $10.2 billion to $12.5 billion, and the four-week auctions of one-year bills ranged from $12.8 billion to $15.0 billion.

In addition to its regularly scheduled sales, the Treasury raises money on an irregular basis through the sale of cash management bills, which are usually "reopenings" or sales of bills that mature on the same date as an outstanding issue of bills. Cash management bills are designed to bridge low points in the

Prior to 1975, the Treasury raised funds on an irregular basis through the sale of tax anticipation bills. Nelson (1977) provides a description of these bills.Treasury's cash balances. Many cash management bills help finance the Treasury's requirements until tax payments are received. For this reason they frequently have maturities that fall after one of the five major federal tax dates. Sixty issues of cash management bills were sold in the decade from 1983 through 1992. Of these, 29 had maturities of less than one month, 21 had maturities between one month and three months, and 10 had maturities between three months and one year.

Types

Treasury bills (T-bills) offer short-term investment opportunities, generally up to one year. They are thus useful in managing short-term liquidity. At present, the Government of India issues three types of treasury bills through auctions, namely, 91-day, 182-day and 364-day. 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. Treasury bills are also issued under the Market Stabilization Scheme (MSS).

Auctions

While 91-day T-bills are auctioned every week on Wednesdays, 182-day and 364-day T-bills are auctioned every alternate week on Wednesdays. The Reserve Bank of India issues a quarterly calendar of T-bill auctions which is available at the Banks website. It also announces the exact dates of auction, the amount to be auctioned and payment dates by issuing press releases prior to every auction.

Type ofDay ofDay of

T-billsAuctionPayment*

91-dayWednesdayFollowing Friday

182-dayWednesday of non-reporting weekFollowing Friday

364-dayWednesday of reporting weekFollowing Friday

* If the day of payment falls on a holiday, the payment is made on the day after the holiday.

The salient features of the auction system of T-Bills are : The 14/91/182/364-days bills are issued for a minimum value of Rs.25,000 and multiples thereof.

They are issued at a discount to face value.

Any person in India including individuals, firms, companies, corporate bodies, trusts and institutions can purchase the bills.

The bills are eligible securities for SLR purposes.

All bids above a cut-off price are accepted and bidders are permitted to place multiple bids quoting different prices at each auction. Till November 6, 1998, all types of T-Bills auctions were conducted by means of 'Multiple Price Auction'. However, since November 6, 1998, auction of 91-days T-Bills are being conducted by means of 'Uniform Price Auction'. In the case of 'Multiple Price Auction' method successful bidders pay their own bid prices, whereas under 'Uniform Price Auction' method, all successful bidders pay an uniform price, i.e. the cut-off price emerged in the auction.

The bills are generally issued in the form of SGL - entries in the books of Reserve Bank of India. The SGL holdings can be transferred by issuing a SGL transfer form. For non-SGL account holders, RBI has been issuing the bills in scrip form.

French Auction or Multiple Price Auction SystemAfter receiving written bids at various levels of yield expectations, a particular yield is decided as the cut-off rate of the security in question. Auction participants (bidders) who bid at yield levels lower than the yield determined as cut-off get full allotment although at a premium. The premium is equal to the yield differential expressed in rupee terms. The yield differential is the difference between the cut-off yield and the yield at which the bid is made. All bids made at yield levels higher than that determined as cut-off yield get entirely rejected.

Dutch Auction or Uniform Price Auction SystemThis system of auction is exactly identical to that of the French Auction System as far as the price discovery mechanism part is concerned. The difference is observed only at the stage of payment obligation. After determination of the market related cut-off rate, allotment is made to all the bidders at a uniform price. The concept of premium on account of yield differential does not exist here.

Other Instruments

New money market instruments like Certificates of Deposits (CDs) and Commercial Paper (CPs) were introduced in 1989-90 to give greater flexibility to investors in the deployment of their short-term surplus funds

2) Certificates of Deposit

Certificates of Deposit (CDs) - introduced since June 1989 - are negotiable term deposit certificates issued by a commercial banks/Financial Institutions at discount to face value at market rates, with maturity ranging from 15 days to one year.

Certificate of Deposit: The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.

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.

Domestic CDS

A certificate of deposit is a document evidencing a time deposit placed with a depository institution. The certificate states the amount of the deposit, the date on which it matures, the interest rate and the method under which the interest is calculated. Large negotiable CDs are generally issued in denominations of $1 million or more.

A CD can be legally negotiable or non-negotiable, depending on certain legal specifications of the CD. Negotiable CDs can be sold by depositors to otherparties who can in turn resell them. Non-negotiable CDs generally must be held by the depositor until maturity. During the late 1970s and early to mid-1980s, between 60 and 80 percent of large CDs issued by large banks were negotiable instruments. The Federal Reserve stopped collecting separate data on negotiable CDs in 1987.

A CD may be payable to the bearer or registered in the name of the investor. Most large negotiable CDs are issued in bearer form because investors can resell bearer CDs more easily. Registration adds complication and costs to the process of transferring ownership of CDs. CDs with original maturities of more than one year must be registered under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA).

Federal banking agency regulations limit the minimum maturity of a time deposit to seven days. Most CDs have original maturities of 1 to 12 months, although some have maturities as long as five years or more. At the end of December 1992 approximately half of the large CDs issued domestically by U.S. banks that were still outstanding, had a maturity of three months or less.

Interest rates on CDs are generally quoted on an interest-bearing basis with the interest computed on the basis of a 360-day year. A $1 million, 90-day CD with a 3 percent annual interest rate would after 90 days entitle the holder of the CD to: $1,000,000 x [1 + (90/360) x 0.03] = $1,007,500.

This method of calculating interest is known as "CD basis," "365/360 basis" or "actual/360 basis." At some banks, however, interest on CDs is computed on the basis of a 365-day year. When calculated on a 365-day year basis a $1 million, 90-day CD would have to pay a stated rate of 3.04 percent to offer the holder a return equivalent to a CD that paid 3 percent on a CD basis: $1,000,000 x [1 + (90/365) x 0.0304] = $1,007,500.

Although the timing of interest payments is subject to negotiation,banks usually pay interest semiannually on fixed-rate CDs with maturities longer than one year.

Variable-Rate CDsVariable-rate CDs (VRCDs), also called variable-coupon CDs or floating-rate CDs, have been available in the United States since 1975 from both domestic banks and the branches of foreign banks. VRCDs have the distinguishing feature that their total maturity is divided into equally long rollover periods, also called legs or roll periods, in each of which the interest rate is set anew. The interest accrued on a leg is paid at the end of that leg.

The interest rate on each leg is set at some fixed spread to a certain base rate which is usually either a composite secondary market CD rate, a Treasury bill rate, LIBOR, or the prime rate. The maturity of the instrument providing the base rate is equal in length to that of the leg. For example, the interest rate on a VRCDwith a one-month roll might be reset every month with a fixed spread to the composite one-month secondary market CD rate. The most popular maturities of VRCDs are 18 months and two years, and the most popular roll periods are one and three months.

VRCDs are used by issuing banks because they improve their liquidity positions by providing funds for relatively long periods. Money Market investors purchase VRCDs because they wantt to invest in instruments with long-term maturities but wish to be protected from loss if interest rates increase. Money market funds are the largest investors in VRCDs. Money market funds are allowed by SEC regulations to treat their holdings of VRCDs as if they had maturities equal to the length of the roll.

Throughout much of the 1980s VRCDs accounted for 10 percent or more of outstanding large CDs. The percentage fell rapidly in the 1990s, however, and as of December 1992 VRCDs were only about 2 percent of outstanding large CDs. This decline may have resulted from a diminished concern of investors with the risk of rising inflation and therefore rising interest rates.

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. (To learn more, read APR vs. APY: How The Distinction Affects You.)

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 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.

The main advantage of CDs is their relative safety and the ability to know your return ahead of time. You'll generally earn more than in a savings account, and you won't be at the mercy of the stock market. Plus, in the U.S. the Federal Deposit Insurance Corporation guarantees your investment up to $100,000.

Despite the benefits, there are two main disadvantages to CDs. First of all, the returns are paltry compared to many other investment. Furthermore, your money is tied up for the length of the CD and you won't be able to get it out without paying a harsh penalty.

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 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.

Being securities in the form of promissory notes, transfer of title is easy, by endorsement and delivery. Further, they are governed by the Negotiable Instruments Act. As these certificates are the liabilities of commercial banks/financial institutions, they make sound investments.

DFHI trades in these instruments in the secondary market. The market for these instruments, is not very deep, but quite often CDs are available in the secondary market. DFHI is always willing to buy these instruments thereby lending liquidity to the market.

Salient features:

CDs can be issued to individuals, corporations, companies, trusts, funds, associates, etc.

NRIs can subscribe to CDs on non-repatriable basis.

CDs attract stamp duty as applicable to negotiable instruments.

Banks have to maintain SLR and CRR on the issue price of CDs. No ceiling on the amount to be issued.

The minimum issue size of CDs is Rs.5 lakhs and multiples thereof.

CDs are transferable by endorsement and delivery.

The minimum lock-in-period for CDs is 15 days.

CDs are issued by Banks, when the deposit growth is sluggish and credit demand is high and a tightening trend in call rate is evident. CDs are generally considered high cost liabilities and banks have recourse to them only under tight liquidity conditions.

3) Commercial Papers:Commercial paper is a short-term unsecured promissory note issued by corporations and foreign governments for many large, creditworthy issuers. Commercial paper is a low-cost alternative to bank loans. Issuers are able to efficiently raise large amounts of funds quickly and without expensive Securities and Exchange Commission (SEC) registration by selling paper, either directly or through independent dealers, to a large and varied pool of institutional buyers. Competitive, market-determined yields in notes whose maturity and amounts can be tailored to specific needs, can be earned by investors in commercial paper.

Commercial paper has become one of America's most important debt markets, because of the advantages of commercial paper for both investors and issuers. Commercial paper outstanding grew at an annual rate of 14 percent from 1970 to 1991. Commercial paper totaled $528 billion at the end of 1991.

This chapter describes some of the important features of the commercial paper market. The first section reviews the characteristics of commercial paper. The second section describes the major participants in the market, including the issuers, investors, and dealers. The third section discusses the risks faced by investors in the commercial paper market along with the mechanisms that are used to control these risks. The fourth section discusses some recent innovations, including asset-backed commercial paper, the use of swaps in commercial paper financing strategies, and the international commercial paper markets.

For many corporations, borrowing short-term money from banks is often a laborious and annoying task. The desire to avoid banks as much as possible has led to the widespread popularity of commercial paper. (See Why do companies issue bonds instead of borrowing from the bank?)

Commercial paper is an unsecured, short-term loan issued by a corporation, typically for financing accounts receivable and inventories. It is usually issued at a discount, reflecting current market interest rates. Maturities on commercial paper are usually no longer than nine months, with maturities of between one and two months being the average.

For the most part, commercial paper is a very safe investment because the financial situation of a company can easily be predicted over a few months. Furthermore, typically only companies with high credit ratings and credit worthiness issue commercial paper. Over the past 40 years, there have only been a handful of cases where corporations have defaulted on their commercial paper repayment.

Commercial paper is usually issued in denominations of $100,000 or more. Therefore, smaller investors can only invest in commercial paper indirectly through money market funds.

CPs enable highly rated corporate borrowers to diversify their sources of short-term borrowings and raise a part of their requirement at competitive rates from the market. The introduction of Commercial Paper (CP) in January 1990 as an additional money market instrument was the first step towards securitization of commercial bank's advances into marketable instruments.

Commercial Papers are unsecured debts of corporates. They are issued in the form of promissory notes, redeemable at par to the holder at maturity. Only corporates who get an investment grade rating can issue CPs, as per RBI rules. Though CPs are issued by corporates, they could be good investments, if proper caution is exercised.

The market is generally segmented into the PSU CPs, i.e. those issued by public sector unit and the private sector CPs. CPs issued by top rated corporates are considered as sound investments.

DFHI trades in these certificates. It will buy these certificates, subject to its perception of the instrument and will also be offering them for sale subject to availability of stock.

Commercial Papers - Salient Features CPs are issued by companies in the form of usance promissory note, redeemable at par to the holder on maturity.

The tangible net worth of the issuing company should be not less than Rs.4 crores.

Working capital (fund based) limit of the company should not be less than Rs.4 crores.

Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2 or higher from any approved rating agencies and should be more than 2 months old on the date of issue of CP.

Corporates are allowed to issue CP up to 100% of their fund based working capital limits.

It is issued at a discount to face value.

CP attracts stamp duty.

CP can be issued for maturities between 15 days and less than one year from the date of issue.

CP may be issued in the multiples of Rs.5 lakh.

No prior approval of RBI is needed to issue CP and underwriting the issue is not mandatory.

All expenses (such as dealers' fees, rating agency fee and charges for provision of stand-by facilities) for issue of CP are to be borne by the issuing company,

The purpose of introduction of CP was to release the pressure on bank funds for small and medium sized borrowers and at the same time allowing highly rated companies to borrow directly from the market.

As in the case of CDs, the secondary market in CP has not developed to a large extent.

Commercial Paper is short-term 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 are a maximum of 9 months. They are very safe since the financial situation of the corporation can be anticipated over a few months.

The concept of raising money through commercial paper was know to the US markets since 20th century. On our country though it was introduced in 1990, the RBI constantly watching the growth of the CP market and it is modifying the guidelines from time to time. For further development of CP market, the stamp duty on CP should be abolished since there is no stamp duty in US, UK and France and RBI has to relax the stringent Credit Rating norms from the present Credit rating P2 of CRISIL to P3, since credit rating is not compulsory in many countries like US, UK and France. The denominations of CP should be reduced further for the growth of secondary market for CP.

Commercial Paper policy changes:

Jan 1990July1990July1991July1992June 1994July1995Sep.1996Feb.1997Oct.2000Oct.2004

Tangible Net Worth10 Crore5 Crore--4 Crore-----

WCFBL*25 Crore15 Crore10 Crore5 Crore4 Crore-----

Minimum Size1 Crore50 Lakh25 Lakh-----5 Lakh-

Maximum Size20% of MPBF**-30% of MPBF75% of MPBF-75% of Cash Credit Compone nt100% of Cash Credit Compone nt100% of WCFBLShould not exceed WCFBL-

Denominations25 Lakh10 Lakh5 Lakh-----5 Lakh-

Maturity Period91days - 6 months---3 months 1year---15 days 1 year7days - One Yr.

Credit RatingP1+ by CRISIL or Equal grade by other agencies-P2-----

Other Measures

4) Bills of Exchange:Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) for the value of the goods delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks, they are called commercial bills. If the seller wishes to give some period for payment, the bill would be payable at a future date (usance bill). During the currency of the bill, if the seller is in need of funds, he may approach his bank for discounting the bill. One of the methods of providing credit to customers by bank is by discounting commercial bills at a prescribed discount rate. The bank will receive the maturity proceeds (face value) of discounted bill from the drawee. In the meanwhile, if the bank is in need of funds, it can rediscount the bill already discounted by it in the commercial bill rediscount market at the market related rediscount rate. (The RBI introduced the Bill Market Scheme in 1952 and a new scheme called the Bill Rediscounting Scheme in November 1970).

With a view to eliminating movement of papers and facilitating multiple rediscounting, the RBI introduced an innovative instrument known as "Derivative Usance Promissory Notes" backed by such eligible commercial bills for required amounts and usance period (up to 90 days). Government has exempted stamp duty on derivative usance promissory notes. This has indeed simplified and streamlined the bill rediscounting by Institutions and made commercial bill an active instrument in the secondary money market. Rediscounting institutions have also advantages in that the derivative usance promissory note, being a negotiable instrument issued by a bank, is good security for investment. It is transferable by endorsement and delivery and hence is liquid. Thanks to the existence of a secondary market the rediscounting institution can further discount the bills anytime it wishes prior to the date of maturity. In the bill rediscounting market, it is possible to acquire bills having balance maturity period of different days upto 90 days. Bills thus provide a smooth glide from call/overnight lending to short term lending with security, liquidity and competitive return on investment. As some banks were using the facility of rediscounting commercial bills and derivative usance promissory notes for as short a period as one day merely a substitute for call money, RBI has since restricted such rediscounting for a minimum period of 15 days.

The eligibility criteria prescribed by the Reserve Bank of India for rediscounting commercial bill inter-alia are that the bill should arise out of genuine commercial transaction evidencing sale of goods and the maturity date of the bill should not be more than 90 days from the date of rediscounting.

RBI has widened the entry regulation for Bill Market by selectively allowing, besides banks and PDs, Co-op Banks, mutual funds and financial institutions.

DFHI trades in these instruments by rediscounting Derivative Usance Promissory Notes (DPNs) drawn by commercial banks. DPNs which are sold to investors may also be purchased by DFHI.

Derivative Usance Promissory Notes"(DUPN)

IT is an innovative instrument issued by the RBI to eliminate movement of papers and facilitating easy rediscounting. DUPN is backed by up to 90 days Usance commercial bills. Government has exempted stamp duty on DUPN to simplify and steam-line the instrument and to make it an active instrument in the secondary market. The minimum rediscounting period is 15 days

Bill RediscountingThe RBI introduced the Bills Market Scheme (BMS) in 1952 which was later modified into the New Bills Market Scheme (NBMS). Under this scheme commercial banks can rediscount the bills which were originally discounted by them with approved institutions (viz., Commercial Banks, Dvelopment Financial Institutions, Mutual Funds, Primary Dealers etc.)

Multiple RediscountingThe individual bills can be substituted by Derivative Usance Promissory Notes (DUPN) of the equal aggregate amount and maturity which are drawn by the issuing bank to eliminate movement of papers and to facilitate multiple rediscounting. DUPNs are exempt from stamp duty and are negotiable instruments5) Repurchase agreement (REPOS):Ready Forward Contracts is short for repurchase agreement. Those who deal in government securities use repos as a form of overnight borrowing. A dealer or other holder of government securities (usually T-bills) sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed price. They are usually very short-term, from overnight to 30 days or more. This short-term maturity and government backing means repos provide lenders with extremely low risk.

Repos are popular because they can virtually eliminate credit problems. Unfortunately, a number of significant losses over the years from fraudulent dealers suggest that lenders in this market have not always checked their collateralization closely enough.

There are also variations on standard repos:

Reverse Repo - The reverse repo is the complete opposite of a repo. In this case, a dealer buys government securities from an investor and then sells them back at a later date for a higher price

Term Repo - exactly the same as a repo except the term of the loan is greater than 30 days.

Ready forward or Repos or Buyback deal is a transaction in which two parties agree to sell and repurchase the same security. Under such an arrangement, the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date in future at a prefixed price. For the purchaser of the security, it becomes a Reverse Repo deal. In simple terms, it is recognised as a buy back arrangement. In a standard ready forward transaction when a bank sells its securities to a buyer it simultaneously enters into a contract with him (the buyer) to repurchase them on a predetermined date and price in the future. Both sale and repurchase prices of securities are determined prior to entering into the deal. In return for the securities, the bank receives cash from the buyer of the securities. It is a combination of securities trading (involving a purchase and sale transaction) and money market operation (lending and borrowing). The repo-rate represents the borrowing/lending rate for use of the money in the intervening period. As the inflow of cash from the ready forward transaction is used to meet temporary cash requirement, such a transaction in essence is a short term cash management technique.

The motivation for the banks and other organizations to enter into a ready forward transaction is that it can finance the purchase of securities or otherwise fund its requirements at relatively competitive rates. On account of this reason the ready forward transaction is purely a money lending operation. Under ready forward deal the seller of the security is the borrower and the buyer is the lender of funds. Such a transaction offers benefits both to the seller and the buyer. Seller gets the funds at a specified interest rate and thus hedges himself against volatile rates without parting with his security permanently (thereby avoiding any distressed sale) and the buyer gets the security to meet his SLR requirements. In addition to pure funding reasons, the ready forward transactions are often also resorted to manage short term SLR mismatches.

Internationally, Repos are versatile instruments and used extensively in money market operations. While inter-bank Repos were being allowed prior to 1992 subject to certain regulations, there were large scale violation of laid down guidelines leading to the 'securities scam' in 1992; this led Government and RBI to clamp down severe restrictions on the usage of this facility by the different market participants. With the plugging of loophole in the operation, the conditions have been relaxed gradually.

RBI has prescribed that following factors have to be considered while performing repo:

1. purchase and sale price should be in alignment with the ongoing market rates

2. no sale of securities should be effected unless the securities are actually held by the seller in his own investment portfolio.

3. Immediately on sale, the corresponding amount should be reduced from the investment account of the seller.

4. The securities under repo should be marked to market on the balance sheet date.

The relaxations over the years made by RBI with regard to repo transactions are:

i. In addition to Treasury Bills, all central and State Government securities are eligible for repo.

ii. Besides banks, PDs are allowed to undertake both repo/reverse repo transactions.

iii. RBI has further widened the scope of participation in the repo market to all the entities having SGL and Current with RBI, Mumbai, thus increasing the number of eligible non-bank participants to 64.

iv. It was indicated in the 'Mid-Term Review' of October 1998 that in line with the suggestion of the Narasimham Committe II, the Reserve Bank will move towards a pure inter-bank (including PDs) call/notice money market. In view of this non-bank entities will be allowed to borrow and lend only through Repo and Reverse Repo. Hence permission of such entities to participate in call/notice money market will be withdrawn from December 2000.

v. In terms of instruments, repos have also been permitted in PSU bonds and private corporate debt securities provided they are held in dematerialised from in a depository and the transactions are done in a recognised stock exchange.

Apart from inter-bank repos RBI has been using this instrument effectively for its liquidity management, both for absorbing liquidity and also for injecting funds into the system. Thus, Repos and Reverse Repo are resorted to by the RBI as a tool of liquidity control in the system. With a view to absorbing surplus liquidity from the system in a flexible way and to prevent interest rate arbitraging, RBI introduced a system of daily fixed rate repos from November 29, 1997.

Reserve Bank of India was earlier providing liquidity support to PDs through the reverse repo route. This procedure was also subsequently dispensed with and Reserve Bank of India began giving liquidity support to PDs through their holdings in SGL A/C. The liquidity support is presently given to the Primary Dealers for a fixed quantum and at the Bank Rate based on their bidding commitment and also on their past performance. For any additional liquidity requirements Primary Dealers are allowed to participate in the reverse repo auction under the Liquidity Adjustment Facility along with Banks, introduced by RBI in June 2000.

The major players in the repo and reverse repurchase market tend to be banks who have substantially huge portfolios of government securities. Besides these players, primary dealers who often hold large inventories of tradable government securities are also active players in the repo and reverse repo market.

6) Banker's Acceptance: A bankers acceptance, or BA, is a time draft drawn on and accepted by a bank. Before acceptance, the draft is not an obligation of the bank; it is merely an order by the drawer to the bank to pay a specified sum of money on a specified date to a named person or to the bearer of the draft. Upon acceptance, which occurs when an authorized bank employee stamps the draft "accepted" and signs it, the draft becomes a primary and unconditional liability of the bank. If the bank is well known and enjoys a good reputation, the accepted draft may be readily sold in an active market.A bankers' acceptance (BA) is a short-term credit investment created by a non-financial firm and guaranteed by a bank to make payment. Acceptances are traded at discounts from face value in the secondary market.

For corporations, a BA acts as a negotiable time draft for financing imports, exports or other transactions in goods. This is especially useful when the creditworthiness of a foreign trade partner is unknown.

Acceptances sell at a discount from the face value:

Face Value of Banker\'s Acceptance $1,000,000

Minus 2% Per Annum Commission for One Year -$20,000

Amount Received by Exporter in One Year $980,000

One advantage of a banker's acceptance is that it does not need to be held until maturity, and can be sold off in the secondary markets where investors and institutions constantly trade BAs.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 the maturity date but the holder has the option to sell it off in the secondary market whenever he finds it suitable.7) Euro Dollars:Eurodollars are bank deposit liabilities denominated in U.S. dollars but not subject to U.S. banking regulations. Banks that offered Eurodollar deposits were located outside the United States. However, since late 1981 non-U.S. residents have been able to conduct business, free of U.S. banking regulations at International Banking Facilities (IBFs) in the United States. Eurodollar deposits may be owned by individuals, corporations, or governments from anywhere in the world, with the exception that only non-U.S. residents can hold deposits at IBFs.

Originally, dollar-denominated deposits, not subject to U.S. banking regulations were held almost exclusively in Europe; hence, the name Eurodollars. Most of these deposits are still held in Europe, but they also are held at U.S. IBFs and in such places as the Bahamas, Bahrain, Canada, the Cayman Islands, Hong Kong, Japan, the Netherlands Antilles, Panama, and Singapore. Regardless of where they are held, such deposits are referred to as Eurodollars.

Banks in the Eurodollar market, including U.S. IBFs, compete with banks in the United States to attract dollar-denominated funds. Since the Eurodollar market is relatively free of regulation, banks in the Eurodollar market are able to operate on narrower margins or spreads between dollar borrowing and lending rates than can banks in the United States. This gives Eurodollar deposits an advantage relative to deposits issued by banks operating under U.S. regulations. The Eurodollar market has grown largely as means of avoiding the regulatory costs involved in dollar-denominated financial intermediation.

Contrary to the name, euro dollars 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 euro dollars can be held anywhere outside the United States.

The euro dollar market is relatively free of regulation; therefore, banks can operate on narrower margins than their counterparts in the United States. As a result, the euro dollar market has expanded largely as a way of circumventing regulatory costs.

The average euro dollar deposit is very large (in the millions) and has a maturity of less than six months. A variation on the euro dollar time deposit is the euro dollar certificate of deposit. A euro dollar CD is basically the same as a domestic CD, except that it's the liability of a non-U.S. bank. Because euro dollar CDs are typically less liquid, they tend to offer higher yields.

The euro dollar 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.

8) Bonds:An interest-bearing certificate of debt, being one of a series constituting a loan made to, and an obligation of, a government or business corporation; a formal promise by the borrower to pay to the lender a certain sum of money at a fixed future day with or without security, and signed and sealed by the maker (borrower); a promise to pay a principal amount on a stated future date and a series of interest payments, usually semiannually until the stated future date; "all subdivided interest-bearing contracts for the future payment of money that are drawn with formality whether they are secured or unsecured, whether the interest is imperative under all conditions, or not, as in the case of income bonds" (L. Chamberlain, The Principles of Bond Investment).The difference between a bond and promissory note is aptly explained by F.A. Cleveland (Funds and Their Uses) as follows:

The only way that a bond is distinguished from an ordinary promissory note is by the fact that it is issued as part of a series of like tenor and amount, and, in most cases, under a common security. By rule of common law the bond is also more formal in its execution. The note is a simple promise (in any form, so long as a definite promise for the payment of money appears upon its face), signed by the party bound, without any formality as to witnesses or seal. The bond, on the other hand, in its old common-law form, required a seal and had to be witnessed in the same manner as a deed or other formal conveyance of property, and though assignable was not negotiable. This is still the rule with many jurisdictions.

A bond differs from an investment note only in the time which it has to run before maturity. Ordinarily the deviding line is five years; if the term of the funded debt exceeds this period, the issue is called bonds; if within this period, notes.

A bond differs from a share of stock in that the former is a contract to pay a certain sum of money with definite stipulations as to amount and maturity of interest payments, maturity of principal, and other recitals as to the rights of the holder in case of default, sinking fund provisions, etc. A stock contains no promise to repay the purchase price or any amount whatsoever. The shareholder is an owner; a bondholder is a creditor. The bondholder has a claim against the assets and earnings of a corporation prior to that of the stockholder, and while the bondholder is an investor, the stockholder speculates on the success of the enterprise. The former's claim is a definite contractual one;the latter's claim is contingent upon earnings.Chapter 7TREASURY BILLS AND INFLATION CONTROL:Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the RBI Treasury. These securities were first issued in 1997. The principal is adjusted to the Consumer Price Index, the commonly used measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation. TIPS are currently offered in 5-year, 7-year, 10-year and 20-year maturities. 30-year TIPS are no longer offered.

In addition to their value for a borrower who desires protection against inflation, TIPS can also be a useful information source for policy makers: the interest-rate differential between TIPS and conventional Treasury bonds is what borrowers are willing to give up in order to avoid inflation risk. Therefore, changes in this differential are usually taken to indicate that market expectations about inflation over the term of the bonds have changed. The interest payments from these securities are taxed for federal income tax purposes in the year payments are received (payments are semi-annual, or every six months). The inflation adjustment credited to the bonds is also taxable each year. This tax treatment means that even though these bonds are intended to protect the holder from inflation, the cash flows by the bonds are actually inversely related to inflation until the bond matures. For example, during a period of no inflation, the cash flows will be exactly the same as for a normal bond, and the holder will receive the coupon payment minus the taxes on the coupon payment. During a period of high inflation, the holder will receive the same equivalent cash flow (in purchasing power terms), and will then have to pay additional taxes on the inflation adjusted principal. The details of this tax treatment can have unexpected repercussions.

By comparing a TIPS bond with a standard nominal Treasury bond across the same maturity dates, investors may calculate the bond market's expected inflation rate by applying Fisher's equation.

Sometimes appropriate market structures have developed only after central banks and governments have taken the lead. For example, Reserve bank of India realized quite early in its existence that a well functioning money market-dealing in treasury bills, commercial paper, overnight funds, and the like-would assist the

implementation of monetary policy as well as the overall efficiency of the economy. But although the banking system as such had been well developed for many decades, an active money market emerged only after a series of RBI

From the viewpoint of monetary control, and therefore inflation control, the development of the Canadian money market had two particularly desirable features. In the first place, the money market's developmentprovided an avenue for increased reliance on price-related methods of monetary management-broadly speaking, open market operations. And in this process, reliance on jawboning and on bank liquidity ratios to influence commercial banks' extension of credit

became less and less-to the point that these features now have no role in India

Secondly, the broadening of outlets for the placement of government debt-to include the money market as well as the bond market-helped to provide a first line of assurance that government deficit financing would not impinge upon monetary control. In general, in the absence of broad and resilient financial markets through which to absorb financing demands, the central bank would find it very difficult to deflect direct pressure from government Monetary Policy and the Control of Inflation deficits on its balance sheet and therefore on inflation of the monetary base.

To deflect the pressure by, for example, imposing higher bankreserve requirements in cash, or in government securities, is not an adequate solution. At the very least it causes problems for the efficiency and competitiveness of the deposit-taking part of the financial system. A better solution would be for the government to pay an interest rate sufficiently high that it attracts willing lenders, and without pumping up the money supply. In general, if credit of various kinds really has to be subsidized or channelled preferentially, the subsidy should be out in the open and not financed through what is in effect a tax (and therefore fiscal, not monetary, policy) on the intermediation of savings through the banking system. A related issue with implications for controlling inflation is the importance of developing at an early stage a workable system of prudential oversight for financial institutions, including determining which institutions will have access to the lender-of-last-resort facility for liquidity purposes. This, too, is a separate topic of discussion in a later session. Its importance for inflation control is to remove a potential constraint on the conduct of monetary policy. The presence of distressed institutions may inhibit monetary discipline, for fear of precipitating a crisis in the financial system or of disrupting the flow of investment finance to the non-financial sector,

Treasury bills are generally considered to be free of default risk because they are obligations of the federal government. In contrast, even the highest grade of other money market instruments, such as commercial paper or certificates of deposit (CDs), is perceived to have some degree of default risk. Concern over the default risk of securities other than Treasury securities typically increases in times of weak economic conditions, and this tends to raise the differential between the rates on these securities and the rates on Treasury bills of comparable maturity (discussed below).

Because Treasury bills are free of default risk, various regulations and institutional practices permit them to be used for purposes that often cannot be served by other money market instruments. For example, banks use bills to make repurchase agreements free of reserve requirements with businesses and state and local governments, and banks use bills to satisfy pledging requirements on state and local and federal deposits. Treasury bills are widely accepted as collateral for selling short various financial securities and can be used instead of cash to satisfy initial margin requirements against futures market positions. And Treasury bills are always a permissible investment for state and local governments, while many other types of money market instruments frequently are not.

Liquidity

A second characteristic of bills is their high degree of liquidity, which refers to the ability of investors to convert them into cash quickly at a low transactions cost. Investors in Treasury bills have this ability because bills are a homogeneous instrument and the bill market is highly organized and efficient. A measure of the liquidity of a financial asset is the spread between the price at which securities dealers buy it (the bid price) and the price at which they sell it (the asked price). In recent years the bid-asked spread on actively traded bills has been 2 basis points or less, which is lower than for any other money market instrument.

Taxes

Unlike other money market instruments, the income earned on Treasury bills is exempt from all state and local income taxes. The relationship between, say, the CD rate (RCD) and the bill rate (RTB) that leaves an investor with state income tax rate t indifferent between the two, other considerations aside, is

RCD(1 - t) = RTB.

From this formula it can be seen that the advantage of the tax-exempt feature for a particular investor depends on (1) the current level of interest rates and (2) the investor's state and local tax rate. For an investor to remain indifferent between bills and CDs, the before-tax yield differential (RCD - RTB) must rise if the level of interest rates rises or if the investor's tax rate increases. For example, the interest rate differential at which an investor subject to a marginal state tax rate of 6 percent is indifferent between CDs and bills rises from 32 basis points when the Treasury bill rate is 5 percent to 64 basis points when the bill rate is 10 percent. And with a 5 percent Treasury bill rate, the interest rate differential at which an investor is indifferent between CDs and bills rises from 32 basis points when the investor's tax rate is 6 percent to 43 basis points when his tax rate is 8 percent.

This characteristic of bills is relevant only for some investors. Other investors, such as state and local governments, are not subject to state income taxes. Still other investors, such as commercial banks in many states, pay a "franchise" or "excise" tax that in fact requires them to pay state taxes on interest income from Treasury bills.

Minimum Denomination

A fourth investment characteristic of Treasury bills is their relatively low minimum denomination. Prior to 1970, the minimum denomination of bills was $1,000. In early 1970 the Treasury raised the minimum denomination from $1,000 to $10,000. The Treasury made this change in order to discourage noncompetitive bids by small investors, reduce the costs of processing many small subscriptions yielding only a small volume of funds, and discourage the exodus of funds from financial intermediaries and the mortgage market. Despite the increase in the minimum denomination of bills, investors continued to shift substantial amounts of funds out of deposit institutions into the bill market in periods of high interest rates such as 1973 and 1974.

Chapter 8Conclusion: The money market specializes in debt securities that mature in less than one year.

Money market securities are very liquid, and are considered very safe. As a result, they offer a lower return than other securities.

The easiest way for individuals to gain access to the money market is through a money market mutual fund.

T-bills are short-term government securities that mature in one year or less from their issue date.

T-bills are considered to be one of the safest investments - they don't provide a great return.

A certificate of deposit (CD) is a time deposit with a bank.

Annual percentage yield (APY) takes into account compound interest, annual percentage rate (APR) does not.

CDs are safe, but the returns aren't great, and your money is tied up for the length of the CD.

Commercial paper is an unsecured, short-term loan issued by a corporation. Returns are higher than T-bills because of the higher default risk.

Banker's acceptances (BA)are negotiable time draft for financing transactions in goods.

BAs are used frequently in international trade and are generally only available to individuals through money market funds.

Eurodollars are U.S. dollar-denominated deposit at banks outside of the United States.

The average eurodollar deposit is very large. The only way for individuals to invest in this market is indirectly through a money market fund.

Repurchase agreements (repos) are a form of overnight borrowing backed by government securities.

Chapter 9AnnexureBIBILOGRAPHY

A) Reference Books:-

TITLE OF BOOK:- DYNAMICS OF INDIAN FINANCIAL SYSTEM

FINANCIAL SERVICE AND MARKET INDIAN FINANCIAL SYSTEM

BUSINESSW ENVIRONMENT

MONEY BANKING TRADE AND PUBLIC FINANCE

AUTHOR'S NAME:- BY - PREETY SINGHBY- BHARATI V. PATHAKBY- DR.S.GURUSWAMYBY -FRANCIS CHERUNILAM

BY - D.M. MITTHANI

B) JOURNALS:-

E-DATA:-

WEBSITES:

www.rbi.org.in/weekly statistical supplement/various issues.co.in

www.investopedia.com .

www.bseindia.com

www.nseindia.com

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