52312818 Indian Money Market

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INDIAN MONEY MARKET

PROJECT REPORT ON

INDIAN MONEY MARKET

SUBMITTED TO

GURU NANAK DEV UNIVERSITY

IN PARTIAL FULFILMENT OF THE

REQUIREMENT FOR THE DEGREE OF

MASTER OF BUSINESS ECONOMICS

UNDER GUIDANCE OF SUBMITTED BY

Mrs. RENU BHATIA YASHVANT SINGH

NEW DELHI INSTITUTE OF MANAGEMENT


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DECLARATION

Hereby I declare that the project report entitled INDIAN MONEY MARKET submitted for

the degree of Master of Business Economics, is my original work and the project report has not

formed the basis for the award of any diploma, degree, associate ship, fellowship or similar

other titles. It has not been submitted to any other university or institution for the award of any

degree or diploma.

Place: YASHVANT SINGH

Date: MBE-IV Sem


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CERTIFICATE

This is to certify that Ms. YASHVANT SINGH of MBE fourth semester of NEW DELHI

INSTITUTE OF MANAGEMENT has completed her project report on the topic PROJECT

REPORT ON INDIAN MONEY MARKET under the supervision of Mrs. RENU BHATIA

faculty member of NDIM.

To best of my knowledge the report is original and has not been copied or submitted anywhere

else. It is an independent work done by her.

Mrs. RENU BHATIA

NDIM


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ACKNOWLEDGEMENT

Survey is an excellent tool for learning and exploration. No classroom routine can substitute

which is possible while working in real situations. Application of theoretical knowledge to

practical situations is the bonanzas of this survey.

Without a proper combination of inspection and perspiration, its not easy to achieve anything.

There is always a sense of gratitude, which we express to others for the help and the needyservices they render during the different phases of our lives. I too would like to do it as I really

wish to express my gratitude toward all those who have been helpful to me directly or

indirectly during the development of this project.

First of all I wish to express my profound gratitude and sincere thanks to my professorMrs.

RENU BHATIA who was always there to help and guide me when I needed help. His

perceptive criticism kept me working to make this project more full proof. I am thankful to him

for his encouraging and valuable support. Working under him was an extremely knowledgeable

and enriching experience for me. I am very thankful to him for all the value addition and

enhancement done to me.

No words can adequately express my overriding debt of gratitude to my parents whose support

helps me in all the way. Above all I shall thank my friends who constantly encouraged and

blessed me so as to enable me to do this work successfully.

YASHAVANT SINGH

MBE


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TABLE OF CONTENTSCHAPTER

NUMBER

CHAPTER NAME CONTENTS PAGE

NUMBER

I INTRODUCTION OF INDIAN

MONEY MARKET

Meaning of Money Market

Definition of Money Market

Objectives of Money Market

General Characteristics ofMoney Market

History of Indian Money

Market

II INTRODUCTION OF

CHOCOLATE AND

COMPANYS PROFILE

HISTORY OF CHOCOLATE

CHOCOLATE

PRODUCTION

CONSUMTION OF

CHOCOLATE IN INDIA

NESTLES PROFILE

CADBURYS PROFILE

III LITERATURE REVIEW

IV RESEARCH & DESIGN

METHODOLOGY

BASIS OF RESEARCH AND

DESIGN

V FINDINGS & ANALYSIS ANALYSIS OF DATAFINDINGS

CONCLUSION

SUGGESTIONS AND

RECOMENDETATIONS

VI BIBLIOGRAPHY

VII ANNEXURE


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SUMMARY:

The seventh largest and second most populous country in the world, India has long been

considered a country of unrealized potential. A new spirit of economic freedom is now stirring

in the country, bringing sweeping changes in its wake. A series of ambitious economic reforms

aimed at deregulating the country and stimulating foreign investment has moved India firmly

into the front ranks of the rapidly growing Asia Pacific region and unleashed the latent

strengths of a complex and rapidly changing nation.

India's process of economic reform is firmly rooted in a political consensus that spans her

diverse political parties. India's democracy is a known and stable factor, which has taken deep

roots over nearly half a century. Importantly, India has no fundamental conflict between its

political and economic systems. Its political institutions have fostered an open society with

strong collective and individual rights and an environment supportive of free economic

enterprise.

India's time tested institutions offer foreign investors a transparent environment that guarantees

the security of their long term investments. These include a free and vibrant press, a judiciary

which can and does overrule the government, a sophisticated legal and accounting system and a

user friendly intellectual infrastructure. India's dynamic and highly competitive private sector

has long been the backbone of its economic activity. It accounts for over 75% of its Gross

Domestic Product and offers considerable scope for joint ventures and collaborations.

Today, India is one of the most exciting emerging money markets in the world. Skilled

managerial and technical manpower that match the best available in the world and a middle

class whose size exceeds the population of the USA or the European Union, provide India with

a distinct cutting edge in global competition.

The average turnover of the money market in India is overRs. 40,000 crores daily. This is

more than 3 percents of the total money supply in the Indian economy and 6 percent of the total

funds that commercial banks have let out to the system. This implies that 2 percent of the

annual GDP of India gets traded in the money market in just one day. Even though the money

market is many times larger than the capital market, it is not even fraction of the daily trading

in developed markets.


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1) Meaning of Money Market:

Money market refers to the market where money and highly liquid marketable

securities are bought and sold having a maturity period of one or less than one year. It is not a

place like the stock market but an activity conducted by telephone. The money market

constitutes a very important segment of the Indian financial system.

The highly liquid marketable securities are also called as money market instruments

like treasury bills, government securities, commercial paper, certificates of deposit, call money,

repurchase agreements etc.

The major player in the money market are Reserve Bank of India (RBI), Discount and

Finance House of India (DFHI), banks, financial institutions, mutual funds, government, big

corporate houses. The basic aim of dealing in money market instruments is to fill the gap of

short-term liquidity problems or to deploy the short-term surplus to gain income on that.

2) Definition of Money Market:

According to the McGraw Hill Dictionary of Modern Economics, money market is

the term designed to include the financial institutions which handle the purchase, sale, and

transfers of short term credit instruments. The money market includes the entire machinery for

the channelizing of short-term funds. Concerned primarily with small business needs for

working capital, individuals borrowings, and government short term obligations, it differs

from the long term or capital market which devotes its attention to dealings in bonds, corporate

stock and mortgage credit.

According to the Reserve Bank of India, money market is the centre for dealing,mainly of short term character, in money assets; it meets the short term requirements of

borrowings 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 agents comprising institutions and individuals and also the government itself.

According to the Geoffrey, money market is the collective name given to the various

firms and institutions that deal in the various grades of the near money.

3) Objectives of Money Market:


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A well developed money market serves the following objectives:

Providing an equilibrium mechanism for ironing out short-term surplus and deficits.

Providing a focal point for central bank intervention for the influencing liquidity in the

economy.

Providing access to users of short-term money to meet their requirements at a

reasonable price.

4) General Characteristics of Money Market:


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The general characteristics of money market are outlined below:

Short-term funds are borrowed and lent.

No fixed place for conduct of operations, the transactions being conducted even overthe phone and therefore, there is an essential need for the presence of well developed

communications system.

Dealings may be conducted with or without the help the brokers.

The short-term financial assets that are dealt in are close substitutes for money,

financial assets being converted into money with ease, speed, without loss and with

minimum transaction cost.

Funds are traded for a maximum period of one year.

Presence of a large number of submarkets such as inter-bank call money, bill

rediscounting, and treasury bills, etc.

4) History of Indian Money Market:

Till 1935, when the RBI was set up the Indian money market remained highlydisintegrated, unorganized, narrow, shallow and therefore, very backward. The planned

economic development that commenced in the year 1951 market an important beginning in the

annals of the Indian money market. The nationalization of banks in 1969, setting up of various

committees such as the Sukhmoy Chakraborty Committee (1982), the Vaghul working group

(1986), the setting up of discount and finance house of India ltd. (1988), the securities trading

corporation of India (1994) and the commencement of liberalization and globalization process

in 1991 gave a further fillip for the integrated and efficient development of India money

market.

5) The Role of the Reserve Bank of India in the Money Market:

The Reserve Bank of India is the most important constituent of the money market. The market

comes within the direct preview of the Reserve Bank of India regulations.

The aims of the Reserve Banks operations in the money market are:


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To ensure that liquidity and short term interest rates are maintained at levels consistent

with the monetary policy objectives of maintaining price stability.

To ensure an adequate flow of credit to the productive sector of the economy and

To bring about order in the foreign exchange market.

The Reserve Bank of India influence liquidity and interest rates through a number of

operating instruments - cash reserve requirement (CRR) of banks, conduct of open market

operations (OMOs), repos, change in bank rates and at times, foreign exchange swap

operations

Treasury Bills:

Treasury bills are short-term instruments issued by the Reserve Bank on behalf of the

government to tide over short-term liquidity shortfalls. This instrument is used by the

government to raise short-term funds to bridge seasonal or temporary gaps between its receipt

(revenue and capital) and expenditure. They form the most important segment of the money

market not only in India but all over the world as well.

In other words, T-Bills are short term (up to one year) borrowing instruments of the

Government of India which enable investors to park their short term surplus funds while

reducing their market risk

T-bills are repaid at par on maturity. The difference between the amount paid by the

tenderer at the time of purchase (which is less than the face value) and the amount received on

maturity represents the interest amount on T-bills and is known as the discount. Tax deducted

at source (TDS) is not applicable on T-bills.

Features of T-bills are:

They are negotiable securities.

They are highly liquid as they are of shorter tenure and there is a possibility of an

interbank repos on them.

There is absence of default risk.


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They have an assured yield, low transaction cost, and are eligible for inclusion in the

securities for SLR purpose.

They are not issued in scrip form. The purchases and sales are affected through the

subsidiary general ledger (SGL) account. T-Bills are issued in the form of SGL entries

in the books of Reserve Bank of India to hold the securities on behalf of the holder. The

SGL holdings can be transferred by issuing a SGL transfer form

Recently T-Bills are also being issued frequently under the Market Stabilization

Scheme (MSS).

Types of Treasury Bills:

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, RBI issues T-Bills for three

different maturities : 91 days, 182 days and 364 days. The 91 day T-Bills are issued on weekly

auction basis while 182 day T-Bill auction is held on Wednesday preceding non-reporting

Friday and 364 day T-Bill auction on Wednesday preceding the reporting Friday. There are no

treasury bills issued by State Governments.

Advantages of investing in T-Bills:

No Tax Deducted at Source (TDS)

Zero default risk as these are the liabilities of GOI

Liquid money Market Instrument

Active secondary market thereby enabling holder to meet immediate fund requirement.

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


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under the Market Stabilization Scheme (MSS). They are available in both Primary and

Secondary market.

Auctions of Treasury Bills:

While 91-day T-bills are auctioned every week on Wednesdays, 182 days 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 shown below (table 1.1). It also announces the

exact dates of auction, the amount to be auctioned and payment dates by issuing press releases

prior to every auction.

Participants in the T-bills market:

The Reserve Bank of India, mutual funds, financial institutions, primary dealers, satellite

dealers, provident funds, corporates, foreign banks, and foreign institutional investors are all

participants in the treasury bill market. The sale government can invest their surplus funds as

non-competitive bidders in T-bills of all maturities.

Treasury bills are pre-dominantly held by banks. In the recent years, there has been a growth in

the number of non-competitive bids, resulting in significant holding of T- bills by provident

funds, trusts and mutual funds.

The table 1.2 presents holding pattern of outstanding T-bills.

Investors At the end of march (Rs.in Cr.)

2008 2007 2006 2005

RBI - - - -

Banks 43,800 51,770 49,187 61,724

State Government 91,988 88,822 60,184 15,874

Others 41,195 27,991 8,146 11,628

Total t-bills outstanding 1,76,983 1,68,583 1,17,517 89,226

Source: RBI, Weekly Statistical Supplement, Various Issues.


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Issuance Process of T-Bills:

Treasury bills (T-bills) are short -term debt instruments issued by the Central government.

Three types of T-bills are issued: 91-day, 182-day and 364-day.

T- bills are sold through an auction process announced by the RBI at a discount to its face

value. RBI issues a calendar of T-bill auctions (Table 1.2) .It also announces the exact dates of

auction, the amount to be auctioned and payment dates. T-bills are available for a minimum

amount of Rs. 25,000 and in multiples of Rs. 25,000. Banks and PDs are major bidders in the

T- bill market. Both discriminatory and uniform price auction methods are used in issuance of

T-bills. Currently, the auctions of all T-bills are multiple/discriminatory price auctions, where

the successful bidders have to pay the prices they have actually bid for. Non-competitive bids,

where bidders need not quote the rate of yield at which they desire to buy these T-bills, are also

allowed from provident funds and other investors. RBI allots bids to the non-competitive

bidders at the weighted average yield arrived at on the basis of the yields quoted by accepted

competitive bids at the auction. Allocations to non-competitive bidders are outside the amount

notified for sale. Non-competitive bidders therefore do not face any uncertainty in purchasing

the desired amount of T-bills from the auctions.

Pursuant to the enactment of FRBM Act with effect from April 1, 2006, RBI is prohibited from

participating in the primary market and hence devolvement on RBI is not allowed. Auction of

all the Treasury Bills are based on multiple price auction method at present. The notified

amounts of the auction is decided every year at the beginning of financial year (Rs.500 crore

each for 91-day and 182-day Treasury Bills and Rs.1,000 crore for 364-day Treasury Bills for

the year 2008-09) in consultation with GOI. RBI issues a Press Release detailing the notified

amount and indicative calendar in the beginning of the financial year. The auction for MSS

amount varies depending on prevailing market condition. Based on the requirement of GOI and

prevailing market condition, the RBI has discretion to change the notified amount. Also, it is


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discretion of the RBI to accept, reject or partially accept the notified amount depending on

prevailing market condition.

Table 1.1 Treasury Bills- Auction Calendar

Type of Day of Day of

T-bills Auction Payment*

91-day Wednesday Following Friday

182-day Wednesday of non-reporting week Following Friday

364-day Wednesday of reporting week Following Friday

*

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

The calendar for the regular auction of TBs for 2008-09 was announced on March 24, 2008.

The notified amounts were kept unchanged at Rs.500 crore for 91-day and 182- day TBs and

Rs.1,000 crore for 364-day TBs. However, the notified amount (excluding MSS) of 91-day and

182 TBs and Rs.1,000 crore for 364 day TBs. However, the notified amount (excluding MSS)

of 91-day TBs was increased by Rs.2,500 crore each on ten occasions and by Rs.1,500 crore

each on ten occasions and by Rs.1,500 crore on one occasion and that of 182 day TBs was

increased by Rs.500 crore on two occasions during 2008-09 (upto August 14, 2008). Thus, an

additional amount of Rs.27,500 crore (Rs.17,500 crore, net) was raised over and above the

notified amount in the calendar to finance the expected temporary cash mismatch arising from

the expenditure on farmers debt waiver scheme.


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The summary of T- bill auctions conducted during the year 2007- 08 is in Table 1.3

Table 1.3: T-bill Auctions 2007- 08 - A Summary

91-days 182-days 364-days

No. of issues 54 27 26

Number of bids received (competitive &

non-competitive)

4,844 1,991 2,569

Amount of competitive bids (Rs. cr.) 301,904 115,531 170,499

Amount of non-competitive bids (Rs. cr.) 101,024 7,321 3,205

Number of bids accepted (competitive & non-

competitive bids)

1935 811 849

Amount of competitive bids accepted (Rs.Cr.) 109,341 39,605 54,000

Devolvement on PDs (Rs. cr.) - - -

Total Issue (Rs. cr) 210,365 46,926 57,205

Cut-off price - minimum (Rs.) 98.06 96.17 92.78

Cut-off price - maximum (Rs.) 98.90 97.18 93.84

Implicit yield at cut -off price - minimum (%) 4.4612 5.82 6.5824

Implicit yield at cut -off price - maximum (%)

Outstanding amount (end of the year)

(Rs.cr.)

39,957.06 16,785.00 57,205.30


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Source: RBI Bulletin, Various Issues.

CUT-OFF YIELDS:

T- bills are issued at a discount and are redeemed at par. The implicit yield in the T-

bill is the rate at which the issue price (which is the cut-off price in the auction) has to be

compounded, for the number of days to maturity, to equal the maturity value. Yield, given

price, is computed using the formula:

= ((100-Price)*365)/ (Price * No of days to maturity)

Similarly, price can be computed, given yield, using the formula:

= 100/(1+(yield% * (No of days to maturity/365))

For example, a 182-day T-bill, auctioned on January 18, at a price of Rs. 95.510 would have an

implicit yield of 9.4280% computed as follows:

= ((100-95.510)*365)/(95.510*182)

9.428% is the rate at which Rs. 95.510 will grow over 182 days, to yield Rs. 100 on maturity.

Treasury bill cut-off yields in the auction represent the default -free money market rates in the

economy, and are important benchmark rates.

Types of auctions of T-bills:

There are two types of auctions:

Multiple-price auction

Uniform-price auction

Multiple-price auction:

The Reserve Bank invites bids by price, that is, the bidders have to quote the price ( per Rs.100

face value) of the stock at which they desire to purchase. The bank then decides the cut-off


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price at which the issue would be exhausted. Bids above the cut-off price are allotted securities.

In other words, each winning bidder pays the price it bid.

The main advantage of this method is that the Reserve Bank obtains the maximum price each

participant is willing to pay. It can encourage competitive bidding because each bidder is aware

that it will have to pay the price it bid, not just the minimum accepted price. If the bidders who

paid higher prices could face large capital losses if the trading in these securities starts below

the marginal price set at the auction. In order to eliminate the problem, the Reserve Bank

introduced uniform price auction in case of 91-days T-bills.

Uniform-price auction:

In this method, the Reserve Bank invites the bids in descending order and accepts those that

fully absorb the issue amount. Each winning bidders pays the same (uniform) price decided by

the Reserve Bank. The advantages of the uniform price auction are that they tend to minimize

uncertainty and encourage broader participation.

Most countries follow the multiple-price auction. However, now the trend is a shift towards the

uniform-price auction. It was introduced on an experimental basis on November 6, 1998, in

case of 91-days T-bills. Since 1999-2000, 91-day T-bills auctions are regularly conducted on a

uniform price basis.

Commercial Paper:

Commercial paper was introduced into the Indian money market during the year 1990,

on the recommendation of Vaghul Committee. Now it has become a popular debt instrument of

the corporate world.

A commercial paper is an unsecured short-term instrument issued by the large banks

and corporations in the form of promissory note, negotiable and transferable by endorsement

and delivery with a fixed maturity period to meet the short-term financial requirement. There

are four basic kinds of commercial paper: promissory notes, drafts, checks, and certificates of

deposit.

It is generally issued at a discount by the leading creditworthy and highly rated

corporates. Depending upon the issuing company, a commercial paper is also known asFinancial paper, industrial paper or corporate paper. Commercial paper was initially meant to
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be used by the corporates borrowers having good ranking in the market as established by a

credit rating agency to diversify their sources of short term borrowings at a rate which was

usually lower than the banks working capital lending rate.

Commercial papers can now be issued by primary dealers, satellite dealers, and all-

India financial institutions, apart from corporatist, to access short-term funds. Effective from 6th

September 1996 and 17th June 1998, primary dealers and satellite dealers were also permitted to

issue commercial paper to access greater volume of funds to help increase their activities in the

secondary market. It can be issued to individuals, banks, companies and other registered Indian

corporate bodies and unincorporated bodies. It is issued at a discount determined by the issuer

company. The discount varies with the credit rating of the issuer company and the demand and

the supply position in the money market. In India, the emergence of commercial paper has

added a new dimension to the money market.

Diagram 2.3 Commercial Paper Issue Mechanism


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Advantage of commercial paper:

High credit ratings fetch a lower cost of capital.

Wide range of maturity provide more flexibility.

It does not create any lien on asset of the company.

Tradability of Commercial Paper provides investors with exit options.

Disadvantages of commercial paper:

Its usage is limited to only blue chip companies.

Issuances of Commercial Paper bring down the bank credit limits.

A high degree of control is exercised on issue of Commercial Paper.

Stand-by-credit may become necessary.

Issuance Process of Commercial Paper:

Obtainedcredit rating

Obtainedworking capital

limit

Net worthnot less than

4 crores

IssuerCompany

Issue CP at discount

InvestorBank/Company

Redeem CPon maturity

Commercial Paper Issue Mechanism


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In the developed economies, a substantial portion of working capital requirement

especially those that are short-term, is promptly met through flotation of commercial paper.

Directly accessing market by issuing short-term promissory notes, backed by stand-by or

underwriting facilities, enables the corporate to leverage its rating to save on interest costs.

Typically commercial paper is sold at a discount to its face value and is redeemed at face value.

Hence, the implict interest rate is function of the size of discount and the period of maturity.

Scheduled commercial banks are major investors in commercial paper and their

investment is determined by bank liquidity conditions. Banks prefer commercial paper as an

investment avenue rather than sanctioning bank loan. These loans involve high transaction

costs and money is locked for a longer time period whereas a commercial paper is an attractive

short-term instrument for banks to park funds during times of high liquidity. Some banks fund

commercial papers by borrowing from the call money market. Usually, the call money market

rates are lower than the commercial paper rates. Hence, banks book profits through arbitraged

between the two money markets. Moreover, the issuance of commercial papers has been

generally observed to be invested related to the money market rates.

Illustration 1.


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X co.ltd issued commercial paper as per following details:

Date of issue 17th January, 2009 no. of days 90 days

Date of maturity 17th April, 2009 interest rate 11.25% p.a.

What was the net amount received by the company on issue of commercial paper?

Let us assume that the company has issued commercial paper worth Rs.10 crores?

No of days = 90 days

Interest rate = 11.25 % p.a.

Interest for 90 days = 11.25% p.a. X 90 days/ 365 days = 2.774%

= 10 crores X 2.774 / 100+2.774 = Rs. 26, 99,126 crores

= or 0.27 crores

Therefore, net amount received at the time of issue = 10 crores 0.27 crores

= Rs. 9.73 crores

RBI Guidelines on Issue of Commercial Paper:


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The summary of RBI guidelines for issue of Commercial paper is given below:

Corporate, primary dealers, satellite dealers and all India financial institutions are

permitted to raise short term finance through issue of commercial paper, which should

be within the umbrella limit fixed by RBI.

A corporate can issue Commercial Paper if:

1. Its tangible net worth is not less than Rs.5 crores as per latest balance sheet.

2. Working capital limit is obtained from banks/ all India financial institutions, and

3. Its borrowal account is classified as standard asset by banks/ all India financial

institutions.

Credit rating should be obtained by all eligible participants in cp issue from the

specified credit rating agencies like CRISIL, ICRA, CARE, and FITCH. The minimum

rating shall be equivalent to P-2 of CRISIL.

Commercial paper can be issued for maturities between a minimum of 15 days and a

maximum of upto one year from the date of issue.

The maturity date of commercial paper should not exceed the date beyond the date upto

which credit rating is valid.

It can be issued in denomination of Rs. 5 lakhs or in multiples thereof.

Amount invested by a single investor should not be less than Rs. 5 lakhs (face value).

A company can issue commercial paper to an aggregate amount within the limit

approved by board of directors or limit specified by credit rating agency, whichever is

lower.

Banks and financial institutions have the flexibility to fix working capital limits duly

taking into account the resource pattern of companys financing including commercial

papers.

The total amount of commercial paper proposed to be issued should be raised within a

period of two weeks from the date on which the issuer opens the issue for subscription.

Commercial paper may be issued on a single date or in parts on different dated provided

that in the latter case, each commercial paper shall have the same maturity date.


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Every commercial paper should be reported to RBI through issuing and paying agent

(IPA).

Only a scheduled bank can act as an IPA.

Commercial paper can be subscribed by individuals, banking companies, corporate,NRIs and FIIs.

It can be issued either in the form of a promissory note or in a dematerialised form.

It will be issued at a discount to face value as may be determined by the issuer.

Issue of commercial paper should not be underwritten or co-accepted.

The initial investor in commercial paper shall pay the discounted value of the

commercial paper by means of a crossed account payee cheque to the account of the

issuer through IPA.

On maturity, if commercial paper is held in physical form, the holder of commercial

paper shall present the investment for payment to the issuer through IPA.

When the commercial paper is held in demat form, the holder of commercial paper will

have to get it redeemed through depository and received payment from the IPA.

Commercial paper is issued as a stand alone product. It would not be obligatory for

banks and financial institutions to provide stand-by facility to issuers of commercial

paper.

Every issue of commercial paper, including renewal, should be treated as a fresh issue.

Growth in the Commercial Paper Market:


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Commercial paper was introduced in India in January 1990, in pursuance of the Vaghul

Committees recommendations, in order to enable highly rated non-bank corporate borrowers

to diversify their sources of short term borrowings and also provide an additional instrument to

investors. commercial paper could carry on an interest rate coupon but is generally sold at a

discount. Since commercial paper is freely transferable, banks, financial institutions, insurance

companies and others are able to invest their short-term surplus funds in a highly liquid

instrument at attractive rates of return.

A major reform to impart a measure of independence to the commercial paper market

took place when the stand by facility* of the restoration of the cash credit limit and

guaranteeing funds to the issuer on maturity of the paper was withdrawn in October 1994. As

the reduction in cash credit portion of the MPBF impeded the development of the commercial

paper market, the issuance of commercial paper was delinked from the cash credit limit in

October 1997. It was converted into a stand alone product from October 2000 so as to enable

the issuers of the service sector to meet short-term working capital requirements.

Banks are allowed to fix working capital limits after taking into account the resource

pattern of the companies finances, including commercial papers. Corporates, PDs and all-India

financial institutions (FIs) under specified stipulations have permitted to raise short-term

resources by the Reserve Bank through the issue of commercial papers. There is no lock in

period for commercial papers. Furthermore, guidelines were issued permitting investments in

commercial papers which has enabled a reduction in transaction cost.

In order to rationalize the and standardize wherever possible, various aspects of

processing, settlement and documentation of commercial paper issuance, several measures

were undertaken with a view to achieving the settlement on T+1 basis. For further deepening

the market, the Reserve Bank of India issued draft guidelines on securitisation of standard

assets on April 4, 2005.


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Accordingly the reporting of commercial papers issuance by issuing and paying agents (IPAs)

on NDS platform commenced effective on April 16, 2005. Activity in the commercial paper

market reflects the state of market liquidity as its issuances tend to rise amidst ample liquidity

conditions when companies can raise funds through commercial papers at an effective rate of

discount lower than the lending rate of bonds. Banks also prefer investing in commercial papers

during credit downswing as the commercial paper rate works out higher than the call rate.

Table 2.2 shows the trends in commercial papers rates and amounts outstanding.

Table 2.2 Commercial Papers - Trends in Volumes and

Discount Rates.

Year Amount Outstanding at

the end of March (Rs. cr.)

Minimum

Discount Rate (%

p.a.)

Maximum

Discount Rate (%

p.a.)

1993-1994 3,264 9.01 16.25

1994-1995 604 10.00 15.50

1995-1996 76 13.75 20.15

1996-1997 646 11.25 20.90

1997-1998 1,500 7.65 15.751998-1999 4,770 8.50 15.25

1999-2000 5,663 9.00 13.00

2000-2001 5,846 8.20 12.80

2001-2002 7,224 7.10 13.00

2002-2003 5,749 5.50 11.10

2003-2004 9,131 4.60 9.88

2004-2005 14,235 4.47 7.69

2005-2006 12,718 5.25 9.25

2006-2007 17,838 6.25 13.35

Sources: RBI, Handbook of Statistics on Indian Economy, 2006-2007

Stamp Duty:

The dominant investors in CPs are banks, though CPs are also held by financial institutions and

corporates. The structure of stamp duties for banks and non-banks is presented in

Table 2.3


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Table 2.3 Stamp Duty For Banks And Non-Banks

Period Banks Non-Banks

Past Present Past Present

I. Upto 3 months 0.05 0.012 0.125 0.06

II. Above 3 months upto 6 months 0.10 0.024 0.250 0.12

III. Above 6 months upto 9 months 0.15 0.036 0.375 0.18

IV. Above 9 months upto 12 months 0.20 0.05 0.500 0.25

V. Above 12 months 0.40 0.10 1.00 0.5

Source: RBI, Report of the Group to review guidelines relating to CPs, March 2004.

Certificate of Deposits:

Certicate of deposit are unsecured, negotiable, short-term instruments in bearer form,

issued by commercial banks and development financial institutions.


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The scheme of certificates of Deposits (CDs) was introduced by RBI as a step towards

deregulation of interest rates on deposits. Under this scheme, any scheduled commercial banks,

co-operative banks excluding land development banks, can issue certificate of deposits for a

period of not less than three months and upto a period of not more than one year. The financial

institutions specifically authorised by the RBI can issue certificate of deposits for a period not

below one year and not above 3 years duration. Certificate of deposits, can be issued within the

period prescribed for any maturity.

Certificates of Deposits (CDs) are short-term borrowings by banks. Certificates of

deposits differ from term deposit because they involve the creation of paper, and hence have

the facility for transfer and multiple ownerships before maturity. Certificate of deposits rates

are usually higher than the term deposit rates, due to the low transactions costs. Banks use the

certificates of deposits for borrowing during a credit pick-up, to the extent of shortage in

incremental deposits. Most certificates of deposits are held until maturity, and there is limited

secondary market activity.

Certificates of Deposit (CDs) is a negotiable money market instrument and issued in

dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other

eligible financial institution for a specified time period. Guidelines for issue of certificate of

deposits are presently governed by various directives issued by the Reserve Bank of India.

Eligibility for Issue of Certificate of Deposits:

Certificate of deposits can be issued by (i) scheduled commercial banks excluding

Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-IndiaFinancial Institutions that have been permitted by RBI to raise short -term resources within the

umbrella limit fixed by RBI.

Banks have the freedom to issue certificate of deposits depending on their

requirements. An FI may issue certificate of deposits within the overall umbrella limit fixed by

RBI, i.e., issue of certificate of deposits together with other instruments, viz., term money,

term deposits, commercial papers and inter-corporate deposits should not exceed 100 per cent

of its net owned funds, as per the latest audited balance sheet.


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Denomination For Certificate Of Deposits:

Minimum amount of a certificate of deposits should be Rs.1 lakh, i.e., the minimumdeposit that could be accepted from a single subscriber should not be less than Rs. 1 lakh and

in the multiples of Rs. 1 lakh thereafter. Certificate of deposits can be issued to individuals,

corporations, companies, trusts, funds, associations, etc. Non-Resident Indians (NRIs) may

also subscribe to certificate of deposits, but only on non-repatriable basis which should be

clearly stated on the Certificate. Such certificate of deposits cannot be endorsed to another

NRI in the secondary market.

Maturity:

The maturity period of certificate of deposits issued by banks should be not less than

7 days and not more than one year. The FIs can issue certificate of deposits for a period not

less than 1 year and not exceeding 3 years from the date of issue.

Discount on Issue of Certificate Of Deposits:

Certificate of deposits may be issued at a discount on face value. Banks/FIs are also

allowed to issue certificate of deposits on floating rate basis provided the methodology of

compiling the floating rate is objective, transparent and market -based. The issuing bank/FI is

free to determine the discount/coupon rate. The interest rate on floating rate certificate of

deposits would have to be reset periodically in accordance with a pre -determined formula that

indicates the spread over a transparent benchmark.

Reserve Requirement and Transferability:

Banks have to maintain the appropriate reserve requirements, i.e., cash reserve ratio

(CRR) and statutory liquidity ratio (SLR), on the issue price of the certificate of deposits.

Physical certificate of deposits are freely transferable by endorsement and delivery. Dematted


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certificate of deposits can be transferred as per the procedure applicable to other demat

securities. There is no lock-in period for the certificate of deposits. Banks/FIs cannot grant

loans against certificate of deposits. Furthermore, they cannot buyback their own certificate

of deposits before maturity

How Certificate Of Deposits Work:

The consumer who opens a certificate of deposits may receive a passbook or paper

certificate, but it now is common for a certificate of deposits to consist simply of a book entry

and an item shown in the consumer's periodic bank statements; that is, there is usually no

"certificate" as such.

At most institutions, the certificate of deposits purchaser can arrange to have the

interest periodically mailed as a check or transferred into a checking or savings account. This

reduces total yield because there is no compounding. Some institutions allow the customer to

select this option only at the time the certificate of deposits is opened.

Commonly, institutions mail a notice to the certificate of deposits holder shortly before

the certificate of deposits matures requesting directions. The notice usually offers the choice of

withdrawing the principal and accumulated interest or "rolling it over" (depositing it into a new

certificate of deposits). Generally, a "window" is allowed after maturity where the certificate of

deposits holder can cash in the certificate of deposits without penalty. In the absence of such

directions, it is common for the institution to "roll over" the certificate of deposits

automatically, once again tying up the money for a period of time (though the certificate of

deposits holder may be able to specify at the time the certificate of deposits is opened that it is

not to be automatically rolled over).

RBI Guidelines on issue of Certificate of Deposits:

The salient features of scheme devised by RBI in issue of certificates of deposit (CDs) by

banks are as follows:


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Certificate of deposits can be issued only by scheduled commercial banks. Regional

rural banks are not eligible for issue of certificate of deposits.

The minimum deposit that cab be accepted from a single subscriber should be Rs. 5

lakhs. Above that, it should be in multiples of Rs. 1 lakhs.

Certificate of deposits can be issued to individuals, corporations, companies, trusts,

funds, associations etc. NRIs can subscribe to certificate of deposits only on non-

repatriable basis.

The minimum maturity period of certificate of depositss is 15 days.

Certificate of depositss should be issued at a discount on face value. The issuing bank is

free to determine the discount rate.

As the certificates of depositss are usance promissory notes, stamp duty would be

attracted as per provisions if Indian Stamp Act.

The issuing banks have to maintain CRR and SLR on the issue price of certificate of

deposits.

certificate of deposits are freely transferable by endorsement and delivery.

Banks cannot grant loan against security of certificate of deposits.

Banks cannot buyback their own certificate of deposits before maturity.

certificate of deposits should be issued only in demat form.

Rating of the certificate of deposit is not mandatory/ compulsory.

Certificate Of Deposits Volume And Rates:


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Table 3.1 shows the trends in rates and volume outstanding of certificate of deposits.

Banks and financial institutions are the largest issuers of certificate of deposits, and are also

subscribers to the certificate of deposits of one another. There are limited other investors such

as mutual funds, in the certificate of deposit markets. Scheduled commercial banks rely on

certificate of deposits to supplement their deposit resources to fund the credit demand. The

flexibility of timing and return that can be offered for attracting bulk deposits has made

certificate of deposits the preferred route for mobilizing resources by some banks.

Table 3.1 certificate of deposits Volume and Rates

Year Amount Outstanding at the end

of March (Rs. cr.)

Minimum rate

(% p.a.)

Maximum rate (%

p.a.)

1993-1994 5,571 7.00 18.00

1994-1995 8,017 7.00 15.00

1995-1996 16,316 9.00 23.00

1996-1997 12,134 7.00 21.00

1997-1998 14,296 5.00 37.00

1998-1999 3,717 6.00 26.00

1999-2000 1,227 6.25 14.20

2000-2001 771 5.00 14.60

2001-2002 1,576 5.00 11.50

2002-2003 908 3.00 10.88

2003-2004 4,461 3.57 7.40

2004-2005 12,078 1.09 7.00

2005-2006 43,568 4.10 8.94

2006-2007 93,272 4.35 11.90

Source: Handbook of Statistics on the Indian Economy 2002-03, RBI & RBI Bulletin.

Call Money Market:

Call and notice money market refers to the market for short -term funds ranging from

overnight funds to funds for a maximum tenor of 14 days. Under Call money market, funds

are transacted on overnight basis and under notice money market, funds are transacted for the

period of 2 days to 14 days.


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The call/notice money market is an important segment of the Indian Money Market.

This is because, any change in demand and supply of short-term funds in the financial system

is quickly reflected in call money rates. The RBI makes use of this market for conducting the

open market operations effectively.

Participants in call/notice money market currently include banks (excluding RRBs)

and Primary dealers both as borrowers and lenders. Non Bank institutions are not permitted in

the call/notice money market with effect from August 6, 2005. The regulator has prescribed

limits on the banks and primary dealers operation in the call/notice money market.

Call money market is for very short term funds, known as money on call. The rate at

which funds are borrowed in this market is called `Call Money rate'. The size of the market for

these funds in India is between Rs 60,000 million to Rs 70,000 million, of which public sector

banks account for 80% of borrowings and foreign banks/private sector banks account for the

balance 20%. Non-bank financial institutions like IDBI, LIC, and GIC etc participate only as

lenders in this market. 80% of the requirement of call money funds is met by the non-bank

participants and 20% from the banking system.

In pursuance of the announcement made in the Annual Policy Statement of April 2006,

an electronic screen-based negotiated quote-driven system for all dealings in call/notice andterm money market was operationalised with effect from September 18, 2006. This system has

been developed by Clearing Corporation of India Ltd. on behalf of the Reserve Bank of India.

The NDS -CALL system provides an electronic dealing platform with features like Direct one

to one negotiation, real time quote and trade information, preferred counterparty setup, online

exposure limit monitoring, online regulatory limit monitoring, dealing in call, notice and term

money, dealing facilitated for T+0 settlement type for Call Money and dealing facilitated for

T+0 and T+1 settlement type for Notice and Term Money. Information on previous dealt rates,

ongoing bids/offers on re al time basis imparts greater transparency and facilitates better rate

discovery in the call money market. The system has also helped to improve the ease of

transactions, increased operational efficiency and resolve problems associated with asymmetry

of information. However, participation on this platform is optional and currently both the

electronic platform and the telephonic market are co-existing. After the introduction of NDS-

CALL, market participants have increasingly started using this new system more so during

times of high volatility in call rates.


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Volumes in the Call Money Market:

Call markets represent the most active segment of the money markets. Though the

demand for funds in the call market is mainly governed by the banks' need for resources to

meet their statutory reserve requirements, it also offers to some participants a regular funding

source for building up short -term assets. However, the demand for funds for reserve

requirements dominates any other demand in the market.. Figure 4.1 displays the average

daily volumes in the call markets.

Figure 4.2: Average Daily Volumes in the Call Market (Rs. cr.)

Committee Recommendation on Call Money Market:

There are various committee suggested recommendation on Call Money Market are as follow:

The Sukhumoy Chakravarty Committee:

The call money market for India was first recommended by the Sukhumoy Chakravarty

Committee, which was set up in 1982 to review the working of the monetary system. They felt

that allowing additional non-bank participants into the call market would not dilute the

strength of monetary regulation by the RBI, as resources from non-bank participants do not

represent any additional resource for the system as a whole, and their participation in call


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money market would only imply a redistribution of existing resources from one participant to

another. In view of this, the Chakravarty Committee recommended that additional non-bank

participants may be allowed to participate in call money market.

The Vaghul Committee Report:

The Vaghul Committee (1990), while recommending the introduction of a number of money

market instruments to broaden and deepen the money market, recommended that the call

markets should be restricted to banks. The other participants could choose from the new

money market instruments, for their short -term requirements. One of the reasons the

committee ascribed to keeping the call markets as pure inter-bank markets was the distortions

that would arise in an environment where deposit rates were regulated, while call rates were

market determined.

The Narasimham Committee II Report:

The Narasimham Committee II (1998) also recommended that call money market in India, like

in most other developed markets, should be strictly restricted to banks and primary dealers.

Since non- bank participants are not subject to reserve requirements, the Committee felt that

such participants should use the other money market instruments, and move out of the call

markets.

Following the recommendations of the Reserve Banks Internal Working Group (1997)

and the Narasimhan Committee (1998), steps were taken to reform the call money market by

transforming it into a pure inter bank market in a phased manner. The non-banks exit was

implemented in four stages beginning May 2001 whereby limits on lending by non-banks

were progressively reduced along with the operationalisation of negotiated dealing system

(NDS) and CCIL until their complete withdrawal in August 2005. In order to create avenues

for deployment of funds by non-banks following their phased exit from the call money market,

several new instruments were created such as market repos and CBLO.

Various reform measures have imparted stability to the call money market. With the

transformation of the call money market into a pure inter-bank market, the turnover in the

call/notice money market has declined significantly. The activity has migrated to other

overnight collateralized market segments such as market repo and CBLO.


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Participants in the Call Money Market:

Participants in call money market include the following:

As lenders and borrowers: Banks and institutions such as commercial banks, bothIndian and foreign, State Bank of India, Cooperative Banks, Discount and Finance

House of India ltd. (DFHL) and Securities Trading Corporation of India (STCI).

As lenders: Life Insurance Corporation of India (LIC), Unit Trust of India (UTI),

General Insurance Corporation (GIC), Industrial Development Bank of India (IDBI),

National Bank for Agriculture and Rural Development (NABARD), specified

institutions already operating in bills rediscounting market, and

entities/corporates/mutual funds.

The participants in the call markets increased in the 1990s, with a gradual opening up

of the call markets to non-bank entities. Initially DFHI was the only PD eligible to participate

in the call market, with other PDs having to route their transactions through DFHI, and

subsequently STCI. In 1996, PDs apart from DFHI and STCI were allowed to lend and

borrow directly in the call markets. Presently there are 18 primary dealers participating in the

call markets. Then from 1991 onwards, corporates were allowed to lend in the call markets,

initially through the DFHI, and later through any of the PDs. In order to be able to lend,

corporates had to provide proof of bulk lendable resources to the RBI and were not suppose to

have any outstanding borrowings with the banking system. The minimum amount corporates

had to lend was reduced from Rs. 20 crore, in a phased manner to Rs. 3 crore in 1998. There

were 50 corporates eligible to lend in the call markets, through the primary dealers. The

corporates which were allowed to route their transactions through PDs, were phased out by

end June 2001.

Table 4.2: Number of Participants in Call/Notice Money Market

Category Bank PD FI MF Corporate Total

I. Borrower 154 19 - - - 173

II. Lender 154 19 20 35 50 277

Source: Report of the Technical Group on Phasing Out of Non-banks from Call/Notice Money

Market, March 2001.


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Banks and PDs technically can operate on both sides of the call market, though in

reality, only the P Ds borrow and lend in the call markets. The bank participants are divided

into two categories: banks which are pre- dominantly lenders (mostly the public sector banks)

and banks which are pre- dominantly borrowers (foreign and private sector banks). Currently,

the participants in the call/notice money market currently include banks (excluding RRBs) and

Primary Dealers (PDs) both as borrowers and lenders.

Call Money Rates:

The rate of interest on call funds is called money rate. Call money rates are

characteristics in that they are found to be having seasonal and daily variations requiring

intervention by RBI and other institutions.

The concentration in the borrowing and lending side of the call markets impacts

liquidity in the call markets. The presence or absence of important players is a significant

influence on quantity as well as price. This leads to a lack of depth and high levels of

volatility in call rates, when the participant structure on the lending or borrowing side alters.

Short-term liquidity conditions impact the call rates the most. On the supply side the

call rates are influenced by factors such as: deposit mobilization of banks, capital flows, and

banks reserve requirements; and on the demand side, call rates are influenced by tax

outflows, government borrowing programme, seasonal fluctuations in credit off take. The

external situation and the behaviour of exchange rates also have an influence on call rates,

as most players in this market run integrated treasuries that hold short term positions in both

rupee and forex markets, deploying and borrowing funds through call markets.

Table 4.3: Call Money Rates

year

Year

Maximum

(% p.a.)

Minimum

(% p.a.)

Average

(% p.a.)

Bank rate (End

March) (% p.a.)

1996 - 97 14.6 1.05 7.8 12.01997 - 98 52.2 0.2 8.7 10.5


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1998 - 99 20.2 3.6 7.8 8.0

1999 - 00 35.0 0.1 8.9 8.0

2000 - 01 35.0 0.2 9.2 7.0

2001 - 02 22.0 3.6 7.2 6.5

2002 - 03 20.00 0.50 5.89 6.252003 -04 12.00 1.00 4.62 6.00

2004 - 05 10.95 0.6 4.65 6.00

Source: Handbook of Statistics on Indian Economy, 2006-07, RBI

During normal times, call rates hover in a range between the repo rate and the reverse

repo rate. The repo rate represents an avenue for parking short -term funds, and during

periods of easy liquidity, call rates are only slightly above the repo rates. During periods of

tight liquidity, call rates move towards the reverse repo rate. Table 4.3 provides data on the

behaviour of call rates. Figure 4.3displays the trend of average monthly call rates.

The behaviour of call rates has historically been influenced by liquidity conditions in

the market. Call rates touched a peak of about 35% in May 1992, reflecting tight liquidity on

account of high levels of statutory pre-emptions and withdrawal of all refinance facilities,

barring export credit refinance. Call rates again came under pressure in November 1995 when

the rates were 35% par.

Repurchase Agreement (Repo):

The major function of the money market is to provide liquidity. To achieve this

function and to even out liquidity changes, the Reserve Bank uses repos. Repo is a useful

money market instrument enabling the smooth adjustment of short-term liquidity among varied

market participants such as banks, financial institutions and so on.

Repo is a money market instrument, which enables collateralized short term borrowing

and lending through sale/purchase operations in debt instruments. Under a repo transaction, a

holder of securities sells them to an investor with an agreement to repurchase at a

predetermined date and rate. It is a temporary sale of debt involving full transfer of ownership

of the securities, that is, the assignment of voting and financial rights.

Repo is also referred to as a ready forward transaction as it is a means of funding by

selling a security held on a spot basis and repurchasing the same on a forward basis. Though

there is no restriction on the maximum period for which repos can be undertaken, generally,

repos are done for a period not exceeding 14 days. Different instruments can be considered as


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collateral security for undertaking the ready forward deals and they include Government dated

securities, treasury bills.

In a typical repo transaction, the counter-parties agree to exchange securities and cash,

with a simultaneous agreement to reverse the transactions after a given period. To the lender

of cash, the securities lent by the borrower serves as the collateral; to the lender of securities,

the cash borrowed by the lender serves as the collateral. Repo thus represents a collateralized

short term lending. The lender of securities (who is also the borrower of cash) is said to be

doing the repo; the same transaction is a reverse repo in the books of lender of cash (who is

also the borrower of securities).

Reserve Repos:

A reverse repo is the mirror image of a repo. For, in a reverse repo, securities are

acquired with a simultaneous commitment to resell. Hence whether a transaction is a repo or a

reverse repo is determined only in terms of who initiated the first leg of the transaction. When

the reverse repurchase transaction matures, the counterparty returns the security to the entity

concerned and receives its cash along with a profit spread. One factor which encourages an

organization to enter into reverse repo is that it earns some extra income on its otherwise idle

cash.

The difference between the price at which the securities are bought and sold is the

lenders profit or interest earned for lending the money. The transaction combines elements of

both a securities purchased/sale operation and also a money market borrowing/lending

operation.

Importance of Repos:

Interest Rate: being collateralized loans, repos help reduce counter-party risk and

therefore, fetch a low interest rate especially in a volatile market.

Safety: repo is an almost risk-free instrument used to even-out liquidity changes in the

system. Repos offer safe short-term outlet for temporary excess cash at close to marketinterest rates.


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Uses: As low-risk and flexible short-term instruments, repos are used to finance

securities held in trading and investment account of security dealers, to establish short

positions, to implement arbitrage activities besides meeting specific customer needs.

They offer low-cost investment opportunities with combination of yield and liquidity.

In India, repo transactions are basically fund management/statutory liquidity reserve

(SLR) management devices used by banks.

Cash Management Tool: the repo arrangement essentially serves as a short-term cash

management tool as the bank receives cash from the buyer in return for the securities.

This helps the banks to meet temporary cash requirements. This also makes the repos a

pure money lending operation. On maturity of repos, the security is purchased back by

the seller of the securities.

Liquidity Control: The RBI uses repos as a tool of liquidity control for absorbing

surplus liquidity from the banking system in a flexible way and there preventing interest

rate arbitraging. All repo transactions are to be affected at Mumbai only and the deals

are to be necessarily put through the subsidiary general ledger (SGL) account with the

Reserve Bank of India.

Repo Rate:

Repo rate is nothing but the annualised interest rate for the funds transferred by the

lender to the borrower. Generally, the rate at which it is possible to borrow through a repo is

lower than the same offered on unsecured (or clean) inter-bank loan for the reason that it is a

collateralized transaction and the credit worthiness of the issuer of the security is often higher

than the seller. Other factors affecting the repo rate include the credit worthiness of the

borrower, liquidity of the collateral and comparable rates of other money market instruments.

In a repo transaction, there are two legs of transactions viz. selling of the security and

repurchasing of the same. In the first leg of the transaction which is for a nearer date, sale

price is usually based on the prevailing market price for outright deals. In the second leg,

which is for a future date, the price is structured based on the funds flow of interest and tax

elements of funds exchanged. This is on account of two factors. First, as the ownership of

securities passes on from seller to buyer for the repo period, legally the coupon interest

accrued for the period has to be passed on to the buyer. Thus, at the sale leg, while the buyer

of security is required to pay the accrued coupon interest for the broken period, at the


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repurchase leg, the initial seller is required to pay the accrued interest for the broken period to

the initial buyer.

Generally, norms are laid down for accounting of repos and valuation of collateral are

concerned. While there are standard accounting norms, generally the securities used as

collateral in repo transactions are valued at current market price plus accrued interest (on

coupon bearing securities) calculated to the maturity date of the agreement less "margin" or

"haircut". The haircut is to take care of market risk and it protects either the borrower or

lender depending upon how the transaction is priced. The size of the haircut will depend on

the repo period, risky ness of the securities involved and the coupon rate of the underlying

securities.

Since fluctuations in market prices of securities would be a concern for both the lender

as well as the borrower it is a common practice to reflect the changes in market price by

resorting to marking to market. Thus, if the market value of the repo securities decline beyond

a point the borrower may be asked to provide additional collateral to cover the loan. On the

other hand, if the market value of collateral rises substantially, the lender may be required to

return the excess collateral to the borrower.

CALCULATING SETTLEMENT AMOUNTS IN REPO TRANSACTIONS:

Repo transactions involve 2 legs: the first one when the repo amount is received by the

borrower, and the second, which involves repayment of the borrowing. The settlement

amount forthe first leg consists of:

a. Value of securities at the transaction price

b. Accrued interest from the previous coupon date to the date on which the first leg is settled.

The settlement amount forthe second leg consists of:

a. Repo interest at the agreed rate, for the period of the repo transaction

b. Return of principal amount borrowed.


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CALCULATING SETTLEMENT AMOUNTS IN REPO TRANSACTIONS:

Security offered under Repo 11.43% 2015

Coupon payment dates 7 August and 7 February

Market Price of the security offered

under Repo (i.e. price of the security

in the first leg)

Rs.113.00 (1)

Date of the Repo 19 January, 2003

Repo interest rate 7.75%

Tenor of the repo 3 days

Broken period interest for the first

leg*

11.43%x162/360x100=5.1435 (2)

Cash consideration for the first leg (1) + (2) = 118.1435 (3)

Repo interest** 118.1435x3/365x7.75%=0.0753 (4)

Broken period interest for the second

leg

11.43% x 165/360x100=5.2388 (5)

Price for the second leg (3) + (4)-(5) = 118.1435 + 0.0753 - 5.2388

= 112.98

(6)

Cash consideration for the second

leg

(5) + (6) = 112.98 + 5.2388 = 118.2188 (7)


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Repo Market in India: Some Recent Issues:

Repos being short term money market instruments are necessarily being used for

smoothening volatility in money market rates by central banks through injection of short

term liquidity into the market as well as absorbing excess liquidity fro m the system.

Regulation of the repo market thus becomes a direct responsibility of RBI. Accordingly, RBI

has been concerned with use of repo as an instrument by banks or non-bank entities and issues

relating to type of eligible instruments for undertaking repo, eligibility of participants to

undertake such transactions etc. and it has been issuing instructions in this regard in

consultation with the Central Government. After evidence of abuse in the repo market during

the period leading to the securities scam of 1992, RBI had banned repos from the markets. It

is only in the recent past that these restrictions have been removed, and after the acceptance of

the report of the technical sub-groups recommendations, RBI has initiated efforts for creating

an active market for repos. It was decided to adopt the international usage of the term Repo

and Reverse Repo under LAF operations. Thus, when RBI absorbs liquidity it is termed as

Reverse Repo and the RBI injecting liquidity is the repo operation. Since forward trading in

securities was generally prohibited in India, repos were permitted under regulated conditions

in terms of participants and instruments. Reforms in this market has encompassed both

institutions and instruments. Both banks and non-banks were allowed in the market. All

government securities and PSU bonds were eligible for repos till April 1988. Between April

1988 and mid June 1992, only inter- bank repos were allowed in all government securities.

Double ready forward transactions were part of the repos market throughout the period.

Subsequent to the irregularities in securities transactions that surfaced in April 1992, repos


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were banned in all securities, except Treasury Bills, while double ready forward transactions

were prohibited altogether.

Repos were permitted only among banks and PDs. In order to reactivate the repos

market, the Reserve Bank gradually extended repos facility to all Central Government dated

securities, Treasury Bills and State Government securities. It is mandatory to actually hold the

securities in the portfolio before undertaking repo operations. In order to activate the repo

market and promote transparency , the Reserve Bank introduced regulatory safeguards such as

delivery versus payment system during 1995-96. The Reserve Bank allowed all non-bank

entities maintaining subsidiary general ledger (SGL) account to participate in this money

market segment. Furthermore, NBFCs, mutual funds, housing finance companies and

insurance companies not holding SGL accounts were allowed by the Reserve Bank to

undertake repo transactions from March 2003 through their gilt accounts maintained with

custodians. With the increasing use of repos in the wake of phased exit of non-banks from the

call money market, the Reserve Bank issued comprehensive uniform accounting guidelines as

well as documentation policy in March 2003. Moreover, the DVP III mode of settlement in

government securities (which involves settlement of securities and funds on a net basis) in

April 2004 facilitated the introduction of rollover of repo transactions in government securities

and provided flexibility to market participants in managing their collaterals.

Secondary Market Transaction in Repos:

Secondary market repo transactions are settled through the RBI SGL accounts, and

weekly data is available from the RBI on volumes, rates and number of days. Though the

NSE WDM also has the facility for reporting repo trades, there were no repo transactions

recorded during 2005- 06, 2006-07 and 2007-08.


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Commercial bill market:

Commercial bill is a short term, negotiable, and self-liquidating instrument with low

risk. It enhances he liability to make payment in a fixed date when goods are bought on credit.

According to the Indian Negotiable Instruments Act, 1881, bill or exchange is a written

instrument containing an unconditional order, signed by the maker, directing to pay a certain

amount of money only to a particular person, or to the bearer of the instrument. Bills of

exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or 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. The bank discount this bill by

keeping a certain margin and credits the proceeds. Banks, when in need of money, can also get

such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI and IRBI. The

maturity period of the bills varies from 30 days, 60 days or 90 days, depending on the credit

extended in the industry.

Types of Commercial Bills:

Commercial bill is an important tool finance credit sales. It may be a demand bill or a

usance bill. A demand bill is payable on demand, that is immediately at sight or on

presentation by the drawee. A usance bill is payable after a specified time. If the seller wishes

to give sometime for payment, the bill would be payable at a future date. These bills can either

be clean bills or documentary bills. In a clean bill, documents are enclosed and delivered

against acceptance by drawee, after which it becomes clear. In the case of a documentary bill,

documents are delivered against payment accepted by the drawee and documents of bill are

filed by bankers till the bill is paid.


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Commercial bills can be inland bills or foreign bills. Inland bills must (1) be drawn or

made in India and must be payable in India: or (2) drawn upon any person resident in India.

Foreign bills, on the other hand, are (1) drawn outside India and may be payable and by a party

outside India, or may be payable in India or drawn on a party in India or (2) it may be drawn in

India and made payable outside India. A related classification of bills is export bills and import

bills. While export bills are drawn by exporters in any country outside India, import bills are

drawn on importers in India by exporters abroad.

The indigenous variety of bill of exchange for financing the movement of agricultural produce,

called a hundi has a long tradition of use in India. It is vogue among indigenous bankers for

raising money or remitting funds or to finance inland trade. A hundi is an important instrument

in India; so indigenous bankers dominate the bill market. However, with reforms in the

financial system and lack of availability of funds from private sources, the role of indigenous

bankers is declining.

With a view to eliminating movement of papers and facilitating multiple rediscounting,

RBI introduced an innovation instruments 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

simplified and streamlined bill rediscounting by institutions and made the commercial bill an

active instrument in the secondary money market. This instrument, being a negotiable

instrument issued by banks, is a sound investment for rediscounting institutions. Moreover

rediscounting institutions can further discount the bills anytime prior to the date of maturity.

Since some banks were using the facility of rediscounting commercial bills and derivative

usance promissory notes of as short a period as one day, the Reserve Bank restricted such

rediscounting to a minimum period of 15 days. The eligibility criteria prescribed by the

Reserve Bank for rediscounting commercial bills are that the bill should arise out of a genuine

commercial transaction showing evidence of sale of goods and the maturity date of the bill

should to exceed 90 days from the date of rediscounting.

Commercial bills can be traded by offering the bills for rediscounting. Banks provide

credit to their customers by discounting commercial bills. This credit is repayable on maturity

of the bill. In case of need for funds, and can rediscount the bills in the money market and get

ready money. Commercial bills ensure improved quality of lending, liquidity and efficiency in


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money management. It is fully secured for investment since it is transferable by endorsement

and delivery and it has high degree of liquidity.

The bills market is highly developed in industrial countries but it is very limited in

India. Commercial bills rediscounted by commercial banks with financial institutions amount

to less than Rs 1,000 crore. In India, the bill market did not develop due to (1) the cash credit

system of credit delivery where the onus of cash management rest with banks and (2) an

absence of an active secondary market.

Measures to Develop the Bills Market:

One of the objectives of the Reserve Bank in setting up the Discount and finance House

of India was to develop commercial bills market. The bank sanctioned a refinance limit for the

DFHI against collateral of treasury bills and against the holdings of eligible commercial bills.

With a view to developing the bills market, the interest rate ceiling of 12.5 per cent on

rediscounting of commercial bills was withdrawn from May 1, 1989.

To develop the bills market, the Securities and Exchange Board of India (SEBI) allowed, in

1995-96, 14 mutual funds to participate as lenders in the bills rediscounting market. During1996-97, seven more mutual funds were permitted to participate in this market as lenders while

another four primary dealers were allowed to participate as both lenders and borrowers.

In order to encourage the bills culture, the Reserve Bank advised banks in October 1997 to

ensure that at least 25 percent of inland credit purchases of borrowers be through bills.

Size of the Commercial Bills Market:

The size of the commercial market is reflected in the outstanding amount of commercial

bills discounted by banks with various financial institutions.

The share of bill finance in the total bank credit increased from 1993-94 to 1995-96 but

declined subsequently. This reflects the underdevelopment state of the bills market. The

reasons for the underdevelopment are as follows:


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The Reserve Bank made an attempt to promote the development of the bill market by

rediscounting facilities with it self till 1974. Then, in the beginning of the 1980s, the

availability of funds from the Reserve Bank under the bill rediscounting scheme was put on a

discretionary basis. It was altogether stopped in 1981. The popularity of the bill of exchange as

a credit instrument depends upon the availability of acceptance sources of the central bank as it

is the ultimate source of cash in times of a shortage of funds. However, it is not so in India. The

Reserve Bank set up the DFHI to deal in this instrument and extends refinance facility to it.

Even then, the business in commercial bills has declined drastically as DFHI concentrates more

on other money market instruments such as call money and treasury bills.

It is mostly foreign trade that is financed through the bills market. The size of this market is

small because the share of foreign trade in national income is small. Moreover, export and

import bills are still drawn in foreign currency which has restricted their scope of negotiation.

A large part of the bills discounted by banks are not genuine. They are bills created by

converting the cash-credit/overdraft accounts of their customers.

The system of cash-credit and overdraft from banks is cheaper and more convenient than bill

financing as the procedures for discounting and rediscounting are complex and time

consuming.

This market was highly misused in the early 1990s by banks and finance companies which

refinanced it at times when it could to be refinanced. This led to channeling of money into

undesirable uses.

The development of bills discounting as a financial service depends upon the existence

of a full fledged bill market. The Reserve Bank of India (RBI) has constantly endeavored to

develop the commercial bills market. Several committees set up to examine the system of bank

financing, and the money market had strongly recommended a gradual shift to bills finance and

phase out of the cash credit system. The most notable of these were: (1) Dehejia Committee,

1969, (2) Tandon Committee, 1974, (3) Chore Committee, 1980 and (4) Vaghul Committee,

1985.This section briefly outlines the efforts made by the RBI in the direction of the

development of a full fledged bill market.


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Bill Market Scheme, 1952 :

The salient features of the scheme were as follows:

(1) The schemes was announced under section 17(4)(c) of RBI Act enables it to make advances

to scheduled banks against the security of issuance of promissory notes or bills drawn on and

payable in India and arising out of bonafide commercial or trade transaction bearing two or

more good signatures one of which should be that of scheduled bank and maturing within 90

days from the date of advances.

(2) The scheduled banks were required to convert a portion of the demand promissory notes

obtained by them, from their constituents in respect of loans/overdrafts and cash credits granted

to them into usance promissory notes maturing within 90 days, to be able to avail of refinance

under the scheme;

(3) The existing loan, cash credit or overdraft accounts were, therefore, required to be split up

into two parts viz.,

(A) one part was to remain covered by the demand promissory notes, in this account further

withdrawals or repayments were as usual being permitted.

(B) the other part, which would represent the minimum requirement of the borrower during the

next three months would be converted into usance promissory notes maturing within ninety

days.

(4) This procedure did not bring any change in offering the same facilities as offered before by

the banks to their constituents. Banks could lodge the usance promissory notes with the RBI for

advances as eligible security for borrowing so as to replenish their loanable funds.

(5) The amount advanced by the RBI was not to exceed the amount lent by the scheduled banks

to the respective borrowers.

(6) The scheduled bank applying for accommodation had to certify that the paper presented by


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it as collateral arose out of bona fide commercial transactions and that the party was

creditworthy.

Bill Market Scheme, 1970:

In pursuance of the recommendations of the Dehejia Committee, the RBI constituted a

working group to evolve a scheme to enlarge the use of bills. Based on the scheme suggested

by the study group, the RBI introduced, with effect from November 1, 1970 the new bill market

scheme in order to facilitate the re-discounting of eligible bills of exchange by banks with it. To

popularize the use of bills, the scope of the scheme was enlarged, the number of participantswas increased, and the procedure was simplified over the years.

The salient features of the scheme:

Eligible Institutions: All licensed scheduled banks and those which do not require a license

(i.e. the State Bank of India, its associate banks and nationalized banks) are eligible to offer

bills of exchange to the RBI for rediscount. There is no objection to a bill, accepted by such

banks, being purchased by others banks and financial institutions but the RBI rediscounts only

those bills as are offered to it by an eligible bank.

Eligibility of Bills: The eligibility of bills offered under the scheme to the RBI is determined

Documents

52312818 Indian Money Market