UNIT 3 MONEY MARKET AND CAPITAL MARKET
INTODUCTIONThere 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.
DEFINITIONAccording toCrowther, "The money market is a name given to the various firms and institutions that deal in the various grades of near money."According to theRBI, "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."
FUNCTIONS OF MM
The major functions of money market are given below:-
To maintain monetary equilibrium. It means to keep a balance between the demand for and supply of money for short term monetary transactions.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.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.To help in implementing Monetary Policy. It provides a mechanism for an effective implementation of the monetary policy.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.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.
CHARACTERISTICS OF MMIn this market the short terms funds are borrowed and lent.In this market the parties mutually agree on the terms & conditions of the exchange of funds.The interest rate is determined on the basis of demand and supply of money.The fund suppliers in the market are commercial banks and financial institutions.The borrowers in this markets are government, commercial banks, manufacturing concerns and firms.
MONEY MARKET INSTRUMENTS
CALL MONEY OR CALL LOANCall moneyis short-termfinancerepayable on demand, with amaturity period of one to fifteen days, used for inter-bank transactions.The money that is lent for one day in this market is known as "call money" and, if it exceeds one day, is referred to as "notice money."Commercial banks have to maintain a minimum cash balance known as the cash reserve ratio. TheReserve Bank of Indiachanges the cash ratio from time to time.
CONTDBanks also work with call loans, issuing call loans to other banks as needed to increase liquidity.Bank A might, for example, take out a call loan from Bank B to ensure that it can cover the payroll checks which it knows will be coming in. Many banks issue call loans for 24 hours and sometimes even less, moving huge sums of money around in the process.
CONTDUsually, when a lender decides to call a loan, it gives the borrower some warning. Brokerage houses, for example, will call clients in the morning to inform them that their loans will be called, so that they have a chance to organize funds to cover the loan. A call loan may go for days, weeks, or even months without being called if the lender feels comfortable, since interest will be racking up all the while, but borrowers should not depend on prolonged inaction when it comes to a call loan.
DEFINITIONAcall loanis aloanthat thelendermay force the borrower to repay at any time.
T-BILLSATreasury Bill, orT-Bill, is short-termdebtissued and backed by the full faith andcreditof the United States government.These debt obligations are issued inmaturitiesof 4, 13 and 26 weeksThe T-bills are issued by the RBI on behalf of the central govt. at a discount.T-Bills are issued at a discount to thematurityvalue.For example, a 26-week T-bill is priced at $9,800 on issuance to pay $10,000 in six months. No interest payments are made
ContdT-billsare considered the safest possibleinvestmentand provide what is referred to as a "risk-free rate of return,"T-bills are very short-terminvestments, there is very little interest rate risk.
CERTIFICATE OF DEPOSITSCertificates of Deposit (CDs) were introduced in India in 1989.Certificate of Deposit is like a promissory note issued by a bank in form of a certificate entitling the bearer to receive interest.It is similar to bank term deposit account.The certificate bears the maturity date, fixed rate of interest and the value.The returns on certificate of deposits are higher than T-Bills because they carry higher level of risk.
CONTDScheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs) Select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI.Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum deposit that could be accepted from a single subscriber should not be less than Rs.1 lakh and in the multiples of Rs. 1 lakh there after. INVESTORS CDs can be issued to individuals, corporations, companies, trusts, funds, associations, etc.The maturity period of CDs issued by banks should be not less than 7 days and not more than one year. The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue.
COMMERCIAL PAPERCommercial Paper is the short term unsecured promissory note issued by corporate and financial institutions at a discounted value on face value.It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers/ to diversify their sources of short-term borrowings and to provide an additional instrument to investors.They come with fixed maturity period ranging from 1 day to 270 days.These are issued for the purpose of financing of accounts receivables, inventories and meeting short term liabilities.The return on commercial papers is higher as compared to T-Bills so as the risk as they are less secure in comparison to these bills.It is easy to find buyers for the firms with high credit ratings. These securities are actively traded in secondary market.
REPURCHASE AGREEMENTS (REPO)Repurchase Agreements which are also called as Repo or Reverse Repo are short term loans that buyers and sellers agree upon for selling and repurchasing.Repo or Reverse Repo transactions can be done only between the parties approved by RBIRBI allowed only between RBI-approved securities such as state and central government securities, T-Bills, PSU bonds and corporate bonds.They are usually used for overnight borrowing.Repurchase agreements are sold by sellers with a promise of purchasing them back at a given price and on a given date in future.
BANKERS ACCEPTANCEBanker's Acceptance is like a short term investment plan created by non-financial firm, backed by a guarantee from the bank.It's like a bill of exchange stating a buyer's promise to pay to the seller a certain specified amount at a certain date.And, the bank guarantees that the buyer will pay the seller at a future date.Firm with strong credit rating can draw such bill.These securities come with the maturities between 30 and 180 days and the most common term for these instruments is 90 days.Companies use these negotiable time drafts to finance imports, exports and other trade.
PROGRESS OF MONEY MARKETRef IFS book, pg- 326, author Aditi Abhyankar, pub-Himalya.Monetary policy decision are transmitted to the whole economy through changes in financial prices and financial quantities.All over the world, the interest rate channel is the key channel of monetary policy transmission.The management of liquidity was essentially done by RBI through direct instruments.After 1991, LPG regime, the interest rates are largely market determined.
ContdThe RBI influences the monetary conditions through market based indirect instruments.(Repo and reverse repo).The other instruments such as standing facilities provide limited liquidity to eligible market participants.All well developed money market are also integrated with other segments of financial markets such as govt. securities , forex etc.
ROLE OF RBI Ref FM vipuls, P.K Bandgar (4th sem BI)ISSUE OF CURRENCY NOTESBANKER TO THE GOVT.BANKERS BANKEXCHANGE CONTROL AUTHORITYCREDIT CONTROLSUPERVISING AUTHORITY.AGRICULTURAL FINANCE
IMPORTANCE OF MONEY MARKET IN INDIAN ECONOMYFinancing trade and industryProfitable ventureHelp to central bankHelp to govt.Capital formation.ref IFS book Dr. G. Ramesh Babu, pub-himalaya, pg-139
CALL MONEY MARKET
INTRODUCTIONref vipuls FM book pg-87-88The call money market exists in almost all developed money markets.The nature of this market is different in different countries apart from one feature i.e dealing in short term securities.Indian economy has well developed money market, it comprises of RBI, commercial banks, foreign banks, cooperative banks, finance corporations and DHFL.
MEANING AND FUNCTIONSIts a part of money market.Day to day surplus funds are traded by the banks.Trading done in short term funds.Maturity period is between 1 15 days.Loans are repayable on demands.It was operationalized in india with the inauguration of the RBI in 1935
CALL RATE Theinterest rate applied to interbank loans, or loans between financial institutions, onmoney not deposited for a fixed period of time. Changes to thisrate have a largeimpact on interest rates forcorporate andconsumer loans, and also affect the amount ofliquidity available to themarket.
IMPORTANCE (vipuls FM pg-90)Fulfills sudden demand for fundsImproves the liquidity position of a firmIt deals in short term assetsIn India it doesnt satisfy the criteria of developed money market. RBI more focus on commercial banks.
COMMERCIAL BILL MARKET
INTRODUCTIONPurchase and discounting of bills of exchange is another way of employing bank funds.Bank provides WC to companies through cash credits, over drafts, and purchase or discounting of commercial bills.Bills of Exchange & Promissory notes are negotiable instruments which enable the debtors to discharge their obligations towards their creditors.Its a money market short term instrument.
BILL OF EXCHANGEIt widely used in the discharge of business obligations.It is generally drawn by a creditor on his debtor and it is presented to the debtor for his acceptance.The debtor is known as Acceptor or Drawee, who commits himself to make payment on the due date.
DefinitionThe Negotiable Instruments Act, 1881 defines a bill of exchange as a written Instrument, containing an unconditional order, signed by the maker, directing a certain person, to pay a certain sum of money only, to or to the order of a certain person or to the bearer of the instrument.
KINDS OF BILLS OF EXCHANGE (vipul fm pg 105)Time & Demand Bills.Trade Bill & Accommodation BillClean & Documentary BillInland & Foreign Bills