129589236 money market instruments project report

7/25/2019 129589236 Money Market Instruments Project Report

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Money market instruments

The term "Money Market" refers to the market for short-term requirement and

deployment of funds. Money market instruments are those instruments, which have a

maturity period of less than one year. The most active part of the money market is the

market for overnight and term money between banks and institutions (called call money

and the market for repo transactions. The former is in the form of loans and the latter are

sale and buy back agreements ! both are obviously not traded. The main traded

instruments are commercial papers (#s, certificates of deposit ($s and treasury bills

(T-%ills. &ll of these are discounted instruments i.e. they are issued at a discount to their

maturity value and the difference between the issuing price and the maturity'face value is

the implicit interest. ne of the important features of money market instruments is their

high liquidity and tradability. & key reason for this is that these instruments are

transferred by endorsement and delivery. &nother important feature is that there is no ta)

deducted at source from the interest component.

Money Market *nstruments +

ommercial #apers

ommercial %ills

ertificates of $eposit

Treasury %ills


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Commercial Paper (CP)

The concept of #s was originated in /& in early 0th century when

commercial banks monopoli1ed and charged high rate of interest on loans and advances.

*n *ndia, the # was launched in 2anuary 003.

*t is an unsecured money market instrument issued in the form of a promissory

note. # was introduced in *ndia in 003 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.

These are issued by corporate entities in denominations of 4s5.6mn and usually

have a maturity of 03 days. #s can also be issued for maturity periods of 73 and one

year but the most active market is for 03 day #s.

Two key regulations govern the issuance of #s-firstly, #s have to be

compulsorily rated by a recogni1ed credit rating agency and only those companies can

issue #s which have a short term rating of at least #. /econdly, funds raised through

#s do not represent fresh borrowings for the corporate issuer but merely substitute a part

of the banking limits available to it. 8ence, a company issues #s almost always to save

on interest costs i.e. it will issue #s only when the environment is such that # issuance

will be at rates lower than the rate at which it borrows money from its banking

consortium.

Who can issue Commercial Paper (CP)

8ighly rated corporate borrowers, primary dealers (#$s and satellite dealers

(/$s and all-*ndia financial institutions (9*s which have been permitted to raise

resources through money market instruments under the umbrella limit fi)ed by 4eserve

%ank of *ndia are eligible to issue #.

& company shall be eligible to issue # provided - (a the tangible net worth of

the company, as per the latest audited balance sheet, is not less than 4s. : crore; (b the

working capital (fund-based limit of the company from the banking system is not less

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than 4s.: crore and (c the borrowal account of the company is classified as a /tandard

&sset by the financing bank's.

ommercial #apers when issued in #hysical 9orm are negotiable by endorsement and

delivery and hence highly fle)ible instruments

Rating Requirement

&ll eligible participants should obtain the credit rating for issuance of

ommercial #aper, from either the redit 4ating *nformation /ervices of *ndia


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instruments. ?on resident *ndians can invest in #s on a non repatriable,

non transferable basis.

Trading

Trading is ver-the-counter or on the ?/=. Market participants quote dealing

levels on yield basis specified up to two decimal places. 9or quotes on the ?/=

equivalent prices up to : decimal prices need to be specified. Two way quotes are rarely

offered for ommercial #aper. /econdary market transactions do not attract any stamp

duty. There are no brokers in the ommercial #aper market. Trading is

done over the counter with the counterparties involved.

Mode of Issuance

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

form through any of the depositories approved by and registered with /=%*. &s regards

the e)isting stock of #, the same can continue to be held either in physical form or can

be demateralised, if both the issuer, and the investor agree for the same.

o! payment is received and made for CP

The initial investor in # shall pay the discounted value of the # by means of a

crossed account payee cheque to the account of the issuer through *#&(*ssuing and

#aying &gent. n maturity of #, when the # is held in physical form, the holder of the

# shall present the instrument for payment to the issuer through the *#&. 8owever;

when the # is held in demat form, the holder of the # will have to get it redeemed

through depository and receive payment from the *#&.

What is the procedure of issuing CP

=very issuer must appoint an *#& for issuance of #. The issuer should disclose to

the potential investors its financial position as per the standard market practice. &fter the

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e)change of deal confirmation between the investor and theissuer, issuing company shall

issue physical certificates to the investor or arrange for crediting the # to the investors

account with a depository. *nvestors shall be given a copy of *#& certificate to the effect

that the issuer has a valid agreement with the *#& and documents are in order

Coupon Terms

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

and redeemable at par on maturity.

Ris"s Involved


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Credit-enhanced commercial paper

/ince its introduction in the *ndian market in 003, commercial paper (# has

gained popularity as a convenient short-term debt instrument. ompanies use it today to

reduce their borrowing costs while investors use the tradable instrument to park their

short-term funds. Det, since commercial paper is a confidence-sensitive instrument, its

benefits have been limited to highly rated companies so far. This is evident from the fact

that C#EC paper accounted for 0: per cent of the *ndian # market. =ven globally,

instruments rated C#C and C#EC account for 70 per cent of the total # market.

4*/*


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enefits to Issuers

The instrument enables lower-rated entities to access cheap funds, even net of

e)penses such as the guarantee charges levied by a bank for issuing such a guarantee. The

effective cost of funds is cheaper than working capital borrowings. urrently most of the*ndian %anks charge a #


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*' +sset$ac"ed Commercial Paper

Concept

&sset-backed #s entail the creation of a pool of assets that are assigned to a

bankruptcy-remote entity (a special purpose vehicle called conduit to back up the

repayment on the #. This special purpose vehicle (/#J buys assets from the issuer and

funds them by issuing a #. The instrument is typically used to fund trade receivables.

The issuer collects the receivables and redeems the instrument by passing funds to the

investors through the conduit. The conduit is a nominally capitalised /#J and is

structured to be bankruptcy-remote. This is accomplished by limiting the scope of the

conduitCs business activities and liabilities. /uch /#Js are generally sponsored by banks,

which also provide liquidity support to ensure timely repayments.

The underlying pool of assets can also be revolving wherein the pool is regularly

replenished with similar assets as and when an asset matures.

International scenario

/ince their introduction in the early 073s, asset-backed #s have become

immensely popular in the /. These issuances have registered a compounded annual

growth rate (&H4 of @3 per cent in the last decade. urrently, they represent 63 per

cent of the total # market in /&. The credit enhancement used includes a wide variety

of assets like credit cards, trade receivables and securities. Multi-seller programmes are

also popular.

enefit to Issuers

/ince an asset-backed # is issued by an /#J, its credit quality is independent of

the issuerCs credit profile. This enables weak entities with a good pool of assets to

tap the market with a higher rating (and hence, lower interest rates.

=ven if a companyCs credit quality deteriorates, unlike in the case of regular #s,

the /#J need not e)it the market. The rating remains unaffected as long as the

credit quality of the underlying assets remain strong.

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This instrumentCs benefits can also be e)tended to smaller issuers if a number of

them come together and pool their assets in the same /#J.

enefit to Investors

& plain vanilla # is an unsecured promissory note without any underlying assets

supporting its repayments. *n the event of a default, these unsecured papers are

last on the priority list of repayments. *nvestors in asset-backed #s, however,

have better protection since the credit is backed by specific assets that offer higher

levels of safety.

*t is also easier to monitor these instruments as the assets in the pool are tracked

closely and a monthly performance report is generated on them.

%esides, credit enhancement is available through pool-specific and programme

support mechanisms, which facilitates timely repayments. ver-collateralisation

and liquidity support from banks are e)amples of such credit enhancement.

Constraints in the Indian mar"et

/o far, only guarantees have found acceptance as a credit enhancement tool in the

*ndian # market. This is because /#Js cannot issue #s under the current regulations

though they can float asset-backed short-term debt programmes.

Conclusion

*t is thus clear that credit-enhanced #s, especially guaranteed and asset-backed

#s, offer several benefits to investors and issuers. These instruments can also help to

deepen the *ndian # market. 4*/*< believes that although the *ndian credit-enhanced

# market is at a nascent stage today, as in the west, these instruments will gain immense

popularity once the securiti1ation market reaches critical mass

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Commercial bills

%ills of e)change are negotiable instruments drawn by the seller (drawer of the

goods on the buyer (drawee of the goods for the value of the goods delivered. These bills

are called trade bills. These trade bills are called commercial bills when they are accepted

by commercial banks. *f the bill is payable at a future date and the seller needs money

during the currency of the bill then he may approach his bank for discounting the bill.

The maturity proceeds or face value of discounted bill, from the drawee, will be received

by the bank. *f the bank needs fund during the currency of the bill then it can rediscount

the bill already discounted by it in the commercial bill rediscount market at the market

related discount rate.

The 4%* introduced the %ills Market scheme (%M/ in 065 and the scheme was

later modified into ?ew %ills Market scheme (?%M/ in 0B3. nder the scheme,

commercial banks can rediscount the bills, which were originally discounted by them,

with approved institutions (vi1., ommercial %anks, $evelopment 9inancial *nstitutions,

Mutual 9unds, #rimary $ealer, etc..

Kith the intention of reducing paper movements and facilitate multiple

rediscounting, the 4%* introduced an instrument called $erivative sance #romissory

?otes ($#?. /o the need for physical transfer of bills has been waived and the bank

that originally discounts the bills only draws $#?. These $#?s are sold to investors

in convenient lots of maturities (from 6 days upto 03 days on the basis of genuine trade

bills, discounted by the discounting bank.

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Certifcates o Deposit (CD)

These are issued by banks in denominations of 4s3.6mn. %anks are allowed to

issue $s with a maturity of less than one year while financial institutions are allowed to

issue $s with a maturity of at least one year. These are issued in denominations of 4s.6


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Ris"s Involved

#rice risk'*nterest rate risk


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Treasury Bills (T-Bills)

These are issued by the 4eserve %ank of *ndia on behalf of the Hovernment of

*ndia and are thus actually a class of Hovernment /ecurities. &t present, T-%ills are issued

in maturity of : days, 0 days and @A: days. The 4%* has announced its intention to

start issuing 75 day T-%ills shortly. The minimum denomination can be as low as 4s33,

but in practice most of the bids are large bids from institutional investors who are allotted

T-%ills in demateriali1ed form. 4%* holds auctions for : and @A: day T-%ills on a

fortnightly basis and for 0 day T-%ills on a weekly basis. 9or e)ample a Treasury bill of

4s. 33.33 face value issued for 4s. 0.63 gets redeemed at the end of itCs tenure at 4s.

33.33. 0 days T-%ills are auctioned under uniform price auction method where as @A:

days T-%ills are auctioned on the basis of multiple price auction method. There is a

notified value of bills available for the auction of 0 day T-%ills which is announced 5

days prior to the auction. There is no specified amount for the auction of : and @A: day

T-%ills. The result is that at any given point of time, it is possible to buy T-%ills to tailor

ones investment requirements.

%anks, #rimary $ealers, /tate Hovernments, #rovident 9unds, 9inancial

*nstitutions, *nsurance ompanies, ?%9s, 9**s (as per prescribed norms, ?4*s >

%s can invest in T-%ills.

Coupon terms

T-%ill is a discounted instrument and is issued in the form of a

1ero coupon instrument at discount to face value redeemable at par on

maturity.

Repayment

The amount on repayment is directly credited to the current

account of the investor held with 4%*.

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Ris"s on investment in T$ills

#rice risk. There is price risk due to interest rate sensitivity


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with the balance amount devolving on it. This is done by the 4%* to check undue

volatility in the interest rates.

?on-competitive bids are also allowed in auctions (only from specified entities

like /tate Hovernments and their undertakings and statutory bodies wherein the bidder isallotted T-%ills at the cut off price.

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/T+T% 0.%R,M%,T 0,D/ 0R TR%+/1R2 I--/5

Theoretically, a retail investor can buy Hovernment of *ndia /ecurities, /tate

Hovernment securities and Treasury %ills. The minimum amount for participation in

securities auctions is 4s3333 but these securities can be made available in

denominations of 4s33. 8owever, there are enormous practical difficulties in buying

these. The main problems are as follows+

These securities are usually traded in large lots ! at least 4s6mn with the average

transaction si1e being at least 3 times higher.

These securities are usually traded in the demateriali1ed form through the /H

129589236 money market instruments project report

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