Money Market Instruments Explained

January 19, 2021
Money Market Instruments

The money market is a market for short-term financial assets that are close substitutes of money. The most important feature of money market instruments is that they are liquid and can be turned into money quickly at low cost and provides an avenue for equilibrating the short-term surplus funds of lenders and the requirements of borrowers.

Money Market Instruments

We shall discuss following money market instruments:

  • T-Bill
  • Commercial Papers
  • Certificate of Deposits
  • Repo Agreements
  • Call/Notice Money Market
  • Non-Convertible Debentures

Money Market Instruments: Treasury Bills (T-Bills)

  • Treasury bills or T-bills, which are money market instruments, are short term debt instruments issued by the Government of India.
  • They are presently issued in three tenors, namely, 91 day, 182 day and 364 day. T
  • reasury bills are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at the face value at maturity.
  • For example, a 91 day Treasury bill of ₹100/- (face value) may be issued at say ₹20, that is, at a discount of say, ₹1.80 and would be redeemed at the face value of ₹100/-.
  • The return to the investors is the difference between the maturity value or the face value (that is ₹100) and the issue price (for calculation of yield on Treasury Bills

Commercial Papers

  • Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.
  • Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP.
  • A corporate would be eligible to issue CP provided –
    • the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore
    • company has been sanctioned working capital limit by bank/s or all-India financial institution/s; and
    • the borrowal account of the company is classified as a Standard Asset by the financing bank/s/ institution/s.
  • The minimum credit rating shall be A-2 [As per rating symbol and definition prescribed by Securities and Exchange Board of India (SEBI)].
  • CP can be issued in denominations of Rs.5 lakh or multiples thereof.
  • Individuals, banking companies, other corporate bodies (registered or incorporated in India) and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. However, investment by FIIs would be within the limits set for them by Securities and Exchange Board of India (SEBI) from time-to-time.

Certificates of Deposits (CD)

  • Certificate of Deposit (CD) is a negotiable money market instrument and issued in dematerialised form or as a Usance Promissory Note against funds deposited at a bank or other eligible financial institution for a specified time period
  • CDs can be issued by (i) scheduled commercial banks {excluding Regional Rural Banks and Local Area Banks}; and (ii) select All-India Financial Institutions (FIs) 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 multiples of Rs. 1 lakh thereafter.
  • CDs can be issued to individuals, corporations, companies (including banks and PDs), trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also subscribe to CDs, but only on non-repatriable basis, which should be clearly stated on the Certificate. Such CDs cannot be endorsed to another NRI in the secondary market.
  • The maturity period of CDs issued by banks should not be less than 7 days and not more than one year, from the date of issue.
  • The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue.

Repurchase Agreements

Repo is a money market instrument, which enables collateralised 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

  • Repo rate is annualised interest rate for the funds transferred by the lender to the borrower.
  • A reverse repo is the mirror image of a repo. For, in a reverse repo, securities are acquired with a simultaneous commitment to resell

Call/Notice Money Market

  • Under call money market, funds are transacted on an overnight basis
  • Under notice money market, funds are transacted for a period between 2 days and 14 days.
  • Scheduled commercial banks (excluding RRBs), co-operative banks (other than Land Development Banks) and Primary Dealers (PDs), are permitted to participate in call/notice money market both as borrowers and lenders.

Non-Convertible Debentures

Non-convertible debentures(NCDs) are a financial instrument that is used by companies to raise long-term capital. These are a debt instrument with a fixed tenure and people who invest in these receive regular interest at a certain rate.

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