MONEY MARKETS
Q1
Write a short note on Commercial paper.
Ans: A commercial paper is an unsecured money market instrument issued in the form of a
promissory note.
The regulation of CP comes under the purview of the Reserve Bank of India which issued
guidelines in 1990 on the basis of the recommendations of the Vaghul Working Group.
These were aimed at:
(i)
Enabling the highly rated corporate borrowers to diversify their sources of short term
borrowings, Subsequently, primary dealers and all-India financial institutions were also
permitted to issue CP to enable them to meet their short-term funding requirements for
their operations.and
(ii)
To provide an additional instrument to the short term investors.
It can be issued for maturities between 7 days and a maximum upto one year from the date of
issue. These can be issued in denominations of Rs. 5 lakh or multiples therefore. All eligible
issuers are required to get the credit rating from credit rating agencies.
CP will be issued at a discount to face value as may be determined by the issuer. The discount
will reflect the general prevailing interest rates.
Eligibility criteria for issuer of commercial paper
The companies satisfying the following conditions are eligible to issue commercial paper.
The tangible net worth of the company is Rs. 5 crores or more as per audited balance
sheet of the company.
The fund base working capital limit is not less than Rs. 5 crores.
The company is required to obtain the necessary credit rating from the rating agencies
such as CRISIL, ICRA etc.
The issuers should ensure that the credit rating at the time of applying to RBI should not
be more than two months old.
The minimum current ratio should be 1.33:1 based on classification of current assets and
liabilities.
For public sector companies there are no listing requirement but for companies other than
public sector, the same should be listed on one or more stock exchanges.
All issue expenses shall be borne by the company issuing commercial paper.
Every issuer must appoint an IPA (only scheduled banks) for issuance of CP.
On maturity of CP,
(a)
when the CP is held in physical form, the holder of the CP shall present the instrument
for payment to the issuer through the IPA.
(b)
when the CP is held in demat form, the holder of the CP will have to get it redeemed
through the depository and receive payment from the IPA.
Q2
Write a short note on Certificate of Deposit.
Ans: A 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. It was introduced in India in 1989.
Guidelines for issue of CDs are presently governed by various directives issued by the
Reserve Bank of India (RBI)
CDs can be issued by:
1.
Scheduled commercial banks {excluding Regional Rural Banks and Local Area Banks}
2.
Selected All-India Financial Institutions (FIs) that have been permitted by RBI
The CDs are issued at discount price on face value. So return is the difference between issue
price and face value.
Issue size
Minimum amount = 1 lakh and in multiple of Rs 1 lakh thereafter
Maximum amount =
1.
Banks can issue CDs depending on their funding requirements
2.
An FI can issue CD within the overall umbrella limit prescribed in the Master Circular on
Resource Raising Norms for FIs, issued by DBOD and updated from time-to-time.
Who can invest in CD?
CDs can be issued to:
Individuals
Corporations
Companies (including banks and PDs)
Trusts
Funds
Associations
Non-Resident Indians (NRIs), but only on non-repatriable basis. Such CDs cannot be
endorsed to another NRI in the secondary market.
Foreign portfolio investors (FPIs) are not permitted to invest in CDs
Maturity of CD
The maturity period of CDs is different for banks and FIs.
For Banks
Minimum Period is 7 days
Maximum period is 1 year
For financial institutions
Minimum Period is 1 year
Maximum period is 3 years
Loan against CD
Banks / FIs cannot grant loans against CDs. Furthermore, they cannot buy-back their own
CDs before maturity.
Q3
Write a short note on Bond Equivalent Yield.
Ans: The bond equivalent yield (BEY) will help you decide, as it is used to determine the annual
yield on a discount bond.
It’s a comparable 'equivalent' yield between two or more investments.
A discount bond is a bond that is issued for less than it's par (face) value in the secondary
market. This also means it has a lower interest rate than the current market rate, which is how
it is sold at a lower price. These are usually paid semiannually.
If you have a long-term bond and want to compare it to a short-term investment, you are going
to need to calculate the bond equivalent yield first. The BEY calculation serves as a useful tool
for determining the annual yield of an investment that does not make annual payments. This
analysis allows investors to compare fixed-income securities whose payments are not annual
or are selling at a discount to be compared with securities with annual yields.
Bond Equivalent Yield is calculated as under:
BEY =
FV − NP
365
×
× 100
NP
Days to maturity
Q4
Write a short note on Equivalent Annual Yield
Ans: The equivalent annual yield (EAY) is the interest rate for an investment product that has more
than one compounding period.
EAY is calculated as under:
n
r⎞
⎛
EAY = ⎜ 1+ ⎟ − 1
⎝ n⎠
Q5
Write a short note on Treasury bills
Ans: When the government is going to the financial market to raise money, it can do it by issuing
two types of debt instruments – treasury bills and government bonds.
Treasury bills are issued when the government need money for a shorter period while bonds
are issued when it need debt for more than say five years.
Treasury bills; generally shortened as T-bills, have a maximum maturity of a 364 days. Hence,
they are categorized as money market instruments (money market deals with funds with a
maturity of less than one year).
Treasury bills are presently issued in three maturities, namely, 91 day, 182 day and 364 day.
Treasury bills are zero coupon securities and pay no interest. Rather, they are issued at a
discount (at a reduced amount) and redeemed (given back money) at the face value at
maturity.
For example, a 91 day Treasury bill of Rs.100/- (face value) may be issued at say Rs. 98.20,
that is, at a discount of say, Rs.1.80 and would be redeemed at the face value of Rs.100/-.
This means that you can get a hundred-rupee treasury bill at a lower price and can get
Rupees hundred at maturity.
The return to the investors is the difference between the maturity value or the face value (that
is Rs.100) and the issue price.
The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills. The
rational is that since their maturity is lower, it is more convenient to avoid intra period interest
payments.
Treasury bills are usually held by financial institutions including banks. They have a very
important role in the financial market beyond investment instruments. Banks give treasury bills
to the RBI to get money under repo. Similarly, they can keep it as part of SLR.
Q6
Write a short note on Repurchase agreements (REPO) and Reverse Repurchase
agreements (Reverse REPO)
Ans: Repo (Repurchase Option) is a formal agreement between two counterparties where one party
sells securities to another party with the explicit intention of buying back the securities at a
later date. The Repo can be called a Sell-Buy transaction.
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. In the case of a repo, the forward clean price of the bonds is set
in advance at a level which is different from the spot clean price by adjusting the difference
between repo interest and coupon earned on the security.
A repo is also sometimes called a ready forward transaction as it is a means of funding by
selling a security held on a spot (ready) basis and repurchasing the same on a forward basis.
The seller of the securities agrees to buy back the securities from the buyer at a
predetermined time and rate. The rate at which the seller agrees to buy back the securities will
include the interest rate charged by the buyer for agreeing to buy the securities from the seller.
The reason a seller wants to sell and buy back securities and paying interest on the
transaction is that the seller requires funds. The seller of securities can be called as the Repo
borrower as he receives funds for selling the securities. The buyer of the securities is the Repo
lender as he pays for the securities purchased.
The Repo rate is the rate of interest charged by the buyer of the securities to the seller of
securities.
A Repo transaction has two legs. The first leg is the sale of securities by the Repo borrower to
the Repo lender. The second leg is the purchase of securities by the Repo borrower from the
Repo lender.
The cash inflow to the Repo Borrower in the first leg is calculated by adding accrued interest to
the price of the bond. The interest outgo for the Repo rate borrower in the second leg is
calculated by the Repo interest rate on the cash inflow. The Repo borrower pays interest on
the full sum of money received by him from the Repo lender.
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
organisation to enter into reverse repo is that it earns some extra income on its otherwise idle
cash.
When an entity sells a security to another entity on repurchase agreement basis and
simultaneously purchases some other security from the same entity on resell basis it is called
a double ready forward transaction.
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) interbank loan for the reason that it is a
collateralised 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.