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Banking Awareness

FINANCIAL INSTRUMENTS – 1

Written by A Moorthy




Financial Market is of two types:

MONEY MARKET and

CAPITAL MARKET

Money Market Instruments- The money market can be defined as a
market for short-term money and financial assets that are near
substitutes for money. The term short-term means generally a period
upto one year and near substitutes to money is used to denote any
financial assets which can be quickly converted into money with
minimum transaction cost.

Some of the important money market instruments are briefly
discussed below:
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposits
5. Commercial Papers

1. Call/Notice- Money Market: Call/Notice money is the money
borrowed or lent on demand for a very short period. When
money is borrowed or lent for a day, it is known as Call
(Overnight) Money. Intervening holidays and/or Sunday are
excluded for this purpose. Thus money, borrowed on a day and
repaid on the next working day (irrespective of the number of
intervening holidays) is “Call Money”. When money is borrowed
or lent for more than a day and up to 14 days, it is “Notice
Money”. No collateral security is required to cover these
transactions.

2. Treasury Bills: Treasury Bills are short term (upto one year)
borrowing instruments of the Union Government. It is an IOU of
the Government. It is a promise by the government to pay a
stated sum after expiry of the stated period from the date of
issue (14/91/182/364 days i.e. less than one year). They are
issued at a discount to the face value, and on maturity the face
value is paid to the holder. The rate of discount and the
corresponding issue price are determined at each auction.

3. Inter-Bank Term Money: Inter-Bank Market for deposi ts of
maturity beyond 14 days is referred to as the term money
market. The entry restrictions are the same as those for
Call/Notice Money except that, as per existing regulations, they
specified entities are not allowed to lend beyond 14 days.

4. Certificate of Deposits: Certificate of Deposits (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 institutions for a
specified time period. Guidelines for issue of CDs are presently
governed by the Reserve Bank of India, as amended from time to
time.

CDs can be issued by:

  1. Scheduled Commercial Banks excluding Regional Rural
    Banks (RRBs) and Local Area Banks (LABs), and
  2. Select all-India Financial 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 CDs depending on their
    requirements. An FI may issue CDs within the overall umbrella
    limit fixed by RBI, i.e. issued of CD together with other
    instruments viz., term money, term deposits, commercial papers
    and inter corporate deposits should not exceed 100% of its net
    owned funds, as per the latest audited balance sheet.

5. Commercial Paper: CP is a note in evidence of the debt
obligation of the issuer. On issuing commercial paper the debt
obligation is transformed into an instrument. CP is thus an
unsecured promissory note privately placed with investors at a
discount rate to face value determined by market forces. CP is
freely negotiable by endorsement and delivery. A company shall
be eligible to issue CP provided-
(a) The tangible net worth of the company, as per the latest
audited balance sheet, is not less than Rs. 4 crore;
(b) The working capital (fund-based) limit of the company from
the banking system is not less than Rs. 4 crore;
(c) The borrowable account of the company is classified as a
Standard Asset by the financing banks;
The minimum maturity period of CP is 7 days. The minimum
credit rating shall be P-2 of CRISIL or such equivalent rating by
other agencies.

Read more: Financial instrument Part 2




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