Saturday, January 31, 2015

Money Market - Part II

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Instruments of Money Market
Now, its time to learn about the several instruments that work in Money Market. Note that the tenure of the money market is overnight (1 day) to 1 year (365 days). So, all the instruments here works within this tenure. Though there is no such restriction, or no such obvious line of distinction.

Government Instruments

1.  Treasury Bills (91 - 364 days)
Treasury Bills or T-Bills are the most important and used mean for the government to acquire money from the market, to maintain its money requirements. On behalf of the government, RBI issues T-Bills to public as auction on some fixed date.

These are the least risky money market instrument and have 3 maturity periods - 91 days, 182 days, 364 days (meaning you can claim for your return only after these term periods). Note that Treasury Bill is a type of debenture (already discussed in the article - Equity & Debt), hence doesn't require any collateral as security. You only buy a T-Bill, because you know that government will never default on your payment.

Treasury Bills are issued on discount basis and can be redeemed at par, and it doesn't bear any interest. Let clear with an example -

Suppose you want to buy a T-Bill of Rs. 10,000 with 91 days maturity. RBI may tell you that the
discount rate is 1.5 %. So you can redeem a discount of = 10,000 x 1.5/100 = Rs. 150. 
This means you can buy the treasury bill in Rs 10,000 - 150 = Rs. 9,850 (your profit will be Rs. 150, which you can redeem as discount). After 91 days (the maturity), you go to RBI to get the return, and RBI will give you Rs. 10,000.
Summary - You buy the T-Bill in Rs. 9,850 and get in return Rs. 10,000 (face value). Note that, there is no interest involved in T-Bill.

2.  Cash Management Bill (CMB) (< 91 days)
Government can take loans from RBI as Ways and Means Advances (WMA; will discuss in later posts). But there is a limit on WMA advances, and the loans above the limit bears extra interest. Therefore, it is better for the government to acquire money from the general public. Cash Management Bill (CMB) is such instrument that helps government to maintain its temporary cash requirements for less than 90 days.

Note that, T-Bills can not be used for the temporary (upto 90 days) or urgent requirements. CMB comes handy for this purpose, instead of high interest loans.

Features of CMB is almost similar to that T-Bills including auction process, discount to the face value, etc.

3.  Dated Securities
Though definition-wise this doesn't come under Money Market. But it is better to discuss it here in government security section.
Dated Securities are long-term securities that helps government to take money from public for more than 1 years. Here government issues securities that bear a date of a distant future, which could help in long-term development projects, or otherwise.

It is important to mention here, that state governments cannot issue T-Bills to public. So state governments can issue only Dated Securities for a long term. These are known as State Development Loans (SDL).

Gilt-edged Security - All the government securities are collectively called gilt-edged securities, or government securities.

Hope this post will help you clear a lot of doubts.

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Happy learning!

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