Q1 What is Call Money/Notice Money in the context of financial market?
Answer:
✓ Call money is a part of the money market where day to day surplus funds, mostly of banks are traded. Moreover, the call money market is most liquid of all short term money market instruments.
✓ The maturity period of call loans vary from 1 to 14 days. The money that is lend for one day in call money market is also known as ‘overnight money’.
✓ Current and expected interest rates on call money are the basic rates to which other money markets and to some extent the Government securities market are anchored.
✓ In India, call money is lent mainly to even out the short term mismatches of assets and liabilities and to meet CRR requirements of banks that they should maintain with RBI every
fortnight and is computed as a percentage of Net Demand and Time Liabilities (NDTL).
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Q2 What is the distinction between Money Market and Capital Market?
Answer :
Q3 Explain briefly what is Money Market Mutual Funds.
Answer:
A money market fund is a mutual fund that invests solely in money market instruments. Money market instruments are forms of debt like Commercial Papers (CPs), Certificate of Deposits (CDs) and Treasury Bills (TBs) that mature in less than one year and are very liquid. Treasury bills make up the bulk of the money market instruments. Securities in the money market are relatively risk-free.
Money market mutual funds are one of the safest instruments of investment for the retail low income investor. The assets in a money market fund are invested in safe and stable instruments of investment issued by governments, banks and corporations etc.
Generally, money market instruments require huge amount of investments and it is beyond the capacity of an ordinary retail investor to invest such large sums. Money market mutual funds allow retail investors the opportunity of investing in money market instrument and benefit from the price advantage.
· The goal of a money-market fund is to preserve principal while yielding a modest return.
· Money-market mutual fund is akin to a high-yield bank account but is not entirely risk free.
Q4 Write a short note on Inter Bank Participation Certificate.
Answer:
Inter-Bank Participation Certificates are instruments issued by scheduled commercial banks only to raise funds or to deploy short term surplus. There will be two types of Participations:
I. Inter-Bank Participations with Risk Sharing
II. Inter-Bank Participations without Risk Sharing
The IBP with risk sharing can be issued for a period between 91daysto 180 days. The IBP without risk sharing is a money market instrument with a tenure not exceeding 90 days and the interest rate on such IBPs is left to be determined by the two concerned banks without any ceiling on interest rate.
Q5 Write short note on Commercial Bill.
Answer:
A commercial bill is one which arises out of a genuine trade transaction i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein after a certain specified date. Thus, a bill of exchange contains a written order from the creditor to the debtor, to a pay a certain sum, to a certain person, after a certain period. A bill of exchange is a ‘self-liquidating’ paper and negotiable; it is drawn always for a short period ranging between3 months and 6 months.
Q6 What are the advantages of developed bill market?
Answer:
A developed bill market is useful to borrowers, creditors and to financial and monetary system as a whole. The bill market scheme will go a long way to develop the bill market in the country. The following are various advantages of developed bill market
i) Bill finance is better than cash credit. Bills are self-liquidating and the date of repay mentof banks loan through discounting or rediscounting is certain.
ii) Bills provide greater liquidity to their holders because they can be shifted to others in the market in case of need for cash.
iii) A developed bill market is also useful to the banks in case of emergency. In the absence of such market the banks in need of cash have to depend either on call money market or the Reserve Bank’s loan window.
iv) The commercial bill rate is much higher than the Treasury bill rate. Thus, the commercial banks and other financial institutions with short term surplus funds find in bills an attractive source of both liquidity as well as profit.
v) A developed bill market will also makes the monetary system of the country more elastic.
Q7 Write short note on Certificate of Deposits.
Answer:
A certificate of deposit (CD) is a fixed-deposit investment option offered by banks and lending institutions. It offers higher interest rates than conventional savings accounts because it requires investors to deposit funds for a specified term ranging from one month to more than five years. However, like savings accounts, CDs are a secure form of investment, as they are insured by government agencies.
A person can buy a certificate of deposit (CD) by depositing the minimum requisite amount. In general, the higher the deposited amount, the better will be the interest rate offered on it. ThebuyerofaCDreceivesawrittendeclarationorcertificatewheretheapplicableinterestrate,termofdepositanddateofmaturityarestated.
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.
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.
[Master Circular dated July 01, 2013: Guidelines for Issue of Certificate of Deposit, RBI/2013- 14/104,IDMD.PCD.05/14.01/03/2013-14]
Q8 Write short note on Commercial Paper.
Answer:
What is it?
Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.
Corporate, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. It is generally issued at a discount freely determined by the market to major institutional investors and corporations either directly by issuing corporation or through a dealer bank. Commercial paper represents a form of financing that allows the issuer of the paper to borrow money at relatively low interest rates. The availability of funding through the commercial paper market means the firm can negotiate to get bank loans, another source of financing, on better terms. From the issuer’s point of view, the inability to retire debt before the end of its term without paying a penalty is a disadvantage. The firm may want to retire the debt early and save money on interest payments.
Q9 What is Repo Rates?
Answer:
✓ Repo rate is the rate at which RBI lends to commercial banks generally against government securities.
✓ Reduction in Repo rate helps the commercial banks to get money at a cheaper rate.
✓ Increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive.
Q10 What is Reverse Repo Rates?
Answer:
✓ Reverse Repo rate is the rate at which RBI borrows money from the commercial banks.
✓ The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit.
✓ As the rates are high the availability of credit and demand decreases resulting to decrease in inflation.
✓ Increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy. As of August 2013, the repo rate is 7.25 % and reverse repo rate is 6.25%
Q11 What is Cash Reserve Ratio (CRR)?
Answer:
✓ Definition: Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank. CRR is set according to the guidelines of the central bank of a country.
✓ Description: The amount specified as the CRR is held in cash and cash equivalents, is stored in bank vaults or parked with the Reserve Bank of India. The aim here is to ensure that banks do not run out of cash to meet the payment demands of their depositors. CRR is a crucial monetary policy tool and is used for controlling money supply in an economy.
✓ CRR specifications give greater control to the central bank over money supply. Commercial banks have to hold only some specified part of the total deposits as reserves. This is called fractional reserve banking.
Q12 What is Statutory Liquidity Ratio (SLR)?
Answer:
✓ Statutory liquidity ratio refers to the amount that the commercial banks require to maintain in the form of gold or govt. approved securities before providing credit to the customers. Here by approved securities we mean, bond and shares of different companies.
✓ Statutory Liquidity Ratio is determined and maintained by the Reserve Bank of India in order to control the expansion of bank credit. It is determined as percentage of total demand and time liabilities.
✓ Time Liabilities refer to the liabilities, which the commercial banks are liable to pay to the customers after a certain period mutually agreed upon and demand liabilities are such deposits of the customers which are payable on demand.
✓ Example of time liability is a fixed deposits for 6 months, which is not payable on demand but after six months. Example of demand liability is deposit maintained in saving account or current account, which are payable on demand through a withdrawal form of a cheque.
✓ SLR is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other approved liabilities (deposits). It regulates the credit growth in India.
Q13 Write short not on Treasury Bills
Answer:
✓ Treasury Bills: Treasury bills are short-term debt instruments of the Central Government, maturing in a period of less than one year.
✓ Treasury bills are issued by RBI on behalf of the Government of India for periods ranging from 14 days to 364 days through regular auctions.
✓ They are highly liquid instruments and issued to tide over short-term liquidity shortfalls.
✓ Treasury bills are sold through an auction process according to a fixed auction calendar announced by the RBI.
✓ Banks and primary dealers are the major bidders in the competitive auction process. Provident Funds and other investors can make non-competitive bids. RBI makes allocation to
non-competitive bidders at a weighted average yield arrived at on the basis of the yields quoted by accepted competitive bids.
✓ These days the treasury bills are becoming very popular on account of falling interest rates.
✓ Treasury bills are issued at a discount and redeemed at par. Hence, the implicit yield on a treasury bill is a function of the size of the discount and the period of maturity. Now, these
bills are becoming part of debt market.
✓ In India, the largest holders of the treasury bills are commercial banks, trust, mutual funds and provident funds. Although the degree of liquidity of treasury bills are greater than trade bills, they are not self liquidating as the genuine trade bills are.
✓ T-bills are claim against the government and do not require any grading or further endorsement or acceptance.
Q14 What is interest rate risk, reinvestment risk & default risk & what are the types of risk involved in investments in G-Sec.?
Answer:
(i) Interest Rate Risk:
✓ Interest Rate Risk, market risk or price risk are essentially one and the same. These are typical of any fixed coupon security with a fixed period to maturity.
✓ This is on account of inverse relation of price and interest. As the interest rate rises the price of a security will fall.
✓ However, this risk can be completely eliminated in case an investor’s investment horizon identically matches the term of security.
(ii) Re-investment Risk:
✓ This risk is again akin to all those securities, which generate intermittent cash flows in the form of periodic coupons.
✓ The most prevalent tool deployed to measure returns over a period of time is the yield-to-maturity(YTM) method.
✓ The YTM calculation assumes that the cash flows generated during the life of a security is reinvested at the rate of YTM.
✓ The risk here is that the rate at which the interim cash flows are reinvested may fall thereby affecting the returns.
✓ Thus, reinvestment risk is the risk that future coupons from a bond will not be reinvested at the prevailing interest rate when the bond was initially purchased.
(iii) Default Risk:
✓ The event in which companies or individuals will be unable to make the required payments on their debt obligations.
✓ Lenders and investors are exposed to default risk in virtually all forms of credit extensions.
✓ To mitigate the impact of default risk, lenders often charge rates of return that correspond the debtor's level of default risk. The higher the risk, the higher the
required return, and vice versa.
✓ This type of risk in the context of a Government security is always zero. However, these securities suffer from a small variant of default risk i.e. maturity risk.
✓ Maturity risk is the risk associated with the likelihood of government issuing a new
security in place of redeeming the existing security. In case of Corporate Securities it
is referred to as credit risk.
Corporate actions.
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