Human Resource and Business Management Full Course: Gate Way, Lecture notes of Human Resource Management

Download Human Resource and Business Management Full Course: Gate Way and more Lecture notes Human Resource Management in PDF only on Docsity!

Financial Market I

Content

Chapter: Money Market and Instruments

Chapter: Operations of Money Market

Chapter: Money Market and Instruments

Money Market

The money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders. The market offers very high liquidity as the assets can easily convert into cash. Thus, it helps businesses and the government in meeting their working capital requirements. The money market refers to trading in very short-term debt investments. At the wholesale level, it involves large- volume trades between institutions and traders. At the retail level, it includes money market mutual funds bought by individual investors and money market accounts opened by bank customers. The money market can be understood as an organized exchange marketplace, wherein, participants can either borrow or lend money. Such a market enables the trading of short-term, high quality debt instruments with an average maturity of a year or less. Banking and finance aspirants looking to prepare for banking awareness must have a clear understanding of the money market Key Takeaways  Money Market refers to the financial segment for the trade of liquid and short-term assets that can be easily converted into cash. Businesses and governments particularly benefit from this market as it helps in meeting their working capital requirements.  Unlike a capital market where long-term securities are exchanged, here the trades investments range from a day, three months, 365 days, etc.  Longer the period of investment, higher the risk and gains. As such, the assets traded here come with low risk and gains.  Due to high transaction value, market investors are largely insurance companies, governments, NBFCs, banks, credit institutions, etc. Retail investors invest using money market funds and accounts.  The money market involves the purchase and sale of large volumes of very short-term debt products, such as overnight reserves or commercial paper.  An individual may invest in the money market by purchasing a money market mutual fund, buying a Treasury bill, or opening a money market account at a bank.  Money market investments are characterized by safety and liquidity, with money market fund shares targeted at $1 (650 FRS).  Money market accounts offer higher interest rates than a normal savings account, but there are higher account minimums and limits on withdrawals. Overview As per the Centre Bank (CEMAC) the term Money Market is referred to as a market where short-term financial assets are traded. These assets have a maturity period of either one year or less. The assets are a close substitute for money and enable money exchange in the primary and secondary markets. The money market is a systemized framework which enables the borrowing and lending of instruments that are usually for a basis of less than a year. Under the financial market, there are two categories of Money Market and Capital Market. Typical features of the money market suggest that it bears high liquidity and short maturity. The components of the money market are non-banking finance corporations (NBFCs), acceptance houses, and commercial banks. The dealings made are not of money or cash but other instruments like promissory notes, government papers, trade bills, etc. The transactions in the money market do not take place through brokers. Rather, they are carried out through oral or written communication or formal documentation.

Types of Money Market Instruments #1 – Call Money Call money is one of the most liquid instruments. The validity is generally one working day. Banks can face shortfalls that can be solved by borrowing through call money. In contrast, those with surplus cash can invest in other banks through call money. Call money work as statutory reserves, the minimum cash balance which banks must hold as part of the central bank’s mandate to ensure enough liquid cash for daily operations. The investment is available to other financial institutions. Financial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. #2 – Treasury Bills Treasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government. The government often raises funds through Treasury Bills that provide quick money. In the money market, it is considered one of the safest investments due to the government backing. They don’t offer an interest income. Interest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. T-bills are issued at a discount and redeemed at par, with the investor pocketing the difference as profit. The tenure of T-bills is generally from 14 days to 364 days. #3 – Commercial Papers (CPs) Companies generally use commercial papers to fund their short-term working capital needs, such as payment of accounts receivables, inventory purchases, etc. However, these are unsecured in nature. As such, in case of liquidation of the company, they will not have priority against other secured financial short-term instruments. CPs come with an average maturity of two odd months. However, just like the Treasury Bills, these are also issued at a discount, and therefore, they don’t come with separate interests. Commercial Paper Formula The formula for estimation discounted price of a commercial paper. Price = Face Value/ [1 + yield x (no. of days to maturity/365)] Yield = (Face value – Price)/ (price x no of days to maturity) X 365 X 100 Calculate the interest yield of the following commercial paper: Commercial Paper Example Particular Amount Face Value 5,00,000 frs Sale Price 4,90,000 frs Maturity Period 100 Brokerage and other charges 3% Solution: Brokerage = 3% of 500,000 = 15, Net Sale Price = 490,000 – 15,000 = 475, Particular Amount Face Value 5,00, Sale Price 4,90, Maturity Period 100 Brokerage and other Charges 3% Brokerage Value 15000 Net Sale Price 4,75, Yield 18.95% Yield = [(Face Value – Sale Price)/Sale Price] * (360/Maturity Period) * 100 = (5,00,000 – 4,75,000)/4,75,000 * (360/100) * 100 = 18.95%

Yield on Security

In simple words, the yield is the interest rate you earn by investing in securities. The below formula can calculate it: _Yield = (Face value – Sale value)/sale value (days or months in a year/period of discount)_** Let’s understand the above with the help of an example: Face value or amount of issue – 100frs Period – 6 months Discount rate – 10% Discount – 100(6/12)(10/100) = 5frs By using the above formula for yield we get Y = (100-95)/100(12/6) Y = 10% #4 – Certificate of Deposits (CDs) A certificate of deposit is a type of time deposit with the bank. Only a bank can issue a CD. Like all other time deposits Time Deposits, also known as term deposit, refers to the deposit account with fixed maturity and interest, CDs also have a fixed maturity date and cannot be withdrawn before maturity. This acts as a major disadvantage for the instrument. #5 – Repos Repo is a repurchase agreement with repo as its abbreviation. For example, Bank A in need of funds, with Bank B having surplus funds. Bank A will enter into an agreement with Bank B to sell its securities (mostly Treasury Bills). Bank B will receive the required funds. However, on a fixed date in future, the Bank A will repurchase these securities from Bank B as part of the agreement. #6 -- Bankers Acceptance Bankers Acceptance (BA) is probably the oldest money market instrument. It has been in use since the 12th century to facilitate trade. Unlike the other money market instruments, BA is a bank’s obligation to pay an individual account holder. In layman’s words, the bank has to pay a specified amount to the account holder. Bankers Acceptance is also available at a discounted price and functions like certified checks; the payment of the owed amount is on the specified date. The maturity period falls between 30 to 180 days. Bankers Acceptance is often used in trade (particularly when there is import-export of goods involved). The importers’ bank guarantees the payment to the exporter. Features Can be traded as bonds in the secondary money market. It is a safe and secure way to make both-end transactions. Banks can demand collateral before issuing it. There are 15 types of money market instruments. Each meets the specific needs of different customers. Some businesses may use an assortment of different money market accounts to cover their financial needs. Some are designed for the use of banks and large financial institutions, while others focus on businesses. Other Money Market Instruments

Federal Funds

Banks are the only businesses that use federal funds. Banks use them to meet the Federal Reserve requirement each night. It's roughly 10% of all bank liabilities over $58.8 million. Board of Governors of the Federal Reserve System. "Reserve Requirements." Note

Role of Money Market Instruments in the Financial Crisis Since money market instruments are generally so safe, it came as a surprise to most that they were at the heart of the 2008 financial crisis. On Tuesday, September 16, 2008, the $62.6 billion Reserve Primary Fund "broke the buck." That meant the fund managers couldn't maintain its share price at the $1 value. Money market funds used that value as a benchmark. Note The Fed had to create many new and innovative programs to keep the money market running. The Fed's programs were created quickly, so the names described exactly what they did in technical terms. For example, the Money Market Investor Funding Facility (MMIFF) allowed the Federal Reserve Bank of New York to provide "senior secured funding to a series of special-purpose vehicles to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets from eligible investors.". This may have made sense to bankers but very few others. Although these tools worked well, they confused the general public. The complexity created mistrust about the Fed's intentions and actions. Once the financial crisis was over, these tools were no longer needed and were discontinued.

Features of Money Market Instruments

1. High liquidity The money market offers short-term securities that are highly liquid. Their high liquidity makes them cash equivalents; that is, they can be traded for cash anytime. Several renowned financial institutions and dealers issue these securities to take loans or generate funds. 2. Secure investment Risk is inevitable, however in the case of the money market, the risk is significantly reduced due to low tenure. Also, only companies and corporations with high credibility and goodwill issue short-term securities and bonds. Hence, the risk of default is low as compared to higher tenure instruments. 3. Fixed returns Money market instruments in India are available at a discount on face value. Therefore, the return on securities and bonds is pre-decided. You can be rest assured while investing in the money market, as it promises fixed returns if held till maturity. 4. Certificates of Deposit Another component of the money market is Certificates of Deposit. It was first used in 1989 to increase the range of money market instruments in India. CDs can be issued obly by Scheduled Commercial Banks, Regional Rural Banks and Small Finance Banks. This instrument offers greater flexibility to investors to utilise their funds. It is issued by banks in a dematerialized form against the deposited amount in a bank for some time. The RBI has issued guidelines for CDs and updates them routinely. Companies, corporations, individuals, etc., can purchase them. The tenure of CDs range from seven days to one year Features Banks are not allowed to grant loans against CDs, unless specifically permitted by the Reserve Bank. Cannot be traded publicly. Issuing banks are permitted to buyback CDs before maturity subject to conditions specified by CEMAC. It is issued in 5frs and its multiples. 5. Repurchase Agreements Repurchase Agreements, also known as repo, are short-term borrowings in government securities for dealers. In 1992, repo was introduced to improve the economy’s short-term liquidity management and to manage and even out interest rates in the money market. Dealers sell government securities as collateral to investors and then buy them at a higher price the next day. Repurchase Agreements do not have a maximum maturity period, but the minimum is

one week. In some repo securities, there is no fixed maturity period, and there can be regular fluctuations in the interest rates contingent on the market conditions. Repurchase Agreements include agency bonds, government bonds, corporate bonds, emerging market bonds, convertible bonds, and supranational bonds. Features Security acts as collateral. Interest is lower in comparison to other securities. Used for lending and borrowing within a tenor of 48 hours or less. Investors can sell the collateral in case of bankruptcy. Importance of Money Market You might be wondering what the need for these instruments is or short-term debts when one can easily access the stock market. Yes, the stock market provides long-term investments and promises wealth creation in the future. But, the role of the money market is equally significant. The following reasons underline the importance of the money market:  The money market balances the demand and supply of monetary and financial transactions.  It helps in implementing monetary policies.  It provides a safe method to access short term funds to businesses, helping them grow and meet short term expenses and liquidity and in turn, further develop the economy.  It helps keep inflation on track. The government can quickly raise funds through these instruments. Without these instruments, the government would have to print more currency or turn to longer tenure loans to fund projects for social welfare, leading to inflation.  Short-term interest rates influence long-term interest rates.  It determines the statutory liquid ratio and cash reserve ratio.  It maintains a balance between the supply of and demand for the monetary transactions done in the market within a period of 6 months to one year..  It enables funds for businesses to grow and hence is responsible for the growth and development of the economy.  It helps in the functioning of the banks. It sets the cash reserve ratio and statutory liquid ratio for the banks. It also engages their surplus funds towards short term assets to maintain money supply in the market.  The current money market conditions are the result of previous monetary policies. Hence it acts as a guide for devising new policies regarding short term money supply.  Instruments like T-bills, help the government raise short term funds. Otherwise, to fund projects, the government will have to print more currency or take loans leading to inflation in the economy. Hence the it is also responsible for controlling inflation. Objectives Of Money Market Instruments Diversification Money market instruments are an excellent option to park your idle money and earn interest by bearing less risk. It can help you diversify your portfolio. Cash flow management: This is a medium to manage cash flows efficiently. You can earn a fixed and steady interest over a stipulated period. Short-term funding: For lenders, it is an excellent source to get loans at lower interest rates to meet their short-term funding requirements. By issuing these securities, they can borrow for a period ranging from a few days to 1 year. Liquidity Management: These instruments are highly liquid, so they allow investors to convert their investments into cash when needed. This helps to manage the flow of cash in the economy efficiently. Providing borrowers such as individual investors, government, etc. with short-term funds at a reasonable price. Lenders will also have the advantage of liquidity as the securities in the money market are short-term.

Chapter 2: Money Market Operations

Definition and Functions:

The money market deals with short-term funds traded for periods less than one year. It acts as a channel for short-term debt capital, distinct from the capital market. Key functions: Efficient utilization of balance capital by financial institutions and the government Providing short-term capital for working capital needs Boosting commerce, industry, and trade by discounting trade bills Assisting banks in cost-effective borrowing Enabling the government to obtain short-term capital through Treasury bills Importance of Money Market: Economic Growth: It fulfills the finance needs of trade and industry promptly. Working Capital: Commercial banks access short-term funds for their working capital requirements. Cost Savings: Banks can borrow from the money market at lower interest rates than from the central bank (CEMAC). Government Financing: Issuing Treasury The Dynamics of Money Market Operations: The operations within the money market are dynamic and involve a myriad of transactions that cater to the short- term financial needs of participants. Here's a closer look at how the money market operates: Trading Mechanism: The trading in the money market is often over-the-counter (OTC) where financial instruments are traded directly between two parties without a central exchange or intermediary. The informal nature of the money market allows for flexible trading hours and terms, catering to the immediate financial needs of the participants. Interest Rate Determination: Interest rates in the money market are determined by the forces of supply and demand for short-term funds. Central banks also play a crucial role in influencing money market rates through their monetary policy actions. Role of Interbank Market: The interbank market is a key segment of the money market where banks lend to and borrow from each other to manage their liquidity positions. Overnight swaps of vast amounts of money between banks and the government are common, helping to maintain stability in the financial system. Discount Window Lending: Central banks provide a discount window where financial institutions can borrow short-term funds at a specified interest rate, which often serves as a benchmark for other money market rates. Repurchase Agreements (Repos): Repos are short-term borrowing arrangements where a party sells securities with an agreement to buy them back at a later date at a higher price. They are crucial for managing short-term liquidity. Who Uses the Money Market and Why? Banks and Financial Institutions: Banks utilize the money market to manage their short-term liquidity needs, ensuring they have enough reserves to meet depositors' demands.

Government Entities: Governments use the money market to manage their short-term funding needs, often issuing treasury bills to cover budget shortfalls or other immediate financial requirements. Corporations: Corporations access the money market to meet their short-term operational needs, such as payroll or inventory purchases. Individuals & Investors: Individuals can invest in the money market to earn a better return on their savings while maintaining liquidity. Mutual Funds: Money market mutual funds provide a platform for individuals and institutions to invest in a diversified portfolio of short-term debt instruments. Insurance Companies: Insurance companies often have large portfolios and use the money market to manage the liquidity of their funds, ensuring they have enough cash on hand to meet claims and other obligations.

The Implications of Money Market Activities:

The activities within the money market have far-reaching implications on the broader economy. The interest rates prevailing in the money market serve as a benchmark for other interest rates across the financial spectrum. Moreover, the liquidity provided through the money market is crucial for the smooth functioning of the financial system, ensuring that entities have access to the funds they need for their short-term operations. In conclusion, the money market is a vital cog in the financial machinery, facilitating the flow of short-term funds between entities in need of liquidity and those with excess funds to lend. Its operations, although less formal and structured compared to the capital markets, are integral in ensuring financial stability and liquidity in the economy. Things To Consider Before Investing In Money Market Instruments Although the money market is a gateway to investing in debt securities, it is not a perfect investment avenue. As the saying goes, “You won’t grow without taking risks.” On the bright side, the money market has little to no risks. Yes, some issues might cause minor problems, but nothing significant leads to an instant downfall. When investing in the money market, you must consider the following points: Figure out your short-term goals. Risk level you can endure with ease. Assets which you plan to invest in. Economic condition and stability of the country Research thoroughly before investing in any company to avoid fraud and scams

Features Of Money Market Instruments

1. High liquidity The money market offers short-term securities that are highly liquid. Their high liquidity makes them cash equivalents; that is, they can be traded for cash anytime. Several renowned financial institutions and dealers issue these securities to take loans or generate funds. 2. Secure investment

 It helps in the functioning of the banks. It sets the cash reserve ratio and statutory liquid ratio for the banks. It also engages their surplus funds towards short term assets to maintain money supply in the market.  The current money market conditions are the result of previous monetary policies. Hence it acts as a guide for devising new policies regarding short term money supply.  Instruments like T-bills, help the government raise short term funds. Otherwise, to fund projects, the government will have to print more currency or take loans leading to inflation in the economy. Hence the it is also responsible for controlling inflation. Objectives Of Money Market Instruments Diversification: Money market instruments are an excellent option to park your idle money and earn interest by bearing less risk. It can help you diversify your portfolio. Cash flow management: This is a medium to manage cash flows efficiently. You can earn a fixed and steady interest over a stipulated period. Short-term funding: For lenders, it is an excellent source to get loans at lower interest rates to meet their short-term funding requirements. By issuing these securities, they can borrow for a period ranging from a few days to 1 year. Liquidity Management These instruments are highly liquid, so they allow investors to convert their investments into cash when needed. This helps to manage the flow of cash in the economy efficiently. Providing borrowers such as individual investors, government, etc. with short-term funds at a reasonable price. Lenders will also have the advantage of liquidity as the securities in the money market are short-term. It also enables lenders to turn their idle funds into an effective investment. In this way, both the lender and borrower are at a benefit. RBI regulates the money market. Therefore, in turn, helps to regulate the level of liquidity in the economy. Since most organizations are short on their working capital requirements. The money market helps such organizations to have the necessary funds to meet their working capital requirements. It is an important source of finance for the government sector for both national and international trade. And hence, provides an opportunity for the banks to park their surplus funds. What is the Yield on Security? In simple words, the yield is the interest rate you earn by investing in securities. The below formula can calculate it: Yield = (Face value – Sale value)/sale value* (days or months in a year/period of discount)* Let’s understand the above with the help of an example: Face value or amount of issue – Rs. 100 Period – 6 months Discount rate – 10% Discount – 100(6/12)(10/100) = Rs. 5 By using the above formula for yield we get Y = (100-95)/100(12/6) Y = 10% Commercial Paper Formula

The formula for estimation discounted price of a commercial paper. Price = Face Value/ [1 + yield x (no. of days to maturity/365)] Yield = (Face value – Price)/ (price x no of days to maturity) X 365 X 100 Calculate the interest yield of the following commercial paper: Commercial Paper Example Particular Amount Face Value 5,00,000 xaf Sale Price 4,90,000 xaf Maturity Period 100 Brokerage and other charges 3% Solution: Brokerage = 3% of 500,000 = 15, Net Sale Price = 490,000 – 15,000 = 475, Particular Amount Face Value 5,00, Sale Price 4,90, Maturity Period 100 Brokerage and other Charges 3% Brokerage Value 15000 Net Sale Price 4,75, Yield 18.95% Yield = [(Face Value – Sale Price)/Sale Price] * (360/Maturity Period) * 100 = (5,00,000 – 4,75,000)/4,75,000 * (360/100) * 100 = 18.95% Money Markets vs. Capital Markets Money markets primarily cater to short-term liquidity needs and offer low-risk options like Treasury Bills and Commercial Papers. Capital markets, however, operate for long-term investments, with instruments like stocks and bonds involving higher risks and potentially higher returns. While instruments of money market include highly liquid assets with shorter maturity periods, capital markets are regulated with longer-term investments. Money market participants primarily include banks and financial institutions seeking short-term funding. The capital market involves various entities such as stockbrokers, mutual funds, retail investors, and underwriters dealing with long-term investment options like stocks and bonds. Overall, money markets aim to meet short-term liquidity needs, while capital markets channel savings for long-term growth and development. Money Market vs Stock Market Particulars Money Market Stock Market Maturity of the instruments The money market instruments carry a maturity period of less than a year. However tradable in the short term, stocks create wealth creation when invested for a number of years. Financing needs These instruments are used to fund the short-term needs of the borrower. Used for long-term fund requirements. Types of instruments Instruments of money market include T-bills, certificate of It’s a stock of an independently listed company