Treasury Bills

Treasury bills are money market instruments issued by the Government of India
as a promissory note with guaranteed repayment at a later date. Funds collected
through such tools are typically used to meet short term requirements of the
government, hence, to reduce the overall fiscal deficit of a country.
They are primarily short-term borrowing tools, having a maximum tenure of
364 days, available at zero coupons (interest) rate. They are issued at a discount
to the published nominal value of government security (G-sec).
Government treasury bills can be procured by individuals at a discount to the
face value of the security and are redeemed at their nominal value, thereby
allowing investors to pocket the difference. For example, a 91-day treasury bill
with a face value of Rs. 120 can be bought at a discounted price of Rs. 118.40.
Upon maturity, individuals are eligible to receive the entire nominal value of Rs.
120, which allows them to realise a profit of Rs. 1.60. Now, take a look at other
important treasury bill details.
Why Does the Government Issue Treasury Bills?
A short term treasury bill helps the government raise funds to meet its current
obligations, which are in excess of its annual revenue generation. Its issue is
aimed at reducing total fiscal deficit in an economy, and also in regulating the
total currency in circulation at any given point of time.
The Reserve Bank of India (RBI) also issues such treasury bills under its open
market operations (OMO) strategy to regulate its inflation level and
spending/borrowing habits of individuals. During times of economic boom
leading to high and persistent inflation rates in the country, high-value treasury
bills are issued to the public, which, thereby, reduces aggregate money supply in
an economy. It effectively curbs the surging demand rates, and in turn, high
prices hurting the poorer sections of the society.
Alternatively, a contractionary OMO regime is undertaken by the RBI during
times of recession and economic slowdown through a reduction in treasury
bill circulation and reduced discounted value of the respective bonds. It
disincentives individuals into channelling their resources in this sector, thereby
boosting cash flows to the stock markets instead, ensuring a boost in the
productivity of most companies. Such a rise in productivity has a positive
impact on the GDP and aggregate demand levels in an economy.
Hence, a treasury bill is an integral monetary tool used by the RBI to regulate
the total money supply in an economy, along with its fundraising usage.
Types of Treasury Bill
The distinction between different treasury bill types is made based on their
tenure, as enumerated below:
 14-day treasury bill
 91-day treasury bill
 182-day treasury bill
 364-day treasury bill
While the holding period remains constant for all types of treasury bills issued
(as per the categories mentioned above), face values and discount rates of such
bonds change periodically, depending upon the funding requirements and
monetary policy of the RBI, along with total bids placed.

Features of Government Treasury Bills

 Risk-free
Treasury bills are one of the most popular short-term government schemes
issued by the RBI and are backed by the central government. Such tools act as a
liability to the Indian government as they need to be repaid within the stipulated
date.
Hence, individuals enjoy comprehensive security on the total funds invested as
they are backed by the highest authority in the country, and have to be paid even
during an economic crisis.
 Liquidity
As stated above, a government treasury bill is issued as a short-term fundraising
tool for the government and has the highest maturity period of 364 days.
Individuals looking to generate short term gains through secure investments can
choose to park their funds in such securities. Also, such G-secs can be resold in
the secondary market, thereby allowing individuals to convert their holding into
cash during emergencies.
 Non-competitive bidding
Treasury bills are auctioned by the RBI every week through non-competitive
bidding, thereby allowing retail and small-scale investors to partake in such bids
without having to quote the yield rate or price. It increases the exposure of
amateur investors to the government securities market, thereby creating higher
cash flows to the capital market.
 Minimum investment
As per the regulations put forward by the RBI, a minimum of Rs. 25,000 has to
be invested by individuals willing to procure a short term treasury bill.
Furthermore, any higher investment has to be made in multiples of Rs. 25,000.
 Zero-coupon securities
G-Sec treasury bills don’t yield any interest on total deposits. Instead, investors
stand to realise capital gains from such investments, as such securities are sold
at a discounted rate in the market. Upon redemption, the entire par value of this
bond is paid to investors, thereby allowing them to realise substantial profits on
total investment.
 Fixed Returns:
The government and the RBI determine fixed rates for treasury bills. These rates
will remain unchanged throughout the investment period. This stability is an
attractive option if you seek fixed returns.
 Price Discovery:
Price discovery involves determining the bill’s market value based on supply
and demand dynamics, and factors like economic conditions, interest rates, and
investor sentiment influence the market-set prices.

Limitations of Treasury Bills

 Low Returns:
Despite being backed by the RBI and offering guaranteed returns, Treasury bills
yield relatively modest returns. Compared to other investment options, the
returns alone may not meet your financial goals.

 Taxation:
Returns from treasury bills are subject to Short-Term Capital Gains (STCG) tax.
They will be taxed at your applicable slab rate and can reduce the effective
returns on your investment.
  Affected by Inflation:
Your returns on treasury bills are susceptible to inflation. If the rate of return is
lower than the inflation rate, the real value of the returns diminishes, reducing
your purchasing power.

 Expensive:
T-bills have a minimum investment requirement of ₹25,000 or ₹1 lakh. This
may be difficult for small investors.

Features of Commercial Paper

Commercial paper possesses several distinct features that make it a popular
choice for short-term financing, particularly in commercial paper in India.
These features are designed to meet the immediate funding needs of
corporations while offering attractive opportunities for investors:
1. Unsecured Nature:
o Commercial paper is typically unsecured, meaning it is not backed
by collateral. This characteristic relies heavily on the issuer’s
creditworthiness and reputation.
o Issuers with high credit ratings can issue commercial paper without
backing assets, making the process quicker and less cumbersome.
2. Short-Term Maturity:
o Maturities range from a few days to a year, with most papers
maturing within 270 days. This short-term nature makes it an ideal
instrument for managing immediate financing needs.
o The quick turnover of these instruments aligns well with the short-
term liquidity requirements of both issuers and investors.
3. Issued at a Discount:
 o Commercial paper is sold at a discount to its face value. The
difference between the purchase price and the face value represents
the investor’s return.
o This structure simplifies the interest payment process, as the return
is realised at maturity when the face value is paid.
4. High Denomination:
o Generally issued in large denominations, often exceeding Rs. 1
crore, it is suitable primarily for institutional investors rather than
retail investors.
o Minimum Amount is Rs. 5 lakh and multipleof
o The large denominations help companies raise substantial amounts
of capital efficiently.
5. Flexible Use of Proceeds:
o Funds raised through commercial paper can be used for various
short-term needs, including working capital, inventory financing,
and other operational expenses.
o This flexibility allows companies to address immediate financial
requirements without impacting their long-term financing plans.
6. Liquidity:
o High liquidity due to short maturities and active secondary
markets. Commercial paper can be easily bought and sold before
maturity, giving investors flexibility.
o The liquid nature of these instruments makes them an attractive
investment for entities looking to manage their cash flows
dynamically.
7. Credit Rating:
o Issuers often obtain credit ratings for their commercial paper from
recognised rating agencies. High credit ratings enhance investor
confidence and reduce borrowing costs.
o Investors rely on these ratings to assess the risk associated with the
commercial paper, making it easier to make informed investment
decisions.
Certificate of Deposit
A Certificate of Deposit or CD is a fixed-income financial tool that
is governed by the Reserve Bank of India and is issued in a
dematerialized form. It is a type of agreement made between the
depositors and the banks, wherein the bank pays an interest on
your investment. Certificate of Deposit is a short-term
investment that comes with fixed investment amounts and
maturity tenure ranging between 1-3 years. Given below are
some of the important features of CDs and the method to buy a
certificate of deposit.

Features of Certificate of Deposit

Here are some salient features of CDs and how they compare to other financial
instruments.
 Certificate of deposit in India can be issued for a minimum deposit of Rs.
1 lakh or in subsequent multiples of it.
 Certificates of deposit are issued by the Scheduled Commercial Banks
(SCBs) and All-India Financial Institutions. The Cooperative Banks and
the Regional Rural Banks(RRBs) are not eligible for issuing a CD.
 There is a term period of 3 months to 1 year for CDs that are issued by
SCBs, whereas the term period ranges from 1 year to 3 years for CDs
issued by financial institutions.
 CDs in dematerialised forms can be transferred through endorsement or
delivery, similar to dematerialised securities.
 There is no lock-in period for a certificate of deposit.
 It is fully taxable under the Income Tax Act.

Repo rate is a crucial monetary policy tool used by central banks to regulate the
money supply and interest rates in an economy. It's the rate at which a central
bank lends money to commercial banks against government securities.
Key Features of Repo Rate:
1. Monetary Policy Tool: The repo rate is a primary instrument for central
banks to control inflation and stimulate economic growth. By adjusting
 this rate, they can influence the cost of borrowing for banks, which, in
turn, affects lending rates to consumers and businesses.
2. Short-Term Lending: Repo loans are typically short-term in nature,
often overnight or for a few days.
3. Government Securities as Collateral: Commercial banks pledge
government securities as collateral when borrowing from the central bank
at the repo rate.
4. Impact on Interest Rates: When the repo rate is lowered, banks can
borrow money at a cheaper rate, which encourages them to lend more to
consumers and businesses. This can stimulate economic activity but may
also lead to higher inflation. Conversely, when the repo rate is raised, it
becomes more expensive for banks to borrow, discouraging lending and
potentially curbing inflation.
5. Liquidity Management: The repo rate also plays a role in managing
liquidity in the banking system. If banks have excess liquidity, they may
choose to deposit it with the central bank at the reverse repo rate (which
is typically lower than the repo rate).
6. Benchmark Rate: The repo rate often serves as a benchmark for other
interest rates in the economy, such as those on loans and deposits.

Reverse repo rate is another monetary policy tool used by central banks. It's
the rate at which commercial banks lend money to the central bank.
Key Features of Reverse Repo Rate:
1. Liquidity Management: The primary function of the reverse repo rate is
to manage liquidity in the banking system. When banks have excess
funds, they can deposit them with the central bank at this rate.
2. Interest Earnings: Banks earn interest on their deposits with the central
bank at the reverse repo rate.
3. Counterbalance to Repo Rate: The reverse repo rate acts as a
counterbalance to the repo rate. When the central bank wants to absorb
excess liquidity from the system, it can raise the reverse repo rate, making
it more attractive for banks to deposit their funds with the central bank.
 4. Impact on Money Supply: By influencing the amount of liquidity in the
banking system, the reverse repo rate can indirectly affect the money
supply.
5. Correlation with Repo Rate: The reverse repo rate is typically lower
than the repo rate. This ensures that banks are incentivized to lend to the
central bank rather than to other banks at a lower rate.

Commercial bill
Commercial bills are also called “bills of exchange,” which are used by firms for
financing their working capital. In addition, it is used as a short-term negotiable and
self-liquidating tool for funding credit sales.

Commercial bills are used when the selling of goods takes place on credit. This
makes the buyer liable for paying the amount on a particular date and time. Here, the
seller has two options: they can wait for the specific future date or use exchange bills
to acquire a credit amount.

The seller generally draws the commercial bills on the purchaser for goods value.
The maturity of the bill can range from 30, 60, and 90 days. Then, if the seller
requires funds, they draw a bill sent for acceptance to the buyer.

The buyer then accepts the bill with a promise to pay the amount on the specified
date. In many cases, the seller might also produce the bill in the bank. The financial
institution will charge a specific commission with a promise to pay if the buyer fails.

If the seller decides to draw a commercial bill and the purchaser accepts the same,
the bill becomes marketable. This bill is further known as a trade bill. Before the bill’s
maturity date, it can be discounted in the bank by the seller. Accepting a trade bill at
any commercial bank is called a commercial bill.

Like commercial paper, the bill also provides various benefits to the business. It is a
strong and important channel that helps to provide short-term finance to small and
medium-sized businesses. The commercial bill validates the cash credit scheme
under bank lending. The large corporate sectors do not accept or use commercial
bills as payment modes.

Call Money
Call money is also known as Money at Call. It is, in fact, a very short-term loan
meant to address issues that arise in banks and financial institutions regarding their
everyday liquidity requirements. It is also operated overnight or for a few days
without any collateral. The interest rates for call money loans can fluctuate daily,
influenced by the market's demand and supply of funds.

Advantages of Call Money

Flexibility: Call money is flexible for managing liquidity day to day. Financial
institutions or organizations borrowing or lending call money do it for the shortest
possible time, sometimes overnight. This liquidity allows them to change their cash
positions according to their immediate requirements.

Efficiency in Liquidity Management: It allows banks to manage their reserve

requirements efficiently. With this facility, a bank may lend or borrow from the call
money market, which will ensure they meet their regulatory liquidity requirements
without having to maintain excess reserves that would draw poor returns.

Cost-Effective: Borrowing through the call money market could be cheaper than
other means of obtaining short-term funding. However, it's important to note that,
being mostly unsecured and for very short tenure, the rate of interest on call money
is very low compared to other borrowings. This low interest rate may not always
compensate for the potential risks involved.

No Collateral Required: In the call money market transaction, collateral is not

required. This eases the borrowing process and helps minimize the transaction cost,
giving an advantage to well-established institutions with a good credit rating.

Supports Monetary Policy: The call money market is of very great use for the
conduct of monetary policy by the central bank. In fact, through manipulation, the
central bank can indirectly impact the liquidity preference of the public and can
influence the short-term money rates in the direction it likes.

Stability of Markets: The call money market's presence helps maintain stability in
the whole financial system. This assists institutions in absorbing unexpected liquidity
shocks and reduces the related risk of default for failing to meet credit obligations by
borrowers.

Regulation in the Money Market

The money market, a vital component of the financial system, is subject to a complex
regulatory framework designed to ensure its stability, efficiency, and fairness. This
framework varies across different jurisdictions, but some common regulatory themes
include:

1. Central Bank Oversight:

 Interest Rate Policy: Central banks often regulate interest rates in the money
market to influence monetary policy, control inflation, and stimulate economic
growth.
 Reserve Requirements: Central banks may mandate that financial
institutions maintain a certain percentage of their deposits as reserves,
affecting the amount of money available for lending.
 Open Market Operations: Central banks can buy or sell government
securities in the open market to influence the money supply and interest rates.

2. Securities Regulations:

 Issuance and Trading: Regulations often govern the issuance, trading, and
settlement of money market instruments like Treasury bills, commercial paper,
and certificates of deposit.
 Disclosure Requirements: Issuers of money market securities may be
required to provide detailed information about their financial condition and risk
factors.

3. Financial Institution Regulation:

 Capital Adequacy: Financial institutions operating in the money market must

maintain sufficient capital to absorb losses and protect depositors.
 Liquidity Requirements: Institutions may be subject to liquidity requirements
to ensure they have enough cash or liquid assets to meet their obligations.
 Risk Management: Regulations often mandate that financial institutions
implement effective risk management practices to mitigate potential risks.

4. Market Conduct:

 Fair Trading: Regulations may prohibit market manipulation, insider trading,

and other forms of misconduct.
 Consumer Protection: Regulations may protect investors from unfair or
deceptive practices.
5. Systemic Risk:

 Stress Testing: Regulators may require financial institutions to conduct

stress tests to assess their resilience to adverse economic conditions.
 Resolution Frameworks: Regulators may develop frameworks for resolving
failing financial institutions in a way that minimizes systemic risk.

Key Regulatory Bodies:

 Central Banks: The Federal Reserve (US), the European Central Bank (EU),
the Bank of England (UK), and the Reserve Bank of India (India) are
examples of central banks that play a significant role in regulating the money
market.
 Securities Regulators: The Securities and Exchange Commission (SEC) in
the US, the Financial Conduct Authority (FCA) in the UK, and the Securities
and Exchange Board of India (SEBI) are examples of securities regulators
that oversee the money market.
 UNIT IV

Capital Market

Meaning of Capital market:

Capital markets are financial markets for the buying and selling of long-term debt or
long term securities having a maturity-period (age) of one year or more. These
markets channel/direct the wealth of savers to those who can put it to long-term
productive/useful use, such as companies or governments making long-term
investments/capital spending. Financial regulators/watchdogs such as the Securities
and Exchange Board of India (SEBI), oversee/direct the capital markets in their
jurisdictions/areas to protect investors against fraud/dishonesty among other duties

Importance or Functions of Capital Market:

The capital market plays an important role in mobilizing saving and channel them
into productive investments for the development of commerce and industry. As such,
the capital market helps in capital formation and economic growth of the country. We
discuss below the importance of capital market.

1. Link between savers and investors: The capital market acts as an important link
between savers and investors. The savers are lenders of funds while investors are
borrowers of funds. The savers who do not spend all their income are called “Surplus
units” and the investors/borrowers are known as “deficit units”. The capital market is
the transmission mechanism between surplus units and deficit units. It is a conduit
through which surplus units lend their surplus funds to deficit units.

2. Basis for industrialization: Capital market generates long term funds, which are
essential for the establishment of industries. Thus, capital market acts as a basis for
industrialization.

3. Accelerating the pace of growth: Easy and smooth availability of funds for medium
and long period encourages the entrepreneurs to take profitable ventures/
businesses in the field of trade, industry, commerce and even agriculture. It results in
the all round economic growth and accelerates the pace of economic development.
4. Generating liquidity: Liquidity means convertibility into cash. Shares of the public
companies are transferable i.e., in case of financial requirements these shares can
be sold in the stock market and the cash can be obtained. This is how capital market
generates liquidity.
5. Increase the national income: Funds flow into the capital market from individuals
and financial intermediaries which are absorbed by commerce, industry and
government. It thus facilitates the movement of stream of capital to be used more
productively and profitability to increase the national income.

6. Capital formation: The capital market prides incentives to savers in the form of
interest or dividend to transfer their surplus fund into the deficit units who will invest it
in different businesses. The transfer of funds by the surplus units to the deficit units
leads to capital formation.

7. Productive investment: The capital market provides a mechanism for those who
have savings transfer their savings to those who need funds for productive
investments. It diverts resources from wasteful and unproductive channels such as
gold, jewelry, conspicuous consumption, etc. to productive investments.

8. Stabilization of the value of securities: A well-developed capital market comprising

expert banking and non-banking intermediaries brings stability in the value of stocks
and securities. It does so by providing capital to the needy at reasonable interest
rates and helps in minimizing speculative activities.

9. Encourages economic growth: The capital market encourages economic growth.

The various institutions which operate in the capital market give quantities and
qualitative direction to the flow of funds and bring rational allocation of resources.
They do so by converting financial assets into productive physical assets. This leads
to the development of commerce and industry through the private and public sector,
thereby encouraging/inducing economic growth.

Structure Of Capital Market

The capital market is a complex system that facilitates the long-term financing
of businesses and governments. It consists of various interconnected
components that work together to allocate capital efficiently. Here is a
breakdown of the primary structures and participants:
Primary Market:
 Issuers: Companies, governments, and other entities that issue securities
to raise capital.
 Investors: Individuals, institutions, and other entities that purchase newly
issued securities.
  Underwriters: Investment banks that facilitate the issuance of securities
by helping to price them, distribute them, and manage risk.
Secondary Market:
 Exchanges: Organized platforms where securities are bought and sold,
such as the New York Stock Exchange, the Nasdaq, and the Bombay
Stock Exchange.
 Over-the-Counter (OTC) Markets: Decentralized networks where
securities are traded directly between buyers and sellers, often through
brokers and dealers.
 Brokers and Dealers: Intermediaries that facilitate the buying and
selling of securities in the secondary market.
Financial Intermediaries:
 Investment Banks: Financial institutions that provide a wide range of
services, including underwriting, mergers and acquisitions, and
investment research.
 Commercial Banks: Banks that provide a variety of financial services,
including loans, deposits, and investment products.
 Mutual Funds: Investment pools that collect money from investors and
invest in a diversified portfolio of securities.
 Pension Funds: Pools of money that are set aside to provide retirement
benefits.
 Insurance Companies: Companies that sell insurance policies to protect
individuals and businesses from financial losses.
Regulatory Framework:
 Securities Regulators: Government agencies that oversee the capital
market to ensure fair and efficient operations.
 Central Banks: Central banks that regulate the money supply and
interest rates, which can affect the capital market.

What are the instruments traded in the Capital Market?

1. Equities:
Equity securities refer to the part of ownership that is held by shareholders in a
company.
In simple words, it refers to an investment in the company’s equity stock for
becoming a shareholder of the organization.
The main difference between equity holders and debt holders is that the former
does not get regular payment, but they can profit from capital gains by selling
the stocks.
Also, the equity holders get ownership rights and they become one of the
owners of the company.
When the company faces bankruptcy, then the equity holders can only share the
residual interest that remains after debt holders have been paid.
Companies also regularly give dividends to their shareholders as a part of
earned profits coming from their core business operations.
2. Debt Securities:
Debt Securities can be classified into bonds and debentures:
1. Bonds:
Bonds are fixed-income instruments that are primarily issued by the centre and
state governments, municipalities, and even companies for financing
infrastructural development or other types of projects.
It can be referred to as a loaning capital market instrument, where the issuer of
the bond is known as the borrower.
Bonds generally carry a fixed lock-in period. Thus, the bond issuers have to
repay the principal amount on the maturity date to the bondholders.
2. Debentures:
Debentures are unsecured investment options unlike bonds and they are not
backed by any collateral.
The lending is based on mutual trust and, herein, investors act as potential
creditors of an issuing institution or company.
3. Derivatives:
Derivative instruments are capital market financial instruments whose values
are determined from the underlying assets, such as currency, bonds, stocks, and
stock indexes.
The four most common types of derivative instruments are forwards, futures,
options and interest rate swaps:
 Forward: A forward is a contract between two parties in which the
exchange occurs at the end of the contract at a particular price.
 Future: A future is a derivative transaction that involves the exchange of
derivatives on a determined future date at a predetermined price.
 Options: An option is an agreement between two parties in which the
buyer has the right to purchase or sell a particular number of derivatives
at a particular price for a particular period of time.
 Interest Rate Swap: An interest rate swap is an agreement between two
parties which involves the swapping of interest rates where both parties
agree to pay each other interest rates on their loans in different currencies,
options, and swaps.
4. Exchange-Traded Funds:
Exchange-traded funds are a pool of the financial resources of many
investors which are used to buy different capital market instruments
such as shares, debt securities such as bonds and derivatives.
Most ETFs are registered with the Securities and Exchange Board
of India (SEBI) which makes it an appealing option for investors
with a limited expert having limited knowledge of the stock market.
ETFs having features of both shares as well as mutual funds are
generally traded in the stock market in the form of shares produced
through blocks.

ETF funds are listed on stock exchanges and can be bought and
sold as per requirement during the equity trading time.

5. Mutual Fund
A mutual fund is a collection of money from multiple investors that is used to
buy a variety of securities, such as stocks and bonds. Professional money
managers, known as asset management companies (AMCs), run the fund and
decide when to buy and sell securities.