1

A

REPORT

ON

MONEY MARKET

2

INDEX

1 INTRODUCTION 1

2 THE ROLE OF MONEY MARKET 4

3 FINANCIAL SECTOR REFORMS 4

4 WHAT IS MONEY MARKET? 12

5 MONEY MARKET INSTRUMENTS 14

5.1 CALL/NOTICE MONEY 14

5.2 TREASURY BILLS 16

5.3 INTER-BANK TERM MONEY 17

5.4 CERTIFICATE OF DEPOSIT 18

5.5 COMMERCIAL PAPERS 19

5.6 READY FORWARD CONTRACTS 21

5.7 COMMERCIAL BILLS 24

3

(1) INTRODUCTION

INDIAN FINANCIAL SYSTEM

The economic development of a nation is reflected by the progress of the

various economic units, broadly classified into corporate sector, government

and household sector. While performing their activities these units will be

placed in a surplus/deficit/balanced budgetary situations.

There are areas or people with surplus funds and there are those with a

deficit. A financial system or financial sector functions as an intermediary

and facilitates the flow of funds from the areas of surplus to the areas of

deficit. A Financial System is a composition of various institutions,

markets, regulations and laws, practices, money manager, analysts,

transactions and claims and liabilities.

FINANCIAL SYSTEM

The word "system", in the term "financial system", implies a set of complex

and closely connected or interlined institutions, agents, practices, markets,

transactions, claims, and liabilities in the economy. The financial system is

concerned about money, credit and finance-the three terms are intimately

related yet are somewhat different from each other. Indian financial system

consists of financial market, financial instruments and financial

intermediation. These are briefly discussed below;

4

FINANCIAL MARKETS

A Financial Market can be defined as the market in which financial assets

are created or transferred. As against a real transaction that involves

exchange of money for real goods or services, a financial transaction

involves creation or transfer of a financial asset. Financial Assets or

Financial Instruments represents a claim to the payment of a sum of money

5

sometime in the future and /or periodic payment in the form of interest or

dividend.

• Money Market

The money market ifs a wholesale debt market for low-risk, highly-liquid,

short-term instrument. Funds are available in this market for periods

ranging from a single day up to a year. This market is dominated mostly by

government, banks and financial institutions.

• Capital Market

The capital market is designed to finance the long-term investments. The

transactions taking place in this market will be for periods over a year.

• Forex Market

The Forex market deals with the multicurrency requirements, which are met

by the exchange of currencies. Depending on the exchange rate that is

applicable, the transfer of funds takes place in this market. This is one of the

most developed and integrated market across the globe.

• Credit Market

Credit market is a place where banks, FIs and NBFCs purvey short, medium

and long-term loans to corporate and individuals.

6

(2) THE ROLE OF MONEY MARKET IN

OUR NATIONAL ECONOMY

The money market is an integral part of the economy and it plays a vital role

in the development of the economy. This is endorsed by the fact that in the

less developed countries, money market too is undeveloped. Consequently,

in the absence of well-developed money market in these countries great

difficulty is experienced in pooling funds large enough to finance private

enterprise. Up to the latter half of the Eighties money market in India was

lopsided. Reserve bank too the initiative and introduced financial sector

reforms to make the money market broad-based and integrated.

(3) FINANCIAL SECTOR REFORMS Objective of Financial Sector Reforms by

Government of India & RBI

To widen, deepen and integrate the different segments of financial sector,

namely, the money market, debt market (particularly Government securities)

and foreign exchange market.

Condition of Money Market in the Pre-Reform

Period (Before 1991)

7

• Financial system functioned in an environment of constriction, driven

primarily by fiscal compulsions. It was geared to provide significant

support for Government expenditure.

• The monetary and debt management policy was underlined by

excessive monetization of Central Government's fiscal deficit.

• Money and Govt. Securities market did not display any vibrancy and

had limited significance in the indirect conduct of monetary policy.

• Money Market instruments were few

• Market had a narrow base and limited to a few participants -

commercial banks and six all India Financial Institutions

• Rate of interest on money market instruments was regulated.

• Money market instruments consisted of Treasury Bills (91-days T-

Bills) and term securities of different maturities issued by the Central

and State Governments.

• The average maturity of securities remained fairly long, that is above

20-years, reflecting the preference of more the Issuers than those of

the Investors

• Government borrowings were done at rates, which were far below the

market rates. For example, for 30-year securities the interest rate was

low at 6.5 per cent in 1977-78.

• The Policy led to distortions in the Banking System with high lending

rates on certain segments combined with relatively low interest rates

on deposits.

8

The Report of the Committee to Review the

Working of the Monetary System - 1985 (Sukkmoy

Chakravarthi Committee)

The committee made several recommendations for the development of

money and government securities markets. As a follow up the RBI set up the

working group on money market (Chairman Mr.N.Vaghul), this submitted

its report in 1987.

The working group recommended a four pronged strategy to activate the

money market.

1. Attempt to be made to widen and deepen the market by selective

increase in the number of participants

2. An endeavor to be made to activate existing instruments so as to have

a well-diversified mix of instruments suited to the different

requirements of borrowers and lenders.

3. A gradual shift from administered interest rates to market determined

rates.

4. To create an active secondary market for money and Securities,

through a process of establishing new sets of institutions, this would

impart sufficient liquidity to the system.

Follow up Measures initiated by R.B.I based on

Chakravarthi Committee and Vaghul Committee

Reports during the period 1985-91

9

Measures taken to encouraging a secondary market in securities:

1. Maximum coupon rate, which was as low as 6.5 per cent in 1977-78,

was raised in stages to 11.5 per cent in 1985-86. Along with this the

maximum maturity period was reduced from 30 years to 20 years.

2. 182 days Treasury bills were introduced in November 1986 for the

first time

3. The Discount and Finance House of India Ltd. was set up in April

1988 as a money market institution jointly by RBI, Public sector

banks and all India financial institutions, to develop a secondary

market for money market instruments and to provide liquidity to these

instruments.

Steps taken to strengthen Money Market

1. Interest rate ceiling was completely withdrawn for all operations in

the call/notice money market and also on rediscounting of commercial

bills in May 1989.

2. In May 1990 THE GIC, IDBI and NABARD were allowed to enter

the Call Money Market as lenders. Also 13 financial institutions,

which were already operating in the Bills Rediscounting Scheme,

were granted entry in the call money market as lenders in October

1990.

3. Certain other non-banking institutions were permitted in October 1991

to enter the call money market as lender through the DFHI

(Discounting and Finance of India Ltd.

4. New money market instruments viz. Certificate of Deposit (CD),

Commercial Paper (CP) and inter-bank participation certificates

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entered the market in 1989-90. RBI framed guidelines for the issuance

of these instruments.

Recommendations of the Committee on Financial

System (the Narasimhan Committee)

A comprehensive package of stabilization and structural reform measures

was initiated by the Government in mid-1991, in the financial sector based

on the recommendations of the Narasimhan Committee. A second Report

was submitted by Narasimhan in 1987 called as the Report of Narasimhan

Committee II

Reforms with regards to Call, Notice, Term Money Market)

In pursuance of the recommendations of the Narasimhan Committee II, the

RBI has a taken a decision to restrict the call, notice, term money market as

a pure inter-bank market with additional access only to PDs. Steps have been

taken to phase out non-bank participants from the market by granting them

permission to operate in the repo market.

Reasons for the step

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Since the withdrawal of the ceiling on the call rate, the call money rate has

shown a tendency to fluctuate significantly on occasions. The sharp

imbalances that arise in the demand and supply of money due to

combination of several factors have led to such volatile behavior. The most

important of these has been bunching of banks' needs for short-term funds in

order to meet the CRR compliance.

Reforms in Primary market

• Auction system of issuing securities has been introduced for both

treasury bills and term securities since 1992-93, in order to pave the

way for market related rates of interest for government paper.

• The base for treasury bills market was widened with auctioning of

different types, introduction of 364-day TB in April 1992 and 91-day

TB in January 1993, and reintroduction of 182-day TBs in May, 1999.

• Funding of auctioned TBs into term securities at the option of holder

as part of debt management.

• New instruments such as Zero coupon bonds, tap stock, partly paid

tap and floating rate bonds were introduced.

• Bringing down the maximum maturity rate government securities

from 30 to 20 years.

• Developments of instruments for repurchase o agreements (repos)

between RBI and commercial banks beginning from December 1997.

• Since April 1997, a new approach was followed by the RBI in its open

market operations that is, sale/purchase operations in government

securities. In setting its price, the RBI responded to market

expectations. It was also prepared to purchase certain securities in

cash.

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The effect of the above reform measures resulted in expanding the investor

base gradually to non-traditional investors. The auction system contributed

to a new treasury culture and progressive development of bidding and

portfolio management skills.

Reforms in Secondary market in Government Securities.

• A phased reduction in SLR requirements from an effective 37.4 per

cent in March 1992 to a little over 28 per cent in March 1996.It has

since been reduced to the statutory benchmark level of 25%.

• The DFHI was authorised to deal in government securities in 1992-93

• The Securities Trading Corporation of India (STCI) was set up in

1994 by the RBI jointly with public sector banks and all India

financial institutions with the main objective of fostering the

development of the government securities market (It commenced

operations in September 1994)

• Market transparency was achieved through regular publication of

details of SGL transactions in Government securities put though

Mumbai PDO since September 1994.

• After its establishment and becoming operational in June 1994, the

National Stock Exchange provided secondary market treading

facilities through its wholesale debt market segment.

• A system of Delivery Versus Payment (DVP) in Government

securities was introduced in Mumbai in June 1995 to ensure that the

transactions in government securities were fully secured.

13

• The Repo market has been activated by allowing repos/reverse repos

transactions in all government securities besides treasury bills of all

maturities.

• Non-bank entities which are holders of account with the RBI have

been allowed to enter reverse repo (but not direct) transactions with

banks/PDs

• With a view to encouraging Mutual Funds to set up gilt funds in

government securities either by way of outright purchase or reverse

repos to the extent of 20 per cent of the outstanding investments.

• Guidelines for satellite dealers in government securities market were

announced in December 1996 And in April 1997 and the RBI granted

approval to 17 entities for registration as satellite dealers in

government securities, to promote/activate retailing in Government

securities

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(4) WHAT IS MONEY MARKET?

Money market refers to the market for short term assets that are close

substitutes of money, usually with maturities of less than a year. A well

functioning money market provides a relatively safe and steady income-

yielding avenue, for short term investment of funds both for banks and

corporate and allows the investor institutions to optimize the yield on

temporary surplus funds. The RBI is a regular player in the money market

and intervenes to regulate the liquidity and interest rates in the conduct of

monetary policy to achieve the broad objective of price stability, efficient

allocation of credit and a stable foreign exchange market. As per definition

given by RBI the money market is "the centre for dealings, mainly short-

term character, in money assets. It meets the short-term requirements of

borrower and provides liquidity or cash to the lenders. It is the place where

short-term surplus investible funds at the disposal of financial and other

institutions and individuals are bid by borrowers, again comprising

Institutions, individuals and also the Government itself".The main segments

of the money market are the call/notice money, term money, commercial

bills, treasury bills, commercial paper and certificate deposits. Mr.G.

Crowther in his treatise "An Outline of Money defines money market as "the

collective name given to the various firms and institutions that deal in the

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various grades of near-money". The money market is as concrete as any

other market and one could see it in operation in London's Lambard Street

or New York's Wall Street. Typical of any other commodity market, there is

very close relationship between different segments of the money market,

(like bankers' Call Money market, commercial paper, treasury bills) that the

one is affected by the other. In other words different segments of the money-

market are broadly integrated.

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(5) MONEY MARKET INSTRUMENTS

Call/Notice Money

Treasury Bills

Inter Bank term Money

Certificate of Deposit (CD)

Commercial Paper (C.P)

Commercial Bills

Inter Bank Participation Certificates

(5.1) CALL/NOTICE MONEY

The most active segment of the money market has been the call money

market, where the day to day imbalances in the funds position of scheduled

commercial banks are eased out. The call notice money market has

graduated into a broad and vibrant institution.

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.

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The entry into this field is restricted by RBI. Commercial Banks, Co-

operative Banks and Primary Dealers are allowed to borrow and lend in this

market. Specified All-India Financial Institutions, Mutual Funds, and certain

specified entities are allowed to access to Call/Notice money market only as

lenders. Reserve Bank of India has recently taken steps to make the

call/notice money market completely inter-bank market. Hence the non-bank

entities will not be allowed access to this market beyond December 31,

2000.

From May 1, 1989, the interest rates in the call and the notice money market

are market determined. Interest rates in this market are highly sensitive to

the demand - supply factors. Within one fortnight, rates are known to have

moved from a low of 1 - 2 per cent to dizzy heights of over 140 per cent per

annum. Large intra-day variations are also not uncommon. Hence there is a

high degree of interest rate risk for participants. In view of the short tenure

of such transactions, both the borrowers and the lenders are required to have

current accounts with the Reserve Bank of India. This will facilitate quick

and timely debit and credit operations. The call market enables the banks

and institutions to even out their day to day deficits and surpluses of money.

Banks especially access the call market to borrow/lend money for adjusting

their cash reserve requirements (CRR). The lenders having steady inflow of

funds (e.g. LIC, UTI) look at the call market as an outlet for deploying funds

on short term basis.

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(5.2) TREASURY BILLS

Treasury Bills are short term (up to 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.

The salient features of the auction system of T-Bills are :

• The 14/91/182/364-day’s bills are issued for a minimum value of

Rs.25, 000 and multiples thereof.

• They are issued at a discount to face value.

• Any person in India including individuals, firms, companies,

corporate bodies, trusts and institutions can purchase the bills.

• The bills are eligible securities for SLR purposes.

• All bids above a cut-off price are accepted and bidders are permitted

to place multiple bids quoting different prices at each auction. Till

November 6, 1998, all types of T-Bills auctions were conducted by

means of 'Multiple Price Auction'. However, since November 6, 1998,

auction of 91-days T-Bills are being conducted by means of 'Uniform

Price Auction'. In the case of 'Multiple Price Auction' method

successful bidders pay their own bid prices, whereas under 'Uniform

Price Auction' method, all successful bidders pay an uniform price,

i.e. the cut-off price emerged in the auction.

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• The bills are generally issued in the form of SGL - entries in the books

of Reserve Bank of India. The SGL holdings can be transferred by

issuing a SGL transfer form. For non-SGL account holders, RBI has

been issuing the bills in scrip form.

(5.3) INTER-BANK TERM MONEY

Inter-bank market for deposits 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, the specified

entities are not allowed to lend beyond 14 days.

The market in this segment is presently not very deep. The declining spread

in lending operations, the volatility in the call money market with

accompanying risks in running asset/liability mismatches, the growing desire

for fixed interest rate borrowing by corporate, the move towards fuller

integration between forex and money markets, etc. are all the driving forces

for the development of the term money market. These, coupled with the

proposals for rationalization of reserve requirements and stringent guidelines

by regulators/managements of institutions, in the asset/liability and interest

rate risk management, should stimulate the evolution of term money market

sooner than later. The DFHI (Discount & Finance House of India), as a

major player in the market, is putting in all efforts to activate this market.

(5.4) CERTIFICATES OF DEPOSIT

20

Certificates of Deposit (CDs) - introduced since June 1989 - are negotiable

term deposit certificates issued by a commercial banks/Financial Institutions

at discount to face value at market rates, with maturity ranging from 15 days

to one year.

Being securities in the form of promissory notes, transfer of title is easy, by

endorsement and delivery. Further, they are governed by the Negotiable

Instruments Act. As these certificates are the liabilities of commercial

banks/financial institutions, they make sound investments.

DFHI trades in these instruments in the secondary market. The market for

these instruments is not very deep, but quite often CDs are available in the

secondary market. DFHI is always willing to buy these instruments thereby

lending liquidity to the market.

• Salient features:

• CDs can be issued to individuals, corporations, companies, trusts,

funds, associates, etc.

• NRIs can subscribe to CDs on non-repatriable basis.

• CDs attract stamp duty as applicable to negotiable instruments.

• Banks have to maintain SLR and CRR on the issue price of CDs. No

ceiling on the amount to be issued.

• The minimum issue size of CDs is Rs.5 lakhs and multiples thereof.

• CDs are transferable by endorsement and delivery.

• The minimum lock-in-period for CDs is 15 days.

CDs are issued by Banks, when the deposit growth is sluggish and credit

demand is high and a tightening trend in call rate is evident. CDs are

21

generally considered high cost liabilities and banks have recourse to them

only under tight liquidity conditions.

(5.5) COMMERCIAL PAPERS

Commercial Papers are unsecured debts of corporate. They are issued in the

form of promissory notes, redeemable at par to the holder at maturity. Only

corporate who get an investment grade rating can issue CPs, as per RBI

rules. Though CPs is issued by corporate, they could be good investments, if

proper caution is exercised.

CPs enable highly rated corporate borrowers to diversify their sources of

short-term borrowings and raise a part of their requirement at competitive

rates from the market. The introduction of Commercial Paper (CP) in

January 1990 as an additional money market instrument was the first step

towards securitization of commercial bank's advances into marketable

instruments.

The market is generally segmented into the PSU CPs, i.e. those issued by

public sector unit and the private sector CPs. CPs issued by top rated

corporate is considered as sound investments.

DFHI trades in these certificates. It will buy these certificates, subject to its

perception of the instrument and will also be offering them for sale subject

to availability of stock.

Salient Features

22

• CPs is issued by companies in the form of usance promissory note,

redeemable at par to the holder on maturity.

• The tangible net worth of the issuing company should be not less than

Rs.4 crores.

• Working capital (fund based) limit of the company should not be less

than Rs.4 crores.

• Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2 or

higher from any approved rating agencies and should be more than 2

months old on the date of issue of CP.

• Cooperators are allowed to issue CP up to 100% of their fund based

working capital limits.

• It is issued at a discount to face value.

• CP attracts stamp duty.

• CP can be issued for maturities between 15 days and less than one

year from the date of issue.

• CP may be issued in the multiples of Rs.5 lakh.

• No prior approval of RBI is needed to issue CP and underwriting the

issue is not mandatory.

• All expenses (such as dealers' fees, rating agency fee and charges for

provision of stand-by facilities) for issue of CP are to be borne by the

issuing company,

The purpose of introduction of CP was to release the pressure on bank funds

for small and medium sized borrowers and at the same time allowing highly

rated companies to borrow directly from the market.

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(5.6) READY FORWARD CONTRACTS

(REPOS)

Ready forward or Repos or Buyback deal is a transaction in which two

parties agree to sell and repurchase the same security. Under such an

arrangement, the seller sells specified securities with an agreement to

repurchase the same at a mutually decided future date and a price. Similarly,

the buyer purchases the securities with an agreement to resell the same to the

seller on an agreed date in future at a prefixed price. For the purchaser of the

security, it becomes a Reverse Repo deal. In simple terms, it is recognized as

a buy back arrangement. In a standard ready forward transaction when a

bank sells its securities to a buyer it simultaneously enters into a contract

with him (the buyer) to repurchase them on a predetermined date and price

in the future. Both sale and repurchase prices of securities are determined

prior to entering into the deal. In return for the securities, the bank receives

cash from the buyer of the securities. It is a combination of securities trading

(involving a purchase and sale transaction) and money market operation

(lending and borrowing). The repo-rate represents the borrowing/lending

rate for use of the money in the intervening period. As the inflow of cash

from the ready forward transaction is used to meet temporary cash

requirement, such a transaction in essence is a short term cash management

technique.

The motivation for the banks and other organizations to enter into a ready

forward transaction is that it can finance the purchase of securities or

otherwise fund its requirements at relatively competitive rates. On account

of this reason the ready forward transaction is purely a money lending

24

operation. Under ready forward deal the seller of the security is the borrower

and the buyer is the lender of funds. Such a transaction offers benefits both

to the seller and the buyer. Seller gets the funds at a specified interest rate

and thus hedges himself against volatile rates without parting with his

security permanently (thereby avoiding any distressed sale) and the buyer

gets the security to meet his SLR requirements. In addition to pure funding

reasons, the ready forward transactions are often also resorted to manage

short term SLR mismatches.

Internationally, Repos are versatile instruments and used extensively in

money market operations. While inter-bank Repos were being allowed prior

to 1992 subject to certain regulations, there were large scale violation of laid

down guidelines leading to the 'securities scam' in 1992; this led

Government and RBI to clamp down severe restrictions on the usage of this

facility by the different market participants. With the plugging of loophole in

the operation, the conditions have been relaxed gradually.

RBI has prescribed that following factors have to be considered while

performing repo:

purchase and sale price should be in alignment with the ongoing

market rates

No sale of securities should be affected unless the securities are

actually held by the seller in his own investment portfolio.

Immediately on sale, the corresponding amount should be reduced

from the investment account of the seller.

The securities under repo should be marked to market on the balance

sheet date.

25

The relaxations over the years made by RBI with regard to repo transactions

are:

In addition to Treasury Bills, all central and State Government

securities are eligible for repo.

Besides banks, PDs are allowed to undertake both repo/reverse repo

transactions.

RBI has further widened the scope of participation in the repo market

to all the entities having SGL and Current with RBI, Mumbai, thus

increasing the number of eligible non-bank participants to 64.

It was indicated in the 'Mid-Term Review' of October 1998 that in line

with the suggestion of the Narasimham Committe II, the Reserve

Bank will move towards a pure inter-bank (including PDs) call/notice

money market. In view of this non-bank entities will be allowed to

borrow and lend only through Repo and Reverse Repo. Hence

permission of such entities to participate in call/notice money market

will be withdrawn from December 2000.

In terms of instruments, repos have also been permitted in PSU bonds

and private corporate debt securities provided they are held in

dematerialized from in a depository and the transactions are done in a

recognized stock exchange.

Apart from inter-bank repos RBI has been using this instrument effectively

for its liquidity management, both for absorbing liquidity and also for

injecting funds into the system. Thus, Repos and Reverse Repo are resorted

to by the RBI as a tool of liquidity control in the system. With a view to

absorbing surplus liquidity from the system in a flexible way and to prevent

26

interest rate arbitraging, RBI introduced a system of daily fixed rate repos

from November 29, 1997.

Reserve Bank of India was earlier providing liquidity support to PDs

through the reverse repo route. This procedure was also subsequently

dispensed with and Reserve Bank of India began giving liquidity support to

PDs through their holdings in SGL A/C. The liquidity support is presently

given to the Primary Dealers for a fixed quantum and at the Bank Rate based

on their bidding commitment and also on their past performance. For any

additional liquidity requirements Primary Dealers are allowed to participate

in the reverse repo auction under the Liquidity Adjustment Facility along

with Banks, introduced by RBI in June 2000.

The major players in the repo and reverse repurchase market tend to be

banks who have substantially huge portfolios of government securities.

Besides these players, primary dealers who often hold large inventories of

tradable government securities are also active players in the repo and reverse

repo market.

(5.7) COMMERCIAL BILLS

Bills of exchange are negotiable instruments drawn by the seller (drawer) on

the buyer (drawee) for the value of the goods delivered to him. Such bills are

called trade bills. When trade bills are accepted by commercial banks, they

are called commercial bills. If the seller wishes to give some period for

payment, the bill would be payable at a future date (usance bill). During the

27

currency of the bill, if the seller is in need of funds, he may approach his

bank for discounting the bill. One of the methods of providing credit to

customers by bank is by discounting commercial bills at a prescribed

discount rate. The bank will receive the maturity proceeds (face value) of

discounted bill from the drawee. In the meanwhile, if the bank is in need of

funds, it can rediscount the bill already discounted by it in the commercial

bill rediscount market at the market related rediscount rate. (The RBI

introduced the Bill Market Scheme in 1952 and a new scheme called the Bill

Rediscounting Scheme in November 1970).

The eligibility criteria prescribed by the Reserve Bank of India for

rediscounting commercial bill inter-alia are that the bill should arise out of

genuine commercial transaction evidencing sale of goods and the maturity

date of the bill should not be more than 90 days from the date of

rediscounting.

Derivative Usance Promissory Notes (DUPN)

IT is an innovative instrument issued by the RBI to eliminate movement of

papers and facilitating easy rediscounting. DUPN is backed by up to 90 days

Usance commercial bills. Government has exempted stamp duty on DUPN

to simplify and steam-line the instrument and to make it an active instrument

in the secondary market. The minimum rediscounting period is 15 days.

With a view to eliminating movement of papers and facilitating multiple

rediscounting, the RBI introduced an innovative instrument known as

"Derivative Usance Promissory Notes" backed by such eligible commercial

bills for required amounts and usance period (up to 90 days). Government

28

has exempted stamp duty on derivative usance promissory notes. This has

indeed simplified and streamlined the bill rediscounting by Institutions and

made commercial bill an active instrument in the secondary money market.

Rediscounting institutions have also advantages in that the derivative usance

promissory note, being a negotiable instrument issued by a bank, is good

security for investment. It is transferable by endorsement and delivery and

hence is liquid. Thanks to the existence of a secondary market the

rediscounting institution can further discount the bills anytime it wishes

prior to the date of maturity. In the bill rediscounting market, it is possible to

acquire bills having balance maturity period of different days upto 90 days.

Bills thus provide a smooth glide from call/overnight lending to short term

lending with security, liquidity and competitive return on investment. As

some banks were using the facility of rediscounting commercial bills and

derivative usance promissory notes for as short a period as one day merely a

substitute for call money, RBI has since restricted such rediscounting for a

minimum period of 15 days.

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PRIMARY DEALERS

In March 1995 the RBI announced guidelines for setting up of primary

dealers (PD) with the objectives of -

a. Strengthening the infrastructure of the government securities market

in order to make it vibrant, liquid and broad based.

b. Ensuring development of underwriting and market capabilities of

government securities outside the RBI.

c. Improving the secondary market trading system, which could

contribute to price discovery, enhanced liquidity and to turn over and

encourage voluntary holdings of government securities outside the

RBI.

d. Making PDs an effective conduit for conducting open market

operations.

The full extent of notified amount of the dated government securities were

offered for underwriting and the underwriting fees and amounts to be

allowed to each PD prior to auction of each security. In respect of TBs, the

PDs are required to give minimum holding commitments and fixed

underwriting fees are paid for successful bids. The RBI granted liquidity

support for PDs against their holding in SGL Account.

Market transparency was established through regular publication of details

of SGL transactions in government securities put through at Mumbai PDO

since September 1994. The NSC which became operational in June 1994

also provided secondary market trading facilities through its wholesale debt

market segment since 1994-95.

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Guidelines for satellite dealers in the government securities market were

announced in December 1996 and in April 1997. Satellite dealers in

government securities are expected to activate retailing of government

securities.

SATELLITE DEALERS

In the Mid-term Review of October 2001, RBI announced its decision to

undertake a review of the Satellite Dealer (SD) system in consultation with

market participants. After obtaining the views of the Primary Dealers

Association of India (PDAI) and after further discussions in TAC and

considering their role in the present conditions, it has been decided to

discontinue the system. Accordingly: No new SDs will be licensed. Existing

SDs will be required to make action plans, satisfactory to RBI for

termination of their operations as SDs by May 31, 2002.

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(6)Foreign Institutional Investor (FII)

FII means an entity established or incorporated outside India which proposes to make investment in India. The FIIs have been a major driver in Indian equities' upward journey in the recent past and resumption of positive momentum is unlikely before FIIs start purchasing again. One who propose to invest their proprietary funds or on behalf of "broad based" funds or of foreign corporate and individuals and belong to any of the under given categories can be registered for FII.

1. Pension Funds 2. Mutual Funds 3. Investment Trust 4. Insurance or reinsurance companies 5. Endowment Funds 6. University Funds 7. Foundations or Charitable Trusts or Charitable Societies who propose

to invest on their own behalf, and 8. Asset Management Companies 9. Nominee Companies 10. Institutional Portfolio Managers 11. Trustees 12. Power of Attorney Holders 13. Bank The parameters on which SEBI decides

eligibility of a FII Applicant.

1) Applicant’s track record, professional competence, financial soundness, experience, general reputation of fairness and integrity. (The applicant should have been in operation for at least one year)

2) whether the applicant is registered with and regulated by an appropriate Foreign Regulatory Authority in the same capacity in which the application is filed with SEBI

3) Whether the applicant is a fit & proper person.

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As per Regulation 6 of SEBI (FII) Regulations, 1995, Foreign Institutional Investors are required to fulfill the following conditions to qualify for grant of registration:

• Applicant should have track record, professional competence, financial soundness, experience, general reputation of fairness and integrity;

• The applicant should be regulated by an appropriate foreign regulatory authority in the same capacity/category where registration is sought from SEBI. Registration with authorities, which are responsible for incorporation, is not adequate to qualify as Foreign Institutional Investor.

• The applicant is required to have the permission under the provisions of the Foreign Exchange Management Act, 1999 from the Reserve Bank of India.

• Applicant must be legally permitted to invest in securities outside the country or its in-corporation / establishment.

• The applicant must be a "fit and proper" person. • The applicant has to appoint a local custodian and enter into an

agreement with the custodian. Besides it also has to appoint a designated bank to route its transactions.

• Payment of registration fee of US $ 5,000.00

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Current scenario of FII The FII inflow has slowed down considerably in the past few days, partly due to valuations getting expensive in India, and the overseas investors have started exploring other markets with better valuations.

Foreign Institutional Investors (FII) have sold shares worth a net of about Rs 1,000 crore so far in November against a net purchase of shares worth over Rs 20,000 crore in October.

So far in 2007, the FIIs have made a net purchase worth over Rs 70,000 crore (more than 17 billion dollars) -- the highest annual inflow so far.

India funds have seen a net outflow of 792 million dollar so far in 2007, against an inflow of 1,751 million dollar in the same period last year.