Money Markets and Capital Markets - Advanced Study Notes | MODULE D: FINANCIAL PRODUCTS AND SERVICES
Money Markets and Capital Markets
Money markets and capital markets are integral components of the financial system. Money markets focus on short-term borrowing and lending (typically up to one year), while capital markets deal with long-term investments and financing.
Call Money, Notice Money, and Term Money
Call Money: Loans repayable on demand, typically with a maturity of 1 day.
Notice Money: Loans with a maturity of 2-14 days.
Term Money: Money lent for a fixed term of over 14 days.
Mathematical Example:
Suppose a bank lends ₹5,000,000 as call money at an interest rate of 3% p.a. for 2 days.
Interest = Principal × Rate × Time
= ₹5,000,000 × (0.03/365) × 2
= ₹821.92
Treasury Bills (T-Bills)
Treasury Bills are short-term debt instruments issued by the government, typically for 91, 182, or 364 days, sold at a discount and redeemed at face value.
Basic Mathematical Example:
If a 91-day T-Bill has a face value of ₹100,000 and is sold for ₹98,000:
Discount Rate = [(Face Value - Purchase Price) / Face Value] × (360 / Days to Maturity)
= [(₹100,000 - ₹98,000) / ₹100,000] × (360/91)
= 0.02 × 3.956
= 7.912% p.a.
Advanced Mathematical Example:
Assume the face value (F) = ₹100,000, purchase price (P) = ₹98,200, days to maturity (D) = 91.
The Bond Equivalent Yield (BEY) is calculated as:
BEY = [(F - P) / P] × (365 / D)
= [(₹100,000 - ₹98,200) / ₹98,200] × (365/91)
= (1,800 / 98,200) × 4.01099
= 0.01832 × 4.01099
= 7.35% p.a.
The Effective Annual Yield (EAY) adjusts for compounding and is calculated as:
EAY = (1 + (Discount / Purchase Price))^(365 / Days to Maturity) - 1
= (1 + (1,800/98,200))^(365/91) - 1
= (1 + 0.01832)^4.01099 - 1
= (1.01832)^4.01099 - 1
= 1.0752 - 1
= 7.52% p.a.
Certificates of Deposit (CDs)
CDs are negotiable money market instruments issued by banks against funds deposited for a specified time at an agreed interest rate.
Commercial Paper (CP)
Commercial Paper is an unsecured, short-term promissory note issued by corporations to raise funds for working capital needs.
Mathematical Example:
A corporation issues a 90-day CP with a face value of ₹1,000,000 at a discounted price of ₹970,000.
Effective Yield = [(Face Value - Issue Price) / Issue Price] × (365 / Days to Maturity)
= (₹1,000,000 - ₹970,000) / ₹970,000 × (365/90)
= 0.03093 × 4.0556
= 12.54% p.a.
Repo (Repurchase Agreements)
Repos are short-term borrowing mechanisms where securities are sold with an agreement to repurchase them at a later date at a predetermined price.
Mathematical Example:
Suppose a repo agreement involves selling securities for ₹5,000,000 with a repurchase agreement at ₹5,005,000 after 1 day:
Repo Rate = [(Repurchase Price - Sale Price) / Sale Price] × (365 / Days)
= (₹5,005,000 - ₹5,000,000) / ₹5,000,000 × 365
= 0.001 × 365
= 36.5% p.a.
Tri-Party Repo
Tri-Party Repo is a type of repo contract where a third party (a clearing agent) manages the transaction, ensuring collateral valuation and settlement efficiency.
Bill Rediscounting Scheme (BRDS)
Under BRDS, banks rediscount commercial bills that have been originally discounted by other banks, improving liquidity in the system.
Long-Term Repo Operations (LTRO)
LTROs allow banks to borrow money from the central bank for longer periods (1 to 3 years) at prevailing repo rates, enhancing liquidity and encouraging lending.
Mathematical Example:
Suppose a bank borrows ₹100 million through LTRO at 5% for 2 years:
Total Interest = Principal × Rate × Time
= ₹100,000,000 × 0.05 × 2
= ₹10,000,000
These concepts and formulas form a foundation for understanding complex financial market dynamics and strategies for liquidity management.
Chapter List
- Overview of Financial Markets
- Money Markets and Capital Markets
- Fixed Income Markets - Debt / Bond Markets
- Forex Markets
- Interconnection of various markets/Market Dynamics
- Merchant Banking Services
- Derivatives Market including Credit Default Swaps
- Factoring, forfaiting & Trade Receivables Discounting System (TReDS)
- Venture capital
- Leasing and Hire Purchase
- Credit Rating agencies & their functions
- Mutual Funds
- Insurance Products
- Pension Funds (include APY, NPS)
- Guidelines on Para Banking & Financial Services provided by Banks
- Real Estate Investment Funds / Infrastructure Investment Fund (concept)
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