Treasury Bills & Commercial Papers

CHAPTER 01

Treasury bills

Treasury bills are short-term instruments issued by the RBI on

behalf of the government to tide over short term liquidity shortfalls.

The instruments are issued by government to raise short term funds

to bridge seasonal or temporary gaps between its receipts (revenue &

capital) and expenditure.

They form the most important segment of the money market

not only in India but all over the world as well.

T- Bills are repaid at par on maturity. The difference between

the amount paid by the tendered at the time of purchase (which is

less than the face value) & the amount received on maturity

represents the interest amount on T-bills & is known as the discount.

Tax deducted at source (TDS) is not applicable on T-bills.

T-bills are short-term securities that mature in one year or less

from their issue date. They are issued with three-month, six-month

and one-year maturities. T-bills are purchased for a price that is less

than their par (face) value; when they mature, the government pays

the holder the full par value. Effectively, your interest is the

difference between the purchase price of the security and what you

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get at maturity. For example, if you bought a 90-day T-bill at $9,800

and held it until maturity, you would earn $200 on your investment.

This differs from coupon bonds, which pay interest semi-annually. 

Treasury bills (as well as notes and bonds) are issued through a

competitive bidding process at auctions. If you want to buy a T-bill,

you submit a bid that is prepared either non-competitively or

competitively. In non-competitive bidding, you'll receive the full

amount of the security you want at the return determined at the

auction. With competitive bidding, you have to specify the return

that you would like to receive. If the return you specify is too high,

you might not receive any securities, or just a portion of what you bid

for. (More information on auctions is available at the Treasury Direct

website.)

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History of Treasury bills

Treasury bills were first authorized by Congress in 1929. After

experimenting with a number of bill maturities, the Treasury in 1937

settled on the exclusive issue of three-month bills. In December 1958

these were supplemented with six-month bills in the regular weekly

auctions. In 1959 the Treasury began to auction one-year bills on a

quarterly basis. The quarterly auction of one-year bills was replaced

in August 1963 by an auction occurring every four weeks. The

Treasury in September 1966 added a nine-month maturity to the

auction occurring every four weeks but the sale of this maturity was

discontinued in late 1972. Since then, the only regular bill offerings

have been the offerings of three- and six-month bills every week and

the offerings of one-year bills every four weeks. The Treasury has

increased the size of its auctions as new money has been needed to

meet enlarged federal borrowing requirements. In 1992 the weekly

auctions of three- and six-month bills both ranged from $10.2 billion

to $12.5 billion, and the four-week auctions of one-year bills ranged

from $12.8 billion to $15.0 billion.

In addition to its regularly scheduled sales, the Treasury raises

money on an irregular basis through the sale of cash management

bills, which are usually "reopenings" or sales of bills that mature on

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the same date as an outstanding issue of bills.   Cash management

bills are designed to bridge low points in the

 Prior to 1975, the Treasury raised funds on an irregular basis

through the sale of tax anticipation bills. Nelson (1977) provides a

description of these bills. 

Treasury's cash balances. Many cash management bills help

finance the Treasury's requirements until tax payments are received.

For this reason they frequently have maturities that fall after one of

the five major federal tax dates. Sixty issues of cash management bills

were sold in the decade from 1983 through 1992. Of these, 29 had

maturities of less than one month, 21 had maturities between one

month and three months, and 10 had maturities between three

months and one year.

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Features of Treasury Bills

 Form
 The treasury bills are issued in the form of promissory note in

physical form or by credit to Subsidiary General Ledger (SGL)

account or Gilt account in dematerialised form.

 Minimum Amount Of Bids :

 Bids for treasury bills are to be made for a minimum amount of Rs

25000/- only and in multiples thereof.

 Eligibility:
 All entities registered in India like banks, financial institutions,

Primary Dealers, firms, companies, corporate bodies, partnership

firms, institutions, mutual funds, Foreign Institutional Investors,

State Governments, Provident Funds, trusts, research organisations,

Nepal Rashtra bank and even individuals are eligible to bid and

purchase Treasury bills.

 Repayment
 The treasury bills are repaid at par on the expiry of their tenor at the

office of the Reserve Bank of India, Mumbai.

 Availability
 All the treasury Bills are highly liquid instruments available both in

the primary and secondary market.

 Day Count
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 For treasury bills the day count is taken as 365 days for a year.

 Yield Calculation
The yield of a Treasury Bill is calculated as per the following formula:

(100-P)*365*100

Y= ------------------

P*D

Wherein  Y = discounted yield

  P= Price

  D= Days to maturity

Advantages of Treasury Bills

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 No tax deducted at source

 Zero default risk being sovereign paper

 Highly liquid money market instrument

 Better returns especially in the short term

 Transparency

 Simplified settlement

 High degree of tradeability and active secondary market facilitates

meeting unplanned fund requirements.

Treasury Bills Market

Primary Market

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The primary market, treasury bills are issued by auction technique.

CALENDAR OF AUCTION FOR TREASURY BILLS

TREASURY DAY OF DAY OF

BILLS AUCTION PAYMENT

91 DAYS Every Following Friday

Wednesday

182 DAYS Wednesday Following Friday

preceding the

non –reporting

Friday

364 days Wednesday Following Friday

preceding the

reporting Friday

 Salient Features Of The Auction Technique

 The auction of treasury bills is done only at Reserve Bank of

India, Mumbai.

 Bids are submitted in terms of price per Rs 100. For example, a

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bid for 91-day Treasury bill auction could be for Rs 97.50.

 Auction committee of Reserve Bank of India decides the cut-off

price and results are announced on the same day.

 Bids above the cut-off price receive full allotment; bids at cut-off

price may receive full or partial allotment and bids below the cut-

off price are rejected.

 Types of Auctions

There are two types of auction for treasury bills:

 Multiple Price Based or French Auction: Under this method, all

bids equal to or above the cut-off price are accepted. However,

the bidder has to obtain the treasury bills at the price quoted by

him.

 Uniform Price Based or Dutch auction: Under this system, all

the bids equal to or above the cut-off price are accepted at the cut-

off level. However, unlike the Multiple Price based method, the

bidder obtains the treasury bills at the cut-off price and not the

price quoted by him.

Secondary Market & Players

The major participants in the secondary market are scheduled banks,

financial Institutions, Primary dealers, mutual funds, insurance

companies and corporate treasuries. Other entities like cooperative

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and regional rural banks, educational and religious trusts etc. have

also begun investing their short term funds in treasury bills.

Advantages

 Market related yields

 Transparency in operations as the transactions would be put

through Reserve Bank of India’s SGL or Client’s Gilt account only

 Two way quotes offered by primary dealers for purchase and sale

of treasury bills.

 Certainty in terms of availability, entry & exit.

Types of treasury bills

A)Ordinary Treasury Bills.

B) Ad Hoc Treasury Bills.

A)Ordinary Treasury Bills;-

The freely marketable treasury bills that are issued by the

Government of India to the public, banks, & other financial

institutions for raising resources to meet the short term financial

needs are known as Ordinary Treasury Bills.

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B) Ad Hoc Treasury Bills: -

The bills which are issued in favour of the RBI only is known as Ad

Hoc Treasury Bills. They are issued to serve the purpose of tapping

cash balances of the Central Government. It provides an investments

avenue to state governments, semi-governments departments &

Foreign Central Banks for parking their surplus & fro earning

income. The holders of this bill can always sell them back to RBI.

Types of Treasury bills on account of maturity:-

1) 91 Days: -
The 91-day Treasury bill is a short term debt instrument issued by the

national government purposefully to generate quick funds needed to

finance outstanding obligations. The day Treasury bill is a weighed

average rate of the weekly auctions of 91-day treasury bills.

2) 182 Days: -
The 182-days Treasury bills are auctioned on Wednesday proceeding

none reporting Friday. They have a maturity period of 182 days &

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3) 364 Days: -
The 364 days bills were introduced in the year 1992. They are

auctioned at Wednesday proceeding the reporting Friday.

Treasury Bills - An Effective Cash

Management Product

Treasury Bills are very useful instruments to deploy short term

surpluses depending upon the availability and requirement. Even

funds which are kept in current accounts can be deployed in treasury

bills to maximise returns Banks do not pay any interest on fixed

deposits of less than 15 days,or balances maintained in current

accounts, whereas treasury bills can be purchased for any number of

days depending on the requirements. This helps in deployment of

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idle funds for very short periods as well. Further, since every week

there is a treasury bills auction, one can purchase treasury bills of

different maturities as per requirements so as to match with the

respective outflow of funds. At times when the liquidity in the

economy is tight, the returns on treasury bills are much higher as

compared to bank deposits even for longer term. Besides, better

yields and availability for very short tenors, another important

advantage of treasury bills over bank deposits is that the surplus cash

can be invested depending upon the staggered requirements.

    Example :

Suppose party A has a surplus cash of Rs 200 crore to be deployed in

a project. However, it does not require the funds at one go but

requires them at different points of time as detailed below:

Funds Available as on 1.1.2000 Rs. 200 crore

Deployment in a project Rs. 200 crore

As per the requirements

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DATE AMOUNT

6/01/2000 Rs. 50 crore

13/01/2000 Rs. 20 crore

02/02/2000 Rs. 30 crore

08/02/2000 Rs. 100 crore

Out of the above funds and the requirement schedule, the party has

following two options for effective cash management of funds:

    Option I

    Invest the cash not required within 15 days in bank deposits

The party can invest a total of Rs 130 crore only, since the balance Rs

70 crores is required within the first 15 days. Assuming a rate of

return of 6% paid on bank deposits for a period of 31 to 45 days, the

interest earned by the company works out to Rs 76 lacs

approximately.

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    Option II

    Invest in Treasury Bills of various maturities depending on the

funds requirements

The party can invest the entire Rs 200 crore in treasury bills as

treasury bills of even less than 15 days maturity are also available.

The return to the party by this deal works out to around Rs 125 lacs,

assuming returns on Treasury Bills in the range of 8% to 9% for the

above periods.

    Portfolio Management Strategies

Strategies for managing a portfolio can broadly be classified as active

or passive strategies.

Buy And Hold A buy and hold strategy can be described as a passive

strategy since the Treasury bills once purchased, would be held till its

maturity. The salient features of this strategy are:

Return is fixed or locked in at the time of investment itself.

The exposure to price variations due to secondary market

fluctuations is eliminated.

There is no risk of default on maturity.

    Buy And Trade

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This strategy can also be described as an active market strategy. The

returns on this strategy are higher than the buy and hold strategy as

the yield can be optimised by actively trading the treasury bills in the

secondary market before maturity.

Growth of Treasury Bills

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350000

300000

250000

200000
T-Blls 91
T-Bills 182
150000 T-Bills 364

100000

50000

0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

The treasury bills have shown a tremendous growth rate in the last

10 years , as it is a risk free investment options which is backed by the

Central Government & RBI.

The treasury bills acts as agreat investment avenue for the people

who likes to avoid risk, as they like to earn lesser return but without

any risk.

The treasury bills market in India have a very huge demand as they

are an good option for investing money for a very short period &

earn a good return on it.

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The treasury bills market are also very popular in the US markets as

it acts as market for the US Central Government to raise short term

funds for their working.

The treasury bills market in India have a very good future prospect

which will see a increase in the volumes traded in treasury bills

market as it has already shown that in the previous years that it is

growing by the rate of 3% to 4% annually which is a good sign.

CHAPTER 02

Commercial Paper

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Commercial Paper (CP) is a short-term, unsecured usance promissory

note issued at a discount to face value by well-known or reputed

companies, who carry a high credit rating and have a strong financial

background. Companies issue CPs typically to finance accounts

receivable and inventories at a discount reflecting the prevailing

market interest rates.

Commercial paper is an unsecured promissory note with a fixed

maturity of 1 to 270 days. Commercial Paper is a money-market

security issued (sold) by large banks and corporations to get money

to meet short term debt obligations (for example, payroll), and is only

backed by an issuing bank or corporation's promise to pay the face

amount on the maturity date specified on the note. Since it is not

backed by collateral, only firms with excellent credit ratings from a

recognized rating agency will be able to sell their commercial paper

at a reasonable price. Commercial paper is usually sold at a discount

from face value, and carries higher interest repayment rates than

bonds. Typically, the longer the maturity on a note, the higher the

interest rate the issuing institution must pay. Interest rates fluctuate

with market conditions, but are typically lower than banks' rates.

Guidelines for issue of CP are presently governed by various

directives issued by the Reserve Bank of India, as amended from time

to time.

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In pursuance of the Statement on Monetary and Credit Policy for the

Year 2000 - 2001, to keep pace with several developments in the

financial market, it has been decided to modify the guidelines in the

light of recommendations made by an Internal Group

“An unsecured obligation issued by a corporation or bank to finance

its short-term credit needs, such as accounts receivable and

inventory. Maturities typically range from 2 to 270days.Commercial

paper is available in a wide range of denominations, can be either

discounted or interest-bearing, and usually have a limited or non

existent secondary market. Commercial paper is usually issued by

companies with high credit ratings, meaning that the investment is

almost always relatively low risk.”

HISTORY OF COMMERCIAL PAPER IN

INDIA

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A working group under the chairmanship of Mr. N. Vaghul was

appointed by Reserve Bank of India in September 1986 to study and

give recommendations for broad basing the money market and

development of money market instruments. The Committee,

submitted its report in January 1987, had recommended the

introduction of Commercial Paper.

The Reserve Bank of India had, with a view to enabling highly rated

corporate borrowers to diversify their sources of short-term

borrowing and also providing an additional instrument to investors,

made for the first time a reference to the commercial papers in March

1989 and accordingly, issued detailed guidelines under "Non-

Banking Companies (Acceptance of Deposits through Commercial

Paper) Directions, 1989" through a notification dated 11th December,

1989 and these Directions were made effective from 1st January, 1990.

Initially, only top rated corporates with tangible net worth of not less

than Rs. 10 crore were allowed to issue CP with maturity between 3-6

months from the date of issue. Further, issuance of the CP had to be

carved out of the working capital (fund based) limit and it was also

stipulated that CP could be issued in multiples of Rs. 25 lakh and the

amount to be invested by a single investor should not be less than Rs

1 crore.

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Purpose of Issuance

While creditworthy corporations can borrow from banks for the

prime rate of interest, they may be able to borrow at a lower rate by

selling commercial paper. Commercial paper is also sold to provide

seasonal and working capital for corporations, to provide bridge

financing until longer term securities are sold or until money is

expected to be received, such as tax receipts, and to finance the

purchase of other securities. CDOs and SIVs, for instance, use

commercial paper to finance the purchase of mortgage-backed

securities (MBSs), profiting from the difference of receiving the

higher yield of MBS securities, and paying the lower yield of

commercial paper.

As an example of bridge financing, a corporation may project that

interest rates will be lower in the future, but, for business reasons,

may want to finance a project immediately. It can finance the project

immediately by issuing commercial paper with a maturity that

coincides with the projected lower interest rates. Then it can issue

long-term bonds, and use the proceeds to pay for the redemption of

the commercial paper.

REFORMS IN COMMERCIAL PAPER

POLICY
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Jan July July July June July Sep.

1990 1990 1991 1992 1994 1995 1996

Tangible Net 10 5 - - 4 Crore - -

Worth Crore Crore

WCFBL* 25 15 10 5 4 Crore - -
Crore Crore Crore Crore

Minimum Size 1 50 25 - - - -
Crore Lakh Lakh

Maximum Size 20% - 30% 75% - 75% 100%

of of of of of Cash
MPBF MPBF MPBF Cash Credit
** Credi Compo
t ne nt
Comp
one
nt

Denominations 25 10 5 - - - -
Lakh Lakh Lakh

Maturity Period 91day - - - 3 - -

s-6 months
mont – 1year
hs

Credit Rating P1+ by CRISIL or - P2 - - -

Equal grade by
other agencies

Other Measures
             

Features of Commercial Paper

1) Type of issuers :-

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Resident and non-resident firms other than credit institutions subject

to the fulfilment of the legal, capital and supervisory requirements

governing public offerings, or equivalent requirements for firms

whose head offices are located abroad, Investment firms, Economic

interest groups and partnerships, made up exclusively of joint stock

companies, Special purpose vehicles

2) Maturity:-
One day to 1 year.

3) Commercial paper does not originate from a specific self-liquidating

transaction like normal commercial bills which generally arise out of

specific trade transactions.

4) CPs are backed by the liquidity and earning power of the issuer, but

are not backed by any assets, and hence they are unsecured.

5) The CP market provides the borrower (i.e. highly rated corporates) a

cheaper source of funds with less paperwork / formalities when

compared to bank finance. Corporates prefer this mode of finance as

they can determine the cost and maturity. Similarly, issuing a CP

involves less of paperwork / formalities, as it is unsecured liability,

unlike bank finance, which is secured.

6) Investors prefer to invest in CPs due to high liquidity, varied

maturity and high yield (when compared to bank deposits). The

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liquidity is high because it can be transferred by endorsement and

delivery.

Who can issue Commercial Papers?

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Corporate, primary dealers (PDs) and satellite dealers (SDs), and the

all-India financial institutions (FIs) that have been permitted to raise

short-term resources under the umbrella limit fixed by Reserve Bank

of India are eligible to issue CP.

A corporate would be eligible to issue CP provided –

(a) The tangible net worth of the company, as per the latest audited

balance sheet, is not less than Rs. 4 crore;

(b) Company has been sanctioned working capital limit by bank/s or all-

India financial institution/s; and

(c) The borrowable account of the company is classified as a Standard

Asset by the financing bank/s/ institution/s.

RATINGS REQUIREMENT

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All eligible participants shall obtain the credit rating for issuance of

Commercial Paper from either the Credit Rating Information Services

of India Ltd. (CRISIL) or the Investment Information and Credit

Rating Agency of India Ltd. (ICRA) or the Credit Analysis and

Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such

other credit rating agency (CRA) as may be specified by the Reserve

Bank of India from time to time, for the purpose. The minimum

credit rating shall be P-2 of CRISIL or such equivalent rating by other

agencies. The issuers shall ensure at the time of issuance of CP that

the rating so obtained is current and has not fallen due for review.

App Major
High Lowe Specul rox. Publicat
er r ative Defau # of ion
A/Pr A/Pr Below lted CP Listing
ime ime Prime Rati CP
ngs Ratings

Moo P-1 P-2, NP NP 2,0 Moody'

dy's P-3 00 s
Global
Short-
Term
Market
Record

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Stan A- A-2, B, C D 2,0 S&P

dard 1+, A-3 00 Comme
& A-1 rcial
Poor' Paper
s Ratings
Guide

Duff Duff Duff Duff 4 Duff 175 Short-

& 1+, 2, 5 Term
Phel Duff Duff Ratings
ps 1, 3 and
Duff Researc
1- h Guide

Fitch F- F-2, F-5 D 125 Fitch

1+, F-3 Ratings
F-1

Rang AAA A, BB, B,  

e of , AA, BBB CCC,
Likel A CC, C
y
S&P
Long
-
Term
Bond
Ratin
g

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Limits and the Amount of Issue of CP

CP can be issued as a "stand alone" product. The aggregate amount of

CP from an issuer shall be within the limit as approved by its Board

of Directors or the quantum indicated by the Credit Rating Agency

for the specified rating, whichever is lower. Banks and FIs will,

however, have the flexibility to fix working capital limits duly taking

into account the resource pattern of companies' financing including

CPs. An FI can issue CP within the overall umbrella limit fixed by the

RBI i.e., issue of CP together with other instruments viz., term money

borrowings, term deposits, certificates of deposit and inter-corporate

deposits should not exceed 100 per cent of its net owned funds, as per

the latest audited balance sheet.

Every issue of CP, including renewal, should be treated as a fresh

issue.

Maturity
CP can be issued for maturities between a minimum of 7 days and a
maximum up to one year from the date of issue.

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Denominations
CP can be issued in denominations of Rs.5 lakh or multiples thereof.

Amount invested by a single investor should not be less than Rs.5

lakh (face value).

Factors affecting the Pricing

CP being a short-term instrument, its primary and secondary market
determination of the interest rate, i.e. the discount rate, depends
upon conditions in short-term money market. The following are the
principal factors in pricing of the CPs.

Interbank Call Rates:

Since call rates affect all the order short-term rates and banks are the
most important investors in CPs, its pricing is affected very much by
call rates. Also, as the lenders in the CP market are predominantly
banks, call markets affect CP market rate; lower call rates mean cash
surplus banks will view CPs as an alternative investment route.

Competing Money Market Investment Products:

Interest rates on CPs are determined by the demand and supply

factors in the money markets and the interest rate on the order
competing money market instrument such as Certificates of Deposit,

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Commercial Bills, Short-term Forward Premias and Treasury Bills.

The investment in CPs give comparably higher yields than those
obtained in bank deposits of similar maturities.

Liquidity:

Pricing and availability of funds under CPs are determined by the

liquidity amongst banks and mutual funds, which are the principal
investors.

Credit Rating:

Most of the secondary market investment in CPS are done only in P1+
(highest CRISIL rating for short-term credit instruments). However,
two P1+ companies may not attract the same rate, due to relative
credit perception by the public and also, to an extent , the company’s
long-term credit ratings.

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Issuers

Issuers can be divided into financial and nonfinancial companies,

although most issuers are financial. There are 3 types of finance

companies:

1.   Captive finance companies,

2.   Bank-Related finance companies,

3.   Independent finance companies.

Captive finance companies are subsidiaries of manufacturers, with

the purpose of providing financing for the manufacturer. The largest

selling of commercial paper—General Motors Acceptance

Corporation (GMAC)—is also a captive finance company that

provides financing for the customers of General Motors. Other

vehicle manufacturers also have captive finance companies to

promote the sale of their vehicles.

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Bank holding companies general use finance companies to cater to

customers with weaker credit. Independent finance companies are

not affiliated with any other company or bank—hence, the name.

Generally, only corporations with the highest credit rating can issue

commercial paper. Some companies with weaker credit can get credit

enhancements, so that they can issue commercial paper. Asset-

backed commercial paper is backed by high quality collateral.

Credit-supported commercial paper is often guaranteed by an

organization with excellent credit, such as a bank. Often, a letter of

credit is used for this purpose, which is referred to as LOC paper.

The bank promises to pay the face value of the paper if the issuer

doesn't. Though the bank generally charges a fee equal to 1/2 of 1% of

the issue, it is still cheaper than obtaining a loan from the bank.

Other costs that the issuer must pay are agents' fees to a bank for

doing the paperwork necessary to issue commercial paper, and

thousands of dollars to have the issue rated by a credit rating

organization, such as Standard and Poor's and Moody's.

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Issuing Procedure

A corporate planning to issue CP requires to fulfill the eligibility

criteria prescribed by RBI, then it needs to select a merchant banker

and an Issuing and Paying Agent (IPA) (mandatory) and obtain a

resolution from the company board for issue of commercial paper.

After the resolution is passed, the company needs to get the CP credit

rated by one of the approved credit rating agencies like CRISIL /

ICRA / CARE / DCR, as prescribed by RBI.

The company then has to approach its principal banker with a

written proposal along with the credit rating certificate for approval.

The banker will, then, scrutinize the same and verify whether all

conditions stipulated by RBI are met, and forward the application to

the RBI for intimation (as the approval from RBI is no longer

required).

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On the other hand, the Merchant Banker or Issuing and Paying Agent

(at times, company appoints IPA as a dealer) will locate the clients

and get their quotes for different maturity periods as discussed

above. Then the company and merchant banker / IPA take a decision

on the maturity, discount rate and the quantum of the issue. A

company can opt for various maturity period within the stipulated

span, i.e. if a company plans to issue a CP for a span of 6 months, it

can raise the money in tranches with different maturity periods of

either 1 months, 2 months or 3 months etc. based on the market

quotes. If a company decides on a 2 months CP, it can raise the

finance within a period of 2 weeks from the date on which the

proposal is taken on record by the bank and it can issue paper on a

single day or in parts on different dates (but the whole issue should

be redeemed on the same date).

The issue proposed should be completed within a span of 2 weeks

and the company should intimate the banker to reduce the working

capital limit to the extent of the amount raised. The company should

pay the applicable stamp duty based on the maturity. After the issue

is completed, within 3 days, the company needs to intimate the RBI

the actual amount raised through CPs. The CP is not allowed to be

underwritten.

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On maturity the holder of the CP presents the instrument to the

paying agent, who arranges the payment. The agent will receive the

amount and brokerage for the services provided. There is no grace

period allowed for the repayment of the paper. If the maturity date is

a holiday, the issuer is supposed to make the payment on the

following working day. Every issue of CP is treated as a fresh issue

(including roll over) and the issuer needs to intimate RBI while doing

so.

Commercial Paper Market

Most commercial paper is bought in the primary market. The

primary market consists of directly placed and dealer-placed paper.

Directly placed commercial paper is sold directly to the investor by

the issuer without the services of a securities firm. Most issuers of

direct paper are finance companies that sell a large amount of paper

continually, and have salespeople to sell the paper to

investors.Dealer paper is issued using the services of a securities

firm, usually an investment bank, but, increasingly, large commercial

banks. Commercial banks were prohibited from underwriting

commercial paper by the Glass-Steagall Act, but the Federal Reserve,

in June 1987, allowed subsidiaries of bank holding companies to

underwrite commercial paper, which has significantly reduced the

costs of issuing dealer paper to the issuer.

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Although commercial paper is the most prevalent money market

instrument, the secondary market is very small, primarily because

the terms of commercial paper are very short, and because buyers of

commercial paper usually purchase paper with maturities that

coincide with their need for money. Hence, most holders of

commercial paper hold it till maturity. However, in many cases, if the

holder of commercial paper needs the money sooner, the commercial

paper can usually be sold back to the issuer of direct paper or to the

dealer of dealer paper

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Commercial Paper Yields

Commercial paper is a discount instrument—the interest earned is

the difference between the face value and the discounted purchase

price. Yields are calculated using a banker's year of 360 days.

The yields on commercial paper are usually 10 to 20 basis points

above Treasury bills of the same maturity, primarily because the

interest earned from commercial paper, unlike T-bills, is not exempt

from state and local taxes. Commercial paper also has lower liquidity

than T-bills, where trading in the secondary market is more active

and bid/ask spreads, narrower.

There is also some credit risk. The main credit risk stems from

rollover risk, when the issuer may not be able to sell new paper to

pay for maturing paper, either because the market has changed, or

the credit rating of the issuer has been downgraded. The best

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example of this is the recent downgrades of CDOs and SIVs by the

credit rating agencies. CDOs and SIVs made money from mortgaged-

backed securities that were financed with commercial paper. Because

the commercial paper has much shorter maturities than the

mortgaged-backed securities, the maturing paper has to be

continually rolled over. But because of the subprime mortgage

debacle, the commercial paper market dried up, especially for the

CDOs and SIVs.

To calculate the investment yield (aka bond equivalent yield) of

commercial paper so as to compare it to the rates of return of other

investments:

1.   calculate the interest rate for the period;

2.   then compound the rate by the number of periods in a year.

Formula

(Face value – Price Paid / Price Paid) x (Actual no.of Days /

Term length in Days)

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Growth of Commercial Paper

Commercial Paper
120000

100000

80000

Commercial Paper
60000

40000

20000

0
April May June July Aug Sep Oct Nov Dec Jan Feb Mar

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Rate of Interest
12

10

8
Rate of Interest
6

0
April May June July Aug Sep Oct Nov Dec Jan Feb Mar

The commercial paper market is a new concept which provides a

platform for the Big Corporate Companies to borrow money from the

public for a short period which is less than 1 year, in order meet their

working capital deficit.

Commercial Paper provides a return in the range of 8% to 10%.which

a very good return for the short run & they are also somewhat risk

free as they issued by the blue chips company who have a very good

financially sound background & have the ability & willingness to

repay the debt taken by them.

It provides a better way for the company to borrow money from the

market directly from the public which may lead to future growth of

the company & increase their stakeholders & their customer base.

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It has shown approximately a rise of 4% annually which shows that it

has a very good & bright future.

CHAPTER 03

CONCLUSION

Money Market is a market for large financial institutions for

borrowing funds & capital for their requirement to run their business

more efficiently. Money market compromises a major part of the

financial markets. Money market is in India has not developed yet,

but it has a great potential & can become a major force in the

economic sector. The money market is growing at a very fast rate due

to awareness created by RBI, SEBI etc.

Instrument likes CBLO, Repo & Reverse Repo helps the RBI to

control the inflation rate in the economy & control the money supply.

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Instrument like treasury bills are used as tool for meeting up a short

term deficit of Central Government & using it for the development of

the country & also providing the investor with a good return.

The future of the treasury bills is very bright as it is managed &

controlled by the RBI, & the people have immense faith in the Apex

bank of our Country that it will never let them down.

The Commercial Paper is a instrument which acts as a base for the

blue chip or big corporate companies from where they can borrow

money for meeting up with their short deficit that is working capital

deficit. They also provide good returns for the investor who purchase

the commercial paper & they are regulated by the RBI which is the

head & controller of the commercial paper who lays the guideline for

the issue of it.

Although the magnitude of funds deal in this market is not large in

relationship to the deposit resources of banks perhaps this is the most

sensitive sector of the money market.

In India there is a considerable overlapping of function among the

institution comprising the organized money market which perhaps is

the outcome of the peculiar circumstances under which they have

developed.

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CHAPTER 04

Bibliography
BOOKS REFFERED
 Financial Markets in India – Rakesh Shahani
 The Indian financial System – Bharati V. Pathak
 The Indian Financial System & Development – Vasant Desai

WEBILOGRAPHY
 www.google.com

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 www.yahoo.com
 www.economictimes.com
 www.wikipedia.com
 www.rbi.com

 www.investopedia.com
 www.indiatimes.com

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