MONEY MARKET INSTRUMENTS

The money market in India is an imp

ortant source of finance to industry, trade, commerce and the government sector for both national and international trade through bills–treasury/commercial, commercial papers and other financial instruments and provides an opportunity to the banks to deploy their surplus funds so as to reduce their cost of liquidity. The money market also provides leverage to the Reserve Bank of India to effectively implement and monitor its monetary policy. 

The instruments of money market are characterised by 

a) short duration, 

b) large volume 

c) de–regulated interest rates. 

d) The instruments are highly liquid. 

e) They are safe investments owing to issuers inherent financial strength. 

The traditional short-term money market instruments consists of mainly call money and notice money with limited players, treasury bills and commercial bills. The new money market instruments were introduced giving a wider choice to short term holders of money to reap yield on funds even for a day or to earn a little more by parking funds by instruments for a few days more or until such time till they need it for lending at a higher rate. The various features of individual instruments of money market are discussed. 

The instruments used by above-mentioned players to borrow or lend in the money market, include, inter-alia, treasury bills (T-bills), Government of India securities (GOI secs), State government securities, government guaranteed bonds, public sector undertaking (PSU) bonds, commercial paper (CP) and certificates of deposit (CDs). Banks, which require short-term funds, borrow or sell

these securities and those having surplus funds would lend or buy the securities. Banks experiencing a temporary rise (fall) in their deposits and hence, a temporary rise (fall) in their statutory liquidity ratio (SLR) obligations, can borrow (lend) SLR securities from those experiencing a temporary fall (rise) in their deposits. Banks invest in T-bills, GOI and State government securities, government-guaranteed bonds and PSU bonds to fulfill their SLR obligations.

(a) Call/Notice money

Call money market, or inter-bank call money market, is a segment of the money market where scheduled commercial banks lend or borrow on call (i.e., overnight) or at short notice (i.e., for periods upto 14 days) to manage the day-to-day surpluses and deficits in their cash-flows. These day to day surpluses and deficits arise due to the very nature of their operations and the peculiar nature of the portfolios of their assets and liabilities.

1. Location: The core of the Indian money market structure is the inter-bank call money market which is centralised primarily in Mumbai, but with sub-markets in Delhi, Kolkata, Chennai and Ahmedabad.

2. Duration: The activities in the call money are confined generally to inter-bank business, predominantly on an overnight basis, although a small amount of business, known as notice money was also transacted side by side with call money with a maximum period of 14 days.

3. Participants:

a. Those who can both borrow as well as lend in the market - RBI, Commercial Banks, Co- operative banks and Primary Dealers.

b. Those who can only lend Financial institutions-LIC, UTI, GIC, IDBI, NABARD, ICICI and mutual funds etc.

c. Corporate entities having bulk lendable resources of minimum of ` 5 crores per transaction have been permitted to lend in call money through all Primary Dealers provided they do not have any short-term borrowings from banks.

d. Brokers are not permitted in the market.

4. Features:

a. Current and expected interest rates on call money are the basic rates to which other money markets and to some extent the Government securities market are anchored.

b. Interest rate in the market is market driven and is highly sensitive to the forces of demand and supply. Within one fortnight, rates are known to have moved as high as and/or touch levels as low as 0.50% to 1% Intra-day variations as also quite large. Hence, the participants in the markets are exposed to a high degree of interest rate risk.

The call money rates have been fluctuating widely going upto 70 per cent and dropping to around 3 per cent in the recent past.

For many years, while a set of institutions like State Bank of India, UTI, LIC, GIC, etc. continue to be lenders, some banks which have limited branch network are regular borrowers. 

a. Although by no means as pronounced as it was once, the activities in the money market are subjected to fluctuations due to seasonal factors, i.e. busy (November to April) and slack (May to October) seasons. 

b. One of the most important factors contributing to volatility in the market is mismatches in assets and liabilities created by the banks. Some banks over-extended themselves by using call money borrowings to finance the build-up of a large portfolio of Government of India securities, other long–term assets and non-food credit. It is this asset-liability mismatch which resulted in a sporadic volatility in the market. 

c. Apart from the mismatches in assets and liabilities, the inherent weakness of the bank of reasonably forecast their liquidity position had often pushed some of them to the pool of liquidity overhang or severe liquidity crunch. 

d. Large-scale diversion of working capital facilities for lending in the inter-corporate deposit market and investments in other treasury products by blue-chip companies amply testify the malady in the current system of working capital financing and its impact on the call money market. The uneasy calm in the money market is attributed to the corporates hunting for cheaper funds in the Euro Dollar and Indian money markets. 

(a) Inter-Bank Term Money: This market which was exclusively for commercial banks and co- operative banks has been opened up for select All India Development Financial Institutions in October, 1993. The DFIs are permitted to borrow from the market for a maturity period of 3 to 6 months within the limits stipulated by Reserve Bank of India for each institution. The interest rates are market driven. As per IBA ground rules, lenders in the market cannot prematurely recall these funds and as such this instrument is not liquid. The market is predominantly 90-days market. The market has shown a lot of transactions following withdrawal of CRR/SLR on liabilities of the banking system. 

The development of the term money market is inevitable due to the following reasons: 

a. Declining spread in lending operations 

b. Volatility in the call money market 

c. Growing desire for fixed interest rates borrowing by corporates 

d. Move towards fuller integration between forex and money market 

e. Stringent guidelines by regulators/ management of the institutions. 

(b) Inter-Bank Participation Certificate (IBPC): The IBPCs are short-term instruments to even- out the short-term liquidity within the banking system. The primary objective is to provide some degree of flexibility in the credit portfolio of banks and to smoothen the consortium arrangements. The IBPC can be issued by scheduled commercial bank and can be subscribed to by any

commercial bank. The IBPC is issued against an underlying advance, classified standard and the aggregate amount of participation in any account time issue. During the currency of the participation, the aggregate amount of participation should be covered by the outstanding balance in account.

The participation can be issued in two types, viz. with and without risk to the lender. While the participation without it can be issued for a period not exceeding 90 days. Participation is now with risk for a period between 91 days and 180 days. The interest rate on IBPC is freely determined in the market. The certificates are neither transferable nor prematurely redeemable by the issuing bank.

In the case of the bank issuing IBPC with risk, the aggregate amount of participation would be reduced from the aggregate advance outstanding. The participating bank would show the aggregate amount of such participation as part of its advances. In cases where risks have materialised, the issuing bank and participating bank should share the recoveries proportionately.

However, in without risk sharing management, the issuing bank will show the amount of participation as borrowing while the participating bank will show the same under advances to banks. In case of any loss, the issuing bank should compensate fully the participating bank.

The scheme is beneficial both to the issuing and participating banks. The issuing bank can secure funds against advances without actually diluting its asset-mix. A bank having the highest loans to total asset ratio and liquidity bind can square the situation by issuing IBPCs. To the lender, it provides an opportunity to deploy the short-term surplus funds in a secured and profitable manner. The IBPC with risk can also be used for capital adequacy management. A bank with capital shortfall can temporarily park its advances with other banks which have surplus capital. It can also be used for meeting shortfall in priority sector lending by swapping such advances with those banks who exceed the priority sector lending obligations.

(a) Inter Corporate Deposit: The inter corporate market operates outside the purview of regulatory framework. It provides an opportunity for the corporates to park their short-term surplus funds at market determined rates. The market is predominantly a 90 days market and may extend to a maximum period of 180 days. The market which witnessed flurry of activities has received a serious jolt in the wake of series of defaults.

Why do companies go for ICD?

v Immediate capital for short term requirements

v Transactions are free from bureaucratic and legal hassles

v Better than bank loans

The market of inter-corporate deposits maintains secrecy. The brokers in this market never reveal their lists of lenders and borrowers, because they believe that if proper secrecy is not maintained the rate of interest can fall abruptly. The market of inter-corporate deposits depends crucially on

personal contacts. The decisions of lending in this market are largely governed by personal contacts. 

(a) Treasury Bills (TBs): Among money market instruments TBs provide a temporary outlet for short-term surplus as also provide financial instruments of varying short-term maturities to facilitate a dynamic asset-liabilities management. The interest received on them is the discount which is the difference between the price at which they are issued and their redemption value. They have assured yield and negligible risk of default. The TBs are short-term promissory notes issued by Government of India at a discount for 14 days to 364 days. 

More relevant to the money market is the introduction of 14 days, 28 days, 91 days and 364 days TBs on auction basis. In order to provide investors with instruments of varying short-term maturities, Government of India introduced the auction of 14 days TBs since June 1997. Further, with a view to developing TBs market and moving towards market rate of interest on Government securities, the auction of 91 days TBs was first introduced in January, 1993. The amount to be auctioned will be pre-announced and cut off rate of discount and the corresponding issue price will be determined in each auction. The amount and rate of discount is determined on the basis of the bids at the auctions. While the uniform price auction method is followed in respect of 91 days TBs, the cut off yield of other TBs are determined on the basis of discriminatory price auctions. The non-competitive bids in respect of 14 and 364 days TBs are accepted outside the notified amount. The discretion to accept non-competitive bids fully or partially rest with RBI. The amount to be accepted at the auctions and the cut-off price are decided by the Reserve Bank of India on the basis of its public debt management policy, the conditions in money market and the monetary policy stance. 

Although State Government also issued treasury bills until 1950, since then it is only the Central Government that has been selling them. In terms of liquidity, for short term financing, the descending order is cash, call loans, treasury bills and commercial bills. Although the degree of liquidity of treasury bills are greater than trade bills, they are not self liquidating as the genuine trade bills are. T-bills are claim against the government and do not require any grading or further endorsement or acceptance. 

Following the abolition of 91 days Tap TBs, 14 days Intermediate TBs was introduced with effect from 1st April, 1997. The 14 days TBs are available on tap. State Governments, foreign, Central Banks and other specialised bodies with whom RBI has an agreement are only allowed to invest in this TBs. 

TBs are issued at discount and their yields can be calculated with the help of the following formula: 

Y = éF -Pù´ 365 ´100

ê P úû M 

where Y = Yield, 

F = Face Value,P = Issue Price/Purchase Price, M = Maturity.

Features of T-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.

Eligibility: TBs can be purchased by any person, firm, company corporate body and institutions. State Government, Non-Government Provident Funds governed by the PF Act, 1925 and Employees Provident Fund and Miscellaneous Provisions Act, 1952 are eligible to participate in the auctions of 14 days and 91 days TBs on a non-competitive basis. Non-competitive bids are accepted at the weighted average price arrived at on the basis of competitive bids accepted at the auctions. TBs are approved securities for the purpose of SLR. While Reserve Bank of India does not participate in the auctions of 14 days and 364 days TBs, it will be at its liberty to participate in the auctions and to buy part or the whole of the amount notified in respect of 91 days TBs. The Primary Dealers also underwrite a minimum of 25% of the notified amount of the 91 days TBs. They also underwrite the amount offered by RBI in respect of 14 and 364 days TBs.

Minimum Amount of Bids: TBs are issued in lots of ` 25,000 (14 days and 91 days)/

` 1,00,000 (364 days).

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: For treasury bills the day count is taken as 364 days for a year.

Additional Features: T- Bills have the following additional features:

(1) Government’s contribution to the money market,

(2) Mop-up short-term funds in the money market,

(3) Sold through auctions,

(4) Discount rate is market driven, and

(5) Focal Point for monetary policy

(6) Helps to meet the temporary mismatches in cash flows

Advantages to Investors:

(i) Manage cash position with minimum balances,

(ii) Increased liquidity,

(iii) Absence of risk of default

(i) Market related assured yield, 

(ii) Eligible for repos, 

(iii) SLR security, 

(iv) No capital loss, 

(v) Two-way quotes by DFHI/Primary Dealers (PDs)/Banks. 

(vi) Low transaction cost 

(vii) No tax deducted at source 

(viii) Transparency 

(ix) Simplified Settlement 

(x) High degree of tradability and active secondary market facilitates meeting unplanned fund requirements. 

The PDs have assumed the role of market makers in treasury bills and they regularly provides two- way quotes. This has added to the liquidity and deepened the secondary market of this instrument. Thus treasury bills have emerged as an effective instrument for dynamic asset-liability management. Apart from liquidating the treasury bills in the secondary market, treasury bills can be used for transactions which will help the fund managers to temporarily deploy or borrow funds without altering their assets portfolio. Due to its mode and periodicity of issue (weekly and fortnightly auctions) as also the existence of a well developed secondary market, the fund manager could build-up a portfolio of treasury bills with varying maturities which will match their volatile liabilities. 

(b) Commercial Bills: A commercial bill is one which arises out of a genuine trade transaction, 

i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein after a certain specified date. Thus, a bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a creation period. A bill of exchange is a ‘self-liquidating’ paper and negotiable; it is drawn always for a short period ranging between 3 months and 6 months. 

Bill financing is the core component of meeting working capital needs of corporates in developed countries. Such a mode of financing facilitates an efficient payment system. The commercial bill is instrument drawn by a seller of goods on a buyer of goods. RBI has pioneered its efforts in developing bill culture in India, keeping in mind the distinct advantages of commercial bills, like, self-liquidating in nature, recourse to two parties, knowing exact date transactions, transparency of transactions etc. The RBI introduced Bills Market Scheme (BMS) in 1952 and the Scheme was later modified into New Bills Market Scheme (NBMS) in 1970 on the recommendation of Narasimham Committee. Under the Scheme, commercial banks can discount with approved institutions (i.e. Commercial Banks, Insurance Companies, Development Financial Institutions,

Mutual Funds, Primary Dealers, etc.) the bills which were originally discounted by them provided that the bills should have arisen out of genuine commercial trade transactions. The need for physical transfer of bills has been waived and the rediscounting institution can raise Derivative Usance Promissory Notes (DUPNs). These DUPNs are sold to investors in convenient lots and maturities (15 days to 90 days) on the basis of genuine trade bills, discounted by the discounting bank. The discounting bank should, inter alia. comply with the following conditions:

(i) Bank which originally discounts the bills only draw DUPN. 

(ii) Continue to hold unencumbered usance bills till the date of maturity of DUPN. 

(iii) Matured bills should be substituted by fresh eligible bills. 

(iv) The transactions underlying the DUPN should be bona fide commercial or trade transactions. 

(v) The usance of the bill should not exceed 120 days and the unmatured period of such bills for drawing DUPN should not exceed 90 days. 

The interest rate on re-discounting of bills was deregulated in May, 1989. Notwithstanding various benefits accruing to this mode of financing, bill financing is yet to develop on a scale commensurate with the credit provided by the banks to the commercial sector. The volume of bills finance to total finance is still an insignificant portion. The DUPNs, like commercial bills, are exempted from stamp duty. 

The DUPN is issued at a discount which is realised at front-end. 

Example: If a bank re-discounted a commercial bill with a face value of ` 100/- @ 15% for 2 months will fetch ` 97.50, on the basis of the following calculation. 

Discount = 100 ´ 15 ´ 2 =` 2.50 

100 12 

However, as the discount amount is paid at front-end. 

Example: The yield to the investor or cost to the borrower will be higher than the discount rate in view of the fact that the discounter can deploy the amount of discount received for earning further income. This can be calculated with the following formula: 

Y = FV - SV × Days or months in a year ×100 

where 

SV M 

Y = Yield 

FV = Face Value SV = Sale Value

M = Period of Discount

Accordingly the Yield as per the data given in the example will be: 

100- 97.50 × 12 ×100 = 15.385% 

97.50 2 

Advantages of a developed bill market 

A developed bill market is useful to the borrowers, creditors and to financial and monetary system as a whole. The bill market scheme will go a long way to develop the bill market in the country. The following are various advantages of developed bill markets. 

(i) Bill finance is better than cash credit. Bills are self-liquidating and the date of repayment of a bank's loans through discounting or rediscounting is certain. 

(ii) Bills provide greater liquidity to their holders because they can be shifted to others in the market in case of need for cash. 

(iii) A developed bill market is also useful to the banks in case of emergency. In the absence of such a market, the banks in need of cash have to depend either on call money market or on the Reserve Bank's loan window. 

(iv) The commercial bill rate is much higher than the treasury bill rate. Thus, the commercial banks and other financial institutions with short-term surplus funds find in bills an attractive source of both liquidity as well as profit. 

(v) A development bill market is also useful for the borrowers. The bills are time-bound, can be sold in the market and carry the additional security in the form of acceptor's signature. Therefore, for the borrowers, the post of bill finance is lower than that of cash credit. 

(vi) A developed bill market makes the monetary system of the country more elastic. Whenever the economy requires more cash, the banks can get the bills rediscounted from the Reserve Bank and thus can increase the money supply. 

(vii) Development of the bill market will also make the monetary control measures, as adopted by the Reserve Bank, more effective. 

(a) Certificate of Deposits (CDs): The CDs are negotiable term-deposits accepted by commercial bank from bulk depositors at market related rates. CDs are usually issued in demat form or as a Usance Promisory Note. 

Eligibility: All scheduled banks (except RRBs and Co-operative banks) are eligible to issue CDs. They can be issued to individuals, corporates, trusts, funds and associations. NRIs can also subscribe to CDs but on non-repatriable basis only. In secondary markets such CDs cannot be endorsed to another NRI. 

Term: The CDs can be issued by scheduled commercial banks (excluding RRBs) at a discount to face value for a period from 3 months to one year. 

For CDs issued by Financial institutions maturity is minimum 1 year and maximum 3 years.

Denomination: The CDs can be issued for minimum amount of ` 5 lakhs to a single investor. CDs above ` 5 lakhs should be in multiples of ` 1 lakh. There is, however, no limit on the total quantum of funds raised through CDs.

Transferability: CDs issued in physical form are freely transferable by endorsement and delivery. Procedure of transfer of dematted CDs is similar to any other demat securities. The CDs can be negotiated on or after 30 days from the date of issue to the primary investor.

Others: The CDs are to be reckoned for reserve requirements and are also subject to stamp duty. Banks are prohibited from granting loans against CDs as buy-back of their own CDs.

Discount: As stated earlier, CDs are issued at discount to face value. The discount is offered either front end or rear end. In the case of front end discount, the effective rate of discount is higher than the quoted rate, while in case of rear end discount, the CDs on maturity yield the quoted rate. The discount on CDs is deregulated and is market determined. Banks can use the CD Scheme to increase their deposit base by offering higher discount rates than on usual time deposits from their retail customers.

The CDs was introduced in June, 1989 with the primary objective of providing a wholesale resource base to banks at market related interest rates. The instrument was effectively used to cover certain asset sources and has since emerged as instrument for effective asset-liability management. Free transferability of instrument (after 30 days from issue) assures liquidity to the instrument. Banks can invest in CDs for better funds management; such investments beside yielding high return can be netted with liability to the banking system for CRR/SLR purpose. This type of asset also attracts only lower rate of weight under Capital Adequacy Standards. The CDs market witnessed a spurt in activities during 1995 against the backdrop of liquidity crisis.

Like Commercial Papers, Certificate of Deposit (CD) is a front–ended negotiable instrument, issued at a discount and the face value is payable at maturity by the issuing bank.

Example:

Amount of Issue – ` 100 Period - 6 months

Rate of discount – 20%

Discount = 100 ´ 20 ´ 6 = ` 10.00

100 12

Hence CD will be issued for ` 100 – 10 = ` 90.00. The effective rate to the bank will, however, be calculated on the basis of the following formula:

E = FV - SV × Days or months in a year ×100

SV M

where

E = Effective Yield FV = Face Value SV = Sale Value 

M = Period of Discount 

Accordingly the Yield as per the data given in the example will be: 

100- 90 × 12 ×100 = 22.226% 

90 6 

In terms of the provisions of CD Scheme, banks were allowed to issue CDs to their customers upto an aggregate amount equivalent to 5 per cent of their aggregate deposit. These instruments are subject to payment of stamp duty like the usance promissory notes. Since a CD is eligible for rediscounting in the money market only after 30 days of holding, the maturity period of CDs available in the market can be anywhere between 1 month to one year. A CD is, therefore, another step in filling the gap between Treasury Bills/Commercial Bills and dated securities. Banks also find this instrument suitable to reward its big size depositors with better rate of return as an incentive. 

Despite the large size of the primary market for CDs, there has been virtually no activity in the secondary market and the holders keep the CDs till maturity. So long as there is sluggish growth of deposits at administered low rates vis-a-vis the high rates offered by the non-banking non-financial institutions and others, banks in distress for funds will always need CDs at any cost. They may be useful where the average yield on advances is higher than the effective cost of CDs and the loan assets are largely in Health Code No. 1. 

(a) Commercial Paper: Commercial paper (CP) has its origin in the financial markets of America and Europe. The concept of CPs was originated in USA in early 19th century when commercial banks monopolised and charged high rate of interest on loans and advances. In India, the CP was introduced in January 1990 on the recommendation of Vaghul Committee subject to various conditions. When the process of financial dis-intermediation started in India in 1990, RBI allowed issue of two instruments, viz., the Commercial Paper (CP) and the Certificate of Deposit (CD) as a part of reform in the financial sector. A notable feature of RBI Credit Policy announced on 16.10.1993 was the liberalisation of terms of issue of CP. At present it provides the cheapest source of funds for corporate sector and has caught the fancy of corporate sector and banks. Its market has picked up considerably in India due to interest rate differentials in the inter-bank and commercial lending rates. 

CPs are unsecured and negotiable promissory notes issued by high rated corporate entities to raise short-term funds for meeting working capital requirements directly from the market instead of borrowing from banks. Its period ranges from 15 days to 1 year. CP is issued at discount to face value and is not transferable by endorsement and delivery. The issue of CP seeks to by pass the intermediary role of the banking system through the process of securitisation.

It partly replaces the working capital limits enjoyed by companies with the commercial banks and there will be no net increase in their borrowing by issue of CP. 

Role of RBI 

As a regulatory body, RBI lays down the policies and guidelines with regard to commercial paper to maintain a control on the operational aspects of the scheme. 

· Prior approval of RBI is required before a company can issue CP in the market. 

· RBI controls the broad timing of the issue to ensure orderly fund-raising. 

· Every issue of CP launched by a company, including roll-over will be treated as fresh issue and the issuing company will be required to seek prior permission from RBI, before each roll- over. 

· RBI approval is valid for 2 weeks only. 

RBI guidelines [as per notification No IECD 1/87 (CP) 89-90] prohibits the banks from providing any underwriting support or co-acceptance of issue of CP. 

The CPs can be issued by all non-banking (financial as well as non-financial) companies and All- India Financial Institutions. The instrument is instantly advantageous to the issuer and the investor. The issue of CPs does not involve bulky documentation and its flexibility with the opportunities can be tailored to meet the cash flow of the issuer. A highly rated company can raise cheaper funds while the investor can deploy its short-term surplus at relatively high return. The secondary market for CPs ensure liquidity and the compulsory credit rating imparts inherent strength to the issuer's ability to meet the obligations on maturity. The bank as managers or dealers of the instrument get fees to supplement their income. Bank can also invest their surplus short-term funds in CP. 

Timing of CP 

The timing of the launch of the CP issue would be indicated by RBI while giving its permission, to ensure an orderly approach to the market. 

Denomination and size of CP 

Minimum size of CP issue – ` 25 lakhs. 

Denomination of CP note – ` 5 lacs or multiples thereof. 

Maximum size of CP issue – 100% of the issuer's working capital (fund based) 

limits (determined by the consortium leader). 

The entire approved quantum of CP can be issued on a single date, or in parts on different dates, within two weeks of the Reserve Bank of India's approval, subject to the condition that the entire amount of issue matures on the same date. 

Period of CP

Minimum currency – 15 days from the date of issue. Maximum currency – 360 days from the date of issue. No grace period for repayment of CP.

If maturity date happens to be a holiday, issuer has to make the payment on the immediate preceding working day. 

The entire approved amount should be raised within a period of 2 weeks from the date of approval of RBI. 

Each CP issue (including roll-over) has to be treated as a fresh issue has to seek permission from RBI. 

Mode of CP 

CP has to be issued at a discount to face value. Discount rate has to be freely determined by the market. 

Negotiability of CP: CP (being usance promissory note) would be freely negotiable by endorsement and delivery. 

Underwriting/co-acceptance of CPs: The CP issue cannot be underwritten or co-accepted in any manner. Commercial Banks, however, can provide standby facility for redemption of CPs on the maturity date. 

Printing of CP: Issuer has to ensure that CP is printed on good quality security paper and that necessary precautions are taken to guard against tampering with the documents, since CP will be freely transferable by endorsement and delivery. CP should be signed by at least 2 authorised signatories and authenticated by the issuer's agent (bank). 

Issue expenses: The issue of CP would be subject to payment of stamp duty. All issue expenses such as dealer's fees, issuing and paying agent's fees, rating agency fees, charges levied by banks for providing redemption standby facilities and any other charges connected with the issue of CPs are to be borne by the issuer. 

The issuer: The CP issuer can be a Company incorporated under the Companies Act subject to some requirements. 

Benefits of Commercial Paper 

CPs have been introduced in the Indian market so as to provide a diversified source of funding to the borrowers as well as an additional investment option to the investors. CPs can now be issued as a low cost alternative to bank financing to meet a part of working capital requirements. 

Benefits to the Issuer – The following are major benefits to issuer of CP:

(a) Low interest expenses: The interest cost associated with the issuance of CP is normally expected to be less than the cost of bank financing, as among other things, it is related to the inter-corporate money market rate, which in normal times is within the cost of bank finance. 

(ii) Access to short term funding: CP issuance provides a company with increased access to short term funding sources. By bringing the short term borrower into direct contact with investors, the CP market will, to some extent, disintermediate the established role of banks and pass on the benefit to both issuers and investors. 

(iii) Flexibility and liquidity: CP affords the issuer increased flexibility and liquidity in matching the exact amount and maturity of its debt to its current working capital requirement. 

(iv) Investor recognition: The issuance of CP provides the issuer with favourable exposure to major institutional investors as well as wider distribution of its debt. 

(v) Ease and low cost of establishment: A CP programme can be established with ease at a low cost, once the basic criteria have been satisfied. 

Benefits to the Investor – The following are major benefits to investor of CP: 

(i) Higher yield: Higher yields are expected to be generally obtainable on CP than on other short term money market instruments like bank deposits. Investment managers are increasingly looking to match investible excess cash with higher yielding securities as compared to those presently available in the market. 

(ii) Portfolio diversification: Commercial Paper provides an attractive avenue for short term portfolio diversification. 

(iii) Flexibility: CPs can be issued for periods ranging from 15 days to less than one year, thereby affording an opportunity to precisely match cash flow requirements. 

(iv) Liquidity: Liquidity in CP is generally provided by a dealer offering to buy it back from an investor prior to maturity, for which a market quote will be available. The investment in CP will therefore be quite liquid. 

(v) Yield: Yield on Commercial Paper is calculated in same manner as calculated in Commercial Bill and Corporate Deposit. 

Difference between Commercial Bill and Commercial Paper

Commercial Bill	Commercial Paper
Commercial Bill arises from sale transactions. Banks finance commercial  bills. Usually the bills consist of an invoice drawn on the buyer, the documents to title to  goods  and  a  bill  of  exchange.  The bills	Commercial paper is an unsecured and discounted promissory note issued to finance the short-term credit needs of large institutional    buyers.    Banks,  corporations and   foreign   governments   commonly  use

are given to the bank for advancing money against sale of goods. Commercial Bill financing is post sale finance. The Bill of Exchange may be on D/P  (document against Payment) or D/A (document against acceptance) terms.

this type of funding.