Indian Economy Quiz: Money Market and Financial Instruments

The correct answer is C, I and II. Statement I is right: commercial paper is an unsecured money market instrument issued in the form of a promissory note, so it is backed only by the credit standing of the issuer and not by any security. Statement II is right as well: commercial paper was introduced in the Indian money market in 1990, to let highly rated companies raise working capital directly instead of borrowing from banks. Statement III is wrong, and that is why B and D fail: commercial paper is issued by companies, primary dealers and all-India financial institutions, while the Reserve Bank only lays down the rules for its issue and acts as the regulator. The Reserve Bank issues treasury bills, but it does so on behalf of the Government of India. A is incomplete because it leaves out the correct statement about the year 1990.

The correct answer is C, M1 plus the net time deposits of commercial banks. M3, called broad money or aggregate monetary resources, is the measure the Reserve Bank watches most closely, and it adds the time deposits of the banking system to narrow money. A is wrong because currency with the public plus demand deposits is only a part of M1; M1 is currency with the public plus demand deposits of banks plus other deposits with the RBI, so the expression given is incomplete and in any case describes M1, not M3. B is wrong because M1 plus savings deposits with post office savings banks is the definition of M2. D is wrong because M1 plus total deposits with post office savings organisations is not a recognised aggregate; M4 is M3, not M1, plus total post office deposits other than National Savings Certificates. Remember the order of liquidity: M1 is the most liquid and M4 the least.

The correct answer is C, one year. By definition the money market is the market for short-term funds, and the dividing line drawn in India and everywhere else is a maturity of one year; anything longer belongs to the capital market. A is wrong because three months is only the tenor of the 91-day treasury bill, one instrument among many, and the market also trades 182-day and 364-day bills. B is wrong for the same reason: six months corresponds roughly to the 182-day bill and not to the limit of the market. D is wrong because a three-year instrument is a capital market security; dated government securities, debentures and bonds of such maturity are issued in the capital market and traded under SEBI's regulation. Fixing the one-year line in memory also answers questions on commercial paper and certificates of deposit, whose maximum maturity is one year.

The correct answer is B. A treasury bill is an instrument of the government's short-term borrowing, and the Reserve Bank of India, as banker and debt manager to the government, issues it on the government's behalf through auctions. A is wrong because SEBI regulates the securities market and protects investors in shares and debentures; it issues no government paper. C is wrong because the State Bank of India is only a participant in the auction, like other banks and primary dealers, and buys treasury bills for its own portfolio. D is wrong because the Ministry of Corporate Affairs administers company law and has nothing to do with government borrowing. Note the related fact that treasury bills carry no coupon: they are sold at a discount to face value and redeemed at face value, so the discount is the return.

The correct answer is B, 91, 182 and 364 days. These are the three tenors of treasury bills auctioned by the Reserve Bank, with the 91-day bill auctioned most frequently. A is wrong because the 14-day treasury bill was discontinued and is no longer part of the regular auction calendar; it survives only in old study material. C is wrong because 30, 60 and 90 days are the usual maturities of trade bills and of some certificates of deposit, not of treasury bills. D is wrong because a 730-day instrument runs for two years and is therefore a dated government security of the capital market, outside the one-year limit of the money market. For periods shorter than 91 days the government uses Cash Management Bills, which were introduced in 2010.

The correct answer is C, call money. Call money is the overnight, unsecured borrowing between banks and primary dealers that lets a bank square its cash reserve position at the end of the day; the interest on it is the call rate, the most sensitive interest rate in the system. A is wrong because term money is an interbank deposit of 15 days to one year. B is wrong because notice money runs from 2 to 14 days and is repayable after a short notice is given, which is exactly the distinction examiners test between call and notice money. D is wrong because bridge finance is a short-term loan given to a borrower, usually a company or a project, until a longer-term loan or an issue of securities is completed, and it is not an interbank money market instrument at all.

The correct answer is B, 1989. Following the Vaghul Committee's recommendations on the money market, the Reserve Bank allowed scheduled commercial banks to issue negotiable certificates of deposit in 1989, and commercial paper followed a year later in 1990. A is wrong because 1985 is associated with the Sukhamoy Chakravarty Committee on the working of the monetary system, whose report led to these reforms but not to the instrument itself. C is wrong because 1991 is the year of the economic reforms and of the Narasimham Committee on the financial system, not of certificates of deposit. D is wrong because 1997 saw other money market changes, such as the phasing out of ad hoc treasury bills and the move to an auction system. The pair of years to memorise is 1989 for certificates of deposit and 1990 for commercial paper.

The correct answer is C, equity share. An equity share has no maturity date at all; it represents ownership of a company for as long as the company exists, so it is the classic capital market instrument, issued in the primary market and traded on stock exchanges under SEBI's regulation. A is wrong as an answer because a certificate of deposit is a money market instrument issued by a bank for seven days to one year. B is wrong because a treasury bill is the government's short-term paper of 91, 182 or 364 days and is the safest money market instrument. D is wrong because commercial paper is the unsecured short-term promissory note of a company, with a maturity of seven days to one year. The test to apply in such questions is simple: if the maturity can exceed one year, the instrument is not a money market instrument.

The correct answer is A. In a repo the bank that needs funds sells government securities to the Reserve Bank and simultaneously agrees to repurchase them a day or a few days later at a slightly higher price; the difference is the interest, and the rate charged is the repo rate, which is the policy rate of the country. B describes the reverse repo, the mirror transaction in which the Reserve Bank absorbs surplus funds from the banking system by selling securities to banks. C is wrong because an unsecured deposit with the RBI is not a repo; the whole point of a repo is that the borrowing is collateralised by government securities. D is wrong because a bank cannot raise money from the Reserve Bank by issuing commercial paper; commercial paper is issued by companies and financial institutions to investors in the market.

The correct answer is B. M1, narrow money, is the most liquid aggregate: currency, that is notes and coins, with the public, plus the demand deposits of banks, which are withdrawable at any time, plus other deposits with the Reserve Bank, a small residual item. A is wrong because adding the net time deposits of banks to currency and demand deposits gives M3, broad money, not M1. C is wrong because post office deposits enter the aggregates separately: savings deposits with post office savings banks are added to M1 to get M2, and total post office deposits other than National Savings Certificates are added to M3 to get M4. D is wrong on two counts: it drops currency with the public, which is the largest single component for a cash-using economy, and it wrongly includes time deposits in narrow money.

The correct answer is A, less than 91 days. Cash Management Bills were introduced by the Government of India and the Reserve Bank in 2010 to meet temporary mismatches in the government's cash flow, and they are issued for periods shorter than 91 days, sometimes for just a few weeks. In every other respect they resemble treasury bills: they are issued at a discount through auctions and redeemed at face value. B is wrong because a maturity of exactly 91 days is the shortest regular treasury bill, which already existed. C is wrong because 182 and 364 days are the other two treasury bill tenors, and a Cash Management Bill is deliberately shorter than all of them. D is wrong because an instrument of more than a year is not a money market instrument at all and would be a dated government security.

The correct answer is B, the Discount and Finance House of India. It was set up in 1988 on the recommendation of the Vaghul Working Group to deal in short-term instruments such as treasury bills and commercial bills and so give depth and liquidity to the money market; it later became a primary dealer. A is wrong because the Securities and Exchange Board of India, though established in 1988 as a non-statutory body, was created for the capital market and became statutory in 1992. C is wrong because the National Housing Bank, set up in 1988 as well, is the apex institution for housing finance, a long-term business. D is wrong because the Small Industries Development Bank of India was set up in 1990 for the financing and development of small-scale industry, not for the money market.