Commercial Papers and Certificate of Deposits


Published on

This presentation talks about the mechanism, advantages and disadvantages of Commercial Papers and Certificate of Deposits

Published in: Economy & Finance, Business
1 Like
  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Commercial Papers and Certificate of Deposits

  2. 2. SOURCES OF FINANCING WORKING CAPITAL SHORT TERM SOURCES Sources of Financing W.C Long Term Sources Short term sources 1. Trade Credit 2. Accrued Expenses & Deferred Income 3. Bank Credit 4. Inter-corporate deposits 5. Advances from Customers 6. Internal sources 7. Some new & innovative sources (Non-bank) a. Commercial Papers b. Convertible Debenture c. Factoring 2
  3. 3. COMMERCIAL PAPER (CP) • Debt instrument issued by corporate houses for raising short term financial resources from the money market are called Commercial Papers • Borrowers along with interest costs a placement fee to the dealer for arranging the sale of the issue • Annual financing cost depends upon:a) maturity date of the issue b) prevailing short term interest rates • Purchasers of CP can be:a) b) c) d) Corporations with excess funds to invest Banks Insurance Companies; and Other Types of Financial Institutions 3
  4. 4. FEATURES OF COMMERCIAL PAPER • Nature 1. 2. 3. 4. Unsecured Debt of corporate Redeemable at par to the holder of maturity Min. Tangible net worth of Rs. 4 crores required to issue CPs No prior approval from RBI required to issue CPs • Market – Public sector as well as Private sector enterprises • Rating – CPs must be graded by org. issuing them. • Interest rates – varies greatly. Factors of such variations are credit rating of the instrument, economic phase, prevailing rate of interest in CP market, call rates etc. 4
  5. 5. FEATURES OF COMMERCIAL PAPER • Marketability – influenced by the rate prevailing in the call money market and the foreign exchange market • Maturity – 3 to 30 days. Reduced to 15 days from April 25, 1998. 5
  6. 6. MECHANISM OF COMMERCIAL PAPER Credit Rating Agency Obtain Credit rating for C.P. issue Issue CP at discount Issuing Company Draw Down Book Limits Lender Bank Investor Bank/Company Redeem CP At Maturity
  7. 7. ADVANTAGES OF COMMERCIAL PAPERS • Large corporations go for Commercial Papers because the interest rates of CP are below the Prime Lending Rate • There is no floating charge or preferential rights on the assets 7
  8. 8. DEMERITS OF COMMERCIAL PAPERS • Not always a reliable source of funds • Sold on a discount basis – Firm receives less amount from the investor and pays full amount at the time of maturity. • Unnecessary burden – If the firm doesn’t want any funds from the CP issue, it will still pay the interest • Only big and financially sound companies can take the advantage of CPs 8
  9. 9. SATELLITE DEALERS (SDs) • Dealers entitled with the RBI to deal in the Govt. Securities market are called SATELLITE DEALERS • From June 17, 1998, SDs were allowed to issue CPs with the approval from RBI • Following conditions must be satisfied by a SD in order to deal in CPs:1. Rating – Min. Credit rating must be obtained from a credit rating agency 2. Maturity of CP – 15 days to 1 year from the date of issue 3. Target market – Individuals, banks, companies 4. Limits of Issue – a) b) Multiples of Rs. 5 lakhs, Issue Amount to be raised within a period of 2 weeks from the date of approval by RBI or maybe issued on a single day or in parts on different days 5. Nature – Shall be in the form of Usance promissory note, 9
  10. 10. CERTIFICATE OF DEPOSITS (CDs) • A marketable document of title to a time deposit for a specified period may be referred to as a ‘Certificate of Deposit’ • It takes the form of a receipt given by a bank or any other institutions for funds deposited with it by the depositor 10
  11. 11. FEATURES • Negotiable Instruments – Negotiable term deposit certificates issued by commercial banks/ financial institutions at discount to face value at market rates. Negotiable Instrument Act governs CDs • Maturity – 15 days to 1 year • Nature – in the form of usance promissory notes • Ideal Source – liabilities of commercial banks/ Financial Institutions 11
  12. 12. THE LAUNCH & MECHANISM • RBI launched CDs w.e.f March 27, 1989. • Scheduled Commercial banks (except RRBs) and all-India Financial Institutions, namely, IDBI, IFCI, ICICI, SIDBI, IRBI & EXIM bank can issue CDs MECHANISM • Individuals, associations, companies, trust funds, NRIs etc. can subscribe for CDs • Freely transferable by endorsement and delivery after the initial lock-in period of 15 days • Stamp duty is payable on CDs • Min. Size of a CD is Rs 5 lakhs and min. Size of an issue to a single investor is Rs. 25 lakhs • Banks must submit fortnightly report on their CDs to RBI under the Section 42 of RBI Act, 1935. • Banks cannot buyback their own CDs before maturity date 12
  13. 13. ADVANTAGE OF CDs • Safe + Liquid + Attractive in returns for both investors as well as scheduled commercial banks • Provides the opportunity for the bulk mobilization of resources as part of effective fund management 13
  14. 14. DISAVANTAGE OF CDs • Holding of CDs till maturity date spearheads to ineffective secondary market • Banks cannot grant loans against CDs 14
  15. 15. CITATIONS • FINANCIAL MARKETS AND INSTITUTIONS (3rd Edition) – Dr. S Gurusamy • WORKING CAPITAL MANAGEMENT (10th Revised Edition) - V.K Bhalla 15
  16. 16. THANK YOU 16