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Introduction History and Background

Commercial Paper Commercial Paper is an important money market instrument in advanced countries like USA to raise short-term funds. In India, on the recommendation of the Vaghul Working Group, the Reserve Bank of India introduced the commercial paper scheme in the Indian Money Market in 1989. Commercial paper, as it is known in the advanced countries, is a form of unsecured promissory note issued by firms to raise short-term funds. The commercial paper market in the USA is a blue-chip market where financially sound and highest rated companies are able to issue commercial papers.1 Depending on the issuing company, a commercial paper is also known as a financial paper, industrial paper, or corporate paper. Individuals, Banks, Corporate Bodies, Unincorporated Bodies, NRIs, and FIIs are the investors in Commercial Paper.2 Certificate of Deposits Certificate of deposit is an unsecured, negotiable, short-term instrument in bearer form, issued by commercial banks and development financial institutions. Certificate of Deposits were introduced in June 1989. Only schedule commercial banks excluding Regional Rural Banks and Local Area Banks were allowed to issue them initially. Certificates of Deposit are time deposits of specific maturity similar to Fixed Deposits. Like other time deposits, CDs are subject to SLR and CRR requirements. Compared to other retail deposits, the transaction cost of CD is lower.3

1 2

I M Pandey on Financial Management, 10 Ed. Vikas Publication, 2011. (pg. 748) rd Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 59-64) 3 rd Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 68-73)

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Literature Review Commercial Paper - Commercial Paper is an important money market instrument in
advanced countries like USA to raise short-term funds. In India, on the recommendation of the Vaghul Working Group, the Reserve Bank of India introduced the commercial paper scheme in the Indian Money Market in 1989. I M Pandey on Financial Management, 10th Ed. Vikas Publication, 2011. (pg. 748)

Certificate of Deposit - Certificate of deposit is an unsecured, negotiable, short-term


instrument in bearer form, issued by commercial banks and development financial institutions. Certificate of Deposits were introduced in June 1989. Bharti V. Pathak on The Indian Financial System 3rd Ed. Pearson Publication (pg. 6873)

Difference between Commercial Paper and Certificate of Deposit


Commercial banks are the major investors in commercial papers and it is through certificates of deposit they raise funds to tide over their short-term requirements. There has been an inverse relationship between commercial paper and certificate of deposit. Bharti V. Pathak on The Indian Financial System 3rd Ed. Pearson Publication (pg. 6873)

Research Question
What are the factors that affect the growth of CP? What measures have been taken to develop CD as a money market instrument? Are there any differences between the CD and CP? If there are any differences, on what grounds they are differentiated?

Research Methodology Objectives of Research To have the in-depth knowledge of a commercial paper and certificate of deposit. To know the differences between a commercial paper and a certificate of deposit. To know the guidelines for issuing the commercial paper and certificate of deposit. To know the market trends of commercial paper and certificate of deposit. Hypothesis of Research There is a very small thin line of difference between a commercial paper and
certificate of deposit.

Certificate of Deposit and Commercial Paper are independent of each other. Bibliography Book Referred: Bharti V. Pathak on The Indian Financial System 3rd Ed. Pearson Publication (pg. 68-73) I M Pandey on Financial Management, 10th Ed., Vikas Publication, 2011. (pg. 748) M. Y. Khan on Indian Financial System, 6th Ed., McGraw Hill Companies, 2009

Money Market The seventh largest and second most populous country in the world, India has long been considered a country of unrealized potential. A new spirit of economic freedom is now stirring in the country, bringing sweeping changes in its wake. A series of ambitious economic reforms aimed at deregulating the country and stimulating foreign investment has moved India firmly into the front ranks of the rapidly growing Asia Pacific region and unleashed the latent strengths of a complex and rapidly changing nation.4 The money market is a market for financial assets that are close substitutes for money. It is a market for overnight to short-term funds and instruments having a maturity period of one or less than one year. The money market constitutes a very important segment of the Indian Financial System. An efficient money market benefits a number of players. It provides a stable source of funds to banks in addition to deposits, allowing alternative financing structures and competition. It allows banks to manage risks arising from interest rate fluctuations and to manage the maturity structure of their assets and liabilities. A developed inter-bank market provides the basis for growth and liquidity in the money market including the secondary market for commercial paper and treasury bills.5

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http://www.scribd.com/doc/17856735/Indian-Money-Market (visited on 27th February, 2013) rd Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 45)

Commercial Paper The Working Group on Money Market in 1987 suggested the introduction of the Commercial Paper (CP) in India. The Reserve Bank of India introduced commercial papers in January 1990. Commercial papers have been in vogue in the United States since the nineteenth century and have become popular in money markets all over the world since 1980s.6 A commercial paper is an unsecured short-term promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is generally issued at a discount by the leading creditworthy and highly rated corporate to meet their working capital requirements. Depending upon the issuing company, a commercial paper is also known as a finance paper, industrial paper, or corporate paper. Initially only leading highly rated corporate could issue a commercial paper. The issuer base has now been widened to broad-base the market. Commercial papers can now be issued by primary dealers and all-India financial institutions, apart from corporate, to access shot-term funds. Effective September 6, 1996 and June 17, 1998, primary dealers and satellite dealers were also permitted to issue commercial papers to access greater volume of funds to help increase their activities in the secondary market. 7 It can be issued to individuals, banks, companies and other registered Indian corporate bodies and unincorporated bodies. It is issued at a discount determined by the issuer company. The discount varies with the credit rating of the issuer company and the demand and the supply position in the money market. In India, the emergence of commercial paper has added a new dimension to the money market.8 Advantage 1. High credit ratings fetch a lower cost of capital. 2. Wide range of maturity provides more flexibility. 3. It does not create any lien on asset of the company. 4. Tradability of Commercial Paper provides investors with exit options.9 Disadvantage 1. Its usage is limited to only blue chip companies.
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Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 58-59) Ibid 8 http://www.scribd.com/doc/17856735/Indian-Money-Market (visited on 27th February, 2013) 9 http://www.scribd.com/doc/17856735/Indian-Money-Market (visited on 27th February, 2013)

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2. Issuances of Commercial Paper bring down the bank credit limits. 3. A high degree of control is exercised on issue of commercial paper. 4. Stand-by-credit may become necessary.10 Guidelines for Issuance of Commercial Paper Eligibility Corporate, primary dealers, and all-India Financial Institutions are eligible to issue a commercial paper. For a corporate to be eligible, it should have tangible net worth of Rs. 4 crore and a sanctioned working capital limit from a bank or a financial institution and the borrowable account is a standard asset. Rating Requirement the minimum credit rating shall be P2 of CRISIL or such equivalent rating by other approved agencies. Maturity Initially, corporate were permitted to issue a CP with a maturity between a minimum of 3 months and a maximum upto 6 months. At present, the maturity period has been brought down to a minimum of 7 days and a maximum of upto one year from the date of issue. Denomination Minimum of Rs. 5 lakh and multiples thereof. Amount invested by a single investor should not be less than Rs. 5 lakh (face value) Limits and Amount A commercial paper can be issued as a stand-alone product. Banks and financial institutions will have the flexibility to fix working capital limits duly taking into account the resource pattern of companies financing including commercial papers. Issuing and Paying Agent (IPA) Only a scheduled commercial bank can act as an IPA. It verifies all original certificates viz., credit rating certificates, letter of offer, and the board resolution authorising issue of the commercial paper. It holds custody of original of credit support document if it is in the form of stand-by assistance/back stop facility with relevant declaration and confirms that the documents are in order. After authentication of the entire commercial paper document, IPA issues an IPA certificate to all
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Ibid

subscribers of the commercial paper in the primary market and then reports the issue to the RBI. Investment in a Commercial Paper A commercial paper may be held by individuals, banks, corporate, unincorporated bodies, NRIs, and FIIs. Investment by FIIs would be within the limits set for their investments by the SEBI. Mode of Issuance A commercial paper can be issued as a promissory note or in a dematerialised form. Underwriting is not permitted. Commercial paper will be issued at a discount to face value as may be determined by the issuer. The total amount of commercial paper proposed to be issued should be raised within a period of 2 weeks from the date on which the issuer opens the issue for subscription. Every issue of commercial paper should be treated as a fresh issue. Preference for Demat Issuers and subscribers are encouraged to prefer exclusive reliance on demat form. Banks, financial institutions and primary dealers are advised to invest only in demat form. Stand-by Facility It is not obligatory for banks or financial institutions to provide stand-by facility. The can provide credit enhancement facility within the prudential norms.11

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Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 60-63)

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Growth of Commercial Papers Commercial paper was introduced in India in January 1990, in pursuance of the Vaghul Committees recommendations, in order to enable highly rated non-bank corporate borrowers to diversify their sources of short term borrowings and also provide an additional instrument to investors. Commercial paper could carry on an interest rate coupon but is generally sold at a discount. Since commercial paper is freely transferable, banks, financial institutions, insurance companies and others are able to invest their short-term surplus funds in a highly liquid instrument at attractive rates of return.12
Accordingly the reporting of commercial papers issuance by issuing and paying agents (IPAs) on NDS platform commenced effective on April 16, 2005. Activity in the commercial paper market reflects the state of market liquidity as its issuances tend to raise amidst ample liquidity conditions when companies can raise funds through commercial papers at an effective rate of discount lower than the lending rate of bonds. Banks also prefer investing in commercial papers during credit downswing as the commercial paper rate works out higher than the call rate.13 Commercial paper is a good instrument to raise short-term funds, but still there is no proper growth of the instrument due to following reasons.

1. Even though the minimum size of investment is Rs. 5 lakh, retail investors see little scope in investing their money. 2. Commercial paper issues involve administrative difficulties and complex procedural formalities which inhibit teh growth of this market. 3. The non-bank institutional investors such as LIC, UTI and GIC are not big buyers in this market because of RBI directive limiting their short0term investments in teh money market to treasury bills and as majority of their investment is either in equitites or other long-term investments. 4. There is no active seconday market for commercial papers even though efforts have been made by the Discount and Finance House of India in this dirction. 5. The commercial market has witnessed ups and downs. Corporate too find it hard to enter as there is neither an underwriting facility nor a roll-over facility in case of commercial papers

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http://www.scribd.com/doc/17856735/Indian-Money-Market (visited on 27th February, 2013) Ibid

6. Stamp duty levy make commercial papers less attractive than short-term credit for corporate.14

Commercial Papers - Trends in Volumes and Discount Rates.


Year Amount Outstanding at Minimum the end of March (Rs. cr.) Discount (% p.a.) 1993-1994 1994-1995 1995-1996 1996-1997 1997-1998 1998-1999 1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 3,264 604 76 646 1,500 4,770 5,663 5,846 7,224 5,749 9,131 14,235 12,718 17,838 9.01 10.00 13.75 11.25 7.65 8.50 9.00 8.20 7.10 5.50 4.60 4.47 5.25 6.25 Maximum Rate Discount (% p.a.) 16.25 15.50 20.15 20.90 15.75 15.25 13.00 12.80 13.00 11.10 9.88 7.69 9.25 13.35 Rate

Sources: RBI, Handbook of Statistics on Indian Economy, 2006-2007

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Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 60-63)

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Certificate of Deposit A certificate of deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift institutions, and credit unions. A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. A certificate of deposit, or CD, is an interest bearing deposit account. However, unlike a savings deposit account in which the interest rate may fluctuate, a CD is higher than on a savings account. Certificates of Deposits (CDs) are short-term borrowings by banks. Certificates of deposits differ from term deposit because they involve the creation of paper, and hence have the facility for transfer and multiple ownerships before maturity. Certificate of deposits rates are usually higher than the term deposit rates, due to the low transactions costs. Banks use the certificates of deposits for borrowing during a credit pick-up, to the extent of shortage in incremental deposits. Most certificates of deposits are held until maturity, and there is limited secondary market activity.15 NRIs can subscribe to the Deposits on a Non-repatriable basis. CDs are issued by banks during periods of tight liquidity, at relatively high interest rates. They represent a high cost liability. Banks resort to this source when the deposit growth is sluggish but credit demand is high. The transaction cost is lower than the other money market instruments. A large amount of money is mobilized through these deposits for short periods, reducing the interest burden when the demand for credit is slack.16 Guidelines for Issue of Certificate of Deposit Eligibility CDs can be issued by schedule banks (excluding the Regional Rural Banks and Local Area Banks) and select all-India Financial Institutions that have been permitted by the RBI to raise shot-term resources. Aggregate Amount Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs within the limit fixed by the RBI. Issue of CD together with the other instruments should not exceed 100% of its net owned funds, as per the latest audted balance sheet.
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http://www.scribd.com/doc/17856735/Indian-Money-Market (visited on 27th February, 2013) rd Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 68-72)

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Minimum Size of Issue and Denomination Minimum amount of a CD should be Rs. 1 lakh and in its multiples thereafter. Maturity The maturity period of CDs issued by the banks should not be less than 7 days and not more than 1 year. FIs can issue CDs for a period not less tan 1 year and not exceeding 3 years from the date of issue.

Reserve Requirements Banks have to maintain the appropriate reserve requirements, i.e., CRR and SLR, on the issue price of the CDs.

Transferability Physical CDs are freely transferable by endorsement and delivery. Dematted CDs can be transferred as per the procedure applicable to other demat securities.17

Certificate of deposits Volume and Rates Year Amount Outstanding at the end Minimum of March (Rs. cr.) 1993-1994 1994-1995 1995-1996 1996-1997 1997-1998 1998-1999 1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 5,571 8,017 16,316 12,134 14,296 3,717 1,227 771 1,576 908 4,461 12,078 43,568 93,272 rate (% p.a.) 7.00 7.00 9.00 7.00 5.00 6.00 6.25 5.00 5.00 3.00 3.57 1.09 4.10 4.35 Maximum rate (% p.a.) 18.00 15.00 23.00 21.00 37.00 26.00 14.20 14.60 11.50 10.88 7.40 7.00 8.94 11.90

Source: Handbook of Statistics on the Indian Economy 2002-03, RBI & RBI Bulletin.

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Bharti V. Pathak on The Indian Financial System 3 Ed. Pearson Publication (pg. 68-72)

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Difference between a Commercial Paper and Certificate of Deposit Certificates of deposit and commercial papers are both instruments used in the money market for different financial purposes. Which money market instrument is to be issued depends on the purpose for which the funds are required, with a distinction between instruments issued by private organizations, and those issued by the governments for treasury purposes. These financial instruments are quite popular among investors who wish to keep their funds in safe investments.18 CDs and commercial papers are both forms of money market instruments and are issued in the money markets by organizations that wish to raise funds, and are traded by investors who wish to profit from the interest rate fluctuations. However, there are many differences between these two forms of instruments, since CDs are issued as a proof of an investment of funds in the bank by a depositor while commercial papers are issued to an investor as a proof of purchase of the issuers debt (purchasing debt means providing funds like a bank gives out a loan). The main difference between the two forms of instruments is the time period of maturity of the two. While a CD is usually for a longer term, a promissory note is for a shorter period. The issuance of a CD, owing to this difference in maturity, entails higher responsibility on the issuers part than for a promissory note; the CD is insured by the Federal Deposit Insurance Corporation (FDIC) so that the depositor will be reimbursed in the incident that the bank fails to repay the deposit.19 Certificate of deposit and commercial papers are both instruments used in the money market for different financial purposes. A certificate of deposit is a document issued by the bank to an investor who chooses to deposit his funds in the bank for a specific amount of time. Once the money has been deposited the depositor cannot withdraw the funds before maturity without incurring a penalty for early withdrawal. Commercial paper is used as a substitute for a bank loan and is a short-term money market instrument which matures within 270 days.

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www.diiferencebwtween.com/difference-between-certificate-of-deposit-and-vs-commercialpaper/ (visited th on 27 February, 2013)


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Ibid

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The main difference between the two forms of instruments is the time period of maturity of the two. While a commercial deposit is usually for a longer term, a promissory note is for a shorter period.

Certificate of deposits are issued as a proof of an investment of funds in the bank by a depositor while commercial papers are issued to an investor as a proof of purchase of the issuers debt (purchasing debt means providing funds like a bank gives out a loan).20

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http://www.caclubindia.com/experts/cp-s-and-cd-s-1123374.asp#.UTC4z6I9G8A

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Conclusion
Commercial Paper is an important money market instrument in advanced countries like USA to raise short-term funds. In India, on the recommendation of the Vaghul Working Group, the Reserve Bank of India introduced the commercial paper scheme in the Indian Money Market in 1989. Certificate of deposit is an unsecured, negotiable, short-term instrument in bearer form, issued by commercial banks and development financial institutions. Certificate of Deposits were introduced in June 1989. The hypothesis that there is a very thin line of difference between the commercial papers and the certificate of deposits is wrong. There are differences between the two which make it easier to identify between the two. The maturity period and the amount for which the commercial paper and the certificate of deposits can be issued are different. The edibility requirements also differ. There is dependency between the commercial paper and the certificate of deposits. There exists an inverse relationship between then. When the outstanding amount of CDs increased, the outstanding amount of CPs decrease. The reason behind this inverse relationship is the liquidity conditions of the respective instrument.

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Bibliography
Books Referred Bharti V. Pathak on The Indian Financial System 3rd Ed. Pearson Publication (pg. 68-73) I M Pandey on Financial Management, 10th Ed., Vikas Publication, 2011. (pg. 748) M. Y. Khan on Indian Financial System, 6th Ed., McGraw Hill Companies, 2009

Websites Visited www.diiferencebwtween.com/difference-between-certificate-of-deposit-and-vscommercialpaper/ (visited on 27th February, 2013) http://www.scribd.com/doc/17856735/Indian-Money-Market (visited on 27th February, 2013) http://www.caclubindia.com/experts/cp-s-and-cd-s-1123374.asp#.UTC4z6I9G8A

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