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

1. MECHANISM & COST-BENEFIT ANALYSIS
FOR FINANCING WORKING CAPITAL WITH
RESPECT TO COMMERCIAL PAPERS &
CERTIFICATES OF DEPOSITS
Presented by:Daksh Bhatnagar
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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
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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
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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.
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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.
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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. 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
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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
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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,
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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
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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
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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
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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
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14. DISAVANTAGE OF CDs
• Holding of CDs till maturity date spearheads
to ineffective secondary market
• Banks cannot grant loans against CDs
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15. CITATIONS
• FINANCIAL MARKETS AND INSTITUTIONS (3rd
Edition) – Dr. S Gurusamy
• WORKING CAPITAL MANAGEMENT (10th
Revised Edition) - V.K Bhalla
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16. THANK YOU
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