Previous Year Question
With reference to the Indian economy, consider the following statements:
‘Commercial Paper’ is a short-term unsecured promissory note.
‘Certificate of Deposit’ is a long-term instrument issued by the Reserve Bank of India to a corporation.
‘Call Money’ is a short-term finance used for interbank transactions.
‘Zero-Coupon Bonds’ are the interest-bearing short-term bonds issued by Scheduled Commercial Banks to corporations.
Which of the statements given above is/are correct?
1 and 2 only
4 only
1 and 3 only
2, 3 and 4 only
Correct Answer: C
Detailed Solution
Statement 1 is correct.
Commercial Paper, or CP, is a short-term unsecured money-market instrument issued in the form of a promissory note. Eligible companies, Non-Banking Financial Companies and other entities permitted under the RBI framework may issue CP to raise short-term funds.
No specific asset is pledged as security for CP. Investors consequently rely upon the creditworthiness and credit rating of the issuer. It is generally issued at a discount to its face value and redeemed at face value upon maturity.
Statement 2 is incorrect.
A Certificate of Deposit, or CD, is a negotiable and unsecured money-market instrument. It is not issued by the RBI to a corporation. It may be issued by eligible Scheduled Commercial Banks and certain financial institutions permitted by the RBI.
Banks use CDs to mobilise wholesale deposits for a comparatively short period. The statement is therefore incorrect on both grounds: it identifies the wrong issuer and describes a short-term money-market instrument as a long-term instrument.
Statement 3 is correct.
The Call Money market facilitates unsecured borrowing and lending for very short periods between banks and other eligible financial institutions.
Under RBI terminology:
overnight borrowing and lending constitute Call Money;
transactions for two to fourteen days constitute Notice Money; and
transactions exceeding fourteen days and extending up to one year constitute Term Money.
Banks use this market to meet daily cash requirements, payment obligations and short-term liquidity mismatches. Therefore, Statement 3 is correct.
Statement 4 is incorrect.
A Zero-Coupon Bond does not make periodic interest or coupon payments. It is generally issued at a discount to its face value and redeemed at face value upon maturity. The investor’s return is the difference between the issue price and redemption value.
Zero-Coupon Bonds are not necessarily issued only by Scheduled Commercial Banks to corporations. Governments and other eligible entities may also issue them. Describing them as interest-bearing short-term bonds is also incorrect.