CENTRAL BANKING MODULE D QUIZ 2

A clear mandate establishes permissible instruments, counterparties, risk limits, liquidity needs, accountability and decision rights. It prevents a reserve portfolio from drifting into speculative or unauthorised assets and makes performance assessment more meaningful. The mandate should reflect the public purpose of reserves rather than a private fund‘s return-maximisation objective.

Bond prices generally move inversely to market yields. When yields rise, existing fixed-rate bonds with lower coupons become less attractive and their market prices fall. The sensitivity depends in part on duration and convexity; short-duration instruments usually have lower price sensitivity than otherwise comparable longer-duration bonds.

When reserve assets are translated into the reporting currency, exchange-rate changes affect their reported value. A euro depreciation against the dollar reduces the dollar value of euro-denominated assets, even if their euro value is unchanged. This is a valuation risk and is distinct from the risk of an issuer defaulting.

Short-term external debt creates foreign-currency repayment needs that may fall due quickly or be difficult to roll over during market stress. Comparing reserves with short-term debt helps assess whether a country could meet near-term external obligations under a sudden stop. It is one indicator among several, not a complete measure on its own.

Gross reserves show the stock of qualifying reserve assets, but an assessment of external strength may also consider short-term external liabilities, forward positions, encumbrances and other contingent needs. Gross reserves remain an important standard measure, but they do not alone reveal every net liquidity exposure.

Authorised dealer banks quote bid and ask prices and facilitate transactions for customers and other market participants. They may also manage their own currency positions within applicable limits. The central bank may intervene for policy or market-orderliness purposes, but it is not the only participant in the FX market.

A spot FX transaction exchanges one currency for another for settlement on the standard spot value date for the currency pair, commonly two business days for many major pairs, though conventions differ by pair and market. It is distinct from a forward contract, which sets an exchange rate today for a future value date.

The importer can agree today to buy dollars at a specified forward rate for settlement in three months, reducing uncertainty about the rupee cost of the future payment. The contract manages exchange-rate risk but may involve opportunity cost if the spot market later moves favourably, and it creates counterparty and documentation considerations.

A direct quotation expresses the domestic currency price of one unit of foreign currency. For an Indian resident, a quote such as ₹83 per US dollar is direct because it states how many rupees buy one dollar. Quotation conventions can differ by market and context, so always identify whose domestic currency is being used.

The money market facilitates short-term borrowing and lending, typically through instruments with short maturities, helping financial institutions and governments manage temporary liquidity needs. It supports monetary policy transmission and cash management. It differs from the capital market, which generally deals with longer-term financing instruments.

Treasury Bills are short-term money-market instruments issued by the Government of India at a discount and redeemed at face value. They do not pay periodic coupons; the investor‘s return is the difference between purchase price and redemption value. They are distinct from dated government securities, which generally have longer maturities and coupon payments.

The call money market is the segment for unsecured overnight borrowing and lending of funds among eligible participants. Notice money generally covers longer short-term tenors as defined by market conventions, while term money extends beyond that period. The call market is important for day-to-day liquidity management and the RBI‘s operating target.

Commercial Paper is an unsecured money-market instrument issued by eligible corporates and other permitted entities to raise short-term funds, subject to applicable RBI rules. Since it is unsecured, investor assessment of issuer credit quality is important. CP differs from a secured bank loan and from a government Treasury Bill.

A CD is a negotiable money-market instrument issued by eligible banks and other permitted financial institutions under applicable rules. It enables issuers to raise funds for a specified tenor and can be held or traded subject to market and regulatory conditions. It is distinct from an ordinary savings deposit and from commercial paper issued by eligible non-bank entities.

In the primary market, new government securities are issued to raise funds for government financing needs. The secondary market allows existing securities to be traded among investors, providing liquidity and price discovery. Secondary-market yields also help establish benchmark rates across maturities.

An upward-sloping yield curve indicates that longer-maturity securities yield more than shorter-maturity securities at that point in time. The shape can reflect expectations about future short rates, inflation and growth as well as term premia, supply-demand factors and liquidity. It does not uniquely predict one economic outcome.

India moved from a tightly controlled exchange-rate and foreign-exchange regime toward a more market-oriented system, supported by reforms including current-account convertibility, development of market instruments and the FEMA framework. The rupee is not a freely floating currency without any official involvement; RBI may act to maintain orderly market conditions.

FEMA, 1999 replaced FERA, 1973 and reflects a framework oriented toward facilitating external trade and payments and promoting orderly development and maintenance of the foreign exchange market. FERA was more control-oriented and treated many contraventions more stringently. FEMA does not mean that foreign exchange transactions are unrestricted; regulatory requirements continue to apply.

Benchmarks can influence loan pricing, derivatives, securities and other contracts. Weak governance, conflicts of interest or unreliable submissions can distort prices and create systemic risks. Transparent methodologies, accountable administrators, data controls, auditability and contingency arrangements help preserve benchmark integrity and confidence.

LIBOR depended on submissions intended to represent banks‘ unsecured interbank funding costs and suffered from declining underlying transaction activity and benchmark-manipulation concerns. Markets transitioned to alternative reference rates, many based more directly on transactions, with conventions adapted for loans and derivatives. Legacy-contract remediation and fallback provisions were important parts of the transition.