Deposit rate, CASA ratio, CDR, ICDR, CD-Ratio, Call rate, MIBOR, Term Rate, Yield, Forward Premia, RBI Reference Rate, etc will get clear in this article.
Comment: Just go through the text sequentially so that everything becomes crystal clear. Central Bank = RBI in India. * labelled terms are dealt with in other articles. We can afford to skip understanding them for now! A few rates and ratios like the CAR, Exchange Rate, Provision coverage ratio, MCLR, etc are dealt under separate articles.
Deposit Rate
In deposit terminology, a term Deposit Rate refers to the amount of money paid out in interest by a bank or financial institution on cash deposits. Banks pay deposit rates on savings and other investment accounts. For example, a deposit interest rate will often be paid for cash deposited into savings and Money Market accounts*. Savings accounts earn a rather low rate of interest, but cash deposited in certain other account types are also paid a deposit rate by banks and financial institutions. Deposit interest rates can be either fixed for a certain period of time with a minimum amount of money on deposit, or it can be variable, which fluctuates and is not usually subject to early withdrawal penalties. Note that the deposit growth rate of an economy will become lower, if the deposit rates are low and inflation is high.
CASA ratio
CASA stands for current and savings account. Different kinds of deposits, current (/demand) account, savings account and term (/fixed) deposits form the major source of funds for banks. The CASA ratio shows how much deposit a bank has in the form of current and saving account deposits in the total deposit. CASA ratio of a bank is the ratio of deposits in current and saving accounts to total deposits. A higher CASA ratio means higher portion of the deposits of the bank has come from current and savings deposit, which is generally a cheaper source of fund. Many banks don’t pay interest on the current account deposits and money lying in the savings accounts attracts a mere 4% interest rate. Hence, higher the CASA ratio better the net interest margin, which means better operating efficiency of the bank.
Net interest margin/Net interest spread
Net interest margin is difference between total interest income and expenditure and is shown as a percentage of average earning assets. Higher income from CASA will improve the net interest margin as the cost of this fund is relatively lower. For instance, most banks lend at over 10%, whereas, the rate of interest that they pay on saving deposit is just 4%. However, actual realisation depends on other expenditure, too. The easiest explanation for this metric is by illustrating how a retail bank earns interest from customer’s deposits. Most banks in India offer interest on deposits from customers, generally in the range of 4% annual interest. The retail bank at that point, turns around and lends an aggregate of multiple clients’ deposits as a loan to small business clients at an annual interest rate of 9%. The margin between these two amounts is considered the net interest spread. In this case it works out to an even 5% spread between the cost of borrowing the funds from bank customers and the value of interest earned by loaning it out to other clients. Net interest margin adds another dimension to the net interest spread by basing the ratio over its entire asset base. If a bank has $1 million in deposits with a 1% annual interest to the deposit holders, and it loans out $900,000 at an interest of 5% with earning assets of $1.2 million, the net interest margin is 2.92% (interest returns — interest expenses/average earning assets). However, if this ratio shows a negative return, the bank or investment firm has not invested their funds efficiently. In a negative net interest margin scenario, the company would have been better served by applying the interest returns against outstanding debt or to fund more profitable revenue streams.
Cash Deposit ratio (CDR)
Cash Deposit ratio (CDR) is the ratio of how much a bank lends out of the deposits it has mobilised. It indicates how much of a bank’s core funds are being used for lending, the main banking activity. It can also be defined as Total of Cash in hand and Balances with RBI divided by Total deposits (Demand + Time Deposits). It can be thought of as the amount of liquidity the banks need to maintain on the deposits. It is usually 0.75% of total deposit. Say, a bank receives total cash deposits of Rs 100 out of which it has to park Rs 4 with the RBI (CRR norms). For now, let’s forget about SLR. The bank can now loan out Rs 96 to its customers but, let’s say, it decides to keep a cash balance of Rs 6 so as to fulfill the withdrawal requests from its customers and lends out the remaining Rs 90. Thus here, the Total Cash in hand + Balances with RBI = Rs 6 + Rs 4 = Rs 10. So the CDR will be 10%. Thus, CDR includes the Cash Reserve Ratio that Indian banks have to maintain with the RBI. Banks in India generally maintain a CDR of ~ 5% (4% CRR + 1% Cash in hand). These days when plastic cards, Internet payments, electronic funds transfer, and so on, are on the increase, banks really don’t require much cash in hand. As cash holding is very expensive, banks try to maintain minimum holding. The CDR as on 5 August 2016 was 4.72%.
However, we should note that banks in India still have high CDRs (~6%). Since the culture of ATMs has been spreading fast, no doubt the banks need to maintain hard cash to meet the demands of customers. The public preference for hard cash continues to be strong indicating, perhaps, the lack of spread of banking habit in its fullest sense, the persistence of corruption, prevalence of black money, high level of inflation and general insistence for cash payments for commodities such as gold and silver in particular. The Reserve Bank through its issue offices, sub-offices and a wide network of more than 4000 currency chests carries out the issue of notes and management of currency and helps the banking system improve its funds management. The high level of cash transactions in the economy necessitates more physical notes in circulation adding responsibilities to the Reserve Bank and increasing the seigniorage* cost. With the implementation of prudential norms, as per the Narasimham Committee’s recommendations and also the Basel I and Basel II guidelines for improving banks’ efficiency, the attention paid in the maintenance of cash and the cost it adds to banks’ overall cost of funds seems to be somewhat missing, affecting, among other things, the profitability of banks. The Reserve Bank has streamlined the process flow in credit-push systems such as the National Electronic Funds Transfer (NEFT), Real Time Gross Settlement (RTGS), Electronic Credit System (credit) (ECS-credit) and National Electronic Clearing Service systems, and banks are in a position to credit beneficiaries account without any hassles. The cash and bank balances have to be considerably brought down taking advantage of the improved telecommunication system and facilities provided by the Reserve Bank. There is ample scope to reduce the physical handling of cash at branches and banks can save all related expenditures. With all these facilities, the cash held at banks has been found to be very high. The asset-liability management (ALM) of the banks will also improve in the process.
*Comment: Seigniorage is the difference between the value of money and the cost to produce it — in other words, it’s the economic cost of producing a currency within a given economy or country. If the seigniorage is positive, then the government will make an economic profit; a negative seigniorage will result in an economic loss. Thus it can be thought of as the profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs.
Credit-deposit ratio (CD Ratio)
Here too, a similar concept applies. Credit-deposit ratio, popularly CD ratio, is the ratio of how much a bank lends (food + non-food credit) out of the deposits it has mobilized. It indicates not just the demand for loans but also banks’ liquidity position. RBI does not stipulate a minimum or maximum level for the ratio, but a very low ratio indicates banks are not making full use of their resources. A too high ratio, implies that banks might not have enough liquidity to cover any unforeseen fund requirements, may affect capital adequacy and asset-liability mis-match. It will be equal to Total Advances divided by Total deposits. If the reserve requirements such as the statutory liquidity ratio (SLR) of 21% and cash reserve ratio of 4% are factored in, the CD ratio should ideally not cross 75%. There have been times when banks in India sometimes tend to exceed this 75% (under high inflation conditions) which indicates that, in such cases, banks are tending to borrow from the market to lend for projects and working capital rather than from lower-cost deposits. A reason behind this is that high inflation and high tax rates dents deposit activity, the result being that deposits grow at a lower rate vis-à-vis credit growth which still remains high. As a result of this banks start borrowing from the market (at, say x% interest rate) and loan out this borrowed money to make more profits (at, x+y% interest rate). However, it is not considered prudent to do so. Thus we can say that CD Ratio gives an indication of a bank’s dependence on borrowed funds to fund its credit growth.
Incremental CD ratio (ICDR)
The Incremental Credit Deposit Ratio (ICDR) is the absolute growth in credit in relation to the absolute growth in deposits. ICDR indicates the rate with which credit is growing vis-à-vis the deposits (for a given financial year). E.g, An ICDR of 100% for a given FY indicates that for every Rs 100 that banks have borrowed by raising deposits, they have loaned out Rs 100. Now if ICDR > 100%, then this means that the banks have been funding their loans out of deposits they had raised in periods previous to the period considered in our given FY. Or, they might have been borrowing from the market. In such situations, banks should hike their deposit rates (i.e, the interest rates on their deposits). If the ICDR is low (i.e, << 100%) then it means that banks have excess liquidity with them that could go into investments in government bonds or other securities. A low credit growth rate (i.e, a less demand for credit), because of higher lending rates, coupled with improvements in deposit mobilisation at other avenues offering a higher deposit rate generally tends to lower the ICDR. Hence, it makes sense for the banks in such a situation to cut their lending rates.
Comment: Data from the Reserve Bank of India show that the incremental CD ratio (ICDR) has plummeted to 10.77% as of August 2016 from 30.45% a year ago. The fall in this ratio has been primarily due to a far greater fall of credit growth compared with deposit growth. Loan growth is at 9.8% and after five years of falls, is showing some signs of improvement, while deposit growth is at a five-decade low at around 9.9%. The deposit growth during 2011-2012, 2012-2013, 2013-2014 and 2014-15 had stood at 11.75%, 14%, 14.29% and 10.7% respectively.A slow economic recovery and a large pile of stalled projects had dragged down fresh investments and, thereby, loan growth over the last three years. Banks are reducing the proportion of their government bond holdings to the total deposits as they begin to lend more than the previous years.Thus the CD Ratio is like to see an upward trend. Currently the CD Ratio is as 74.76% indicating that banks are lending a bigger portion of every Rs 100 taken as deposit. As a result, the government borrowings could get costlier. The banking landscape has also undergone a change with two new banks – Bandhan Bank and IDFC Bank – starting operations this fiscal. They are estimated to add Rs 50-60,000 crore to the loan book of banking sector. Economists feel if the slowdown in deposits continue, with a pickup in credit demand, there could be pressure on rates. Retail loans have been the largest contributor to bank credit growth in the past one-two years. Now in such a case if RBI cuts its policy rate by say 50 bps, it is hoped that banks will cut their lending rates as well. We know that as banks cut their interest rates on their loans, people start borrowing and spending more. Low interest rates will also help companies which have huge debts to service. But the past experience shows that the direct correlation between RBI cutting the repo rate and banks passing on that cut at the same rate in the form of lower lending rates, is rather weak. The point being that when the repo rate goes up, the banks are fast to pass on the hike to the end consumers, in the form of higher lending rates. But the vice versa does not seem to be true. Why is that? A simple answer is greed or the need to make more money. Further, the trouble this time around is that public sector banks are staring at a huge amount of corporate bad loans. In order to handle this, banks are hoping to make a greater profit by cutting their deposit rates, but not cutting their lending rates at the same rate. We know that banks make loans from deposits which they are able to raise. And if the deposit growth is almost at an all-time low, their ability to cut interest rates on their loans, will be limited. If banks cut deposit rates any further, the deposit growth will fall further and this will hurt their ability to give out loans. Currently banks are left with Rs 75 to lend out of every Rs 100 that they raise as deposits. The fact is that they have lent > Rs 75 during the last one year. This has been possible because of the fact that the incremental credit deposit ratio between 2014 and 2015 had been low. The low number gave banks scope to lend more in 2015-2016. The point is that if the loan growth does pick up a little more from here, the incremental credit deposit ratio is likely to get worse in the days to come. If we take this possibility into account, banks will have a tough time cutting down their deposit rates any further. And that being the case, the chances of lending rates being cut further are limited.
Investment-Deposit Ratio
This is calculated as the ratio of how much a bank has invested in Government and other Approved Securities out of the deposits it has mobilized. Thus, it is equal to Investments (Government Securities and Other Approved Securities)/Total Deposits. This helps one understand how much of the deposit is being invested in fixed income securities. The ratio averages around 29-30%. Since, banks need extra government security to meet their day to day liquidity therefore this ratio would be higher than SLR. Currently it is 29.32%.
Incremental Investment-Deposit Ratio
Incremental Investment-Deposit Ratio (%) = Incremental Investments (Government Securities and Other Approved Securities) / Incremental Deposits
Term deposit
A term deposit is a deposit held at a financial institution that has a fixed term. These are also popularly known as Fixed Deposits or FD accounts. These are generally short-term with maturities ranging anywhere from a month (short-term) to a few years. When a term deposit is purchased, the lender (the customer) understands that the money can only be withdrawn after the term has ended or by giving a predetermined number of days notice. These types of financial products are sold by banks, thrift institutions and credit unions. Term deposits are an extremely safe investment and are therefore very appealing to conservative, low-risk investors. They are generally insured upto a limit by government authorities. They are called so because they allow banks to hold onto a deposit for a specific amount of time, thus allowing banks to invest in higher gain financial products. In return, financial institutions are more likely to pay higher interest rates to the lender. Most institutions will offer fixed rates for such deposits. Generally, interest rates should be proportional to the time and amount that the principle is lent. Closing a term deposit before the end of the term, or maturity, comes with the consequence of lost interest on the principal. Sometimes, if the financial environment is right and interest rates have risen a considerable amount, the penalty a financial institution may not be enough of a deterrent for an investor to withdraw their term deposit and refinance it at a higher rate. On term deposits, interest rates can track inflation rates, making it so any gain on the principal is in fact not a gain in value but simply a gain in capital. However, the issue is not whether or not term deposit track inflation, but how closely they do. This can be to the benefit or disadvantage to the investor. If the projected inflation rate is high, and inflation goes below what is expected and the interest rate on the principal invested is locked in, then the investor stands to gain value on the term deposit. If the inflation rate ends up going higher than anticipated and the interest rate isn’t adjusted, an investor could lose value on their investment.
Term Deposit rate
The Term Deposit Rates refers to the amount of money in interest paid on the maturity date for a specified amount of money placed in a Term Deposit. Term Deposits generally carry a fixed rate of interest. As of now the Term Deposit Rate >1 Year in India = 7.00/7.50%. The earlier trend that private sector and foreign banks offer higher rate of interest is no more valid these days. However, nowadays small banks are forced to offer higher rate of interest to attract more deposits. Usually a bank FD is paid in lump sum on the date of maturity. However, most of the banks have also facility to pay/ credit interest in saving account at the end of every quarter. If one desires to get interest paid every month, then the interest paid will be at a marginal discounted rate. In the changed computerized environment, now the Interest payable on Fixed Deposit can also be easily transferred on due dates to Savings Bank or Current Account of the customer.
Savings Account/ Savings Deposit
A savings account is an interest-bearing deposit account held at a bank or another financial institution that provides a modest interest rate. Banks or financial institutions may limit the number of withdrawals you can make from your savings account each month. Generally, banks have the concept of minimum Monthly Average Balance (MAB) for savings account. When the account balance does not meet the MAB requirements, non-maintenance charges will be levied. In some cases, banks do not provide cheques with savings accounts. In contrast to savings accounts, chequing accounts allow you to write checks and use electronic debit to access your funds, and these accounts typically do not have limits on the number of withdrawals or transactions you may make each month. Because savings accounts pay interest, it is more financially advantageous to keep unneeded funds in a savings account than a checking account. In addition, savings accounts are one of the most liquid investments outside of demand accounts and cash. While savings accounts facilitate saving, they also make it very easy to access your funds. While some analysts recommend keeping more than that in your savings account, most think that excess money should be placed in higher interest-bearing accounts or used to pay down debts with higher interest rates. Savings accounts almost always pay lower interest rates than Treasury bills and certificates of deposit* (CDs). As a result, they should not be used for long-term holding periods. Your savings account may become dormant if there are no customer-initiated transactions for a specified period of time. Transactions through ATM, internet and phone banking will not be allowed by the bank if your account becomes dormant and you must activate it again to continue enjoying the benefits. However, any “Basic Savings Account” (no frills account) opened in India has no minimum balance requirements. Recently, the RBI has asked banks to stop imposing charges for non-maintenance of minimum balance once the balance in a savings account touches zero.
E.g, Here are the current restrictions (2016) on an SBI basics saving bank account :
Note that the minimum balance requirement is NIL. The customer is also provided with cheque book facility. The interest rate @ 4% pa based on daily balance.
- Maximum 4 withdrawals in a month, including ATM withdrawals at own and other Bank’s ATMs.
- Thereafter service charges as per regular Savings Bank Account will apply.
- Holders of Basic Savings Bank Deposit Account will not be eligible to open any other Savings Bank Account. In case, he/she already has an account, the same will have to be closed within 30 days of opening a Basic Savings Bank Deposit Account.
- Only Basic ATM-cum-debit card will be issued. Variants of ATM cards can be issued on payment of stipulated charges.
Savings Deposit Rate
The interest rate paid by banks on a savings deposit to deposit account holders. Deposit accounts include certificates of deposit, savings accounts and self-directed deposit retirement accounts. Till 2011, the interest on saving bank accounts was regulated by RBI and it was fixed at 4.00% on daily balance basis. However, wef 25th October, 2011, RBI has deregulated saving fund account interest rates and now banks are free to decide the same within certain conditions imposed by RBI. Under directions of RBI, now banks are also required to open no-frill accounts or Zero Balance Account (this term is used for accounts which do not have any minimum balance requirements). Although Public Sector Banks still pay only 4% rate of interest, some private banks like Kotak Mahindra Bank, RBL Bank and Yes Bank may pay higher interest rates (6%) on such deposits. Following the RBI mandate, Basic Savings Bank Deposit Account or BSBDA is now offered by all banks. A BSBDA has no minimum balance requirement and the customers are offered debit card. BSBDA is zero-balance account but banks may offer the zero-balance flexibility to other types of savings account variants also.
Zero Balance Savings Account
Here the account holder is free to operate the account without strings of maintaining a minimum balance. This type of savings account is offered by banks to specific category of customers such as salary account holders and on basis of Pradhan Mantri Jan Dhan Yojana (PMJDY) – a scheme from Government of India with a mission of financial inclusion. All PMJDY accounts also have an Accidental Insurance Cover of Rs.1.00 lac. Other facilities include – Direct benefit transfer from Government schemes are credited to this account, overdraft facility is offered after 6 months of satisfactory operation and RuPay debit card. However , the debit balance should not exceed Rs.50,000 at any point of time.
Call money
Call money is short-term finance repayable on demand, with a maturity period of one to fourteen days or overnight to fortnight. It is used for inter-bank transactions. The money that is lent for one day in this market is known as “call money” and, if it exceeds one day, is referred to as “notice money” or “short notice money”. Banks resort to these type of loans to fill the asset liability mismatch, comply with the statutory CRR and SLR requirements and to meet the sudden demand of funds. Call money is a method by which banks lend to each other to be able to maintain the cash reserve ratio.
Call rate
The interest rate paid on call money is known as the call rate. It is a highly volatile rate that varies from day to day and sometimes even from hour to hour. There is an inverse relationship between call rates and other short-term money market instruments such as certificates of deposit and commercial paper. A rise in call money rates makes other sources of finance, such as commercial paper and certificates of deposit, cheaper in comparison for banks to raise funds from these sources.
Interbank Call Money Market
A short-term money market, which allows for large financial institutions, such as banks, mutual funds and corporations (e.g, insurance companies) to borrow and lend money at interbank rates. The loans in the call money market are very short, usually lasting no longer than a week and are often used to help banks meet reserve requirements. India allows only banks and financial institutions to participate in the call money markey.
Interest Rates in Call / Notice Money Markets
Interest rates in these markets are market determined i.e. by the demand and supply of short term funds. In India, 80% demand comes from the public sector banks and rest 20% comes from foreign and private sector banks. Then, around 80% of short term funds are supplied by Financial Institutions such as IDBI and Insurance giants such as LIC. Rest 20% of the short term funds come from the banks. Since banks work as both lenders and borrowers in these markets, they are also known as Inter-Bank market. The short term fund market in India is located only in big commercial centres such as Mumbai, Delhi, Chennai and Kolkata. The intervention of RBI is prominent in the short term funds money market in India. Call Money / Notice Money market is the most liquid money market and is indicator of the day to day interest rates. If the call money rates fall, this means there is a rise in the liquidity and vice versa.
Comment: Over Night MIBOR – MIBOR refers to Mumbai Interbank Offer Rate. It is the weighted average of the call money rates offered by a set of specific banks on a given day. It is calculated everyday by the National Stock Exchange of India (NSEIL) as a weighted average of lending rates of a group of banks, on funds lent to first-class borrowers. The MIBOR was launched in 1998 by the Committee for the Development of the Debt Market, as an overnight rate. The NSEIL launched the 14-day MIBOR on November 10, 1998, and the one month and three month MIBORs on December 1, 1998. MIBOR serves as a benchmark to which various entities in the market benchmark their short term interest rates. Here are the products linked with MIBOR:
- Call, Notice, Term Money
- Forward Rate Agreements*
- Future Interest Rate*
- Interest Rate Swaps (IRS)*
- Swap Options*
- Overnight Index Swaps*, etc.
Several financial markets follow different Inter-bank offer rates, like –
- London Inter-Bank Offer Rate (LIBOR)
- Mumbai Inter-Bank Offer Rate (MIBOR)
- Tokyo Inter-Bank Offer Rate (TIBOR)
- Singapore Inter-Bank Offer Rate (SIBOR)
- Hong Kong Inter-Bank Offer Rate (HIBOR)
LIBOR was first published in 1986 for three currencies – USD, GBP (Great Britain Pound) and JPY (Japanese Yen). Later on several other currencies were added in the list (currently 10 currencies). It is published daily at 11:30 A.M (London time) by Thomson Reuters, and Libor rates are determined for 15 borrowing periods (e.g., overnight, 1 week, 2 weeks, 1 month, etc. up to 1 year). Some products which are linked / bench marked / reference rated to LIBOR include, Forward Rate Agreements, Interest Rate Futures, Interest Rate Swaps, Swaptions, Overnight Index Swaps, Interest Rate Options, Floting Rate Notes, Range Accrual Notes.
Mumbai Inter-Bank Bid Rate (MIBID) is the opposite of MIBOR. While MIBOR is the benchmark rate at which banks are willing to offer loans to other bank, MIBID is the benchmark rate at which banks are willing to take loans (paying the MIBID interest rate) from other banks. Note that MIBID rate is always less than MIBOR rate, because, banks will try to pay less interest after taking loans, and will try to get more interest while offering loans. It is also the weighted average of interest rates at which several banks (taken as survey) are willing to pay.
Call Money Rate and Margin Interest Rate (International Markets)
The call money rate is the interest rate on a type of short-term loan that banks give to brokers who in turn lend the money to investors to fund margin accounts. A margin account is an account offered by brokerages that allows investors to borrow money to buy securities. Brokerage firm can lend the investor money against the value of certain stocks, bonds, and mutual funds in his/her portfolio. An investor might put down 50% of the value of a purchase and borrow the rest from the broker. The broker charges the investor interest for the right to borrow money and uses the securities as collateral. For both brokers and investors, this type of loan does not have a set repayment schedule and must be repaid on demand. A margin loan can be a valuable tool in the right circumstances, but be aware that it can magnify both profits and losses. When investors trading on margin experience a decline in equity past a certain level relative to the amount they have borrowed, the brokerage will issue a margin call that requires them to deposit more cash in their account or to sell enough securities to make up the shortfall.
E.g, of a margin call – Consider an investor who buys Rs 1,00,000 of stocks by using Rs 50,000 of his own funds and borrowing the remaining $50,000 from his broker. Let’s say that the investor’s broker has a maintenance margin of 25% with which the investor must comply. At the time of purchase, the investor’s equity is Rs 50,000 (the market value of securities of Rs 100,000 minus the broker’s loan of Rs 50,000), and the equity as a percent of the total market value of securities is 50% (the equity of Rs 50,000 divided by the total market value of securities of Rs 100,000), which is above the maintenance margin of 25%. Suppose that on the second trading day, the value of the purchased securities falls to Rs 60,000. This results in the investor’s equity of Rs 10,000 (the market value of Rs 60,000 minus the borrowed funds of Rs 50,000). However, the investor must maintain at least Rs 15,000 of equity (the market value of securities of Rs 60,000 times the 25% maintenance margin) in his account to be eligible for margin, resulting in a Rs 5,000 deficiency. The broker makes a margin call, requiring the investor to deposit at least Rs 5,000 in cash to meet the maintenance margin. If the investor does not deposit Rs 5,000 in a timely manner, his broker can liquidate securities for the value sufficient to bring his account in compliance with maintenance margin rules.
As with any loan, when you buy securities on margin you have to pay back the money you borrow plus interest, which varies by brokerage firm and the amount of the loan. Margin interest rates are typically lower than credit cards and unsecured personal loans. And there’s no set repayment schedule with a margin loan—monthly interest charges accrue to your account, and you can repay the principal at your convenience. Also, margin interest may be tax deductible if you use the margin to purchase taxable investments.
Spot Rate
The spot rate is the immediate purchase price posted on exchanges for purchasing commodities, currency and securities. It’s the market price at the moment of a quote. This value is in turn based on how much buyers are willing to pay and how much sellers are willing to accept, which depends on factors such as current market value and expected future market value. As a result, spot rates change frequently and sometimes dramatically. Thus, as the markets where spot rates are determined are very fluid and dynamic, so spot rates change often as the markets rise and fall. In the currency (foreign exchange) markets, the spot rate is sometimes called the benchmark rate. The currency spot rate is affected by the needs of businesses and individuals transacting in foreign currency, as well as foreign currency traders. Besides currencies, assets that have spot rates include commodities (e.g., crude oil, conventional gasoline, propane, cotton, gold, copper, coffee, wheat, lumber) and bonds. Commodity spot rates are based on supply and demand for these items.
Forward Rate
A forward rate is a rate applicable to a financial transaction that will take place in the future. Forward rates are based on the spot rate, adjusted for the cost of carry (The cost of carry refers to costs incurred as a result of an investment position and can include financial costs, such as the interest costs on bonds, interest expenses on margin accounts, and interest on loans used to purchase a security) and refer to the rate that will be used to deliver a currency, bond or commodity at some future time. It may also refer to the rate fixed for a future financial obligation, such as the interest rate on a loan payment. In forex, the forward rate specified in an agreement is a contractual obligation that must be honored by the parties involved. For example, consider an American exporter with a large export order pending for Europe, and undertakes to sell 10 million euros in exchange for dollars at a rate of 1.35 euros per U.S. dollar in six months’ time. The exporter is obligated to deliver 10 million euros at the specified rate on the specified date, regardless of the status of the export order or the exchange rate prevailing in the spot market at that time. Forward rates are widely used for hedging purposes in the currency markets.
Futures Exchange
A futures exchange, traditionally, is a term referring to a central marketplace where futures contracts and options on futures contracts are traded. More recently, with the growth in electronic trading, it is also used to describe the activity of futures trading itself. A futures contract is a legal agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a predetermined price at a specified time in the future.
Forward Premium
A forward premium occurs when dealing with foreign exchange (FX); it is a situation where the spot futures exchange rate, with respect to the domestic currency, is trading at a higher spot exchange rate then it is currently. A forward premium is frequently measured as the difference between the current spot rate and the forward rate, but any expected future exchange rate suffices. It is a reasonable assumption to make that the future spot rate will be equal to the current futures rate.
An important aspect of functioning of the foreign exchange market relates to the behavior of forward premia in terms of its linkages with economic fundamentals such as interest rates and its ability to predict future spot rates. Forward premia reflects whether a currency is at a premium/discount with respect to other reserve currencies. Forward premia is particularly important for importers and exporters who need to hedge their risks to foreign currency. The forward market in India is active up to one year where two-way quotes are available.
Bid and Offer Rates
The bid price represents the maximum price that a buyer or buyers are willing to pay for a security. The ask price represents the minimum price that a seller or sellers are willing to receive for the security. A trade or transaction occurs when the buyer and seller agree on a price for the security. The difference between the bid and asked prices, or the spread, is a key indicator of the liquidity of the asset – generally speaking, the smaller the spread, the better the liquidity. Thus, a bid-ask spread is the amount by which the ask price exceeds the bid price for an asset in the market. The bid-ask spread is essentially the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept to sell it. For example, if the bid price for the stock is Rs 98 and the ask price for the same stock is Rs 100, then the bid-ask spread for the stock in question is Rs 2. The bid-ask spread can also be stated in percentage terms; it is customarily calculated as a percentage of the lowest sell price or ask price. For the stock in the example above, the bid-ask spread in percentage terms would be calculated as Rs 21 divided by Rs 100 (the bid-ask spread divided by the lowest ask price) to yield a bid-ask spread of 2% (Rs 2 / Rs 100 x 100). This spread would close if a potential buyer offered to purchase the stock at a higher price or if a potential seller offered to sell the stock at a lower price. The size of the bid-ask spread from one asset to another differs mainly because of the difference in liquidity of each asset. Certain markets are more liquid than others. For example, currency is considered the most liquid asset in the world, and the bid-ask spread in the currency market is one of the smallest (one-hundredth of a percent). On the other hand, less liquid assets, such as small-cap stocks, may have spreads that are equivalent to 1 to 2% of the asset’s lowest ask price.
RBI Reference Rate
The Reserve Bank of India compiles on a daily basis and publishes reference rates for four major currencies i.e. USD, GBP, YEN and EUR. The rates are arrived at by averaging the mean of the bid/offer rates polled from a few select banks around 12 noon every week day (excluding Saturdays). The contributing banks are selected on the basis of their standing, market-share in the domestic foreign exchange market and representative character. The Reserve Bank periodically reviews the procedure for selecting the banks and the methodology of polling so as to ensure that the reference rate is a true reflection of the market activity.
Return On Investment – ROI
A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. ROI measures the amount of return on an investment relative to the investment’s cost. To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment, and the result is expressed as a percentage or a ratio.
Yield
The yield is the income return on an investment, such as the interest or dividends received from holding a particular security. The yield is usually expressed as an annual percentage rate based on the investment’s cost,current market value or face value. Yields may be considered known or anticipated depending on the security in question as certain securities may experience fluctuations in value. The yield of an investment is tied to the risk associated with the aforementioned investment. The higher the risk is considered to be, the higher the associated yield potential. Except in the most secure investments, such as zero coupon bonds also known as accrual bonds (a bond that is issued at a deep discount to its face value but pays no interest but as it traded at a deep discount it renders profit at maturity when the bond is redeemed for its full face value), a yield is not a guarantee. Instead, the listed yield is functionally an estimate of the future performance of the investment. Generally, the risks associated with stocks are considered higher than those associated with bonds. This can lead stocks to have a higher yield potential when compared to many bonds currently on the market. In regards to a stock, there are two stock dividend yields. If you buy a stock for Rs 30 (cost basis) and its current price and annual dividend are Rs 33 and Rs 1, respectively, the cost yield will be 3.3% (Rs 1/Rs 30) and the current yield will be 3% (Rs 1 /Rs 33). Bonds have multiple yield options depending on the exact nature of the investment. The coupon is the bond interest rate fixed at issuance. The current yield is the bond interest rate as a percentage of the current price of the bond. The yield to maturity is an estimate of what an investor will receive if the bond is held to its maturity date.
Treasury Yield
The return on investment, expressed as a percentage, on the a government’s debt obligations (government bonds, notes and treasury-bills/T-bills). Looked at another way, the Treasury yield is the interest rate the government pays to borrow money for different lengths of time. Treasury yields don’t just influence how much the government pays to borrow and how much investors earn by investing in this debt, however; they also influence the interest rates individuals and businesses pay to borrow money to buy real estate, vehicles and equipment. Treasury yields also tell us how investors feel about the economy. The higher the yields on Treasuries, the better the economic outlook. Treasuries are considered to be a low-risk investment because they are backed by the full faith and credit of the government, which includes the government’s authority to raise taxes to cover its obligations. RBI publishes :91-Day Treasury Bill (Primary) Yield, 182-Day Treasury Bill (Primary) Yield, 364-Day Treasury Bill (Primary) Yield and 10-Year Government Securities Yield. The 10-Year Government Securities Yield is calculated by Fixed Income Money Market and Derivatives Association of India (FIMMDA).
Here is a list of all the types of ratios and rates and related terms that are relevant:
Total Advances = Bills purchased & discounted (Short term) + Cash credits, overdrafts & loans (Short term) + Term loans
Total Deposits = Demand Deposits + Savings Bank Deposit + Term Deposits
CASA Deposits = Demand Deposits + Savings Bank Deposits
CASA Ratio (%) = CASA Deposits/Total Deposits
Total Business = Total advances + Total deposits
Net-worth = Capital + Reserves & Surplus
Total Borrowings = Secured Borrowings (In India and Outside India) + Unsecured Borrowings (In India and Outside India)
Total Assets = Cash in hand + Balances with RBI + Balances with banks inside/outside India + Money at call + Investments + Advances + Fixed Assets + Other Assets
Average Total Assets = [Total Assets CY+ Total Assets PY]/2
Total Liabilities = Capital + Reserves & surplus + Deposits + Borrowings + Other liabilities & provisions
Net Interest Income = Interest Earned – Interest Expended
Net Interest Margin (%) = Net Interest Income/Average Assets
Non Interest Income Margin (%) = Other Income/Average Assets
Interest Cost (%) = Interest expended/Average Borrowed funds
Yield in carry business (%) = Interest earned/Average funds in carry business
Spread (%) = Yield in carry business – Interest cost
Core fee income = Other income – [Net Profit/Loss sale of investments, land and other assets + Net profit/Loss on revaluation of investments + 50% of the miscellaneous income]
Core fee income Ratio (%) = Core fee income/Average funds deployed
Operating Expense Ratio = Operating Expenses/Average funds deployed
Cost to Income Ratio (%) = Operating expenses/[Net interest income + Other income]
Cost to Net Income Ratio (%) = Operating expenses/[Net interest income + Other income – {Net P&L from sale & revaluation of other assets, land and investments}]
Net Profit Margin (%) = Spreads + Core fee income Ratio – Operating expense Ratio
Return on Assets (%) = Net Income or Profit/Average Total Assets
Return on Equity (%) = Net Income or Profit/Net-worth
Cash – Deposit Ratio (%) = [Cash in hand + Balances with RBI]/ Total deposits
Credit – Deposit Ratio (%) = Total Advances/Total Deposits
Incremental Credit (Advances) = Total Advances CY – Total Advances PY
Incremental Deposit = Total Deposits CY – Total Deposits PY
Incremental Credit – Deposit Ratio (%) = Incremental Advances/ Incremental Deposits
Investment – Deposit Ratio (%) = Total Investments/Total Deposits
Incremental Investment = Total Investment CY – Total Investments PY
Incremental Investment – Deposit Ratio (%) = Incremental Investments/Incremental Deposits
SLR Investments = Investment in Government Securities + Investment in Approved Securities
SLR Investment Ratio (%) = SLR Investments/Total Investments
Statutory Liquidity Ratio (%) = SLR Investments/Total Deposits
Restructured Assets = Corporate Debt Restructured {Standard/Sub-standard/Doubtful} + Other than Corporate Debt Restructured {Standard/Sub-standard/Doubtful}
Off-balance sheet exposure = Outstanding Forward Exchange Contracts + Guarantees given on behalf of constituents + Acceptances & Endorsements + Other contingent liabilities
Sensitive Sector Advances = Capital Markets Sector Advances + Real Estate Sector Advances + Commodity Sector Advances
Total Branches (including ATMs) = Branches {Rural + Semi-urban + Urban + Metros} + ATMs {On-site/Off-site}
Profit per branch = Net Profit/ Total Branches
Profit per employee = Net Profit/ Total Employees
Employee per branch = Total Employee/Total Branches
That’s all for now.
IASBakra 