Topic 6

1. Zzz bbb bb Course WF5023 Conventional & Islamic Financial Markets, Instruments, & Institutions Topic 6 Conventional Money Market Prepared by: Abmalek F. Abubakar aabmalek@yahoo.com mbmbmbmbmbmbmbmbmbbmbmbmbmmmbmm

2. Introduction to Money Market Just what & where is the Money Market ?

3. Money Markets ● characterized by borrowing and lending large amount of money ● for short periods – typically one day up to, and including 12 months. Bond Markets ● debt market that generally pay interest on instruments for a fixed period of time for loan periods over 12 months up to 30 years. ● also known as the Fixed Income Markets ● involve medium to long term borrowing. (1 to 10 year instruments are called notes and instruments exceeding 10 years in maturity are called bonds) Equity Markets ● involve medium to long term borrowing but in this case interest is not paid to the lender. ● borrowing institutions issue stocks or shares to investors who become part owners of the organization ● investors may or may not be paid dividend on their shares depending on how well the organization performs.

4. Relationship between Money Market & Other Financial Markets

5. Recalling the role of a bank … … acts as an intermediary between depositors and borrowers places money lend money

6. Recalling the role of a bank … In fulfilling its role as an intermediary between units that seek funds and units with surplus funds, the bank always finds itself in the following undesirable positions … Bank Bank

8. So, what is money market? In general terms, the money market is the market where liquid and short-term borrowing and lending take place.  The lending of funds in this market constitutes short-term investments. 

9. Activities of the Money Market • Through the money market, participants are able to: • 1. borrow and lend funds; and • 2. buy and sell money market instruments

10. Structure of the Money Market in Malaysia can be broadly divided into ● Wholesale (Inter-bank Market), and ● Retail (Commercial Market)

11. Players of the Interbank Money Market are • 1. Commercial Banks • 2. Merchant Banks • 3. Finance Companies (some only) • 4. Discount Houses • 5. Money Brokers

12. In the Interbank Money Market… • ● direct lending and borrowing among participants take place. Funds lent or borrowed are of short term tenors, usually between overnight to twelve months; • ● financial instruments are traded; • ● money brokers act as middlemen between lenders and borrowers. They play an important role especially in a fast moving and active market; • ● the central bank acts as market regulator. It engages in open market operations to influence the supply of money in the banking system, stabilize interest rates, etc. in order to bring about a more desirable and systematic market environment.

13. At the Commercial Money Market… • ● there are other players like non-bank financial • institutions, corporate bodies, government agencies, • statutory bodies, trust and pension funds, insurance • companies, cash-rich individuals, etc; • ● they utilize their temporary surplus funds; • ● either for direct placements in fixed deposits or term • deposits or call money; or • ● for purchasing of money market instruments. • ● they have no access to direct borrowing from the • money market

14. Major Players in Malaysian Money Market ● Bank Negara Malaysia ● Commercial Banks ● Merchant Banks ● Finance Companies ● Discount Houses ● Khazanah Berhad ● Cagamas Berhad ● EPF ● Fund Managers ● Insurance Companies ● Major Corporations ● Cash-rich Individuals ● Money Brokers

15. Money Market Products can be categorized as ● Short term Inter-bank Funds ● Instruments under Scriptless Securities Trading System (SSTS) ● Instruments which are not under SSTS ● Other financial products

16. Short-term Interbank Funds ● borrowing and lending of Ringgit among financial institutions that participate in the interbank money market ● availability of funds is subject to size of inflows and outflows in the banking system which include ♦ government disbursements ♦ maturities & issuance of govt debts such as MGS, MTB ♦ interest payments on govt debts ♦ tax, royalty and customs payments to govt ♦ central bank intervention ● cost of funds is determined by market forces of supply and demand ● maturities range from overnight to 1 year or more

17. Money Market Instruments under SSTS ● Malaysian Government Securities (MGS) ● Malaysian Government Treasury Bills (MTB) ● Bank Negara Bills (BNB) ● Government Investment Issuance (GII) ● Cagamas Bonds & Notes ● Khazanah Bonds ● Some Commercial Papers (CP), Medium Term Notes (MTN), and Corporate Bonds

18. Money Market Instruments Not Under SSTS ● Bankers Acceptance (BA) ● Negotiable Instrument of Deposits (NID)

19. Other Money Market Products ● Fixed Deposits (FD) ● Repo/Reverse Repo ● Short Term Revolving Credits (STRC) ● Securities Borrowing and Lending (SBL) ● Onshore Foreign Currency Loans (OFCL) ● Foreign Currency Accounts (FCA) ● KLIBOR Futures, Bond Futures ● Interest Rate Swaps (IRS) ● Forward Rate Agreements (FRA) ● Currency Swaps ● Currency Options ● Structured Products

20. Interest-bearing Instruments & Discount Instruments • There are basically two types of instruments issued and traded in the money market, namely: • 1. Interest-bearing instruments • These are instruments which pay interest on the amount invested, where the interest is normally paid to the holder of the instrument (the lender), together with the redemption amount at redemption date.  Interim interest payments may be made in certain cases. • 2. Discount instruments • These are instruments that do not pay interest on the amount invested but are issued at a discount of the nominal value (the redemption amount).  The full nominal amount is paid only on maturity date. These instruments are called discount instruments.

21. Interest Rates Vs. Discount Rates The discount rate on an instrument and the interest rate paid on an instrument are not the same, and cannot be compared to when deciding on an investment.  E.g. Lets compare a one-year NCD with a nominal amount of RM1 million and an interest rate of 11% with a one-year BA of RM1 million and a discount rate of 11%

22. Interest Rates Vs. Discount Rates From the above illustration, the yield on the NCD is: The yield on an investment on the BA is, however: The BA would thus give a higher yield and is the better investment, if the difference in risk on these instruments is ignored.

23. Interest Rates Vs. Discount Rates The discount rate on discount instruments must thus be converted to yield before it can be compared to interest rates offered on interest rate instruments.   The compounding period of rates must also be equal before they can be compared.

24. Functions of a Money Market Department Basically a Money Market Department performs the following functions:

25. Functions of the Money Market - Meeting Statutory Reserve Requirements

26. Functions of the Money Market - Meeting Statutory Reserve Requirements

27. Functions of the Money Market - Meeting Statutory Reserve Requirements

28. Functions of the Money Market - Meeting Statutory Reserve Requirements New Liquidity Framework (NLF) Under the NLF, liquidity requirement of a banking institution is assessed from 3 levels : 1st – sufficiency of bank liquidity in the normal course of business over the next few months, 2nd – the capability of bank to withstand liquidity withdrawal shocks, and 3rd – the degree of dependency by bank on a certain funding source

29. New Liquidity Framework (NLF) (contd) 1st Level Assessment To determine sufficiency of bank liquidity in the normal course of business over the next few months. This is done by putting the assets, liabilities and off-balance sheet commitments of a bank into maturity ladder profile of 5 bands – “up to 1 week”,” >1 week – 1 mth”, “1 mth – 3 mth”, “ >3 mth – 6 mth”, “ >6 mth – 1 yr”, and “ > 1 year”. Based on the net maturity mismatch profile for each band, banks should be able to make necessary arrangement to meet any liquidity shortfalls.

30. New Liquidity Framework (NLF) (contd) 2nd Level Assessment To determine the capability of bank to withstand liquidity withdrawal shocks. Liquidity measurement at this level takes into account the additional emergency funds that can be quickly realised from the sale of liquefiable assets or drawn upon from available credit lines.

31. New Liquidity Framework (NLF) (contd) 3rd Level Assessment To determine the degree of dependency by bank on a certain funding source. Measurement for this assessment consists of a series of broad ratios and supplementary information designed to indicate the extent of dependency a banking institution on a particular market for its funding sources.

33. – Cost of Statutory Requirements Example : Banks are required to hold 8% of their total deposits in reserve accounts with the central bank which gives a yield of 1% p.a. In addition, an amount equal to 18% of deposits is required to be held in liquefiable assets which yield 8% p.a. If the bank pays its depositors an average of 12% p.a., what would be the break-even rate before it can quote a lending rate for a new loan ? If the bank collects deposit totaling RM100, it is required to lodge RM8 with the central bank, thereby have available only RM92 for lending or investment activities.

34. Example : (contd.) The break-even cost of funds, b, is computed as follows: (8 x 0.01) + (18 x 0.08) + (100 – (8 + 18) b = 0.12 x 100 0.08 + 1.44 + 74 b = 12 74 b = 12 – 0.08 – 1.44 74 b = 10.48 b= 10.48 / 74 = 0.1416 = 14.16% p.a. Effective cost of funds = 14.16% p.a. Nominal deposit rates = 12.00% p.a Effective cost of reserve requirements = 2.16% p.a.

35. Money Market & BNM SRR is one of the monetary tools used by BNM in managing the country’s monetary policy

36. Money Market Instruments

37. Money Market Instruments ● They are negotiable instruments, i.e., they can be traded as there are bids and offers made by buyers and sellers who are mainly inter-bank participants ● It can be held until maturity for long-term investment purposes; or ● For short-term investment (of which the paper is acquired to utilize short-term surplus cash position); ● It is also held to fulfil statutory reserve requirements; ● The instrument can also be acquired for trading purposes where the paper is disposed when price is right.

38. Money Market Instruments Instruments can either be ● interest-bearing papers; or ● discounted papers

39. Money Market Instruments - Interest-bearing Securities ● normally issued at par and redeemed on maturity with principal plus any due interest ● some have a short original maturity and interest is paid only at maturity ● some have a longer original maturity where interest is normally paid periodically ● the rate of interest paid on these securities is referred to as “coupon rates” ● these papers are traded either on ♦ yield % p.a. basis (e.g. 5.0%-6.0%), or ♦ price per 100 basis (e.g. 99.20-99.70 or 101.20-101.70)

40. Money Market Instruments - Discounted Securities ● normally issued at a discount from face value and redeemed for full face value at maturity ● they do not pay interest ● return to investor is the full amount receives on maturity compared to what he receives at issue or purchase ● these papers are traded on rates of discount that normally reflects prevailing market rates ● as the sale and purchase of these papers represents the borrowing and lending of funds, price is quoted such that the bid is higher than the offer (e.g. 5.5% - 4.5% ) bid offer

41. Money Market Instruments - Malaysian Government Treasury Bills (MTB) Definition MTB are short term government debts with original maturities of less than one year, issued at a discount and redeemable at full face value on maturity

42. Money Market Instruments - Malaysian Government Treasury Bills (MTB) Characteristics & Features ● an SSTS instrument ● issued weekly (normally on a Friday of the week) ● original issuance are of 3 mths, 6 mths, or 1 year ● distributed via competitive tender through Fully Automated System of Tendering (FAST) ● anybody can participate in the tender through Principal Dealers ● traded in secondary market in Bands ● purchased at discount, redeemed on maturity at par ● settlement using true discount formula

43. Money Market Instruments - Malaysian Government Treasury Bills (MTB) The Bands Band 1 - 1 to 21 days Band 2 - 22 to 43 days Band 3 - 44 to 67 days Band 4 - 68 to 91 days Band 5 - 92 to 131 days Band 6 - 132 to 171 days Band 7 - 172 to 211 days Band 8 - 212 to 261 days Band 9 - 262 to 311 days Band 10 - 312 to 364 days

44. Money Market Instruments - Malaysian Government Treasury Bills (MTB) Discount Formula where, FV is the Face Value, r is the discount rate of interest, and t is the tenor of the bill.

45. Money Market Instruments - Malaysian Government Treasury Bills (MTB) Example An MTB of face value RM1.0 million with 157 days remaining to maturity is sold at a rate of 5.2% p.a. Sales Proceeds = RM1,000,000 { 1 – ( 5.2 x 157) } 36500 = RM977,600.00

46. Money Market Instruments - Malaysian Government Treasury Bills (MTB) Example An MTB of face value RM1.0 million with 157 days remaining to maturity is purchased at a rate of 6.0% p.a. Purchase Proceeds = RM1,000,000 { 1 – ( 6.0 x 157) } 36500 = RM974,200.00

47. Money Market Instruments - Malaysian Government Treasury Bills (MTB) Trading Mechanics ● MTB is traded on yield per annum basis ● The sale and purchase of MTB represents the borrowing and lending of funds ● As a discount paper, quotation for MTB is the reverse of the short-term interbank funds i.e. the bid is higher than the offer rate E.g. 4.35 - 4.25 (buying) (selling)

48. Money Market Instruments - Malaysian Government Securities (MGS) Definition MGS are long term interest-bearing securities issued by the Malaysian Government to finance development projects and form part of the sources of funding in the annual budget.

49. Money Market Instruments - Malaysian Government Securities (MGS) Characteristics & Features ● an SSTS instrument ● no fixed schedule for its issuance ● longest ever bond issued has original tenor 21 years ● issued by auction to appointed Principal Dealers (PD) ● anybody can participate in the auction through PDs ● interest-bearing notes with coupon payments ½ yearly ● traded in secondary market on a price per 100 units ● not active secondary market – unattractive rates & tenor too long ● mainly held by financial institutions to fulfil statutory requirements ● acts as benchmark for all RM bond issues

50. Money Market Instruments - Malaysian Government Securities (MGS) • Why hold MGS ? • Investment Purposes • MGS is a source of fixed income in the form of • periodical coupon interest payments • Trading Purposes • Possible capital appreciation • Compliance Purposes • To fulfill minimum statutory requirements