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Zzz bbb bb Conventional Money Market
Conventional & Islamic Financial Markets, Instruments, & Institutions
Topic 6
Conventional Money Market
WF5023 Semester July 2005
Conventional Money Market
Introduction to Money Market
Just what & where is the Money Market ?
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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.
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Relationship between Money Market & Other Financial Markets
Money Markets Bond Markets
● Short –term debt ● Non-permanent funding ● Medium to long term ● Non-permanent funding ● 1 day to 1 year ● 1 year to 30 yrs
Equity Markets
● Long-term ● Permanent funding ● Perpetual School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Recalling the role of a bank … … acts as an intermediary between depositors and borrowers
depositors
place money
bank
lend money
borrowers
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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
…
Long $ Position
Bank
School of Finance & Banking WF5083 Financial Risk Management
Short $ Position
Bank
WF5023 Semester July 2005
Conventional Money Market
Non-bank Lenders
Retail Market
● Repo placement ● Purchase of Financial Instruments ● (Savings / Fixed Depots ● ●
Interbank Market
Mixed of Interbank Lenders / Borrowers ● Direct lending & borrowing of Ringgit Trading of Financial Instruments Repo / Reverse Repo ● Swaps School of Finance & Banking WF5083 Financial Risk Management ● Foreign currency lending / borrowing
Retail Market
● Sale of Financial Instruments ● (Loans / Advances) ● No direct access to borrowing Non-bank Borrowers WF5023 Semester July 2005
Conventional Money Market
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.
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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 School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Structure of the Money Market in Malaysia can be broadly divided into ● Wholesale (Inter-bank Market), and ● Retail (Commercial Market) School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Players of the Interbank Money Market are 1.
2.
3.
4. Commercial Banks Merchant Banks Finance Companies Discount Houses 5. Insurance companies 6. Large corporations 7. 8.
Pension funds Money Brokers School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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 earn a commission for broking services.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.
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Regulation for Money Market? In January 1994, BNM introduced the Malaysia Code of Conduct for Principals and Brokers in the Wholesale Money and Foreign Exchange Market which sets out the market practices, principles and standards to be observed in the Malaysia market.
The code also imposed a mandatory requirement for new dealers and brokers to complete an entry examination held by the Institute of Bankers Malaysia.
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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 School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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 School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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 School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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 School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Money Market Instruments Not Under SSTS ● Bankers Acceptance (BA) ● Negotiable Instrument of Deposits (NID) School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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 School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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.
certain cases.
Interim interest payments may be made in 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.
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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% Product NCD BA Amt Invested RM1,000,000 Interest/Discount amt RM 110,000 Redemption amt RM1,110,000 11.0% RM 890,000 RM 110,000 RM1,000,000 11.0% 12.3% School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Interest Rates Vs. Discount Rates From the above illustration, the yield on the NCD is: Interest Received Amount Invested = RM 110,000 RM1,000,000 = 11.0% The yield on an investment on the BA is, however: Discount Amount Amount Invested = RM 110,000 RM 890,000 = 12.3% The BA would thus give a higher yield and is the better investment, if the difference in risk on these instruments is ignored.
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
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.
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Functions of a Money Market Department Basically a Money Market Department performs the following functions: ♦ ♦ ♦ ♦ To manage the bank’s statutory reserve account at the central bank To manage the bank’s liquid assets by complying to the BNM’s New Liquidity Framework To manage the bank’s excess funds To take proprietary money market position through trading in approved money market products and instruments School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Functions of the Money Market - Meeting Statutory Reserve Requirements The present Statutory Requirements imposed by BNM include, ♦ ♦ the keeping of some portion of liabilities in the form of reserves kept with the central bank (
Statutory Reserve Requirement
), and prudent management of assets, liabilities, and off balance sheet commitments through maintenance of sufficient liquefiable assets and available credit lines (
New Liquidity Framework
).
School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Functions of the Money Market - Meeting Statutory Reserve Requirements Maintenance of Reserve Account with BNM ♦ ♦ ♦ ♦ Under the existing guidelines, banking institutions must set aside a certain portion of all deposits collected to be placed with the central bank under a special reserve account.
This placement earns no returns to the banking institution.
The minimum amount of reserve required depends on the net eligible liabilities of the banking institution and differs between commercial banks, merchant banks and finance companies.
Amount of Reserve = Eligible Liabilities x SRR% School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Functions of the Money Market - Meeting Statutory Reserve Requirements Maintenance of Minimum Liquidity Ratio ♦ ♦ ♦ Banks are required to maintain certain ratios of liquid assets to deposits at all times The ratios are determined by BNM from time to time The types of liquid assets are also determined by BNM (what are the items under this category?) School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
♦ ♦ ♦ ♦ Components of Liquefiable Assets include, ♦ ♦ ♦ ♦ RM marketable securities/papers issued by Fed Govt or BNM RM marketable securities/papers guaranteed by Fed Govt or BNM Danaharta bonds Cagamas bonds and notes Danamodal bonds NIDs (excluding own-issued NIDs) issued by Tier-1 or AAA rated institutions BAs (excluding own BAs) RM corporate bonds and papers with at least an AAA/P1/MARC 1 rating or its equivalent Class-1 Liquefiable Assets Class-2 Liquefiable Assets School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005
Conventional Money Market
Money Market & BNM SRR is one of the monetary tools used by BNM in managing the country’s monetary policy School of Finance & Banking WF5083 Financial Risk Management WF5023 Semester July 2005