• Share
  • Email
  • Embed
  • Like
  • Save
  • Private Content
Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic
 

Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic

on

  • 260 views

Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic

Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic

Statistics

Views

Total Views
260
Views on SlideShare
260
Embed Views
0

Actions

Likes
0
Downloads
1
Comments
0

0 Embeds 0

No embeds

Accessibility

Upload Details

Uploaded via as Microsoft Word

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment

    Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic Document Transcript

    • Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic. Name: Bilal Ahmed Roll no: Am552469 Course: Financial management Level: M.com Assignment submitted to: Prof Shoaib Saleem Couse code: 8513 ALLAMA IQBAL OPEN UNIVERISITY Page 1 of 13
    • Acknowledgement All the praises are for “Allah Almighty “whose uniqueness, oneness and wholeness are absolute. He is the one who gave me courage to gain knowledge and made it possible for to accomplish the report. All respects are for His “Holy Prophet Hazrat Muhammad” (Peace Be Upon Him) who enabled us to recognized oneness of our Creator. Page 2 of 13
    • Critically examine the features of various common money market instruments available in corporate sector of Pakistan. Also give theoretical background of the topic. Money Market: The money market exists for the purpose of issuing and trading of short-term instruments, that is, Instruments where the term remaining from the date when trading takes place to the date of maturity, is of a short-term nature. History: The money market developed because parties had surplus funds, while others needed cash.[3][4] Today it comprises cash instruments as well. Participants: The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods of time, typically up to thirteen months. Money market trades in short-term financial instruments commonly called "paper." This contrasts with the capital market for longer-term funding, which is supplied by bonds and equity. The core of the money market consists of interbank lending--banks borrowing and lending to each other using commercial paper, repurchase agreements and similar instruments. These instruments are often benchmarked to (i.e. priced by reference to) the London Interbank Offered Rate (LIBOR) for the appropriate term and currency. Finance companies typically fund themselves by issuing large amounts of asset-backed commercial paper (ABCP) which is secured by the pledge of eligible assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial mortgage loans, mortgage-backed securities and similar financial assets. Certain large corporations with strong credit ratings, such as General Electric, issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf via commercial paper lines. In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issue municipal paper, while the US Treasury issues Treasury bills to fund the US public debt. Page 3 of 13
    • Trading companies often purchase bankers' acceptances to be tendered for payment to overseas suppliers. Retail and institutional money market funds Banks Central banks Cash management programs Merchant Banks Functions of the money market: The money market functions are: Transfer of large sums of money transfer from parties with surplus funds to parties with a deficit Allow governments to raise funds help to implement monetary policy determine short-term interest rates Common money market instruments: Certificate of deposit - Time deposit, commonly offered to consumers by banks, thrift institutions, and credit unions .Repurchase agreements - Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date. Commercial paper - short term usanse promissory notes issued by company at discount to face value and redeemed at face value Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located outside the United States. Federal agency short-term securities - (in the U.S.). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association. Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate. Municipal notes - (in the U.S.). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues. Treasury bills - Short-term debt obligations of a national government that are issued to mature in three to twelve months. Money funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors. Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal of the exchange of currencies at a predetermined time in the future. Short-lived mortgage- and asset-backed securities Page 4 of 13
    • Features of Money Market: It is a market purely for short-terms funds It is a market purely for short-terms funds or financial assets called near money. Or financial assets called near money. It deals with financial assets having at deals with financial assets having maturity period less than one year only. Maturity period less than one year only. In Money Market transaction cannot taken Money Market transaction cannot take place formal like stock exchange, only place formal like stock exchange, only through oral communication, relevant through oral communication, relevant document and written communication document and written communication transaction can be done. Transaction can be done. Transaction have to be conducted without Transaction has to be conducted without the help of brokers. The help of brokers.. The component of Money Market is the component of Money Market is the commercial banks, acceptance houses &commercial banks, acceptance houses &NBFC (Non-banking financial companies).NBFC (Non-banking financial companies). The following are the Money Market instruments in Pakistan: 1) Pakistan Investment Bonds (PIBs) 2) Federal Investment Bonds (FIBs) 3) Market Treasury Bills (MTBs) 4) Term Finance Certificates (TFCs) 5) Certificate of Investments (COIs) 6) Certificate of Deposits (CODs) 7) Commercial Papers (CPs) 8) Foreign exchange platform (forex) Introduction of state bank of Pakistan: History/background: State bank of Pakistan is the central bank of Pakistan. It was established in 1948. Initially state bank of Pakistan was entrusted with the task to “regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in Pakistan and generally to operate the currency and credit system of the country to its advantage" (SBP order, 1948). In financial sector reforms of 1994 State Bank of Pakistan got full autonomy. “On January 21, 1997 this autonomy was further strengthened when the government issued three Amendment Ordinances. These changes gave full and exclusive authority to the State Bank to regulate the Page 5 of 13
    • banking sector, to conduct an independent monetary policy and to set limit on government borrowings from the State Bank of Pakistan” (Wikipedia, 2010). Currently its primary functions include regulating banking sector, maintenance of public accounts, devising monetary policy, management of public debt, issuance of currency notes, and maintaining inflation. State Bank of Pakistan Banking Services Corporation SBP-BSC was established in 2002 in order to perform operational functions of SBP (SBP website). SBP-BSC is subsidiary of State Bank of Pakistan having 16 offices in major cities of the country and its key functional and operational areas include currency management, foreign exchange operations and adjudication, export finance scheme, payment & settlement systems, and banking services to the government. While State Bank of Pakistan performs the important function of policy making, SBP-BSCs handle most of the operational areas (SBP website). Objectives: As we all know that state bank of Pakistan is a nonprofit making organization. Its main objective is to manage or maintain the currency supply in country. Increase and decrease in money supply can create inflation or deflation in country, so these things should be handled immediately and state bank is doing this. The mission and vision of SBP is as under. Vision: To develop SBP-BSC into a dynamic and efficient organization equipped with requisite technology and human resource capable of extending sustainable support to the State Bank of Pakistan in achieving its objectives (SBP website) Mission: To provide excellent banking and financial services to stakeholders besides ensuring implementation of SBP policies in order to command their trust and respect. Page 6 of 13
    • Some of the money market instrument of state bank of Pakistan: Treasury Bills:  Commercial Papers  Repurchase Agreements Bankers acceptance  Eurodollar Deposits  Federal Funds Pakistan Investment Bonds (PIBs) Treasury Bills:  T -bills are the Government debt securities that matures in one year or less from their issue date.µ A Treasury bill differs from other types of investments in that they do not pay interest in the traditional way. When an investor wishes to purchase a treasury bill, he buys it at a discount rate. Features:  Issued through bidding process  Zero Coupon bonds sold at a discount to their face values Purchased by individuals, institutions and corporate bodies including banks irrespective of their residential status can be traded freely in the country’s secondary market. Physical delivery could be affected if required. Types of T-Bills They are issued with the maturities of 3 months 6 months 1year. Investment Characteristics of Treasury Bills: Default risk: T-bills are on the guarantee of government, so they have minimum default risk. Page 7 of 13
    • Liquidity: T-bills are highly liquid instrument of financial market. Securities can be liquidated whenever the holder wants. Minimumdenomination: T-bills are trade on the face value ofRs.100 in Pakistan and in denominations of multiples of 100. How to calculate return on T-Bills? T-Bills are sold at a discount from their par value  Yield is based on their appreciation in price b/w time of issue time they mature or are sold by the investor Bill yield are determined by the discount method; treats the par value as the investment base uses a 360-day year for simplicity Discount rate= par value purchase price/ par value *360/ number of days in maturity.  Supposeyoubuya12WeeksT-billat Rs.98andkeepituntilmaturityhavingfacevalueofrs.100.Then the discount rate on this bill can be calculated as: dr= (100-98)/100 * 369/90 = 0.06 How T-Bills are traded in Pakistan? At start Treasury bills were issued on fixed rate.eg; six months at 6 percent per year In April 1991; Introduce the American-style auction-based system. The role of primary market restrict to fortnightly auctions. Primary dealers were appointed. PRIMARY DEALERS: Only primary dealers can participate in the auctions and OMOs. •All the commercial banks (having account with SBP) •NBFIs (Non-Banking Financial Institutions)If the primary dealer wants to buy a T-bill, must submit a bid that is prepared either; Page 8 of 13
    • •Non-Competitively •Competitively the Non-competitive bids are normally submitted by the small investors who agree to accept the price determined by the auction. The Competitive bids are submitted by large investors,who bid for several millions. They have to specify the return that they want to receive. If the return specified is too high, might not receive any securities. State Bank of Pakistan use following two methods to trade T-bills. 1) Auction system. 2) Open market operation (omo). Auction System: 1) 2) 3) 4) 5) 6) SBP announces the T-Bill auction SBP announces the T-Bill auction Primary dealers submit the bids After the submission deadline,bids will open MOF decides the cut off price. After one or two days of finalizingprice, securities are issued. OPEN MARKET OPERATION:  In OMO Government fix the discountrate before the announcing the newsecurities and can be issued whenthey need funds. Through OMO Government can sell aswell as buy back securities. Trading T-Bills in OMO is mainly tocontrol the circulation of money in themarket. Commercial paper:  Short-term, unsecured promissory notes issued by well-known companies carrying high credit rating.  Used to meet immediate cash needs. Funds raised from commercial paper are commonly used for current transactions.  SBP and SECP started process of creatingcommercial paper market in Pakistan in2003. Page 9 of 13
    • Maturity Period: Between 30 days and one year from the date of subscription. Issuer of Commercial Paper: highly rated companies and financialinstitutions with minimum equity of Rs.100 million. Minimum current ratio of 1: 1 anddebt/equity ratio of 60: 40. Minimum credit rating of the issuer shall be‘A’. No overdue loan or defaults. Size and Denomination: Minimum size of the issue of commercialpaper shall not be less than Rs.10 million  In case of private placement, CP would be denominated in Rs. 100,000 or in multiple thereof  In case of offer to general public, CP may be denominated in Rs. 5,000 or in multiples thereof. Mode of Issue and Discount Rate: In the form of a promissory note. Discount to face value is determinedby the issuer keeping in view the prevailing T-bill rates, KIBOR and issuers credit rating. Calculation of Rate of Return: DRcp= (Par Value Purchase Price) / Par Value * 360 /Days to Maturity. Investor of Commercial Paper:  can be issued by way of public offer and/or to Scheduled Banks Large Institutions as the issue size is often too high for individual investors Advantages for Investor:  Higher yields than time deposits  Safe investment REPURCHASEAGREEMENT: Repurchase agreements are agreements between a borrower and a lender . Borrower sells securities to the lender with the stipulation that the securities will be repurchased on a specified date and at a fixed price and interest.  Securities serve as collateral for loan. Page 10 of 13
    • Types of Repo (In Term of Maturity): 1. Overnight repos. (One day one) 2. Term repos. (One day to one weak) 3. Open repo.( mutual relation between two parties and interest rate is greater than both repos) Major Borrowers and Lenders: Major borrowers include government bond dealers of Treasuries and federal agency securities, and large banks Active lenders include state and local governments, insurance companies, Large banks, non-financial corporations, and foreign financial institutions  Government securities are the main collateral for most repos Repo Interest Income: The difference between the underlying securities current price and repurchase price is the amount of interest paid by the borrower to the lender RP Interest in come= Amount of loan x Current Repo Rate x (Repo Term in days/360 days) Purpose of Repo: To meet deposit reserve requirements  In order to purchase interest bearing securities  Companies lend to avoid losing even a single days interest. Advantages of Repo: Repo rate is less than borrowing from bank Benefit to lenders is that the maturity of the Repo can be precisely tailored to the lender’s needs BANKERS ACCEPTANCE: Acceptance means a vow to pay a definite amount of money The person who will pay is called as the promissory while the one who will receive is the beneficiary Page 11 of 13
    • Requirements of the Time Draft: Promissory Signature The word accepted on top of his signatures and The date on which the amount will be paid Bankers Acceptance of draft: If the time draft is formally accepted by bank then it becomes a bankers acceptance The maturities of banker’s acceptancemostly range from 30 to 180 days The promissory uses the banks creditworthiness instead of his own. EURODOLLAR DEPOSITS: Eurodollars are the leading component of the Eurocurrency markets today. There is a need for Eurocurrency markets because funds are required in international currencies worldwide mainly in Dollars, Euros and Pounds. Eurodollars are the deposits of US dollars in banks which are located outside United States. These can also be the branches of the US banks located outside US. The deposits are recorded in the denomination of dollars rather than their home currency. Generally, the "euro" prefix can be used to indicate any currency held in a country where it is not the official currency. These deposits are loaned to the home offices of the banks in US, lent to business enterprises that have to make their payments in dollars. It can be retained as well to meet the reserve requirements and to maintain liquidity. These can be lent to government if it needs dollars and to private investors as well. The Eurodollar deposits are always moving in the form of loans. MECHANISM OF EURODOLLAR DEPOSITS: We suppose that you own a textile firm in Pakistan. To keep the example simple we assume that you shipped an assignment worth one million to the American importer. Here we also suppose that you have an account in an American bank as well. The importer pays the bills in dollars and deposits it in your account held at the American bank. After all these transactions a Eurodollar deposit has not been created. If we further mature the same example and presume that you transfer that one million dollars in your bank in Pakistan then the deposit that is now created in Pakistan is a Eurodollar deposit. As it is a dollar account maintained outside US. The dollar amount in the Pakistani account can be given as a loan to an investor who is liable to pay the money in dollars. In all these transactions this fact should be acknowledged that the amount of dollars was merely transferred in between the banks but the original dollar amount remained the same. Eurodollar activity did not alter the total reserves of the US banking system. The chain of Eurocurrency and Eurodollars will remain functioning until they are in demand and funds are being deposited in the international banking system. The Eurocurrency accounts are formed by giving out loans and are destroyed when the loan is repaid. Hence they did not create money but they act as an efficient distributor of liquidity. Eurocurrency deposits are usually held from one day till one year so they are pure money market instruments. Many are held for one month that is the usual time period for the shipment of goods. They are mostly interbank liabilities when loaned so a fixed interest rate is charged on them. There is no central location for the trading of the Eurocurrency deposits. They Page 12 of 13
    • move rapidly from one bank to another to meet the liquidity requirements of corporations, governments and Euro banks themselves.Eurocurrencies are not without risk. They are volatile and sensitive to fluctuations in interest rates and currency values. Difference of interest rate or value between two countries can initiate the massive flow of funds from one to another. There is a Political risk as well that the governments might restrict the flow of money across borders. The daily cost of funds derived from Eurodollars is Amount to be loaned * interest rate * 1/360 Federal funds: Federal funds refer to the overnight borrowings which are undertaken in order to meet the state bank’s reserve requirements. These are transferred from the lending institution’s account to the borrowers account. The funds are not physically transferred. When they are repaid then an entry in books satisfies the whole loan. The most important borrower in the federal funds market is the commercial banks. Other financial banks. Other financial institutions, security dealers, business corporations and the local government provide readily available funds for lending in the federal market. The banks and DFIs are legally obliged to keep a certain amount of funds in the reserve account which is kept with the state bank of Pakistan. Thesis equal to the fraction of the deposits which are kept with a bank. To meet the requirement of this legal reserve ratio the banks borrow funds mostly on overnight basis from the federal funds market. Most federal funds are for overnight basis and they have a fixed interest rate. Today the online system has made it very easy to know that which institutions are short of funds and which have surplus. The one who is short gets the benefit that its immediate requirement of money is fulfilled while the one with surplus gets interest income on its funds and thus earns it through the federal fund market. The interest rates which are levied on these funds highly fluctuate daily. It depends on the volume of funds which is surplus in the market and the volume of fund needed by the market. Pakistan Investment Bonds (PIBs): PIBs are long-term, semi-annual coupon-based instruments issued by the Government through auction in tenors of 3, 5, 10, 15 & 20 years. PIBs are SLR eligible securities up to 5% of DTL. They were launched in 2000 to replace FIBs. Page 13 of 13