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.
Name: Bilal Ahmed
Roll no: Am552469
Course: Financial management
Assignment submitted to: Prof Shoaib Saleem
Couse code: 8513
ALLAMA IQBAL OPEN UNIVERISITY
Page 1 of 13
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
All respects are for His “Holy Prophet
Hazrat Muhammad” (Peace Be Upon Him)
who enabled us to recognized oneness of
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.
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.
The money market developed because parties had surplus funds, while others needed cash.
Today it comprises cash instruments as well.
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
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
Retail and institutional money market funds
Cash management programs
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:
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).
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.
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)
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:
Pakistan Investment Bonds (PIBs)
T -bills are the Government debt securities that matures in one year or less from their issue
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.
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
can be traded freely in the country’s secondary market. Physical delivery could be affected if
Types of T-Bills
They are issued with the maturities of
Investment Characteristics of Treasury Bills:
T-bills are on the guarantee of government, so they have minimum default risk.
Page 7 of 13
T-bills are highly liquid instrument of financial market. Securities can be liquidated whenever the
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
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.
Rs.98andkeepituntilmaturityhavingfacevalueofrs.100.Then the discount rate on this bill can be
dr= (100-98)/100 * 369/90
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.
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
•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
State Bank of Pakistan use following two methods to trade T-bills.
1) Auction system.
2) Open market operation (omo).
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.
Short-term, unsecured promissory notes issued by well-known companies carrying high credit
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
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
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
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
Page 11 of 13
Requirements of the Time Draft:
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.
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 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