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Lecture # 8The Money Markets
Presented by Dr. Zeeshan Atiq
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• Annual report of Microsoft of 2009 reveals that it contained over $6bn in cash and equivalents.
• $25 bn in short-term securities. $30 bn in highly liquid short-term securities.
• These all investments Microsoft made in Money Markets. Money markets are short-term, low risk and very liquid.
• These all characteristics near them to money in nature.
• The money markets are on rise since 1970s.
• In this chapter we discuss why the money markets are important to our financial systems.
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The Money Market
• The money market is traditionally defined as the market for financial assets that have original maturities of one year or less.
• In essence, it is the market for short-term debt instruments.
• The term money market is actually a misnomer. Money—currency—is not traded in the money markets.
• The securities that are traded there are short-term and highly liquid, however, they are close to being money.
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Money Market: Definition
• Characteristics:• Low default risk
• Maturity period of one or less than one year.
• Sold in large denominations.
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The Money Market
• The scope of the money market has expanded in recent years to include securitized products such mortgage-backed and asset-backed securities with short average lives.
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Money Market: Definition
• Money Market is a financial market in which only short-term debt instruments (maturity less than one year) are traded. MM is for transactions in wholesale short term loans and deposits and for trading short term financial instruments.
• Money market transactions do not take place in any one particular location or building. Instead, traders usually arrange purchases and sales between participants over the phone and complete them electronically.
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Why Do We Need the Money Markets?• The banking industry exists primarily to provide
short-term loans and to accept short-term deposits.
• Banks should have an efficiency advantage in gathering information, an advantage that should eliminate the need for the money markets.
• Furthermore, short-term securities offered for sale in the money markets are neither as liquid nor as safe as deposits placed in banks.
• Given the advantages that banks have, why do the money markets exist at all?
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Why Do We Need the Money Markets?
• The banking industry exists primarily to mediate the asymmetric information problem between saver-lenders and borrower-spenders, and banks can earn profits by capturing economies of scale while providing this service.
• However, the banking industry is subject to more regulations and governmental costs than are the money markets.
• In situations where the asymmetric information problem is not severe, the money markets have a distinct cost advantage over banks in providing short-term funds.
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The Purpose of the Money Markets• The well-developed secondary market for money
market instruments makes the money market an ideal place for a firm or financial institution to “warehouse” surplus funds until they are needed.
• Similarly, the money markets provide a low-cost source of funds to firms, the government, and intermediaries that need a short-term infusion of funds.
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Who Participates in the Money Markets?• Central Bank (State Bank of Pakistan).
• Commercial Banks,
• Co-operative Banks and Primary Dealers are allowed to borrow and lend.
• Specified Pakistani Financial Institutions, Mutual Funds, and certain specified entities are allowed to access to Call/Notice money market only as lenders.
• Individuals, firms, companies, corporate bodies, trusts and institutions can purchase the treasury bills, CPs and CDs.
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Money Market Instruments
• Treasury Bills
• Certificate of Deposit
• Commercial Paper
• Call Deposit
• Term Deposit
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Treasury Bills
• Treasury bills, commonly referred to as T-Bills are issued by Government of Pakistan against their short term borrowing requirements.
• Zero coupon bonds issued at discount to face value by SBP through PDs (Primary Dealers) via opening of IPS (investment policy statement) account for 3,6 and 12 months – Issued in multiples of Rs.5000-Risk free as borrower is GoP so no need of colleteral-Accepted as colleteral by Banks-
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• T-Bills are the most marketable money market security due to its simplicity.
• Their standard maturity periods are 4, 13, 26 or 52 weeks(1, 3, 6, 12 months)
• T-Bills are considered to be the safest investment.
• They are considered to be risk free as they are backed by the government.
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Short term certificate of deposit: Short term saving certificate
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Short term certificate of deposit: Short term saving certificate• The Government of Pakistan launched Short Term
Savings Certificates (STSCs) scheme on July 1, 2012.
• The scheme has been specifically designed to meet the short term financial requirements of the depositors.
• STSCs is pledge-able and having 3-month, 6-month and 1-year maturity scheme.
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Who can purchase
• All Pakistani Nationals as well as Foreign Nationals can purchase STSCs.
• An adult can also purchase STSCs on behalf of a single minor, two minors jointly or as a joint with a minor.
• Institutions may also invest their employees related funds such as pension, gratuity, superannuation, contributory provident fund and trusty fund etc.
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How to purchase
• STSC can be purchased from any National Savings Centre (NSC) by filling in the SC-1 (Application form), available free of cost from all NSCs.
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Commercial Papers
• Commercial paper is an unsecured, short term loan issued by a corporation, typically for financing Accounts Receivables and Inventories.
• Maturities on Commercial Papers are no longer than nine months, with maturities of between one and two months being the average.
• Commercial Paper is a very safe investment because the financial situation of a company can easily be predicted over a few months.
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Commercial Papers in Pakistan
• Commercial paper, as an SECP source explained, is a short-term promissory note issued by corporations with a minimum credit rating of A- for long-term and A2 in short-term arrangements.
• These instruments are typically used for financing working capital requirements.
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Commercial Papers in Pakistan
• The maturity period of a Commercial Paper range from as short a duration as 30 days and as long as one year.
• This would, however, be subject to the condition that the equity of the issuing company would be not less than Rs100 million as per its latest audited balance sheet.
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T-Bill Auctions in Pakistan• Treasury bills are sold through auction system
• The cut off yield is determined by the Auction Committee, keeping inview monetary targets, prevailing economic and financial conditions andexpected market response. The Six months’ T-bill is considered the mostimportant benchmark by the money market and is considered to be thesignaling tool of SBP for interest rate movements.
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T-Bills Main Characteristics
• Issued in tenors of 3, 6 and 12 months;
• Denominated in multiples of PKR 5,000;
• A 10% withholding tax is deducted at source by SBP upon maturity;
• Non-paper instrument;
• Negotiable instruments and have an active secondary market;
• Redemption of the face value upon maturity is guaranteed by GoP.
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Discounting of T-bills
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Repurchase Agreements
• Repurchase agreements (repos) work much the same as fed funds except that nonbanks can participate.
• A firm can sell Treasury securities in a repurchase agreement whereby the firm agrees to buy back the securities at a specified future date.
• Most repos have a very short term, the most common being for 3 to 14 days.
• There is a market, however, for one- to three-month repos.
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Repurchase Agreements
• Repurchase Agreement
• There is no Secondary market for REPOs.
• REPO transactions are negotiated through telecommunications network.
• Dealers & Brokers perform the role of financial mkt. & receive commission for such services.
• Mkt. Participants:-Central Bank financial institutions & non-financial institutions.
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Glossary
• Repurchase/ Repo: A repurchase agreement is the sale of a security with a commitment by the seller to buy the security back from the purchaser at a specified price at a designated future date. Basically a repurchase agreement is a collateralized loan, where the collateral is a security.
• Reverse Repurchase/ Reverse Repo: A Reverse Repurchase is an agreement to purchase and resale of a security at a specific price and a specific future date. It is the mirror image of a Repo transaction. Provider of funds does Reverse Repo transaction.
• Overnight Money Market Repo Rate: The rate at which overnight repo deals are transacted in the money market.
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• Call Money: Funds placed with a financial institution without a fixed maturity date. The money can be “called” (withdrawn) at any time. It is a form of clean borrowing / lending in the MM for short term requirements without collateral.
• Delivery Versus Payment (DVP): Clearing and settlement of transactions in money market instruments (MMIs) is through book-entry system of transferring ownership with delivery of the securities against payment i.e. Delivery Versus Payment (DVP).
• Over The Counter (OTC): A secondary market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities “ over the counter ” to anyone who comes to them and is willing to accept their prices.
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• Interbank market: A market for wholesale loans and deposits traded between banks.
• Bid: A bid rate is the rate that a bank will wish to pay on any borrowing it makes.
• Offer: Offer rate is the rate that a bank will want to receive on any lending it makes.
• Primary Market: The market in which new issues of financial instruments/ securities are sold initially.
• Secondary Market: A market for buying and selling securities in the period between their issue and maturity. A liquid secondary market enhances the attractiveness of financial instruments/securities to investors.