conventional money market school of finance & banking wf5083 financial risk management wf5023...

Conventional Money Market

School of Finance & BankingWF5083 Financial Risk Management

WF5023Semester June

2003

Topic 6


Prepared by:Abmalek F. [email protected]

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Course WF5023 Course WF5023 Conventional & Islamic Conventional & Islamic Financial Markets, Instruments, & InstitutionsFinancial Markets, Instruments, & Institutions

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WF5023Semester June

2003

Introduction to Money Market

Just what & where is theMoney Market ?

Just what & where is theMoney Market ?



WF5023Semester June

2003

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.



WF5023Semester June

2003

Money Markets Bond Markets Equity Markets

● Short –term debt

● Medium to long- term

● Long-term

● Non-permanent funding

● Non-permanent funding

● Permanent funding

● 1 day to 1 year

● 1 year to 30 yrs

● Perpetual

Relationship between Money Market & Other Financial Markets



WF5023Semester June

2003

Recalling the role of a bank …

… acts as an intermediary between depositors and borrowers

depositors

bank borrowers

placesmoney

lendmoney



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2003

Recalling the role of a bank …

In fulfilling its role as an intermediary between units thatseek funds and units with surplus funds, the bank alwaysfinds itself in the following undesirable positions …

Long$

Position

Short$

Position

Bank Bank



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2003

RetailMarket

Interbank

Market

Retail Market

Non-bankLenders

Mixed ofInterbankLenders /Borrowers

Non-bankBorrowers

● Repo placement

● Direct lending & borrowing of Ringgit

● Sale of Financial Instruments

● Purchase of Financial Instruments

● Trading of Financial Instruments

● (Loans / Advances)

● (Savings / Fixed Depots

● Repo / Reverse Repo

● No direct access to borrowing

● Swaps

● Foreign currency lending / borrowing



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2003

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.



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2003

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



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2003

Structure of the Money Market in Malaysia

can be broadly divided into

● Wholesale (Inter-bank Market), and

● Retail (Commercial Market)



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2003

Players of the Interbank Money Market are

1. Commercial Banks

2. Merchant Banks

3. Finance Companies (some only)

4. Discount Houses

5. Money Brokers



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2003

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.



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2003

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



WF5023Semester June

2003

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



WF5023Semester June

2003

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



WF5023Semester June

2003

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



WF5023Semester June

2003

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



WF5023Semester June

2003

Money Market Instruments Not Under SSTS

● Bankers Acceptance (BA)

● Negotiable Instrument of Deposits (NID)



WF5023Semester June

2003

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



WF5023Semester June

2003

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.

Interest-bearing Instruments & Discount Instruments



WF5023Semester June

2003

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 InvestedRM1,000,000

11.0%

RM 890,000

11.0%

Interest/Discount amt

RM 110,000

RM 110,000

Redemption amtRM1,110,000

RM1,000,000

12.3%



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2003


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.

Interest Received

=RM 110,000

Amount Invested

RM1,000,000

= 11.0%

Discount Amount

=RM 110,000

Amount Invested

RM 890,000

= 12.3%



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2003


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.



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2003

Functions of a Money Market Department

♦ 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

Basically a Money Market Department performs the following functions:



WF5023Semester June

2003

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).



WF5023Semester June

2003


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%



WF5023Semester June

2003


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(what is the current ratio?)

♦ The types of liquid assets are also determined by BNM(what are the items under this category?)



WF5023Semester June

2003


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, and3rd – the degree of dependency by bank on a certain funding source

New Liquidity Framework (NLF)



WF5023Semester June

2003

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.

New Liquidity Framework (NLF) (contd)



WF5023Semester June

2003

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.




WF5023Semester June

2003

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.




WF5023Semester June

2003

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

Class-1 Liquefiable Assets

♦ 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-2 Liquefiable Assets



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2003

– 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.



WF5023Semester June

2003

Example : (contd.)

The break-even cost of funds, b, is computed as follows:

Interest received from central bank and borrowers = Interest paid to depositors

(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.aEffective cost of reserve requirements = 2.16% p.a.



WF5023Semester June

2003

Money Market & BNM

SRR is one of the monetary tools used by BNM in managing the country’s monetary policy



WF5023Semester June

2003

Money Market Money Market InstrumentsInstruments



WF5023Semester June

2003

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.



WF5023Semester June

2003

Money Market Instruments

Instruments can either be

● interest-bearing papers; or

● discounted papers



WF5023Semester June

2003

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)



WF5023Semester June

2003

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



WF5023Semester June

2003

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



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2003


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



WF5023Semester June

2003


The Bands

Band 1 - 1 to 21 daysBand 2 - 22 to 43 daysBand 3 - 44 to 67 daysBand 4 - 68 to 91 daysBand 5 - 92 to 131 daysBand 6 - 132 to 171 daysBand 7 - 172 to 211 daysBand 8 - 212 to 261 daysBand 9 - 262 to 311 daysBand 10 - 312 to 364 days



WF5023Semester June

2003


DiscountedProceeds

= FV 1 -

( r x t )

36500

Discount Formula

where, FV is the Face Value, r is the discount rate of interest, and t is the tenor of the bill.



WF5023Semester June

2003


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



WF5023Semester June

2003


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



WF5023Semester June

2003


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)



WF5023Semester June

2003

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.



WF5023Semester June

2003



● 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



WF5023Semester June

2003


Why hold MGS ?

1. Investment Purposes MGS is a source of fixed income in the form of periodical coupon interest payments

2. Trading Purposes Possible capital appreciation

3. Compliance Purposes To fulfill minimum statutory requirements



WF5023Semester June

2003


Example : MGS as an Investment Tool

● Government issued a 10-year MGS● Stock Details

♦ Issue Amount - RM5,000,000,000♦ Issue Date - 28 September 2001♦ Stock Code - MN01001V

● Summary Results♦ Applied - RM14,808,000,000♦ Accepted - RM 5,000,000,000♦ Rejected - RM 9,808,000,000

● Tender Results♦ Highest - 3.847%♦ Lowest - 3.800%♦ Average - 3.833%



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2003



● Cash inflows for Stock MN01001V for every RM1 million

♦ 28 Mar 2002 - RM19,165 ♦ 28 Mar 2007 - RM19,165♦ 28 Sep 2002 - RM19,165 ♦ 28 Sep 2007 - RM19,165♦ 28 Mar 2003 - RM19,165 ♦ 28 Mar 2008 - RM19,165♦ 28 Sep 2003 - RM19,165 ♦ 28 Sep 2008 - RM19,165♦ 28 Mar 2004 - RM19,165 ♦ 28 Mar 2009 - RM19,165♦ 28 Sep 2004 - RM19,165 ♦ 28 Sep 2009 - RM19,165♦ 28 Mar 2005 - RM19,165 ♦ 28 Mar 2010 - RM19,165♦ 28 Sep 2005 - RM19,165 ♦ 28 Sep 2010 - RM19,165♦ 28 Mar 2006 - RM19,165 ♦ 28 Mar 2011 - RM19,165♦ 28 Sep 2006 - RM19,165 ♦ 28 Sep 2011 - RM1,019,165



WF5023Semester June

2003



● Selected price movement of Stock MN01001V ♦ 29 Sep 2001 Price 100.90 YTM 3.724 ♦ 02 Oct 2001 Price 102.95 YTM 3.481 ♦ 15 Oct 2001 Price 103.77 YTM 3.383 ♦ 06 Nov 2001 Price 103.52 YTM 3.410 ♦ 12 Nov 2001 Price 104.11 YTM 3.340 ♦ 30 Nov 2001 Price 102.65 YTM 3.511 ♦ 15 Jan 2002 Price 97.00 YTM 4.215 ♦ 22 Jan 2002 Price 95.95 YTM 4.350 ♦ 25 Jan 2002 Price 92.00 YTM 4.881 ♦ 06 Feb 2002 Price 95.65 YTM

4.391 ♦ 18 Feb 2002 Price 95.25 YTM

4.446 ♦ 07 Mar 2002 Price 95.30 YTM

4.442



WF5023Semester June

2003


General Bond Characteristics

The price or valuation of a bond is influenced by a number of factors including:

♦ The value of a government bond of similar maturity♦ The coupon rate and frequency♦ The maturity – the longer the period the risky it is♦ The credit rating of the issuer♦ The type of bond – straight, callable, puttable,

sinking fund, index-linked, zero-coupon, etc♦ Registered or in bearer form – bearer bonds often

have tax advantages♦ Liquidity of bond – transaction costs, volatility, etc♦ Taxation aspects – is the income taxed at source,

at what rate and when



WF5023Semester June

2003


Bond Trading – Settlement Formula

Proceeds =( FV x P )

+ FV( c * t )

100 ( 200 * e )

where FV = Face Value P = Price of Stock per 100 units t = No. of days between last interest payment date and the value date c = Coupon Rate e = No. of days in the coupon period in which settlement takes place

Proceeds = Principal + Accrued Interest



WF5023Semester June

2003


Bond Trading – Calculation of Proceeds (Example)

Investor purchased RM1.0 million of Stock MN0100V on28 Mar 2002 over spot at 93.50

Stock Details c = 3.833 Coupon Dates = every 28 Sep and 28 Mar

Transaction Details Value Date = 01 Apr 2002 t = 4 days e = 184 days

● Principal = (93.50 / 100) x 1,000,000 = 935,000.00● Accrued Interest = 1,000,000 x ((4 x 3.833) / (200 x 184))

= 416.63

● Buyer Pays = 935,000.00 + 416.63 = RM935,416.63



WF5023Semester June

2003

Money Market Instruments- Bankers Acceptance (BA)

Definition

BA is a bill of exchange, issued at a discount, drawn on and accepted by an authorized bank to finance genuine trade transactions



WF5023Semester June

2003



● not an SSTS instrument● drawn by a customer on his bank to finance either export, import, domestic sales, or domestic purchases● normally customer has prior facility arrangement with his bank● tenor at creation is normally 21 days to 200 days● issued at a discount and redeemable at par on maturity● minimum amount is RM30k and in multiple of RM1k● active secondary market● eligible as liquid assets held by banks● settlement based on discounted formula



WF5023Semester June

2003


Examining the Life Cycle of BAs

● customer makes sales or purchases● bank extends financing and owns the BA certificate

● bank may sell the BA certificate to potential investor (and thereby obtain funding for the BA), ● or bank may retain the BA till maturity (thereby collects discounted income)● on maturity, BA customer pays bank the full face value and bank pays investor (if BA had been sold before maturity)



WF5023Semester June

2003


BA as a Financing Instrument

BANK(lender)

CUSTOMER(borrower)

advance money

draws BA



WF5023Semester June

2003


BA as a Investment Instrument

BANK(seller)

INVESTOR(buyer)

lend / advance money

delivers BA



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2003


Creation of BA

INVESTOR

CUSTOMER

BANK



WF5023Semester June

2003


Redemption of BA

INVESTOR

CUSTOMER

BANK



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2003


Example: An importer draws a BA with face value RM5.0 million for 90 days at a discount rate of 3.70

On Creation Day:

Proceeds to the importer is

= RM5,000,000 1 – (90 x 3.70) 36500

= RM4,954,384



WF5023Semester June

2003


Example (contd)

Assuming on 3rd day, bank sells the BA to an investor at 3.65%

On Day 3 :

Bank receives

= RM5,000,000 1 – ( 87 x 3.65 ) 36500

= RM4,956,500



WF5023Semester June

2003


Example (contd)

Assume investor is able to sell the BA 30 days after purchase at 3.50%On Day 57 :

Investor receives

= RM5,000,000 1 – ( 57 x 3.50 ) 36500

= RM4,972,621.23

Trading income to investor is RM4,972,621.23 – RM4,956,500.00 = RM16,121.23



WF5023Semester June

2003


Example (contd)

Redemption of the BA on maturity date

On Day 90 :

Importer pays full Face Value RM5,000,000 to Bank,

and

Bank pays full Face Value to last holder of BA certificate



WF5023Semester June

2003


Advantages of Trading in BA

● Liquidity BA can be easily liquidated for cash if the need arises, or take profit if price is right

● Secondary market is active and discount rates reflect market prevailing rates

Limitation of Trading in BA

Amount and tenor required depend very much on paperavailability



WF5023Semester June

2003

Money Market Instruments- Cagamas Bonds & Notes

Definition

… debt instruments created by Cagamas Berhad, the Malaysian National Mortgage Corporation, to purchaseprimarily housing loans from primary lenders (financial institutions)



WF5023Semester June

2003


Types of Bonds / Notes Issued by Cagamas

1. Cagamas Fixed Rate Bonds2. Cagamas Floating Rate Bonds3. Cagamas Notes4. Sanadat Mudharabah Cagamas



WF5023Semester June

2003


1. Cagamas Fixed Rate Bonds

● these bonds have tenures of 1 ½ to 12 years● carry a fixed coupon rate which is determined at the

point of issuance, based on tenders submitted by Principal Dealers

● interest on these bonds is paid half-yearly● the redemption of the bonds is at nominal value

together with the last interest due on maturity date



WF5023Semester June

2003


2. Cagamas Floating Rate Bonds

● these instruments have a tenure of up to 7 years and an adjustable interest rate pegged to the 3-months or 6-months KLIBOR

● the coupon is reset every 3 or 6 months while interest is paid at 3 or 6 monthly intervals

● interest on these bonds is paid half-yearly● they are redeemed at face value together with the

last interest due on maturity date



WF5023Semester June

2003


3. Cagamas Notes

● these are short-term instruments with maturities between 1 to 12 months

● issued at a discount from the face value● other features of these notes are similar to that of

the MTB● the notes are redeemable at their nominal value

upon maturity



WF5023Semester June

2003


4. Sanadat Mudharabah Cagamas

● these are bonds issued under the Islamic principle of Al-Mudharabah (profit-sharing) to finance the purchase of house financing debts which were granted under Al-Bai Bithaman Ajil

● medium tenor instruments with maturity up to 7 yrs● issued at par with pre-determined profit sharing

ratio payable semi-annually● the bonds are redeemed at face value, together with

final dividend payments (if any) on maturity date



WF5023Semester June

2003


Trading Formula for Cagamas Bonds

Proceed =p

x FV +( c x t )

100 36500where, p = Price

FV = Face Value of Bond c = Coupon Rate t = No. of days from last interest date

to settlement date



WF5023Semester June

2003


Example :

An investor buys RM1.0 million worth of Cagamas Bondon 28 Mar 2002 for value date 01 Apr 2002 at 105.10Details of the stock is as follows :

● c = 5.449● t = 21 days● Last coupon date = 11 Mar 2002

P = {105.1

0}

*1,000,00

0+ {

(5.449 x 21)

}100 36500= RM1,054,035.04



WF5023Semester June

2003

Money Market Instruments- Khazanah Bonds

Definition

… debt securities issued by Khazanah Nasional Berhad, the Malaysian Government corporate arm, to participatein acquiring shares of corporatised government bodies and in companies of strategic national interests.

Primary issue is on price per 100 units, based on tender basis, normally underwritten by approved Principal Dealers.

It carries the implicit guarantee from the government and at present all issues are zero coupon bonds.



WF5023Semester June

2003


Example :

● Khazanah issue a 3-year zero coupon bond● Stock Details

♦ Issue Amount - RM1,000,000,000♦ Issue Date - 18 September 2001♦ Stock Code - QG00002V

● Summary Results♦ Applied - RM 3,708,000,000♦ Accepted - RM 1,000,000,000♦ Rejected - RM 2,708,000,000

● Tender Results♦ Highest - 87.118♦ Lowest - 87.016♦ Average - 87.040



WF5023Semester June

2003


Example :

● Selected price movement of Stock QG00002V

♦ 14 Sep 2000 Price 86.93 YTM 4.72 ♦ 16 Oct 2000 Price 87.40 YTM 4.67 ♦ 11 Jan 2001 Price 90.20 YTM 3.90 ♦ 22 Mar 2001 Price 92.00 YTM 3.40 ♦ 30 May 2001 Price 92.60 YTM 3.38 ♦ 16 Aug 2001 Price 93.77 YTM 3.12 ♦ 02 Jan 2002 Price 95.05 YTM 3.00 ♦ 07 Mar 2002 Price 95.54 YTM 3.03



WF5023Semester June

2003


Trading Formula for Khazanah Bonds

Proceed of sale

or purchase=

p

x FV100

where, p = Price FV = Face Value of Bond



WF5023Semester June

2003


Example :

An investor buys RM1.0 million Khazanah Bond QG00002Von 30 Mar 2001 at 92.10

Investor pays = {92.10

} x 1,000,000100

= RM921,000.00If investor hold the stock till maturity, he would receiveRM1,000,000.00 on 18 Sep 2003



WF5023Semester June

2003

Money Market Instruments- Negotiable Instruments of Deposits (NID)

Definition

NID is a document issued by an authorised bank which certifies that a certain sum in Ringgit has been deposited with the bank for a stated rate of interest with a specified maturity date.



WF5023Semester June

2003


General Features & Characteristics

● NID is like a fixed deposit with a bank, however, it offers the holder/purchaser an important additional advantage in that it is negotiable

● Because it is a bearer document, the original certificate is kept with an authorized depository (usually the issuing banks) at all times

● Minimum nominal value RM100,000, issued in multiple of RM50,000 up to RM1,000,000 per certificate

● An active secondary market enables an investor to make a re-sale at any time before maturity



WF5023Semester June

2003


Trading of NID

An NID may be traded in the secondary market based on

● outright sale and purchase, which results in a transfer of ownership from seller to buyer, without recourse, except to the Issuer

● Purchase and redemption prior to maturity date by Issuer of its own NID, which results in premature liquidation

● Repo – first buyer and first seller respectively undertake to repurchase and sell-back the NID at an agreed price & on a specified future date

● transaction value “same day”, “spot”, or “forward”



WF5023Semester June

2003


Issuer(Bank)

Depositor

InvestorAnother

Bank

issues

sells

resell

AnotherInvestor

redeems the certificate on maturity

pays principal plus last interest due

anotherresell

pays full principal



WF5023Semester June

2003


Presently NIDs are issued under 4 broad categories :

● Short-term Negotiable Instruments of Deposits (SNID)

● Long-term Negotiable Instruments of Deposits (LNID)

● Zero-coupon Negotiable Instruments of Deposits (ZNID)

● Floating-rate Negotiable Instruments of Deposits (FRNID)



WF5023Semester June

2003


Short-term Negotiable Instruments of Deposits (SNID)

● Tenor ranges from 1 month to 12 months● Minimum value RM100k, in multiples of RM50k, Maximum value up to RM1.0 million● Interest, based on fixedcoupon rate, will be paid on maturity together with principal● Redemption proceeds is based on following formula,

NV 1 +( c x t )

36500where, NV is nominal value, c is coupon interest rate p.a., t is no. of days between issue date and maturity



WF5023Semester June

2003


Example : SNID (primary issue)

A SNID was issued with the following features:

Issue Date 08 Feb 2002 (Fri), Maturity Date 07 Feb 2003 (Fri)Nominal Value is RM1.0 mil., Coupon Rate is 7.0 % p.a.

If depositor holds the instrument till maturity, his redemptionproceeds is

Redemption

Proceeds=

1,000,000

1 +

(7.0 x 364)

36500

= RM1,069,808.22



WF5023Semester June

2003


SNID : Trading in Secondary Market

In the secondary market, SNID is traded on yield p.a. basis.The proceeds to be paid by a buyer is computed as follows:

Proceeds = NV36500 + (C x DIM)

36500 + (Y x DSM)

where, NV = Nominal Value, C = Coupon Rate,

y = Yield in % p.a. DIM = No. of days between issue date and maturity,

DSM = No. of days between settlement date and maturity date



WF5023Semester June

2003


Example : SNID (secondary market)

A SNID has the following features:

Proceeds from buyer

=1,000,00

0

36500 + (7.45 x 181)

36500 + (7.50 x 94)

= RM1,017,294.72

Issue Date 05 Feb 2002 (Tue), Maturity Date 05 Aug 2002 (Mon)Nominal Value is RM1.0 mil., Coupon Rate is 7.45 % p.a.

The original bearer sold the SNID for value same day at a yield of 7.50% p.a. to a buyer on 03 May 2002,



WF5023Semester June

2003


Long-term Negotiable Instruments of Deposits (LNID)

● Tenor must be at least 12 months up to 120 months

● Minimum value RM100k, in multiples of RM50k, Maximum value up to RM10 million

● Coupon payments made semi-annually or quarterly except for the 1st interest payment which could be earlier than 3 or 6 months

● Traded on price basis, i.e. quoted in terms of “price per 100 nominal value” (e.g. “99.90” or “100.15”)



WF5023Semester June

2003


LNID : Computation of 1st Interest Payment

Computation of the 1st Coupon Proceeds is based on

CP = NV x( c/n )

xDIC

100 DCC

where, CP = Coupon Proceeds, NV = Nominal Value,

c = Coupon Rate, n = Frequency of coupon payments p.a. DIC = Actual no. of days between issue date and

to the first interest date, DCC = No. of days in the next interest period



WF5023Semester June

2003


Example : Computation of 1st Interest Payments on LNID

An LNID was issued with the following features:

Issue Date 12/02/2002 (Tue) Maturity Date 12/05/2002 (Mon)Nominal Value RM1.0 mil Coupon Rate 7.8%p.a.Interest Dates : every 12/05 and 12/11

The 1st interest date would be 12/05/2002, i.e. only 3 monthsafter issue date. Interest payment would be

CP =RM1,000,00

0x

7.8 / 2x

89

100 181

= RM19,176.80



WF5023Semester June

2003


LNID : Computation of Remaining Interest Payments

Computation of Coupon Proceeds is based on

CP = NV x( c/n )

100

where, CP = Coupon Proceeds, NV = Nominal Value,

c = Coupon Rate, n = Frequency of coupon payments p.a.



WF5023Semester June

2003


LNID : Trading in Secondary Market

In the secondary market, LNID is traded on price basis.Proceeds to be paid by a buyer is computed as follows:

where, NV = Nominal Value, p = Price,

c = Coupon Rate, n = Frequency of coupon payments p.a.DCS = No. of days between last interest date and

settlement date,DCC = No. of days in the current interest period

Proceeds

= NV xp

+

c / n x

DCS

100 100 DCC



WF5023Semester June

2003


Example : LNID (secondary market)

Proceeds =RM1,000,00

0

99.95

+

8.0 / 2

x61

100 100 184

= RM1,012,760.87

Issue Date 04/05/2002 (Fri) Maturity Date 04/05/2006 (Thu)Nominal Value RM1.0 mil Coupon Rate 8.0% p.a.Interest Dates : 04/11 and 04/05

The LNID was sold on 04/07/2001 at a price of RM99.95; andthe sale proceeds are calculated as follows:

(of which accrued interest is RM13,260.87)



WF5023Semester June

2003


Zero-coupon Negotiable Instruments of Deposits (ZNID)

● Tenor must be at least 1 month up to 120 months


● Full nominal value to be paid by Issuer at maturity

● Traded on yield basis (e.g. 7.05%) for papers with remaining maturity of less than 365 days, and on price (e.g. 98.90) for papers exceeding 365 days to maturity



WF5023Semester June

2003


ZNID : Trading in Secondary Market

Proceeds to be paid by buyer for papers < 365 days to maturity

where, NV = Nominal Value, y = yieldDSM = No. of days from previous settlement

date to current interest date

Proceeds

=

NV

1 +Y x DSM

36500



WF5023Semester June

2003


Example : Trading ZNID in Secondary Market ( < 365 days)

Issue Date 07/02/2000 (Mon) Maturity Date 07/02/2002 (Thu)Nominal Value RM1.0 mil.

The paper was sold on 04/09/2001 at a yield of 7.5% p.a. The sales proceeds were

Proceeds

=

1,000,000

1 +

7.5 x 156

36500

= RM968,940.80



WF5023Semester June

2003


ZNID : Trading in Secondary Market

Proceeds to be paid by buyer for papers > 365 days to maturity

where, NV = Nominal Value, p = price

Proceeds = NV +

p

100



WF5023Semester June

2003


Example : Trading ZNID in Secondary Market ( > 365 days)

A ZNID with a nominal value of RM1.0 million is purchased at aprice of RM95.00

Proceeds to be paid by buyer,

Proceeds =RM1,000,00

0x

95

100

= RM950,000



WF5023Semester June

2003


Floating-rate Negotiable Instruments of Deposits (FRNID)

● Tenor must be at least 12 month up to 120 months


● Interest payment every 3 or 6 monthly intervals based on KLIBOR ± margins fixed every interest payment date

● Traded on price basis (e.g. 98.90)



WF5023Semester June

2003


Floating-rate Negotiable Instruments of Deposits (FRNID)

Computation of proceeds is based on formula,

Proceeds = NVp

+c x DCS

100

36500where, NV = nominal value,

p = price, c = coupon



WF5023Semester June

2003


Example : Trading FRNID

Issue Date 01/03/2000 (Wed) Maturity Date 01/03/2005 (Tue)Nominal Value RM1.0 mio Coupon Rate KLIBOR + 0.25%Interest Dates : every 01/09 and 01/03

Proceeds

=RM1,000,00

0

99.95

+

7.85 x 31

100 36500

= RM1,006,167.12

On the 1st interest date of 01/09 2002, KLIBOR was 7.6% p.a.The coupon rate was then fixed at 7.85% p.a.

The FRNID was sold for value 02/10/2002 at a price of 99.95.Proceeds to be paid by buyer



WF5023Semester June

2003

Money Market Instruments- Bank Negara Bills (BNB)

BNB are short term securities issued by Bank Negara Malaysia and are bidded on yield basis. The yield is specified as a rate of discount and the tenor of BNB is expressed as a number of days.



WF5023Semester June

2003

Money Market Instruments- Repurchase Agreements (Repo / Reverses)

What is a Repo ?

■ By definition, a repo is an agreement whereby a bank sells its valued money market papers to an investor with an understanding to repurchase them at an agreed price on a specified future date.

■ The type of money market papers normally used for repo include

(i) Bankers Acceptances (BAs)(ii) Negotiable Certificate of Deposits (NIDs)(iii) Malaysian Government Stocks (MGSs, MTBs)



WF5023Semester June

2003


How does a Repo work ?

INVESTOR BANK

1. On Day 1

pledges money market papersfor the tenor of placement

places surplus funds with bank on short term



WF5023Semester June

2003


How does a Repo work ?

INVESTOR BANK

2. On Maturity Date

returns the right ofclaim to the money

market papers

returns principalplus interest



WF5023Semester June

2003


Who can do repo ?

■ Private and public companies with surplus funds

■ Government agencies with surplus funds

■ Cash-rich individuals



WF5023Semester June

2003


Advantages of repo to investors

■ able to maximise returns on short term surplus funds rather than leaving the funds idle in current account which yield no return

■ can manage and plan cash flow more efficiently as the tenor for repo is very flexible

■ in emergency cases, funds can be withdrawn before maturity date of repo, with interest paid for the number of days the funds were held by bank



WF5023Semester June

2003


Formula for Computation of Interest Payable on Repo

I =P x R x T

100

The calculation of interest payable on repo transactions is basedon the simple interest formula

where, I = Interest payable P = Principal sum placed under repo R = Rate of interest for the placement T = Tenor of the repo



WF5023Semester June

2003


Example :

A repo placement by an investor of RM1,000,000 for 7 days at 6.50 percent

I = 1,000,000 x 0.065 x 7 365

= RM 1,246.58

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