MATHEMATICS IN FINANCIAL RISK MANAGEMENT

(MAT 740)

ASSIGNMENT 1

“MOVEMENT OF BASIC LENDING RATES

AND EXCHANGE RATES IN MALAYSIA”

NAME : WAN SYALWANNA BT WAN MAHAMOOD

NO. MATRIC :2012234814

GROUP :CS773 2C

Basic Lending Rate

What Is Basic Lending Rate?

In Malaysia, housing loan interest rates are usually quoted as a percentage above or below the

Basic Lending Rate. This means, if the BLR increases or decreases by a certain amount, the

interest rates charged on floating rate home loans also increase or decrease by the same amount.

Basic Lending Rate (BLR) is the minimum interest rate calculated by financial institutions based

on formula which takes into account the institutions cost of funds and other administrative costs.

It is typically similar amongst major banks. The adjustments to the BLR are made by banks at

the almost same time, though not regularly. BLR adjustments correlate with adjustments of the

Overnight Policy Rate (OPR) which is determined by Bank Negara Malaysia (BNM) during

Monetary Policy Meeting. Effective 1 November 1995, BNM imposed a ceiling on the BLRs

quoted by banking institutions. The ceiling rate would be determined by a formula. This

framework was further revised on 1 September 1998 to enhance the speed of transmission of

changes in BNM’s monetary policy to changes in the economy’s interest rate levels.

How Does BLR works?

Banks charge interest on the unpaid loan amount of a home loan (also known as the loan

principal or outstanding loan balance). Typically, home loan interest rates are calculated and

charged on a monthly basis. As an example, assumed that the amount borrowed is RM500, 000 a

home loan from a bank at an interest rate of BLR – 2.1%. Assume that the BLR is 6.6%. The

interest charged by the bank for the home loan is 6.6% - 2.1% = 4.5% annually. However, at any

given time, base lending rate is fixed, so the only variable in this equation is the percentage

discount (BLR minus) or premium (BLR plus) from the BLR. The interest rate on home loan

may be different among banks in Malaysia depending on their home loan packages.

Basic Lending Rates in Malaysia

1989 1992 1995 1998 2001 2004 2007 20100

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YearBLR (%) Year

BLR (%)

2011 6.6 2001 6.752010 6.3 2000 6.752010 6.05 1999 82011 6.6 1998 12.52010 5.8 1997 9.252009 5.55 1996 8.52008 6.75 1995 6.62007 6.75 1994 8.252006 6 1993 9.52005 6 1992 92004 6 1991 7.52003 6.5 1990 72002 6.5 1989 7

Factors Affecting Basic Lending Rate in Malaysia

1. Overnight Policy Rate

Overnight Policy Rate is an overnight interest rate set by Bank Negara Malaysia (BNM)

used for monetary policy direction. It is the target rate for the day-to-day liquidity

operations of the BNM. Overnight Policy Rate (OPR) is the interest rate at which a

depository institution lends immediately available funds (balances within the central

bank) to another depository institution overnight. This is an efficient method for banks

around the world to practice 'Accessing short-term financing' from the central bank

depositories. The interest rate of the OPR is influenced by the central bank, where it is a

good predictor for the movement of short-term interest rates.

In Malaysia, changes in the OPR trigger a chain of events that affect Base Lending Rate

(BLR), short-term interest rates, fixed deposit rate, foreign exchange rates, long-term

interest rates, the amount of money and credit, and, ultimately, a range of economic

variables, including employment, output, and prices of goods and services which is the

micro and macro factors on the economic. The BLR is usually adjusted at the time in

correlation to the adjustments of the OPR which is determined by Bank Negara Malaysia

during Monetary Policy Meeting.

2. Economy

Hike in the cost of borrowing has the intention of slowing down consumer demand &

spending in an overheated economy, usually characterized by a steadily increasing

inflation rate, uptrending share market and business activity. In layman terms, when it

cost more to borrow money, consumer spending power will reduce. Demand-pull

inflation is partly driven up by up-spiralling consumer demand, so when money supply

drops, price will remain steady (or drops) in theory. The increase in money supply is

usually the primary factor for demand-pull inflation, so hiking the Overnight Policy Rate

(OPR) is probably the most effective way. The highest percentage of BLR from 1989 to

2011 is in 1998 where the BLR is 12.5%. This is when Malaysia faced the Asian

Financial Crisis. The BLR was at the highest point at that time because to stop or

decreases the spending in ringgit currency especially in overseas. The more the

consumers need to pay the loans, the less ringgit is spends.

3. Internal Factors

One’s personal credit profile or credit score is important as it can often decide whether

hat someone will qualify for a home loan or not, as well as the amount and interest rate

the bank is prepared to lend. Banks normally look at two things: credit worthiness, and

the level of income. The interest rate on the home loan may vary depending on the terms

of the loan.

4. The Loan

a) Home Loan Amount – Generally the more the amount of the loan, the more

bargaining power the borrower has, and the lower the interest rate on the home

loan.

b) Home Loan Period – Loans with a shorter term are generally more expensive

(i.e. higher interest rates) than loans with a longer term. While it may seem like a

good strategy to extend the term of your loan, you should be aware that the dollar

amount of interest you pay is generally less on a loan with a shorter term.

c) Home Loan Insurance – Some banks offer a discount on your interest rate if you

apply for a mortgage insurance along with your loan. These insurances (e.g.

Mortgage Reducing Term Assurance or MRTA) help cover your outstanding loan

amount in the event of death or permanent disability, thus reducing your risk as a

borrower in the eyes of banks.

5. Location of Your Home

The interest rate on the home loan can vary depending on where the property is

physically located. The rationale here is that not all locations provide the same level of

risk to the bank. An area that is growing and experiencing property price increase will be

less risky to a bank. As the price of property increases, borrowers in these locations

effectively become “richer” and will less likely default on their loans.

Exchange Rates

What Is Exchange Rate?

In finance, an exchange rate between two currencies is the rate at which one currency will be

exchanged for another. It is also regarded as the value of one country’s currency in terms of

another currency. For example, the exchange rate for 3.2 Malaysia Ringgit to United States

Dollar means that RM3.20 will be exchanged for each USD1.00 or vice versa.

Factors That Affecting the Exchange Rate

1. Differentials in Inflation

As a general rule, a country with a consistently lower inflation rate exhibits a rising

currency value, as its purchasing power increases relative to other currencies. During the

last half of the twentieth century, the countries with low inflation included Japan,

Germany and Switzerland, while the U.S. and Canada achieved low inflation only later.

Those countries with higher inflation typically see depreciation in their currency in

relation to the currencies of their trading partners. This is also usually accompanied by

higher interest rates.

2. Differentials in Interest Rates

Interest rates, inflation and exchange rates are all highly correlated. By manipulating

interest rates, central banks exert influence over both inflation and exchange rates, and

changing interest rates impact inflation and currency values. Higher interest rates offer

lenders in an economy a higher return relative to other countries. Therefore, higher

interest rates attract foreign capital and cause the exchange rate to rise. The impact of

higher interest rates is mitigated, however, if inflation in the country is much higher than

in others, or if additional factors serve to drive the currency down. The opposite

relationship exists for decreasing interest rates - that is, lower interest rates tend to

decrease exchange rates.

3. Current-Account Deficits

The current account is the balance of trade between a country and its trading partners,

reflecting all payments between countries for goods, services, interest and dividends. A

deficit in the current account shows the country is spending more on foreign trade than it

is earning, and that it is borrowing capital from foreign sources to make up the deficit. In

other words, the country requires more foreign currency than it receives through sales of

exports, and it supplies more of its own currency than foreigners demand for its products.

The excess demand for foreign currency lowers the country's exchange rate until

domestic goods and services are cheap enough for foreigners, and foreign assets are too

expensive to generate sales for domestic interests.

4. Public Debt

Countries will engage in large-scale deficit financing to pay for public sector projects and

governmental funding. While such activity stimulates the domestic economy, nations

with large public deficits and debts are less attractive to foreign investors. This is because

a large debt encourages inflation, and if inflation is high, the debt will be serviced and

ultimately paid off with cheaper real dollars in the future.

In the worst case scenario, a government may print money to pay part of a large debt, but

increasing the money supply inevitably causes inflation. Moreover, if a government is not

able to service its deficit through domestic means selling domestic bonds or increasing

the money supply, then it must increase the supply of securities for sale to foreigners,

thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if

they believe the country risks defaulting on its obligations. Foreigners will be less willing

to own securities denominated in that currency if the risk of default is great. For this

reason, the country's debt rating is a crucial determinant of its exchange rate.

5. Terms of Trade

A ratio comparing export prices to import prices, the terms of trade is related to current

accounts and the balance of payments. If the price of a country's exports rises by a greater

rate than that of its imports, its terms of trade have favourably improved. The increasing

terms of trade shows greater demand for the country's exports. This, in turn, results in

rising revenues from exports, which provides increased demand for the country's

currency (and an increase in the currency's value). If the price of exports rises by a

smaller rate than that of its imports, the currency's value will decrease in relation to its

trading partners.

6. Political Stability and Economic Performance

Foreign investors inevitably seek out stable countries with strong economic performance

in which to invest their capital. A country with such positive attributes will draw

investment funds away from other countries perceived to have more political and

economic risk. Political turmoil, for example, can cause a loss of confidence in a

currency and a movement of capital to the currencies of more stable countries.

The Exchange Rate of Malaysia Ringgit

28/10/199524/7/1998 19/4/2001 14/1/200410/10/2006 6/7/2009 1/4/2012 27/12/20140

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USDGBPEURJPY100CNY

Malaysian ringgit has been one of the few strong currencies in the Asian continent. The country

is one of the rapidly developing countries in the world that is experiencing the phase of

industrialization. The currency of the country plays an important part in the development as it

had been strong for quite some time and the policies of the central bank of the country that

believes in the keeping the ringgit’s exchange rate down rather than supporting it.

When the Malaysian ringgit came into existence, it was made to peg with the US dollar and with

time, the peg was removed. But in 1997, during the time of severe Asian financial crisis, the

currency was re-pegged to the US dollar at a fixed rate regime @ RM3.80 to a dollar. The 7-year

peg to the US dollar has now been removed and the currency has been floated against several

major currencies of the world. The import and export restrictions of the currency are like the

import and export of the local currency is free if the amount does not exceed 1000 ringgits. The

import and export is free up till 10000 ringgits if it is pertaining to the foreign currency in the

country.

REFERENCES

1. http://www.blr.my/blr-history.htm

2. http://www.imoney.my/articles/everything-about-home-loan-interest-rate

3. http://www.imoney.my/articles/5-things-that-affect-your-housing-loan-interest-rate

4. http://en.wikipedia.org/wiki/Exchange_rate

5. http://www.investopedia.com/articles/basics/04/050704.asp