19. Unit 11 Money Market of Pakistan (Unsolved Complete)

8/12/2019 19. Unit 11 Money Market of Pakistan (Unsolved Complete)

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From the desk of Zaheer Swati

Lecture 11 M oney Market of Pakistan


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Financial Institution

2Zaheer A Swati

Unit 11

MONEY MARKET OF PAKSITAN

Efficient transfer of resources from those having idle resources to others who have a pressing need for them isachieved through financial markets. Stated formally, financial markets provide channels for allocation of savings to

investment

The Money market refers to the market where borrowers and lenders exchange short-term funds to solve theirliquidity needs

The securities in the money market are short term with high liquidity; therefore, they are close to being money Money market securities are usually sold in large denominations They have low default risk They mature in one year or less from their issue date, although most mature in less than 120 days

Money market is not some preset place like commodity market but a collective name given to all financialinstitutions dealing with short term debt financing

It performs various functions like divert saving into investment, brings financial stability by transferring credit fromone sector to other, easing the implementation of monetary policy, providing short term finance to governments,

lending the surplus funds ( if any) for short term etc

In Pakistan primary participants of money market are many like government of Pakistan, state bank of Pakistan,commercial, cooperative and saving banks etc

11. Money Market Securities/Instruments in Pakistan

Money market instruments are defined as negotiable debt instruments with a maturity of one year or less Money market instruments give businesses, financial institutions and governments a means to finance their short-

term cash requirements. Three important characteristics are:

Liquidity: Since they are fixed-income securities with short-term maturities of a year or less, moneymarket instruments are extremely liquid

Safety: They also provide a relatively high degree of safety because their issuers have the highest creditratings

Discount Pricing:A third characteristic they have in common is that they are issued at a discount to theirface value


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Unit 11

11.1 Treasury Bills

The Government of Pakistan raise debts through the auctions of short term Government of Pakistan Market TreasuryBills (MTBs)

MTBs are the Government of Pakistans debt securities that mature in one year or less from their issue date 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. when they mature; the government pays the

holder the full par value

Purchased by individuals, institutions and corporate bodies including banks irrespective of their residential status Can be traded freely in the countrys secondary market T-bills are issued through a competitive bidding process Finally, the interest is the difference between the purchase price of the security and what you get at maturity. T-bills

are considered to be the safest investments, because in these Government confirms the holder of security to pay back

face value. Returns are less because Treasuries are usually safe

They are issued with the maturities of

11.1.1 Investment features of Treasury Bills:

o Following are three important features of T-Bills


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DO M E S T I C M A R K E T S & MO N E T A R Y M A N A G E M E N T D E P A R T M E N T S T A T E B A N K O F P A K I S T A N

M A R K E T S & M O N E T A R Y M A N A G E M E N T D I V I S I O N T E L 9 2 ~ 2 1 ~ 9 9 2 2 1 9 6 7 F A X

9 2 ~ 2 1 ~ 9 9 2 1 2 4 7 6

AuctionTargetCalendarforSaleofGovernmentofPakistanMarketTreasuryBills

Auction Target calendar for sale of Government of Pakistan Market Treasury Bills 3Months, 6

Months&12Monthsfor4thQuarterFY14fromApriltoJune,2014ismentionedbelow.

Bidswillbeinvited(separately)oneachauctiondatebytheDirector,DomesticMarkets&Monetary

ManagementDepartment,StateBankofPakistan,KarachifromPrimaryDealersthroughBloomberg

OnlineAuctionmoduleMaturitydatesofGovernmentofPakistanMarketTreasuryBillssoldinthe

auctionswillbeasfollows:

Note:Bidscanberejectedwithoutassigninganyreason.

2Apr

14 03

Apr

14 94,217 30,783

125,000

16Apr14 17Apr14 644,951 (144,951) 500,000

30Apr141 02May14 321,020 28,980 350,000

14May14 15May14 483,048 (33,048) 450,000

28May14 29May14 382,392 17,608 400,000

11Jun14 12Jun14 222,149 27,851 250,000

25Jun14 26Jun14 71,163 128,837 200,000

2,218,940 56,060 2,275,000

MTBAuctionCalendarQ4FY14

ApriltoJune,2014(AmountinPKRMlllions)

AuctionDate SettlementDate MaturingAmountAdditional

Requirement

Targets

(RoundedOff)

TotalQ4FY14Amounts

1:/Maturityamounton02May14alsoincludesOutright(MTB)maturityofPKR289.10Blnfallingon05May

Tenor 3Month 6Month 12Month

3Apr14 26Jun14 2Oct14 2Apr15

17Apr14 10Jul14 16Oct14 16Apr15

2May

14 24

Jul

14 30

Oct

14 30

Apr

15

15May14 7Aug14 13Nov14 14May15

29May14 21Aug14 27Nov14 28May15

12Jun14 4Sep14 11Dec14 11Jun15

26Jun14 18Sep14 26Dec14 25Jun15

MaturityDates


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D O M E S T I C M A R K E T S & MO N E T A R Y M A N A G E M E N T D E P A R T M E N T

S T A T E B A N K O F P A K I S T A N

M A R K E T S & M O N E T A R Y M A N A G E M E N T D I V I S I O N T E L 9 2 ~ 2 1 ~ 3 2 4 5 3 4 9 1

F A X

9 2 ~ 2 1 ~ 9 9 2 1 2 4 7 6

ResultofAuctionofGovernmentofPakistanMarketTreasuryBills

TendersforSaleof3Months,6Months&12MonthsGovernmentofPakistanMarketTreasuryBills

wereinvitedbytheStateBankofPakistan,KarachithroughPrimaryDealersonApril30,2014.The

settlement date is May 02, 2014. Bids were opened at 12:00 hours on April 30, 2014 which was

receivedasfollows:

(Rs.InMillions)

RealizedValue FaceValue

03Month 5,976.999 6,112.675

06Month

56,306.199

59,090.000

12Month 272,578.140 299,650.000

Total 334,861.338 364,852.675

Theresultisasunder:

(Rs.InMillions)

Maturity

Period

Cut Off

Yield

Weighted

Avg.Yield

Realized

Amount

Face

Value

03Month 9.9383 9.9383 246.113 251.675

06Month 9.9675 9.9675 49,993.899 52,465.000

12Month 9.9932 9.9865 272,578.140 299,650.000

Total 322,818.152 352,366.675

InadditiontoaboveNonCompetitiveBidsacceptedareasunder:

(Rs.InMillions)

Tenor RealizedValue FaceValue Price

03Month

4,422.333

4,522.275

97.79

06Month 2,532.589 2,657.770 95.29

12Month 1,653.261 1,817.370 90.97

Total 8,608.183 8,997.415


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Unit 11

11.1.2 How to calculate return on T-Bills?

As we have studied earlier that T-Bills do not carry any interest rate but instead are sold at a discount from their parvalue or face value

Thus their yield is based on their appreciation in price between time of issue and the time they mature or are sold bythe investor

Bill yields are determined by the discount method; which ignores the compounding of interest rates, treats the parvalue as the investment base, and uses a 360-day year for simplicity

The Discount Rate for T-Bills can be calculated by the following formula:

Discount Rate= X

x

Example 11.1: Suppose you buy a 12 Weeks T-bill at Rs.98 and keep it until maturity having face value of rs.100. Then

the discount rate on this bill can be calculated as:

Solution:

11.1.3 How T-Bills are traded in Pakistan?

At start, Treasury bills were issued on tap basis for six months at 6 percent per year Afterwards when the government moved to a market-based system as part of the process of economic deregulation,

disinvestment, and decentralization in April 1991 then the following changes were made:

o Introduce the American-style Auction-Based System (ABS)o Primary dealers were appointed

State Bank of Pakistan use following two methods to trade T-bills. Auction System Open Market Operations(OMO)

360Par Value-Purchase Price

Par Value Number of Days to Maturity


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Unit 11

11.1.3.1 Auction System: SBP is acting as an agent on behalf of the government for raising short term funds from the

market. The MTBs are sold by SBP to approved Primary Dealers through multiple price sealed bids auction

11.1.3.2 Open Market Operation:

SBP conducted the first formal open-market operation (OMO) sale of government securities in 1995. AlthoughOMOs were meant to support interest-rate policy, the MOF first used them only as a borrowing vehicle

In Open Market Operations rather sale of securities Government can purchase treasuries back to increase the moneysupply

When money is invested in treasuries, it is considered to be out of circulation since it is held by the government When treasuries are purchased by the government, the investor will probably then invest that money in some sort of

securities and if the securities are checking accounts, savings accounts, money market accounts, or CDs, that

increases the money supply to banks, allow banks to loan more money

In OMO Government fix the discount rate before the announcing the new securities and can be issued when theyneed funds

11.2 Commercial Paper

Commercial paper consists of short-term, unsecured promissory notes issued by well-known companies that arefinancially strong and carry high credit rating

Commercial paper is generally used to meet immediate cash needs Funds raised from commercial paper are commonly used for current transactions i.e. to purchase inventories, pay

taxes and cover other short-term obligations rather than for capital transactions like long-term investments

SBP and SECP started process of creating commercial paper market in Pakistan in 2003 The commercial paper shall be issued for maturities between 30 days and one year from the date of subscription The commercial paper shall be in the form of a promissory note and be issued at such discount to face value as may

be determined by the issuer keeping in view the prevailing T-Bill rates, KIBOR and its Credit Rating


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Unit 11

11.2.1 Calculation of rate of return on commercial papers

Most commercial paper is issued at discount from par and Yield to investor can be calculated by bank discountmethod just like treasury bills

Investors yield arises from the price of security between its purchase date and maturity dateExample 11.2:If Rs. 1,000,000 commercial paper with a maturity of 120 days is acquired by an investor at a discount

price of Rs. 950,000. What will be the discount rate of return on commercial paper?

Solution:

11.3 Bankers Acceptances

The meaning of the term acceptance is approval. In financial terms acceptance means a promise to pay a specific

amount of money

The person who will pay is called as the promissory while the one who will receive is the beneficiary

The document which is the evidence of this promise is called a draft. When this draft tells the promissory to pay the

money on a predetermined specified date then this draft is termed as a time draft. The promissory puts his

Signature

The word accepted on top of his signatures and

The date on which the amount will be paid.Now the promissory is legally bound to pay the amount as mentioned in the draft to the beneficiary because it has

been accepted properly by him according to all requirements of official acceptance

If the time draft is formally accepted by a bank then it becomes a bankers acceptance

In case of a bankers acceptance the initial promissory is to pay the sum of money and the interest money charged

before or on the maturity date to the bank while the bank is bound to pay the money to the beneficiary.

Bankers acceptance is usually used in trade; mostly for international business but is also frequently used for

domestic dealing as well

The maturities of bankers acceptance mostly range from 30 to 180 day

Suppose that you own a software house and you need computers. You order a dealer in Japan to send you ten

computers on credit. Now that dealer does not know your credit worthiness. A very easy way to resolve this problem

is that you go straight to your bank with which you have a very good past record. There you get a time draft issued

on which the date you will pay the money is mentioned. Most probably the date mentioned will be one or two weeks

later after getting the shipment. The bank trusts you because of your good credit rating and it signs the draft adds its

signature and mentions the date. This draft has now become a bankers acceptance. The draft is then sent to the

manufacturer who is very much satisfied now as he knows the banks credit rating.


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Mechanism of Bankers Acceptance

Bankers acceptances are short-term, negotiable securities issued by a bank for a customer, usually to finance

export/import financing. The draft can be traded in the secondary market and represents an outstanding liability of

the issuing bank. They are typically traded at a discount from face value

The BAs marketability is limited only by the reputation of the accepting branch and the market demand

The net proceeds after the sale = the face amount of the acceptance - the discount rate (interest rate*days into

maturity*face amount) + the banks acceptance commission

The combination of these is called the all in rate

11.4 Repurchase Agreements

Repurchase agreements are agreements between a borrower and a lender where the borrower, in effect, sellssecurities to the lender with the requirement that the securities will be repurchased on a specified date and at a

specified, higher price

The securities serve as collateral for the loan. Most Repo agreements mark the collateral to market daily. If the valueof the collateral drops below the required margin, then the borrower must send more securities to the lender to

maintain margin or some money to reduce the principal outstanding

Example 11.3: We assume a financial institution has Rs 1 million cash surplus. The borrowing dealer and lending

company agree on 1 million RP loan collateralized by treasury bills, with the dealer agreeing to buy back the bills within

a few days and the interest on loan.


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Unit 11

Financial Institution Security Dealer

- Rs. 1 million + Rs 1 million

+ Securities worth 1 million - Securities worth 1 million

After Maturity of Agreement

+ Rs. 1 million - Rs 1million

- Securities worth 1 million + Securities worth 1 million

11.4.1 Types of Repo (In Term of Maturity)

Overnight repos

Overnight repos are 1 day loans

Term repos

Term repos have terms of greater than 1 dayusually weeks to months

Open repoOpen repo or continuing contracts are a contractual relationship that allows the borrower to borrow funds up to a certain

limit, without signing a new contract. However, each party has the right to terminate the contract on a short notice. The

interest rate on open repos is slightly higher than on overnight repos.

11.4.2 Calculating Repo Interest Income

The difference between the underlying securities current price and repurchase price is the amount of interest paid bythe borrower to the lender

Interest income from repurchase agreement can be determined by this formulaRP Interest income = Amount of loan x Current Repo Rate x (Repo Term in days/360 days)

Example 11.4:An overnight loan of Rs 1 million to a dealer at 12% Repo rate would yield interest income?

Solution:


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11.5 Eurodollar Deposits

o Eurodollars are the leading component of the Eurocurrency markets todayo There is a need for Eurocurrency markets because funds are required in international currencies worldwide mainly in

Dollars, Euros and Pounds

o Eurodollars are the deposits of US dollars in banks which are located outside United States.o 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

o The daily cost of funds derived from Eurodollars isAmount to be loaned * interest rate * 1/360

Mechanism of Eurodollar Deposits

11.6 Federal Funds

Federal funds refer to the overnight borrowings which are undertaken in order to meet the state banks reserverequirements

These are transferred from the lending institutions account to the borrowers account. The funds are not physicallytransferred. 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 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 withthe state bank of Pakistan. This is 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 thefederal 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 havesurplus. 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


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Unit 11

11.7 Certificates of Deposit

Negotiable certificates of deposit are money market instruments sold by banks, typically in maturities less than sixmonths

These negotiable instruments are traded in the secondary market and are a major tool used by large banks to managetheir liquidity

Instruments Pricing Issuer Characteristic

Treasury

Bills

Discount

Paper

SBP

Full Faith and Credit of the Pakistans

Government

Commercial

PaperCorporations

Short term corporate debt

Bankers

Acceptance

Banks

Finances self-liquidating transaction

Certificate of

Deposit

Interest

at

Maturity

Borrowing by banks from investors

Federal

Funds

Borrowing by Banks from other banks

Repurchase

AgreementMoney Market Dealers

Borrowing with financial assets as

collateral in order to lend at a higher rate


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19. Unit 11 Money Market of Pakistan (Unsolved Complete)

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