Topics Covered

Topics CoveredMoney Market - ComponentsInstruments Traded in the Malaysian Money MarketThe Pricing of Money Market InstrumentsDetermining the Yield of a Money Market InstrumentInterest Rates, Yields and Price of Money Market InstrumentsMalaysia Money Market Trading PerformanceThe Central Bank, Money Market and Monetary Policy OperationsCommercial Banks and The Money Markets1

IntroductionMoney markets(MMs) can be thought of as a gear of a vehicle with the banking system and capital market as its wheelsThe short-end of the yield curve is derived from money market tradingMMs began as a needed extension of the correspondent banking systemBanks depend on the money market to manage their liquidityUsed by central banks to conduct monetary operationsA well functioning money market properly transmits policy initiatives to the rest of the financial systems it is linked to both the capital markets and the banking sys.2Key Players in the Money Market3

Early Days of Money Market4Typical evolution of money markets in the UK and USCreation of Correspondent banks inter-relationship among banksCommercial papers were created to minimize counterparty riskA market to discount these papers was the next logical extension

Malaysias money market was established by fiat in the 1980s

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Malaysias Money Market6A total of 5 key initiatives were undertaken by Bank Negara over the next several years. These were:

appointment of principal dealers to make markets creation of a benchmark yield curve by issuing Khazanah bondsinterest rate deregulation (Feb 1991) to aid price discovery processincreased capital requirement for non bank players in money market (1998) so as to minimize counterparty riskinfrastructure development (1989-1997)

Money Market Components71.The interbank deposit system

The mismatches in the daily cash-flow of a bank lead to the creation of the interbank deposit system.Mismatches occur:When the bank faces excess amount of withdrawals orWhen the bank lends more than it ought to orWhen the items in the banks balance sheet matureThe size and timing of the maturing assets and liabilities decides whether a bank will have a net cash inflow or outflow

The interbank deposit system helps to manage the above temporary imbalances The Interbank Deposit System8Tenors for interbank deposits range from overnight to a maximum one yearDifferent KLIBOR (Kuala Lumpur Interbank Offer Rate) rates are used to charge interest rates on instruments depending upon their tenors.

KLIBOR rates are mostly determined by market forces, depending upon the periods of high liquidity or low liquidity and hence, fluctuateThe KLIBOR rates constitute a benchmark cost of funds to commercial banksKLIBOR rates are in essence risk-free rates

As an interbank market, the money market is a wholesale market where only large transactions are executed.A Typical Interbank Deposit Transaction9Suppose given temporary excess outflows, CIMB wants to borrow RM 100 million for a one month period. Assume that Maybank has a cash surplus which it wants to place out for a short period in the interbank market. Given CIMBs needs, Maybank would place RM 100 million as a one month deposit with CIMB. The interest rate that CIMB will pay for interbank deposit will be the prevailing one month KLIBOR rate.

A Typical Interbank Deposit Transaction10If the one month KLIBOR rate is say 6% annualized, the amount that CIMB would have to return to Maybank one month later would determined as;

Where;RA = the redemption amountKLIBOR = the appropriate annualized KLIBOR by tenorN = number of tenor periods within a yeart = tenor periodA Typical Interbank Deposit Transaction11In this case, the redemption amount would be:

The redemption amount is simply the initial deposit plus accumulated interest.Note that these amounts are not physically moved but debited and credited into respective banks accounts.Money Market Components122. Interbank deposits trading activityMoney Market Components13Interbank deposits trading activityWithin interbank deposits, the short tenors, overnight, weekend and 1 week tenors were most popular Overnight deposits typically account for close to 70% of volume traded in ringgit terms. This popularity of overnight deposits is attributable to the overnight borrowing/lending needed to settle balances arising from the cheque clearingMoney Market Components14Illustration Overnight Interbank Deposit from cheque clearance

Suppose on a given day, HSBC has RM 250 million of cheques drawn on it from Maybanks customers but only RM 200 million drawn on Maybank by HSBCs customers.At the end of cheque clearing, HSBC has to pay Maybank the differential amount of RM 50 million.If the amount is settled the following day by HSBC, it will be liable to Maybank for the interest accrued for the overnight period.In essence, at the end of the cheque clearing process, Maybank would be deemed to have placed an overnight interbank deposit of RM 50 million with HSBC.Money Market Components15Illustration Overnight Interbank Deposit from cheque clearance Assuming the quoted overnight interest rate is 5.8% overnight KLIBOR (annualized), the amount HSBC will have to pay Maybank can be determined using our earlier equation, which is as follows:

The amount of RM 7,945.21 would constitute the interest for the overnight period.Money Market Components163. The trading of money market instrumentsThe money market instruments enable the debt to be transferred easily through secondary market tradingThe highly liquid secondary market for money market instruments enables debt to be sold and resold before maturityRelative to interbank deposits, money market instruments have a much larger constituent baseWhile the term money market instruments typically refers to short-term debt papers, it is quite common to see long dated debt like government bonds being tradedMalaysian Money Market Instruments 17Malaysian Treasury Bills (MTB)MTB are short-term government securities and are traded on yield basis. The yield is specified as a rate of discount and the tenor of MTB are expressed in actual number of days. The typical maturities are 3, 6 and 12 months.

Bank Negara Malaysia Bills (BNB)BNB are short-term securities issued by Bank Negara Malaysia and are bidded on yield basis. The maturity is always less than a year. The yield is specified as a rate of discount and the tenor of BNB are expressed in actual number of days.

Malaysian Money Market Instruments 18Malaysian government securities (MGS)MGS are sovereign debt papers or bonds issued by the Malaysian government to raise funds in the domestic capital market. They typically have fixed coupon rates (interest rates) that are paid on a semi annual basis. The coupon rate is determined by the weighted average of the successful yield. Bankers acceptances (BAS)Bankers Acceptances (BAs) are short term, zero coupon debt papers issued by companies. They are guaranteed by a bank and are therefore known as BAs. The bank guarantee enhances credit rating and makes it transferable and therefore suited to secondary market trading.

Malaysian Money Market Instruments 19Commercial Papers (CP)Commercial Papers are short term, unsecured (promissory notes) debt instruments issued by corporations. Typically issued by companies with good credit rating, they can be very liquid. Yields are higher than government paper of similar maturity, reflecting the risk spread. Cagamas notesCagamas Notes are short-term securities with the tenor of 12 months or less. The notes are similar to MTB and normally issued at a discount. The issuer is the National Mortgage Corporation; CAGAMAS. At maturity they are redeemable at nominal value.

Malaysian Money Market Instruments 20Cagamas bondsCagamas bonds are longer term debt instruments issued by the National Mortgage Corporation. The bonds are often the result of securitization of housing loans of local commercial banks that have been purchased by CAGAMAS. The bonds have either a fixed coupon rate or a floating coupon.Khazanah bondsIssued by Khazanah Nasional Bhd. , a government agency charged with managing Government Linked Companies (GLCs)Khazanah bonds are essentially rated as government paper. They share many of the same features of MGS securities. Malaysian Money Market Instruments 21Negotiable instrument of deposits (NIDS)To enable bank deposits to be traded on the secondary marketNIDs being of private issuance, typically provide a higher yield than the treasury bills. They are traded on a discounted basis to their nominal value.Repurchase agreements (repos)REPOs are not an instrument but an extremely popular type of transaction in money markets. This is also true of the Malaysian Money MarketREPOs are bilateral transactions involving the purchase and resale of securities by agreement. The underlying asset is typically an MGS, government bond or other liquid instrumentsPricing Of Money Market Instruments22What are the factors that determine an instruments price?

Time left to maturity (in days)The nominal or face value of the instrument (redeemable amount)The required return or yield for the instruments (discount factor) and The coupon / interest payment, if any

Pricing Of Money Market Instruments23A generalized pricing model

Where;

P = Price of instrumentFV = Face value or redeemable amount at maturityr = Required yield (discount factor)t = number of days left to maturityExample: Determining the price of a Money Market Instrument24Suppose a bankers acceptance with 48 days left to maturity and a Face value of RM 100,000 is available. What would be the correct price if the required yield is 7% annualized?

Determining The Yield Of A Money Market Instrument 25The yield on an instrument can be determined as;

where; Y = yield on instrument FV = face value of instrument P = Current price t = days to maturityInterest Rates, Yields And Price Of Money Market Instruments 26Pricing of most money market instrument is based on discounting and hence, are very sensitive to changes in interest ratesBoth the interbank deposit system and the market for money market instruments are intricately linked

Funds flow easily between the two and this ensures co-movement in their yields/rates of return.Lend fundsInterest Rates, Yields And Price Of Money Market Instruments27Malaysia Money Market Trading Performance 28

The Central Bank, Money Market And Monetary Policy Operations29A central banks activity in money markets typically has four broad policy objectives;

1) Ensuring the smooth functioning of the banking system2) Implementation of monetary policy3) Offsetting imbalances resulting from the external sector4) Sterilization of forex market operations

The Central Bank, Money Market And Monetary Policy Operations30Ensuring the smooth functioning of the banking system

The central bank uses the money market to ensure that there are no imbalances in liquidity

A huge net shortage could lead to a credit crunch if unchecked.

Alternatively, a huge surplus can cause excess liquidity within the overall monetary system causing the interest rates to fall below desired levels.The Central Bank, Money Market And Monetary Policy Operations31If there is a net deficit the central bank creates liquidity by either allowing banks to borrow from it or through open-market-operations (OMO)An open-market-operation (OMO) is essentially an activity initiated by the central bank to influence liquidity. This is done through the sale or purchase of government securities and/or money market instrumentsSince a sale of government securities, for example Bank Negara Bills (BNB), would enable the central bank to place-out government papers in exchange for cash, the sale drains cash or liquidity from the systemThe Central Bank, Money Market And Monetary Policy Operations32Implementation of monetary policy

Monetary policy has two legsinterest rates money supplyTo raise interest rates and money supply via the money market, the central bank can undertake the sale of government securitiesSustained selling would drive down liquidity and thereby raise the yields and interest ratesIn the interbank market, the central bank can achieve the objective by offering higher rates on deposits of commercial banks that are placed with it

The Central Bank, Money Market And Monetary Policy Operations33Offsetting imbalances resulting from the external sector

External imbalances can quickly translate into sudden imbalances within the domestic economy especially if it is a small economy like Malaysia

Sudden inflow of funds through FDIOutflow due to higher rates elsewhere

The Central Bank, Money Market And Monetary Policy Operations34Sterilization of forex market operations

Central banks often intervene in foreign exchange markets to influence exchange rates

In order to offset any side effects due to the foreign exchange intervention, such as changes in domestic liquidity, money markets will be used by central banks

Commercial Banks And The Money Market35Managing asset liability mismatchesWhy do mismatches occur??Due to the different maturity of items in the balance sheetWhen a banks asset-liability imbalances are temporary in nature, depending on the interbank money market is perfectly acceptable. How?A bank with surplus funds can either lend by placing deposits with other banks in the interbank deposit system or lend by purchasing money market instrumentsA bank with a cash deficit can borrow by either taking / accepting deposits in the interbank deposit system or sell money market instrumentsRelying on money markets to fund asset growth is a risky strategy.

Q & A

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