Topics Covered

Money Market - Components

Instruments Traded in the Malaysian Money Market
The Pricing of Money Market Instruments
Determining the Yield of a Money Market Instrument
Interest Rates, Yields and Price of Money Market Instruments
Malaysia Money Market Trading Performance
The Central Bank, Money Market and Monetary Policy Operations
Commercial Banks and The
Money Markets
1
Introduction
Money markets(MMs) can be thought of as a gear of a vehicle with the
banking system and capital market as its wheels
The short-end of the yield curve is derived from money market trading
MMs began as a needed extension of the correspondent banking system
Banks depend on the money market to manage their liquidity
Used by central banks to conduct monetary operations
A 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.
2
Key Players in the Money Market
3
Early Days of Money Market
4
Typical evolution of money markets in the UK and US
Creation of Correspondent banks inter-relationship among banks
Commercial papers were created to minimize counterparty risk
A market to discount these papers was the next logical extension

Malaysias money market was established by fiat in the 1980s
Title 5
Money Markets and Correspondent Banking


















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Bank A
(Rural Bank)
$
C. Bills
Bank As
Correspondence
Bank)
$
C. Bills
Money Market
$
C Bills
Bank B
(Rural Bank)
C. Bills
$
D
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$
C. Bills
Malaysias Money Market
6
A 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 bonds
interest rate deregulation (Feb 1991) to aid price discovery process
increased capital requirement for non bank players in money market
(1998) so as to minimize counterparty risk
infrastructure development (1989-1997)

Money Market Components
7
1.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 or
When the bank lends more than it ought to or
When the items in the banks balance sheet mature
The 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 System
8
Tenors for interbank deposits range from overnight to a maximum one
year
Different 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, fluctuate
The KLIBOR rates constitute a benchmark cost of funds to commercial
banks
KLIBOR 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
Transaction
9
Suppose 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
Transaction
10
If 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 amount
KLIBOR = the appropriate annualized KLIBOR by tenor
N = number of tenor periods within a year
t = tenor period
A Typical Interbank Deposit Transaction
11
In 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 Components
12
2. Interbank deposits trading activity
Trading activity in Ringgit amount - 2005
Interbank
deposits: 54%
Money market
instruments: 46%
Money Market Components
13
Interbank deposits trading activity
Within 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
clearing
Money Market Components
14
Illustration 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 Components
15
Illustration 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 Components
16
3. The trading of money market instruments
The money market instruments enable the debt to be transferred easily
through secondary market trading
The highly liquid secondary market for money market instruments enables
debt to be sold and resold before maturity
Relative to interbank deposits, money market instruments have a much
larger constituent base
While 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 traded
Malaysian Money Market
Instruments
17
Malaysian 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
18
Malaysian 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
19
Commercial 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 notes
Cagamas 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
20
Cagamas bonds
Cagamas 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 bonds
Issued 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
21
Negotiable instrument of deposits (NIDS)
To enable bank deposits to be traded on the secondary market
NIDs 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 Market
REPOs are bilateral transactions involving the purchase and resale of
securities by agreement.
The underlying asset is typically an MGS, government bond or other liquid
instruments
Pricing Of Money Market Instruments
22
What 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 Instruments
23
A generalized pricing model
Where;

P = Price of instrument
FV = Face value or redeemable amount at maturity
r = Required yield (discount factor)
t = number of days left to maturity
Example: Determining the price of a Money
Market Instrument
24
Suppose 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
25
The yield on an instrument can be determined as;
where;
Y = yield on instrument
FV = face value of instrument
P = Current price
t = days to maturity
Interest Rates, Yields And Price Of Money Market
Instruments
26
Pricing of most money market instrument is based on discounting and
hence, are very sensitive to changes in interest rates
Both 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.
SURPLUS
BANK
DEFICIT
BANK
Lend funds
Interest Rates, Yields And Price Of Money Market
Instruments
27
Price
Interest rates
Malaysia Money Market Trading
Performance
28
The Central Bank, Money Market And Monetary Policy
Operations
29
A central banks activity in money markets typically has four broad policy
objectives;

1) Ensuring the smooth functioning of the banking system
2) Implementation of monetary policy
3) Offsetting imbalances resulting from the external sector
4) Sterilization of forex market operations

The Central Bank, Money Market And Monetary
Policy Operations
30
Ensuring 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 Operations
31
If 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 instruments
Since 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 system
The Central Bank, Money Market
And Monetary Policy Operations
32
Implementation of monetary policy

Monetary policy has two legs
interest rates
money supply
To raise interest rates and money supply via the money market, the
central bank can undertake the sale of government securities
Sustained selling would drive down liquidity and thereby raise the
yields and interest rates
In 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
Operations
33
Offsetting 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 FDI
Outflow due to higher rates elsewhere

The Central Bank, Money Market And Monetary Policy
Operations
34
Sterilization 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 Market
35
Managing asset liability mismatches
Why do mismatches occur??
Due to the different maturity of items in the balance sheet
When 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 instruments
A bank with a cash deficit can borrow by either taking / accepting
deposits in the interbank deposit system or sell money market
instruments
Relying on money markets to fund asset growth is a risky strategy.

Q & A

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