Comprehensive Notes on Money Market Instruments

Money Market Funds

  • Money market funds are mutual funds that invest in highly liquid, high-quality money market securities.

  • Investors purchase shares directly from money market mutual fund companies at the Net Asset Value (NAV) plus any incidental costs.

  • Advantages:

    • Provides small investors access to professionally managed and diversified portfolios.

    • Fund managers handle the buying of securities, pooling funds from various investors.

    • Investors share in the gains or losses of the fund.

  • Investments typically include:

    • Long-term negotiable certificates of deposit (LTNCDs)

    • Time deposits

    • Government, bank, and corporate bonds

    • Treasury bills

    • Commercial papers

    • Other debt securities approved by the Bangko Sentral ng Pilipinas (BSP).

  • Managed by licensed mutual fund agents aiming to generate capital appreciation and income.

  • Generally considered less risky than stocks and bonds due to their short-term nature and high credit rating securities.

  • Advantages:

    • Liquid.

    • Good for parking excess money.

    • Less risky.

  • Disadvantages:

    • Moderate returns.

    • Returns may not cover inflation.

    • Not insured

    • Returns are not guaranteed and are based on NAV.

  • Can be bought from:

    • Mutual fund companies

    • Unit investment trust funds

    • Personal Equity and Retirement Account (PERA)

    • Variable universal life (VUL) plans

    • Investment companies

    • Other financial institutions authorized by BSP

Investment Companies

  • Two types:

    • Open-end investment companies

    • Closed-end investment companies

  • Investors buy shares or units in funds created by investment companies.

Closed-End Investment Companies

  • Operate with a fixed number of units or shares.

  • Do not issue new shares regularly.

  • Shares are bought and sold between investors.

Open-End Investment Companies

  • Issue new shares when investors buy into the fund.

  • Use the money received to invest.

  • Sell assets to pay investors who want to sell their shares.

Rationale

  • Attracts small-scale investors.

  • Allows investment in a diversified portfolio of securities through a single investment vehicle.

  • Investment companies pool funds and buy securities.

  • The cost of investment is based on the Net Asset Value (NAV) at the end of the day the transaction is placed.

  • NAV fluctuations impact the final price for both buyers and sellers.

Examples of Money Market Funds in the Philippines

  • ALFM Money Market Fund, Inc. (Mutual funds)

  • First Metro Save and Learn Money Market Fund, Inc. (Mutual funds)

  • Sun Life Prosperity Money Market Fund, Inc. (Mutual funds)

  • BPI PERA Money Market Fund (PERA)

  • Landbank PERA Money Market Fund (PERA)

  • Peso Money Market Fund (UITF)

  • ATRAM Peso Money Market Fund (UITF)

  • Diversity Money Market Fund (UITF)

  • BDO Peso Money Market Fund (UITF)

  • BPI Money Market Fund (UITF)

Net Asset Value (NAV) Calculation

  • Formula:

    NAV=TMVMFSNAV = \frac{TMV}{MFS}

    • Where:

      • TMVTMV = Total market value of assets under management

      • MFSMFS = Number of mutual fund shares outstanding

Example Calculation

  • Scenario: An investment company offers a money market fund with 20,000 shares.

  • Securities on May 5, 2019:

    • Security A: 100,000 units, 3.5% yield, Market value = P 103,500

    • Security B: 200,000 units, 2.0% yield, Market value = P 204,000

    • Security C: 500,000 units, 4.0% yield, Market value = P 520,000

    • Security D: 200,000 units, 5.0% yield, Market value = P 210,000

  • Market values on December 31, 2019:

    • A = P 102,500

    • B = P 207,500

    • C = P 550,000

    • D = P 212,000

Calculations

  1. NAV on May 5, 2019:
    NAV=P103,500+P204,000+P520,000+P210,00020,000=P51.875 per unitNAV = \frac{P103,500 + P204,000 + P520,000 + P210,000}{20,000} = P51.875 \text{ per unit}

  2. NAV on December 31, 2019:
    NAV=P102,500+P207,500+P550,000+P212,00020,000=P53.60 per unitNAV = \frac{P102,500 + P207,500 + P550,000 + P212,000}{20,000} = P53.60 \text{ per unit}

  3. If FLT bought 5,000 units on May 5, 2019:

    • Purchase value: 5,000 units×P51.875=P259,3755,000 \text{ units} \times P51.875 = P259,375

    • Gain on NAV: 5,000 units×(P53.60−P51.875)=P8,6755,000 \text{ units} \times (P53.60 - P51.875) = P8,675

Commercial Papers

  • Unsecured promissory notes issued by firms with high credit standing.

  • Interest earned is typically higher than savings accounts.

  • No collateral is offered because of the firm's good track record of cash inflows, and normally only big corporations issue commercial paper.

  • Maturity period: less than a year.

  • Investors rely on the issuer's liquidity and earning power.

  • Proceeds are used for:

    • Current operations

    • Working capital (purchase of inventories)

    • Paying maturing obligations

    • Other short-term needs

  • Sometimes used for long-term projects (expansion, infrastructure) due to lower financing costs compared to long-term loans.

  • Issued in multiples of P 100,000 or more.

  • Sold at a discount from their face value.

  • Interest is normally below the prime rate offered by banks.

  • Issuance costs include fees paid to:

    • Banks for a line of credit

    • Credit rating companies

    • Flotation costs

  • A credit line backs up the issue, ensuring payment if the issuer defaults.

  • A letter of credit can substitute the issuer's credit rating, reducing risk and resulting in a higher credit rating for the commercial paper.

  • Requires approval from the Securities and Exchange Commission (SEC) before issuance or sale.

  • Initially sold to the public at a discounted value through selling agents.

  • Available in the secondary market after the issue date.

  • Can be sold before maturity in the secondary market or endorsed to a retail investor.

Repurchase Agreement

  • A company borrows funds by selling money market securities with an agreement to repurchase them later at a specified price (plus interest).

  • Essentially a loan collateralized by money market securities.

  • Securities used: T-bills, T-notes, government securities.

  • Types:

    • Overnight repos: Immediate return of borrowed amount plus interest.

    • Term repos: Longer term with a fixed period.

    • Continuing contract: No maturity date, can be terminated in a short period by either party.

  • Collateral has a "haircut" applied: The amount lent is less than the market value of the pledged securities.

  • Haircut protects the investor if the value of the pledged securities declines.

  • Banks use repurchase agreements to finance needs, such as meeting reserve requirements.

  • Reverse repurchase agreement: The lender agrees to buy back the government securities pledged in the future.

  • Most repurchase agreements are short-term (1-14 days), but a market for 1-3 month agreements is growing.

Interbank Money Market

  • Loans granted from one bank to another.

  • Occurs when one bank has surplus funds and another needs funds to meet loan demand or faces reserve depletion.

  • Financial institutions must maintain a reserve requirement set by the central bank (Bangko Sentral ng Pilipinas (BSP) in the Philippines, Federal Reserve in the US).

  • Reserve requirement: A certain amount of deposits that must be held as assurance to cover liabilities.

  • Banks with a deficit borrow from banks with a surplus to meet this requirement.

  • The reserve requirement earns minimal interest.

  • Banks prefer lending excess deposits to other banks rather than depositing them with the central bank.

  • Interest rate charged is called overnight or Interbank rate.

  • Loans are unsecured.

  • Reserve requirements in the Philippines decreased from 18% in April 2019 to 12% in March 2020.

  • This reduction aimed to promote a more efficient financial system by lowering financial intermediation costs.

Loans Offered in the Interbank Money Market

  1. Overnight money: Borrowed/loaned for less than a week (typically one banking day).

    • Repayment occurs at the start of the next banking day, plus interest.

    • Weekend money: Loan granted on a Friday, repaid on the next banking day.

    • Money borrowed on weekends or holidays is subject to interest.

  2. Call Money: Loan payable on demand.

    • Used by large financial institutions (banks, mutual funds, corporations).

    • Very short-term (no longer than a week).

    • Used to meet reserve requirements.

  3. Notice money: Borrowing/lending on an unsecured basis to meet short-term mismatches in fund positions.

    • Term: 2 to 14 days.

  4. Term money: Loaned/deposited for a fixed period.

    • Term: One week or one month.

  5. Intraday money: Loan borrowed and repaid on the same day.

Eurocurrency Market

  • Market for short-term deposits denominated in currencies other than the country in which the bank operates.

  • International equivalent of the domestic money market.

  • Originated in the early 1960s in eastern European countries.

  • Eurocurrency: Maintaining a US dollar account in a bank whose currency is different from the US currency.

  • Became popular as multinational corporations and governments stored funds denominated in dollars outside their country for easier international transactions.

  • Example: A US-based multinational corporation opens a regional office in London and maintains a US dollar account in a London bank, creating a Eurodollar deposit.

  • Eurocommercial paper (Euro-CP): Issued in Europe by dealers of commercial papers without bank involvement, offering a higher interest rate compared to LIBOR.

  • Eurodollar: A U.S. dollar deposit outside the jurisdiction of the Federal Reserve.

  • Euroyen: A yen deposit outside Japan.

  • The term "euro-" refers to deposits outside the jurisdiction of the local central bank.

  • In the Philippines, maintaining a US dollar account in a Philippine bank is also a Eurocurrency.

  • Almost all Eurocurrency deposits are time deposits.

  • Terms: 30, 60, 90, 180 days (typically less than a year).

  • Interest rate is subject to a final tax and depends on the amount and maturity of the deposit.

  • Like local deposits, Eurocurrency can be lent to multinational corporations, government agencies, or international banks.

  • London Interbank Offered Rate (LIBOR): The interest rate charged on interbank loans in the Eurocurrency market.

  • All Eurocurrency loans are based on the LIBOR rate.

  • Unregulated in terms of reserved requirements and deposit insurance premiums.

  • Interest paid is generally higher than in the home country.

  • Benefits borrowers and lenders in an international market.

  • Investors with excess funds can make short-term and safe deposits at reasonable interest rates.

  • Borrowers can acquire funds quickly at attractive borrowing costs.

Banker's Acceptances

  • Used for transactions to finance the shipment and handling of merchandise between exporters and importers.

  • Short-term financing, maturing in less than a year (30 to 270 days).

  • Payable to the bearer at maturity and can be traded in the secondary market.

  • Low risk due to backing by the importer's bank to the exporter's bank and the exporter's bank to the exporting company.

  • Example: A Philippine company imports goods from an American company for P 100,000 with 90-day credit.

    • The American company requires a letter of credit from the Philippine company's bank (e.g., RCBC).

    • RCBC issues a letter of credit in favor of the American Company, sent to a US-based bank (e.g., Citibank).

    • Citibank confirms the letter of credit, assuring the American company of payment.

    • The letter of credit specifies conditions for exporting the goods.

    • Once the conditions are met, the goods are shipped to the Philippines.

    • Shipping documents are sent to Citibank for confirmation.

    • Citibank pays the American Company and sends the shipping documents with a bank draft to RCBC.

    • RCBC verifies the documents and stamps "accepted" on the draft, making it a banker's acceptance.

    • RCBC is now liable to pay the US bank P 100,000.

    • The American company holds the banker's acceptance until the maturity date.

    • At the end of the 90-day term, the Philippine company pays RCBC P 100,000 plus fees.

    • If the exporter needs cash, they can sell the banker's acceptance at a discount in the secondary market.

    • The bearer receives payment at face value upon presentment on the maturity date.

  • Transactions involve companies in different countries and two banks.

  • The exporter seeks the bank's help as a guarantor if the importer has no prior business history.

  • Goods covered by the commercial paper are viewed as collateral if the importer and importer's bank fail to pay.

Banker's Acceptances Yield Calculation

  • Formula:

    BA=P<em>f−P</em>iPi×360nBA = \frac{P<em>f - P</em>i}{P_i} \times \frac{360}{n}

    • Where:

      • PfP_f = Face Value

      • PiP_i = Purchase Price

      • nn = Days to Maturity

Example

  • Mr. X purchased a banker's acceptance in the secondary market for P 485,000 with a face value of P 500,000 and 90 days remaining until maturity.

Calculations

BA=P500,000−P485,000P485,000×36090=0.12 or 12.0%BA = \frac{P500,000 - P485,000}{P485,000} \times \frac{360}{90} = 0.12 \text{ or } 12.0\%