TOPIC 2 - MONEY MARKET

TOPIC 2: MONEY MARKET

  • Updated: Sept23

LEARNING OUTCOME

  • At the end of this lecture, students should be able to:

    • Explain the nature and role of money market

    • Identify participants in the money market

    • Understand instruments traded in the money market

    • Recognize money market risks

CONTENTS

  1. Nature and Role of Money Market

  2. Participants in the Money Market

  3. Instruments Traded in Money Market

  4. Money Market Risk

1. NATURE AND ROLE OF MONEY MARKET

  • Definition: A segment of the financial markets where short-term maturity securities are issued and traded.

  • Purpose: To provide liquidity through short-term financing.

  • Characteristics of Money Market Securities:

    • Highly liquid: Short maturity allows quick conversion to cash.

    • Low default risk: Generally considered safe.

    • Maturity: Securities have a maturity period of one year or less.

Importance of Money Market

  1. Provides secure and effective financing for domestic and international trade.

  2. A vibrant marketplace for short-term government or corporate debt securities with higher interest rates.

  3. Facilitates governments and industries in meeting working capital requirements.

  4. Enables surplus economic units to invest in low-risk, near-money assets, easily convertible to cash.

  5. Helps banks maintain self-sufficiency by reducing reliance on central bank borrowing.

  6. Serves as a barometer for monetary and banking conditions, aiding central bank policy decisions.

2. PARTICIPANTS IN THE MONEY MARKET

  • Key players include:

    • Private Sector Companies

    • Central Government

    • Insurance Companies

    • State Government

    • Commercial Banks

    • Public Sector Undertakings

3. INSTRUMENTS TRADED IN MONEY MARKET

  • Types of Instruments:

    1. Bankers’ Acceptances (BA)

    2. Treasury Bills (TB)

    3. Certificates of Deposit (CD)

    4. Commercial Paper

    5. Eurodollars

    6. Repurchase Agreements (Repo)

3.1 Bankers’ Acceptances (BA)

  • Definition: Time draft payable to the seller, offering security against counterparty default.

  • Used in international trade, acting as short-term working capital extended by banks.

  • Negotiable: Can be sold on the secondary market at a discounted price.

  • Maturity: Typically 21 days to 365 days.

  • Regulation: Subject to Bank Negara Malaysia guidelines; minimum of RM50,000 denomination.

3.2 Treasury Bills (TB)

  • Definition: Short-term debt obligations issued by the government.

  • Purpose: Cover expenditures, budget deficits, and working capital requirements.

  • Maturity: 3-month, 6-month, or 1-year.

  • Trading: Issued weekly via competitive auction; actively traded in the secondary market.

3.3 Certificates of Deposit (CD) / Negotiable Certificates of Deposit (NCD)

  • Definition: Issued by banks, allowing depositors to earn interest on fixed deposits.

  • Maturity: Ranges from one month to five years; not liquid assets unless early withdrawal penalties are paid.

  • NCDs: Tradable instruments available for sale in secondary markets, can have terms negotiated with issuers.

3.4 Commercial Paper

  • Definition: Unsecured short-term promissory note from highly credit-rated corporations.

  • Purpose: To finance working capital needs and meet short-term obligations.

  • Maturities: Up to nine months; often sold at a discount.

  • Assessment: Credit risk evaluated by independent agencies.

3.5 Eurodollars

  • Definition: Currency deposited outside the home market, primarily in US dollars.

  • Features: Earnings interest; penalties for early withdrawal; regulated by neither US banking laws nor regulations.

  • Importance: Major tool for foreign corporations and governments to hold dollar-denominated deposits.

3.6 Repurchase Agreements (Repo)

  • Definition: Agreement involving selling securities with a promise to repurchase them later at a specified price.

  • Purpose: Mitigates credit risk through collateralized securities, often involving overnight transactions.

  • Adjustment: Maturity options can be adjusted, protecting against market price fluctuations.

4. MONEY MARKET RISK

  • Relatively low risk due to the short-term nature of instruments traded.

REFERENCE

  • Mohd Nizal Haniff, Norli Ali, Norashikin Ismail, Noreena Md Yusoff. Introduction to Malaysian Financial Markets (2024). McGraw Hill. Revised First Edition.