Chapter 2

THE MONEY MARKET

LEARNING After reading this chapter, students will
be able to:
OUTCOMES • Define money market

• Explain the importance of the money

market
• Explain the various money market
instruments
What is the Money Market?
The money market is a segment of the financial markets where short-term maturity securities are issued and traded.

The purpose of this market is to provide liquidity to market participants through short-term financing.

Money market securities are highly liquid (because of its short maturity period) and considered safe (has relatively
low default risk).

The securities have a maturity period of one year or less.

The main participants in the money market include financial institutions, non-financial institutions such as pension
and unit trust funds and insurance companies, and reputable local as well as foreign companies.
Functions of Money Market?
Facilitates governments and industries in issuing short-term loan instruments to meet their working capital requirements and other
financial needs.

Acts as a vibrant marketplace for short-term government or corporate debt securities. Money market securities typically earn higher
rates of interest than a bank’s fixed deposit or savings accounts.

Provides secure and effective financing that supports both domestic and international trade.

Enables surplus economic units to invest in near-money assets which are highly liquid, low risk and can be easily converted into cash.
Thus, these units earn profits without losing liquidity from a very safe investment.

Helps the commercial banks to become self-sufficient. Short-term interbank borrowing and lending allows banks to meet their short-
term needs and investment, plus they need not approach the central bank and borrow at a higher interest rate.

The prevailing short-run interest rates of the money market serve as a barometer of the monetary and banking conditions in the
country, and this helps the central bank to adopt an appropriate monetary and banking policy.
 Bankers’
Acceptance

Negotiable
Depending on the
Treasury Bills Certificates
specific money
of Deposit
market instrument,
investors can
invest in either

Money Commercial
Paper
yield instruments
or discounted
instruments.
Market
Instruments
Eurodollars Repurchase
Agreements
Bankers’ Acceptance (BA)
Banker’s acceptance is a time draft payable to the seller that a business can order from the bank if it wants additional security
against the risk of default by the counter party. Used in international trade because of the advantages of security of payment
for both buyer and seller.

This instrument is a short-term working capital facility extended by the firm’s bank to the firm to finance its
purchases/imports or sales/exports of goods supported by documents as evidence of genuine transfer of goods to the receiving
party.

Bankers’ acceptance needs to be held until maturity. However, it is a negotiable instrument, which may be sold to investors
for a discounted price on a secondary market, giving investors a relatively safe, short-term investment. Upon maturity of the
BA, the holder of the bearer presents the BA through the holder’s banker to the paying bank for full payment stated on the
BA.

In Malaysia, BA is subject to the prevailing Guidelines on Bankers Acceptances (2004) issued by Bank Negara Malaysia
(BNM BA Guidelines). Bankers’ acceptances are issued in multiples of RM1,000 with a minimum denomination of
RM50,000. Minimum period of financing usually starts from 21 days and a maximum financing period of 365 days. The
Islamic Acceptance Bills (IAB) is the Shariah compliant BA.
Treasury Bills
A treasury bill (T-Bill) is a short-term debt obligation issued by the government to cover development
expenditures, budget deficits and working capital requirements with a maturity period of one year or less.

Malaysian Treasury Bills (MTBs) are issued with original maturities of 3-month, 6-month, and 1-year. The
bills are discounted securities that are issued at a discount from the face value. When the bills mature, the
government pays the holder the full par value. Each certificate of MTB carries a face value in multiples of
RM10,000.
MTBs are issued on a weekly basis through competitive auction. The successful bidders are determined
according to the most competitive yield offered. The standard trading amount is RM5 million and are actively
traded in the secondary market.

Bank Negara Malaysia, on behalf of the Malaysian government, also issues Malaysian Islamic Treasury Bills
(MITB) and Bank Negara Bills in the form of Bank Negara Monetary Notes in both conventional and Islamic
forms.
Certificates of Deposit (CD)
Refers to a type of money market instrument issued by a bank or financial institution that allows customers to
earn an amount of interest on their deposits. CD is issued for a specific period for a fixed amount of deposit
with a fixed rate of interest and can be issued in any denomination.

The maturity of a CD generally ranges from one month to five years. CDs with terms of a year or more are
called term CDs. The amount deposited cannot be withdrawn until the maturity period. Therefore, it is not a
liquid asset as the funds are blocked for a fixed duration and any withdrawal of deposit before the maturity
period is possible only if the early withdrawal penalty is paid.
A CD may not be attractive to some investors because it is not a negotiable instrument.

A CD cannot be sold to other investors in a secondary market. This lack of liquidity may not be suitable for
investors who do not wish to hold a money market instrument until maturity.
Negotiable Certificates of Deposit (NCD)
An NCD differs from a regular CD where its terms can be negotiated with the issuer (banks and financial
institutions). The more money that the investor is willing to deposit, the more favourable terms can be agreed
with the issuer.

It is a tradable instrument which can be bought or sold before the date of maturity. If a depositor/investor
wishes to have cash before the maturity of the NCD, the investing party can sell the NCD to another investor in
a readily active secondary market. The bank guarantees that the investors holding the certificate are paid their
deposits and the interest earned.
NIDs are issued in multiples of RM50,000, subject to a minimum deposit of RM100,000. The tenure can be
from one month and up to ten years.

There are also the Shariah compliant form of NID which are categorised as Islamic Negotiable Instruments
(INI).
Commercial Paper
Commercial paper is an unsecured, short-term promissory note issued by a highly credit rated corporation, typically for the
financing of accounts payable and inventories (working capital) and meeting short-term liabilities usually on a roll-over basis.
.

Commercial paper is usually sold at a discount, with the interest immediately deducted from the face value of the note by the
creditor that reflects prevailing market interest rates. Maturities on commercial paper are usually no longer than nine months,
with maturities of between one and two months being the average. In practice, the denomination of commercial paper is large
as the issuers are mostly big institutions and corporations.

Most investors assess a commercial paper’s credit risk using independent ratings by credit rating agencies to evaluate and rate
the quality of the commercial paper.

In the Islamic money market, there is an equivalent instrument in the form of Islamic Commercial Papers (ICP).
 Eurodollars
• “Eurocurrency” is the general term for any currency deposited in banks and financial institutions by
governments or corporations operating outside of their home market.
• Since the US dollar is the major international medium of exchange, many foreign governments and
businesses would hold a time deposit denominated in dollars outside of the US. These time deposits can
earn the depositor interest income but there is a penalty for early withdrawal.
• These dollars denominated deposits in a bank outside the US are called the Eurodollar market.
Eurodollars may be held by governments, corporations and individuals from anywhere in the world and
are not subject to US bank regulations.
• The rate offered for sale on Eurodollar and other Eurocurrencies deposits is known as the London
Interbank Offered Rate (LIBOR). Other benchmark rate includes the Euro LIBOR.
• The average Eurodollar deposit is very large (in the millions) and the terms range from overnight to one
year.
Repurchase Agreements (Repos)
• A repurchase agreement (repo) is an agreement involving the sale of securities at a particular price by one party (repo seller) to
another (repo buyer) with a promise to repurchase the securities at a specified price and on a specified date in the future. .
• If the seller defaults during the life of the repo, the buyer (as the new owner) can sell the asset to a third party to offset his loss.
The asset, therefore, acts as collateral and mitigates the credit risk that the buyer has on the seller. Therefore, companies issue
corporate bonds for their capital requirements.
• Repos are thus collateralised and are usually in very short-term transactions, mostly in overnight terms, although some extend for
a period of years.
• Two major reasons why a company with surplus cash prefer repo to marketable securities; The first reason is the adjustable
maturity provision embedded in the repos. The original repo’s maturity period can be adjusted to suit the needs of investing
companies. The second reason is repos are protected against market price fluctuations throughout the contract period, and
therefore, any risk involved in the liquidation is removed. Thus, companies can invest any surplus cash for a few days.
• In Malaysia, the securities that can be used in repo include Negotiable Instruments of Deposit (NID), Malaysian Government
Securities (MGS), Cagamas Bonds, bankers’ acceptance and other securities allowed by Bank Negara Malaysia.
Mechanics of a Repurchase Agreement
Thank You

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