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CHAPTER 3: MONEY & FOREIGN EXCHANGE MARKET - Coggle Diagram
CHAPTER 3: MONEY & FOREIGN EXCHANGE MARKET
MONEY MARKET
STRUCTURE OF MM
Market for short-term mobilization of funds
Trading financial instruments
Bankers Acceptance (BA)
Khazanah Bonds
Bank Negara Bills
Treasury Bills (T-Bills)
Cagamas bonds & cagamas notes
Maturity: overnight to 1 year
Changes in the basis for the variable rate in MM instruments:
KLIBOR (Kuala Lumpur Interbank Offered Rate) – also known as indicator of the interbank rate
KLIBOR – changed to Intervention Rate
New framework from 2004 – OPR as the target rate for the day-to-day liquidity operations of BNM
DEVELOPMENT OF MM
Jan 1990
Introduction of SPEEDS (Sistem Pemindahan Elektronik untuk Dana & Sekuriti)
Electronic fund transfer and scripless trading system.
Faster settlement of the MM instruments
SPEEDS was replaced by a new payment system called RENTAS (Real-Time Electronic Transfer of Funds and Securities)
which fund transfers are settle IMMEDIATELY
Jan 1994
Launched of the Islamic Interbank Money Market (IIMM)
Transactions are done using Islamic nterbank Cheque Clearing System (IICCS)
Sales and purchases of Islamic financial instruments
Investment activities
Cheques clearing
1989 - Appointment of selected FIs as Principal Dealers
Underwrite and create markets for the PRIMARY ISSUES of MGS, T-Bills and Cagamas Bonds.
1990 - Formation of Rating Agency of Msia (RAM)
1995 - Formation of Malaysian Rating Corporation Berhad (MARC)
Purpose of credit rating:
To evaluate creditworthiness of corporate bond issues by issuing ratings to corporate bonds
Provide mechanism to investors to choose which bonds should be invested based on ratings
Ensure investors’ confidence in MM.
OBJECTIVES
Ensure participants are able to trading MM instruments
Lend out (obtain funds) at competitive rates
Maximize profits and minimize costs of funds
Manage liquidity position and reserve requirements
CATEGORIES OF MM OPERATIONS
Direct lending & borrowing
Bank will lend (deposits) or borrow directly from another bank.
Rate is agreed by both parties.
Transactions can be done directly or through intermediaries (money brokers)
The amount that the lender can lend is LIMITED (called credit line or credit limit). - Normally depends on the financial strength & size of the bank.
Sale & purchase of MM instruments
Done in securities market.
Indirect method of borrowing or lending funds.
2 types of securities market:
1) Outright S&P of instruments
(Bank sell / purchase instruments)
2) Repurchase agreement (REPO)
At maturity, bank repurchase MM instruments which were initially sold to customers at agreed price for a specified future date.
PARTICIPANTS OF MM OPERATIONS
BNM – supervising and controlling authority
Banking institutions (commercial and investment banks)
Non-bank financial institutions
Pension funds
Unit trust funds
Insurance companies
Corporations
Multinational
Small & medium scale enterprises
Cagamas Berhad
Money brokers - intermediaries to market participants
FOREIGN EXCHANGE MARKET
STRUCTURE
Vital to complete international transactions
Importers & Exports
Speculators
Place to purchase @ sell required currencies
CHARACTERISTICS OF FOREX MARKET
Must have a willing buyer and willing seller (foreign exchange dealers) of the currencies.
Exchange rate is available for 2 currencies required
Facilities are available for the institutions to operate (e.g. Dealing room in a bank)
Mechanism to effect large amount of payments locally and globally through an electronic computer network system
Corporation must have commercial documents to support their foreign exchange needs
Letter of credit, invoice, shipping document, bill of lading
HISTORY & DEVELOPMENT
Active FOREX market is a result of:
Strong economic activities (GDP)
Increase in private investment
Volatile ST capital flows
Statistically in Malaysia, FOREX market is not in line with GDP
During regional financial crisis – heavy speculation on MYR.
Currency attack
Panic selling activites - corporations, banks, mutual funds moved out their funds from the region.
Remedies:
Fix MYR against USD on 2nd Sept 1998 at RM 3.8 per USD 1.
Limit offer of swap transactions with non-resident banks in Aug 1997
PARTICIPANTS OF FOREX MARKET5)
1) Commercial Banks
Meet requirements of the corporations
Own trading positions
Authority was given under BAFIA 1989 (Banking & Financial Institution Act)
2) Corporations
-Pay exporters for the purchase of goods and services
-Investment in FOREX
3) Non-bank financial institutions
Investment in FOREX
4) Money brokers
Act as a middleman in identifying buyers and sellers who have the same amount to trade in foreign currencies
Income comes from commission for any transactions done
Interact with banks by giving “indication rates” and “dealing rates” of various currencies.
5) BNM
Ensure exchange rate is stable and not fluctuate excessively
Manage foreign reserves of Malaysia
Intervene in FOREX market to reduce market volatilities by buying or selling large amount of currencies.
Decide to impose policies on FOREX such as fixed rate or managed floating exchange rate regime (depends on economic condition)
FOREX QUOTATIONS (SPOT & FORWARD)
Quotations
To buy a currency, rate between currencies must QUOTED
Involves buying a currency & selling another currency
USD - Centerpiece of the FOREXT market is USD & considered as base currency for quotation.
Sport Market
Market for spot rate & spot date
Spot rate = value of currency to be transacted
Spot date = 2 days after the transaction date
Transaction date = date of which 2 parties deal with each other to perform foreign currency transactions
Good business days = days exclude holidays and weekends.
Forward Market
FOREX market for value ANYTIME after 2 good business days
A day after spot date @ 1 week @ 1/3/6/9 months @ 1 year
DESCRIPTIONS OF MONEY MARKET INSTRUMENTS
1) NEGOTIABLE INSTRUMENTS OF DEPOSITS (NIDS)
Yield instrument – interest bearing
Deposit document issued by a bank to a customer which certain amount has been deposited w/ the bank at specific rate & maturity date.
Can be sold before maturity
Negotiable instrument – if sold before maturity at secondary market.
Tenure range from 1 month to 10 years
Issued in multiple of RM 50,000
Minimum deposit is RM 100,000 per certificate
Maximum deposit is RM 10 million per certificate
Interest rate of NIDs depends on interbank rates. (The higher deposits, the better the rate)
Withholding tax (0% withholding tax for placement made by companies & 5% for placement by individuals.)
2) BANKERS' ACCEPTANCE (BA)
Discounted instrument - non-interest bearing
Bill of exchange drawn on a bank
Created to finance a customer for trade transaction
Trade financing facility facility available to importers & exporters (buyers & sellers)
Provide competitive source of working capital
Negotiable instrument - can be sold to investors
Maturity: 21 days - 200 days
Issued in multiple of RM1000
Minimum denomination is RM30,000.
3) MALAYSIAN GOVERNMENT SECURITIES (MGS)
Yield instrument - Interest bearing
Issued by BNM - obtain funds from public specifically to finance national development projects.
Government agreed to pay:
a) Periodic interest to the instrument’s holder
b) Return of the par value upon maturity
Issued in multiples of RM1000
Quoted in price terms per RM100 nominal value.
4) REPURCHASE AGREEMENT (REPO)
Yield instrument
Sale of financial instrument by a bank with an undertaking to repurchase back at agreed price on specified future date.
Period: no. of days
Collaterized deposit arrangement
Deposit is collaterized by financial instruments such as NIDs, MGS, BA, Cagamas Bonds and other allowed by BNM.
5) TREASURY BILLS
Discounted instrument – non-interest bearing
-Discounted proceeds are paid upfront (not at maturity date)
-Face value is paid at maturity
Issued by BNM on behalf of Malaysia government
Used to raise short-term funds to finance government’s expenditures
Maturity not exceeding a year
6) BANK NEGARA BILLS
Discounted instrument - non-interest bearing
-Discounted proceeds are paid upfront (not at maturity date)
-Face value is paid at maturity.
Issued by BNM & Maturity not exceeding a year
Often used for Open Market Operations (monetary policy tool)
Categorized as liquid asset for financial institution compliance of the liquidity and SRR.
CALCULATION OF PROCEEDS OF YIELD INSTRUMENTS AND DISCOUNTED INSTRUMENTS
a) Simple Interest
To calculate interest for NIDs. REPO, MGS
Interest = (principal x rate x number of days) / 36500
b) Proceeds of NIDs
To calculate sales proceeds / cost of purchases of NIDs when they are traded in secondary market.
Proceeds = FV x (36500 + (T1 X R1)) /
(36500 + (T2 X R2))
FV = face value @ principal amount
T1 = original issue rate
T2= rate at which the sale / purchase is agreed
R1= original tenor (in days)
R2= remaining days to maturity
c) Proceeds of discounted instruments
Used to calculate proceeds of the discounted instruments (BA, T-Bills, Bank Negara bills)
Proceeds = FV X [(1/365000) – (r x t)]
FV = face value @ principal amount
r = maturity
t = rate agreed
RISKS, FACTORS AFFECTING FOREX MARKET
FACTORS
1) Domestic economic condition & economic policies
-GDP, inflation (CPI), unemployment, trade balances, money supply
-Taxation policies, fiscal & monetary policies, govt debt positions, etc.
2) Geopolitical factors:
Political uncertainties, election, scandal
3) Global economic conditions (external factors)
Economic conditions of large economies (US, EU, China)
Political changes in major countries
Policies announced by world institutions (World Bank, IMF)
Changes of global prices of oil, palm oil, rubber
4) Market sentiments:
Optimism, pessimism, fears, rumours
5) Speculation - Normally conducted by foreign banks, international fund managers and hedgers who have huge funds
6) Differences in interest rates between countries - High demand for FOREX if a country has high interest rate – currency appreciation
RISKS
Transaction risk
Happens when exchange rate fluctuates causing:
-Different amount need to be paid by importers (not as per the agreed amount)
-Value of assets and liabilities denominated in foreign currency move adversely
-Revaluation losses (for firms who have offices outside the country)
Settlement Risk
Happens when there is a default payment on the delivery date by one party, causing another party to incur losses.
BASIC TRADING STRATEGIES
2) Commercial purpose
Dealers take care of customers who are in need of foreign exchange
Once customer buy/sell currency, dealers will IMMEDIATELY square the position to avoid any risk
1) Speculative purpose
Riskier – anticipate movement of currency that he bought or sold.
If speculator is optimistic on USD
-> He anticipates USD is moving upward in near future
-> Buy USD against MYR
-> Position: long USD
If speculator is pessimistic on USD
-> Sell USD against MYR
-> Position: short USD
Difference between buying rate and selling rate is the profit generated.
If selling rate > buying rate = profit (vice versa)
Profit/losses = difference in buying and selling rates x position amount
Normally done by interbank dealers of commercial banks - Short term basis
MINIMIZING RISK
Stop-Loss Strategies
Can be used to Limit losses and Minimize risks
Stop-Loss Rate = (maximum amount of losses / position amount) +/- position rate