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TREASURY BILLS
T-bills are the Government debt securities that matures in one year or less from their issue date.A treasury bill differs from other types of investments in that they do not pay interest in the traditional way. When an investor wishes to purchase a treasury bill, they buy it at a discount rate. Concept taken from What is a Treasury Bill. http://www.wisegeek.com/what-is-a-treasurybill.htm The Government of Pakistan raise large portion of floating and permanent debt through the auctions of short term Government of Pakistan Market Treasury Bills (MTBs) T-bills are issued through a competitive bidding process rather than paying fixed interest payments for a price that is less than their face (par) value and when they mature; the government pays the holder the full par value. Finally, the interest is the difference between the purchase price of the security and what you get at maturity. T-bills are considered to be the safest investments, because in these Government confirms the holder of security to pay back face value. Returns are less because Treasuries are usually safe.
TYPES OF T-BILLS
They are issued with the maturities of Three-months (12-Weeks / 90-days) Six-months (24-Weeks) Twelve-months (one-year)
MONEY MARKET INSTRUMENTS Bill yields are determined by the discount method; which ignores the compounding of interest rates, treats the par value as the investment base, and uses a 360-day year for simplicity. Concept taken from (Rose & Marquis 2005) . The Discount Rate for T-Bills can be calculated by the following formula:
360
Discount Rate =
Explained With Example: Suppose you buy a 12 Weeks T-bill at Rs.98 and keep it until maturity having face value of rs.100. Then the discount rate on this bill can be calculated as:
Dr = =
(100 - 98)
100
360 90
0.06
This shows that for this T-bill the discount rate will be 6% .
Information taken from (Naz Chohan 1991) State Bank of Pakistan use following two methods to trade T-bills. Auction System Open Market Operations(OMO)
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PRIMARY DEALERS
Only primary dealers can participate in the auctions and OMOs. All the commercial banks (having account with SBP) NBFIs (Non Banking Financial Institutions) If the primary dealer wants to buy a T-bill, must submit a bid that is prepared either; Non-Competitively Competitively
The Non-competitive bids are normally submitted by the small investors who agree to accept the price determined by the auction. The Competitive bids are submitted by large investors ,who bid for several millions. They have to specify the return that they want to receive. If the return specified is too high, might not receive any securities.
AUCTION SYSTEM
SBP is acting as an agent on behalf of the government for raising short term funds from the market. The MTBs are sold by SBP to approved Primary Dealers through multiple price sealed bids auction. The Auction for MTBs is held under a fixed schedule on fortnightly basis. The actual yield to the investor depends on the accepted bid price at each auction. Each bidder at an auction gets the amount at his bid price (if accepted), as opposed to a single price for all the accepted bids. In the auctions of treasury bills yield is not set by the central bank but the bidder. The auctions conduct after every two weeks at Wednesday and are announced approximately one week in advance. Primary dealers, which include commercial banks and non bank financial institutions are only allowed to submit any number of sealed price-quantity bids on their own behalf or on behalf of clients. All auctions were conducted on a discriminatory price basis, so each bid formulate in the expectation that, if accepted, the price bid would be that paid. After the deadline for bid submission, the bids open in the presence of the bidders. After the opening of bids, The Ministry of Finance decides on the cut-off price after seeing the bids; the highest competitive bidders receives bills and those who bid successively lower price also receive bills until all available securities have been awarded. Although notionally the size of the auction issue are pre-announced, in practice the cut-off price seems to have been the main decision variable and the amount allocated bore little relation to the preannounced size.
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MONEY MARKET INSTRUMENTS The setting of the cut-off price was influenced by a number of factors, of which Debt service costs-cost of the factors related to the debt services, e.g. cost for organizing auction etc. Need for funding-having insufficient funds for regular operations, also influence the cut-off price, that how urgently funds are required. On a number of occasions the authorities decide to reject all bids because when they feel that the bids are unreasonably low. Information taken from Daniel C Hardy (2001)
SETTLEMENT OF BID
Settlement is normally done through book entry and securities can be issued with in one or two days after finalizing cut-off price. Primary dealers must have to maintain a current account (for cash settlement) with the SBP. The positions of primary dealers are maintained by the SBP in these accounts. The marketable lot-size for MTBs will be in range of PKR 100.0mln - 300.0mln (multiples of PKR 100.0mln). Information taken from (Naz Chohan 1991)
TAX LIABILITY
Investors in T-bills are subject to a withholding tax, which is adjusted against their final tax rate, because the earnings of T-bills are treated as income of the security holder not the capital gain. Information taken from (Naz Chohan 1991)
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COMMERCIAL PAPERnnnnnnnnnnnnnn nn
Commercial paper consists of short-term, unsecured promissory notes issued by well-known companies that are financially strong and carry high credit rating. Commercial paper is generally used to meet immediate cash needs. Funds raised from commercial paper are commonly used for current transactions i.e. to purchase inventories, pay taxes and cover other short-term obligations rather than for capital transactions like long-term investments.SBP and SECP started process of creating commercial paper market in Pakistan in 2003.
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For example; if a million Rs commercial paper with a maturity of 120 days is acquired by an investor at a discount price of Rs. 950,000.the discount rate of return on commercial paper will be DRcp = (Par Value Purchase Price) / Par Value * 360 / Days to Maturity DRcp = (1,000,000 950,000) / 1,000,000 * 360 /120 = 0.15 so,discount rate of return on this commercial paper will be 15%.
Rate of return on commercial paper fluctuate with the daily ebb and flow of supply and demand in marketplace. {Rose, marquis (2005) page 334}
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PURPOSE OF REPO
Large banks borrow from dealers and other non-bank institutions through Repo in order to avoid deposit reserve requirements and prohibitations against their paying interest on deposit accounts, while the dealers enter in RPs to borrow at the low cost RP interest rate in order to purchase interest bearing securities. Companies and financial institutions eager to loan its temporary cash surplus to avoid losing even a single days interest.
ADVANTAGES OF REPO
The main benefit of Repo to borrowers is that the Repo rate is less than borrowing from a bank. The main benefit to lenders over other money market instruments is that the maturity of the Repo can be precisely tailored to the lender's needs. Concept taken from Repurchase agreements www.riskglossary.com/repurchaseagreements-html
http://www.investopedia.com/terms/r/repurchaseagreement.asp
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MONEY MARKET INSTRUMENTS Bankers acceptance is usually used in trade; mostly for international business but is also frequently used for domestic dealing as well. The maturities of bankers acceptance mostly range from 30 to 180 days. It allows the international as well as national dealers to trade with each other. As the dealing firms have not met or may even never meet; have a problem of trusting each other. So bankers acceptance minimizes their risk. The promissory uses the banks credit worthiness instead. Hence the beneficiary is satisfied. Meanwhile the promissory http://www.eagletraders.com/books/afm/im 1 also gets more time to make the payments.
http://www.fraudaid.com/Dictionary-of-Financial-Scam-Terms/Acceptance.htm
According to Rose the importer secures a line of credit from his bank and sends the documents to the importer. Now the foreign dealer can draw a time draft against the issuing bank. The exporter goes to his bank which is called the accepting bank. Now this bank gives the importer that specified sum of money and sends the shipment documents and the time draft to the issuing bank. The issuing bank after verifying stamps the word accepted on the draft. By doing this it has become liable to paying that some of money to the bank. The accepting bank is paid that specific sum of money. Concept taken from Rose, Peter & Marquis, Milton. (2005), pg.322-327
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MONEY MARKET INSTRUMENTS So by deploying both of these ways a bankers acceptance can be created. In essence whenever any bank will agree to pay any importer on behalf of the exporter that document having all these abiding will be termed as the bankers acceptance.
If the accepting bank which is the primary obligor fails to pay the amount the holder of the BA (assuming the bank has sold the BA in the open market) has recourse back to the issuer of the draft the secondary obligor. The secondary obligor has the unconditional responsibility to pay the acceptance if the primary obligor dishonors it. This characteristic makes the BA; referred to as a two-name paper, a safe investment instrument usually with lower rates than might be available in a direct borrowing. Concept taken from Ira Weissman, Bankers' acceptance financing--the link to financing global market activity august 1996 / the CPA journal
http://www.nysscpa.org/cpajournal/1996/0896/cpai82f96.htm
The BAs marketability is limited only by the reputation of the accepting branch and the market demand. The net proceeds after the sale = the face amount of the acceptance - the discount rate (interest rate*days into maturity*face amount) + the banks acceptance commission. The combination of these is called the all in rate. BA financing may be used by exporters, importers, domestic buyers and sellers, traders, shippers, manufacturers, processors, distributors, or almost anyone involved in international or domestic trade. Concept taken from Michael Dennis Bankers acceptance financing http://www.encyclopediaofcredit.com/WebHelp/financing_methods/bankers_accpt.htm
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MONEY MARKET INSTRUMENTS deposits. They move rapidly from one bank to another to meet the liquidity requirements of corporations, governments and Eurobanks themselves. Eurocurrencies are not without risk. They are volatile and sensitive to fluctuations in interest rates and currency values. Difference of interest rate or value between two countries can initiate the massive flow of funds from one to another. There is a political risk as well that the governments might restrict the flow of money across borders. The daily cost of funds derived from Eurodollars is Amount to be loaned * interest rate * 1/360 Text adapted from Rose, Peter & Marquis, Milton. (2005), pg. 316-322
FEDERAL FUNDSnnnnnnnnnnnnnnnnnnnn
Federal funds refer to the overnight borrowings which are undertaken in order to meet the state banks reserve requirements. These are transferred from the lending institutions account to the borrowers account. The funds are not physically transferred. When they are repaid then an entry in books satisfies the whole loan. The most important borrower in the federal funds market is the commercial banks. Other financial institutions, security dealers, business corporations and the local government provide readily available funds for lending in the federal market. The banks and DFIs are legally obliged to keep a certain amount of funds in the reserve account which is kept with the state bank of Pakistan. This is equal to the fraction of the deposits which are kept with a bank. To meet the requirement of this legal reserve ratio the banks borrow funds mostly on overnight basis from the federal funds market. Most federal funds are for overnight basis and they have a fixed interest rate. Today the online system has made it very easy to know that which institutions are short of funds and which have surplus. The one who is short gets the benefit that its immediate requirement of money is fulfilled while the one with surplus gets interest income on its funds and thus earns it through the federal fund market. The interest rates which are levied on these funds highly fluctuate daily. It depends on the volume of funds which is surplus in the market and the volume of fund needed by the market. Text adapted from Rose, Peter & Marquis, Milton. (2005), pg. 307-310
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REFERENCESnnnnnnnnnnnnnn nnnnnnnn
Acceptance: Banker's Acceptance, Trade Acceptance http://www.fraudaid.com/Dictionary-of-Financial-Scam-Terms/Acceptance.htm (Accessed 28th Oct, 2009)
Daniel C Hardy (2001) (pg. 29-30); The Pakistan Development Review. Profitability and Pricing in Treasury Bill Auctions: Evidence from Pakistan (Accessed October 28,2009)
Ira Weissman, Bankers' acceptance financing--the link to financing global market activity august 1996 / the CPA journal http://www.nysscpa.org/cpajournal/1996/0896/cpai82f96.htm (Accessed 31st Oct, 2009)
Michael Dennis Bankers acceptance financing http://www.encyclopediaofcredit.com/WebHelp/financing_methods/bankers_accpt.htm (Accessed 28th October, 2009)
http://www.reliancepakistan.com/products/products_tfcs.php (Accessed October 19, 2009) www.riskglossary.com/repurchaseagreements-html (Accessed October 27, 2009) Naz Chohan (1991) (pg. 406-409);Mortgage-Backed Securities Markets in Asia. http://www.adb.org. (Accessed October 28, 2009).
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MONEY MARKET INSTRUMENTS Rose, Peter & Marquis, Milton. (2005), Money and Capital markets: Financial institutions and instruments in a global marketplace. McGraw-Hill/Irwin
http://www.mysmp.com/bonds/bankers-
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