SOCIAL SCIENCE III. ROUTINE INTRODUCTION LECTURE WRAP-UP ASSIGNMENT.
FIN_536 Assignment Group Otai III
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Transcript of FIN_536 Assignment Group Otai III
1. INTRODUCTION
What is Financial Instrument?
Financial instrument can be define as any written instrument having
monetary value or evidence of an ownership in a entity, or contractual
right to receive, or deliver a monetary transaction. Financial instrument
can be a physical (certificate) or electronic document that has legal force
and intrinsic monetary value or transfers value. Financial instruments can
be categorized by form depending on whether they are cash instruments
or derivatives instrument. Cash instrument are financial instruments
whose value is determined directly by markets while derivates instruments
are financial instruments which derives their value from the value.
Alternatively, financial instrument can be categorized on whether they are
equity based that reflect ownership of the issuing entity or debt base that
reflecting a loan the investor has made to the issuing entity. If it is debt, it
can be further categorized into short term or long term.
Money Market Regulatory Body
Bank Negara Malaysia is responsible to maintain the national
currencies stability through monetary policies and other mechanism taken
to control overall monetary activities doing by financial institution. Bank
Negara also plays a significant role in the development of financial system
infrastructure such as Securities Commission (SC) and Credit Guarantee
Corporation. As a banker to Government of Malaysia, BNM playing an
active role in advising government regarding Malaysia’s macro and
microeconomic environment and managing government debt. To have a
systematic money market trading platform, Bank Negara
2.0 GOVERNMENT SECURITIES
Government securities are marketable debt instrument issued by
the Government of Malaysia to raise fund from the domestic capital
market to finance the Government’s development expenditure and
working capital. It also acts as monetary tools for open market operation
that is a part of government Monetary Policy. An open market operation is
the purchase or sale of government securities, such as Treasury Bill and
Bonds in the open market. When Bank Negara conducts an open market
operation, it purchased government securities to increase money supply
and sale government securities to reduce the money supply.
BNM also has introduced Islamic Interbank Money Market (IIMM).
The scope of activities of the IIMM included the purchase and sale of
Islamic financial instruments among market participants (including the
Bank), interbank investment activities through the Mudarabah Interbank
Investment (MII) Scheme and a cheque clearing and settlement system
through an Islamic Interbank Cheque Clearing System (IICCS).
Currently, the various forms of Government securities in Malaysia
are Malaysia Government Securities (MGS), Malaysia Treasury Bill
(MTB), Government Investment Issues (GII) and Malaysia Islamic
Treasury Bill (MITB).
2.1 MALAYSIA GOVERNMENT SECURITIES (MGS)
MGS is long–term Bond issued by government of Malaysia which
issued in multiples of RM1000 and quoted in price term per RM100
nominal value. MGS were initially issued to meet the investment needs of
the Employee Provident Fund (EPF), local bank and insurance
companies. In late 1970’s and early 1980’s, MGS were issued to finance
the public sector’s development expenditure. By 1990’s the purpose of
MGS extend to funding part of government’s budget deficit and
prepayment of some of the Government’s external debt. The issuance
size of MGS range from RM500 million to RM 3.5 billion depending on
government financing requirement with maturity period 3-year, 5-year, 10-
year, 15-year and 20-year. MGS are issued according to the Government
Securities Issuance Calendar which is published annually to facilitate
financial institution to plan ahead and invest more efficiently their
investment and trading books.
MGS characterized by fixed-rate coupon bearing that payment are
made semi annually while bullet repayment of principles at the maturity
period. Malaysia government also introduced Callable MGS which
provides the government with option to redeem the issues at par by giving
an advance notice of five advance days to the Bond holder. Normally
Callable Provision Bond bring higher coupon rate or attractive discounted
selling price to compensate investor because terminal value and maturity
date change when issuer force the investor immediately after they bought
it. Both MGS and Callable MGS are issued by bank Negara on behalf of
government through competitive auction. The successful bidders are
determined according to the lowest yields offered and the coupon rate is
fixed at the weighted average yield of successful bids.
2.2 MALAYSIA TREASURY BILL (MTB)
MTB are issued by Bank Negara Malaysia on behalf of the
Government Of Malaysia with the purpose of raising short term fund to
finance Government’s working capital. The standard trading amount of
MTB is RM5 million. Typically MTB are issued within the size of RM80
million to RM110 million with maturity period range from 3 month to I year
and redemption will be made at par. These instruments are issued on a
discounted rate basis through competitive auction by Bank Negara.
MTB are issued on weekly basis and the auction will be held one
day before the issue date. The successful bidders will determined
according to the most competitive yield offered. Normally auction day is
Thursday and the result of successful bidders will be announced on day
after. The formula on calculating the proceed are on yield basis based on
band of remaining tenure. MTB actively traded in the secondary market
through over the counter via a broker, direct dealing on telephones or via
the Electronic Broking System (EBS).
2.3 MALAYSIA ISLAMIC TREASURY BILL (MITB)
MITB are short term securities issued by Bank Negara on behalf of
Government based on Islamic principles. To ensure all Islamic capital
market product are compliance with the Islamic principles, the Shariah
Advisory Council (SAC) was established in 1996 by Securities
Commission (SC). The conventional securities and the Islamic securities
differ in its structure in term of complying with Islamic principles in its
issuance. MITB are similar to conventional Government securities such as
MGS and MTB in term of their effective cash flow, issuance structure, and
legal status in being obligation of the government, its holding and nature of
transaction.
MITB are usually issued on weekly basis with original maturity of 1
year. Typically maturity period are between 273 days to 365 days (one
year) with the issuance size range from RM100 million to RM200 million.
Normal auction day is Thursday and the result of successful bidder will be
announced one day after. Both conventional and Islamic institution can
buy and trade on MITB.
The MITB are structured based on Bai’ Al-Inah principles, part of
sell and buy back concept. Bank Negara will sell the identified
Government’s asset on competitive tender basis, to form underlying
transaction of the deal. Allotment is based on the highest price tendered.
Price is determining after profit element is imputed (discounting factor).
The successful bidders will the pay cash to the Government. The bidder
will subsequently sell back the asset to the government at par based on
credit term. The governments will issues MITB to bidder to represent the
debt created.
MITB are tradable on yield basis (discounted rate) based on band
of remaining tenure. These government securities actively trade based on
Bai ad-Dayn (debt trading) principles in the secondary market over-the-
counter by via a broker, direct dealing on telephones or via the Electronic
Broking System (EBS).
2.4 GOVERNMENT INVESTMENT ISSUES (GII)
Government Investment Issues (GII) is long term Government
securities based on Islamic principles issued by Bank Negara on behalf of
Government of Malaysia for funding development expenditure. The
issuance size range from RM1 billion to RM 3.5 billion depending on
government financing requirement with maturity period range from 3 to 10
year. Similar with MGS, GII is issued through competitive auction by Bank
Negara.
GII is based on Bai Al Inah principles, part of the sell and buy back
concept in Islamic finance. Under these principles, the Government will
sell specified nominal value of its assets and subsequently will buy back
the asset at its nominal value plus profit through a tender process. Profit
rate based on the weighted average yield of the successful bids of the
auction. The nominal value of buying back the assets will be settled at a
specified future date or maturity, while the profit rate will be distributed half
yearly. The obligation of the Government to settle the purchase price is
securitized in the form of GII and is issued to the investors. At maturity,
Government will redeem the GII and pay the nominal value of the
securities the GII holders. GII is one of the financial instruments that are
actively traded in the Islamic Interbank Money Market.
3.0 COMERCIAL SECURITIES
3.1 CAGAMAS BOND AND NOTES
Cagamas is the second largest issuer of debt instruments after the
government of Malaysia and its debt securities have been rated ‘AAA’ by
RAM rating Services Berhad and Malaysian Rating Corporation Berhad.
Cagamas Berhad was established in 1986 to promote the secondary
mortgage market in Malaysia. Cagamas issues debt securities to finance
the purchase of housing loans and other consumer receivables from
financial institutions, selected corporations and the government. For the
accounting year 2008, Bond and Notes stated at the company liabilities
amounted to RM 18.5 billion for conventional Bonds and RM 12.38 billion
for Islamic Bonds. Five types of debt securities issued by Cagamas
Berhad to fund its portfolio of loans and debt purchased under the facilities
for housing loans, industrial property loans, hire purchase and leasing
debts, Islamic house financing debts and Islamic hire purchase debts are
as follow:
i. Cagamas Fixed Rate Bonds
These Bonds have maturity period between 1.5 to 10 year and
carry a fixed coupon rate which determined at issuance. Interest on these
Bonds is paid semi annually. The redemption of the Bonds is at nominal
value together with the interest due upon maturity.
ii. Cagamas Floating Rate Bonds
This financial instrument has tenure of up to 10 years and an
adjustable interest rate pegged to the 3 month or 6 month KLIBOR. The
interest rate is reset every 3 to 6 month while interest is paid at 3 or 6
month intervals. They are redeemed at their nominal value upon maturity.
iii. Cagamas Notes
Cagamas Notes are short term instruments with maturities between
1 to 12 month issued at a discounted basis from the face value. The other
features of these notes are similar to those of the MTB. They are
redeemable at their nominal value upon maturity.
iv. Sanadat Mudharabah Cagamas
This is Islamic Bonds issued by Cagamas under the Islamic
principles of Mudharabah (profit sharing) to finance the purchase of
Islamic house financing debts which were granted on basis of Bai
Bithamam Ajil and the purchase of Islamic hire purchase debts which were
granted under the principles of Ijarah Thumma Al-Bai. This Instrument
may have tenure up to ten year. Dividend based on pre-determined profit
sharing ratio is payable semi-annually. This Bonds redeemable at par on
maturity date unless there is principal diminution (principal reduction).
v. Sanadat Cagamas
Sanadat Cagamas are Islamic Bonds issued by Cagamas under
Islamic principles of Bai Bithamam Ajil to finance the purchase of Islamic
house financing debts and Islamic hire purchase debts. This Instrument
may have tenure up to 10 year. Dividend is payable semi annually. They
are redeemable at par together with the dividend due on maturity date.
3.2 NEGOTIABLE INSTRUMENTS DEPOSITS (NID)
A Negotiable Instrument of Deposit (NID) is a financial instrument
issued by banks for the deposit of a specific sum of money for a fixed
period of time at a prefixed interest rate. An NID can be bought or sold
before the date of maturity. NID issued and traded in the Malaysian
market can be based on either fixed, zero coupon or floating rates or a
combination of either the three.
3.3 PRIVATE DEBT SECURITIES (PDS)
The term Private Debt Securities (PDS) includes Bonds, Notes,
loan stock and Commercial Papers whether convertible into equity or not
and whether redeemable or otherwise. PDS issued by corporation that
wishes to obtain funds to finance its business activities. In the late 1980s,
Bank Negara Malaysia was the Government agency responsible for the
regulation of corporate bond issuance. In March 1993, the Securities
Commission (SC) was established to act as the single regulatory body to
promote the development of the capital market, in particular to rationalize
securities market regulations. PDS characterized as follow:
Unsecured loan. The loan will be pledged against assets i.e. property,
securities, etc.
Pricing of bonds are market driven. Can also be determined by
investors demand.
All bonds and commercial papers will be kept by Authorized Depository
institution (ADI) which has an account with BNM.
PDS is a negotiable instruments, it can be freely traded in the
secondary market.
3.4 Repurchase Agreement (REPO)
A repurchase agreement (or repot) is an agreement between two
parties whereby one party sells the other a security at a specified price
with a commitment to buy the security back at a later date for another
specified price. Most repose are overnight transactions, with the sale
taking place one day and being reversed the next day. Long-term repose
—called term repose—can extend for a month or more. Usually, repose is
for a fixed period of time, but open-ended deals are also possible.
Reverse repo is a term used to describe the opposite side of a repo
transaction. The party who sells and later repurchases a security is said to
perform a repo. The other party—who purchases and later resells the
security—is said to perform a reverse repo.
Repos are widely used by the managers of money market funds
because they generally offer three distinct benefits:
Liquidity – Repos provide the ability to invest cash overnight,
making them a critical component in the effort to manage
liquidity.
Yield Advantage – Repos generally provide additional yield as
compared to traditional money market instruments, such as
Treasury bills, time deposits or agency discount notes. The yield
advantage depends on such factors as the repo’s maturity dates
and the credit quality of the repo’s collateral.
Flexibility – The principal amount of repos can be adjusted up
or down as fund cash flows dictate.
3.4.1 Types of repo
There are three types of repo maturities:
Overnight - Overnight refers to a one-day maturity
transaction.
Term - Term refers to a repo with a specified end date.
open repo - Open simply has no end date.
While a repo is legally the sale and subsequent repurchase of a
security, its economic effect is that of a secured loan. Economically, the
party purchasing the security makes funds available to the seller and
holds the security as collateral. If the repoed security pays a dividend,
coupon or partial redemptions during the repo, this is returned to the
original owner. The difference between the sale and repurchase prices
paid for the security represents interest on the loan. Indeed, repos are
quoted as interest rates.
Securities dealers use repos to finance their securities inventories.
They repo their inventories, rolling the repos from one day to the next.
Counterparties may be institutions, such as money market funds, which
have short-term funds to invest, or they may be parties who wish to briefly
obtain use of a particular security. For example, a party may want to sell
the security short, or they may need to deliver the security to settle a trade
with another party. Accordingly, there are two possible motives for
entering into a reverse repo:
short-term investment of funds, or
to obtain temporary use of a particular security.
In the latter case, the security is called a special security. In the
former case, it is called general collateral or GC.
Interest rates payable on special repos tend to be lower than those
payable on GC repos. This is because a party reverse repoing a special
security will accept a reduced interest rate on its funds in exchange for
receiving the special security it requires. Economically, the transaction is
no different from cash collateralized securities lending. Pricing of either
type of deal depends upon demand for the desired security.
Because repos are essentially secured loans, their interest rates do
not depend upon the respective counterparties' credit qualities. For GC
repos, the same rates apply for all counterparties. Accordingly, GC repo
rates—or simply repo rates—are benchmark short-term interest rates that
are widely quoted in the marketplace. They differ from Libor rates in that
they are for secured loans whereas Libor rates are for unsecured loans
4.0 Conclusion
Bank Negara Malaysia play a role as an adviser to government in
Malaysia’s macro and micro economic environment, managing the
government debt and as an arm of the government in develop a
systematic money market trading. Government need a lot of money to
fund the development of the country. Marketable debt instrument is issued
to raise fund from domestic capital market to finance the Government’s
development expenditure and working capital. There are few ways for the
Government to raise the fund through Government Securities and
involvement of private sector in money market through the Commercial
Securities private sectors. Malaysia Government Securities, Malaysia
Treasury Bill, Malaysia Islamic Treasury Bill and Government Investment
Issues are part of the Government Securities that issued for the country
development. The private company such as Cagamas Berhad and banks
institution involve in issuance of Commercial Securities such as Cagamas
Bond and Notes, Negotiable Instruments Deposits, Private Debt Securities
and Repurchase Agreement.
All the above is the instruments for the Government to finance the
development activities and working capitals either through their arm body
or private sectors. Therefore, financial and banking Institutions are major
player in support the government either direct or indirect in the money
market activities through the money market instruments.
References:
1. A Guide To Malaysia Government Securities 2007Second Edition; Monetary Policy Implementation Section, Investment Operation and Financial Market Department; Bank Negara Malaysia
2. Economics For Degree ProgramsThird Edition; Fatimah Setapa; Faculty Of Business Administration
3. Financial Market & InstitutionRohani A.Ghani , Ibrahim Ab. Rahman; Institute Of Education Development
4. Websites:www.bnm.gov.my www.argmax.com ( financial glossary)www.wikipedia.org www.maybank2u.com.my www.cagamas.com.my