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 2007

Second Edition; Monetary Policy Implementation Section, Investment
Operation and Financial Market Department; Bank Negara Malaysia

2. Economics For Degree Programs

Third Edition; Fatimah Setapa; Faculty Of Business Administration

3. Financial Market & Institution

Rohani 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