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Money and Capital Market
Submitted By: Tanveer Ahmad Exam# 394 MBA (B/F) Final
Prof: Sir M. Yasir
Deptt: of Business Administration Gomal University Dera Ismail Khan
Table Of Contents
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Introduction What is it? Treasury Bills (T Bills) Certificates of Deposit (CD) Commercial Paper Banker s Acceptance Repose Conclusion Features of Money Market Dhaka 2009 Summit Current Members Observers Future Membership Secretaries General List Of SAARC Summits SAARC Preferential Trading Arrangement South Asian Free Trade Area End Notes
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Whenever a bear market comes along, investors realize (yet again!) that the stock market is a risky place for their savings. It's a fact we tend to forget while enjoying the returns of a bull market! Unfortunately, this is part of the risk-return tradeoff. To get higher returns, you have to take on a higher level of risk. For many investors, a volatile market is too much to stomach - the money market offers an alternative to these higher-risk investments. The money market is better known as a place for large institutions and government to manage their short -term cash needs. However, individual investors have access to the market through a variety of different s ecurities. In this tutorial, we'll cover various types of money market securities and how they can work in your portfolio.
What Is It actually?
The money market is a subsection of the fixed income market. We generally think of the term fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short term debt securities (debt that matures in less than one year). Money market investments are also called cash investments because of their short maturities. Money market securities are essentially IOUs issued by governments, financial institutions and large corporations. These instruments are very liquid and considered extraordinarily safe. Because they are extremely conservative, money market securities offer significantly lower returns than most other securities. One of the main differences between the money market and the stock market is that most money market securities trade in very high denominations. This limits access for the individual investor. Furthermore, the money market is a dealer market, which means that firms buy and sell securities in their own accounts, at their own risk. Compare this to the stock market where a broker receives commission to acts as an agent, while the investor takes the risk of holding the stock. Another characteristic of a dealer market is the lack of a central trading floor or exchange. Deals are transacted over the phone or thr ough electronic systems. The easiest way for us to gain access to the money market is with a money market mutual funds, or sometimes through a money market bank account.
These accounts and funds pool together the assets of thousands of investors in order to buy the money market securities on their behalf. However, some money market instruments, like Treasury bills, may be purchased directly. Failing that, they can be acquired through other large financial institutions with direct access to these markets. There are several different instruments in the money market, offering different returns and different risks. In the following sections, we'll take a look at the major money market instruments.
Treasury Bills (T-Bills)
These are the most marketable money market security. Their
popularity is mainly due to their simplicity. Essentially, T -bills are a way for the U.S. government to raise money from the public. In this tutorial, we are referring to T-bills issued by the U.S. government, but many other governments issue T bills in a similar fashion. T-bills are short-term securities that mature in one year or less from their issue date. They are issued with three -month, six-month and one-year maturities. Tbills are purchased for a price that is less than their par (face) value; when they mature, the government pays the holder the full par value. Effectively, your interest is the difference between the purchase price of the security and what you get at maturity. For example, if you bought a 90-day T-bill at $9,800 and held it until maturity, you would earn $200 on your investment. This differs from coupon bonds, which pay interest semi-annually. Treasury bills (as well as notes and bonds) are issued through a competitive bidding process at auctions. If you want to buy a T -bill, you submit a bid that is prepared either non-competitively or competitively. In non-competitive bidding, you'll receive the full amount of the security you want at the return determined at the auction. With competitive bidding, you have to specify the return that yo u would like to receive. If the return you specify is too high, you might not receive any securities, or just a portion of what you bid for. The biggest reasons that T-Bills are so popular is that they are one of the few money market instruments that are affordable to the individual investors. Other positives are that T-bills (and all Treasuries) are considered to be the safest investments in the world because the U.S. government backs them. In fact, they are considered risk-free. Furthermore, they are exempt from state and local taxes. The only downside to T-bills is that you won't get a great return because Treasuries are exceptionally safe. Corporate bonds, certificates of deposit and money market funds will often give higher rates of interest. What' s more, you might not get back all of your investment if you cash out before the maturity date.
Certificate Of Deposit (CD)
A certificate of deposit (CD) is a time deposit with a bank. CDs are generally issued by commercial banks but they can be bought through brokerages. They bear a specific maturity date (from three months to five years), a specified interest rate, and can be issued in any denomination, much like bonds. Like all time deposits, the funds may not be withdrawn on demand like those in a checking account. CDs offer a slightly higher yield than T -Bills because of the slightly higher default risk for a bank but, overall, the likelihood that a large bank will go broke is pretty slim. Of course, the amount of interest you earn depends on a number of other factors such as the current interest rate en vironment, how much money you invest, the length of time and the particular bank you choose. While nearly every bank offers CDs, the rates are rarely competitive, so it's important to shop around. A fundamental concept to understand when buying a CD is the difference between annual percentage yield (APY) and annual percentage rate (APR). APY is the total amount of interest you earn in one year, taking compound interest into account. APR is simply the stated interest you earn in one year, without taking compounding into account. The difference results from when interest is paid. The more frequently interest is calculated, the greater the yield will be. When an investment pays interest annually, its rate and yield are the same. But when interest is paid mo re frequently, the yield gets higher. For example, say you purchase a one -year, $1,000 CD that pays 5% semi-annually. After six months, you'll receive an interest payment of $25 ($1,000 x 5 % x .5 years). Here's where the magic of compounding starts. The $25 payment starts earning interest of its own, which over the next six months amounts to $ 0.625 ($25 x 5% x .5 years). As a result, the rate on the CD is 5%, but its yield is 5.06. It may not sound like a lot, but compounding adds up over time. The main advantage of CDs is their relative safety and the ability to know your return ahead of time. You'll generally earn more than in a savings account, and you won't be at the mercy of the stock market. Plus, in the U.S. the Federal Deposit Insurance Corporation guarantees your investment up to $100,000. Despite the benefits, there are two main disadvantages to CDs. First of all, the returns are paltry compared to many other investments. Furthermore, your money is tied up for the length of the CD and you won't be able to get it out without paying a harsh penalty.
Commercial paper is an unsecured, short-term loan issued by a corporation, typically for financing accounts receivable and inventories. It is usually issued at a discount, reflecting current 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. For the most part, commercial paper is a very safe investment because the financial situation of a company can easily be predicted over a few months. Furthermore, typically only companies with high credit ratings and credit worthiness issue commercial paper. Over the past 40 years, there have only been a handful of cases where corporations have defaulted on their commercial paper repayment. Commercial paper is usually issued in denominations of $100,000 or more. Therefore, smaller investors can only invest in commercial paper indirectly through money market funds.
A bankers' acceptance (BA) is a short-term credit investment created by a non financial firm and guaranteed by a bank to make payment. Acceptances are traded at discounts from face value in the secondary market. For corporations, a BA acts as a negot iable time draft for financing imports, exports or other transactions in goods. This is especially useful when the creditworthiness of a foreign trade partner is unknown. Acceptances sell at a discount from the face value: Face Value of Banker's Acceptan ce Minus 2% Per Annum Commission for One Year Amount Received by Exporter in One Year
$1,000,000 -$20,000 $980,000
Repo is short for repurchase agreement. Those who deal in government securities use repos as a form of overnight borrowing. A dealer or other holder of government securities (usually T-bills) sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed price. They are usually very short-term, from overnight to 30 days or more. This short -term maturity and government backing means repos provide lenders with extremely low risk. Repos are popular because they can virtually eliminate credit problems.
There are also variations on standard repos:
Reverse Repo - The reverse repo is the complete opposite of a repo. In this case, a dealer buys government securities from an investor and then sells them back at a later date for a higher price Term Repo - exactly the same as a repo except the term of the loan is greater than 30 days.
We hope this tutorial has given you an idea of the securities in the money market. It's not exactly a sexy topic, but definitely worth knowing about, as there are times when even the most ambitious investor put s cash on the sidelines.
Features Of Money Market
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The money market specializes in debt securities that mature in less than one year. Money market securities are very liquid, and are considered very safe. As a result, they offer a lower return than other securities. The easiest way for individuals to gain access to the money market is through a money market mutual fund. T-bills are short-term government securities that mature in one year or less from their issue date. T-bills are considered to be one of the safest investments ± they don't provide a great return. A certificate of deposit (CD) is a time deposit with a bank. Annual percentage yield (APY) takes into account compound interest, annual percentage rate (APR) does not. CDs are safe, but the returns aren't great, and your money is tied up for the length of the CD. Commercial paper is an unsecured, short-term loan issued by a corporation. Returns are higher than T -bills because of the higher default risk. Banker's acceptances (BA)are negotiable time draft for financing transactions in goods. BAs are used frequently in international trade and are generally only available to individuals through money market funds. Repurchase agreements (repos) are a form of overnigh t borrowing backed by government securities.
What are Capital Markets? Capital markets are like any other markets, but differ in terms of the products traded and their organization. Capital markets deal with the trading of Securities. Capital markets provide a venue where companies can raise funds To expand on their businesses or establish new ones by issuing securities Owned by the companies. Like businesses in the private sector, Government Issue its securities to raise funds in capital markets to build electricity, damn, Construct new roads, bridges by issues. What are Securities?
Securities are financial instruments or legal documents signifying either an Ownership position in a company (i.e. shares) or a creditor relationship with a Company or government (i.e. Stocks and bonds).
What are Stocks, Bonds and Shares?
Stocks and bonds are long -term fixed interest bearing securities issued by Government and companies. When one invests in stocks and bonds, one Gets interest income, which is paid periodically until the loan matures or is Called back by the issuer. The holder of stocks and bonds gets interest even if The issuer does not make a profit. Shares represent part-ownership in a business concern. Shareholders, therefore, between them own the company, have a vote in how it's affairs are run and if the company makes profit, they are entitled to a share of it. However, the dividend which share holders receive is dependent on the company's profitability and management decisions such as company shares, bonds issued by governments in private companies, units In Collective Investment Schemes, debentures, commercial paper and notes.
How are shares bought and sold?
Shares can be bought either from the primary or secondary market. Primary Market refers to the purchase of shares in an Initial Public Offering (IPO), where by a company offers its shares to members of the public for the First time. During an IPO, shares are bought through the selling agents or Banks of the company issuing the shares. In the secondary market, the purchase and sale of shares is done through the Stock Exchange.
What Is A Stock Exchange
The Stock Exchange is one of the institutions in the Capital markets. It is an Organized market in securities (shares, stocks and bonds).On this market, Individuals and companies can buy shares of companies through Licensed Dealing Member(Stockbrokers)of the Stock Exchange and hence become part-owners or shareholders of these companies. Similarly, individuals or companies through Stock brokers can buy stocks and bonds of other companies and the Government, and become lenders to or creditors of these companies or the Government. Any individual or company who at one time or the other lent money or Bought shares through the Stock Exchange can also sell back the relevant Shares or stocks through the stock Exchange at anytime. The Stock Exchange has its rules and regulations which govern it. These rules And regulations are designed to protect all market participants, including the Individual who puts up some funds to invest.
Are there any other Schemes available in Capital Markets?
Yes, Collective Investment Schemes (CIS) such as Mutual Funds or Unit Trusts. These are form a listed system of Community Savings Schemes otherwise known As Osusu. The CIS allows individuals to make periodic contributions of various amounts.
What Is A Unit Trust Scheme?
It is a vehicle established to enable many small investors pool their funds Together and enjoy the benefits of diversification and professional Management at low cost without impairing the liquidity and safety of the investment. In some jurisdictions it is called Mutual Fund.
What is Community Savings Scheme?
Community Savings Schemes otherwise known as Osusu is the in-formal way Of capital formation by traders or other individuals by making periodic Contributions of various amounts. These schemes are used by low income Earners to acquire assets, initial capital for petty trading, etc. However some
People have lost their meager savings in these schemes as some of the Collectors vanish after collecting the money of their victims. The Osusu schemes will therefore stand to benefit from the development of a Capital market which will provide the enabling environment for the effective And secure operation of the schemes which are registered with recognized Regulatory body, like the Bank of Sierra Leone.
What Are The Benefits To Be Gained By A Formalized Community Savings Scheme? y y y y
The business will be recognized by Gover nment Access to free investment and financial advice Opportunity to participate in capital market operations Builds confidence and attracts more contributors.
What Does The Saver Stand To Gain By Saving With A Registered Collector? y y y
Savings will be more secured by maintaining proper records by the collectors. A saver will be assisted in locating his collector should he abscond A saver will have a wider choice of collecto r
What Are The Potential Advantages Of Investing In Collective Investment Schemes?
There are many advantages for investing in Collective Investment Schemes.
Investing in a number of different securities helps reduce the risk of investing. When the investor buys a share/unit in a fund, he /she buys an interest in a Portfolio of dozens of different securities, giving him/her instant diversification, At least within the type of securities held by the fund. For example, a portfolio Made up of shares from various companies is a good example of diversification.
With many funds, the investor can begin buying shares/units with a relatively Small amount of money .Some funds allow investors to buy more shares on a regular basis with even smaller Monthly installments.
Mutual funds/Unit trusts are managed by professionals who are experienced In investing money and who have the skills and resources to research many Different investment opportunities. Investors in these funds, therefore, get Access to the professional management of their funds.
Shares of CIS can be redeemed at any time.
Many fund management companies administer several different funds.(e.g. Money market, fixed-income, growth, balanced and international fun ds) and Allow the investor to switch between funds within theirµfund family¶ at little or No charge. This can enable the investor change the balance of his portfolio As his personal needs or market conditions change.
The bid and offer prices of CIS are reported in the press and on many internet Sites as obtains in other markets, allowing the investor to continually monitor The performance of his/her invest
What role do capital markets play in an economy?
Capital markets have an important role to play in stimulating economic development. The following are some of the examples: Capital markets help mobilize domestic savings, hence facilitating the Real location of financial resources from dormant to mor e productive activities. Capital markets provide an avenue for the divestiture of State Owned Enterprises(SOEs),where by shares in these companies may be sold Through the Stock exchange, allowing members of the public to Participate in the ownership of these companies. The privatization of SOEs through a stock exchange helps to broaden the asset base by Providing a means through which ordinary citizens can acquire a share In the country¶s assets. Companies have the opportunity to raise long-term finance through Equity and debt financing (issuing shares and bonds respectively). Members of the public are given an opportunity to buy shares or bonds Providing them with an alternative method of investing their savings.
Capital raised through the issue of shares, bonds or other instruments
Can be invested by the company to expand production, invest in more Efficient productive processes and improve competitiveness.
How do companies benefit from capital markets?
A share issue allows companies to increase the equity base of the company And raise capital without bearing the burden of interest payments associated With borrowed funds. Full disclosure requirements encourage companies to observe good business And management practices and ensure better corporate governance, Benefiting not just the firm but the economy as a whole. The public profile of the company is improved thus attracting greater business opportunities.