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TREASURY BILLS
n
“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-treasury-bill.htm
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
“As we have studied earlier that T-Bills do not carry any interest rate but
instead are sold at a discount from their par value or face value. Thus
their yield is based on their appreciation in price between time of issue
and the time they mature or are sold by the investor.
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.”
ParNumber
Par360
Value
of Days to
Value-Purchase
Price Maturity
Discount Rate = x
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:
360
100
90- 98)
(100
Dr = x
= 0.06
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This shows that for this T-bill the discount rate will be 6% .
“At start, Treasury bills were issued on ‘tap basis’ for six months at 6
percent per year. Afterwards when the government moved to a market-
based system as part of the process of economic deregulation,
disinvestment, and decentralization in April 1991 then the following
changes were made:
• Auction System
• Open Market Operations(OMO)
PRIMARY DEALERS
If the primary dealer wants to buy a T-bill, must submit a bid that is
prepared either;
• Non-Competitively
• Competitively
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AUCTION SYSTEM
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 pre-announced size.
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SETTLEMENT OF BID
TAX LIABILITY
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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.
The commercial paper shall be issued for maturities between 30 days and
one year from the date of subscription. Commercial papers are mainly in
the primary market. Opportunities for resale in secondary markets are
very limited.
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The equity of the company is not less than Rs. 100 million as per
the latest audited balance sheet and the company maintains a
minimum current ratio of 1: 1 and debt/equity ratio of 60: 40.
The company has obtained the credit rating from a rating agency.
The minimum credit rating of the issuer shall be “A-” (medium to
long-term) and “A2” (short-term). At the time of issue of
commercial paper company rating should not be more then two
months old.
The company should have no overdue loan or defaults in the Report
obtained from the Credit Information Bureau (CIB) of the State Bank
of Pakistan (SBP).
The minimum size of the issue of commercial paper shall not be less than
Rs.10 million. The commercial paper, in case of private placement, would
be denominated in Rs. 100,000 (face value) or in multiples thereof and in
case of offer to general public, may be denominated in Rs. 5,000 or in
multiples thereof.
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Rate of return on commercial paper fluctuate with the daily ebb and flow
of supply and demand in marketplace.
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REPURCHASE AGREEMENT
(REPO)nnnnnn
Repurchase agreements are agreements between a borrower and a
lender where the borrower, in effect, sells securities to the lender with the
stipulation that the securities will be repurchased on a specified date and
at a specified, higher price. The securities serve as collateral for the loan.
Most Repo agreements mark the collateral to market daily. If the value of
the collateral drops below the required margin, then the borrower must
send more securities to the lender to maintain margin or some money to
reduce the principal outstanding.
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Overnight repos
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Term repos
Open repo
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 day’s
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.
BANKER’S ACCEPTANCEnnnnnnnn
nnnnnn
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Signature
The word accepted on top of his signatures and
The date on which the amount will be paid.
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Suppose that you own a software house and you need computers. You
order a dealer in Japan to send you ten computers on credit. Now that
dealer does not know your credit worthiness. A very easy way to resolve
this problem is that you go straight to your bank with which you have a
very good past record. There you get a time draft issued on which the
date you will pay the money is mentioned.
Most probably the date mentioned will be one or two weeks later after
getting the shipment. The bank trusts you because of your good credit
rating and it signs the draft adds its signature and mentions the date. This
draft has now become a banker’s acceptance. The draft is then sent to
the manufacturer who is very much satisfied now as he knows the banks
credit rating.
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
So by deploying both of these ways a banker’s 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 banker’s acceptance.
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There is a very strong and affluent market for it. The issuing bank can
either keep it in his portfolio or sell the bankers acceptance in the money
market. It is sold at a discount from the value which will be payable on
maturity. In this way the seller is getting funds from the money market
hence it provides liquidity to the seller.
BA provides a very low risk interest income to the buyer. They are mostly
sold at a spread over t-bills and this rate is referred to as the BA rate.
Some banks also purchase the BAs which are nearing their maturity in
order to increase their liquidity.
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 net proceeds after the sale = the face amount of the acceptance -
the discount rate (interest rate*days into maturity*face amount) + the
bank’s acceptance commission. The combination of these is called the
“all in” rate.
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EURODOLLAR DEPOSITS
nnnnnnnnnnnnn
Eurodollars are the leading component of the Eurocurrency markets
today. There is a need for Eurocurrency markets because funds are
required in international currencies worldwide mainly in Dollars, Euros
and Pounds. Eurodollars are the deposits of US dollars in banks which are
located outside United States.
These can also be the branches of the US banks located outside US. The
deposits are recorded in the denomination of dollars rather than their
home currency. Generally, the "euro" prefix can be used to indicate any
currency held in a country where it is not the official currency.
These deposits are loaned to the home offices of the banks in US, lent to
business enterprises that have to make their payments in dollars. It can
be retained as well to meet the reserve requirements and to maintain
liquidity. These can be lent to government if it needs dollars and to
private investors as well. The Eurodollar deposits are always moving in
the form of loans.
MECHANISM OF EURODOLLAR DEPOSITS
We suppose that you own a textile firm in Pakistan. To keep the example
simple we assume that you shipped an assignment worth one million to
the American importer. Here we also suppose that you have an account in
an American bank as well. The importer pays the bills in dollars and
deposits it in your account held at the American bank. After all these
transactions a Eurodollar deposit has not been created.
If we further mature the same example and presume that you transfer
that one million dollars in your bank in Pakistan then the deposit that is
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FEDERAL
FUNDSnnnnnnnnnnnnnnnnnnnn
Federal funds refer to the overnight borrowings which are undertaken in
order to meet the state bank’s reserve requirements. These are
transferred from the lending institution’s 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
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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)
http://ezinearticles.com/?Short-Term-Financing-Through-Commercial-
Paper&id=235046
(Accessed October 20, 2009)
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http://www.investopedia.com/terms/r/repurchaseagreement.asp
(Accessed October 28, 2009)
http://www.reliancepakistan.com/products/products_tfcs.php
(Accessed October 19, 2009)
www.riskglossary.com/repurchaseagreements-html
(Accessed October 27, 2009)
www.secp.gov.pk/corporatelaws/.../Guidelines_CommercialPaper.doc -
(Accessed October 19, 2009)
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www.thefinancialdaily.com/viabilityofcommercialpaper-news
(Accessed October 20, 2009)
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