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The Money Markets.

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The Money Markets.

 

The money markets are a segment of the financial markets that trade in debt instruments with a maturity of less than a year. To elucidate this, we will go to the fundamentals of business. There are several forms of business units. These units require capital to finance their operations. They can acquire capital through issuing equity instruments (advertising shares for public subscription) or debt instruments. A debt instrument is a financial instrument in the form of a certificate whereby the certificate holder has given the certificate issuer a specific amount of money to return within a given period. Money market instruments have a maturity period of less than a year. That means the issuer will repay the loan within a time-frame that is less than a year.

 

The Money markets are where such financial instruments are advertised for public subscription. From the buyers’ perspective, a money market instrument is an investment they make whereby they buy the instrument for an amount x and receive back their money and a rate of interest on top of it.

 

Money market instruments.

They are traded by organizations to raise short term funds.

They include treasury bills, certificate of deposits, commercial papers, banker’s acceptances, inter-bank loans, and repurchase agreements.

They have the following characteristics :

  1. They are highly negotiable securities, i.e., they are easy to purchase.
  2. They are unsecured and, therefore, heavily dependant on the trader’s goodwill.

III. They are relatively expensive.

  1. They are mainly used to solve the liquidity problem of a particular party.
  2. The money market is imperfect as demand exceeds supply and above average, therefore calling for the central bank’s intervention.
  3. Treasury Bills.

They are issued by the government to cover the deficit, finance maturity debts, and control inflation.

They are sold on an auction system that depends on the value and the maximum period.

 

The yield(total anticipated return) is calculated as follows:

 

(Face value – Market value)/ Face value * 360/ x (days to maturity)

 

In Kenya, there are three types of treasury bills, namely:- The 28-day bill, the 91-day bill, and the 182-day bill. The terms transacted in are sh500000,sh100000, sh1000,000-sh20,000,000. Market forces determine yield through competitive bidding. An increase is taxed at normal rates on interest on the part of the receiver.

 

Treasury bills are risk-free; therefore, an ideal investment for the risk-averse investor.

 

  1. Certificate of deposit.

They are issued by banks and non-banking financial institutions, indicating a specified sum of money has been deposited. It is a certificate that bears a maturity date and interest rate. It can be issued in a bearer and non-bearer form. The bearer form is whereby anyone having it has the right to the funds even if it has no name. The non-bearer form is where it has the depositor’s name, and it may not be transferable.

The interest is paid after maturity. The deposited funds can be withdrawn but at a penalty.

The types of CD’s include:-

  1. Normal C.D’s – issued by commercial banks, e.g., KCB.
  2. Eurodollar CD’S – denominated in Dollars/Euro and issued by the commercial bank.

iii. Yankee C.D’s – denominated in dollars and issued by a foreign bank having a branch in the U.S

  1. Thrift C.D’s – issued by non-banking financial institutions.

 

 

  1. Commercial paper.

These are promissory notes issued by financially stable companies and sold to investors in the markets. They are mainly sold on a discount basis, which has the impact of increasing the effective rate of interest.

The yield is calculated as follows :

 

(F.V – M.V)/F.V * 360/X(number of days to maturity) F.V – face value

M.V- market value

 

 

It can be discounted before maturity and is negotiable, depending on the creditworthiness of the company.

 

  1. Banker’s acceptances.

They’re bills of exchanges drawn in and accepted banks. A bank’s customer is under an agreement with the bank to draw a bill on the bank, and the bank accepts it. The bank charges acceptance commission, and the drawer will have a two name bill: his name and the bank.

 

  1. Repurchase agreements.

It is an agreement undertook by dealers of government securities whereby the dealer sells the security to investors usually on an overnight basis and repurchases them the following day at a higher price. The small difference in the price is the implied interest rate. They are a standard tool of the central bank open market operations.

 

Impact of Covid-19 on the money markets.

 

Since the first reporting of covid-19 on December 31st, 2019, in Wuhan China, world economies have experienced unseen turbulence, and Kenya hasn’t been left behind. According to the Cytonn report, one of the significant effects has been the sell-off of equity(shares) investments by investors. Kenyan investors have opted to divest away from risky investments, which led to the Nairobi All Share Index (NASI) drop by 0.5% between March 13th, 2020, and March 20th, 2020, and 20.1% on a year to date basis. The aforementioned has led to heightened demand for fixed income securities, which are traded in the money markets. The Kenyan shilling has also experienced high currency volatility due to covid 19 and has depreciated by 3.7% against the dollar.

 

Due to this, central banks worldwide have opted to ease monetary policies to aid the economy during the adverse macroeconomic effects of COVID-19. The Federal Reserve, which is the USA’s central bank, has reduced the policies with a 1% margin, and they now have a current rate of 0%-0.25%. In Australia, the Reserve Bank of Australia has done the same by a 0.25% margin to a current rate of 0.5%. The People’s Bank of China has reduced by 0.1% to a rate of 4.1%. The Central bank of Malaysia has reduced by 0.25% to 2.75%. The Bank of England reduced the rates by 0.5% points to 0.25%. The Monetary policy committee in Kenya lowered the Central Bank Rate(CBR) to 7.25% at its March 23rd, 2020 meeting. The Cash Reserve Rate was reduced to 4.25 %. On July 29th, CBR was further reduced to 7.00%. The next meeting in September will give way forward on the issue.

 

 

Money Market Funds(MMF) constituents and how COVID-19 has affected Money market instruments.

A money market fund principally invests in the securities we described above with high credit quality. It is ideal for the risk-averse investor who prefers stability and security of the invested capital. The interest is calculated daily and is credited to the account of the client costs after costs. According to Cytonn Investments’ analysis of the MMF, the industry’s exposure to Cash was at 31.2%. The exposure to Fixed deposit and securities issued by the Kenyan government was at 55.7%, bringing the combined exposure to 86.8%.

 

The yield on treasury bills is expected to remain stable despite the reduced central bank rate with a bias to the yield curve’s upward readjustment. With heightened inflationary pressures, investors will continue to demand higher yields to compensate for the inflation risk. It is, therefore, a positive effect. The investment limit(the maximum allowable limits for Money Market Funds) on treasury bills is 80%, whereas the actual exposure is 55.7%. The expected yield on the market funds will remain stable with a probability of going higher.

  Remember! This is just a sample.

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