Assignment Of Managerial Finance _____________________________________________________ Submitted By: SAMEIA FARHAT Roll No: 36 Department: B.B.A (Hon's) Submitted To: Ma'am Huma Fatima Topic: Capital Market and Money Market of Pakistan ______________________________________________________ UNIVERSITY OF EDUCATION Capital Market and Money Market of Pakistan A financial market is a place for buying and selling of financial securities such as stocks and bonds. Financial Market in Pakistan consists of: (i) Money Market - provides short term funds (ii) Capital Market - makes long terms funds available to businesses and industries. Money Market Money markets are the markets which offer the short term investments and debt financing. There are limited authorized shares of the companies and if they need extra finances for the business, they issue bonds and other short-term securities to raise funds. These markets give a platform to the borrowers and lenders to make money transactions. People who buy securities get the interest payments on the securities and companies which raise funds, use that fund in business operations. That's why money markets provide an investment opportunity to the people who have idle money and those who need money can raise money through this market. Functions of Money Market Various functions of “Money Market” are discussed below: 1. Financing Trade: Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade. 2. Financing Industry: Money market contributes to the growth of industries in two ways: (a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc. (b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long- term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market. 3. Profitable Investment: Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity. 4. Self-Sufficiency of Commercial Bank: Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market. 5. Help to Central Bank: Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank. Money market helps the central bank in two ways: (a) The short-run interest rates of the money market serves as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy, (b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy. Instruments of Money Market The following are the Money Market instruments in Pakistan: 1) Federal Investment Bonds (FIBs) FIBs are half yearly coupon bonds and have 3, 5 & 10 years maturity. They are discontinued in the Primary Market. FIBs are issued by GOP. These bonds are only traded in the secondary market. 2) Pakistan Investment Bonds (PIBs) PIBs are launched in the year 2000 to replace FIBs as a long term investment. Pakistan investment bonds are issued by State Bank of Pakistan on behalf of Federal Government of Pakistan. Pakistan investment bonds are only long term debt securities and they benchmark for long term tenure debt and they are risk free. Inter bank transfer of PIB's are possible. The tenure of the PIB could be of 3, 5, 10, 15, 20 and 30 years. 3) Market Treasury Bills (MTBs) Treasury bills are short-term securities issued by the U.S. Treasury. It also helps to finance current federal deficits. They further sell bills on an irregular basis to smooth out the uneven flow of revenues from corporate and individual tax receipts. 4) Term Finance Certificates (TFCs) TFCs are debt instrument issued by a corporation to raise funds. TFCs typically offer higher rates of return than bank deposits and government bonds. Unlike bonds, TFCs offer investors the option to redeem a portion of the principal during the term of the instrument. 5) Certificate Of Investments (COIs) COIs are debt instrument issued by a corporation to raise funds. TFCs typically offer higher rates of return than bank deposits and government bonds. Unlike bonds, TFCs offer investors the option to redeem a portion of the principal during the term of the instrument. 6) Certificate Of Deposits (CODs) A certificate of deposit is a document evidencing a time deposit placed with a depository institution. The following information appears on the certificate: - the amount of the deposit; - the date on which it matures; - the interest rate; and - the method under which the interest is calculated. Large negotiable CDs are generally issued in denominations of $1 million or more. 7) Commercial Papers (CPs) Commercial paper is a short-term unsecured promissory note issued by corporations and foreign governments for many large, creditworthy issuers. Commercial paper is a low-cost alternative to bank loans. Issuers are able to efficiently raise large amounts of funds quickly and without expensive Securities and Exchange Commission (SEC) registration by selling paper, either directly or through independent dealers, to a large and varied pool of institutional buyers. 8) Foreign exchange platform (Forex) In the exchange market “Forex or fx” market where currency trading takes place. In terms of banks and other official institutions to facilitate the buying and selling foreign currencies currency transactions typically involve one party purchasing a quantity of one currency in exchange. The purpose of the foreign exchange market is to facilitate trade and investment. Capital Market As the name denotes the capital market is a market of capital funds. Basically capital markets are the stock markets and the bond markets. The stock markets are those which provide finance though the issuance of the shares. In the bond markets, finances are collected by issuing the bonds. Capital markets are very important for the companies because they provide a way to the companies to collect finance to operate their businesses. These markets also provide the liquidity option to the shareholders to pay back the shares to take money out of the market. Any investor is willing to invest in the stock only if they have the option to liquidate and this is only provided through capital markets. The capital market is sub-divided into: (1) Primary Market - concerned with the sale and purchase of new securities. (2) Secondary Market - concerned with the sale and purchase of even the old and already issued securities. Functions of Capital Market The important functions and role of the capital market are: 1. Mobilization of Savings: Capital market is an important source for mobilizing idle savings from the economy. It mobilizes funds from people for further investments in the productive channels of an economy. In that sense it activates the ideal monetary resources and puts them in proper investments. 2. Capital Formation: Capital market helps in capital formation. Capital formation is net addition to the existing stock of capital in the economy. Through mobilization of ideal resources it generates savings; the mobilized savings are made available to various segments such as agriculture, industry, etc. This helps in increasing capital formation. 3. Provision of Investment Avenue: Capital market raises resources for longer periods of time. Thus it provides an investment avenue for people who wish to invest resources for a long period of time. It provides suitable interest rate returns also to investors. Instruments such as bonds, equities, units of mutual funds, insurance policies, etc. definitely provides diverse investment avenue for the public. 4. Speed up Economic Growth and Development: Capital market enhances production and productivity in the national economy. As it makes funds available for long period of time, the financial requirements of business houses are met by the capital market. It helps in research and development. This helps in, increasing production and productivity in economy by generation of employment and development of infrastructure. 5. Proper Regulation of Funds: A capital market not only helps in fund mobilization, but it also helps in proper allocation of these resources. It can have regulation over the resources so that it can direct funds in a qualitative manner. 6. Service Provision: As an important financial set up capital market provides various types of services. It includes long term and medium term loans to industry, underwriting services, consultancy services, export finance, etc. These services help the manufacturing sector in a large spectrum. 7. Continuous Availability of Funds: Capital market is place where the investment avenue is continuously available for long term investment. This is a liquid market as it makes fund available on continues basis. Both buyers and seller can easily buy and sell securities as they are continuously available. Basically capital market transactions are related to the stock exchanges. Thus marketability in the capital market becomes easy. Instruments of Capital Market The capital market instruments are debt and equity instruments. These instruments are not liquid in nature and have maturities more than one year. The principal capital market instruments are: 1. Shares Finance is essential to any business. The larger the business grows, the wider the sources of finance should be available to it. A public company raises capital through the sale of shares called equity financing and by borrowing named as debt de-financing. Shares are the equity claims on the net income and assets of a company. The holders of ordinary shares or equity shares are the real owners of the company. In case of bankruptcy claims of share holders are paid only after the other claims have been paid. 2. Debentures Debenture is a long term loan to the company with a very strong credit rating. Each year debenture holders receive a fixed rate of interest whether a company is making profit or not if the company goes bankrupt, the debenture holders must be paid before any other claim is met. 3. Mortgages Mortgages are long term loans provided to individuals, firms against tangible security. When the loan is not paid in accordance with the terms of loan the title of the property is transferred to the creditors. The commercial banks and specialized financial institutions are actively engaged in providing long term loans to business in Pakistan. 4. Federal Investment Bonds The Government of Pakistan mobilizes long term loans by the sale of Federal Investment Bonds having a maturity of 15 to 20 years. The objective of introducing this debt instrument is to mobilize private savings, contain inflationary pressure in the economy by absorbing funds of the financial sector and also to provide investment opportunities to the financial institutions.