Introduction
A money market refers to a financial market that allows trading of short-term securities. This market provides for availability of liquid funds, which matures over a short period. In Bahrain, some of instruments that are traded include treasury bills, commercial papers, repurchase agreements (repos), negotiable certificate of deposits (CDs), Eurodollars, Bankers acceptance, municipal notes, and other short-term securities.
This market is more secure than other markets due to the collateralized instruments. In this regard, the participants who are involved in borrowing and lending include financial institutions, large corporations, individual investors, and foreign governments. During the proceedings of the market, the participants attend to ensure that their financial instruments are in good condition. In the country, the maturity period of short-term instruments is usually within twelve months.
Due to the high level of security associated with the financial instruments, the market returns are comparatively low (Dew, 2003). For the individuals who cannot enter the market direct since most participants have huge capital base, they buy units from mutual funds that participate in the market. Nevertheless, there exist other financial instruments, which individual investors can trade directly like the treasury bills. Generally, the Central Bank of Bahrain controls the conduct of the money market to ensure that both investors and financial instrument issuers benefit.
Financial instruments in the money market of Bahrain
Treasury Bills
These refer to the government debt securities, which have a maturity period of less than a year. Through a competitive bidding, the treasury bills are issued to the investors who purchase them on discount (Dufey, 1998). This implies that the treasury bills do not pay fixed interests payments, but rather the par value of the security is paid at the maturity. The investors therefore are bound to benefit from the margin that exists between the purchasing value and the par value of the security.
During periods of inflation, the government adopts this form of investment to counter the severity of inflation. The process involves the issuance of the securities, which lead to massive investment of the participants in the market. As a result, the government can reduce the money supply that is under circulation in the economy.
Similarly, since this form of financial instrument is risk-free, the government offers small interest. Therefore, at the maturity of treasury bills, the government will not be overburdened. Considering these benefits, the government can address its monetary and fiscal policies by adopting the financial instruments.
Commercial paper
This refers to a short–term loan issued by large corporation. The main reason for issuance is to finance accounts receivable and payments inclusive of inventories. These financial instruments are unsecured since it depends with the performance of the corporation. In this regard, the corporations issue the financial instruments at a discount while offering small interest rates. The interest rates usually reflect the prevailing market conditions.
At the course of contract between the corporation and the investor, the financial instrument earns interest, which compensates for the forgone expenditure (Fanno, 2001). These interests are often established at the negotiation of the contract. In the country, this market is flourishing and has become the most convenient form for corporation to meet their short-term liabilities. In addition, the investors use the market for commercial paper to earn interest without exposing themselves to high risks associated with bond market.
Repurchase agreements (Repos)
These refer to short-term contracts that allow borrowing and lending among dealers in the government securities. In this regard, dealers often issue the government securities to the interested investors where a contract is signed for the repurchase. The contract usually takes place on an overnight basis, where after the dealer issues the financial instrument, he or she repurchases it in the next day. This implies that the organizer of the contract with a need to repurchase the instrument is a repo, while the party agreeing to buy the instrument to sell it in future undertakes the reverse of the repurchase agreement.
Within Bahrain, the dealers are involved in such contracts, where depending on the performance of the underlying securities, the investor, or seller of the repurchase agreement benefit. This form of financial instrument is partially secured, but earns a small interest to the investor or seller in the short-term. As a result, dealers have been able to gain on a short period without exposing themselves to high risks prevalent in other markets (Ferguson, 2008).
Negotiable certificate of deposits (CDs)
This refers to a short-term form of investment where the investor is issued with a savings certificate indicating the entitlement of interest to the bearer. In the certificate, the maturity date as well as the specified interest agreed on by the issuer and investor is documented. This form of financial instrument allows the investor as well as the issuer to agree on the type of information to settle their contract. Due to flexibility associated with the CDs, they are usually issued by the commercial banks (Seznec, 2003).
This form of financial instrument allows the commercial banks to generate short-term funds to meet their liabilities, thus, not interfering with their reserves. For the investors, they are bound to gain from the fixed interest agreed on without severe exposure to high level of risks. Most commercial banks adopt this form of short-term instrument during hard economic times. As a result, this form of short-term loan plays key role to evade the shock of economic challenges since it cushions the commercial banks.
Eurodollars
This entails the deposition of the money in US denomination at foreign countries out American territory or in foreign subsidiary of US banks. This activity leads to protection of the funds from the regulation of the Federal Reserve Board. The Central Bank of Bahrain adopts this form of short-term investment from which it can benefit from interests attributed to the savings.
Similarly, the fact that Bahrain uses a fixed exchange rate policy, necessitate the government to reserve of the US dollar funds to regulate its monetary and fiscal policies. As a result, the government uses the Eurodollars as a good investment vehicle from which its reserve can earn interest on short period. For other investors, they can engage in the Eurodollars by making deposits in foreign countries from where they benefit with the fluctuation of currency in the short-term.
In the event, when the Eurodollars are performing well beyond the pegged value of the dollar, the investors dispose it and earn interest with increase in Bahrain dinar (Rowaily, 1997). This form of investment is crucial in the engagement of the international trade as it allows the investors to compete on a similar platform. Additionally, the government benefit from it under conditions of financial crisis due to the increase in amount of reserves. This cushions the economy of the country against any severity of economic hard times.
Bankers Acceptance
These refer to the short-term contracts that non-financial firms and the investor organize, but are guaranteed by the commercial banks. The short-term credit investment is usually negotiable where the acceptance of the contract by the investor allows him or her some interest. The financial instrument is usually traded at discounts.
This implies that the investor purchases the financial instrument at discount, but redeems it at par value. In this regard, the investor is bound to benefit from the margin for forgoing expenditure and exposure to the risks. Regardless of the similarity that exists between the T-bills and the Bankers’ acceptance, this form of financial instrument is vulnerable to high risks.
For the investor, in case the issuer fails to comply with the promise, the bank bears the liability. Non-financial institutions often use this form of financial instruments to generate short-term funds to meet the immediate costs in Bahrain. As a result, this market boosts the overall performance of both the financial and non-financial institutions (Stigum, 1999).
Financial challenges
The conduct of business in the Bahrain money market is flexible, but with exposure of investors to varied risks. Treasury bills are one of the most fully secured financial instruments, but have low level of interests, which discourages the investors. The other financial instruments have reasonably high interest rates, but are attributed to high risks. Some of the key risks, which influence the conduct of trade in the market, include default risk, interest rate risk, inflation risk, and exchange rate risk.
Depending on the performance of the corporations that issue most of the financial instruments in the money market, there outcome poses risk of default. With poor performance, the corporations may not have the ability to comply with the agreed terms of the contracts. Interest rates risk refers to the challenges that interest rates attributable to the investment may not reflect the real cost of investment. This poses a challenge to the investors discouraging them from the market.
With the prevalence of inflation, the inflation influences though regulated by the central bank of Bahrain, its adversity erodes the value of investment in the money market (Dew, 2003). The exchange rate risks related to the fluctuation of the Bahrain dinar value in respect of other foreign currency. In this regard, if the local currency loses its value, it implies that investors especially in Eurodollars may face severity of the risk. Nevertheless, the adoption of regulation in the money market of the country controls adversity of these risks.
Conclusion
The money market of Bahrain is the main source of short-term funds for both borrowers and lenders. In the market, the lenders offer the funds in exchange of contracts, which promises to pay the value with interests at the maturity time. This form investment though associated with insecurity to the investors compensates the investors with interest for the degree of risk. Similarly, the fact that most players are large corporation, the level of risk is low compared to other markets.
This implies that the countries financial and non-financial institutions have been able to generate funds at low interests on short-term basis. For the government, it has used the market to counter the adversities of economic fluctuations that could have hampered the economic development. This depicts the value attached to money market of Bahrain.
References
Dew, P. (2003). Kingdom of Bahrain: the financial capital of the Middle East. London England: Euromoney Books in association with the Bahrain Monetary Agency.
Dufey, G., & Giddy, I. H. (1998). The international money market. Englewood Cliffs, N.J.: Prentice-Hall.
Fanno, M. (2001). The money market. New York: St. Martin’s Press.
Ferguson, N. (2008). The ascent of money: a financial history of the world. New York: Penguin Press.
Rowaily, S. O. (1997). Bahrain versus Beirut as a regional financial center. New York, NY: New Press.
Seznec, J. (2003). The financial markets of the Arabian Gulf. London: Croom Helm.
Stigum, M. L. (1999). The money market (Rev. ed.). Homewood, Ill.: Dow Jones-Irwin.