DEVELOPMENT OF BOND MARKET &

FINANCIAL MARKET

ACKNOWLEDGEMENTS

Thanks to Almighty ALLAH the one and only who gave such
appreciable and worthy opportunity and enabled us to
complete our project and we are also in-debt to Holy Prophet
(PBUH) whose life is a living example for every Muslim.
Thanks to our loving families and our caring friends those
helped us a lot, encouraged us in every despair moment and
enabled us to face the challenges of this project.

Our acknowledgment is due to many people for their help in

the completion of this project, the foremost among them
being our teacher Mr. Muhammad Arif who has been
guiding us on every step and without whose help and
guidance we would not have completed this project. We owe
a lot to him for giving us time out of his very tight schedule.
We are also thankful to all the teachers of our department
who helped us in the completion of this project.

DEVELOPMENT OF BOND MARKET IN PAKISTAN

Introduction of Bond Market
The bond market also known as the debt, credit, or fixed income market is a
financial market where participants buy and sell debt securities usually in the
form of bonds.

Background
Bond markets play an important role in mobilization of capital. The
investments are very necessary for economic development of a country. A
good market will help promote economic growth and reduce the risk of
financial crises. To improve the efficiency of the bond market what can be
done is that financial market regulation and supervision should be
strengthened, market infrastructure should be enhanced, new investments
areas(products) for better mobilization of savings and improvement of
investor bases.
((Developing Bond Markets in APEC - Toward Greater Public-Private Sector
Regional Partnership)))

The bond market is composed of Pakistan investment bonds, corporate

bonds, Sukuks and commercial paper. Overall this market is 5% of GDP at the
moment which is very small as compared to other economies. (((bond market
development in Pakistan by Muhammad Arif 2007)))

Significance of Bond Market for Pakistan

Bond market is of great significance to a country that faces large budget
deficits, like Pakistan. Generally, a well-developed bond market is important
for these reasons:

Increasing the competitiveness and efficiency of the financial system, which

here is dominated by large banks. At micro economic level development of
securities market helps change the financial system from bank-oriented
system to multi layered system where capital markets can complement bank
financing.

Enhancing the stability of the financial system by creating alternatives to

banks, that will reduce the power of banks simply

It provides a resort for domestic funding and budget deficits other than by
central bank

Bond market helps in the implementation of monetary policy, including

achievement of monetary targets or may be inflation objectives

The development of bond market can force the financial intermediaries to

develop other products like Repo, Structured finance and Derivatives.

Cost of debt servicing can be reduced through funding of Government Budget

deficits on market-oriented funds.

(((bond market development in Pakistan by Muhammad Arif 2007)))

Further I can say development of local bond market provides:

Diversification of financial sector into equity, debt and bank financing

Effective allocation of capital competition in financial sector

Supports infrastructure development, privatization, securitization, and

the rise of new institutional investors requiring long term assets to match
long term liabilities

Reduces the currency, interest rate and funding exposures risks


Allows more efficient allocation of savings by reducing banks role that
also reduces the element of political interference

Allows borrowers to use capital that is tailored to their assets and

operations

Provides retail and institutional investors with several high quality and
liquid domestic saving vehicles.

(((PeerPapers.com)))

Objectives of Bond Market

To establish a free market that encourages the widest participation of

ownership in enterprises

A free market that regulates itself

Enhance the democratization of wealth

Promote the development of the capital market

Protect investors

Ensure full and fair disclosure about securities

Minimize insider training and keep the market efficient up to the

possible limit

Problem Statement
Mechanics of Bond Market
Development of bond market

Following are the essential areas which are necessary to be developed for realization
of fixed income market in Pakistan.

Money market and Monetary operations

Issuance strategy, market access and debt management framework

Developing benchmark issues

Investor base

Primary market

Secondary market

Settlement infrastructure

Legal and regulatory framework

Taxation policy

Linkages of sub national/Private sector bonds with government bond

market

Sequencing of development

Plan for the development of bond market

There cannot be any doubt that financial system of Pakistan has a lot of
potential, however, it is to be searched and put in place. Another angle, which
needs to be brought into the system, is to integrate it with global financial
system. The vision, which anybody can have in the market for the future
financial system of Pakistan, can be briefed as :

It has to be market based

The market should have its own policing system in addition to

Regulatory framework.

Development of new hedging products like derivatives.

Updating of accounting/auditing and reporting system in line with the

international standards.

Fully automated financial system.

New Government Securities Act to replace out dated Public Debt Act
1944.


Listing of Government Securities on Stock Exchange to widen investor
base.

Implementation of Real Time Gross System to mitigate systematic risk

in fund settlement.

Bond stripping to create liquidity in the bond market and to induct zero
coupon yield curve.

To foster growth of corporate Bond market in Pakistan by making it cost

effective.

To develop trading/Risk Management/Price dissemination mechanism

for Corporate Bond Market.

Financial Institutions to have controls i.e. Clear Strategies of duties at

all levels, Dual Controls, Rotations of assignment of duties, Internal auditing
of all operations, Audit programs for external auditing, Operational reviews

Development of newly inducted Islamic finance

Development of investor base specifically Mutual Funds

Development of Sub National Bond Market in Pakistan

Development of Infrastructure/Mortgage Finance

Bond market in Pakistan

Current status and Overview
Liberalization of the financial system and the switch from credit planning to a
market based monetary policy has created a secondary market for
government bonds in Pakistan. Trading in treasury bills and in short-term
federal bonds provides the basis for open market operations of the state
bank.
In 1991, the government with the consultation of World Bank, started
issuance of two types of securitiesone of short-term maturity and the other
of long-term maturity on the basis of auction through the intermediation of
primary dealers, i.e. treasury Bills (short-term) and federal investment bonds
(long-term). The salient features of the treasury bills are as under:

T-Bills
The bills are issued at a discount. The investors are required to quote the
price at which they are willing to buy T-bills of Rs.100 face value. Individuals,
institutions and corporate bodies including banks/DFIs are eligible to
purchase the bills. The principal and profit accrued thereon is guaranteed by
the government. Principal and profit is payable on maturity. T-bills can be
traded freely and are transferable by endorsement and delivery.
Tax is deducted at source under the Income Tax Ordinance 1979.

Federal Investment Bonds

Bonds are of three different maturity periods viz. three years, five years and
ten years. Short-term FIBs have also been issued.
Individuals, institutions and corporate bodies including banks, irrespective of
their residential status can purchase bonds. There is no quantitative limit on
purchases.
Bonds are redeemable at par on completion of their respective maturity
period. In case cash is require before the maturity date of the bond, the
investor may approach his banker et his bonds converted into cash at the
market price. In the manner, the government bonds can be traded freely in
the secondary market before their maturity date. Each bank is required to
display daily sale and purchase prices of bonds at their main branches in
major cities.
WAPDA, NDFC, BEL, PICIC, and some other firms have also issued nongovernment corporate bonds and certificates. Trading is very limited.
Investment banks which were expected to play a major market-making role
have not succeeded in doing so. Term Finance Certificate (TFCs) has been
issued by financial and manufacturing companies from time to time. 62 TFCs
instruments have been issued on the KSE during 1996-2003 (21 of these
were issued in 2002-2003).
The secondary market is shallow and largely confined to the public debt
sector. The range of financial assets available is limited. The growth of the
secondary market has been restricted by the expansion of the national saving
schemes (NSS), which are very popular with the public. Rates of return in the
secondary market are generally lower than those offered by the national
saving schemes although rates on these schemes have been drastically

reduced during 2000-2002. The growth of the secondary market is limited by

the interventions of the government in the auctioning process to hold down
interest rates. Such intervention has been reduced since 1997, when the
autonomy of the state bank was recognized through the amendment of the
State Bank of Pakistan Act 1962.
About Rs.5 billion worth of TFCs were issued during 1995-2000. There was
major upsurge in 2002 but the secondary market in TFCs is very
undeveloped. Pakistan Investment Bond issues are significantly larger
(exceeding Rs.100 billion in 2001-2002 for example). A secondary market has
not developed in PIBs and PIBs are not regarded as a capital market
instrument. The public is not informed of what the government does with the
money raised through Pakistan Investment Bond issues.

((money and banking in Pakistan, fifth edition, SA Meenai, oxford university

press,2004))

Hindrances in development of Bond Market

Fiscal and Trade Deficits

Law and Order Problem

Bad Governance, lack of accountability on the part of bureaucracy,

Public and Private Sector institutions.

Ineffective Implementation of law and delay in adjudication

Lack of market expertise

Lack of awareness of new financial products

Lack of infrastructure and automation

Lack of stringent regulatory policies and their effective enforcement.

Lack of self-policing system in the market.

Lack of awareness of market ethical values.

Political interference in the regulatory functions.

Clear laws curtailing clear interpretations

Inconsistent supply and small size issues of Government Bonds.

Corporate Bond market being not cost effective due to stamp duties
levied by the issuance and time taking procedure for their approval.

Non issuance of sovereign Sukuk.

Transaction cost as stamps duties on Commercial Paper making them

non cost effective.

Opportunities

????

Action plan for development of Bond Market of Pakistan

o
Create depth in money and securities market to improve the
transmission channel of monetary policy. This would facilitate
investors/issuers to have better view of interest rate movements. This
includes introduction of SBP own instruments, review of monetary policy
execution framework to switch over to explicit interest rate targeting,
establishment of Market Stabilization Fund (an arrangement in which
government share the cost of monetary policy operations with central bank),
capacity building of DPCO, Projections of Government Cash flows.
o
Building up institutional and market microstructure for developing
Government securities market in Pakistan i.e. developing distribution channel
through market makers and dealers having expertise in securities business.
o
Keeping consistent supply of large size long-term government
instruments for creating liquidity and proper yield curve. To achieve this goal,
reopening, stripping and fundability need to be allowed
o
Timely market information to he issuers as well to investor through
data dissemination.
o
Diversifying the investor base. The steps include development of Asset
Management Firms/Mutual Funds/Discount Houses to diversify investor base
through legislative support.
o
Containing crowding-out effect through reducing deficit financing for
developing Corporate Bond Market.

o
Creating appetite for bond market by supporting Islamic Fund Industry,
Mortgage and Infrastructure Finance initiatives.
o
Building Bench mark curves i.e. Revaluation, Clean, IRS, zero coupon
curves.
o
Aligning Sub National/local Governments/Public Sector requirements
with Government Bond Market by providing them same infrastructure.
o
Reducing fees/Stamp duties on Corporate Bonds/Commercial papers to
make them cost effective.
o
Allowing Supranational Bonds in Pakistan to create liquidity in
Corporate Bonds Market and to have best international practices through
their presence.
o
Attracting non-resident investors by providing them better
opportunities to have positive yields by extending some concessions like tax
exemptions.
o
New legislation aligned with current environment for Government as
well Corporate Securities Market.
o
Creating tax base on equity providing level playing field to all
investors.
o
Allowing international depositories linked with domestic depositors for
facilitating international investors to invest in Pakistan.
o
Establishing cross border settlement mechanism. This would reduce
cost of doing business in own and with others markets.
o
Developing Derivatives market for facilitating investors/issuers to
hedge the risks on their portfolios.
o
Developing Bond Market in sequenced manner i.e. from simple to
complex instruments/infrastructure.
o
for developing above Government as well regulators (central bank and
securities commission) to work together in devising policies and then
coordination in their implementation process.

(((bond market development in Pakistan, Muhammad Arif sept 2007)))

FINANCIAL MARKET OF PAKISTAN

Economy of Pakistan:
The economy of Pakistan is the 27th largest economy in the world in terms of
purchasing power, and the 48th largest in absolute dollar terms. Pakistan has
a semi-industrialized economy, which mainly encompasses textiles,
chemicals, food processing, agriculture and other industries. Growth poles of
Pakistan's economy are situated along the Indus River, diversified economies
of Karachi and Punjab's urban centers; coexist with lesser developed areas in
other parts of the country. The economy has suffered in the past from
decades of internal political disputes, a fast-growing population, mixed levels
of foreign investment, and a costly, ongoing confrontation with neighboring
India. However, IMF-approved government policies, bolstered by foreign
investment and renewed access to global markets, have generated solid
macroeconomic recovery the last decade. Substantial macroeconomic
reforms since 2000, most notably at privatizing the banking sector have
helped the economy.

Financial assets are investor for the purpose of

(i) Generating Income
(ii) Satisfying Transaction Requirements.
The balance sheet restrictions can be derived by summing Equation Quarterly
data on holdings of five types of financial assets,
a)

Saving deposits,

b)

Fixed deposits,

c)

Khas deposit certificates (KDCS),

d)

National deposit certificates (NDCS),

e)

Defence saving certificates (DSCS),

Overview of financial market of Pakistan:

Markets for sale and purchase of stocks (shares), bonds, bills of exchange,
commodities, foreign currency, etc., which work as exchanges for capital and
credit in known as financial market. OR A financial market is a process that
allows people to easily buy and sell financial securities, commodities items of
value at low transaction costs and at prices that reflect efficient markets.
Pakistan Financial market comprise of

1.

Capital Market.

2.

Money Market,

3.

Forex Market (foreign exchange),

Capital Market:
The market in which corporate equity and longer-term debt securities (those
maturing in more than one year) are issued and traded. Financial instruments
traded in the capital market include shares, and bonds. Capital markets, and
especially the stock markets in Pakistan, have come a long way over the last
decade. Since 1991, when the boom first resulted from the liberalization
policies of the government at the time, we have seen many major
developments such as a manifold increase in the number of listed companies
and the traded volumes, introduction of automated trading and settlement
systems on the pattern of the world's modern stock exchanges, as well as
intensifying competition for the business evident from the quality of research
being published and distributed.

As the workings of capital markets in Pakistan are gradually exposed to the

market forces, the impact of various instruments of monetary policy will
assume greater significance. In the emerging scenario the effectiveness of
monetary policy will largely depend on the growth of non-bank financial
intermediaries, the determination of interest rates, and the substitutability
between money and other assets. The money demand function has been
frequently estimated for Pakistan. The substitutability of monetary assets
under alternate aggregation procedures is investigated. We supplement the

above research by studying the determinants of financial assets and quantify

intra-assets substitutability within a system-wide portfolio framework.

Stock exchange:
The place where bonds and stocks are exchanged. Its basic function is to
enable public companies, governments and local authorities to raise capital
by selling securities to investors. Presently, in Pakistan there 3 markets,
mainly in Karachi.
Stock Exchange in Pakistan:
In Pakistan there are three Stock Exchanges where we can invest through
broker.
1.

Karachi Stock Exchange (KSE)

2.

Lahore Stock Exchange (LSE)

3.

Islamabad Stock Exchange (ISE)

Money Market:
A segment of the financial market in which financial instruments with high
liquidity and very short maturities are traded. The money market is used by
participants as a means for borrowing and lending in the short term, from
several days to just under a year. Money market securities consist of
negotiable certificates of deposit (CDs), bankers acceptances, Treasury bills,
and repurchase agreements (repos), etc.

Banks:
An organization that provides various financial services, for example keeping
or lending money is known as bank. There are two types of bank
1.

Central bank

2.

Commercial bank

Central bank:
A government monetary authority that issues currency and regulates the
supply of credit and holds the reserves of other banks and sells new issues of
securities for the government.

Function of Central Bank

In the monetary and banking setup of Pakistan, central bank occupies central
position and perhaps, it is because of this fact that this called as the central
bank. In this way, this bank works as an institution whose main objective is to
control and regulate money supply keeping in view the welfare of the people.
Central bank is an institution that fulfills the credit needs of banks and other
credit institution, which woks as banker to the banks and the government and
which work for the economic interest of the country.

Monopoly of note issue

Note issue primarily is the main function of a central bank in every country.
These days, in all the countries where there is a central bank generally it has
got the monopoly of the sole right of note issue. In the beginning this was not
the function of central bank, but gradually all the central bank gas acquires
this function.

Bankers, Agent and Adviser to the Government

As banker to the government, central bank provides all those service and
facilities to the government which public gets from the ordinary banks. It
operates the account of the public enterprise. It mangers government
departmental undertaking and government funds and where there is a need
gives loan to the government. From time to time, central bank advice the
government on monetary, banking and financial matters.

Custodian of Cash Reserve of Commercial Bank

Central bank is the bank of banks. This signifies that it has the same
relationship with the commercial banks in the country that they gave with
their customers. It provides security to their cash reserves, gives them loan
at the time of need, gives them advice on financial and economic matter and
work as clearing house among various members bank.

Custodian of Nations Reserve of International

Central bank is the custodian of the foreign currency obtained from various
countries. This has become an important function of central bank. These
days, because with its help it can stabilize the external value of the currency.

Lender of the Last Resort

Central bank works as lender of the last resort for commercial banks because
in the time of need it provides them financial assistance and accommodation.
Whenever a commercial bank faces financial crisis, central bank as lender of
the last resort comes to its rescue by advancing loans and the bank is saved
from being failed.

Clearing House Function

All commercial bank have their accounts with the central bank. Therefore,
central bank settles the mutual transactions of banks and thus saves all
banks controlling each other individually for setting their individual
transaction.

Credit Control
These days, the most important function of a central bank is to control the
volume of credit for bringing about stability in the general price level and
accomplishing various other socioeconomic objectives. The significance of
this function has increased so much that for property understanding it. The
central bank has acquired the rights and powers of controlling the entire
banking. A central bank can adopt various quantitative and qualitative
methods for credit control such as bank rate, open market operation, changes
in reserve ratio selective controls, moral situation etc.

Other Functions
Besides the 7 functions explained above, central banks perform many other
functions that are as follows:

Collection of Data
Central banks in Pakistan collects statistical data regularly relating to
economic aspects of money, credit, foreign exchange, banking etc. from time
to time, committees and commission a reappointed for studying various
aspects relating to the aforesaid problem

Central Banking in Developing Countries like

Pakistan
The basic problem of underdeveloped countries like Pakistan is the problem
of lack of capital formation whose main causes are lack of saving and
investment. Therefore, central bank can play an important role by promoting
capital formation through mobilizing savings and encouraging investment.

Commercial banks:

An institution which accepts deposits, makes business loans, and offers

related services. Commercial banks also allow for a variety of deposit
accounts, such as savings, current and fixed deposit account. While
commercial banks offer services to individuals, they are primarily concerned
with receiving deposits and lending to businesses.

Functions of Commercial Banks

The functions of commercial banks are divided into two categories:

A.

Primary functions,

B.

Secondary functions including agency functions.

Primary functions:
The primary functions of a commercial bank include: a) Accepting deposits;
and b) Granting loans and advances;

a)Accepting deposits
The most important activity of a commercial bank is to mobilize deposits
from the public. People who have surplus income and savings find it
convenient to deposit the amounts with banks. Depending upon the nature of
deposits, funds deposited with bank also earn interest. Thus, deposits with
the bank grow along with the interest earned. If the rate of interest is higher,
public are motivated to deposit more funds with the bank. There is also safety
of funds deposited with the bank.
b)Grant of loans and advances
The second important function of a commercial bank is to grant loans and
advances. Such loans and advances are given to members of the public and
to the business community at a higher rate of interest than allowed by banks
on various deposit accounts. The rate of interest charged on loans and
advances varies depending upon the purpose, period and the mode of
repayment. The difference between the rate of interest allowed on deposits
and the rate charged on the
Loans is the main source of a banks income.
Secondary functions:

Besides the primary functions of accepting deposits and lending money,

banks perform a number of other functions which are called secondary
functions. These are as follows
a)

Issuing letters of credit, travelers cheques, circular notes etc.

b)
Undertaking safe custody of valuables, important documents, and
securities by providing safe deposit vaults or lockers.
c)

Providing customers with facilities of foreign exchange.

d)
Transferring money from one place to another; & from one branch to
another branch of the bank.
e)
Standing guarantee on behalf of its customers, for making payments
for purchase of goods, machinery, vehicles etc
f)

Collecting and supplying business information.

g)

Issuing demand drafts and pay orders.

Money Market Mutual Funds:

A money market fund is a mutual fund that invests solely in money market
instruments. Money market instruments are forms of debt that mature in less
than one year and are very liquid. Treasury bills make up the bulk of the
money market instruments. Securities in the money market are relatively
risk-free. Money market funds are generally the safest and most secure of
mutual fund investments. Money-market mutual fund is akin to a high-yield
bank account but is not entirely risk free. When investing in a money-market
fund, attention should be paid to the interest rate that is being offered.

Types of Money Market Mutual Funds

Money market funds are of two types:
1. Institutional Money Market Mutual Funds:
2. Retail Money Market Mutual Funds:

The Foreign Exchange Market

The foreign exchange market or forex market as it is often called is the
market in which currencies are traded; people trade one country's money for
another's. If, for example, you decide to travel to Thailand, you will need to

buy some baths, the currency of Thailand, either before you go or once you
get there. Though there is no physical existence of this market, the foreign
exchange market is the largest financial market in the world, with its average
daily traded amount reaching to US $2-2.5 trillion. The development of
communication has helped the foreign exchange market more than any other
field. The computerized communication network that embraces all the major
financial centers of the world is the main trait of the foreign exchange
market, where the buyers and sellers of any country can trade currency
quickly and efficiently. The main players in the forex market are large banks,
governments, central banks, multinational corporations, and currency
speculators.