1. Overview

Question 0

Primary vs Secondary markets

Answer 0

1. Primary: debt instruments issued for the 1st time
   - Public offer or private placement
2. Secondary: Previously issued securities are traded until maturity.
   - Liquidity (raise cash)
   - Liquidity: liquid markets enable fair market prices, reduces investor’s interest rate and liquidity risks, reduces premium that issuers would need to pay otherwise.
   - Price discovery for govt bond trading

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Question 1

Main objectives of debt market (3)

Answer 1

1. Bring borrowers & lenders of funds together efficiently
2. facilitate efficient allocation of monetary resources
3. Provide an easily accessible medium for participants with excess funds to invest at transparent market levels, in assets of generally high quality credit.

Question 2

Methods of issue

Answer 2

1. Tender
   - details announced, registered bidders bid for desired amounts of stock at interest rates they are prepared to buy
   - bids accepted from lowest yield up until issue amount is filled.
   - Conversion tender: issuer requests quotes on buying new issue and selling existing issue. Done to change maturity profile, re-coupon issues closer to par etc.
2. Dealer Panel
   - make mkt in primary & secondary bonds for benchmark lines
   - receive retainer fee
   obtain exclusive access to primary issue
   Benefits: dealer panel has strong relationship with issuer; issuer has reliable channel to issue debt instruments; liquidity is improved
3. Leads
   - Most non govt issues done this way.
   - Issuer chooses intermediary. Lead manager prepares bond issue, sets final conditions, selects underwriters and selling groups, provides ongoing support in secondary market

Question 3

Features of Debt Instruments (8)

see notes if detail required

Answer 3

1. Term to maturity
2. Yield to maturity (average rate or single interest rate at which bond’s remaining cashflow is discounted)
3. Discount vs coupon (discount is short term, 6 mths = coupon security
4. Fixed vs floating rate
5. Settlement date
6. Credit quality and liquidity
7. Security (secured, unsecured, junior, subordinated)
8. Interest Rate Risk

Question 4

Participants in Australian market: RBA

• mandate (target sustainable growth and low inflation)
• monetary policy

Answer 4

1. mandate: stability of currency, maintenance of full employment, economic prosperity and welfare
2. monetary policy: target the rate at which banks exchange overnight funds in the money market, ie the cash rate. Banks settle obligations with each other and with RBA through exchange settlement accounts. Therefore, changes on the interest rate applied to these accounts has immediate effect - an increase will increase cost of short term liabilities at bank.
   - announce target cash rate
   - liquidity management

Question 5

RBA continued:

• Liquidity management, open market operations
• Methods

Answer 5

1. manage underlying payments system liquidity while maintaining cash rate close to target
2. Methods: Repos
   - bank bills, CDs acceptable for repo, govvies, semis, etc. Cannot repo own bills. WIth RITS members (Res Bank Information and Transfer System)

Outright purchase / sale of short term securities
- purchase / sell govvies / semis < 18 months to add or withdraw funds from system.

FX swaps
- efficient in accommodating large flows, eg intra year mismatches in timing of cwlth receipts & payments

Intraday repurchase facility

Long Dated Liquidity operations
longer dated cwlth & semi purchases

RBA also is administrator for issue and redemption of cwlth securities, acting under instruction from AOFM

Question 6

Australian Office of FInancial Management (AOFM)

Answer 6

• est 1999
• manages AUs debt & associated financial assets
• repsonsibile for managing Aus GOvt cash balance
• part of Treasury portfolio
• securities lending facility - participants can borrow, must provide collateral (treasury bonds, notes, indexed bonds), fee for use

Question 7

Semi Govts

Answer 7

• finance state borrowings arising from budget deficits; refinance maturing debt, manage finance for govt business enterprises such as state owned electricity generators
• issue debt securities; provide investment facilities & portfolio management for state owned corps; financial & operating advice for clients; operate stock lending facility

Question 8

Banks & investment banks

Answer 8

• financial intermediaries
• trading banks = link between retail sector & wholesale market
• investment banks focused on risk taking & collecting fee income from servicing client needs in wholesale market
• raise deposits, raise LT & ST funds, risk taking using variety of debt instruments; hedge market risk, securitisation

Question 9

1. fund managers & superannuation funds
2. Building SOc’s
3. Finance Co’s
4. Life insurance
5. Large corporates
6. Brokers
7. Individuals

Answer 9

Fund Managers
- invest money pooled from wholesale (incl super funds) & retail investors

Building Soc’s, Credit Unions & Friendly SOc’s
- use debt transactions similar to banks, but rarely directly to investors. Major source of funds is retail deposits

Finance Co’s
- various: leasing, personal, housing, commercial finance etc

Life insurance
- Invests premium income in debt securities with similar duration to liabilities
 Large COrps
Brokers
Individuals

Question 10

Price maker vs price taker

Answer 10

1. Price maker actively quotes 2-way price

2. Price taker requests that the price maker quote a price