Chapter 9 - Bond and Money Market

Question 1

Understanding investment characteristics through SYSTEM T

Answer 1

S - security (default risk)
Y - yield(nominal/real , expected return)
S - spread(volatility of market values)
T - term(short/medium/long)
E - expenses/exchange rate
M - marketability

T - Tax

Question 2

Cash on Deposit

Answer 2

Call Deposit
- instant access to withdraw capital deposited
Notice Deposit
- access to withdraw capital by giving notice period
Term Deposit
- no access to funds until maturity of fixed term quoted at outset

Question 3

Money market key players

Answer 3

Clearing Banks
- borrow when they need short term funds
- lend when they have excess funds

Central Bank
- act as lenders of last resorts
- buy and sell Treasury bills
- use their operations to set level of short term interest rates

Other institutions
- eg. short term insurers for liquidity

Question 4

SYSTEM T

Answer 4

S - spread (volatility of capital values )
- not very volatile as short term in nature
Y - yield
- generally a positive real return since short term interest rates > inflation in most cases to incentivise savings
- lower expected return vs other asset classes due to very low/minimal risk
S - security
- high security and minimal to no risk
T - term
- short term
- less than a year usually
E - expenses
- dealing and management expenses low
M - marketability
- not as marketable if call or term deposit
- the rest are highly marketable but ,
- they are unquoted and traded on interbank money market not stock exchange

T - return from money market instruments treated as income for tax purposes

Question 5

Why invest in the money market if it offers low returns ?

Answer 5

Practical Considerations:
- Known short term commitments
- Take advantage of opportunities
- Uncertain outgo
- Recent cashflow ( recent receipt of large sum of money thats not used to purchase other assets immediately )
- Nominal value of capital preservation and risk aversion

Economic Considerations:
- rising interest rates
- domestic currency weakening so foreign money market attractive
- start of economic recession
- general economic uncertainty

Question 6

Bonds

Answer 6

2 main types:

1. Fixed interest bonds
   - usually issued by industrial company , public body or government to raise money
   - initial negative cashflow to buy the bond
   - a single known positive cashflow on the redemption date , and a series of smaller known positive cashflows on the interest payment dates. Although the amounts and timing of these positive cashflows are known, there is still uncertainty associated with them due to credit risk
2. Index linked bonds

Gross redemption yield of a bond is the return the investor would expect to get if they hold the bond to redemption

Question 7

Bonds SYSTEM T

Answer 7

S - security
- depends on issues
- little to no risk if government bonds
- slightly riskier for company bonds
Y - Yield
- higher expected returns vs money market
- lower expected returns vs other asset classes due to higher security
S - spread (volatility of market values)
- market values can fluctuate from day to day due to supply and demand
- large shifts in market value possible for less liquid , long dated bonds
T - Term
- can be short/medium/long/undated term
E - expenses
- minimal dealing and handling expenses
M - Marketability
- highly marketable
- can deal in large quantities with little to no impact on the price

T - Tax
- individual investors taxed on income and capital gains
- institutional investors taxed at uniform rate