Topic 6 – Government Debt, Monetary Policy and Payment System

Question 1

Why Do Governments Need to Borrow?

Answer 1

Governments need to fund capital and recurrent expenditures.

- This is achieved by issuing debt securities in the money and capital markets.

Question 2

Fiscal policy

Answer 2

relates to the annual incomes and expenditures of a government.

Question 3

Monetary policy

Answer 3

affects the level of short-term interest rates by adjusting the level of financial system liquidity.

Question 4

The borrowing requirement over a Full Financial Year:

Answer 4

To finance budget deficits.
Rollover existing bonds that mature.
Retire debt at/prior to maturity if budget is in surplus

Question 5

Crowding-out effect

Answer 5

• Government demand for debt financing reduces amount of funds available for investment in private sector.
• Minimized in times of strong fiscal management, i.e. budget surplus

Question 6

T-Bonds issued are held by market participants for a range of reason including

Answer 6

Liquidity management
Portfolio investments
Risk management
Payments system requirements
Prudential requirements

Question 7

The borrowing requirement Within the Financial Year

Answer 7

Borrow to finance short-term mismatches between receipts and payments, i.e. manage day-to-day liquidity.
Rollover existing debt.

Question 8

Instruments issued for intra-year budgetary purposes

Answer 8

are short term, i.e. Treasury notes (T-notes).

Question 9

Main Feature of T-Bonds

Answer 9

• Coupon instrument).
• Coupon payment = coupon rate x face value of bond.
• Face value of bond redeemed at maturity date or may be sold in secondary market for early redemption.

Question 10

Who buys Treasury Bonds?

Answer 10

RBA
Commercial Banks
Life insurance offices
Other private financial institutions
State governments

Question 11

T-bonds Primary Market Transactions

Answer 11

Issued by Commonwealth Treasury.

Australian Office of Financial Management (AOFM) holds the tenders

Question 12

Tender System

Answer 12

Investors bid a price on government securities, thus setting the yield; allocated in order of lowest yields

Question 13

Australian Office of Financial Management (AOFM)

Answer 13

A body established to manage Commonwealth government debt issues

Question 14

1982–present, tender system

Answer 14

• Bids submitted through AOFM;
• Minimum $1 Million;
• Bids made in terms of yield to maturity up to three decimal places – not in terms of price;
• Bids accepted in ascending order of yield, i.e. lowest-yield bid (highest price) first, until issue fully subscribed;
• Settlement is via Austraclear.

Question 15

Why does RBA buy treasury bonds

Answer 15

to change the level of financial system liquidity by either buyin or selling government securities to other investors

Question 16

Financial System Liquidit

Answer 16

The amount of exhange settlement accounts in the system

Question 17

Why do banks buy treasury bonds

Answer 17

To manage their operational and prudential liquidity

The hold bonds as part of their liquidity management strategy

Question 18

Operational Liquidity

Answer 18

Access to funds to meet day to day expenses and take advantage of business opportunities

Question 19

Prudential Liquidity

Answer 19

Liquidity held above operational liquidity needs; may be prescribed by a regulator

Question 20

T-Bonds: Secondary Market Transactions

Answer 20

On Exchange

Over-the-counter

Question 21

On exchange transactions

Answer 21

Buying/selling securities on a formal exchange such as stock exchange

Question 22

Over-the-counter transactions

Answer 22

buying/selling of securities conducted directly, no formal exhange, normal in between institutional investors

Question 23

Individuals and institutions may participate in the secondary market for the following reasons

Answer 23

funding requirements
liquidity needs
reserve requirements
interest rate expectations
to maintain the maturity profile of a bond portfolio.

Question 24

T-Bonds Pricing:

Answer 24

𝑷=𝑷𝑽𝒄+𝑷𝑽𝒇

𝑃𝑉𝑐 = PV of the coupons;
𝑃𝑉𝑓 = PV of the face value of bond.

Question 25

T-Notes

Answer 25

T-notes are short-term discount securities issued by the Commonwealth Government through the Australian Office of Financial Management (AOFM).

Question 26

T-notes Tendering Process

Answer 26

• Tenders held periodically on a competitive basis to meet funding needs.
• Minimum parcel of $1 million face value
• Bids accepted in ascending order of yield, i.e. lowest-yield bid (highest price) first, until issue is fully subscribed.
• T-Note purchases are settled using the Austraclear settlement system.

Question 27

State Government Securities

Answer 27

Each state has formed a central borrowing authority to facilitate debt management programs

Issue similar securities as the Commonwealth, i.e.

• Medium-term notes and longer-term bonds (referred to as semi-government securities)
• Discount securitiesI

Question 28

The RBA, in determining its monetary policy stance, strive to achie

Answer 28

stability of the currency
maintenance of full employment
economic prosperity and welfare of the Australian people

Question 29

By impacting on the cash rate (overnight interbank rate), the RBA can affect rates of longer term securities, e.g.:

Answer 29

RBA tightens monetary policy by selling Commonwealth Government securities (CGSs) and reducing the money supply.
This causes investment and household spending to decrease.

Question 30

In reviewing monetary policy settings, some of the important underlying indicators considered by the RBA include

Answer 30

IR
IR for borrowers
ER
Unemployment
Economic productivity and capacity
Trends in asset values
International monetary and economic conditions

Question 31

Open Market Operations

Answer 31

Actions of the reserve bank in the money markets to maintain a cash rate consistent with its stance on the monetary policy

Question 32

Open market operations conducted primarily by

Answer 32

• repurchase agreements (repos) on nominated debt securities
• outright or direct transactions in short-dated Commonwealth Government Securities
• foreign exchange swap.

Question 33

The RBA holds and manages a portfolio of Commonwealth Government Securities to

Answer 33

maintain system liquidity and effect monetary policy.
- The RBA achieves this by purchasing CGSs in the secondary market and occasionally taking an allotment at tender in a primary issue.

Question 34

Factors impacting on the liquidity of the financial system (or money base) are:

Answer 34

• Commonwealth Government budget deficits or surpluses
• official (RBA) FX transactions
• net sales of Commonwealth Government Securitie and repurchase agreements.

Question 35

Factors impacting on the liquidity of the financial system (or money base) are:
(Commonwealth Government budget deficits or surpluses)

Answer 35

taxation receipts
government securities
budget recurrent expenditures
budget capital expenditures

Question 36

Factors impacting on the liquidity of the financial system (or money base) are:
(official (RBA) FX transactions)

Answer 36

• sales of FX reduce financial system liquidity

- sales of FX by the RBA reduce system liquidity, which can be neutralised through market operations by buying CGSs

Question 37

taxation receipts

Answer 37

Income tax, company tax, cgt, gst, gbt

Question 38

Payments system

Answer 38

Facilitates the transfer of value of a financial instrument, used in transactions for goods and services, from one party to another

Question 39

Payments system clearing systems

Answer 39

• Australian Paper Clearing System
• Bulk Electronic Clearing System
• Consumer Electronic Clearing System
• High Value Clearing System
• Australian Cash Distribution Exchange System

Question 40

Australian Paper Clearing System

Answer 40

for cheques, payment orders and other paper-based payment instructions

Question 41

Bulk Electronic Clearing System

Answer 41

for recurring electronic credit and debit payment instructions

Question 42

Consumer Electronic Clearing System

Answer 42

for card-based ATM and EFTPOS transactions and ‘pay anyone’ via the internet

Question 43

High Value Clearing System

Answer 43

for high-value payment instructions

Question 44

Australian Cash Distribution Exchange System

Answer 44

for the movement of notes and coins.

Question 45

Payments classified by RBA in two ways:

Answer 45

Low-value day-to-day payments for goods and services, particularly by the household sector.

High-value, large-value transactions for assets (e.g. property, wholesale market equity, debt securities and FX transactions) cleared by real-time gross settlements (RTGS).`

Question 46

Exchange settlement accounts:

Answer 46

Same day funds held with the reserve bank; facilitates settlement of payments system value transactions

Question 47

Real-time gross settlement (RTGS)

Answer 47

High value payments system, transactions are settled immediately through exchange settlement accounts

Question 48

Repurchase Agreements (Repos)

Answer 48

sale of CGSs to the RBA on condition the seller will normally buy them back by day’s end

It provides intra-day liquidity for same-day funds for exchange settlement account holders.

RBA also provides end-of-day repurchase facility by offering overnight repos, but subject to interest being charged @ 25 basis points above the official cash rate (only for overnight repos). Incentive to use sparingly.