5/02/

introduction
A debt security is one that promises to make defined payments (could be
payment at maturity) (not necessarily defined amounts) on specified dates in the
future. (one cash flow- zero-coupon bond (snow ball), bill, treasury note)
Debt instruments do not give the holder ownership rights. (tax, maturity, out of
profits, going concern, entitled to money in liquidation security)
The Debt Market
Australian debt markets can be divided into three levels:
-

Cash market
Money market
Fixed-interest market

In Australia terminology typically attaches words bills or notes to shorter-term

securities (<1 year) and bonds to longer-term securtiesw. Not uniform across the
world
Cash market
Deals in very short-term securities- impacted by positions taken by the reserve
bank of Australia (RBA):
- includes overnight interbank market
- Typical maturity of 24 hours with 11 am settlement
- Settlements arranged through exchange settlement accounts (ES)
- ES accounts dominated by financial institutions and subject to strict (generally
liquidity) conditions (also a public company)
Money Market
Deals in short-term securities- up to 12 months (sizable amount of money min
50,000 dollars)
- includes government securities, treasury notes
- Also bank bills and promissory notes (one transaction to investor) (discount
securities government and non government)
- Participants include private sector, financial intuitions, financial investors.
Fixed-Interest Market
Deals in short, medium and long-term securities:
- often active secondary market for securities (personal or private loan, term
deposit- no secondary market)
- government securities include state, local and semi-government organisations
- large number of participants
Desirable qualities of securities markets

-Negotiability: a desirable characteristic of a financial security. It refers to the

ability to transfer ownership from one party to another (can be issued as bearer
(whoever holds the paper can cash it in, no names recorded)/ inscribed stock
(transferred name)) (evidence- trade online, on or off) (chess system is
beneficial)
-liquidity: given longer term securities in fixed-interest market being able to sell
easily at any time adds to attractiveness of securities. (want to have a market
attractiveness, buyers sellers, confidence)
-Low risk: various facets need to be considered including;
- default risk
- capital risk; and
- inflation risk

Commonwealth Government Securities (cgs)

-CGS: securities issued by the RBA on behalf of the federal government (treasury
notes/bonds)
-As at June 2013, CGS on issue in Australia totalled $257 billion, up from a low of
$59 billion in 2006 and more than double the figure of $101 billion in 2009
Holders of CGS
Major holders are:
- Rba
- Bank
- Private managed funds
- Other holders
Treasury notes
-treasury notes are a short term discount security (considered riskless see for
example CAPM formula) (RF= treasury note)
- discount securities are issued at a price lower than their face value (interest
represents the difference)
-traditionally issued at a weekly tender with maturities of 5, 13 or 26 weeks;
today used by the RBA in liquidity management in multiples of $1m face value.
Treasury Bonds
-Treasury bonds are a long term coupon security 10-30 yeasrs
- coupon securities pay a fixed stream of interest payments (typically half
yearly) plus a final payment (interest rate fixed over term)
-issued at occasional tenders with maturities of 5-15 years and used by the RBA
in liquidty management.

-treasury bonds are issued on bealf of the commonwealth government

-all cgs are inscribed stock
-treasury indexed bonds are available (capital value adjusted by inflation rate)
payments 1/4ly increase with change in capital values (not popular) (will change
the coupon payment (maturity value change)
Zero coupon bonds (zcb)
- A zcb is a bond that pays a single cash payment, comprising both principal and
interest, at matuiry (interest compounded snowball effect) -may be appropriate
as a form of financing for some projects (commercial property developments
etc.) (can minimise their cash flowsa)
Repurchase agreements (REPOS)
-definition: a security is bought or sold with an agreement to reverse the
transaction a short time later (principally govt. or semi govt security)
Purpose: -provide a cheap funding source
-place to park short term surplus cash,
-A way to alter a portfolio mix
-a means to cover short-term liquidity shortfalls)
Credit rating agencies
Attached to debt securities
-definition: firms paid to rate the creditworthiness of securities issuers
-seprerate issuer/ issue credit rating
-purpose: to inform the pricing of securities
-examples: moodys
Rating process:
Rating scale AAA to CCC
-Fitchs website investment grade:
AAA- the best quality companies, reliable and stable
AA- quality companies, a higher risk than AAA
A: economic situation can affect finance
BBB: medium class companies, which are satisfactory at the moment
Credit rating criteria:
Short term private instruments
-Bank accepted bill: a promise to pay issued by a private borrower but
guaranteed by a bank
-certificates of deposit: equivalent to a bank bill, where the issuer is a bank

-promissory note: a promise to pay that does not have a bank guarantee.
Long term private instruments
-Corporate bonds: a long-term non-government fixed interest security (also
known as debentures)
-Issuers include corporates, banks and overseas entities
-junk bonds are corporate bonds with below investment grade credit ratings
and higher interest rates
Interest rate securities
-floating rate notes (adjusted in line with benchmark eg 90 day BAB rate)
-converitble note (typically to equity- specified date/ conversion rate)

Securitisation
-Securitised bonds: a packaging of small income- generating assets into large
fixed interest (asset-backed) security. ILLIQUID. Bring those cash flows together.
Selling off the asset, which gives cash flows)
Example: housing loans- were popular up to GFC- dropped by >50% following
GFC.
Enhancement: means taking on the risk of a seucirity to its credit rating
-better risk management
-diversify funding base
-balance sheet management assets vs liabilities
-product diversification