1203AFE Lecture Notes - Lecture 6: Annuity, Investment, Debenture
30 May 2018
School
Department
Course
Professor
Week 6 Money, Bank and Finance Lecture Notes
Topic 5: Bond Markets
Capital Markets
• Money market securities like BABs are used to finance short term projects
• Firms like to match the expected life of an asset with the maturity of the debt
• The capital markets allow firms and governments to issue long term debt securities
• With longer term debt, the cost of funds may be known for the life of the asset and
there are likely to be fewer refinancing problems
Market Participants
• Capital markets bring together borrowers and suppliers of long-term funds
• The largest purchasers of capital market securities are individuals and households
• The largest issuers are the Commonwealth and state governments
Issuers of Capital Market Securities
What is a Bond?
• Fixed income securities with fixed redemption value:
o Face value: amount of money a holder will get back when a bond matures
o Maturity date: date on which the issuer/ borrower has to repay the amount
borrowed
o Coupon rate: the interest rate (different from the yield which is used to price
a security)
o Payment frequency (half yearly or yearly usually)
Example
find more resources at oneclass.com
find more resources at oneclass.com
• A bond's price fluctuates throughout its life in response to a number of variables
o Premium price: when a bond trades at a price above the face value.
o Discount price: when a bond sells below face value.
• For example, say you buy a bond with a face value of $1,000, a coupon of 8%, and a
maturity of 10 years.
o This means you'll receive a total of $80 ($1,000*8%) of interest per year for
the next 10 years.
o Actually, because most bonds pay interest semi-annually, you'll receive two
payments of $40 a year for 10 years.
o When the bond matures after a decade, you'll get your $1,000 back.
Bond Issuers
• The issuer of a bond is a crucial factor to consider = credit risk.
• Government default risk is considerably small - so small that commonwealth
government securities may be considered risk-free assets.
• Corporate default risk is linked to risk and profitability = higher risk and therefore a
higher yield in order to entice investors - this is the risk/return trade-off in action.
• Bond credit rating systems help investors.
Characteristics of the Bond Market
• Wholesale, OTC market.
• Dealer, quote driven market where dealers quote yield.
• Main borrowers: Governments & Corporations.
• Main investors:
o Fund managers
o Banks, including overseas financial institutions
o Private investors
o Central banks (RBA in Australia)
o Government
Offshore Bond Issuance
• Many companies and governments obtain financing in countries other than their
home country.
• Offshore bond issuance among Australian corporate entities increased from $60
billion to more than $460 billion between 1994 and 2009.
• Most bonds are issued in major currencies like the US dollar, Euro and Yen.
The Growth of Offshore Issuance
find more resources at oneclass.com
find more resources at oneclass.com
The Regulators
• Regulation of financial markets in Australia is three-tiered:
o ASIC is responsible for market integrity and consumer protection.
o APRA is responsible for the prudential supervision of ADIs.
o RBA is responsible for the stability of the financial system and the payments
system.
ASIC and Corporations Law
• Corporations law is also relevant.
• Corporations law, for example, requires that a bond issue be accompanied by a
prospectus.
• The prospectus contains the relevant information about the issue and must be
registered with ASIC.
Types of Bonds
• Zero Coupon Bonds (or accrual bonds):
o a type of bond that makes no coupon payments but instead is issued at a
considerable (deep) discount to par value.
o For example, let's say a zero-coupon bond with a $1,000 par value and 10
years to maturity is trading at $600; you'd be paying $600 today for a bond
that will be worth $1,000 in 10 years.
• Fixed-rate bonds:
o where the coupon rate stays as a fixed percentage of the par value.
• Floating-rate bonds:
o where the coupon rate is not fixed but adjustable i.e. tied to market rates
through an index, such as the rate on Treasury bills.
Pricing Bonds
• The price of a bond is the peset alue of the ods ash flos.
• Befoe e a appl the peset alue foula to the ods ash flos, e eed to
understand the nature of these cash flows.
o Present value is the value today of a sum of money to be received at a given
point in the future:
• Fortunately, this is easy. A bond is just a series of regular interest payments plus a
lump sum repayment of principal.
• A bond consists of two sets of cash flows: coupon (interest) payments + principal.
• The bond pays periodic interest payments (coupons) to the bond holder.
• At maturity, the bond pays the bondholder the principal, face value or par value of
the bond.
• The size of the oupo iteest paets is deteied the oupo ate.
• For example, if the coupon rate is 7.00% per annum, a bond with a face value of
$1000 will pay $70 in interest each year.
( )
ú
û
ù
ê
ë
é
+
=n
i
FVPV
1
1
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Week 6 money, bank and finance lecture notes. Market participants: capital markets bring together borrowers and suppliers of long-term funds, the largest purchasers of capital market securities are individuals and households, the largest issuers are the commonwealth and state governments. Characteristics of the bond market: wholesale, otc market, dealer, quote driven market where dealers quote yield, main borrowers: governments & corporations, main investors, fund managers, banks, including overseas financial institutions, private investors, central banks (rba in australia, government. Asic and corporations law: corporations law is also relevant, corporations law, for example, requires that a bond issue be accompanied by a prospectus, the prospectus contains the relevant information about the issue and must be registered with asic. 1 i n: fortunately, this is easy. will pay in interest each year: because bond coupons are usually paid semi-annually, each coupon payment will be.
