ACTSC 445: Asset-Liability Management
Department of Statistics and Actuarial Science, University of Waterloo
Unit 2 Overview of the Types and Features of Fixed Income Securities
References (recommended readings): Chap. 1 of Fabozzi et al.
Major Types of Financial Assets (Securities)
Financial markets are structured as follows:
Debt Instruments xed income securities
Note: Money market instruments are usually also considered to be xed income securities (FIS).
In what follows, we will mostly talk about FIS.
Fixed Income Securities: a quick tour
What does it refer to?
(From Wikipedia) Any type of investment that yields a regular (xed) payment.
(From Ind. All.s web page) Product with a pre-established income, maturity date, and value.
Idea: An investor lends money to a borrower, who agrees to pay it back under some conditions related
to the time-value of money.
Can be contrasted with variable return securities like stocks.
Types of FIS: Money market instruments; Bonds; Preferred stock; Mortgage-backed securities (MBS).
Money Market Securities
Refers to securities issued by corporations and governments for short-term borrowing (maturity
one year or less).
1 Sometimes called cash equivalents because they have such short maturity, high liquidity, and
safety, that they can be converted into cash immediately.
Types of Money Market Securities
1. Treasury Bills (T-bills)
2. Certicates of Deposit
3. Repurchase Agreements (REPOs) and Reverse REPOs
4. Commercial Paper
Short term unsecured debt note issued in the open market; alternative to bank borrowing; usually
less than 270 days (often 1-2 months)
5. Bankers acceptance
Can think of it as a post-dated check, which is created when a customer asks a bank to make a
payment to a third party at some future date; when the bank stamps the check as being accepted,
the bank is now responsible for the future payment and a bankers acceptance has been created.
This type of instrument is mostly used to facilitate international commercial exchanges, when the
creditworthiness of one trader is unknown to the trading partner. It is considered very safe, and can
be traded on secondary markets as a discount security.
6. Eurodollars deposits
Deposits made in $US at a bank located outside the US.
Well now discuss the three rst types in more details, and talk about the LIBOR rate as well.
issued by governments no default risk
also known as discount or zero-coupon securities because they dont pay coupons, and are
(at least in Canada and US) discount instruments (i.e., trade at a discount from face value)
issued in weekly auctions
3 maturities: 4, 13 and 26 weeks
secondary market for US T-bills is the largest and most liquid in the world; run by dealers who trade T-bills
on a bid-ask spread basis (bid price is the one at which one can sell to a dealer; ask price is the price at which
one can buy from a dealer)
quoting convention uses discount rate and a 360-day year (also known as bank discount yield)
Example: T-bill quoted at 5.27% with 61 days until maturity and a face value of 100 000 means the
price P is given by
P = 100000 1 0.0527 61 = 99107
(Here, it is useful to remember that a discount rate d satises 1 d = v = 1/(1 + i)).
2Equivalently, a price of 99 050 for a T-bill with 32 days to maturity and face value of 100 000 means
that the bank discount yield is
100000 99050 360
= 0.1069 or 10.69%
More generally, the formula that relates the price P and the bank discouDtisield r
F P 360
D = ,
where F is the face value, and n is the number of days until maturity.
The eective annual yield is the yield that would be obtained over a year if the return obtained over the
holding period would continue (and be compounded) over a whole year. Hence it is the rate r such that
(F/P) = 1 + r.
maturities of 1, 3, 6 and 12 months
uses simple interest and 365-day year for quotation
Example: Canadian T-bill quoted at a rate of 5.27% with face value of 100 000 and 61 days to
maturity means the price P satises
P 1 + 0.0527 61 = 100000
therefore P = 100000/(1 + 0.0527 (61/365)) = 99127.
In general, if we denote Cythe rate quoted in Canada, it is given by (F P)/P (365/n).
Comparing US and Canada: price of 9600 for a 10