The Debt Securities and

Markets

FINANCIAL MARKETS AND INSTITUTIONS

Topic 4
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 Money Market

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Characteristics of the Money Market

Features of the Market
No physical location
 The Money Market is a world-wide communications
network and a mechanism which allows short-term debt
assets to be created and traded
Over the Counter (OTC) market
 There is no central exchange. Market participates must
contract directly with another counterparty to complete a
transaction
Primarily a wholesale market
 The majority of Money Market transactions are of the order
of several million dollars in value
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Characteristics of the Money Market

Functions of the market

Transfer of funds from surplus economic units to deficit
economic units for periods of less than 1 year
Trading of existing money market securities
A mechanism for government to:
Raise short-term funding
Implement monetary policy
•“Determinant” of term structure interest rates
•Facilitate short-term international trade transactions
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Participants
Investment
banks
Commercial
banks Finance
companies

Central Money
Bank Market

Corporations
Brokers
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Central banks

Use the money market for:

 Raising short-term government funding
 Implementing monetary policies (using open market
operations to influence the money supply, and hence
interest rates, inflation, economic growth, unemployment,
etc)
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Brokers

Match borrowers with lenders (buyers with sellers)

Allow for anonymity
Provide a range of financial services
Are paid fees or commissions
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Corporations

Borrow and lend in the overnight Money Market

Use overdraft facilities
Place short-term deposits and take out short-term
loans with banks
Issue commercial bills and promissory notes
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How do participants profit?

Borrowers and lenders use the market to borrow

and invest respectively.
Only intermediaries profit from their activities in
the market, by
 Borrowing at a lower rate of interest than that at which they
lend
 Buying financial assets at a lower price than that at which
they sell
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Money Market Instruments

Cash products
Discount securities
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Cash products

Overnight cash
7-day cash
Overdrafts
Fixed term deposits
Fixed term loans
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Cash Products

Overnight cash (11 am cash)

Initial deposit or loan is made overnight
Deposits/withdrawals by 11am the following day, or
the loan/deposit is “rolled over” for another day
Interest rate reset daily
Parcels of 5/10 million
Market mainly used by Banks
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Cash Products

7-day cash (24 hour cash)

Initial period of deposit/loan is 7 days

After 7 days, deposits/withdrawals require 24 hours
notice
Interest rate reset daily after initial 7 day period
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Other short-term loans

Committed loans
Uncommitted loans
Bank overdrafts
 Customer permitted to overdraw cheque account up to
agreed limit
 Interest charged daily (compounded daily)
 Repayable on demand
 Rate higher than fully-drawn loans
 Rate usually follows Bank Bill Swap Index (BBSW)
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Discount Securities
Some Common Products:

• Bills of Exchange • Promissory

 Commercial bills Notes
 Non-bank bills • Treasury Notes
Bank Accepted • Certificates of
Bills (BAB) Deposits (CD)
Bank Endorsed • Repurchase
Bills (BEB) Agreements
 Trade Bills (Repos)
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Bills of Exchange / Commercial

Bills

Bills of Exchange can be used to:

 Facilitate international trade (trade bills)
 Raise finance (accommodation bills or commercial bills)
Definition of a Bill of Exchange:
 “An unconditional order in writing addressed by one person
to another, signed by the person to whom it is addressed to
pay on demand or at a fixed or determined future time a
sum certain in money to or to the order of a specified
person(s).”
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Bills of Exchange: Categorisation

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Commercial Bills

Usually involve 3 parties:

 Drawer (borrower)
 Acceptor/Drawee/Guarantor
 Discounter (lender)

If the bill is sold in the secondary market, it must be

endorsed, which incurs a “contingent liability”
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Commercial Bills  Borrower

 Issuer of bill

 Lender
 Receiver of
bill
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Commercial Bills

Features
Terms 7 - 180 days
Traded on yields
$5 - $10 million parcels
2-way pricing
Extra fees apply to borrowers
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Promissory Notes

Also known as P-Notes or Commercial Paper

Essentially an IOU
Only issued by large companies with excellent
credit ratings
No contingent liability when sold
Higher yields than BABs
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Treasury Notes
Essentially Promissory Notes issued by the
government to raise short-term finance
Issued weekly by tender with Maturities 5, 13 or 26
weeks
Active secondary market amongst commercial banks
Extremely liquid instruments. Can be used for Prime
Asset Ratio purposes.
Bought and sold by Central Bank in the secondary
market (open market operations)
Lower yields than BABs
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Certificates of Deposit

Essentially Promissory Notes issued by banks

Maturities 90 - 180 days
Yields the same as BABs
Trade in the secondary market
Minimum denomination $50,000
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Repurchase Agreements

An agreement under which a financial asset is

sold and then repurchased at a later date at an
agreed price
Effectively a short-term loan using the asset as
security - title is transfer.
Buy a repo: lend cash - buy at a discount a security now
and sell it back at a predetermine date.
Sell a repo: Borrow cash- sell at a discount a security now
and buy it back at a predetermine date.
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Financing choices - Long-term

Debt
 Direct finance or Indirect (intermediated) finance?
Criterion for decision
 Advantages and disadvantages of indirect finance (Topic 1)
• Corporate
bonds / non-
govt bonds

Direct
Debt finance
Corporat
e Internal finance Indirect
LT • Refinancing of
funding Equity finance ST loans
decision External finance • Overdrafts
• Term loans
s • Mortgage
Debt
ST finance finance
• Lease finance

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Financing choices: Corporate

Long-term direct finance

This is obtained by issuing bonds

“Bonds” is the most general term. Debentures and
notes are types of bonds.
Fixed Income securities
 Interest payment fixed by contract
There are two components of the bond market in
Australia
 Corporate bond market
 Government bond market
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Corporate Bond Market

• Australian domestic market has been heavily used by

mining firms.
• Australian firms issue offshore is comparable if not
greater than onshore

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Corporate bonds
aka non-government bonds

Traditional corporate Bonds – initially dominated by

Financials corporations
Authorised Deposit taking institutions issue medium term
floating rate securities to raise funds that have a longer-term
to maturity than deposits
Kangaroo bonds issued by non-residents
• Non-financial companies who issue long-term bonds
for large amounts
 Some lower rated issuers have their credit standing improved by
credit wrapping such as guarantees by a third party
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Non-government bonds

• Dominated by Financials in the recent years

• Second are non resident issue – Kangaroo bonds

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Financing choices: Government

Government bond market
85% of government debt is raised through the issue of long-
term fixed-interest securities (Treasury bonds)
Treasury bonds are issued by the RBA on behalf of the Treas
ury (a department of the Commonwealth Government)

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Financing choices: Government

Treasury bonds

Issued by tender to finance budget deficits and long-

term government expenditure
Very liquid market - especially 3 and 10-year bonds
Main holders are the RBA, banks, life offices,
superannuation funds
Traded in parcels of $5 - $10m.

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Financing choices: Government

Semis
Government bonds issued by State governments and
semi-government authorities are referred to as
“semis”

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Financing choices: Government

Trading and settlement
A wholesale, OTC market where dealers are market makers
under Australian Financial Market Association protocols
Treasury bonds:
 Actively traded
 Trade by telephone or electronic systems
 Dealers quote bid-offer yields
 Standard parcel size is $10 million
 Each treasury bond has a face value of $1000
 Settlement is through Austraclear
Many non-government bonds are not actively traded
A retail market is growing for corporate bond (notes)
 Trade trough the ASX
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Key features of a standard bond

Face value
 The amount to be repaid on maturity
Coupon rate
 The annual rate of interest.
Annual Interest Amount = Face Value x Coupon rate

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Key features of a standard bond

Maturity Date
 The date on which the bond matures
Term to maturity
 The period of time between now and the maturity date
Price
 The present value of the cash flows to be received by the
bond-holder
Yield
 The rate of return if the bond is held to maturity
 “Market yield”
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Variations to a standard bond

Floating rate (notes) bonds

 The coupon rate varies periodically, and is based on an
marker rate such as LIBOR, BBSW
Zero-coupon bonds
 The only cash flow is the face value on maturity. These
bonds are sold at a steep discount
Deferred coupon bonds
 There are no coupon payments for a fixed period after the
bond issue

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Variations to a standard bond

Convertible (notes) bonds

 The bond holder has the option to convert to equity at or
prior to maturity of the bond

Bonds with embedded options

 The bond-holder may have the option to sell the bond back
to the issuer (puttable) or the bond-issuer may have the
option to buy it back from the holder (callable)
 Often used in combination with each other and with
convertible bonds
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International bonds

Foreign bonds
 Issued in a country, other than that of the borrower, in the
currency of the country in which they are issued
 Sold in Japan “Samurai”, in the USA “Yankee”, in Australia
“Kangaroo” bonds.

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International bonds

Eurobonds
 Issued in a currency other than that of the country in which
they are issued
 Medium to long-term fixed interest securities paying
coupon payments
 Bearer securities
 Sold directly to public
 Listed on exchanges although most trading is between
dealers
 Underwritten by a syndicate of banks

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The Euromarkets

The Euromarket is considered a major finance source for

international trade/transaction.
A debt transaction denominated in a currency other than the
currency of the country in which the transaction occurs
USD is the dominant currency, while all major currencies are
issued
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Variations to standard
Eurobond
Floating rate notes (FRNs)
Exotics
 Eurobonds with special features
 E.g. optional conversion to equity
Dual currency bonds
 Funds are raised in one currency and coupon payments
and/or face value paid in another

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