EFB201 Lecture 5 – Public Debt Markets Reading – Viney chapters 2 and 6 Tutorial Questions – Viney chapter 6 Essay Questions 8-12 Additional Questions on Blackboard Site. Outline Short Term Instruments Background Commercial Bills Promissory Notes Negotiable Certificates of Deposit
EFB201 Lecture 5 –
Public Debt Markets
Viney chapters 2 and 6
Tutorial Questions –
Viney chapter 6 Essay Questions 8-12
Additional Questions on Blackboard Site
Short Term Instruments
Negotiable Certificates of Deposit
Valuation of Securities
Long Term Instruments
Corporate debt instruments can be broadly split into
two categories :-
Short Term – less than one year to maturity
Long Term – greater than one year to maturity
Key characteristics in both markets are creditworthiness
Short Term Instruments – Background
Bills of Exchange
A bill of exchange is a short-term money market
security that pays the face value at maturity.
It may be categorised as a trade bill which is used to
finance specific international trade transactions or a
commercial bill which is a method of borrowing.
Repay acceptor ($100,000 plus fee and margin)
Borrowing Corporation Ltd
Funds lent ($95,800)
Present mature bill
ABC Bank Ltd
(current holder of bill)
Bill discharged (holder receives $100,000)
On the issue date a discount price will be paid:
At the maturity date the face value will be paid:
The primary liability to exchange the bill at maturity
falls on the acceptor, not the drawer.
In the short-term money market there is an active
market in bank-accepted bills.
In an efficient market transactions will be recorded
electronically through an authorised central securities
Austraclear, which is part of the Australian Securities
Exchange, is the main central securities depository in
Once a bill is drawn and discounted, the bill is physically
lodged with the depository and each successive
rediscounting and change of ownership is recorded
electronically by the depository.
Commercial bills typically have a maximum maturity of
up to 180 days and a minimum face value of $100,000.
In reality a business may require funding for a longer
period of time.
A bank-accepted bill facility can be set up to extend the
overall term of a bill financing arrangement.
This involves a rollover facility being set up with the bank.
Under this facility the bank agrees to accept and discount
new commercial bills for the borrower at each maturity
On each rollover date the borrower will pay the bank
the difference between the face value on the maturing
bill and the discount price of the new bill.
Promissory notes (P-notes) are discount securities
normally with a minimum face value of $100,000
and a term to maturity of up to 180 days.
The cost to the borrower is the difference between the
amount raised on the issue date and the face value payable
It is market convention to refer to the P-notes as
P-notes are similar to bills of exchange except
there is no acceptor involved.
There is also no need for the seller to endorse the bill.
Typically, only large companies with excellent credit
reputations in the market are able to attract investors
willing to discount P-notes.
Negotiable Certificate of Deposit (CD)
A CD is short-term discount security issued by a bank,
typically with an initial maturity of up to 180 days.
CDs are an investment product offered by banks in the
money market to attract institutional investors.
Banks issue CDs, in part, to manage their liabilities and
Within the money market there is an active secondary
market in CDs.
PRICE = PRESENT VALUE
OF FUTURE CASH
IF INTEREST RATES RISE, PV FALLS
IF INTEREST RATES FALL, PV RISES
An investor buys a 180-day commercial bill with a
face value of $100,000 yielding 8.75%pa. They decide
to sell the bill 90 days later at a market yield of 7.8%pa.
Price paid for the 180-day commercial bill:
Price received when the bill is sold 90 days later:
Calculating Face Value
In many instances a company needs to raise a specific
amount of funds, the issue price, from a bill issue.
As the issue price and yield are known the face value
can be calculated using:
FV = P × (1 + (yield × DTM/365))
For example, a company issues a 60 day bank accepted
bill to raise $500,000. The bank agrees to discount the
bill at 8.75%pa so the bill’s face value will be:
$507,192 = 500,000 ×(1 + 0.0875 × 60/365)
The yield is the rate of interest, expressed as per cent
per annum, on the amount outlaid to purchase the
The yield can be calculated using:
(sell price – buy price)/buy price × (365/DTM)
At the maturity date the sell price will be the face value.
If the security is sold prior to the maturity date,
then DTM is replaced by days held.
For example, an investor plans to purchase a 180-day
bill with a face value of $100,000 and a price of $95,000.
The yield on the investment will be:
($100,000 – $95,000)/$95,000 × 365/180
= 0.1067 = 10.67%pa
Reconsider example 1 and calculate the
Holding Period Yield (HPY)
(sell price – buy price)/buy price × (365/Days Held)
HPY = ($98,113 – $95,864)/$95,864 × 365/90
= $2,249/$95864 x 365/90
= 0.02346 x 365/90
= 0.0951 = 9.51%pa
Long Term Instruments
The major long-term debt market in developed countries
is the bond market.
Again the key factors in the market are
1. Default Risk (Creditworthiness) and
2. Liquidity of the market
The Australian bond market consists of:
1. Treasury bonds issued by the Commonwealth
2. Semi-government bonds issued by state government
3. Corporate bonds issued by financial institutions and
other large listed corporations
4. Asset-backed securities
5. Australian-dollar-denominated bonds issued in
Australia by non-resident borrowers
(known as Kangaroo bonds).
A bond pays a specified periodic interest rate for the
term of the bond and the principal is repaid at maturity.
The periodic interest payment made by a bond is
normally referred to as a coupon.
Typically the coupon is a fixed percentage of the face
value, but floating rate coupon bonds also exist.
It is cheaper for corporations to raise debt funds
directly from capital markets as it removes the cost
of the financial intermediary, such as a bank.
Investors can obtain a higher return, although
at a higher risk, from buying corporate bonds
than if they placed their funds with a financial
A credit rating agency such as Standard & Poor’s
provides measures of an issuer’s credit risk.
In recent years managed funds have been the
major buyers of bonds.
A corporate bond is a bond issued by a company and can be categorised as a debenture or
A debenture is secured by a fixed and/or floating charge
over the issuing company's unpledged assets. These are
assets over which there is no charge or interest conveyed
to another party.
An unsecured note has no underlying
For most corporate bond issues, the price paid on
subscription is the same as the face value of the security.
In most countries corporations law will require any
invitation to the public to deposit money with or lend
to a corporation to be accompanied by a prospectus
that has first been registered with the corporate regulator.
A prospectus will provide detailed information on the
issuer corporation, the purpose of the finding, company
financial statements and projections, management
profiles, expert reports and other material information.
However, a prospectus is costly and time consuming to
prepare so companies often prefer to use placements where they are only required to provide an information
PVcoupons = $5,000×[(1-(1+0.04)-12)/0.04] = $46,925.37
PVface value = $100,000×(1+0.04)-12 = $62,459.70
So the bonds price discounted to the last coupon
will be: $46,925.37 + $62,459.70 = $109,385.07
So the bonds price now will be
($109,385.07) x (1+0.04)140/181 = $112,754.27
Zero Coupon Bond Valuation
A zero coupon bond is one which pays no
Coupons, only the Face Value at maturity
Price = Face Value x (1 + i)-n
= Face Value/(1 + i)n
E.g..A 5 year $100 Zero Coupon Bond is
yielding 12% pa.