Functions of Australian Bonds - Essay Example

Introduction There are different ways for the government and private business owners to raise funds to fulfil their liquidity needs. One of the most commonly used tools for the government to raise funds for dealing with the monetary policies is treasury based securities. Central bank of the country deals with the supply of money by incorporating different strategies. Treasury securities of any country are considered as the most secured investment for the investors because these are backed by government and with full faith. Therefore, these are also referred to as the risk free investments. Govt. Raises funds for different tenors. These include both long term, as well as, short term papers. The terms, used for short term and long term papers, are different depends upon the definition of the maturity of the paper. On the basis of international standards, the short term paper ranges from 3month, 6months and 12 months maturities. On the other hand, long term paper is referred to as those securities which are issued for a time period more than one year. The short term papers, which are issued by the government, are called Treasury Securities. Similarly, the long term papers by the government are called Treasury Bonds. In the middle of government issued and Private Securities, there are some other securities, which are partially backed by Govt. and private owners. Such kinds of securities are referred to as the Semi Govt. securities. Functions of Australian Bonds Australian economy is considered as one of the most developed economies of the world. The financial markets are strong. The current inflation rate is around 1.2 %, which is relatively very low as compared to developing markets. The Reserve Bank of Australia is mainly responsible for issuing and purchasing Govt. based long term paper. The Reserve Bank of Australia is the central bank of Australia. The government of Australia raises funds by issuing the Securities named as treasury bonds. The main features of Treasury bonds are as follows 1. These are issued by central bank on behalf of Govt. through auctions 2. The Primary Dealers Participate in the auctions and make their Bids in terms of Rates along with the amounts. 3. The Rates or yields on Treasury Bonds are determined based on the cash rate or discount rate of the period. 4. The Treasury Bonds pay coupon after regular intervals, normally after every six month. 5. The Coupon rates are quoted in terms of annual rates 6. The face value of the bonds is repaid by the Govt. at the time of maturity. 7. The Treasury Bonds are fixed income securities and are backed by the Govt. with full faith Process of Issuing Treasury Bonds The issuance of treasury bonds follows the following steps; Step 1: The reserve bank of Australia offers the primary dealer, which are normally the big banks of the country, to buy the treasury bonds through auctions (Armantier, 2006). The schedule of the auctions is normally published on Reuters and Bloomberg. Step 2: The Primary Dealers, make their bids for auctions, depends upon the inventory position of the securities along with the projections of market movements. Step3: Many of the corporate clients along with non-primary dealers can purchase or participate in the auction through pass through and Non-Competitive Biddings. Pass Through: It refers to the demands of corporate clients in which they can enter into auction via primary dealers based with pre-defined rates. It means if the cut off rate lies in the predefined rate then the bid will be exercise otherwise it will be wasted. Non-Competitive Biddings: The Corporate Clients and most of Non Primary Dealers can enter into auction by mentioning the amount regardless of the cut off rates which are announced at the time of publishing the results of auctions. Step 4: Brokers, who work for primary dealers normally issues the Bid pattern after all the primary dealers have posted their bids for auctions of treasury bonds. Step5: Reserve Bank of Australia, after collecting the bids for the issuance of treasury bonds, announce the result of the auction, which describes the cut off rate along with the amount. All the bidders whose bids lie under the cut off rates are issued the treasury bonds. Step6: The investors normally have to make investments by buying the treasury bonds from the primary dealers or from those who are allowed to participate in the auction via pass through process or Non Competitive biddings. Example: The Risk Free Long term bonds issued by the government of Australia through the Reserve Bank of Australia, are one of the most common examples of Treasury bonds (RBA, 2011). Reasons for Issuing Treasury Bonds The motivational factor for the investor to invest in the treasury bonds is that the treasury bonds are considered risk free with fixed coupon payments after regular intervals (Kenny, 2011). Therefore, for managing the banks liquidity, banks’ treasuries normally maintains large inventory of treasury bonds (Hewett, 2008). Semi Govt. Bonds Semi government bonds are those kinds of securities, which are backed by govt. and non-government organizations (Lancaster, 2011). Following are the main features of semi government bonds: 1. The Market for Australian and Territory Govt. Debt are considered as the Semi government bond Debt. 2. These are not risk free but with low risk 3. The Yields are lower than purely non govt. bonds but higher than the pure government bonds. 4. Share significantly in the contribution towards the liquid assets for the Australia’s Financial Institutions. 5. Pays Coupon at regular intervals and principal payment at the time of maturity Process of Semi Government Bonds The Process of issuance of semi government Bonds is quite much similar to the issuance of treasury bonds. Queensland Treasury Corporations and New South Wales Treasury corporations are the largest issuers of semi government bonds. It follows the Following steps Step 1: The Treasury Corporations announce the auctions of semi government bonds. Step2: The Investors, such has financial institutions and corporate investors participate in the auctions Step 3: The Issuers decide the cut off rates Step 4: on the Basis of Cut off Rates, auction results are announced and the Semi Government Bonds are issued Reason for Issuing Semi Government bonds The main reason for issuing semi government bonds is to raise funds for state and territory government for infrastructural investments. Examples of Treasury Bonds and Semi Government Bonds Treasury corporations, such as Queensland treasury corporation and New South Wales treasury corporation issues the fixed income securities to raise funds for infrastructure investments that represent around 2/3rd of the market, which can be represented with the help of following numbers issued by state and territory treasury corporations The Australian Semi-Government Bond Market Table 1: State and Territory Treasury Corporations’ Borrowing As at end June 2011 Long-term Short-term State/ Onshore Offshore Onshore Offshore Total Credit Territory $billion $billion $billion $billion $billion rating(a) Qld 63.8 2.7 2.9 1.8 71.1 AA+ NSW 44.7 6.2 1.9 1.7 54.5 AAA Vic 24.8 0.7 0.3 1.9 27.7 AAA WA 19.4 0.0 3.4 3.2 26.0 AAA SA 8.5 0.3 1.4 1.1 11.2 AAA Tas 2.2 0.0 1.9 1.6 5.7 AA+ NT 2.7 0.0 0.1 0.0 2.8 AA+ ACT 1.2 0.0 0.3 0.0 1.5 AAA Total 167.3 9.8 12.0 11.4 200.5 (a) Standard & Poor’s rates all Australian states and territories, except the Northern Territory which is rated equivalent to AA+ by Moody’s1 Following graph clearly represents the trend of outstanding debt since 2001 to 2011; the Graph 1 clearly depicts that in Australia, the debt level increased significantly in the last decade, which may be an indication of increasing market share of semi government bonds. The Australian Semi-Government Bond Market Domestic Government Bond Outstanding2 Key Differences between Treasury Bonds & Semi Government Bonds As most of the differences between Treasury bonds and Semi government Bonds are already mentioned above. Following are some key differences. 1. T-bonds are risk free, whereas Semi government bonds are not purely risk free 2. T-bonds are backed by full faith of government, whereas the Semi government Bonds are not backed by full faith 3. T-bonds have low yields than the semi government bonds due to the difference in level of risk 4. T-bonds are issued to fulfil the need of federal govt. and to control the money supply, whereas Semi government bonds are issued to fulfil the territory infrastructural needs Key reflection After studying and thoroughly analysing the literature, which is available regarding the treasury bonds and the semi government bonds, I have found that the purpose behind issuing securities is to fulfil the financial needs of the govt. as well as, non-government institutions. The Major participants in the financial markets are the treasuries of the banks along with other Non-banking finance corporations. The research on the area under study has helped me to develop the cognizant regarding the functions and processes of treasury bonds and semi government bonds, which are issued in the Australian financial market. The process of issuance along with the yield calculation method is almost same for both types of bonds. Moreover, the investors who are more risk averse with low appetite for risk have their predilection for investments in Govt. Bonds because they are relatively secured investments than the other securities, which are backed by non-government institutions. Before studying the literature, i thought the semi government bonds have the purpose to fulfil the financial needs of private businesses, but the Private Investors also incorporate different strategies to raise funds for their business e.g. debt and equities. Raising funds through issuing equities can be a bit risky for an investor. The equities are also referred to as investments in stocks of the company. The Investors may share in profits, as well as losses of the company. If the company may not be paying dividends then the investors may only have the opportunity to use capital gain if any. On the contrary, in order to build the confidence of the investors, the company issues fixed income securities. The most common of these are private bonds, which makes fixed interest payments to the investors along with the face value at maturity. Therefore, the literature helped me as student to develop a sound understanding regarding the investment strategies followed by government and other territorial institutions. Reference List Armantie, O 2006, ‘Estimation and comparison of treasury auction formats when bidders are asymmetric’, Journal of Applied Econometrics, vol. 21, issue 6, pages 745-779, Viewed 22 September 2012, via EconPapers Hewett, J 2008, RBA warns on bank guarantee as reserve and treasury at loggerheads. The Australian News Limited, Kenny, T 2011, 2012 outlook: US treasuries. New York Times Company, Lancaster, D., 2011. The Australian semi-government bond market. Reserve Bank of Australia Publication, Access Date 22 September 2012, Reserve Bank of Australia 2011, The Australian semi-government bond market, Reserve Bank of Australia Bulletin, September 2011, Access Date 22 September 2012 Read More