Topic 6 – Government Debt, Monetary Policy and Payment System Flashcards Preview

Money and Capital Markets > Topic 6 – Government Debt, Monetary Policy and Payment System > Flashcards

Flashcards in Topic 6 – Government Debt, Monetary Policy and Payment System Deck (48)
Loading flashcards...

Why Do Governments Need to Borrow?

Governments need to fund capital and recurrent expenditures.
- This is achieved by issuing debt securities in the money and capital markets.


Fiscal policy

relates to the annual incomes and expenditures of a government.


Monetary policy

affects the level of short-term interest rates by adjusting the level of financial system liquidity.


The borrowing requirement over a Full Financial Year:

To finance budget deficits.
Rollover existing bonds that mature.
Retire debt at/prior to maturity if budget is in surplus


Crowding-out effect

- Government demand for debt financing reduces amount of funds available for investment in private sector.
- Minimized in times of strong fiscal management, i.e. budget surplus


T-Bonds issued are held by market participants for a range of reason including

Liquidity management
Portfolio investments
Risk management
Payments system requirements
Prudential requirements


The borrowing requirement Within the Financial Year

Borrow to finance short-term mismatches between receipts and payments, i.e. manage day-to-day liquidity.
Rollover existing debt.


Instruments issued for intra-year budgetary purposes

are short term, i.e. Treasury notes (T-notes).


Main Feature of T-Bonds

- Coupon instrument).
- Coupon payment = coupon rate x face value of bond.
- Face value of bond redeemed at maturity date or may be sold in secondary market for early redemption.


Who buys Treasury Bonds?

Commercial Banks
Life insurance offices
Other private financial institutions
State governments


T-bonds Primary Market Transactions

Issued by Commonwealth Treasury.
Australian Office of Financial Management (AOFM) holds the tenders


Tender System

Investors bid a price on government securities, thus setting the yield; allocated in order of lowest yields


Australian Office of Financial Management (AOFM)

A body established to manage Commonwealth government debt issues


1982–present, tender system

- Bids submitted through AOFM;
- Minimum $1 Million;
- Bids made in terms of yield to maturity up to three decimal places – not in terms of price;
- Bids accepted in ascending order of yield, i.e. lowest-yield bid (highest price) first, until issue fully subscribed;
- Settlement is via Austraclear.


Why does RBA buy treasury bonds

to change the level of financial system liquidity by either buyin or selling government securities to other investors


Financial System Liquidit

The amount of exhange settlement accounts in the system


Why do banks buy treasury bonds

To manage their operational and prudential liquidity
The hold bonds as part of their liquidity management strategy


Operational Liquidity

Access to funds to meet day to day expenses and take advantage of business opportunities


Prudential Liquidity

Liquidity held above operational liquidity needs; may be prescribed by a regulator


T-Bonds: Secondary Market Transactions

On Exchange


On exchange transactions

Buying/selling securities on a formal exchange such as stock exchange


Over-the-counter transactions

buying/selling of securities conducted directly, no formal exhange, normal in between institutional investors


Individuals and institutions may participate in the secondary market for the following reasons

funding requirements
liquidity needs
reserve requirements
interest rate expectations
to maintain the maturity profile of a bond portfolio.


T-Bonds Pricing:


𝑃𝑉𝑐 = PV of the coupons;
𝑃𝑉𝑓 = PV of the face value of bond.



T-notes are short-term discount securities issued by the Commonwealth Government through the Australian Office of Financial Management (AOFM).


T-notes Tendering Process

- Tenders held periodically on a competitive basis to meet funding needs.
- Minimum parcel of $1 million face value
- Bids accepted in ascending order of yield, i.e. lowest-yield bid (highest price) first, until issue is fully subscribed.
- T-Note purchases are settled using the Austraclear settlement system.


State Government Securities

Each state has formed a central borrowing authority to facilitate debt management programs

Issue similar securities as the Commonwealth, i.e.
- Medium-term notes and longer-term bonds (referred to as semi-government securities)
- Discount securitiesI


The RBA, in determining its monetary policy stance, strive to achie

stability of the currency
maintenance of full employment
economic prosperity and welfare of the Australian people


By impacting on the cash rate (overnight interbank rate), the RBA can affect rates of longer term securities, e.g.:

RBA tightens monetary policy by selling Commonwealth Government securities (CGSs) and reducing the money supply.
This causes investment and household spending to decrease.


In reviewing monetary policy settings, some of the important underlying indicators considered by the RBA include

IR for borrowers
Economic productivity and capacity
Trends in asset values
International monetary and economic conditions