Flashcards in Topic 6 – Government Debt, Monetary Policy and Payment System Deck (48)
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.
relates to the annual incomes and expenditures of a government.
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
- 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
Payments system 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?
Life insurance offices
Other private financial institutions
T-bonds Primary Market Transactions
Issued by Commonwealth Treasury.
Australian Office of Financial Management (AOFM) holds the tenders
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
Access to funds to meet day to day expenses and take advantage of business opportunities
Liquidity held above operational liquidity needs; may be prescribed by a regulator
T-Bonds: Secondary Market Transactions
On exchange transactions
Buying/selling securities on a formal exchange such as stock exchange
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
interest rate expectations
to maintain the maturity profile of a bond portfolio.
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.