Debt - Topic 3 (Principles of Finance)

Flashcards covering key debt concepts from Topic 3: amortising loans, short- and long-term debt securities, yields, and green bonds.

What is an amortising loan?

A loan repaid by regular payments (an annuity) that cover both principal and interest; the amount owed at any time equals the present value of the remaining payments.

Present value of an ordinary annuity formula

PV = CF × [1 − (1 + r)^(−n)] / r.

Takeaways for amortising loans

Use the annuity PV formula; the amount owing is the PV of remaining payments; ensure r and n are expressed consistently with payment frequency.

What is a short-term debt security?

A debt security with term under 1 year (usually under 6 months), typically one future cash flow, traded using simple interest; can be secured or unsecured.

Two practice groups of debt securities in Australia

Short-term debt securities (term <1 year; single cash flow; simple interest) and Long-term debt securities (term >1 year; multiple cash flows; compound interest).

Treasury Notes pricing (short-term)

Price is PV = FV / (1 + r × n), where n is the fraction of a year (days/365).

Price–yield relationship for Treasury Notes

Prices and yields are inversely related: as yield rises, price falls; as yield falls, price rises.

Bills of exchange vs Promissory notes

Bills of exchange are bank-guaranteed short-term private debt; Promissory notes are private debt notes; both priced similarly in secondary markets.

Endorser risk in bills of exchange

Endorsers may be liable if both the borrower and the accepting bank fail to pay; endorsers can be required to pay.

Yield to maturity (YTM) Definition

The rate of return required by investors; the discount rate that equates a bond’s price to its PV; reflects risk and demand.

Green bonds

Bonds whose proceeds are used for environmental projects; feature similar mechanics to ordinary bonds but with a use-of-proceeds focus.

Greenium

Pricing premium for green bonds; yields tend to be slightly lower due to demand; Australian issuance showed a small average greenium (~0.1 bp).

Yield curve

A plot of yields by term to maturity for a single borrower; depicts the term structure of interest rates and market expectations.

Spreads

Difference in yields across bonds with different risk levels; reflects the risk premium demanded by the market.

Long-term debt securities features (Australia)

Includes Commonwealth government bonds, semi-government bonds, debentures, and corporate bonds; typically coupon-paying and often unsecured.

Pricing coupon-paying bonds (PV formula)

PV = C/r × [1 − (1 + r)^(−n)] + FV/(1 + r)^n, where C = coupon payment (C = c × FV), r = yield per period, n = number of payments.

Semi-annual coupon pricing

Price bonds with semi-annual coupons by using a half-year yield (e.g., 9% p.a. → 4.5% per half-year) and discounting each half-year cash flow.

Discount vs premium bonds

If coupon rate < yield, bond trades at a discount (P < FV); if coupon rate > yield, bond trades at a premium (P > FV).