Topic 5: Fixed Income

What are money markets?

where short-term borrowing and lending take place, usually for periods of up to one year.

What do money markets mainly do?

manage liquidity amongst corporate and financial institutions

What are capital markets?

where long-term finance is raised and invested, usually through shares and longer-term debt.

What do capital markets do?

They help businesses and governments raise money for major investments and long-term projects.

What are the short-term financial instruments for money markets?

• Cash and bank deposits

• Overnight lending between banks

• Certificates of Deposit (CDs)

• Commercial Paper & Promissory Notes

• Treasury (government) bills of less than one year

What are cash and cash equivalents for money markets?

they are assets on a company’s balance sheet that consist of cash or investments that can be quickly converted into cash.

What are examples of cash and cash equivalents?

• bank deposits

• marketable securities

• commercial paper

• Treasury bills

• short-term government bonds with maturities of three months or less.

What do investments need to be classified as cash equivalents?

need to be highly liquid, be easily converted into cash, and have a very low risk of significant changes in value.

What is the interbank loans market for money markets?

where banks lend money to other banks for short periods, ranging from overnight to one year, although most loans are very short-term.

What is the purpose for interbank loans market?

banks borrow and lend to manage their liquidity to meet immediate financial obligations.

What are interbank deposits?

Money one bank deposits with another bank for an agreed period.

What is call money?

Money lent for a very short period that can be recalled by the lender, often at short notice.

What is notice money?

Money lent for a short period that can be withdrawn after giving an agreed period of notice.

What is the London Inter-Bank Offer Rate (LIBOR)?

the rate at which banks lent to one another for the short-term

What is the London Inter-Bank Bid (LIBID)?

the rate at which banks were prepared to accept short-term deposit

Did the LIBOR dominate the global money market?

Yes, until the 2012 criminal scandal

What was LIBOR based on?

daily non-binding survey quotes (“fixings”) submitted by panels of banks rather than actual transacted trades.

What was the 2012 criminal scandal?

Revealed the panel was manipulating rate to conceal credit stress and generate trading profits.

What did global regulators transition financial markets to after the 2012 criminal scandal?

Robust, transaction-based near risk-free rates (RFRs)

What are the Near risk-free rates for the US, UK, and Europe?

• SOFR - Secured Overnight Financing Rate - US

• SONIA - Sterling Overnight Index Average - UK

• ESTR - Euro Short-Term Rate - Europe

Why were certificates of deposit introduced?

Introduced in 1960s to enable banks to trade short term deposits

What is a certificate of deposit?

a tradable time deposit issued by depositing institutions, such as commercial banks. It involves depositing money for an agreed period, typically ranging from one month to one year, in return for interest

What are the denominations and minimum value of a Certificate of Deposit (CD)?

Issued in £10,000 increments, with a minimum investment of £100,000.

Can certificates of deposit be sold?

Yes, they can be sold from one investor to another, they are negotiable in the secondary market

What are the interest rates of CD closely linked to?

the current interbank deposit rates for the same time period, but are usually slightly lower.

What does the pricing of CD depend on?

the amount the investor will receive when the deposit reaches its maturity date.

How is a CD valued?

by working out how much the money you will receive in the future is worth today, similar to a zero-coupon bond.

What is commercial paper?

A short-term promissory note that can be issued by both financial firms and creditworthy corporations.

What is a promissiory note?

a written promise by a person or business to repay a specific amount of money to a lender, either on a set date or when requested.

How are commercial papers issued?

at a discount, less than its face value

When will investors receive full face value or issuing commercial papers?

at maturity

What is the usual maturity period of commercial paper?

Usually repaid between 7 days and 1 year after it is issued

Are CD’s negotiable?

Yes, they can generally be transferred or sold to another investor.

What does it mean that commercial paper is unsecured?

It is not backed by specific assets, so investors rely on the company's creditworthiness. Its credit rating helps assess risk, and backup bank credit facilities may support repayment.

What is a treasury bill? (T-Bill)

Is a short-term government security that is issued at discount. (with a maturity of one year or less)

What risk are T-bills considered to be?

Default-risk-free

What is the Treasury Bill yield equation?

(Note: US Treasury bills use an Actual/360 bank discount basis; UK Gilts and Bills use Actual/365).

What are two main types of financial instruments for capital markets?

• bonds

• equities

What are the key features of bonds?

• fixed maturity date

• fixed interest rate

• fixed repayment value

• debt instrument only

• market value fluctuates

What are the key features of equities?

• Shareholder part ownership

• no guaranteed payments

• dividends

• market value fluctuates

What is a bond?

a financial security in which issuer promises to make interest and principal payments to holder

Who are bonds issued by?

governments, corporations, and financial institutions

What are the different types of bonds available and what are their percentages?

1. government bonds - 65%

2. corporate bonds - 25%

3. financial institution bonds - 10%

What are government bonds?

bonds issued by governments or international organisations to raise money

What are examples of government bonds?

• national/sovereign - issued by country’s national government

• municipal/local - issued by local authorities

• global - issued by international organisations

What are corporate bonds?

bonds issued by companies to raise money for their business activities.

What are examples of corporate bonds?

• investment grade - bonds from companies considered reliable

• higher-risk, higher-yield bonds - bonds that pay higher interest as greater risk

• convertible bonds - bonds that can be exchanged for company shares under agreed conditions.

Variations on a basic bond: Callable

can be redeemed by issuer priory to maturity date

Variations on a basic bond: Putable bonds

can be sold back to issuer priory to maturity date

Variations on a basic bond: convertibles

corporate bonds convertible into firms equity

Variations on a basic bond: eurobonds

issue din country other than currency demonination