week 7

Maturity <1

Maturity >1

Commercial papers

NCDs

T-bills or T-note

Repo

Corporate bonds.

T-bonds

• Providing a way for economic units to undertake liquidity management.

• allowing economic units to manage the mismatches that occur between cash payments and cash receipts and thereby solve their liquidity problems

Allows corporates and governments to maturity match by funding long-term assets with long-term liabilities

• Commercial banks

• The RBA with T-note

• The Commonwealth government with T-note

• Corporations

• Issuer: Commonwealth and state governments and corporates

• Buyers: mainly individuals and households

the future risk potential of the bonds. low rating company, high risk, high interest rate

Standard & Poor’s, Moody’s, and Fitch Investor Services.

AAA, AA, A, BBB, BB, B, CCC, CC, C, D

higher probability of default. It also means that the rate of return demanded by the capital markets will be higher on such bonds.

As the coupon payments are fixed, if interest rate (or market yield) increases, investors would prefer to pay less for the bond to achieve the higher rate of return, vice versa. If the coupon rate equals the interest rate, investors would pay the face value of the bond.  As the market yield falls in the previous part, hence the price of bond increases

·      The required rate of return will increase (0.5 marks). Creditors would require a higher return due to the higher possibility of the company failing to pay back what they have borrowed (0.5 marks).

·      Shareholders would also require a higher return due to the increased risk as larger amounts of interest are committed to being paid to creditors (0.5 marks).

·      No change to IRR (0.5 marks$). IRR is determined only by the cash flows of the project. It is not affected by the cost of the capital$ (1 mark)