QUESTION

Tutorial Questions Week 6

1.    In this tutorial you are asked to provide some background to how you made your first formal decisions in the CM Game. Specifically, for each of the areas traded (AUD/USD, ASX 200, 90 day Bank Bills, 10 year Treasury Bonds) answer the following questions:

(a)             What information sources have you referred to in making this decision?

(b)             Have you decided to buy or sell that particular financial asset? What is your reasoning behind this decision?

2.         Based on the following information, answer the questions that follow.

Selected Tenders Of Commonwealth Government Securities

Source:www.aofm.gov.au/content/bondtender/bondtender.asp?tendernumber=478  Accessed 27^th March, 2012.

(a)       Explain whether Tender Number 520 is a Treasury Bond or a Treasury Note tender. Explain whether Tender Number T08062 is a Treasury Bond or a Treasury Note tender.

(b)       What will the money raised from Tender T08062 be used for? What will the money raised from Tender 520 be used for?

(c)       How much money will the government raise from Tender T08062? You should use the weighted average yield in your calculation.

(Total Raised = $495,556,027.33)

(d)       The weighted average issue yield for Tender T08062 (at 4.1964%) was more than the weighted average issue yield for Tender 520 (at 3.6904%). Is this what you would have expected?

(e)       Will the Australian Office of Financial Management (AOFM) accept the lowest yield first or the highest yield first?

(f)        Why is there a difference in the weighted average issue yield for the two tenders? Use the following yield curve in your answer. What does the shape of the current yield curve tell you about what the market expects to happen to the cash rate in the future?

3.         Prior to 2009, the last Treasury Note tender was held on 08 October 2003.

(a)       Why were there no Treasury Notes issued by the government between 2003 and 2009?

(b)       Why do you think that the government, through the AOFM, is now saying that it will maintain $10billion of Treasury Notes in the market at all times.

4.         The AOFM has the following information on its website.

“Treasury Bond issuance in 2011-12 (that is 1 July 2011 to 30 June 2012) is expected to be around $53 billion. After accounting for maturities of $14 billion this represents net issuance of $39 billion. In 2011-12 tenders will be held on Wednesdays and Fridays, with details of the bond lines and amounts to be offered in a particular week announced at noon on the Friday of the preceding week. The face value amount offered at each tender will be in the range $500 million to $1.2 billion, unless otherwise advised.”

(a)       Explain why there will be maturities of $14 billion during the financial year 2011-2012. Is there any way that the AOFM could stop these maturities?

(b)       What does net issuance of $39 billion mean to you?

(c)       Is the government running a budget surplus or a deficit at the moment? And how does this budget surplus or deficit link to the net issuance of $39 billion?

(d)       A list of bonds is provided in Tutorial Question 1, Week 5. Which of these bonds will mature during 2012?

5.         As at March 28th, 2012, the following Treasury Bond tenders had been held since the start of the year.

Source: www.aofm.gov.au/content/statistics/transactional_data.asp

Accessed March 28^th, 2012.

(a)       How many different bonds have been issued so far in 2012? Note that each bond is uniquely described by its coupon and maturity date.

(b)       Why do you think the AOFM issued some bonds a number of times? Why didn’t they issue different bonds during that time rather than issuing the same bonds a number of times?

(c)       The July 2022 bond was issued on two occasions: once in February and once in March 2012. The weighted average yield of the bond on those two occasions was quite different (3.8059% and 4.3695%). If it was the same bond on each occasion, why wasn’t the weighted average yield the same on each occasion?

(d)       Of the different bonds being issued during the period, which bond do you think the market would watch most closely (in terms of its yield)?

(e)       There have been 16 different bond tenders conducted since the start of 2012. One of those bond tenders involved the very first issue of that particular bond. Can you identify which bond tender it was? (NOTE: In a previous week we did a question which looked at comparing coupon rates and yields of bonds at the time of their first issue.)

5.         “The Treasurer said today he would offer no advice on interest rates to the independent RBA, which meets for the first time in 2010 next week, but noted that banks had no excuses for hiking rates beyond any official rate increase”

(Source: http://www.theaustralian.com.au/politics/swan-warns-banks-to-limit-rate-rises/story-e6frgczf-1225823994164, Accessed 27/01/2010)

(a)       Why do you think it is so important for the RBA to be seen as independent from the government?

(b)       Are you aware of any countries in which the central bank is not independent from the government? What have been the consequences?

(c)       When did the RBA enter into an agreement with the government about the conduct of monetary policy (titled the “Statement On The Conduct Of Monetary Policy”)? How have Australian government bond yields behaved since then? Did this agreement give the RBA control over Australian government bond yields?

Source: RBA Chart Pack

SOLUTION

2.         Based on the following information, answer the questions that follow.

Selected Tenders Of Commonwealth Government Securities

Source:www.aofm.gov.au/content/bondtender/bondtender.asp?tendernumber=478  Accessed 27^th March, 2012.

(a)       Explain whether Tender Number 520 is a Treasury Bond or a Treasury Note tender. Explain whether Tender Number T08062 is a Treasury Bond or a Treasury Note tender.

Ans:    The Tender Number 520 is a Treasury Bond tender as it satisfies the criteria of a Treasury Bond i.e. 1. The bond has to pay coupon (4.50% in this case). 2. They are medium to long term securities; generally 2 to 14 years, here more than 2 years (March 2012- Oct 2014).

Whereas the Tender Number T08062 is a Treasury Note tender, as it satisfies the criteria of a treasury note which is 1. Discount securities i.e. they are offered at a discount and at maturity are redeemed at face value. 2. They are short-term securities; here it is approximately 3 months (March to June).

(b)       What will the money raised from Tender T08062 be used for? What will the money raised from Tender 520 be used for?

Ans:    Treasury Notes (T08062) are issued for a very short term to maturity and the funds raised are used for maintaining short term funding or expenditure by the Government of Australia. However, Treasury Bonds (520) are used in order to meet any budget deficit, and even though there is a budget surplus, the Government issues bonds in order to maintain a liquid market for bonds. Treasury Bonds are generally issued with a term to maturity of 2 to 14 years (medium to long-term).

(c)       How much money will the government raise from Tender T08062? You should use the weighted average yield in your calculation.

(Total Raised = $495,556,027.33)

Ans:

Formula used: P (price per $100 face value) = 100/ [1+(f/365)*i)]

Where f= No. of days between settlement and maturity, and i = annual yield to maturity given in percentage. (‘Pricing Formulae for Treasury Notes’, Australian Office of Financial Management)

(d)       The weighted average issue yield for Tender T08062 (at 4.1964%) was more than the weighted average issue yield for Tender 520 (at 3.6904%). Is this what you would have expected?

Ans:    With current economic conditions in the country, it is expected that the interest rates on short-term government securities will be higher than that of medium to long-term securities. Further, the CGS (Commonwealth Government Securities) yield curve also points out that the interest rates on short term securities (treasury notes) are more than that of medium term securities (1-3 year treasury bonds). Thus, the higher weighted average yield for Treasury Note is expected in the current scenario.

(e)       Will the Australian Office of Financial Management (AOFM) accept the lowest yield first or the highest yield first?

Ans:    There exists an inverse relation between yield to maturity and the price of a bond; (other factors remaining constant) i.e. bonds having high yield to maturity are traded at lower price than that of low yield bonds. The bids are quoted in yields rather than price, therefore, the AOFM will accept the bids in ascending order of bids, i.e. lowest yield bid would be accepted first, this means the entity quoting lowest bid will be paying highest price for the bond being auctioned.

(f)        Why is there a difference in the weighted average issue yield for the two tenders? Use the following yield curve in your answer. What does the shape of the current yield curve tell you about what the market expects to happen to the cash rate in the future?

   Ans:    A yield curve is a graph between the interest rates (yield) on similar debt             securities with            different term to maturities. Typically it is expected that the yield curve is upward             sloping. There is a difference in the weighted average issue yield for the two tenders        because, they are instruments with different term to maturities, and the investors,             generally, demand higher return for longer investment periods as longer term to maturity    securities are riskier than short term securities. However, as it is visible in the yield curve   above, the short term securities are   trading at higher yield than that of the long-term          rates. Yield curve generally forecast the direction in which the economy of a country. The    yield curve above indicates slowdown, or in the worst case recession, of the Australian       economy. Thus, the market expects the cash rates to be reduced in the future by the             Reserve Bank of Australia.

3.         Prior to 2009, the last Treasury Note tender was held on 08 October 2003.

(a)       Why were there no Treasury Notes issued by the government between 2003 and 2009?

Ans:    The Australian Office of Financial Management (AOFM) had discontinued the issuance          of the Treasury Notes in addition to the Treasury Indexed Bonds order to concentrate the           market liquidity in Treasury Bonds. This step was taken in reaction to the declining   market and low demand for the Commonwealth Government Securities in and around      2003. However, in 2009 after the sub-prime lending crisis hit the world, the AOFM had      to start issuing the Treasury Notes again so as to use the proceeds from the issue to fund   short-term expenditures. (Australian Office of Financial Management, annual report 2010-11)

(b)       Why do you think that the government, through the AOFM, is now saying that it will maintain $10billion of Treasury Notes in the market at all times.

Ans:    The AOFM has declared that the minimum outstanding amount of Treasury Notes will be                         $10 billion in order to maintain short-term liquidity in the market. The term to maturity of             the Treasury Notes is less than 6 months and, thus, by maintaining such amount the                              AOFM wants to ensure liquidity in the system and consequently to maintain demand for                          the Commonwealth Government Securities that are being traded in the secondary market.

4.         The AOFM has the following information on its website.

“Treasury Bond issuance in 2011-12 (that is 1 July 2011 to 30 June 2012) is expected to be around $53 billion. After accounting for maturities of $14 billion this represents net issuance of $39 billion. In 2011-12 tenders will be held on Wednesdays and Fridays, with details of the bond lines and amounts to be offered in a particular week announced at noon on the Friday of the preceding week. The face value amount offered at each tender will be in the range $500 million to $1.2 billion, unless otherwise advised.”

(a)       Explain why there will be maturities of $14 billion during the financial year 2011-2012. Is there any way that the AOFM could stop these maturities?

Ans:    Australian Government issues Treasury Bonds through tenders every year. These bonds issued are of different maturities. During the year 2011-12 (1-jul-2011 to 30-jun-2012) there is a treasury bond which is maturing on 15th April 2012 which has an outstanding amount of approximately $14 billion (14.055) and pays coupon of 5.75% (‘Treasury Bonds’, Australian Office of Financial Management).

No, the maturity of the Treasury Bonds cannot be stopped and the Treasury Bonds are not payable until maturity.

(b)       What does net issuance of $39 billion mean to you?

Ans:    As mentioned in the paragraph, the government will be issuing Treasury Bonds worth   $53 billion, however, due to maturity of a bond (5.75%, 15-apr-12) it has to redeem the       bond which is worth $14 billion. Therefore, the net issuance is arrived after subtracting      the outstanding amount of the maturing bond from the total issuance ($53 billion). The    net issuance means that the government will be borrowing a net borrower of $39 billion      through Treasury Bonds in order to fund its Budget Deficit.

(c)       Is the government running a budget surplus or a deficit at the moment? And how does this budget surplus or deficit link to the net issuance of $39 billion?

Ans:    Currently the government is running a deficit of $37.5 billion, as per the mid-year budget update and aims to achieve budget surplus by the end of next financial year 2012-13 (Uren, D 2012, ‘Why Swan needs a budget surplus’, The Australian). The net issuance of $39 billion will be used to fund the budget deficit and as mentioned the number is close to the net issuance, thus, helping the Government in meeting its expenses.

5.         As at March 28th, 2012, the following Treasury Bond tenders had been held since the start of the year.

Source: www.aofm.gov.au/content/statistics/transactional_data.asp

Accessed March 28^th, 2012.

(a)       How many different bonds have been issued so far in 2012? Note that each bond is uniquely described by its coupon and maturity date.

Ans:    According to the table provided, so far in 2012, 12 different bonds have been issued.

(b)       Why do you think the AOFM issued some bonds a number of times? Why didn’t they issue different bonds during that time rather than issuing the same bonds a number of times?

Ans:    The AOFM follows a passive consolidation policy through which it has ensured availability of only few benchmarks trading in the secondary market. Such action has been taken in order to ensure liquidity in the existing benchmark bonds, i.e. Government Securities, as well as in the bond market. Passive Consolidation follows a process of re-issuing existing securities rather than frequent issuance of new bonds. Moreover, presence of large number of bonds increases redemption pressure on the Government as they approach maturity.

(c)       The July 2022 bond was issued on two occasions: once in February and once in March 2012. The weighted average yield of the bond on those two occasions was quite different (3.8059% and 4.3695%). If it was the same bond on each occasion, why wasn’t the weighted average yield the same on each occasion?

Ans:    For an auction of a Treasury Bond, bids are accepted only in yields, and they are accepted          in ascending order i.e. the lowest yield is accepted first. A newly floated bond is expected         to trade at its face value, i.e. the yield is equal to the coupon rate. However, for an already         existing bond, the price of the bond changes due factors like, interest rates, inflation,          exchange rates, liquidity in the market etc. The investors during the issuance of an       already existing bond would quote yields depending on the demand as well as other         factors mentioned above. Moreover, weighted average yield (WAY) is the weighted          average of the yields of all successful bids in an auction where the weights are the share         of the total amount allotted (‘Information Memorandum Treasury Bonds’, Australian   Office of Financial Management). This WAY depends on the range of the yields bid          (lowest to highest) and the amount bid for each quote. Therefore, it is highly unlikely that    the WAY for any two bonds issued would be the same.

(d)       Of the different bonds being issued during the period, which bond do you think the market would watch most closely (in terms of its yield)?

Ans:    Government bonds generally offer low risk (no credit risk) and high liquidity to investors. The market, however, watches closely the 10-year Benchmark Bond, here the bond maturing in Jul-22 and paying a coupon rate of 5.75%. Moreover, the newly issued 15-year bond Apr-27 bond paying 4.75% will also be closely watched.

(e)       There have been 16 different bond tenders conducted since the start of 2012. One of those bond tenders involved the very first issue of that particular bond. Can you identify which bond tender it was? (NOTE: In a previous week we did a question which looked at comparing coupon rates and yields of bonds at the time of their first issue.)

Ans:    One can determine whether a bond has been issued for the first time or not, by comparing       the weighted average yield and the coupon rate of the bonds. If the weighted average           yield of a bond is closer to its coupon rate then it is the first issue of the bond as newly             issued bonds are traded at or close to face value. In this case, the Apr-27 bond paying           4.75% has been issued for the very first time (weighted average yield 4.6245%)

6.         “The Treasurer said today he would offer no advice on interest rates to the independent RBA, which meets for the first time in 2010 next week, but noted that banks had no excuses for hiking rates beyond any official rate increase”

(Source: http://www.theaustralian.com.au/politics/swan-warns-banks-to-limit-rate-rises/story-e6frgczf-1225823994164, Accessed 27/01/2010)

(a)       Why do you think it is so important for the RBA to be seen as independent from the government?

Ans:    It is important for the RBA to be independent from the government so that there are political pressures or influence over the monetary policy, which is one of the main objectives of a Central Bank. It is understood that with government influence, the central bank would not be able to take the correct measures to maintain an effective monetary policy. The RBA is required to increase or decrease interest rates in order to control inflation and many other factors which affect the economy of Australia. Ex-RBA Governor Mr B.W.Fraser emphasised in his speech in 1996 <http://www.rba.gov.au/publications/bulletin/1996/sep/pdf/bu-0996-4.pdf> that the government and the politicians might not take the right decisions with respect to interest rates. Therefore, in order to maintain an effective monetary policy and to perform its duties effectively and efficiently it is necessary for the RBA to be independent from the government.

(b)       Are you aware of any countries in which the central bank is not independent from the government? What have been the consequences?

Ans:    Previously central banks existed which were dependent on banks, however, now almost all the countries’ central banks are independent. But recently the European Central Bank’s independence has been questioned due to the influence of the government of France and Germany which has been prohibiting the bank from doing its job. The consequences are that the main motto of the central bank to control inflation has been compromised.

(c)       When did the RBA enter into an agreement with the government about the conduct of monetary policy (titled the “Statement On The Conduct Of Monetary Policy”)? How have Australian government bond yields behaved since then? Did this agreement give the RBA control over Australian government bond yields?

Source: RBA Chart Pack

Ans:    RBA entered into an agreement titled “Statement on The Conduct of Monetary Policy” (‘Statement on The Conduct of Monetary Policy’, 1996) on 14 August 1996. The above shown graph indicates that the 10-year government yields have been less volatile than since the agreement has been signed. The agreement highlighted not only the conduct of monetary policy, but also encouraged the independence of the RBA for its proper functioning. Thus, since then the RBA has been able to lay out effective monetary policies in order to maintain inflation rates, exchange rates and provide employment to the people of Australia. The yield curve also reflects the fact that the RBA has been meeting the market’s expectation in maintain the monetary policy.

References:

Australian Office of Financial Management, ‘Annual Report 2010-2011’ viewed 03 April 2012 <http://www.aofm.gov.au/content/publications/reports/AnnualReports/2010-2011/html/05_Feature_Article.asp>

Australian Office of Financial Management ‘Information Memorandum Treasury Bonds’, viewed 03 April 2012 <http://www.aofm.gov.au/content/_download/Treasury_Bond_Information_Memo_21_July_2011.pdf>

Australian Office of Financial Management, ‘Pricing Formulae for Treasury Notes’, viewed 03 April 2012 < http://www.aofm.gov.au/content/pricing_formulae.asp?NavID=58>

Australian Office of Financial Management, ‘Treasury Bonds’ viewed 03 April 2012

< http://www.aofm.gov.au/content/investors/bonds.asp?NavID=208>

Fraser B.W. 1996, Governor, Reserve Bank of Australia 1989-96, ‘Reserve Bank Independence’ viewed 03 April 2012

< http://www.rba.gov.au/publications/bulletin/1996/sep/pdf/bu-0996-4.pdf>

‘Statement on The Conduct of Monetary Policy’, 1996, viewed on 04 April 2012

<http://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=4&ved=0CDkQFjAD&url=http%3A%2F%2Fwww.aph.gov.au%2FParliamentary_Business%2FCommittees%2FHouse_of_Representatives_Committees%3Furl%3Defpa%2Frba9899%2Fappendix%2520g.pdf&ei=vtJ7T4XZC8uciQef3dWXCQ&usg=AFQjCNG7_CZW7069P7LXN1b9x5-cbubxuA>

Uren, D 4-apr-2012, ‘Why Swan needs a budget surplus’, The Australian, viewed 03 April 2012

<http://www.theaustralian.com.au/national-affairs/opinion/why-swan-needs-a-budget-surplus/story-e6frgd0x-1226317939617>

JF02

But you can order it from our service and receive complete high-quality custom paper.  Our service offers Accounting essay sample that was written by professional writer. If you like one, you have an opportunity to buy a similar paper. Any of the academic papers will be written from scratch, according to all customers’ specifications, expectations and highest standards.”