Key characteristics of the major fixed income products

To assist you identify the type of fixed income product that can help you meet your investment objectives (and that has a level of risk that is acceptable to you), outlined below are some of the features of the various instruments and securities traded in the fixed income markets. If there are other aspects of the products that you are unsure about +but would like further information on, we invite you to contact a RIMsec authorised representative who can assist you further.

Cash or term deposits

• Deposits can be placed with commercial banks, building societies and finance companies for a fixed period of time from 1 week to 3 years.
• Minimum deposit amounts can be quite low e.g. $10,000.00
• The interest rate is fixed at the start of the deposit and can be paid on a simple basis (interest is calculated on the principal alone) or on a compounded basis (which means that interest is calculated on both the principal and the interest previously earned). The frequency of the compounding can make a big difference to your return. The more frequent the compounding, the higher the return.
• When you break a deposit earlier than its maturity date, there is often a penalty or interest rate adjustment that will be incorporated into the principal repayment. This adjusts the interest earned to the appropriate interest rate for the actual term of the deposit compared to the term initially agreed to. Remember that higher interest rates will usually apply to longer terms and vice versa.
• The market convention is to assume there are 365 days in each year.
• The Rule of 72 can be used to estimate the time it will take to double your investment money when earning compound interest. Simply take the compound interest rate and divide it into 72. The result is the time it will take to double your investment. For example, if an investment pays an annual return of 6%, it will take 12 years to double your money (72 divide by 6).

Treasury notes

• Treasury notes are short term securities issued by weekly tender by the Federal Government through the Reserve Bank of Australia.
• As a government issued security, treasury notes have low risk compared to other issuers or you can say they have a high credit rating.
• They are issued in maturities of 5, 13 or 26 weeks.
• The minimum bid amount is $100,000, thereafter multiples of $5,000.
• Whilst the Reserve Bank of Australia offers a rediscount facility on treasury notes which means that they will buy the treasury notes back from investors at current market yields, it is rarely used. However, there is a very active secondary market between banks and other financial institutions for treasury notes which trades on a yield basis.
• Treasury notes are used primarily by large institutional investors to manage their short term cash flows.
• Minimum investment amount is $100,000, thereafter multiples of $5,000
• Treasury notes are issued at a discount and bid for on the basis of the lowest yield.
• Normal dealing practice is to quote a net redemption yield calculated to two decimal places.
• Settlement occurs on the same day if the trade occurs in the morning and the next day if it takes place in the afternoon.
• The interest you earn is the difference between the discounted price paid to purchase the Treasury note and the par value repaid on maturity.
• There is no withholding tax on treasury notes.

Bank bills

Bank bills are negotiable instruments sold at a discount to their face value. They are defined in the Bills of Exchange Act 1909 as "an unconditional order in writing addressed by one person to another signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable further time, a sum certain in money to the order of a specified person, or to bearer."

• Terms can vary from 1 day to 6 month but the most common periods are 30, 90 or 180 days.
• There are two main types: bank endorsed bills or bank accepted bills. Bank accepted bills are more common these days.
• Title of "bearer" bills can be readily transferred by delivery. "Order" bills require endorsement before delivery can be effected.
• Physical possession and safe custody of the bill is of paramount importance.
• Treasury notes are issued at a discount and bid for on the basis of the lowest yield.
• Normal dealing practice is to quote a net redemption yield calculated to two decimal places.
• Settlement occurs on the same day if the trade occurs in the morning and the next day if it takes place in the afternoon.
• Bank bill yields provide the standard reference for pricing all short term securities in Australia.
• Bank bills are very liquid because they have an active secondary market.
• Interest rates on bank bills are published daily in the financial press.

Commercial paper (promissory notes)

Commercial paper or promissory notes are unconditional promises to repay a certain amount of money at maturity.

Commercial paper, as it is now more commonly known, is issued for periods of up to six months and can be easily traded without endorsement by the issuer. This enhances their liquidity compared to other products.

Only issuers with a very high credit rating can issue commercial paper and they include industrial companies, state governments, other government borrowers and finance companies.

Negotiable certificates of deposit (NCDs)

• Negotiable certificates of deposits are issued by banks and are like cash deposits.
• The bank issues the investor with a certificate of deposit as proof of the ownership of the deposit.
• The deposit will be for a specified term or maturity, ranging from a few days to eighteen months, and will bear an agreed interest rate.
• Many of these certificates of deposit will be negotiable and can be traded in the secondary market making them more liquid than say, term deposits.

Treasury bonds

• Treasury bonds are debt securities with maturities of 1, 3, 5, 7, 10, 15 and 30 years issued at periodic tenders by the Commonwealth Government. Minimum bids are for $100,000 and increments of $1000 thereafter.
• The coupon (or interest) on a Treasury bond is paid semi-annually on the 15th of the month.
• At maturity, the Government pays the amount borrowed back to the bondholder.
• Because the bonds are issued for periods greater than a year, the value of the bond at a particular point in time fluctuates according to the level of market interest rates. In this way, the bondholder can either make a capital gain or loss on the bond.
• The Treasury bond market is a deep and liquid market with the major traders being the banks, investment banks, large institutions and fund managers.
• Treasury bonds are rated AAA by Standards and Poors and Aaa by Moodys.
• Treasury bonds are bid for and traded in the secondary market on the basis of nominated yield to maturity.
• Bond prices are quoted to three decimal places per $100 nominal using the Reserve Bank of Australia's standard pricing formula. The price includes the capital/principal price plus accrued interest. See Pricing formulas section.
• Settlement occurs within three business days after the trade date. However, bonds with only six months to maturity are traded like money market instruments and settled the same day.
• The accrual basis for calculating accrued interest is actual/actual meaning that the actual number of days in the period is used.
• Treasury bonds trade ex-coupon 7 days prior to the coupon date.
• The primary benchmarks for the Treasury bond market are the 3 year and 10 year bond futures contracts and the 90 day bank bill futures contract. Physical bonds with these maturities are the most liquid securities in the market.

Semi-government bonds

• Semi-government bonds are long term securities issued with maturities of 1, 3, 5, 7, 10, 15 and 30 years by the agencies of the Commonwealth Government for example state governments.
• Bond prices are quoted to three decimal places per $100 nominal using the Reserve Bank of Australia's standard pricing formula. The price includes the capital/principal price plus accrued interest. See Pricing formulas section.
• Settlement occurs within three business days after the trade date. However, bonds with only six months to maturity are traded like money market instruments and settled the same day.
• The accrual basis for calculating accrued interest is actual/actual meaning that the actual number of days in the period is used.
• Treasury bonds trade ex-coupon 7 days prior to the coupon date.

Corporate bonds

• Corporate bonds are long term securities issued with maturities of 1, 3, 5, 7, 10, 15 and 30 years by financial and non-financial companies.

Floating rate notes (FRNs)

• Floating rate notes, as their name suggests, are securities with a variable coupon rate.
• The coupon rate will be typically set as a fixed margin above an index, for example, the bank bill index.
• The coupon will be reset and paid quarterly to reflect changes in market rates.
• Trading of FRNs in the secondary market is limited and dealers will generally price and place FRNs on a best endeavors basis.

Asset-backed securities

• Asset backed securities are securities secured by a pool of assets held by a trust or other entity and managed by a professional manager. The Australian market is dominated by "mortgage backed securities".
• Most investors buy these securities on the assumption they will be held to maturity.
• Trading of asset-backed securities in the secondary market is limited and dealers will generally price these securities on a best endeavors basis.
• Pricing of asset backed securities is not straight forward. In most cases, it will have to be done according to individual circumstances.
• Mortgage-backed securities are priced according to the standard Reserve Bank of Australia formula for pricing bullet securities.
• Settlement terms are negotiable but these trades will usually be settled in accordance with standard settlement procedures i.e. T+3

Index linked securities

• Index-linked securities have part of their returns linked to an index of some kind, for example, the consumer price index. Using the consumer price index ensures that the investor enjoys stable "real" returns (i.e. Inflation adjusted returns).

Hybrid Securities

• Hybrid securities is a broad classification for a group of securities, used by ASX listed companies to raise money, that combine both debt and equity characteristics.
• Hybrid securities pay a predictable fixed or floating rate of return or dividend until a certain date. At that date the holder has a number of options including converting the securities into the underlying share. Therefore, unlike a share, the holder has a known cash flow, and, unlike a fixed interest security, there is an option to convert to the underlying equity.
• More common examples include convertible and converting preference shares.
• It is important to note that a hybrid security is structured differently and while the price of some securities behave more like fixed interest securities, others behave more like the underlying shares that they convert into.