Fixed Interest Glossary

Accrued interest

The amount of interest that has been accumulated from the last coupon payment date to the date when a bond is bought or sold.

Accumulation index

An index of movements in a market which takes into account both capital movements in prices as well as the effect of income received.

Active management

An approach to managing investments which aims to achieve returns above a set benchmark. Decisions with respect to asset allocation and stock selection within the portfolio are actively reviewed. See also Passive Management.

Active return

The difference between the return achieved by an investment manager, and the return to the fund's established benchmark.

ADI

Authorised Deposit-taking Institution. ADI's are regulated by APRA.

AFMA

Australian Financial Markets Association. AFMA is the national industry body representing the nearly 200 organisations who participate in the Australian over-the-counter (OTC) wholesale financial markets.

Agency issues (Agencies)

Bonds on issue that are used to fund mortgage financing agencies set up by US statute or subject to a level of implicit or explicit US Government support. Agencies provide home finance to the general public, but focussing on specific socio-economic groups.

American Option

Option which can be exercised by the owner (buyer) at any time through the life of the option.

Annualised rate

The actual interest rate per annum adjusted for the compound effect of interest paid quarterly or semi-annually

Annuity

A series of fixed-amount payments paid at regular intervals over the specified period of the annuity.

AOFM

The Australian Office of Financial Management is an agency within the Commonwealth Treasury responsible for the Commonwealth of Australia's debt management activities.

APRA

Australian Prudential Regulatory Authority. APRA is the prudential regulator of banks, insurance companies and superannuation funds, credit unions, building societies and friendly societies.

ASIC

Australian Securities and Investment Commission.

Asset allocation

The split of assets within an investment portfolio among asset categories such as fixed interest, equites, cash and property. Typically, such allocation is made with a view to balance risk and create diversification.

Austraclear

An electronic system for the settlement of money market securities, as well as Commonwealth, Semi-Government and Corporate Bonds.

Authorised investment

Any authorised investments referred to under the Trust Deed in which any Fund may invest.

Bank bill

A bill of exchange that has been accepted or endorsed by a bank. Liability for repayment at maturity rests with the bank which accepted the bill.

Basis Point

One one-hundred of a percent or 0.01%.

BBSW

Bank Bill Swap Reference Rate. Is a daily calculation of the yields on bank bills of 1, 2, 3, 4, 5, and 6 month maturities. It is calculated as at 10 a.m. each day with reference rates used for the setting of financial arrangements.

Bear market

A market in which yields are rising (prices falling).

Benchmark

A standard used for comparison. These are market recognised indicators such as the UBS Warburg Composite Bond Index which measures the price movement of selected securities which comprise the Australian bond market. Benchmarks are used as a measure of comparing a portfolio's return against a similar portfolio of securities.

BoE

Bank of England.

BoJ

Bank of Japan

Bull market

A market in which yields are falling (prices rising).

Bid/Offer spread

The difference in basis points between a security’s buy and sell yield (or price). Fixed interest market makers use this to pay for the provision of liquidity to a market as opposed to separate brokerage as is in the case of equity markets.

Capital gain

Profit from the sale of capital assets such as bonds. Investors often buy securities for expected the increase in value rather than for coupon income.

Capital guaranteed

A guarantee to return to you at least the amount invested.

Capital Notes

Very similar to unsecured debentures. They pay a fixed unfranked rate of interest, may exist for many years and are redeemed at face value at the end of that period.

Capital price

Gross price less accrued interest. Also known as ‘clean price’.

Cash Management Trust

Unit trust in which the manager of the trust invests the pooled investor funds primarily in a range of short term securities including Treasury notes, bank bills and selected commercial bills. Because these investments are usually for periods of between 90 and 180 days (securities which can easily be resold if required) it means that there is a pool of cash always available for those investors who wish to withdraw their funds at short notice. As there are generally minimal fixed long term investments, the return received may vary on a daily basis.

Cash rate

The interest rate which financial institutions pay to borrow or charge to lend funds in the money market on an overnight basis. The RBA uses a narrower definition of the cash rate as an operational target for the implementation of monetary policy.

CGS

Commonwealth Government Securities. Includes all securities issued by the AOFM on behalf of the Commonwealth Government, comprising Treasury bonds, Treasury notes, Treasury indexed bonds and, previously, Treasury adjustable rate bonds. These securities are issued by multi-price tender.

Clean price

See Capital Price.

Contract note

Formal confirmation of the details of a transaction done between you and your adviser.

Convertible note

A loan made to a company at a fixed rate of interest with the right to be either redeemed for cash or converted into ordinary shares at a predetermined date or within a certain period.

Corporate bonds

A fixed interest security where the borrower is a company rather than a Government or Semi-Government Authority. Generally considered to be more risky than Government issued debt, therefore attracting a higher yield.

Counterparty

Party with which a trade is done.

Coupon

The interest rate paid on the specified date to an investor in a bond. Coupons can be paid monthly, quarterly, semi-annually or annually. Most bonds pay a semi-annual coupon (i.e. twice a year).

Coupon date

The date on which a coupon is paid to bond investor.

Coupon margin (or issue margin)

The spread above the variable rate (BBSW) on a floating rate instrument. If a FRN pays the 3-month bank bill + 0.50% each quarter then 0.50% (or 50 basis points) is the coupon margin.

CPI

Consumer Price Index, official government measure of inflation published by the Australian Bureau of Statistics.

CPI Bond

A bond where the coupon payment or the principal amount is adjusted in line with the CPI. Also known as indexed linked bonds.

Cum interest

A security is cum interest if its price includes the next due interest payment.

Credit risk

The possibility that a borrower will fail to pay the principal amount and/or interest on a debt instrument in a timely manner. Typically the higher the perceived credit risk, the higher the yield or interest rate spread to like maturity securities.

Debenture

A loan made to a company for a fixed period of time at a fixed rate of interest. The loan is not secured by a charge over the company's assets, but rather is backed by the credit status of the borrower. Debentures are not considered liquid or tradeable securities.

Derivatives

These are financial instruments such as interest rate futures, swaps and options, whose value is "derived" from underlying physical assets. Derivatives are used:

• To offset the risk of price variations of securities
• As an alternative to purchasing/selling the physical security
• To benefit from any opportunities for profit which may exist in the market from time to time

Dirty price

See Gross Price.

Discount

When the capital price of a bond is less than its face value it is said to trade "at a discount". This will occur when the security’'s current yield is trading above its coupon.

Discount security

A security that is issued and traded at a discount to face value. Discount securities make only one payment the face value, on the maturity date and include Treasury Notes, Bank Bills and Promissory Notes. The difference between what is paid for the security at purchase and face value is the interest component.

Diversification

The act of spreading investments, that is “not putting all your eggs in the one basket”. A diversified portfolio has a spread of securities across various assets and asset classes in such a way that attempts to control the risk and the variability of returns.

Dividend

Distribution of part of a company's after-tax profit to shareholders by way of cash or as additional shares in the company.

Duration

A technical measure of the length of maturity of a fixed interest security. The longer the duration of a security, the more sensitive its price is to changes in yield.

ECB

European Central Bank.

Effective exposure

The total economic (or underlying) exposure to a market generated by the use of derivatives.

Emerging markets

The financial markets of developing economies. Returns are potentially high relative to more mature economies, but are subject to a higher degree of risk and volatility.

European option

Option which can be exercised by the owner (buyer) only at expiry.

Ex-Interest

A security is ex-interest if it excludes the next due interest payment. If you purchase a bond ex-interest (thus close to an interest payment date) the seller will receive the entire next due coupon and the price paid is adjusted accordingly.

Exchange traded

A security traded on an exchange.

Fixed Interest Security

A debt security where the coupon is generally fixed and where the capital value is known if the asset is held to maturity. Securities are issued by Government and corporate borrowers.

FOMC

Federal Open Market Committee, the body responsible for setting monetary policy in the United States. The FOMC chairman is Alan Greenspan.

FRA

Forward Rate Agreement. Is a derivative used for managing cash flow and risk in financial markets.

Franked dividend

A dividend which carries the right to an imputation (tax) credit, arising because of the difference between the rate of company tax paid and the investor's marginal tax-rate. The declaration (by the company) of the right to an imputation credit attaching to dividends is known as franking. Has relevance to hybrid type securities that exhibit interest rate characteristics when considering the total return of the investment.

FRN

Floating Rate Note, a security with a yield that is reset periodically (typically every 90 days). The yield is set with reference to BBSW.

Fund

A Trust individually constituted under or governed by the Trust Deed.

GDP

Gross Domestic Product. A measure of the total value of goods and services produced in an economy in a period (usually a quarter or a year).

Government bond

A debt security issued domestically by the Commonwealth of Australia, or internationally by the central government of a sovereign nation.

Gross price

The total price an investor pays when buying a bond. Gross price = capital price + accrued interest. Also known as “dirty price”.

Hedging

An investment made in order to reduce the risk of adverse price movements in a security, by taking an offsetting position in a related security or instrument, such as an option or futures contract.

Investment grade

The description used by ratings agencies for securities such as bonds and notes that are of sufficient quality to be classed as sound investments. For example, Standard & Poor's consider their top four long term categories, AAA to BBB, to qualify as investment grade. The equivalent long term categories from Moody’s are Aaa to Baa3.

Issue margin

Or coupon margin is the spread above the variable rate (BBSW) paid on a floating rate instrument. If a FRN pays the 3 month bank bill + 0.50% each quarter then 0.50% (or 50 basis points) is the issue margin.

Liquidity

The ease with which an asset can be converted into cash without any significant price discount. For example, cash is considered to be the most liquid asset, followed by bonds which are considered more liquid than equities.

Listed Securities

Securities that are approved for admission to trading on the Stock Exchange.

Market timing

Referred to commonly as buying when yields are high (prices low) and selling when they are low (prices high). Market and economic factors are taken into account when considering the best time to invest.

Maturity date

The date on which the face value and the final coupon payment will be repaid to the investor.

Modified Duration

The percentage change in price (or market value of a security) for a one percent change in yield from current levels.

Monetary policy

Measures adopted by a Central Bank to influence the economy. In Australia, the Reserve Bank is responsible for monetary policy. It has a target inflation range of 2-3%, and therefore adjusts interest rates so as to achieve sustainable level of growth in the economy without endangering this target band through the business cycle.

Money market

The securities market dealing in short-term debt and monetary instruments. Money market instruments are forms of debt that mature in less than one year and are generally very liquid.

MBS

Mortgage Backed Securities are securities whose value is derived from an underlying pool of residential mortgages. The mortgages are pooled and secured against the issue of bonds. The bonds are known as MBS.

NCD

Negotiable certificate of deposit. Debt instrument issued by a bank in its own name for funding purposes.

OECD

Organisation for Economic Co-operation and Development.

Option

An instrument which conveys the right, but not the obligation, to the buyer to buy (call option) or sell (put option) a certain security on specified terms within or at a specified time. The seller of the option position has the obligation to satisfy the buyer’s right.

Over the counter

A security that is not traded on an exchange such as Sydney Futures Exchange but transacted over the phone between professional investors and brokers.

Overnight Cash (11am)

Wholesale cash deposit made with a bank, with the rate renegotiated each day by 11am.

Par

A bond at par is one whose market value is the same as its face value (i.e. price = 100.000).

Passive management

An approach to managing investments whereby the composition of a market segment or index is mirrored in order to achieve a similar return and risk profile. See also Active Management.

Perpetual income securities

Interest rate securities which pay an annual interest rate, but have an infinite life (i.e. no redemption). The interest rate may be fixed forever, or periodically reset (eg every 90 days).

Preference shares

Securities issued by a company that rank above ordinary shares for claims on assets, earnings and dividends but rank below creditors and debenture holders. These shares usually have a fixed dividend rate.

Premium

When a bond's price exceeds 100.000 (face value) it is said to be trading "at a premium". This will occur when the security’s current yield is trading below its coupon.

Price index

An index of movements in a market which takes into account only the movement in prices.

Primary market

The new issue market.

Promissory note

An unconditional promise to pay to the holder of the note a fixed amount (face value) at a fixed date (maturity date). Defined more fully in the Bills of Exchange act as: "an unconditional promise in writing by one person to another, signed by the maker, engaging to pay on demand or at a fixed or determinable future time a sum certain in money for or to the order of a special person or to bearer".

Property trust

Trust established to allow investors to pool their funds and invest in large properties (eg. shopping centres). Securities are often analysed or traded on the income yield they are expected to pay to investors.

Purchase price

The dollar amount paid for bonds (gross price to 3 decimal places multiplied by units in lots of 10,000). If a bond’s price equals 102.120 and its face value equals $500,000, the purchase price equals $510,600.

Rally

A fall in yields (rise in price).

Rated securities/investments

Securities that have been assigned a credit rating by a recognised rating service indicating the likelihood that a debt issuer will be able to meet scheduled interest and principal repayments.

RBA

Reserve Bank of Australia.

RTGS

Real-time gross settlement. A payment system used in wholesale markets in which processing and settlement of securities takes place in real time (continuously) as opposed to at “end-of-day”.

Repurchase agreement

The mechanism by which most Reserve Bank of Australia (RBA) domestic market operations are conducted. Repurchase agreements (usually called 'repos') involve the sale or purchase of securities with an undertaking to reverse the transaction at an agreed date in the future and at an agreed price. Repos provide flexibility in that they allow the RBA to inject liquidity on one day and withdraw it on another with a single transaction. There is also an informal market whereby securities are borrowed and lent within the financial markets.

Reset Preference Shares

Securities issued by a company that rank above ordinary shares for claims on earnings and dividends but rank below creditors and debt holders. In the event that the company is wound up RPS holders will generally rank in line with ordinary share holders. These securities can have a fixed or floating rate dividend. The term Reset applies because these securities have no fixed maturity but allow the issue to reset the terms at a known date in the future.

RITS

Reserve Bank Information and Transfer System. RITS is an electronic system for the settlement of exchange settlement cash transactions with the RBA and other banks.

S&P/ASX 200

Index which measures the level of Australian share prices at any given time. The S&P/ASX 200 is calculated using the current prices of 200 Australian companies listed on the Australian Stock Exchange.

Secondary market

Market where existing securities are traded.

Secured note

A note backed by a charge over an asset of the borrower.

Semi-Government bond

A negotiable debt instrument issued by an Australian State Government.

Senior note

Class of debt that ranks ahead of other debt and equity.

Settlement date

The date at which the payment for the security is made.

SPV

Special Purpose vehicle. Usually used in securitisations (eg Mortgage Backed Securities)

Subordinated debt

A class of debt that ranks behind other debt but ahead of equity.

Swap

A financial arrangement where two parties agree to exchange cashflows based on an agreed rate and/or basis. For interest rate swaps, one party to the swap would typically pay a fixed interest rate to and receive a variable interest rate from their counterparty.

Stock selection

The selection of the individual securities within a portfolio. This follows a process of analysis and the exercise of judgement as to which securities are most likely to add value to a portfolio’s return.

Sub-investment grade

Investments rated below investment grade. Speculative in nature.

Supra-national issue

A security issued by an entity that does not have one particular national identity, such as the European Community or a regional bank such as the Asian Development Bank or World Bank. Typically very highly rated.

Term deposit

Money invested (with a Bank or Building Society) for a fixed period of time at a pre-determined rate of interest in a non-negotiable form.

Tier 1 capital

That part of a bank's capital base consisting of share capital and other non-redeemable capital and reserves.

Trading margin

The margin above (or below) a variable market indicator (BBSW) where a floating rate security is trading in the market. It is the actual effective margin you will receive on a FRN if you buy it at the current price and hold it until maturity.

Transfer & Acceptance

Manual registration form used to register change of ownership of securities. Treasury Note Commonwealth Government issued short term securities for 5, 13 and 26 week periods issued at a discount to face value.

Trust

Investment vehicle which pools investors’ money, and is managed by financial professionals on behalf of those investors. Trusts generally concentrate on one area of investment.

Unit

An undivided part or share in a Fund as defined in the Trust Deed.

Unit holder

Investor registered under the Trust Deed as the holder of a Unit in a particular Fund.

Unit Trust

A form of pooled investment where a manager invests funds on behalf of a group of investors.

Unrated securities

Securities that have not been assigned a credit rating by a rating agency.

Unsecured note

A bond or note that is not backed by an asset or charge over an asset.

Wholesale market

Term used to describe that sector of the financial market where large institutions generally deal in minimum size parcels of at least $10,000,000.

Yield

The return to investors from a particular security, expressed as a percentage. Typically expressed as Yield to Maturity (YTM).

Yield curve

A visual representation of the term structure of interest rates, showing the relationship between yields and maturity.

Zero coupon bond

A bond with a coupon rate of zero. It trades at a deep discount to (well below) face value. Investors who buy and hold to maturity receive the face value, therefore earning the purchase yield on the security. Such securities are not common in Australia subsequent to the introduction of Division 16E of Part III the Income Tax Assessment Act 1936, which requires investors to bring to account for tax purposes, notional accrued interest in each year, despite actually receiving no cash income.

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