Question

Clearly describe the trading arrangements, pricing conventions and settlement provisions in the Australian bond market.

Answer 1

Australia has well-developed financial markets across major products, including money, debt, equities, foreign exchange and derivatives.The Australian debt market is relatively small on a global scale.

Trading arrangements

Debt securities which are also quoted on ASX are traded, cleared and settled in the same way as equity securities. Trading in ASX quoted debt securities is conducted between broking firms who act on behalf of their clients, in the same way as for quoted equity securities. The trading is conducted electronically via the ASX Trade platform. Settlement occurs in the Clearing House Electronic Subregister System (CHESS) where the participants are ASX brokers, specialist third party clearing organisations and approved institutions.

You can buy corporate bonds directly from the issuer through a public offer (known as the primary market) at face value. You can also buy some corporate bonds on the ASX after they have been in the primary market (known as the secondary market).

Pricing conventions

Each bond has a par value, and it can either trade at par, at premium, or at discount. ... The price of a bond is determined by discounting the expected cash flow to the present using a discount rate. Three primary influences on bond pricing on the open market are supply and demand, age-to-maturity and credit ratings.

Understanding Market Pricing – Dirty vs. Clean Price

There are 17 eTBs and 5 eTIBs listed on the ASX. Each of these securities has a similar name but their market values are very different and hence investors should be careful not confuse one security with another. The price of each security is driven by its yield to maturity, which in turn is driven by the shape of the yield curve and expectation of inflation. When you purchase an eTB (or eTIB) on the exchange, the price you pay is referred to as the ‘dirty price’, which includes accrued interest. To calculate the correct yield, we must first subtract the accrued interest and thereby remove unnecessary volatility from the market price.

As an example, let’s take a TB which settles on 15 December paying a 6.25% coupon semi-annually on 15 April and October. At the settlement date the bond has accrued interest for 61 days, which equates to: $100 (notional) x 0.16711 x 6.25% (Coupon) = $1.04 Hence: Clean Price = Dirty Price - $1.04

Settlement Provision

Settlement takes place two business days after a trade occurs. For settlement through CHESS, payment and title exchange take place simultaneously.

Settlement occurs automatically two business days after a trade takes place (referred to as T+2). It is an automatic process provided by ASX, and involves two simultaneous processes:

1. Payment is made for the trade by electronic transfer.
2. The legal ownership of the security is transferred to the buyer.

This process is referred to as ‘delivery versus payment’ (DvP). The settlement process is handled by a settlement participant, who may be your broker or an agent contracted by your broker.

Off-market settlement

CHESS also enables investors to carry out off-market transfers, such as giving shares to another person as a gift. To do this, you simply tell your broker you wish to make an off-market transfer.