Library/CFA (Chartered Financial Analyst)/JuiceNotes 2024 Fixed Income/Fixed-Income Markets for Government Issuers

Fixed-Income Markets for Government Issuers

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Government Balance Sheets and Sovereign Profiles5 min

Sovereign credit analysis requires looking beyond standard cash-based financial accounting. The economic balance sheet offers a more comprehensive view by including the present value of future tax revenues as assets and promised future expenditures as liabilities. The text highlights the structural differences between Developed Markets (DM) and Emerging Markets (EM). DMs typically enjoy diverse economies and reserve currency status, allowing unconstrained access to capital. EMs often rely on dominant industries, face political instability, and may struggle with debt denominated in restricted domestic currencies or volatile foreign currencies.

Key Points

Financial balance sheets often exclude depreciation and unfunded liabilities.
Economic balance sheets include expected future tax revenue and obligations.
DMs have transparent fiscal policies and stable, diversified economies.
EMs face higher risks due to industry concentration and currency illiquidity.

Debt Management and Ricardian Equivalence5 min

Ricardian Equivalence posits that government deficits do not stimulate the economy because rational taxpayers save in anticipation of future taxes. While this suggests debt maturity is irrelevant, governments in reality utilize maturity management to mitigate rollover risk. Issuing long-term debt helps establish a risk-free benchmark curve, aids in hedging interest rate risk, and provides high-quality collateral for repo markets, despite the typically higher cost compared to short-term funding.

Key Points

Ricardian Equivalence assumes rational, altruistic taxpayers and perfect capital markets.
Short-term debt minimizes cost but increases rollover risk.
Long-term issuance creates benchmarks for private market pricing.
Government bonds serve as collateral for repo and derivatives.

Sovereign Debt Issuance: Auction Mechanisms6 min

Sovereign debt is issued via public auctions involving competitive and non-competitive bids. In a single-price (Dutch) auction, all winning bidders pay the yield of the lowest accepted bid (the stop yield), encouraging aggressive bidding and reducing the winner's curse. In a multiple-price auction, winners pay the price they bid, which can lead to a narrower distribution of bids. The process involves announcement, bidding, ranking by yield (lowest to highest), and allocation.

Key Points

Competitive bids specify price/yield; non-competitive bids accept the auction result.
Single-price auctions result in one uniform price for all winners.
Multiple-price auctions charge winners their specific bid prices.
Bids are ranked from lowest yield (highest price) to highest yield.

Secondary Markets and Non-Sovereign Debt5 min

The secondary market distinguishes between on-the-run securities (most recent, highly liquid) and off-the-run securities (older, less liquid). Primary dealers facilitate liquidity and serve as counterparties for central banks. The chapter also covers non-sovereign debt, including agency bonds, supranational debt (e.g., IMF, World Bank), and local government bonds. Local bonds are split into General Obligation (tax-backed) and Revenue bonds (project-specific cash flows).

Key Points

On-the-run bonds are benchmarks with lower bid-ask spreads.
Off-the-run bonds trade at higher yields due to lower liquidity.
Supranational debt has high credit quality due to member state support.
Revenue bonds are repaid from specific project income, not general taxes.

Questions

Question 1

Which of the following items is most likely to be included in a government's economic balance sheet but excluded from its standard financial balance sheet?

Fixed-Income Markets for Government Issuers

Questions

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