Fixed Income & Rates Path

The **money market** is the wholesale market for short-term debt with maturity of **one year or less**. It supplies liquidity and funding for governments, banks, and large corporations. Core instruments are **Treasury bills**, **bank-accepted bills**, **negotiable certificates of deposit**, **commercial paper**, **repurchase agreements**, and the units of **money market funds**. Rates pivot off the central bank's policy rate, the **cash rate** in Australia and the **federal funds rate** in the United States.

**Treasury bills** are short-term government securities issued at a discount to face value and redeemed at par. **Bank-accepted bills** are similar instruments issued by corporations but **guaranteed (accepted) by a major bank**, which substitutes the bank's credit for the issuer's. Both are **zero-coupon**. Australian Treasury Notes (AOFM) and bank bills use **simple interest ACT/365**, while US T-bills (Treasury Direct) use the **bank discount basis ACT/360**.

**Commercial paper (CP)** is an **unsecured short-term promissory note** issued by large, creditworthy corporations and financial institutions to fund working capital and short-term liabilities. US CP maturities cap at **270 days** to avoid SEC registration under section 3(a)(3) of the Securities Act. Issuers typically need a short-term credit rating of **A-1, P-1, or F1** to access the market at competitive yields. CP is **zero-coupon**, sold at a discount to face value, and predominantly held by money market funds.

A **certificate of deposit (CD)** is a time deposit issued by a bank with a fixed term, fixed interest rate, and fixed face value. **Negotiable CDs (NCDs)** are tradable in secondary markets, while retail CDs are not. Australian banks issue large quantities of NCDs in the wholesale money market, and US institutional NCDs typically come in denominations of US$100,000 or more. Interest is paid at maturity in money market form for short tenors, or periodically for longer-dated CDs. **Note** in this Atlas CD refers to *certificate of deposit*, not credit default swap.

A **money market fund (MMF)** is a pooled vehicle that invests in short-term, high-quality debt such as T-bills, bank bills, certificates of deposit, commercial paper, and repurchase agreements. In the US, MMFs are regulated under **SEC Rule 2a-7**. Government and retail MMFs may use a **stable $1.00 NAV** under amortised cost, while institutional prime and tax-exempt funds must use a **floating NAV**. The Australian equivalent is a **cash management trust** or **enhanced cash fund**. MMFs are the largest single buyer of commercial paper and short-dated bank debt.

Australian **bank-accepted bills** are priced by **simple-interest discounting** of face value, $P = FV/(1 + y \times d/365)$. The convention is set by the **Australian Financial Markets Association (AFMA)** and follows **ACT/365**. $FV$ is face value, $y$ is the annualised yield, and $d$ is the number of calendar days to maturity. The same formula prices **negotiable certificates of deposit** and **Treasury Notes** in the AUD market.

The **yield curve** plots interest rates against maturity for a homogeneous credit such as Australian Government Bonds or US Treasuries. Four canonical shapes appear. A **normal** curve slopes upward (long yields exceed short yields), an **inverted** curve slopes downward, a **flat** curve has roughly equal yields, and a **humped** curve peaks at intermediate maturities. Three theories explain shape, the **pure expectations** theory, the **liquidity preference** theory, and the **market segmentation** or preferred habitat theory.

A **zero rate** (or **spot rate**) is the yield on a single payment due at a future date with no intervening cash flows. It is the rate that discounts a payment at time $T$ to its present value. Zero rates form the **discount curve** used to price every cash flow in a fixed-income portfolio. The discount curve is recovered from observable market data via **bootstrapping** of T-bills, coupon bond prices, and swap rates.

A **forward interest rate** is the rate implied by today's zero curve for borrowing or lending over a future period $[T_1, T_2]$. It is the rate that makes investing in a zero-coupon bond to $T_2$ equivalent to a zero to $T_1$ rolled into a forward zero from $T_1$ to $T_2$, by **no-arbitrage**. Forward rates are inputs for forward rate agreements (FRAs), interest rate futures, swaps, and the valuation of any contract whose cash flows reset against future short rates.

A **bond's price** is the present value of its future cash flows, namely the coupon stream and the face value at maturity. The most common shortcut uses a single **yield to maturity** $y$ to discount every cash flow. The theoretically correct method discounts each cash flow at the **zero rate** matching its date. Bond prices move **inversely** to yields, and the sensitivity is summarised by **duration** and **convexity**.

The **coupon rate** is the annual interest the bond promises to pay, expressed as a percentage of face value. The **yield to maturity (YTM)** is the discount rate that equates the present value of all future cash flows to the bond's market price, the effective return if held to maturity with coupons reinvested at the same rate. **Accrued interest** is the share of the next coupon that has accumulated since the last payment date. It is added to the clean (quoted) price to give the **dirty price** that actually settles.

The **settlement date** is the day on which the bond changes hands and the buyer pays the seller. Australian Government Bonds and US Treasuries both settle on **T+1** following Austraclear and Fedwire reforms, while corporate bonds in most jurisdictions settle on **T+2**. Accrued interest is calculated from the **last coupon date to the settlement date** and added to the clean price. The buyer pays the **dirty price** at settlement and later receives the full coupon at the next coupon date.

**Interest rate futures** are exchange-traded contracts whose value depends on a future interest rate or bond price. On the ASX, the two flagship contracts are the **90-day Bank Bill futures** (short-term rates) and the **3-year and 10-year Treasury Bond futures** (long-term rates). Globally, the equivalents are **SOFR futures** at the CME (replacing Eurodollar futures after the 2023 transition) and **Euribor futures** at Eurex (Hull, 2022, §6.3). Outstanding notional in OTC interest rate derivatives was about US$600 trillion at end-2024 (BIS).

ASX **90-day Bank Bill futures** are short-term interest rate contracts on A$1 million face value of 90-day Bank Accepted Bills issued by **Prime Banks** (as defined in the BBSW conventions). Quotes follow the $P = 100 - Y$ convention. The contract cash-settles against the 3-month **BBSW** (Bank Bill Swap Rate) on the second Friday of March, June, September or December. A 1 basis-point move corresponds to roughly A$24 of P&L per contract (ASX 90-Day BAB Factsheet).

ASX **3-Year and 10-Year Treasury Bond futures** are exchange-traded contracts on a notional Commonwealth Government bond with A$100,000 face value and a 6% coupon. Quotes use the $P = 100 - Y$ convention, where $Y$ is the yield of the underlying bond basket. Settlement is **cash**, against the average yield of a basket of eligible Commonwealth bonds on the second Wednesday of March, June, September or December. These two contracts are among the **most liquid** rate futures globally (ASX 3 & 10 Year Factsheet).

Most short-term interest rate futures use the **100 minus yield** quoting convention. ASX 90-day Bank Bill futures, ASX 3-year and 10-year Treasury Bond futures, CME 3-Month SOFR futures and Eurex 3-Month Euribor futures all quote $P = 100 - Y$, where $Y$ is the annualised yield in per cent. This is a **convention**, not a fair-value price. The key consequence is the **inverse relationship**, yields up means futures price down (Hull, 2022, §6.3).

A **Forward Rate Agreement (FRA)** is an over-the-counter contract that locks in an interest rate for a future borrowing or lending period. The buyer pays the **fixed FRA rate** and receives the prevailing market rate. Settlement is **in cash at the start** of the reference period, with the interest differential **discounted** back to the settlement date because the cash flow comes earlier than the natural end-of-period payment (Hull, 2022, §4.7).

FRAs and short-term interest rate futures both lock in a future rate, but they differ on five dimensions, **venue** (OTC vs exchange), **standardisation** (custom vs fixed lot and expiry), **settlement** (start of period, discounted, vs daily mark-to-market), **counterparty risk** (bilateral, usually collateralised vs central clearing) and the **convexity adjustment** that makes futures-implied rates slightly higher than forward rates for long maturities (Hull, 2022, §6.4).