What is Risk-Free Debt?

What are the Risk-free debt properties?

• Increases in value at times of market stress as investors seek its safety to protect them from volatility
• Referred to as safe-haven assets – investors are sure they’ll receive their money back regardless of market conditions
• Typically offer low returns

How can investors calculate the returns they should demand?

Capital Asset Pricing Model:

What are High-Quality Liquid Assets?

Assets that are:

• Unencumbered
• Freely transferable
• Well diversified
• Easily and immediately converted into cash
• Capacity to generate liquidity remains intact, even during periods of severe market stress

What are the benefits of HQLAs?

• Low risk and low volatility
• Ease and certainty of valuation
• Low correlation with risky assets
• Are listed on recognised exchange
• Have an active and sizeable market
• Flight-to-quality characteristics (go up in value in stressed market scenarios)

What are some examples of Level 1 Assets?

• Coins and banknotes
• Funds held in central bank reserves
• Debt securities representing claims on zero risk-weighted sovereigns, central banks and some public-sector entities
• For domestic banks, sovereign debt of their home country

What are some examples of Level 2A Assets?

• Securities representing claims on, or guaranteed by 20% risk-weighted sovereigns, central banks, public sector entities or multilateral development banks
• Plain-vanilla debt securities issued by non-financial corporates and covered bonds
• Corporate debt securities that have a long-term credit rating from a recognised rating agency of at least AA-, or a short-term rating equivalent in quality to the long-term rating.

What are some examples of Level 2B Assets?

• Residential mortgage backed securities that meet stringent conditions
• Non-financial corporate debt securities including commercial paper with an eligible long-term credit rating of between A+ and BBB-, or with an internal PD assessment consistent with this level of credit rating
• Exchange-traded common equity shares, not issued by a financial institution, that are included in the major stock index of local jurisdiction, and denominated in the local currency of a bank’s local jurisdiction