Types of Australian government bonds
The Australian Federal Government (also called the Commonwealth Government) conducts regular offers of bonds by public auction through the Australian Office of Financial Management (AOFM). There are two types of bond offered - Treasury Fixed Coupon Bonds (the largest type by face value on issue), and Treasury Capital Indexed Bonds (which are linked to inflation). The government also sells Treasury Notes, which are short dated debt instruments with maturity measured in months instead of years, and no coupon payment before maturity. The two types of bonds have the following features.
Fixed Coupon Bonds
These are traditional fixed interest bonds, which pay a fixed coupon on a semi-annual (6 monthly) basis. The coupon rate is expressed as a percentage applied to the face value. For example, a 4.5% coupon will pay $4.50 per annum per $100 of face value. It is important to note that the coupon is applied to the face value, not the purchase price (which will usually be different from the face value). The coupon payments can be sent to you by cheque, or paid directly into an Australian bank account.
The full face value of the bond is repaid at maturity (see box on the right for the various maturities available for purchase). There is no ability to have your bond redeemed early, although you can sell it back to the Reserve Bank of Australia (RBA) at their published buy rate (which may be higher or lower than face value).
Capital Indexed Bonds (inflation linked bonds)
Capital Indexed Bond pay interest on a quarterly (3 monthly) basis at the set coupon rate, applied to the face value of the bond. As with fixed coupon bonds, the coupon is based on the face value, not the purchase price or market price.
Unlike fixed coupon bonds, the face value of a capital indexed bond is adjusted each year by indexing (increasing) the principal amount of the bond to match increases in inflation. At maturity, bond holders are repaid the adjusted principal value of the security (i.e. the face value as increased by inflation over the life of the bond). Likewise, the coupon payment increases year to year as it is calculated as a percentage of the increased face value of the bond. For these reasons, capital indexed bonds are often called Inflation Linked Bonds.
Inflation linked bonds provide a built in hedge or protection against rising inflation, which can help preserve the "real" value of your capital and income. However, the initial percentage coupon rate will be lower than the coupon on a Fixed Coupon Bond because of the value of the indexing feature. In other words, the yield on a capital indexed bond is a "real" rate, compared with the "nominal" yield on a fixed coupon bond.