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Trading and Capital-Markets Activities Manual

Instrument Profiles: Spanish Government Bonds
Source: Federal Reserve System 
(The complete Activities Manual (pdf format) can be downloaded from the Federal Reserve's web site)


The Spanish Treasury issues medium- and long-term bonds, Bonos del Estado (Bonos) and Obligaciones del Estado (Obligaciones), which are guaranteed by the Spanish government. Since 1987, these bonds have been issued in book-entry form only. 


Bonos are issued with maturities of three or five years, while Obligaciones are issued with maturities of 10 or 15 years. Both types of bonds are issued in denominations of 10,000 pesetas (pta). Bonos and Obligaciones are non-callable with bullet maturities and can be issued with either annual or semi-annual coupons. All Spanish government bonds bear a fixed coupon. Domestic settlement takes place the market date after the trade date (T+1), while international settlement takes place seven calendar days following the trade date (T+7). Settlement is done on a delivery-against-payment basis for all transactions between interbank market participants. Bonos and Obligaciones are also eligible for settlement through Euroclear and Cedel. Interest is calculated using an actual/365-day count. 


Historically, Bonos and Obligaciones have been used as medium- and long-term investments. However, in the early 1990s, the trading volume of these bonds doubled as banks and corporations began to use Bonos and Obligaciones for cash-management purposes. These securities can also be used for hedging and speculative purposes. 


Issuing Practices 

Currently, all Bonos and Obligaciones are issued through monthly competitive auctions. The Spanish Treasury publishes the auction calendar at the beginning of the year. On the first Tuesday of the month, the 3- and 10-year bonds are issued. The 5- and 15-year bonds are issued on the following Wednesday. Each issue is sold in at least three competitive tenders. Bids are submitted before 10:30 a.m. on the auction date. Auction results are announced at 11:30 a.m. on the same day on Reuters page BANCN. Payments generally occur on the 15th of the same month. 

At the beginning of each issue, the Treasury fixes the coupon to be paid for at least the next three auctions. After all bids are made, the Treasury fixes the total issue amount and allocates bids from the highest price to a cut-off price. The total issue amount is not disclosed. The lowest bid submitted is referred to as the marginal price of the issue. Bids between the average and the marginal price are filled at the price the bidders submitted. Bids above the average are filled at the average price bid. If the Treasury announces a target issuance level and the volume awarded during the initial bidding stage is equal to or higher than 70 percent of the target level-but does not reach the target issuance level-the Treasury has the right, but not the obligation, to hold a second auction exclusively with the primary dealers. In this case, every primary dealer must submit bids for an amount at least equal to- 
(target issuance level - the volume awarded) /the number of primary dealers.

If the target issuance level is met with the first bidding stage or if the Treasury does not announce a target issuance level, primary dealers may submit up to three additional bids. These bids cannot have yields higher than the average yield during the first bidding stage. In this scenario, the Treasury must accept bids equal to at least 10 percent of the volume awarded during the first bidding stage if it had accepted more than 50 percent of the bids. If it had accepted less than 50 percent of the bids, the Treasury must accept bids equal to at least 20 percent of the volume awarded during the first bidding stage. 

Interest begins to accrue from a date nominated by the Treasury. Historically, the date has been set so that the first coupon period will be exactly one year. Thus, tranches issued before the nominated date have an irregular period during which they trade at a discount without accrued interest. 

Secondary Market 

About 40 percent of all transactions are executed through a system of inter-dealer brokers (blind brokers) instituted by the Bank of Spain. In the secondary market, only entities designated as ''primary dealers'' can deal directly with the Bank of Spain. For example, if a customer wants to buy a bond that a dealer does not have in inventory, a primary dealer can go to the Bank of Spain to obtain the bond. Non-primary dealers would have to obtain the bonds through inter-dealer trading. Inter-dealer trading is executed through information screens. Amounts and prices are quoted, but counterparties are not disclosed. 

Competitive tenders must be at least pta 50 million in the interbank market and pta 100 million in the blind-broker system. Trading volume in the secondary market varies between pta 500 million and pta 1 billion. Trading hours are between 9:00 a.m. to 5:00 p.m. local time through blind brokers, and at any hour through regular brokers. 

Market Participants 

Sell Side 

As noted above, the dealers of government securities are classified as either primary dealers or non-primary dealers. The Bank of Spain designates primary dealers with whom they will conduct business. Other dealers obtain government securities through inter-dealer trading. 

Buy Side 

The primary holders of Bonos and Obligaciones are private and savings banks. The Bank of Spain, corporations, and foreign investors, including U.S. commercial banks, securities firms, insurance companies, and money managers also hold outstanding bonds. 


Several information vendors disseminate price information on Spanish government bonds. Reuters and Telerate provide pricing information for Bonos and Obligaciones. A Telerate service called ''38494'' provides the latest auction information. Reuters carries bond prices, dealer prices, the latest auction results, and Spanish Treasury pages. 


Bonos and Obligaciones are quoted on a percentage of par basis in eighths. Bid/offer spreads are typically 5 to 10 basis points for actively traded issues and about 20 basis points for illiquid issues. Bonos and Obligaciones do not trade ex-dividend, but they do trade before the Treasury nominates a date to begin coupon accruals. The period before the nomination date is referred to as the irregular period. Because there is no accrued interest until a coupon payment date is nominated by the Treasury, issues outstanding before the nomination are priced at a discount and adjustments to yield must be made accordingly. The following price/yield relationship holds during the irregular period: 

PV0 = PV1 / (1 + y)(n/ 365), 


PV1 = standard price/yield on the nominated date 
y = annual internal rate of return 
n = the number of days until the end of the irregular period 


Foreign-currency and interest-rate risk may be hedged by using derivative instruments such as forwards, futures, swaps, or options. Interest-rate risk may also be hedged by taking an offsetting position in another Spanish fixed-income security. 


Liquidity Risk 

Liquidity risk is increased when market volumes of a security are low. In the case of Bonos and Obligaciones, market volumes have been volatile as investor objectives and strategies change, for example, when banks and corporations began to use Bonos and Obligaciones as cash-management instruments rather than as medium--term investments. Therefore, these bonds may experience varying levels of liquidity. Liquidity may also be a function of how close to maturity a bond issue is. In other words, more recently issued bonds tend to be more liquid than bonds that have been traded in the market for a longer period of time. 

Interest-Rate Risk 

Interest-rate risk is derived from price fluctuations caused by changes in interest rates. Longer-term issues have more price volatility than shorter-term issues. A large concentration of long-term maturities may subject a bank's investment portfolio to greater interest-rate risk. 

Foreign-Currency Risk 

From the perspective of an international investor, the total return from investing in Spanish government securities is partly dependent on the exchange rate between the U.S. dollar and the Spanish peseta. Several factors affect the volatility of a foreign-exchange rate including the following: the country's balance of payments and prospective changes in that balance; inflation and interest-rate differentials between countries; the social and political environment; relative changes in the money supply; and central bank intervention in the currency. 

Political Risk 

A change in the political environment, withholding tax laws, or market regulation can have an adverse impact on the value and liquidity of an investment in foreign bonds. Investors should be familiar with the local laws and regulations governing foreign bond issuance, trading, transactions, and authorized counterparties. 


The accounting treatment for investments in foreign debt is determined by the Financial Accounting Standards Board's Statement of Financial Accounting Standards (SFAS) No. 115, ''Accounting for Certain Investments in Debt and Equity Securities," as amended by SFAS 125, ''Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.'' SFAS 125 has been replaced by SFAS 140, which has the same title. Accounting treatment for derivatives used as investments or for hedging purposes is determined by SFAS 133, ''Accounting for Derivatives and Hedging Activities.'' (See section 2120.1, ''Accounting,'' for further discussion.) 


Spanish government bonds are assigned to the 0 percent risk-weight category. 


Spanish government bonds are type III securities. As such, a bank's investment in them is limited to 10 percent of its equity capital and reserves. 


 Fabozzi, Frank J. Bond Markets, Analysis, and Strategies. 3d ed. Upper Saddle River, N.J.: Prentice-Hall, 1996. 
 Fabozzi, Frank J., and T. Dessa Fabozzi, ed. The Handbook of Fixed Income Securities. 4th ed. New York: Irwin, 1995. 
 Fabozzi, Frank J., and Franco Modigliani. Capital Markets: Institutions and Instruments. Englewood Cliffs, N.J.: Prentice-Hall, 1992. 
 J.P. Morgan Securities. Government Bond Outlines. 9th ed. April 1996.


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