The debt market

Topic 4 tests what debt is, how bonds are classified, how they are priced and how the debt market works. Expect recognition questions on bond features and categories, and a cluster of calculations: effective and real interest rates, present and future values, and the prices of zero-coupon and coupon bonds. Learn the handful of formulas and the rating-scale boundaries first, then the yield curve, repos and the structure, participants and trading and settlement systems of the Hong Kong debt market.

24 min read14 sections

Checked against S&P Global Ratings, 'S&P Global Ratings Definitions' (republished 1 September 2026) and 'Understanding Credit Ratings' (spglobal.com); Moody's Ratings, 'Rating Symbols and Definitions' (1 July 2026); Fitch Ratings, 'Rating Definitions' (fitchratings.com); standard time value of money and bond pricing formulas, every figure recomputed by script; HKSI LE Paper 7 syllabus Topic 4 (v3.5, effective 1 March 2026). As at October 2026. Checked on 11 October 2026 against hkma.gov.hk (Bond Market Development; Hong Kong Dollar Liquidity Facilities, revised 7 August 2026; Exchange Fund Bills & Notes Programme, revised 30 June 2026; Debt Securities Settlement System, revised 9 October 2026; System Linkages; Milestones of Monetary Reform), hkgb.gov.hk (the Infrastructure Bond Programme and Government Sustainable Bond Programme Institutional Issuances Information Memorandum of 10 November 2025; Government Bond Programme overview, institutional key facts and participants, iBond, Silver Bond, retail infrastructure bond and Sustainable and Infrastructure Bond Programme pages), and standard bond mathematics and yield curve theory. Independent prep, not endorsed by HKSI Institute or the SFC.

Must-know for the exam

Effective annual rate = (1 + r/m)^m − 1, with m compounding periods a year: 8% compounded quarterly is 8.24% (standard interest rate maths).
Real rate: (1 + nominal) = (1 + real) × (1 + inflation), roughly nominal minus inflation. A 6% deposit with 2% inflation earns a real 3.92% (Fisher relation).
Zero-coupon price = face value ÷ (1 + y)^n. HK$1,000 due in five years at a 4% yield is worth HK$821.93 today (present value of cash flows).
Coupon bond price = present value of coupons plus face value. Coupon above yield: premium; equal: par; below: discount (standard bond pricing).
Investment grade: BBB- and above at S&P and Fitch, Baa3 and above at Moody's. Plus/minus from AA to CCC; Moody's 1, 2, 3 from Aa to Caa (agency definitions, 2026).
Price and yield move inversely. Current yield = coupon / price. Approximate YTM = [C + (F - P)/n] / [(F + P)/2]. Below par: coupon < current yield < YTM.
Pure expectations: no term premium, inverted curve means falling rates expected. Liquidity preference: premium for longer maturities. Segmentation: investors stay put. Preferred habitat: they move for enough premium.
Exchange Fund Bills: under 1 year, no interest, bid-yield tender, minimum HK$500,000. Notes: fixed semi-annual coupon (Actual/365), 2-year issued regularly; none of 3 years or more since 2015 (HKMA, 2026).
Hong Kong dollar fixed-rate institutional government bonds: tender through Primary Dealers, each bidder pays its own price, settled next business day, listed on SEHK (Information Memorandum, November 2025).
CMU: set up by the HKMA in 1990; real-time DvP and final settlement. Since January 2025 CMU OmniClear assists, but the HKMA still owns and operates it (HKMA, October 2026).

On this page · 14 sections

Traps that cost marks

Mixing up the two sides of the balance sheet. Shareholders own the company; bondholders lend to it and hold contractual, not ownership, rights.
Thinking a bond gives some of the upside of shares. A straight bond's return is capped at its coupon and principal; only a conversion right adds equity upside.
Assuming anything a company issues to investors is debt. Ask whether the issuer owes the holder a sum of money; with a warrant it does not.
Treating 'safe' as 'inflation-proof'. A fixed-rate bond protects the nominal amount, not its purchasing power.
Treating the rating as part of the bond's terms. The indenture fixes the issuer's promises; the rating is an outside opinion that can change at any time.
Treating 'subordinated' as a type of equity. Subordinated bonds are still debt: they rank behind senior debt but ahead of shareholders.
Mixing up the protective covenants. A negative pledge is about security for other lenders; cross-default is about defaults on other debt.
Adding inflation instead of subtracting it. The real rate is what is left after inflation, so it is lower than the nominal rate when inflation is positive.

Debt, debt securities and why investors buy them

Debt is money borrowed on a promise to repay it, usually with interest. A debt security turns that promise into a transferable instrument: the issuer (borrower) owes the holder (lender) the principal and, usually, periodic interest called the coupon. Bills, notes, bonds, certificates of deposit (a bank's negotiable receipt for a time deposit) and commercial paper (short-term unsecured company debt, usually issued at a discount) are all debt securities. A subscription warrant is not: the issuer owes the holder nothing.

	Debt (bonds)	Equity (ordinary shares)
Holder is	A creditor	An owner
Income	Contractual coupon; missing one is a default	Dividend at the directors' discretion
Maturity	Fixed date (perpetual bonds excepted)	None
In a winding up	Paid before shareholders	Paid last, from whatever is left
Vote at general meetings	Not normally	Yes

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LE Paper 7 · Topic 4

The debt market

24 min read14 sections

Must-know for the exam

Effective annual rate = (1 + r/m)^m − 1, with m compounding periods a year: 8% compounded quarterly is 8.24% (standard interest rate maths).
Real rate: (1 + nominal) = (1 + real) × (1 + inflation), roughly nominal minus inflation. A 6% deposit with 2% inflation earns a real 3.92% (Fisher relation).
Zero-coupon price = face value ÷ (1 + y)^n. HK$1,000 due in five years at a 4% yield is worth HK$821.93 today (present value of cash flows).
Coupon bond price = present value of coupons plus face value. Coupon above yield: premium; equal: par; below: discount (standard bond pricing).
Investment grade: BBB- and above at S&P and Fitch, Baa3 and above at Moody's. Plus/minus from AA to CCC; Moody's 1, 2, 3 from Aa to Caa (agency definitions, 2026).
Price and yield move inversely. Current yield = coupon / price. Approximate YTM = [C + (F - P)/n] / [(F + P)/2]. Below par: coupon < current yield < YTM.
Pure expectations: no term premium, inverted curve means falling rates expected. Liquidity preference: premium for longer maturities. Segmentation: investors stay put. Preferred habitat: they move for enough premium.
Exchange Fund Bills: under 1 year, no interest, bid-yield tender, minimum HK$500,000. Notes: fixed semi-annual coupon (Actual/365), 2-year issued regularly; none of 3 years or more since 2015 (HKMA, 2026).
Hong Kong dollar fixed-rate institutional government bonds: tender through Primary Dealers, each bidder pays its own price, settled next business day, listed on SEHK (Information Memorandum, November 2025).
CMU: set up by the HKMA in 1990; real-time DvP and final settlement. Since January 2025 CMU OmniClear assists, but the HKMA still owns and operates it (HKMA, October 2026).

On this page · 14 sections

Traps that cost marks

Mixing up the two sides of the balance sheet. Shareholders own the company; bondholders lend to it and hold contractual, not ownership, rights.
Thinking a bond gives some of the upside of shares. A straight bond's return is capped at its coupon and principal; only a conversion right adds equity upside.
Assuming anything a company issues to investors is debt. Ask whether the issuer owes the holder a sum of money; with a warrant it does not.
Treating 'safe' as 'inflation-proof'. A fixed-rate bond protects the nominal amount, not its purchasing power.
Treating the rating as part of the bond's terms. The indenture fixes the issuer's promises; the rating is an outside opinion that can change at any time.
Treating 'subordinated' as a type of equity. Subordinated bonds are still debt: they rank behind senior debt but ahead of shareholders.
Mixing up the protective covenants. A negative pledge is about security for other lenders; cross-default is about defaults on other debt.
Adding inflation instead of subtracting it. The real rate is what is left after inflation, so it is lower than the nominal rate when inflation is positive.

Debt, debt securities and why investors buy them

	Debt (bonds)	Equity (ordinary shares)
Holder is	A creditor	An owner
Income	Contractual coupon; missing one is a default	Dividend at the directors' discretion
Maturity	Fixed date (perpetual bonds excepted)	None
In a winding up	Paid before shareholders	Paid last, from whatever is left
Vote at general meetings	Not normally	Yes

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Characteristics of debt

A bond's terms, set out in its offering document and often a trust deed, fix its characteristics at issue. Together they define the cash flows the holder is promised. The market price is not one of them: it moves every day after issue with interest rates, credit quality and liquidity.

Characteristic	What it means
Issuer	Who owes the money: government, agency, supranational body, bank or company
Face (par) value	Amount repaid at maturity; the base on which the coupon is calculated
Coupon rate and frequency	Annual interest as a percentage of face value, paid annually, semi-annually or quarterly
Maturity date	When principal is repaid; term to maturity shortens as time passes
Currency	The currency of coupons and principal
Security	Secured (a charge over named assets) or unsecured
Seniority	Senior or subordinated: the order of payment if the issuer fails
Embedded options	Call (issuer may redeem early), put (holder may sell back), conversion into shares
Covenants	Issuer's promises, e.g. negative pledge (no security for other lenders unless bondholders share it), cross-default, sinking fund

Order of payment in a winding up: senior secured bonds, then senior unsecured bonds, then subordinated bonds, then ordinary shareholders. Lower priority is why subordinated bonds pay higher coupons.

Trap: calculating the coupon on the market price. The coupon rate is always a percentage of face value, so a 5% bond pays HK$5 per HK$100 face, whatever its price.

Takeaway: The terms fix the cash flows (face value, coupon, maturity, security, seniority, options, covenants); the market fixes the price.