14.2 Short term investments

Question 1

Reasons for short term investing

Answer 1

• A business may have surplus cash for a period of time, usually temporary and available for several weeks or months (will eventually be used to pay suppliers, settle liabilities, invest in assets or pay dividends)
• Money in an operational bank account earns no income (banks don’t pay interest to businesses for cash in their day to day accounts)
• If a business wants to maximise its profits it should consider using this surplus to earn a return

Question 2

Cash surpluses can be invested a number of short term interest earning investments

Answer 2

• Interest bearing bank accounts
• Negotiable instruments
• Short dated government bonds
• Other short term investments

Question 3

Criteria that should be considered when a business is deciding on which investment to choose

Answer 3

• Maturity
• Return
• Risk
• Liquidity
• Diversification

Question 4

Interest bearing accounts can call into two categories

Answer 4

• Bank deposit accounts (instant liquidity, low interest)
• Money market deposits (inter bank market, cant be withdrawn until matures, higher interest)

Question 5

Calculation for amount of interest earned

Answer 5

Amount deposited X Annualised interest rate X (Number of days interest earned / 365)

Question 6

Negotiable instruments

Answer 6

• Are financial instruments that may be obtained as investments
• Title passes when the instrument is handed from oner person to another
• They are bearer instruments and ownership does not have to be recorded in a register of owners (can easily be sold by one to another)

Question 7

Examples of negotiable instruments

Answer 7

• Bank notes
• Bearer bonds
• Certificates of deposit
• Bills of exchange
• Treasury bills

Question 8

When entities invest in short dated government bonds

Answer 8

• They will receive interest on the due payment dates
• They can liquidate their investment at any time by selling bonds in secondary market
• If the bonds are short dated when purchased, they can hold the bonds to maturity and have them redeemed at par

Question 9

Risk with government bonds

Answer 9

• There is some price with, particularly longer dated bonds, if interest rates change in the market, the market value of bonds will rise or fall
• Bond prices rise when interest rates fall and prices fall when interest rates go up (movement in price is greater with longer dated bonds)

Question 10

Other short term investments

Answer 10

• Corporate bonds
• Commercial paper

(More likely to be purchased by investment institutions than entities)