SHORT TERM INVESTMENTS Flashcards
What are short-term investments?
Investments to be held one year or less
Commonly used for temporary excess
cash
What are the criteria for short-term investments? MaPS
Marketability/liquidity
Price stability
Safety of principal
Others:
Taxability Administrative costs Diversification
What is the requirement for safety of principal?
Investments should have little default risk by the issuer.
What is the requirement for price stability?
Investments should not be subject to market declines that would result in a significant loss.
What is the requirement for marketability?
Investments should have a ready market for converting into cash.
How to manage short-term investments?
Guide only
Short-term investments are investments that are held for one year or less.
When a firm has excess cash, it should invest those funds for a higher return than provided when cash left idle.
Investments should be made short-term because the funds will be needed in the near term.
Criteria?
Various options of ST investments available in the money market.
Treasury bills Federal Agency securities Negotiable securities of deposits Bankers Acceptance Commercial Paper Repurchase agreements
Summary:
As described above, a firm has a variety of options available for short-term investment opportunities.
In selecting from among these opportunities, the basic factors to be considered are the safety of principal, price stability, and marketability of the investment.
The objective in considering these factors is to minimize the risk associated with the investment while seeking to earn a competitive rate of return.
What are the different short-term investments?
Treasury bills Federal Agency securities Negotiable securities of deposits Bankers Acceptance Commercial Paper Repurchase agreements
What are treasury bills?
Debt investment instruments that are the direct obligation of the US government.
What are Federal Agency securities?
Securities issued by and obligation of the individual federal agency
- responsibility of the issuing agency not
the US Treasury - not backed by the Federal Government
- slightly higher risk than US Treasury
obligations and pay a slightly
higher return
Negotiable securities of deposits
Issued by a bank in return for a fixed time deposit with the bank
** can be bought and sold in the secondary market
** high safety of principal and relative price stability
Bankers Acceptance/demand drafts
Draft or order to pay drawn on a bank by a firm with an account at the bank
If the bank accepts the draft, it becomes a negotiable instrument available for investment
Used in financing foreign transactions
Riskier and less marketable than fed securities
Pay higher yield the fed secs
Commercial Paper
Short-term unsecured promissory notes issued by large, established firms with high credit ratings
***available in various
denominations
**maturities up to 270 days
*** less marketable than others but provide a higher return
Repurchase agreements
Securities issued for loans with a simultaneous commitment by the buyer to
- *resell the loan security to the issuer
- *at the original contract price
- plus an agreed interest for holding period
- **for large denominations
- **maturities specified in each agreement
- *Usually for large amounts
- *can be issued for any length of time
Repurchase agreements advantages
Can be issued for a very short time even a day
Risk of market price declines is avoided because the
amount of interest is specified when the instrument
originated
What is default risk?
Default risk is a measure of the likelihood that the issuer will not be able to make future payments of interest and principal to a security holder.
