Subject 3. Investing Short-Term Funds

Cash does not pay interest. Companies should invest funds that are not needed in daily transactions. Short-term investment is discussed in the reading.

Nominal rate: a rate of interest based on a security's face value. For a non-zero-bond, the coupon rate is the nominal rate.

A yield is the actual return on the investment if it is held to maturity.

  • Money market yield and bond equivalent yield. Refer to Reading 7 [Discounted Cash Flow Applications].
  • Discount-basis yield (also referred to as the investment yield basis) is often quoted in the context of U.S. T-securities: [(Face value - Purchase price) / (Face value)] x (360 / Number of days to maturity).

Strategies

Short-term investment strategies can be grouped into two types:

  • Passive strategy.

    • One or two decision rules for making daily investments.
    • Safety and liquidity first.
    • Passive strategies must be monitored and the yield should be benchmarked against a comparable standard (such as a T-bill).

  • Active strategy.

    • More daily involvement and a wider choice of investments.
    • Matching / mismatching: the timing of cash inflows and outflows.
    • A laddering strategy is a strategy in which a bond portfolio is constructed to have approximately equal amounts invested in each maturity within a given range (to reduce interest rate risk).

A company should have a formal, written investment policy or guideline that protects the company and its investment managers.

User Contributed Comments 5

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harpalani: Did't understand Laddering strategy
johntan1979: Heard of a very useful search tool called Google?
jonan203: instead of one $100,000 3 month CD earning 1%

you buy:
$25,000 3 month CD earning 1%
$25,000 4 month CD earning 1.1%
$25,000 5 month CD earning 1.2%
$25,000 6 month CD earning 1.3%

laddered.
jonan203: instead of one $100,000 3 month CD earning 1%

you buy:
$25,000 3 month CD earning 1%
$25,000 4 month CD earning 1.1%
$25,000 5 month CD earning 1.2%
$25,000 6 month CD earning 1.3%

laddered.
khalifa92: simply more steps for a higher risk-reward trade-off