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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 44 [Introduction to Fixed-Income Valuation].
  • 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).


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.

Practice Question 1

Short-term working capital portfolios consist of securities that are ______ than other types of investment portfolios.

I. highly liquid
II. highly illiquid
III. more risky
IV. less risky
V. longer in maturity
VI. shorter in maturity

Correct Answer: I, IV and VI

Practice Question 2

A company is investigating the purchase of a banker's acceptance (BA). The $1,000,000 face value BA has 150 days to maturity and is quoted at 4.05 percent on a discount-basis yield. If the company's marginal tax rate is 25 percent, then the money market yield on the BA is closest to ______.

A. 3.13%
B. 4.12%
C. 4.18%

Correct Answer: B

Money market yield = discount-basis yield x (face value / purchase price) Purchase price = face value - [face value x discount-basis yield x (days to maturity / 360)] = $1,000,000 - [$1,000,000 x 0.0405 x (150 / 360)] = $983,125 Money market yield = 4.05% x ($1,000,000 / $983,125) = 4.12%

Study notes from a previous year's CFA exam:

3. Investing Short-Term Funds