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Short Term Investment Vehicles

ArticleID 105  
Writer Isaac Thuku
Category Personal Article

Short - term investment vehicles are all those which mature in one year or less. These investment vehicles are often defined as money-market instruments, because they are traded in the money market. The money market presents the financial market with short term marketable financial assets. The risk and the return on investments for short-term investment vehicles is usually lower compared with other types of investments.

Some common short term investment vehicles are:

• Certificates of deposit

This is a debt instrument issued by banks. It indicates that a specified sum of money is deposited at the issuing depository institution.

It bears a maturity date, specified interest rate and can be issued in any denomination. Most certificates of deposit cannot be bought or sold and they incur specific penalties for early withdrawal. For large investors, financial institutions allow large-denomination certificates of deposits to be traded as negotiable certificates of deposits.

• Treasury bills

They are also called T-Bills and are securities which represent financial obligations of the government. They have a short maturity period of less than one year. T-Bills are issued at a discount from their nominal value. Only the difference between nominal value and discount price is paid at the maturity for these short term securities because the interest is not paid in cash, only accrued. Another important feature of T-bills is that they are considered risk-free securities.

T-bills are issued on an auction basis where the issuer accepts competitive bids and allocates bills to those offering the highest prices. A noncompetitive bid is an offer to purchase the bills at a price that equals the average of competitive bids. The bills can be traded before the maturity, and their market price is subject to change with changes in the rate of interest. However, due to early maturity dates of T-bills, large interest changes are needed to move T-bills prices very far. For this reason, the bills are considered very liquid assets.

• Commercial paper

Commercial paper refers to unsecured promissory notes issued by corporations. Commercial paper is short term method of borrowing allowed by large financial institutions. Large corporations have realized that borrowing directly from investors through commercial paper is cheaper compared to reliance on bank loans. The promissory note can be issued directly from the firm to the investor or using an intermediary. Like T-bills, commercial papers are issued at a discount. Commercial paper takes no more than two months to reach maturity. They carry more risk than T-bills, because there is a bigger possibility that a corporation will default. Also, the commercial paper is not easily traded once it is issued, because the issues are relatively small compared with T-bills. Hence their market is not liquid.

• Banker‘s acceptances

Banker's Acceptances are vehicles created to ensure commercial trade transactions. These vehicles are so called because a bank accepts the responsibility to repay a loan to the holder of the vehicle in case the debtor defaults. They are short-term fixed-income securities that are created by non-financial institution and payment is guaranteed by a bank. This loan contract typically has a higher interest rate than other short –term securities to compensate for the default risk. Since bankers’ acceptances are not standardized, the securities are not traded. • Repurchase agreement (or repo) Repurchase agreement (or repo) is the sale of security with a promise by the seller to buy it back from the buyer at a specified price at a specified future date. Basically, a repo is a short-term loan, where collateral is a security. The collateral in such an agreement may be a Treasury security or any other money-market security. The difference between the purchase price and the sale price is the interest cost of the loan, from which repo the rate can be calculated. Due to high default risk, the maturity of repo is usually very short. The I the repayments should take one day, it is called overnight repo; if the term of the agreement is for more than one day, it is called a term repo.

Short Term Investment Vehicles
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