LIQUID INVESTMENTS FOR VALUE INVESTORS
Some time back I did a post on money market funds and how they are used as alternatives to cash by investors- aggressive and conservative alike. They also come highly recommended by Benjamin Graham in the sixth edition of security analysis. He says that if an aggressive investor can see no investment that fits the criteria set out as a value approach would, then be should put his cash in the money markets.
There are many reasons for this but the main reason is the short term maturity period and very high liquidity and the safety that these investments provide for the investor’s hard earned cash among other things.
So in this post I will mainly dwell in the type of money market instruments available for the value/ fundamental investor. The definition of a money market is the global market where short term financial instruments are bought and sold.
These money market instruments include:
CERTIFICATES OF DEPOSIT [CDs]
These are offered by depository institutions like banks and credit unions but they are sometimes bought through established brokerages. These money market instrument is also referred to as a time deposit because they have specific investment durations like 3 weeks to five years much like bonds. Other things that these CDs have in common with bonds are a predetermined interest rate and being available in more than one denomination. To give evidence that you have invested cash into the institution, the certificate is awarded to you and the information that appears is the amount invested, the maturity date and the interest rate how the interest is calculated.
These certificates of deposit while they have a higher interest rate than T bills and savings accounts in banks have the down side of being a little riskier [just like bonds in that the higher the interest rate offered to the investor, the higher the risk of default the investor has to bear] but overall the interest offered is much smaller than most other investments.
Another advantage is the safety from the whimsical stock market and the ability to calculate what your cash will amount to when it matures.
Another thing about certificates of deposit is that there are restrictions on withdrawing cash. This can be a good thing in that the investor will not be tempted to withdraw cash all the time (and thus forcing him to delay gratification) and a bad thing in that he cannot count on the investment in when disaster comes a knocking. But it is worth adding that the larger denomination CDs can be sold before maturity.
They are perfect for keeping cash safe for a specific amount of time and I think that this is why security analysis recommends them.
Finally they differ from money market accounts, something that about.com has brought out rather well.
TREASURY BILLS (T bills)
These are ways that a government uses to raise money from the public, much like government bonds
With T bills, the investor buys them at less than the par value or full value or at a discount and government will buy them back at the predetermined par value. The difference is what the investor keeps
The investment period of these T-bills is 3months(90 days), six months and one year and the various short maturities is one of the things that make them so popular. Other reasons for their immense popularity are;
-the fact that they are so simple to understand and invest unlike investments like stock options and bonds and warrants and stocks
-the fact that it is possible for the investor to get a T bill that matures at the time convenient for him and at an interest that he can specify at an auction
-A variety of denominations that cater for the investor with modest funds to the richest of the rich
– A very low risk of default since they are backed by the government and it is only in very extreme cases that a government can go bankrupt and fail to pay back cash to investors
While the returns are not the best, let us not forget that this is a security that an investor uses when he is between investments.
Just like corporate bonds, commercial paper is a way for the corporation to increase working capital by borrowing from everyone else other than the evil banks and just like T bills, they are offered at a discount from the face /par value.
These have fixed maturity periods between one to nine months and are issued by companies with a very high credit rating much like the first rate corporate bonds making then a very safe short term investment. This is where they differ from corporate bonds in that these have shorter maturity periods. The high credit rating requirement by issuing companies is because they are not backed by any form of collateral and so only companies that have a very strong financial base and thus cannot default are allowed to issue them unlike bonds which are issued by any type of company but are graded according to the risk that the investor is to incur when he decides to invest in them.
The down side of commercial paper to investors with modest funds is that they are only in very high but variable denominations and thus only cater for rich investors who have the luxury of choosing whether to buy then on discount or with an interest attached.
REPURCHASE AGREEMENTS (REPOS)
This security only works with government securities. With these, the government securities holder sells the security to the investors with the agreement to buy them back at a predetermined date and price which is normally worked out for the investors benefit. This is a real short term investment i.e. one(overnight) to over a month
There s a lot to know about repos like types and the structure, all of which are addressed in this answers.com linked article
Another name for the repurchase agreement apart from the repo is the buyback. A fitting name.
MONEY MARKET FUNDS.
I did a post about them some time back and instead or redoing it, you can just read through here
BANKER’S ACCEPTANCES (BAs)
For companies with a credit worthiness so low that they cannot issue commercial paper, this security somewhat more suitable. They are essentially created by a non financial firm and guaranteed by a bank.
The corporations issues this non interest security at a discount from the full value with a maturity period of less than one year and is backed by a bank with a very high credit worthiness. They are not very common in other areas apart from international trade
Apart from the fact that they don’t necessarily have to be held to maturity and offer the investor security for his money, this security also reduces the company’s cost of borrowing cash from a financial institution
They are very similar to treasury bills because of the discount issue.
Unlike the implication in the name, these securities have nothing to do with Europe. They are US dollar deposits in banks outside the USA. The maturity period is around six months and investments are in very large amounts and individual investors with modest funding are usually locked out unless through a money market mutual fund.
These are used by persons or organizations that need to keep large amounts free from government regulation, deposit insurance and thus allow for larger margins
There are Eurodollar time deposits and Eurodollar CDs and it is also worth mentioning that they are only found in the developed countries like USA and Europe.
FOREIGN EXCHANGE SWAPS
This nifty investment allows to parties to exchange different foreign currencies at a certain time in the future at a mutually agreed on exchange rate. The main advantage here is that this reduces the risk that the currencies will change in ways that will be inconvenient for either party and this saves them a lot of cash that can be lost in the easily fluctuating forex markets
Other names for these swaps are forex swaps, currency swaps, FX swaps and are mainly used by multinational companies or those that frequently deal with foreign currency
They are much more complicated than the one liner with which I have tried to explain them with, as Wikipedia shows
These securities are issued by municipalities to get cash in anticipation of tax revenues unlike munis bonds that are used to increase the cash that the municipality has to spend by borrowing from the public(a loan of sorts) as they wait for other forms of revenue. Their maturity periods range from a few months to a few years depending on many things.
Apart from the short maturity period and the relatively safe form of investments that they are, they do not have wide price and interest rate movements as compared to stocks and bonds
These are a few short term investments that are available to the value investor in between investments and those that are saving cash for a specified time like to buy a house or for school or something. I hope they are well explained
I realize that this post is longer than the ones that I usually write but I needed to give you all that I could find on highly liquid investments instead of hiding your money under the mattresses :~)