ShortTerm Finance Investments Samantha Karandagoda Short Term investments

Short-Term Finance & Investments Samantha Karandagoda

Short Term investments

Short Term Investments • Businesses have Surplus Cash At Certain Times • This is Held Temporarily but Sometimes Remain in the Business for Several Weeks/Months • It can be used to Generate Interest Income

Short Term Investments • Cash Surpluses Can Be Invested in to: –Interest Bearing Bank Accounts –Negotiable Instruments –Short Dated Government Bonds –Other

Investment Criteria • Before Deciding on Whether to Invest or Not As Well as What Kind of Investment is to be Made, following needs to be considered –Maturity –Return –Risk –Liquidity –Diversification

Maturity • Duration within which the Principal Amount will be Returned • Interest Might Be Paid Throughout the Time • Should be within the Time Period that Cash is Available in Excess

Return • With Short Term Investments, Return is the Interest Yield on the Investment • If the Investment is “Redeemable” (capital amt will be repaid to the investor) then the capital repayment will also form part of the return

Risk • Risk is the Possibility of the Investment Falling in Value • Having a Doubt about Eventual Payment of Interest of Repayment of Investment Principal • Higher Risk Investments have Higher Returns • Short term – Easier to Foresee

Risk of Equity (Shares) • Investment in Equity (Shares) is a High Risk • Value of Equity Depends on Future Prospects of the Company • Share Prices Fluctuate based on Several Factors • Not Suitable for Short Term Investments

Liquidity • Liquidity Refers to the Ease of “Cashing In” of a Investment without a Significant Loss of Value of the Asset • Savings Accounts are More Liquid than Fixed Deposits

Diversification • Avoid Putting all Eggs in One Basket • Invest in to a Mix of Different Investment Opportunities • Short Term Investments are Not Required to Diversify as Much as Long Term Investments

Interest bearing accounts

Interest Bearing Accounts • Main Categories: –Bank Deposit Accounts –Money Market Deposits

Deposit Accounts • Some are “Instant Access” Accounts which allow the investor to withdraw money without Notice & without loss of Interest • Best when Need to Earn Interest but Still Needing Instant Liquidity

Deposit Accounts • Some Deposit Accounts do not need notice but there’s a loss of Interest • Some Deposit Accounts Make it Compulsory to Notice before withdrawing Funds

Money Market Deposits • These are Monies Deposited in Money Markets through Banks • Usually the Banks Borrow & Lend Money between them • Some Banks arrange Deposit of Surplus Cash from Customers in the Money Market at Money Market Interest Rates

Money Market Deposits • Can’t Withdraw Until the Deposit Matures • Should be Invested for a Period Less than the Cash Surplus Lasts • Very Short Term (1 day) Deposits Available for Large Amounts of Funds

Effective Annual Interest Yield • Interest on Bank Deposits Accumulates on the Principal Sum Invested • Interest is Added at Regular Intervals e. g. Monthly/Annually • Frequency of Adding Interest Affects the Yield on the Investment

Calculation • Invest 1, 000 for 1 year –At 10% interest, calculated quarterly (2. 5% per quarter) –Total: = [(1+2. 5%)4 -1] x 1, 000 = 1, 103, 813 Interest: 103, 813 P. A. Interest Rate: 10. 38% Better than a Deposit that Calculate Year End 10. 25% Interest!

Interest Earned No. of Days Interest = Amount x Deposited Annualized Interest Rate x No. of Days Interes t Earned Annual Day Count

Negotiable Instruments • Financial Instruments Obtainable as Investments • Title Passes when Handed Over from One Person to Another – Bearer Instruments

Negotiable Instruments • Bank Notes • Bearer Bonds • Certificates of Deposit • Bills of Exchange • Treasury Bills

Certificate of Deposit • A Negotiable Instrument that Provides Evidence of a Short Term Deposit with a Bank for a Fixed Term • Earns a Specific Amount of Interest • Usually the Maturity is 90 days or Less • Amount at Least US$100, 000 or Equivalent

Certificate of Deposit • Holder has the Right to Take the Deposit with Interest • CD Holder can Present the CD to a Recognized Bank at the Maturity to Arrange the withdrawal • Can’t Withdraw Until Maturity • Can be Sold before Maturity

Investment Yield on CD • CSs are Attractive in Money Market since Negotiable • Money Market Deposits Can’t be Withdrawn before Maturity • Therefore the Yields on CDs are Slightly Lower than that of Money Market Deposits

Bills of Exchange

Bills of Exchange • Used for Export Finance as well as for other Purposes • Negotiable Instruments • There’s an Active Market for Bills of Exchange (known as the Discount Market) • Active in Bills of Exchange that are Payable by the Top Quality Banks

Bills of Exchange • A Buyer of a Bill of Exchange Obtains the Right to Receive Payment by the Issuer of the Bill when it Matures • Investors buy at a Discount to Face Value. Hence Bills of Exchanges are a Type of Discount Paper • Investors Prefer Bank Bills (High Credit Rating) Compared

Bills of Exchange • Yields Vary According to the Credit Risk Associated with the Bill • Investors are Willing to Pay More for a Bill Issued by a Bank with Better Credit Score

Treasury bills

Treasury Bills • Treasury Bills are Negotiable Instruments Issued by the Government • Maturity Less than 1 Year; usually 3 months (91 Days) • Government Issues them for Short Term Cash Requirements • Debts of the Government

Treasury Bills • Since Government Backed; Less Risk • Yields are Lesser than Other Short Term Investments • It’s Considered that a Treasury Bill Issued within a Country in Domestic Currency is of Zero Risk

Treasury Bills • Treasury Bills are Redeemable at Face Value • Since the Bills are Redeemable at Par, the Investors Pay Less than the Face Value to Buy them • A Type of a Discount Paper • Attractive Because of Low Risk Even Though Yield is Less

Short-Term Finance & Investments Samantha Karandagoda