Some common money market instruments

The firm’s marketable securities portfolio manager usually restricts securities purchases to money market instruments. These instruments are generally short-term (original maturity of less than one year), high-quality government and corporate debt issues. In addition, government securities originally issued with maturities of more than one year but now having a year or less until maturity would also qualify as money market instruments. In what follows we will explore the most common types of money market instruments available to the company as near-cash investments.

Treasury Securities

Treasury securities are direct obligation of the government and carry its full faith and credit. Bills, notes, and bonds are the principal securities issued. Treasury bills (T-bills) with maturities of 13 and 26 weeks are auctioned weekly by the Treasury. (All sales by the Treasury are by auction). In addition, one-year bills are sold every four weeks. Smaller investors can enter a “noncompetitive� bid, which is filled at the market clearing price. Treasury bills carry no coupon but are sold on a discount basis. Bills are sold in minimum amounts of $1,000and multiples of $1,000 above the minimum. These securities are very popular with companies, in part because of the large and active market in them. In addition, transactions costs involved in the sale of Treasury bills in the secondary market are small.

The original maturity on Treasury notes is 2 to 10 years, whereas the original maturity on Treasury bonds is over 10 years. With the passage of time, of course, a number of these securities have maturities of less than one year and serve the needs of short-term investors. Notes and bonds are coupon issues, and there is an active market for them. Overall, Treasury securities are the safest and most marketable money market investments. Therefore, they provide the lowest yield for a given maturity of the various instruments that we consider (Once again, we see the trade-off between risk and return). Interest income on these securities is taxed at the federal level, but it is exempt from state and local income taxes.

Repurchase Agreements

In an effort to finance their inventories of securities, government security dealers offer repurchase agreements (RP;repos) to corporations. The repurchase agreement, or repo is the sale of short-term securities by the dealer to the investor whereby he agrees to repurchase the securities at an established higher price at a specified future time. The investor thereby receives a given yield while holding the securities. The length of the holding period itself is tailored to the needs of the investor. Thus, repurchase agreements give the investor a great deal of flexibility with respect to maturity. Rates on repurchase agreements are related to rates on Treasury bills, federal funds, and loans to government security dealers by commercial banks.

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