Characteristics of Short Term Securities

Given that a firm has some temporarily idle cash, there are a variety of short-term securities available for investing. The most important characteristics of these short-term marketable securities are their maturity, default risk, marketability, and taxability.

Maturity From Chapter 7, we know that for a given change in the level of interest rates, the prices of longer-maturity securities will change more than those of shorter-maturity securities. As a consequence, firms that invest in long-term securities are accepting greater risk than firms that invest in securities with short-term maturities.

We called this type of risk interest rate risk. Firms often limit their investments in marketable securities to those maturing in less than 90 days to avoid the risk of losses in value from changing interest rates. Of course, the expected return on securities with short-term maturities is usually less than the expected return on securities with longer maturities.

Default Risk Default risk refers to the probability that interest and principal will not be paid in the promised amounts on the due dates (or will not be paid at all). In Chapter 7, we observed that various financial reporting agencies, such as Moody's Investors Service and Standard and Poor's, compile and publish ratings of various corporate and other publicly held securities. These ratings are connected to default risk. Of course, some securities have negligible default risk, such as U.S. Treasury bills. Given the purposes of investing idle corporate cash, firms typically avoid investing in marketable securities with significant default risk.

Marketability Marketability refers to how easy it is to convert an asset to cash; so marketability and liquidity mean much the same thing. Some money market instruments are much more marketable than others. At the top of the list are U.S. Treasury bills, which can be bought and sold very cheaply and very quickly.

Taxes Interest earned on money market securities that are not some kind of government obligation (either federal or state) is taxable at the local, state, and federal levels. U.S. Treasury obligations such as T-bills are exempt from state taxation, but other government-backed debt is not. Municipal securities are exempt from federal taxes, but they may be taxed at the state level.

0 0

Post a comment