Cash Equivalents

What are cash equivalents?
Cash equivalents are highly liquid securities that mature typically within three months. Cash equivalents include money market securities, short term Treasury bills, short term Government bonds etc. Money in savings accounts and checking accounts too would be considered equivalent to cash as long as the funds can readily be accessed. In most countries, a government linked body guarantees checking and saving deposits in banks up to a certain limit; e.g. FDIC(USA), MAS(Singapore), RBI(India).

Money Market Instruments
Money market instruments are highly liquid, short term securities issued by governments and corporations. These include:

1. Commercial Paper: Commercial papers are unsecured short term securities (maturities below 9 months) issued by banks and corporations with very high credit ratings to meet short term obligations such as debt and payrolls. Most commercial paper is sold at a discount to par value.
2. Repurchase Agreements: Repurchase agreements are a form of collateralized borrowing and are used very often in the inter-bank market.
3. Certificates of Deposit: Certificates of Deposit (CDs) are bank deposits which can usually be sold before maturity in the secondary market.
4. Bankers Acceptances: Bankers Acceptances (BAs) are short term instruments that are often used during international trade. They are generally very safe instruments when issued by large banks. These instruments can be traded in the secondary market as discount instruments. However, the face value of such instruments is usually in excess of US$ 100,000.

How can individual investors invested in Money Market Instruments?
Most money market instruments have very high face values and are probably not of much interest to the individual investor. However, small investors can invest in money market funds which invest in these instruments. This is a good option as long as such funds don’t charge heavy entry/exit loads and administrative fees.

Investors can invest in Certificates of Deposits and Time Deposits through any commercial bank.

Advantages

1. Cash equivalents are highly liquid and hence can be used in case of emergencies.
2. Since most cash equivalents tend to be of very high credit quality, they are generally very safe.

Disadvantages

1. The returns from cash equivalents tend to be very low, usually less than 2% p.a. in most developed economies.
2. Though most money market instruments are of very high credit quality, they are not 100% risk free.
3. Investors, especially those who invest in discount securities face interest rate risk.

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