Introductory Corporate Finance: Working Capital Management - Marketable Securities, TBills Commercial Paper Bankers Acceptances Repos Money Market Funds Choosing Based on Maturity Yield Risk Liquidity

Marketable Securities (T-Bills, Commercial Paper, Bankers' Acceptances, Repos, Money Market Funds)

What This Is

Marketable securities are short-term debt instruments that can be easily bought and sold on the market. They are used by companies to raise funds for short-term needs and by investors to earn a return on their money. For example, Apple Inc. uses commercial paper to finance its working capital needs. Suppose Apple issues $100 million of commercial paper with a 3-month maturity and a 2% interest rate. The investor will receive $102 million after 3 months.

Key Formulas & Models

• T-Bill Yield = (Face Value - Purchase Price) / Purchase Price: measures the return on investment in a T-Bill.
  • Face Value: the amount borrowed or invested
  • Purchase Price: the price paid for the T-Bill
  • Interpretation: the yield is the interest earned on the investment
• Commercial Paper Yield = (Face Value - Purchase Price) / Purchase Price: measures the return on investment in commercial paper.
  • Face Value: the amount borrowed or invested
  • Purchase Price: the price paid for the commercial paper
  • Interpretation: the yield is the interest earned on the investment
• Bankers' Acceptance Yield = (Face Value - Purchase Price) / Purchase Price: measures the return on investment in a bankers' acceptance.
  • Face Value: the amount borrowed or invested
  • Purchase Price: the price paid for the bankers' acceptance
  • Interpretation: the yield is the interest earned on the investment
• Repo Rate = (Face Value - Purchase Price) / Purchase Price: measures the return on investment in a repurchase agreement.
  • Face Value: the amount borrowed or invested
  • Purchase Price: the price paid for the repurchase agreement
  • Interpretation: the yield is the interest earned on the investment
• Money Market Fund Yield = (Net Asset Value - Initial Investment) / Initial Investment: measures the return on investment in a money market fund.
  • Net Asset Value: the current value of the fund's assets
  • Initial Investment: the amount invested in the fund
  • Interpretation: the yield is the interest earned on the investment
• Maturity = Time to Maturity: measures the length of time until the security matures.
  • Time to Maturity: the number of days until the security matures
  • Interpretation: the maturity is the length of time until the security is repaid
• Risk = Standard Deviation of Returns: measures the volatility of the security's returns.
  • Standard Deviation: a measure of the spread of the returns
  • Interpretation: the risk is the uncertainty of the security's returns
• Liquidity = Ability to Sell Quickly: measures the ease of selling the security.
  • Ability to Sell Quickly: the speed at which the security can be sold
  • Interpretation: the liquidity is the ease of selling the security

Step-by-Step Calculation

1. Determine the face value and purchase price of the security.
2. Calculate the yield using the formula: Yield = (Face Value - Purchase Price) / Purchase Price
3. Determine the maturity of the security.
4. Calculate the risk using the formula: Risk = Standard Deviation of Returns
5. Determine the liquidity of the security.
6. Compare the yield, maturity, risk, and liquidity of the security to determine its suitability for investment.

Common Mistakes

• Mistake: Using the wrong formula for calculating the yield.
  • Correction: Use the correct formula: Yield = (Face Value - Purchase Price) / Purchase Price
  • Why: The formula is used to calculate the return on investment.
  • Counterexample: Suppose a T-Bill has a face value of $100,000 and a purchase price of $99,000. The correct yield is 1%, but if the wrong formula is used, the yield would be 0.5%.
• Mistake: Ignoring the maturity of the security.
  • Correction: Consider the maturity when evaluating the security's suitability for investment.
  • Why: The maturity affects the security's liquidity and risk.
  • Counterexample: Suppose a commercial paper has a face value of $100,000 and a maturity of 3 months. If the maturity is ignored, the security's liquidity and risk may be underestimated.
• Mistake: Confusing the risk of the security with its yield.
  • Correction: Risk and yield are two separate measures of the security's performance.
  • Why: Risk measures the uncertainty of the security's returns, while yield measures the return on investment.
  • Counterexample: Suppose a T-Bill has a face value of $100,000 and a yield of 2%. If the risk is confused with the yield, the security's risk may be overestimated.

Exam / CFA Tips

• Tip: Be able to calculate the yield, maturity, risk, and liquidity of a security.
• Tip: Understand the differences between T-Bills, commercial paper, bankers' acceptances, and repurchase agreements.
• Tip: Be able to evaluate the suitability of a security for investment based on its yield, maturity, risk, and liquidity.

Quick Practice Problem

A company issues $100 million of commercial paper with a 3-month maturity and a 2% interest rate. What is the yield on the commercial paper?

Answer: 2% Explanation: The yield is the interest earned on the investment, which is 2% in this case.

Last-Minute Cram Sheet

• T-Bill: a short-term debt instrument issued by the government.
• Commercial Paper: a short-term debt instrument issued by companies.
• Bankers' Acceptance: a short-term debt instrument issued by banks.
• Repo: a short-term debt instrument issued by banks.
• Money Market Fund: a type of investment fund that invests in short-term debt instruments.
• Yield: the return on investment in a security.
• Maturity: the length of time until a security matures.
• Risk: the uncertainty of a security's returns.
• Liquidity: the ease of selling a security.
• In M&M Proposition I (no taxes), firm value is independent of capital structure – but with taxes, value increases with debt due to the interest tax shield.