ACCA FM Syllabus B. Financial Management Environment - Treasury Function - Notes ^{6 / 6}

It’s a relatively safe place to put money as everything is short term and highly liquid

Money market securities

These are essentially IOUs issued by governments, financial institutions and large corporations

Most trade in very high denominations

Let’s look at some in more detail..

1. Treasury Bills

   (T-bills) are the most marketable money market security.

   • Short-term government securities that mature in one year or less

   • Issued at a discount and then the government pays the full par value on maturity

   • One of the few money market instruments that are affordable to individuals with investors denominations as low as $1,000

   • Considered safe as government backed, but this means a small return also

   • Might not get back all of your investment if you cash out before maturity

2. Certificates on Deposit

   Normally issued by commercial banks but they can be bought through brokerages

   • Have a maturity date (from three months to five years), a specified interest rate, and can be issued in any denomination

   • Cannot be withdrawn on demand

3. Commercial Papers

   For companies, borrowing from banks can be a pain (in the a**). This is where commercial papers on a money market comes in..

   • No security is needed, and they are short term. Normally 1 - 2 months. This makes them safe to invest in, though normally only good credit companies issue these

   • They’re normally used to finance working capital (trade finance) such as receivables and inventories

   • They are normally in denominations of $100,000 or more - Therefore, smaller investors can only invest in commercial paper indirectly through money market funds

   • They are normally issued at a discount and paid back at par value (the difference is obviously the interest)

4. Bankers Acceptance

   A BA is a short-term credit investment, and a bank guarantees payment.

   • Companies use them for financing imports and exports, when the creditworthiness of a foreign trade partner is unknown

   • They don’t need to be held until maturity, and can be sold off in the secondary markets where investors and institutions constantly trade BAs

Money Market Derivatives

These derive their value from Treasury bills, Eurodollars,  certificates of deposits (CD) and interest rates. 

They are commonly traded as futures, forwards, options and swaps as well as caps and floors.

Let's have a quick look at futures (there's more further on in the course for the others)

• When a currency futures contract is bought or sold, the buyer or seller is required to deposit a sum of money with the exchange, called initial margin.

  If losses are incurred as exchange rates and hence the prices of currency futures contracts change, the buyer or seller may be called on to deposit additional funds (variation margin) with the exchange

• Equally, profits are credited to the margin account on a daily basis as the contract is ‘marked to market’.

  Most currency futures contracts are closed out before their settlement dates by undertaking the opposite transaction to the initial futures transaction, ie if buying currency futures was the initial transaction, it is closed out by selling currency futures.

  A gain made on the futures transactions will offset a loss made on the currency markets and vice versa.

• Advantages
  Lower transaction costs than money market
  They are tradable and so do not need to always be closed out

• Disadvantages
  Cannot be tailored as they are standard contracts

  Only available in a limited number of currencies

  Still cannot take advantage of favourable movements in actual exchange rates (unlike in options)

A Money Market Fund
This provide investors with a safe place to invest easily accessible cash-equivalent assets

However the fund will provide only relatively low returns so it’s not a long-term investment option.