Treasury Today Country Profiles in association with Citi

Short-term investment

Treasury plays a central role in the stability and success of a business. Its ability to manage liquidity requirements reflects on the credit standing of the company and can ultimately mean the difference between company growth and collapse. Effectively managing surplus cash is an important part of this process. In this article we consider some of the issues surrounding the short-term investment of surplus cash in the money markets.

Why invest?

In today’s uncertain economic climate it may be tempting to leave surplus cash in current accounts. Whilst these may offer a small yield (depending on negotiation), a treasurer should be looking for more appropriate ways in which to optimise the return on surplus cash, such as through the use of money market instruments and deposits. Maintaining a short-term investment portfolio offers potential benefits to a company including:

  1. Reduction of risk through matching of expected or planned operational cash inflows and outflows.

  2. Benchmarking of terms of trade (ie, credit allowed to customers and credit taken from suppliers).

  3. Increasing overall profitability.

  4. Conserving cash supplies for supporting the business during lean times.

  5. Having unqualified access to a reserve of funds available to finance projects and expansion activities.

  6. Obtaining instruments that may be useful collateral (guarantee/security) for credit facilities such as performance bonds or letters of credit.

The money markets

The money markets (or wholesale markets) are where financial and other institutions lend cash to each other to increase income on short-term funds and to borrow cash to meet short-term needs. This may be for overnight purposes or for a number of weeks or months but rarely exceeds one year.

In the current markets, liquidity beyond very short deposit maturities is almost non-existent, in other words very few deals are being done. In less unusual times, banks trade extensively with each other in various fixed date maturities at rates determined by market forces, as reflected in the UK by the daily fixing by the British Bankers Association (BBA) of the London Interbank Offered Rate (LIBOR). BBA LIBOR is used extensively in the market for corporate loans and issued debt as the fixing reference upon which debt pricing is based. LIBOR has been varying wildly during the trading day throughout the crisis but the interest rates applied by banks to their corporate relationships would normally vary above and below LIBOR for loans and deposits respectively.

Institutional and highly rated commercial borrowers also issue debt securities into the money market in order to raise short-term funds eg commercial paper and, in the case of banks, certificates of deposit. Short-term securities are also issued by governments and central banks eg treasury bills. These instruments are described later in this article.

Potential risks

Traditionally, the money markets are considered to provide low risk, good quality and high liquidity investment opportunities although the recent ‘financial crisis’ has left this perception somewhat tarnished.

As with any investment, there is a degree of risk. For short-term investments, the main risks relate to credit (eg obligor default or failure), market fluctuations (eg interest rate and foreign exchange) and liquidity (where, for instance, reliance may be placed on the availability of market bids for a particular instrument to meet unplanned calls on corporate cash). Credit ratings published by the three main credit rating agencies – Fitch Ratings, Moody’s and Standards & Poors – should help investors to judge the financial health and credit standing of counterparties and, in some cases, the investment instruments themselves.

The rating agencies have been criticised for failing to anticipate the banking crisis and its effects on the banks. The ratings they provide do, however, continue to indicate the perception of credit strength of each bank. When rating non-bank counterparties who are not as reliant on investor confidence in order to survive, credit ratings may be a more reliable indicator of the financial strength of the counterparty.

Whether credit ratings are relied upon to a greater or lesser extent, all investment decisions must be fully supported by judicious research and understanding of the counterparties, the markets and the investment instruments to be used.

Investment objectives

There are three critical objectives for short-term investment by a corporate treasury. These are:

  • Security.

    Minimising the potential risk to the original sum invested (the principal).

  • Liquidity.

    Ensuring timely realisation of the cash or of the availability of market bids for investment assets.

  • Yield.

    Achieving the best possible return on the cash.

Generally speaking, investments offering better returns also increase exposure to risk and reduce liquidity – the ‘no free lunch’ principle. As short-term investment is usually performed using cash needed for working capital purposes, investment decisions should not place the objective for greater yield above the overriding need to maintain the principal and to access cash when the business requires it. That said, investment choices must be made in line with the company’s overall investment policy and/or investment guidelines in the treasury policy.

The investment policy

The content of the investment policy will vary according to the needs of the business. However, it is important to define clearly any differences between short-term investment and long-term investment needs. The following issues should be addressed in the policy (although this list is by no means exhaustive):

  • Investment instruments that may be used or are prohibited.

  • Currencies that may be used or are prohibited.

  • Limits on investments in specific countries, currencies, industries or with specific issuers.

  • The minimum credit ratings of counterparties and (where applicable) instruments.

  • Maximum maturity limits for specific instruments and/or the portfolio as a whole; or if a certain number of instruments are required to mature at regular intervals (eg to meet specific business needs such as monthly salaries or other recurring outgoings).

  • Maximum positions that may be held per instrument, country, industry or issuer.

  • Concentration limits and diversification requirements, eg the proportion of the portfolio to be invested in certain instruments, industries or currencies, individual maturities or time bands etc.

  • Risk management limits which can be set at the level of treasury as a whole, separate portfolios or individual investment assets.

  • Investment strategy to be adopted ie passive management or active management.

  • Tolerance to risk in relation to safeguarding principal, maintaining liquidity and generating investment income (this will reflect the company’s overall risk appetite as defined in its risk management policy).

  • The individual roles and associated requirements involved in investment activity and supervision (eg treasury controls and measuring portfolio performance).

  • The process for measuring risk and performance, monitoring exposures and amending any of the issues covered in the policy.

Investment options

A wide range of investment options is available to a corporate treasurer. The main ones are outlined overleaf. However, treasurers must undertake extensive research and seek professional guidance before conducting investment activity of any kind. Indeed, it is essential that treasurers fully understand where and how particular options should be used as well as the issues (including the risks) and potential consequences surrounding their choices.

Current accounts

Banks do not encourage their customers to use current accounts for investment purposes. However, cash flow forecasting techniques are not infallible and there will be times when unexpected cash is left in current accounts – or where a small amount is left to service a particular liquidity need, for example, on local accounts.

Most banks will pay a fixed rate of interest on these credit balances although a minimum balance may be required before interest is payable and there may be a cap on the amount of cash that can be left overnight in the account. The rate of interest often depends on the size and strength of the relationship between the bank and the corporate but regardless of this, the return it generates is usually relatively low compared with other investments. When markets are particularly volatile, a treasurer should closely monitor the interest rates being achieved on their current accounts.


Deposit accounts

Deposit accounts are interest-bearing, typically at a fixed rate (although it may vary over time). They provide greater yield than current accounts although this is still potentially lower than most money market instruments.

Term deposits

Cash is placed in term (or time) deposits for a fixed period eg overnight or for a certain number of days, weeks or months. Alternatively, a bank may require an advance notice period to withdraw the deposited funds.

A minimum deposit amount is usually required and varies considerably from, for example, €20,000 to €1m. Larger amounts and longer investment periods will normally attract better interest rates. Interest is typically paid on maturity or, for longer deposits, at interim periods.

The fixed nature of term deposits reduces cash liquidity although funds can usually be withdrawn before maturity, but at a price (penalty). However, bank deposits offer a secure and effective means for investing cash when specific business requirements are known eg monthly salaries.

Sight deposits

Sight deposits are also known as on-demand or instant access deposits. They provide immediate access to funds without applying a penalty. This convenience means interest rates will be lower than for term deposits but are usually better than leaving surplus cash in current accounts. Rates may be improved by agreeing to a restricted number of withdrawals before the bank applies penalties. Options may also be available for an automatic sweep to move funds into this type of account, subject to pre-determined peg balances.

Money market instruments

Most money market instruments are designed to be liquid. This means they can be traded in the secondary market so an investor can usually realise their investment of the principal amount, plus some yield, before the instrument’s maturity date. Whilst these investments can, depending on demand in secondary markets, offer good liquidity, they are subject to market price volatility.

Money market instruments are either discount or interest bearing. Discount instruments are sold for less than their face value on issue but pay the holder (bearer) face value on maturity. The difference between the price at purchase and the price at maturity is essentially the interest income earned on the investment.

The more commonly used short-term instruments are described below.

Treasury bills

Frequently referred to as T-bills, these debt securities are issued by governments usually for periods of less than one year. They are often released (and repurchased) on a regular basis in order to control money supply and therefore liquidity in the money markets. Their maturity dates and availability depends on individual government policy. T-bills are usually sold at a discount. The major T-bill markets include the US and UK. During the banking crisis the yield on these instruments has fallen as, until government started to guarantee depositors, T-bills represented the safest money market investments.

Certificates of deposit

A certificate of deposit (CD) is issued by a bank to acknowledge that the investor has deposited a certain amount of money with that bank for a specified period. The bank is committed to paying the bearer of the CD the full amount of the original principal plus interest, on the date the CD matures. CD maturities vary from overnight to one year and beyond. CDs with longer maturity dates may pay interest at pre-agreed intervals (known as coupon payments) and/or at variable rates (eg quarterly or annually).

Commercial paper

Commercial paper (CP) is an unsecured promissory note issued by a company and is therefore a form of corporate debt. CP maturity periods are typically defined by the number of days (eg 30, 50 or 60) but rarely exceed a year, primarily due to local securities regulations. CP is usually sold at a discount. In some cases, it may be possible to achieve extra yield by extending the maturity date of the CP rather than redeeming its value on the original maturity date.

The largest domestic CP market is for US CP. In the euro CP market (the international CP money market), CP is issued in a currency other than a company’s domestic currency. The predominant currencies are US dollar, euro and sterling.

Asset-backed CP is supported by the asset value and expected cash flows from a package of short-term receivables such as mortgages, credit card or other loans. In these cases, the investor needs to assess and understand thoroughly the legal structure of the instrument, the issuer and the assets involved as well as the credit standing of the underlying obligors. Rating agency reports are helpful but not infallible.

In the current crisis the CP market liquidity is unreliable and markets are hardly functioning. Although steps have been taken by the US authorities to unlock the markets, demand for CP has been weakening since US money market funds (traditionally the largest single source of demand for US CP) started conserving cash following Lehman’s default and the failure of ‘The Reserve’ money fund. In Europe, demand for straight issue and asset-backed CP has also fallen. Secondary market activity was always patchy (given that CP would normally be issued to buy and hold investors for specifically tailored maturities) but it is currently negligible.

Banker’s acceptances

Banker’s acceptances (BAs) originate as corporate debt obligations but are guaranteed by a bank and are therefore a liability of the bank to the investor. They arise usually for financing specific trading transactions especially in relation to import and export activity. BAs are sold at a discount. Their face value represents the amount of the associated trade transaction.

Reverse repurchase agreements

A repurchase agreement (or repo) is a two stage transaction agreement to sell and repurchase securities. The reverse repurchase agreement (or reverse repo) is where a cash investor (cash lender) buys securities for cash and then resells those securities to the borrower for a specified price (principal plus interest) on a pre-agreed date. The securities effectively act as collateral to protect the investor. Many repos are based on government securities as these are considered to be one of the more secure instrument types.

Maturity dates range from overnight to a year, although longer periods may be available.

Money market funds

A triple-A rated money market fund (MMF) is an actively managed mutual fund that specialises in investing in high quality, short-term instruments such as those described above. Different investors participate in the ‘pooled’ fund by purchasing shares. These shareholders are entitled to a return in proportion to their investment and the underlying performance of the MMF portfolio.

Income accrues daily but may be distributed in one of two ways, depending on the fund. A constant net asset value fund (NAV) retains a fixed value for the share and distributes income at regular intervals. An accumulating net asset value fund (ANAV) increases the value of the share to reflect the accumulated income.

Investors can redeem their funds daily within specified cut-off deadlines. Consequently, MMFs are popularly used as overnight investment vehicles. By participating in an MMF, individual investors achieve the advantages of scale such as a more diversified investment portfolio and therefore diversified risk.

MMFs are generally considered to be a sound alternative to bank deposits offering security, better liquidity and comparable, and usually better, rates of return. How money funds have performed in the banking crisis is the subject of a special article in this month’s magazine, see pages 17-22.


Economic and market volatility adds additional pressure to the treasurer’s already challenging job of controlling cash flow and managing liquidity. With customers being squeezed by the ‘credit crunch’ and the global markets still rocking from the downfall of big name financial institutions and the help of government intervention, many treasurers may well be nervous about investing surplus cash. However, the lending and borrowing activity in the money markets is critical to the smooth running of the financial system. As long as corporates adopt well planned and controlled investment procedures, the money markets can still offer additional earnings, at acceptable risk and liquidity levels, for the short-term investment of surplus cash.

Essentially the CD is like a term deposit, but it has the advantage of being a negotiable instrument which can be sold if funds are needed before maturity.