What is Short Term Investment: A Corporate Treasurer’s Guide
This article explores the considerations a corporate treasurer needs to make when handling the short term Investment of a corporation and the tools they can use to meet their objectives. Have you ever pondered the strategic moves that corporate treasurers make in handling a corporation’s short-term cash? If these thoughts have crossed your mind, you’ve landed in the right place!
A successful short term investment approach revolves around leveraging the most suitable financial instruments to fulfill a corporation’s specific needs. In this comprehensive article, we aim to explore the thought process behind a corporate treasurer’s decisions and the various instruments they employ to meet their objectives. We’ve brought together valuable insights from our Corporate Treasury 101 podcast, where Guillaume, a treasury expert, shed light on managing short-term cash in a corporation.
By diving into this article, you’ll learn:
- The Key Principles of Corporate Treasury: Understand the crucial balance between security, liquidity, and yield in managing short-term corporate cash.
- Different Short-term Investment Options: Uncover the ins and outs of treasury bills, time deposits, and commercial papers.
- Risk and Reward Dynamics: Explore how risk levels vary across different investment options and how they correspond to potential returns.
- Importance of Liquidity: Discover why the ability to convert investments into cash quickly is critical in the world of corporate treasury.
- Investment Flexibility: Learn about the potential for selling or transferring investments before maturity.
- Role of Commercial Papers: Get a grip on commercial papers and how corporations use them.
- Understanding Unsecured Investments: Delve into the meaning of ‘unsecured’ in investment terms and its implications.
- The Power of Money Market Funds: Understand how these funds can simplify your investment process and provide a good alternative to bank deposits.
- The Art of Diversification: How diversifying investments can help mitigate risk and stabilize returns.
Before we proceed, we strongly suggest you familiarize yourself with “4 Pillars of Corporate Treasury Departments” and “Cash Positioning and Cash Flow Forecasting” for better understanding.
Ready to dive in? Let’s get started and unlock the secrets to successful short-term cash management.
Short-Term Cash Management: What’s Involved?
Short-term cash management is a hot topic in the corporate treasury circle. Let’s get some understanding about it. It’s all about managing your money (cash) in the short term. The funds could come from various sources, and once they’re in, the question is: What next?
Our guest, Guillaume, opened the conversation about the role of a corporate treasurer in managing short-term cash. He began by bringing up the concept of short-term funding, which we discussed previously, emphasizing its importance in cash flow forecasting strategies.
You see, short-term funding is about getting the cash a corporation needs to operate, often to meet immediate expenses or for quick projects. However, sometimes a company may find itself with excess cash, perhaps due to efficient cash flow management or profitable operations. That’s when you must decide what to do with the surplus money.
Surplus Cash: A Common Scenario
Surplus cash might sound like a dream come true, but it’s common in many industries. For instance, large retail companies often negotiate long-term payment delays with their suppliers. This means they have a longer window to pay their suppliers, while customers immediately pay for their purchases.
In simpler terms, imagine this: You’re running a shop where customers pay you immediately when they buy something. But your suppliers, who provide you with the items to sell, give you months to pay them back. Over time, this situation can result in a pile of cash sitting idle in your account.
Making the Most of Your Cash
Now, having cash sitting idle isn’t necessarily a good thing. It’s like having a car but not using it. The goal of a corporate treasurer is to put that money to work through short-term investments. And how do they do this? By investing it.
But remember, we’re not talking about long-term investments. This episode specifically focuses on short-term and medium-term investments more relevant to a corporate treasurer’s role.
Now, let’s dive deeper into these short-term investment options and how they can help you maximize your cash utilization. Stay tuned to learn more about efficient cash management and investment strategies, including short-term investment opportunities!
How Can a Corporate Treasurer Effectively Invest In A Company’s Cash Reserves?
Managing a corporation’s funds is a delicate balance. It’s not just about accumulating money but also effectively using it. Let’s look at how a corporate treasurer can strategically invest in the company’s existing cash reserves.
From Funding to Investing
In a company’s financial journey, there comes a point where we move from needing funding to having extra cash. In funding, the procedure is quite clear-cut. You assess your money requirements and select the most fitting instrument to acquire that cash. These instruments can be cash markets, loans, and so on. But what about when it comes to investing the cash you already have? How does a company approach that?
Investing Like an Individual Vs A Corporation
You may think that investing money is the same for everyone, whether you’re an individual or a corporation. But that’s not quite right. Investing strategies vary greatly based on whether you deal with personal finances or manage a corporation’s treasury.
Take it from our guest, Guillaume, who pointed out that while individuals and investment funds aim to grow their own or their clients’ money, corporate treasurers have a somewhat different approach. A corporate treasurer, or more specifically, the cash manager, is usually in charge of this aspect of the treasury. The cash manager’s role involves getting funds when needed and investing surplus money.
Guiding Principles for Investing Surplus Cash
When deciding on investments, there are several key considerations that a cash manager needs to remember.
Firstly, it’s important to note that letting cash sit idle in a bank account is the worst thing you can do. Why? Because it brings little to no interest, and in some cases, like with the Euro in a context of negative interests, you might even lose money. That’s right; leaving your cash in the bank could be costing you!
You might be thinking, “So I should just invest all my extra cash right away, right?” Hold on a second; there’s more to consider. As a corporate treasurer, your goal is to manage risk. That means avoiding putting the principal, or the amount invested, at too much risk. After all, losing money isn’t exactly optimizing cash, right?
Secondly, you need to ensure that the cash remains reasonably available. This concept is known as liquidity. It means that whatever instrument you use to invest, you should be able to sell it quickly if you suddenly need cash.
And lastly, you aim to optimize the return. This means getting as much return as possible within the small low, risk, and high liquidity window.
So, when you invest as a corporate treasurer, remember these three crucial factors in this order of priority: Security of the principal, liquidity, and yield, which means the return on investment. By keeping these elements in mind, you can make the most of your company’s surplus cash without jeopardizing its financial health.
How Can Corporate Treasurers Secure Investments While Managing Risk and Yield?
Regarding managing a corporation’s finances, safety and yield, seem to pull in opposite directions. But with a keen understanding of risk appetite and a thorough approach to assessing investment opportunities, a corporate treasurer can strike a winning balance.
The Role of Risk Appetite in Investment Decisions
Here comes the crucial term you must remember – risk appetite. It’s a fancy term describing how much risk you’re willing to take. In the corporate treasury, this risk appetite plays a vital role in every decision you make. It can shape your decisions about how much liquidity you want to keep versus how much yield, or return on investment, you want to chase.
These variables often conflict. For instance, investments with higher yields typically come with more risk, and ultra-safe investments may not bring much return. So, you need to optimize based on your risk appetite.
Yet, in all these decisions, one priority stands out – security. Sure, you don’t want to keep your cash idle, especially during low or negative interest rates. But that doesn’t mean you want to toss it carelessly into any investment that comes your way.
Investing, by its very nature, involves risk. So, the question arises, how can you ensure your investments are as secure as possible?
Maintaining Investment Security
Protecting the value of your investments is paramount. You don’t want to put your money into something like stocks, which can fluctuate wildly. Remember, from a corporate treasury perspective, you want to avoid investments that could potentially decrease value. More importantly, you want to be able to recover all of the money you’ve invested.
So, how do you navigate this tricky terrain? By closely monitoring credit and counterparty risk.
While these terms might sound technical, they are simple enough once you get the hang of them.
- Credit risk refers to the risk that a borrower will default on any type of debt by failing to make required payments. In other words, you want to avoid a loss resulting from a borrower’s inability to repay a loan or meet contractual obligations.
- Counterparty risk is similar. It involves the possibility of a loss from a transaction, such as a loan or a derivatives contract, if the counterparty fails to fulfil its side of the deal.
To minimize these risks, you must focus on low-credit risk investments and counterparties with good credit ratings. In this way, you balance the need for yield with the essential security requirement. And that’s the delicate dance of a corporate treasurer when investing surplus cash!
How Do Credit Ratings Work in The Corporate World?
While individual investors might focus on maximizing yield, corporate treasurers’ priority is ensuring their funds’ security. One of the tools they use to manage this is the credit rating. You might have heard of credit ratings before, but they take on a slightly different flavor in the corporate world.
Understanding Credit Ratings
In individual finance, credit ratings often refer to an individual’s creditworthiness. However, for corporates, these ratings extend beyond individual creditworthiness to cover companies and even governments.
In the corporate world, credit ratings are typically assigned by rating agencies, such as Moody’s, S&P (Standard & Poor’s), and Fitch. These agencies made headlines following the 2008 financial crisis when they gave high ratings to banks that later proved unstable.
The role of these rating agencies is to thoroughly analyze the financial health and other aspects of businesses and assess their ability to repay their debts. They’re essentially doing the homework for investors, giving you a sense of how safe it is to lend money to these businesses.
The worse a company’s credit rating, the higher the risk that they won’t repay their debts – and as an investor, that means a higher chance you won’t get your money back. Therefore, as a corporate treasurer, you’d ideally want to invest in companies with good credit ratings.
Using Credit Ratings in Investment Decisions
Using these ratings and considering the broader picture is vital as a corporate treasurer. While these ratings are a valuable tool, they aren’t infallible (as the 2008 crisis showed us). Therefore, alongside checking the credit rating, you also need to evaluate how likely the counterparty you are investing your money in will be able to repay you.
Remember, you don’t want to lose your principal, so assessing a company’s credit rating is part of managing and minimizing risk. Always remember that it’s not just about getting a return on your investment; it’s about ensuring it is safe and secure.
By considering these factors and keeping your risk appetite in check, you can ensure your company’s funds are invested wisely, maximizing security and yield. It’s all part of the delicate balancing act of being a corporate treasurer.
Does Corporate Treasury Apply The “High Risk Equals High Reward” Investment Principle?
Risk and reward are twin aspects of investing that are just as relevant in the corporate treasury space as they are for individual investors. The popular belief is that higher risk brings higher rewards. But how does this play out in the world of corporate treasury?
The High-Risk, High-Reward Dynamic
The high-risk, high-reward principle is fairly straightforward. They’re considered a higher risk if you lend money to a company with a low credit rating (as given by rating agencies like Moody’s, S&P, or Fitch). Therefore, they’ll need to offer a higher interest rate to borrow money, which can lead to a bigger payoff for you, the investor, if they manage to repay the loan. So yes, the principle applies here too.
However, here’s where the role of a corporate treasurer differs significantly from that of an individual investor. While an individual investor may be willing (or even eager) to take on higher risk for potentially higher rewards, as a corporate treasurer, your primary job is to minimize and manage risk associated with the company’s money.
Balancing Risk and Reward in Corporate Treasury
Even though high-risk investments could potentially bring in high rewards, you generally want to avoid these risky investments. Instead, you should focus on counterparties with good or excellent credit ratings. This strategy allows you to protect the company’s money and ensure a more predictable return on investment.
Ultimately, the level of risk you’re willing to accept goes back to your company’s risk appetite and the overall treasury and risk policy. While there might be exceptions where certain financial and treasury departments consciously decide to take on higher risk, this is generally rare in practice.
Why Is Liquidity Key in Corporate Investments, And How Do We Categorize Such Cash?
In financial terms, liquidity refers to the ease with which an asset can be converted into cash without losing its value. It’s a critical element to consider when investing, as it ensures that money is available when needed. But why is liquidity so vital for corporate investments, and how can we classify different types of corporate cash meant for investment? Let’s delve into this.
The Importance of Liquidity
As a corporate treasurer, you ensure the company’s money isn’t just sitting idle in a bank. Given the low-interest rates and the risk of negative interest rates or inflation eroding the value of money over time, you want your money to be actively working for you. Yet, you also want it to be as easily accessible as cash, ideally.
Why is this accessibility important? It’s simple: you need an instantly available cash reserve to manage unforeseen circumstances like a crisis. You never know when an unexpected expense might arise, so having accessible cash is crucial to keep business operations running smoothly.
Categorizing Corporate Cash for Investment
Guillaume offers a handy way to think about the cash you want to invest or not. He suggests segregating it into three buckets: operating cash, liquidity reserve, and strategic balance. Let’s break these down:
- Operating Cash: This is the money you need for your daily operating needs. It’s the cash you need for everyday business expenses, from employee wages to utility bills. You can’t afford to lose any part of it, and you want to always have direct access to it. You could consider investing it overnight (an investment made overnight where you get your money back the next morning), but it must remain readily available.
- Liquidity Reserve: This represents cash you won’t use in the coming weeks or months. You can afford to invest this but want to keep it reasonably liquid for unforeseen circumstances. Investment instruments with a tenure of 3 to 12 months are ideal for this bucket.
- Strategic Balance: This is cash you won’t need anytime soon. It’s often the money that has remained unused on the balance sheets so that you can invest it for longer periods.
Remember, managing the different types of cash is an art and a science. You must find the right balance between getting the most from your investments and maintaining enough liquidity to cover business operations and potential crises. Consider your company’s financial situation and risk tolerance when deciding where to allocate your funds.
Does Longer-Term Investment Correlate with Higher Returns in Corporate Cash Management?
We’re all familiar with the principle of investing: the longer your money is invested, the higher the return due to the magic of compounding and time. But does this principle hold when it comes to managing corporate cash? The simple answer is yes. Let’s dive into why and how it fits into the broader cash management strategy.
The Benefit of Longer-Term Investments
Just like in personal finance, in corporate finance too, when you invest money for a longer period, you give the counterparty more time to use that cash. This can lead to higher rewards or interest rates. The reasoning here is straightforward: the longer you can do without your money (i.e., the longer you let it be invested), the more valuable it becomes to the counterparty. This principle is rooted in the concept of the cost of cash—the longer you invest it, the higher the reward.
This idea is central to what is known as the yield curve—a key term in investment strategies. The yield curve shows the relationship between the maturity of an investment (how long it takes to mature or come to an end) and the interest rate or yield associated with that investment.
Understanding the Yield Curve
If you place your funds in a short-term investment with a three-month maturity, it will be blocked for three months, and you’ll get it back after that period, plus any interest earned. Or depending on the type of short-term investment, it could potentially yield interest throughout the life of the investment.
On the other hand, if you invest your money for 12 months, you’re more likely to get a higher interest rate. This is because, in normal market conditions, the longer the maturity, the better the interest rate. This principle is precisely why your strategic balance—the money you won’t need for sure—can be invested for longer periods in short-term investments to garner higher returns.
However, it’s important to note that there can be exceptions to this rule, particularly during recession times when the future value of money can be uncertain. In such cases, money invested for a longer period may not be worth as much as in a short-term investment.
How Do Liquidity Preference and Risk Appetite Affect Corporate Cash Investment Returns?
We’re exploring the idea that the more accessible (or liquid) your cash is, the less return you can get from it. Conversely, the longer your cash is tied up and inaccessible, the more return you can expect. This principle is prevalent not only in personal finance, such as government bonds and yield farms, but also at the corporate level.
The Trade-Off Between Liquidity and Returns
In plain terms, if you need your money to be readily available, you can’t expect a high return on it. Why? Because the party you’re investing with is not getting much benefit from holding your cash as they know you could need it back at any time.
On the other hand, if you can afford to tie up your cash for longer, the investing party is more willing to reward you with higher returns. They get more value from your money because they know they can use it for a more extended period without the risk of you suddenly needing it back. It’s like bonds: the longer the term, the higher the return.
The Role of Risk Appetite
Now, as a treasurer, your primary concern is protecting your cash so it doesn’t lose its principal value. Making a return (yield) on your cash is secondary. You don’t want to make risky investments because you don’t want to lose money. This might mean accepting lower yields or returns.
At the same time, you don’t want to tie up your cash for too long because you need to have it available or liquid. This also means you won’t earn a lot. So, as a treasurer, you’re not investing to earn as much as you invest to keep the money safe.
The Bottom Line
The role of the treasurer is to manage money most efficiently, balancing the need for security and liquidity with the opportunity to earn some interest. Even though the returns might not seem substantial, they can add up quickly when dealing with large sums.
For example, if your company has an average available cash balance of 500 million euros and you invest this at a 2% interest rate (which might seem low but is decent given negative euro interest rates), at the end of the year, you’d have earned your company an extra 10 million euros. That’s a substantial amount of money that can be put to good use, all while ensuring the group’s solvency without endangering the business.
So, while a treasury professional’s priority is safeguarding the company’s principal cash balance, even seemingly small investments can yield significant returns over time, particularly for large companies. It’s all a matter of perspective.
What Investment Instruments Offer High Security, High Liquidity, And A Decent Yield?
So, we’ve established that the priority for a corporate treasurer when investing cash is not necessary to make a large profit but rather to ensure the security and liquidity of the cash. But you might wonder, “What investment options meet these criteria?” We’re going to delve into that.
Money Markets
We first need to know how cash managers usually invest in short-term instruments. They do this through what’s called “money markets.” Imagine money markets as a huge marketplace where banks, other financial institutions, money managers, brokers, dealers, and corporates meet to deal in short term investment.
The investment instruments you’ll find in money markets are known to be:
- Available in large quantities (meaning they’re liquid)
- Short-term
- Usually low in credit risk (although some are riskier than others)
Like a stock exchange, money markets have primary and secondary markets. The primary market is where an investment instrument is initially issued, and the secondary market is where these instruments are bought and sold second-hand. In money markets, you can invest or borrow some if needed.
Main Issuers
The next question is, “Who are the main issuers of these investment instruments?” The answer to this falls into three categories, in order of perceived risk:
- Governments and government agencies: These are the safest options. Think of the treasury bills we discussed earlier.
- Banks and financial institutions are a bit riskier than governments and government agencies. However, they’re generally considered safe, thanks to mandatory ratios and by-law enforcement.
- Corporations: This is the final category.
And there you have it. These are your options for investing cash securely and liquidly with a decent yield.
What Kind of Instruments Are Available for Making Short-Term Investment with Governments?
Now that we have understood the concept of money markets and the main issuers of investment instruments let’s delve into specifics. You may wonder, ” What investment options are available when dealing with governments?”
Treasury Bills or Bonds
When you think of investing with governments, you’re primarily looking at treasury bills, often called T-bills in the US, or more generally, bonds.
These are:
- Short-term debt instruments are issued by a government, typically with a maturity of less than a year, though it can vary.
- Considered the safest investment you could make.
- Very liquid. You can easily exchange them on the secondary market.
While treasury bills offer the lowest interest rates, the chance of a government failing to repay its debt is extremely slim. In the past 50 years, only about 20 governments (usually ones already rated very low) have been unable to fulfil their debt obligations.
Liquidity And the Secondary Market
You may wonder, “What does it mean for a treasury bill to be liquid?”
Being liquid doesn’t mean the government can repay the loan quicker. Rather, it means that because these are such safe investments, other parties in the market (like other corporates) are willing to buy these bonds from you.
You don’t need to return to the government to get your money. Instead, you can sell the bond or treasury bill to another party willing to buy it off you, knowing it’s a safe investment.
Government Bonds as An Economic Tool
Another important point to note is the role of these bonds or treasury bills in managing market liquidity, especially in the context of inflation. When the government issues a short-term investment like a bond, they effectively take money out of the markets. This reduces the amount of cash available in the market.
This issuance of bonds as a short-term investment is not solely because the government needs money, but it also serves as a tool to control the economy’s liquidity. However, these bonds also play a critical role in funding governmental activities.
So, to sum up, if you’re looking to make a short-term, secure, and liquid investment, government-issued treasury bills or bonds, as forms of short-term investment, are your best bet. Remember, while the return may be low, the safety and liquidity these instruments offer are unmatched.
What Are the Investment Tools Available with Banks and Financial Institutions?
After discussing investments with governments, you might wonder, “What if I want to invest in banks and financial institutions? What are the available options?”
Overnight Investment Funds
The first type of investment tool we are looking at is an ‘overnight investment fund.’ Let’s break this down:
- Banks usually offer these.
- They serve as automatic overnight investment vehicles.
- The money is taken out of your account at the end of the day and returned the next morning.
- This investment is safe because the money is invested for a very short period, and liquidity is high – your funds are back in your account the next day.
- However, the returns (interest rates) on these are usually low.
Bank Deposits or Time Deposits
The second type of instrument is ‘bank deposits’ or ‘time deposits.’ Here’s what you need to know:
- These are fixed-term investments, typically for one to six months.
- These are not very liquid. You can’t withdraw funds before maturity without paying heavy penalties.
- They’re unavailable on the secondary market, meaning they can’t be bought or sold there.
Certificates of Deposit
Next up, we have ‘certificates of deposits:
- These are similar to bank deposits but with a critical difference – they’re negotiable.
- They can be bought or sold on the secondary market.
- They have a term of one to six months.
- Even though they require more paperwork compared to bank deposits, the ability to negotiate makes them an attractive option.
Banker’s Acceptance
The fourth instrument we are discussing is a ‘banker’s acceptance’:
- These are short-term notes issued by commercial banks.
- They arise from specific trade transactions.
- Most of these have a maturity of six months and are tied to a particular trade transaction.
Repurchase Agreements
Finally, we have ‘repurchase agreements:
- These are short-term investment, often made overnight.
- The investor (or lender) buys certain securities from the borrower, usually safe ones such as government securities.
- The borrower promises to repurchase the securities at a specified price and date. The price difference makes it profitable for the lender.
These are your five primary tools when considering short-term investment in banks and financial institutions. Each of these tools comes with its unique features, benefits, and risks. Therefore, it’s essential to understand them thoroughly and choose the one that best aligns with your corporate investment strategy.
How Do Corporate Investments Work, And What Is the Associated Risk and Reward?
Okay, we’ve chatted about governments and banks as avenues for investment, so now you might be thinking, “What’s the deal with corporate investments? Are they risky, or do they offer substantial returns?” Let’s clear this up!
Commercial Paper – The Go-To Corporate Investment
For corporations, the most common instrument for short-term investment is called ‘commercial paper.’ Let’s break this down:
- Commercial paper is a short-term, unsecured promissory note.
- ‘Unsecured’ means there is no collateral to secure the investment. You’re not putting down any assets as a safety net. You might recall this term from discussions about bank overdrafts. Just like an unsecured overdraft doesn’t require any guarantee from the bank, a commercial paper investment doesn’t have collateral backing it.
- ‘Promissory note’ is a fancy way of saying the borrower promises to pay back a certain amount of money at a specific time.
Typically, commercial papers are issued for 30 to 60 days, but some could be as short as one day.
Liquidity and Market Resellability
Liquidity isn’t just about the length of the investment term. It’s also about how easy it is to sell that investment to someone else. If you’ve got a six-month fixed-period investment, some people might think that’s not liquid at all. But if you can sell it to someone else tomorrow willing to wait six months, then it becomes a highly liquid asset.
Money Market Funds – A Handy Option
Now, let’s talk about ‘money market funds.’ This is a bit different from the corporate tool we just discussed:
- Money market funds are standalone pooled investments that actively invest in the aforementioned instruments.
- You don’t have to do all the work or research. Instead, you entrust your money to a third party, typically managed by large banks or financial institutions.
- These funds stick to the three principles we keep returning to – security first, liquidity second, and yield finally.
- They work similarly to an investment fund where you just give them your money, and they invest for you, diversifying as much as possible.
- You can choose different risk profiles depending on how you want to invest your money.
To put it simply, investing in corporations can be high risk but also high reward. Commercial paper is popular due to its short-term nature and potential yield. Moreover, money market funds are a practical alternative for seeking diversification and professional investment management. Remember, these investments are riskier, so weigh your risk tolerance and financial goals before diving in!
Wrapping It Up
Whew! We’ve covered quite a bit of ground, haven’t we? In this friendly guide, you’ve navigated the dynamic world of treasury management, learned about Short Term Investment options, and dived into their risks and rewards.
Let’s just take a moment to recap:
- We began with government-backed instruments, your safe bet when security is the name of the game.
- Then we shifted gears to banks and financial institutions, looking at diverse tools like overnight investment funds, bank deposits, certificates of deposits, banker’s acceptance, and repurchase agreements.
- Finally, we dived into the riskier yet potentially rewarding realm of corporate investments with commercial paper and money market funds.
Each investment tool has its place in a well-rounded treasury strategy, depending on your risk tolerance, liquidity needs, and yield expectations.
Remember, it’s all about balance. You have safe choices like government-backed instruments and slightly riskier ones like bank tools. And then there are the high-reward, high-risk corporate investments. All these tools have pros and cons; the best approach will depend on your unique circumstances and financial goals.
The world of treasury management is rich and diverse, with opportunities waiting for those willing to understand and navigate it. However, it’s crucial to make well-informed decisions. Arm yourself with knowledge, take calculated risks, and never stop learning.
The journey may seem challenging, but no one said managing a treasury would be a cakewalk. It’s a vibrant, ever-changing field that demands attention, understanding, and smart decision-making. But the rewards? They’re worth the effort. So, keep these tips and insights handy, and embrace the treasury management adventure.
Remember, the goal is to manage your funds and grow them. And now, you’re a step closer to doing just that. You’ve got this!
