Investing Short Term Funds

  • One of the goals of Working Capital Management is to ensure that the company’s asset is efficiently utilized to generate profits for the company.
  • A company may have surplus cash flow which is not required to finance the day to day activities and the company may invest this surplus in the market to generate profits. However, the company needs to ensure that these funds are invested in short term liquid securities so that it may be converted to cash whenever required.

Short Term Investment Instruments

Instrument Maturity
Government Securities Minimum 90 Days to 40 Years
Treasury Bills 91 Days, 182 days, 364 Days
Certificate of Deposits 7 days to 1 Year
Commercial Papers 1 day to 270 days
Repo 1 day to average 7 days
Bankers’ Acceptance 30 days to 180 days
Call and Notice Money 1 day to 14 days
Mutual Funds (Debt and Liquid Funds) Variable (as per need)
  • The instruments highlighted above are preferred options for short term investments, most of them are money market instruments (except Mutual Funds). The short-term investment options do not promise high return, rather a reasonable return is given as per the market rate and instrument.
  • Upon investing the funds in the instruments, the company can either follow a fixed strategy known as a passive strategy or it can observe the returns, market and other factors to decide the appropriate investment strategy, this is known as a passive strategy.
  • The short-term investment strategy keeps a balance between the risk and returns, low risk and stable return are preferred for short term funds so that the principal amount is safe and can be easily converted to cash if the need arises.

Types of Risk in Short Term Investments

  1. Credit or Default Risk: This risk implies that the issuer of the security may default on payment/maturity. E.g. ABC Bank was not able to honour the maturity of its bonds due to unfavourable situations in the economy.
  2. Market/Interest Rate Risk: This risk implies that the rate of return on the instrument may arise in the future. E.g. XYZ Ltd. purchased G-Sec in November 2019 at the return rate of 6%, however, in January the interest rate for the same security rose to 7.5%
  3. Liquidity Risk: This risk implies that the sale of securities may be difficult before maturity. E.g. PRS Ltd. purchased bonds with a locking period of 5 years, however, due to some crisis PRS Ltd. required cash after a year but due to the locking period the bond was not liquidated.
  4. Foreign Exchange Risk: This risk implies that the depreciation in a currency may affect the returns on security. E.g. SBC Ltd. invested in a foreign currency instrument, at the time of maturity the currency was devalued which affected the returns of the company.

Strategy of Investment

  • To mitigate the various types of risks associated with investment instruments, it is recommended to diversify the portfolio of investment.
  • Diversification means dividing the total investable fund into many parts and investing them in various instruments, this helps to mitigate the risks associated with instruments. In the end, the net return is calculated by taking the average return of the investment portfolio.
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