In this article we will discuss about the principles of investment in marketable securities.
The cash surplus built up in excess of daily cash requirements can be invested in readily marketable short-term securities. These securities are also called as ‘cash equivalents’.
The investment in short-term marketable securities is made keeping in view the following objectives:
(a) To earn interest for the holding period of investment.
(b) To convert the marketable securities into cash by disposing off in the market as and when the need arise to meet the situations of cash shortage.
(c) To increase return on investment by earning interest on idle funds.
(d) To maintain mix of investments in various short-term instruments and modes.
The short-term marketable instruments are sometimes referred as ‘money market instruments’, which include, Government treasury bills, Certificates of deposits, Repurchase agreement, Commercial paper, Inter corporate deposits, Short-term deposits, Money market mutual funds, Money at call and short notice, Bankers acceptance etc.
The primary criteria a firm should use in selecting short-term marketable securities in its portfolio should consider the following principles:
i. Default Risk:
The funds invested in short-term marketable instruments should be safe and secure as regards repayment of principal and interest as and when it matures since the return on short- term investments is offered less than long-term investments, the acceptable risk level is required to be lesser commensurate with lower return.
Some of the investments like commercial paper are offered with credit ratings. The government treasury bills, bankers acceptance, certificate of deposits carry minimum default risk.
The liquidity is the basic objective of investment in these instruments. It should offer the facility of quick sale in the market as and when need arises for cash, with low transaction cost, without loss of time and no erosion of amounts invested with fall in price of investments.
iii. Maturity Date:
Firms generally invest in marketable securities that have relatively short maturities. The maturity periods of different investments should match with the payment obligations like dividend payment, tax payment, capital expenditure, interest payments on debt instruments etc. Investments with long-term maturity periods are subject to fluctuations due to changes in interest rates, and are considered as risky than short-term instruments.
Many firms restrict their temporary investments to those maturing in less than 90 days. Short-term investments relatively carry lesser return than long-term investments, since the default risk and interest rate risk are minimized with short-term instruments.