Money market offers options for short-term investments - column

Healthcare Financial Management, Oct, 1989 by David J. Deluccia

Money market offers options for short-term investments

The United States money market is a significant segment of the nation's overall financial system. Banks and other institutions trade hundreds of billions of dollars each day in the money market. Where those billions go and the prices at which they are traded affect how the U.S. government finances its debt, how business finances its expansion, and how consumers choose to spend or save.

The money market is a wholesale market for low-risk, highly liquid, short-term IOUs. The money market, unlike the equity market, is a market for debt securities such as U.S. Treasury securities, Federal agency securities, bankers' acceptances, negotiable bank certificates of deposit (CDs), Eurodollar CDs, commercial paper, and others.

Each day, domestic and foreign banks actively trade in multimillion-dollar blocks of money market instruments, providing a great deal of liquidity for those who participate in the investment of short-term debt securities.

Although the safety of each money market instrument must be analyzed individually, the risk of default in money market instruments is far less than other significantly longer and less collateralized issues.

Healthcare organizations face short-term cash investments for funded depreciation, operational accounts, and bond proceeds accounts. Construction of a short-term portfolio begins with a study of money market investment options.

Treasury Bills (T-Bills) represent 40 percent of the total marketable securities issued by the Treasury Department. All T-Bills are negotiable, non-interest-bearing securities with an original maturity of one year or less. They are offered by the Treasury in minimum denominations of $10,000 with multiples of $5,000 thereafter. Bills are always issued at a discount from face value, and the amount of the discount is determined in bill auctions each time the Treasury issues new bills. Safety is found in the full faith and credit of the U.S. government.

Commercial paper is an unsecured promissory note with a fixed maturity. The issuer of commercial paper (the borrower) promises to pay the buyer (the lender) a fixed amount on a future date. The issuer pledges no assets -- only his liquidity and ability to repay. Risk, therefore, lies in the assessment of the issuer's ability to repay. Like T-Bills, paper is issued at a discount with maturities up to 270 days.

Bankers' acceptances are negotiable time drafts drawn primarily to finance the import, export, transfer, or storage of goods. The drafts are termed "accepted" when a bank guarantees payment at maturity. Bankers' acceptances closely resemble commercial paper--they are short-term (270 days or less) non-interest-bearing notes sold at a discount. The risk on bankers' acceptances is very low because of the bank participation and credit quality in addition to the underlying collateral involved.

CDs are negotiable instruments in denominations of $100,000 or more issued by banks and thrifts usually for fixed periods from two weeks to a year. Three types of CDs dominate the marketplace: Domestic CDs, which are issued by domestic banks; Eurodollar CDs, U.S. dollar denominated CDs issued by a bank in a foreign country; and Yankee CDs, CDs payable in dollars issued by foreign banks located in the United States. Credit quality rests in the underlying credit risk of the individual bank. Unlike discounted investments, CDs will project a yield based on their coupon (interest rate) and price.

Agency discount notes are used by Federal agencies to manage their short-term cash needs. Agencies such as the Federal National Mortgage Association will issue discount paper with maturities up to 270 days. Credit quality is widely considered to be extremely high because the agencies are creations of the U.S. government.

A short-term portfolio should always be managed by healthcare organizations within certain investment parameters that establish limits for the types of instruments the portfolio may buy; the percentage of the portfolio that may be invested in any one investment; acceptable issues and credit risk; whether the portfolio may invest in Eurodollar CDs and foreign investments; and the length of maturities.

Healthcare organization cash managers must be familiar with the alternative investments in which excess cash may be invested and the return and risk characteristics of each investment. Careful installation and review of short-term investment policies will enable healthcare organizations to successfully invest short-term excess cash with a great deal of safety.

David J. Deluccia is vice president at Kidder, Peabody & Co. Inc., San Diego, Calif.