Short-Term Investments & Marketable Securities: Types, Valuation & Strategies

TAKEAWAYS:

• Short-term investments (marketable securities) are liquid, low-risk assets held to earn returns on temporary cash surpluses.
• Treasury bills (T-bills), commercial paper (CP), and certificates of deposit (CDs) are the three primary instruments, differing in issuer, maturity, and yield.
• Valuation uses discounted cash flow (DCF) and yield-to-maturity (YTM) calculations to compare returns across instruments.
• Risk-return tradeoff dictates that higher liquidity (e.g., T-bills) means lower returns, while higher yields (e.g., corporate CP) carry more risk.
• Strategic deployment involves matching investment horizons with cash flow needs (e.g., Ncell’s short-term investments in T-bills for liquidity).
• Nepali context: NEPSE’s short-term government securities (G-secs) and bank CDs are key tools for businesses like Daraz or Pathao to park excess cash.

1. Introduction to Short-Term Investments and Marketable Securities

Short-term investments (STIs) are highly liquid, low-risk financial assets purchased with temporary cash surpluses (e.g., seasonal sales revenue, loan repayments). They mature within 1 year and include:

• Marketable securities: Negotiable instruments traded in secondary markets (e.g., T-bills, CP).
• Non-marketable securities: Held until maturity (e.g., bank CDs, interbank deposits).

Why invest short-term?

• Earn risk-free or near-risk-free returns on idle cash.
• Maintain liquidity for operational needs (e.g., paying suppliers, salaries).
• Arbitrage opportunities: Exploit interest rate differentials (e.g., investing in higher-yielding CDs than savings accounts).

IMAGE: Treasury Bill (T-bill) Certificate | Example of a Nepali government T-bill (Nepal Rastra Bank issuance)

IMAGE: Commercial Paper (CP) Issuance Process | How Pathao or Daraz might issue CP to fund short-term needs

2. Types of Short-Term Investments

Mermaid Diagram: Short-Term Investment Decision Flowchart

flowchart TD
    A["Temporary Cash Surplus"] --> B["Assess Liquidity Needs"]
    B -->|"High Liquidity Needed"| C["T-bills or CDs"]
    B -->|"Moderate Liquidity"| D["Commercial Paper"]
    B -->|"Low Liquidity"| E["Money Market Funds or Banker’s Acceptances"]
    C --> F["Lowest Risk, Lowest Yield"]
    D --> G["Higher Yield, Moderate Risk"]
    E --> H["Diversified, Professional Management"]

3. Valuation of Short-Term Investments

Key Concepts:

1. Discounted Cash Flow (DCF) Approach:

   • STIs are valued based on future cash flows (face value + interest) discounted to present value.
   • Formula: $$PV=\frac{FV}{(1+r{)}^n}$$ Where:
     • $PV$ = Present Value (purchase price)
     • $FV$ = Face Value (e.g., Rs 100,000)
     • $r$ = Discount rate (market interest rate)
     • $n$ = Days to maturity (converted to years)

2. Yield Calculations:

   • Holding Period Yield (HPY): $$HPY=\frac{FV-PV+Interest}{PV}\times \frac{365}{n}$$
   • Yield to Maturity (YTM): Annualized return if held to maturity.

Worked Example: Valuing a T-Bill in Nepal

Scenario: A Kathmandu-based retail shop (e.g., Sano Commerce) has Rs 500,000 to invest for 90 days. A T-bill is auctioned at Rs 98,000 for a face value of Rs 100,000 (discount of Rs 2,000). Calculate:

1. Discount Rate: $$\text{Discount Rate}=\left(\frac{\text{Discount}}{\text{Face Value}}\right)\times \left(\frac{365}{n}\right)=\left(\frac{2000}{100000}\right)\times \left(\frac{365}{90}\right)=8.11\%$$
2. HPY: $$HPY=\left(\frac{100000-98000}{98000}\right)\times \left(\frac{365}{90}\right)=8.33\%$$
3. Decision: If the shop’s cost of funds is 7%, investing in this T-bill is profitable.

IMAGE: T-Account for T-Bill Investment | Journal entry for Sano Commerce buying a T-bill

4. Risk-Return Tradeoff in Short-Term Investments

Real-World Example:

• Ncell invests excess cash in T-bills and CDs to earn risk-free returns while maintaining liquidity for dividend payments.
• Pathao might issue commercial paper to fund driver incentives, accepting higher yields but with moderate risk.

5. Strategic Deployment of Short-Term Investments

Businesses use STIs to:

1. Match Cash Flow Cycles:
   • Example: A Kathmandu hotel invests in 90-day CDs during off-season (low cash flow) to earn interest until peak season.
2. Speculative Opportunities:
   • Example: Daraz might buy T-bills at low rates when Nepal Rastra Bank cuts repo rates, then sell before maturity for a profit.
3. Regulatory Compliance:
   • Banks (e.g., NMB) must hold liquid assets (STIs) to meet Nepal Bankers’ Association (NBA) liquidity ratios.

Mermaid Diagram: Cash Flow Matching Strategy

flowchart LR
    A["Seasonal Sales Peak\n(June–August)"] -->|"Excess Cash"| B["Invest in 3-Month CDs\n(Rs 8% yield)"]
    C["Off-Season\n(December–February)"] -->|"Cash Shortage"| D["Sell CDs Early\n(Liquidate for Working Capital)"]
    B --> E["Earn Rs 200,000 Interest\non Rs 10M Investment"]
    D --> F["Cover Payroll & Inventory\nWithout Loans"]

6. Short-Term Investments in Nepali Context

mindmap
  root((Short-Term Investments in Nepal))
    Nepal Rastra Bank
      T-bills
        - 3/6/12-month
        - ~5–8% yield
        - Tax-free
      CDs
        - Bank-issued
        - ~7–9% yield
        - Taxable
    Corporates
      Commercial Paper
        - Daraz, Pathao
        - ~6–10% yield
        - Medium risk
    Money Market
      NABIF Funds
        - eSewa/Khalti-linked
        - ~6–9% yield
        - Low risk
    Regulatory
      NBAF Compliance
        - Liquidity ratios
        - Risk diversification

Case Study: eSewa’s Short-Term Investment Portfolio

• Instrument: Nepal Rastra Bank T-bills (3-month, Rs 7.5% yield).
• Amount: Rs 500 million parked in 2023.
• Why?
  • Liquidity: eSewa needs cash for merchant payouts and loan disbursements.
  • Safety: T-bills are default-free (backed by the government).
  • Returns: Better than savings accounts (5%) or fixed deposits (6.5%).

Journal Entry for eSewa:

7. Exam Tips for Unit 9

1. Memorize Key Formulas:
   • Discount rate, HPY, and YTM calculations are highly tested. Practice with NPR amounts (e.g., Rs 50,000, Rs 100,000).
2. Compare Instruments:
   • Exams often ask: "Which would you recommend for a firm needing Rs 2M in 60 days?" → T-bills (liquidity) vs. CP (yield).
3. Real-World Applications:
   • Link answers to Nepali businesses (e.g., "How would Daraz use STIs?").
4. Risk-Return Tradeoff:
   • Always discuss tradeoffs (e.g., "Why not invest all in CDs?" → Liquidity risk).
5. Case Study Ready:
   • Be prepared to value a T-bill or CP given face value, discount, and maturity.

## In the Real World

1. Ncell’s T-Bill Investments:

   • What it uses: Treasury bills (T-bills) to park excess cash from dividend payments.
   • How it works: Ncell buys 3-month T-bills at auctions (e.g., Rs 99 for Rs 100 face value) to earn ~7% risk-free returns while keeping funds liquid for emergencies.

2. eSewa’s Liquidity Management:

   • What it uses: Certificates of Deposit (CDs) and money market funds to earn higher yields than savings accounts.
   • How it works: eSewa invests Rs 300M in 6-month CDs (8% yield) while maintaining Rs 200M in T-bills for immediate payouts to merchants.

3. Daraz’s Commercial Paper Issuance:

   • What it uses: Commercial paper (CP) to fund short-term inventory purchases.
   • How it works: Daraz issues 90-day CP at 9% yield to suppliers, reducing reliance on bank loans. This is cheaper than a bank loan (12%+) but carries moderate credit risk.

## Past Exam Questions Solved

Question 1:

A firm’s credit term is 2/10 net 30. Write the meaning of 2, 10, and net 30. Answer:

• 2: 2% discount offered.
• 10: 10 days to avail the discount.
• net 30: Full payment due in 30 days if discount is not taken. Exam Tip: Always relate this to accounts receivable management (Unit 5).

Question 2:

Champion Manufacturing turns over its inventory 8 times/year, has an average payment period of 35 days, and an average collection period of 60 days. Calculate its operating cycle investment. Solution:

1. Inventory Conversion Period (ICP): $$ICP=\frac{365}{8}=45.625\text{ days}$$
2. Receivables Collection Period (RCP): 60 days (given).
3. Payables Deferral Period (PDP): 35 days (given).
4. Operating Cycle (OC): $$OC=ICP+RCP=45.625+60=105.625\text{ days}$$
5. Operating Cycle Investment:
   • Assume annual sales = Rs 100M, COGS = 70% → Rs 70M.
   • Daily COGS = Rs 70M / 365 = Rs 191,781.
   • Investment = Rs 191,781 × 105.625 = Rs 20.26M.

## Summary Table: Short-Term Investment Instruments

## Final Exam Checklist

Before the exam, ensure you can:

1. Calculate HPY and YTM for any STI.
2. Compare T-bills vs. CP vs. CDs in terms of risk, return, and liquidity.
3. Explain how a Nepali firm (e.g., Pathao, a hotel, or eSewa) would use STIs.
4. Draw a T-account for buying/selling STIs.
5. Discuss the risk-return tradeoff with real-world examples.