C4 investing surplus
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Surplus cash arises when a company's cash inflows exceed its cash outflows. Companies hold surplus cash for transaction, precautionary, and speculative motives rather than immediately investing it. There are tradeoffs between risk, liquidity, maturity, and return that must be considered when determining how to invest surplus cash. Risks include unsystematic (diversifiable) risks that affect individual companies and systematic (non-diversifiable) risks that affect the overall market. Common options for investing surplus cash include retail bank accounts, marketable securities like bonds, and other investments.
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C4 investing surplus
- 2. Definition: May arise when a company’s cash inflows exceed its cash outflows during a period of time. OR Extra cash after all the expenditure.
- 3. Why company should hold surplus cash rather than investing it: 1. Transaction motive - Hold cash to meet regular commitments. 2. Precautionary motive - For emergency purpose. 3. Speculative motive - For good opportunity to invest.
- 4. RISK • Variability of return & potential loss of principal • High risk, high return LIQUIDITY • Cash must be available when needed • High liquidity, low return MATURITY • Length of time an investment must be held • Longer maturity, high risk, high return RETURN • Income & capital gain from the investment
- 5. UNSYSTEMATIC RISK SYSTEMATIC RISK • Non-diversifiable / market risk • Can’t be eliminated through diversification • Affect large number of companies in the stock market • Diversifiable risk • Can be eliminated through diversification • Affect a specific company or small group of companies
- 7. Retail Bank & Building Society Accounts Marketable Securities
- 8. Deposit Account Other Investment • Instant access accounts • Notice accounts • High interest accounts • Money market deposit • Option deposit • Specialist bonds
- 9. Instant access account • Allow its customers to gain access at any time to their deposits simply by making use of the ATM card. Notice accounts • Account holder is required to give a notice of withdrawal a specified no. of days before making withdrawal to avoid penalties High interest accounts • Suitable when have large sum of money • Give higher rate of interest
- 10. Money Market Deposit • Deposit account offered by the bank which invest in government of corporate securities • Guaranteed by Federal Government • Higher rate of return compared to simple checking account Option deposits • Predetermined periods of investment - 2 to 7 years • Interest rate linked to base rate • Restricted access
- 11. Generally issued by bank & building society Indicating that a sum of money has been deposited with a bank & will be repaid at a later date Duration – 7 days to 5 years Low credit risk Negotiable – can be bought & sold at any time before maturity High liquidity
- 12. Issued by the UK Government Reason – to finance government spending & to control MS Face value of $100 Index-linked – interest & redemption value are linked to inflation Categories of Gilts: Short-dated: lives up to 5 years Medium-dated: lives from 5 to 15 years Long-dated: lives of more than 15 years Perpetual: irredeemable yield – expressed Coupon as a % of face value Promises to buy back on a specific date in the future Usually have fixed interest rates Yield Interest yield – expressed as a % of the mkt $ Redemption yield – coupon yield +/- (difference between mkt $ & redemption value)
- 14. Issued by local government authorities Maturity period (2 days to 10/15 years) • Longer-dated stock – local authority bond • Shorter-dated stock – local authority bills Fixed coupon rate of interest – paid every 6 months Minimum investment $1,000. Yield slightly higher than gilts: • Security of a local authority is NOT considered good as GILTs • Market for local authority stock much THINNER than for GILTs – smaller amounts & few institutions
- 16. Trade bills • Used in commerce as a mechanism of payment • Drawn by 1 nonbank company on another company Bank bills • Exchange drawn on a bank • Lower credit risk than trade bills BOE • An unconditional order in writing from 1 person / company to another, requiring the person / company to whom it addressed to pay a sum of specified amount of money • Immediately – sight bill • Future date (2 weeks to 6 months) – term bill
- 18. 5) Pays for bill (+ charges) at maturity 1) Draw bill at bank ACCEPTING BANK DRAWER 2) Bank accepts & returns 3) Drawer discounts the bills (using its bank to arrange the sale Discounted payment INVESTOR 4) Pays the bill at maturity ACCEPTING BANK’S CUSTOMER
- 19. Issued by the central governmen t Maturity period – 91 days Sell at discount – lower than face value Issued through competitive bidding process Buyers – large financial institutions Active ‘second hand’ market. Return to investor – difference between buying price & face value.