Some Basic Financial Terms and Definitions
Credit Risk
Credit risk is the risk of default of a security. The higher the risk, the higher the yield of the security has to be to be attractive to investors.
Liquidity
Liquidity is measured according to how easily a security can be converted into cash.
Tax Status
The tax status of an investor matters when investing in securities. The higher the tax bracket of the investor, the more taxes need to be paid on the gains/yield of a security.
Term to Maturity
The term to maturity is a specified term of time (days, months, years) that a security needs to exist to mature.
Call Feature
The call feature is an option that allows the issuer of a bond to buy bonds before the maturity date back, at a specified price.
Conversion Feature
The convertibility clause allows investors to convert bonds into shares of common stock. This is beneficial if the market price of a bond decreases, because an investor will have an additional option of converting the bonds into a specified number of shares of common stock, rather than selling the bonds in the market.
Common Instruments of a Money Market Fund
Treasury Bills
Treasury bills are highly liquid, short-term securities issued by the government to borrow funds from investors. Treasury bills are typically sold through auctioning on a weekly basis; however treasury bills with a one year maturity term are issued monthly. The lowest amount of a treasury bill (par value) is $1000 and thereafter in multiples of $1000 and is sold at a discount rate of the par value whereas at the maturity of the treasury bill, the investor receives the par value and therefore has a profit between the par value and the discount price he/she purchased the treasury bill at. A benefit of treasury bills is that they are free of credit default risk, because they are backed by the government.
Commercial paper
Issued primarily by finance and bank holding companies with a maturity date between one day and 270 days, commercial paper is a short-term debt instrument with a goal to either provide liquidity or finance a company's investment. The minimum amount investment in a commercial paper equals $100,000.
Negotiable certificates of deposit
NCDs are short-term certificates with maturity terms ranging from two weeks to a year with a minimum investment amount of $100,000. Nonfinancial corporations are the most common investors, while individuals rarely invest indirectly invest in NCDs through money market funds. NCDs offer some liquidity.
Repurchase agreements
Repurchase agreements usually amount for $10,000,000 or more with maturity terms between one day and six months and are agreements where one party sells securities to another party with a certain date and price to repurchase the securities specified in the terms of the agreement. Common participants in repurchase agreements are financial and nonfinancial institutions.
Federal Funds
The most common participants in the federal funds market, which allows depository institutions to lend funds from each other at the federal funds rate, are commercial banks. The transactions are usually completed by funds brokers that receive a commission for their service. Common maturity terms of these transactions are between one and seven days with amounts starting at $ 5 million.
Banker's acceptances
Banker's acceptances are slightly credit risky short-term (usually between 30 and 270 days) agreements between (most commonly) exporters and a bank with the bank accepting responsibility for future payment. For this risky agreement (from the bank's perspective) the bank is reimbursed the funds by the importer in addition to a fee.
Municipal Bonds
A municipal bond is a bond issued by the federal government to finance the difference between spending by the government and the revenues they receive. Municipal bonds have a credit risk of default; the level of risk can be measured by the bond rating issued by Standard and Poor's. The minimum amount for a municipal bond equals $5000. The majority of municipal bonds are callable; generally interest is paid out semiannually to investors and the interest gained from municipal bonds is tax-exempt. Secondary markets for municipal bonds can be either active or inactive. Finally, municipal bonds generally offer a lower yield than Treasury bonds.
Over-The-Counter Transactions
Over-The-Counter transactions are completed through a telecommunications network, which means that a stock is traded through a telecommunications network in a market without a trading floor. Over-the-Counter trades do not require the purchase of a seat for the trade, because they are not listed as organized exchanges.
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