Finance Basics: Money Market Funds: Treasury Bill, Commercial Paper, Certificate of Deposit

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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How to Define Personal Finance

In the modern world, personal finance is more important than ever. A person's entire life revolves around the decisions they make about their money. The media would have one believe that big banks are what make the economy function or fail, but the truth is that individuals should be much more concerned about what they can control, namely their personal finances.

For many people, personal finance simply means keeping their checkbook balanced and having enough money in the account to pay the monthly bills. This is a great start, but only a start. Other important decisions affect a person's financial well-being. Everyone eventually have to rely on the decisions they made in the past to provide them with suitable income in their golden years. Decisions like this are just as important as keeping the checkbook organized.

The old-fashioned bank is the financial institution most likely to play the greatest role in a person's daily personal finance strategy. Banks offer a variety of ways to help one manage their money. Most people need only concern themselves with four main types of financial accounts. The first two account types, checking and savings, shouldn't be anything new to the average person living in the modern world. Checking accounts offer the most convenience and easiest access to your money.

Savings account also allow you access, but are designed with long term savings in mind. These accounts pay interest, but it's usually very low and shouldn't be viewed as an investment. Money market accounts are similar to savings accounts but have a few restrictions. In return for a higher interest rate, banks usually require a minimum deposit to open one of these accounts and the number of transactions that can be made on the account per month is limited. Though not actually an account, certificates of deposit (CDs) offer some of the best returns on one's money. The longer one invests the money in the CD, the greater the return on one's capital.

Before knowing the best account type or types to use in a personal finance strategy, a person first must analyze his or her own financial situation. It is important to consider one's sources of income as well as one's personal liabilities such as mortgage, car payment, credit card bills, daily living expenses, etc. Once all this information is gathered, a plan can be formulated. If one discovers a budget surplus, this money can be invested in money market or CDs. However, if the bills are barely being paid, it makes no sense to put money into a savings account just to have to remove it the following month.

The goal of all this information is not only to stay out of the red in your personal finances, but to also accrue a sizable savings surplus. By examining one's daily spending habits, extraneous expenses can be removed and more money can be saved. The savings can then be put into money market or CD accounts and earn interest. The old saying that a penny saved is a penny earned is somewhat misleading. A penny saved and invested is can actually become several pennies if left alone over a period of time.

People who are really serious about getting their personal finance plan in order can take advantage of the services of a financial advisor who can help them make a long term plan. Government tax rules can boggle the mind and professionals dedicate their lives to staying knowledgeable about these rules. Professional advice along with personal discipline can lead to a life of financial security.

Bret Dashel is a senior copywriter for Ratelines.com. For nearly 6 years, Ratelines has been an objective and reliable source of financial information. For factual advice on top cd rates or low-low mortgage rates, please visit our site.

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