Question

Present 3 different types of money market securities with their main characteristics and assess what are the major risks associated with holding them?

Answer 1

Answer: Money market securities- Money market securities are short term investment alternatives that trade in money market.

Characteristics of money market securities-

Liquidity- These securities are more liquid and can be easily converted into cash by giving short notice.

Safety- These securities are safe because they are issued by Government or the institutions that have good credit ratings.

Issued at discount- This is also one of the characteristics of money market instruments that they are issued at discount on the face value.

Horizon- These securities are for short term that is below one year.

Types of money market securities- Are as following:

Treasury bills- These are issued by Government and one of the safest money market securities. Their return is risk free because they have zero risk. These are 91 days, 182 days and 364 days

Certificate of deposit- It is the deposit receipt that is deposited with the bank or any financial institution. These are for 3 months, 6 months and 12 months.

Commercial papers- They are issued by the corporate to raise capital from money market. These are short term unsecured promissory note.

Risk in money market securities-

Reinvestment risk- It is the risk that matured investment can be reinvested at lower interest rate.

Counterparty risk- This is the risk that issuer may default in repaying the principal amount.

Liquidity risk- It happens when money market experience more cash outflows than cash inflows so liquidity comes down in the market.