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EXAMPLE

San Marcos Co. purchased a 1-year Treasury bill with a par value of $100,000 and paid $94,000 for it. If it holds the Treasury bill until maturity, its return for the period will be

If San Marcos plans to hold the Treasury bill for 2 months (60 days) and then sell it in the secondary market, the return over this period is uncertain. The return will depend on the selling price of the Treasury bill in the secondary market 2 months from now. Assume that San Marcos expects to sell the Treasury bill for $95,000. Thus its expected return over this time period would be

Returns from investing in money market securities are commonly measured on an annualized basis by multiplying the return by 365 (days in a year) divided by the number of days the investment is held. In this example, the expected annu-alized return is

In this example there is uncertainty because the firm is not planning to hold the Treasury bill until maturity. If San Marcos wished to take a risk-free position for the 2-month period, it could purchase a Treasury bill in the secondary market that had 2 months remaining until maturity. For example, assume that San Marcos could purchase a Treasury bill that had 2 months until maturity and had a par value of $100,000 and a price of $99,000. The annualized yield that would be earned on this investment is

Commercial Paper

Commercial paper is a short-term debt security issued by well-known, creditworthy firms. It serves the firm as an alternative to a short-term loan from a bank. Some firms issue their commercial paper directly to investors; others rely on financial institutions to place the commercial paper with investors. The minimum denomination is $100,000, although the more common denominations are in multiples of $1 million. Maturities are typically between 20 and 45 days but can be as long as 270 days.

Commercial paper is not so liquid as Treasury bills, because it does not have an active secondary market. Thus investors who purchase commercial paper normally plan to hold it until maturity. Like Treasury bills, commercial paper does not pay coupon (interest) payments and is issued at a discount. The return to investors is based solely on the difference between the selling price and the buying price. Because it is possible that the firm that issued commercial paper will default on its payment at maturity, investors require a slightly higher return on commercial paper than what they would receive from risk-free (Treasury) securities with a similar maturity.

commercial paper

A short-term debt security issued by firms with a high credit standing.

negotiable certificates of deposit (NCD)

Debt securities issued by financial institutions to obtain short-term funds.

 
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