Chapter 13, Short Term Investing & Borrowing

Operational Disadvantages to ST Financing

1. Continuing need to renegotiate or roll over the financing 2. Lenders that provide lines of credit typically require that loans used to finance ST capital needs be paid in full for a min. period of time (1-3 months) Asset-based lending is an approach to continued use of ST debt that carries lower risk and involves revolving loans secured by AR or inventory. Downsides include: 1. Assets used as security must be monitored 2. Key ratios related to assets must be maintained 3. Lending is generally limited to some % of the asset value.

Operational Advantages of ST Financing

1. Ease of Access 2. Flexibility 3. Ability to Finance Seasonal Credit Needs 4. Less restrictive covenants ST loans are a primary tool for financing seasonal increases in current assets. ST Financing can also be obtained from spontaneous sources such as AP and accruals, which are referred to as spontaneously generated financing. As sales grow, these sources spontaneously generate funds that can offset required investments in current assets.

Third Party Custodial Services

1. Engage a 3rd party t o provide custodial services for an investor. The corporate trust department of the commercial bank serves as a custodian and collects income from the securities, redemption monies, and other cash flows from a particular investment on behalf of an investor. A custodian bank also services as a conduit to the underlying investor for any notices, official information or other actions regarding the securities. 2. Alternative to fee-based, 3rd party custodians is to keep the securities at the institution (brokerage firm) from which they were purchased. This offers the same support as with a custodian bank, but these services are offered at no charge, which is attractive to smaller organizations. This is a more risky approach because there is the potential for fraud, as the custodian is supposed to act as a 3rd party control step in the process.

Rating Classes

1. Issuer Credit Ratings represent the agency's opinion on the issuer's capacity to meet its financial obligations. These include counterparty, corporate, and sovereign ratings. Counterparty ratings are used by key counterparties in financial transactions. Corporate credit ratings are on corporate debt issuers. Sovereign ratings are on govt debt issuers 2. Issue-Specific Credit Ratings are ratings of ST and LT securities and considers the attributes of the issuer, terms of the issue, quality of the collateral, and creditworthiness of the guarantors.

Interest Rate Components for 3 Basis Types of Bonds/Notes

1. US Treasuries = risk-free, no default risk, no liquidity risk (highly liquid) 2. Corporate & Municipal Bonds have default and liquidity risk 3. Maturity risk increases with the issue's time to maturity.

CP Nominal Yield (Calc)

= (Dollar Discount/Purchase Price) * (365/Days to Maturity) This is the annual yield to the investor.

Annualized Cost of Credit Line (Calc)

= (Interest + Unused Fee) / (Used Portion of the Line - Compensating Balance)

Total Fees (Calc)

= All Commitment Fees + Placement Fees + Issuance Costs

Total Interest Rate on Credit Facility (Calc)

= All-in rate * Outstanding Loan Balance

Prorated Dealer Fee (Calc)

= Annual Dealer Fee Rate * CP Issue Size * (Days to Maturity/360)

Prorated Backup LC Fee (Calc)

= Annual LC Fee Rate * CP Issue Size * (Days to Maturity/360)

Interest on Credit Line (Calc)

= Average Borrowings * All-In Rate

Average Usable Funds (Calc)

= Average Outstanding Loan for the Year - Required Compensating Balance

Required Borrowings Factoring in Compensating Balance (Calc)

= Desired Borrowed Amount / (1 - Compensating Balance %)

Dollar Discount (Calc)

= Discount Rate * Par Value * (Days to Maturity/360) Also equals purchase price calc which is par value - purchase price

Dollar Discount/Purchase Price (Calc)

= Par Value (amount received at maturity) - Purchase Price Many money market securities do not pay interest and instead sell at a discount from par value (T-bills, commercial paper, banker's acceptances). These are discount instruments

Cost of Debt (Calc)

= Risk-Free Rate of Interest + Inflation Premium + Default Premium + Liquidity Premium + Maturity Premium Real Risk-Free Rate of Interest = rate demanded by investors to compensate for delaying purchases made today, in the absence of any risk or inflation for a one-year maturity. The real risk-free rate + ST inflation rate = US T-Bill rate. Referred to as the nominal rate Default Risk Premium = For investments other than govt securities, there is a risk of default on the part of the borrower that must be factored into the rate of interest. As default risk rises, so does the interest rate. Liquidity Premium = markets for most securities issued by large govts are very efficient and highly liquid but others are not as easily traded, resulting in higher transaction costs and lower liquidity Maturity Premium = LT fixed instrument investments generally have more price risk (they fluctuate more in price for a given change in interest rates). As a result, LT securities have a maturity premium in addition to other interest rate adjustments.

After Tax Yield (Calc)

= Taxable Yield * (1 - Marginal Tax Rate)

Fee on Unused Portion (Calc)

= Unused Portion * Unused Fee

Annualized Cost of CP (Calc)

= [(Dollar Discount + Dealer Fee + Backup LC Fee] / (Usable Funds)] * (365/Days to Maturity) Cost to Issuer

Investment Risk Considerations

A ST investment portfolio will consist mostly of Money Money instruments, which are typically low risk and low return. Major risk to consider in ST investments are: 1. Credit or Default Risk: Risk that payments to investors will not be made under the original terms of the security 2. Asset Liquidity Risk: Risk that a security cannot be sold quickly without an unacceptable loss 3. Price/Interest Rate Risk: Risk that interest rates will change for securities that are similar to portfolio securities 4. Foreign Exchange Risk: Risk that there is a change in exchange rates in the currency in which security is held and the investor's local currency.

Securities Safekeeping and Custodian Services

After purchasing a security, it must be warehoused and tracked to ensure any interest income, dividends, or other proceeds are credited properly to the owner. This is commonly done by registering the securities in the name of an institution that holds securities on behalf of other investors (referred to as the nominee or street name). These institutions are required to maintain separate records that evidence the underlying ownership of the securities. The purpose of this process is to facilitate efficient transfer of securities from one broker to another.

In-House Management

Appropriate if you have staff with proper training and experience to effectively manage a portfolio. Advantage of inhouse is that the firm maintains control over the investment process. Disadvantage is that it is costly to hire, train, retain staff with the skills needed to execute a ST investment strategy. Some firms deal with this by only investing in MMFs to alleviate the need for market knowledge and research.

Asset Based Borrowing

Commercial finance companies and commercial banks specialize in asset-based lending, which are typically secured by AR, inventory and can support temporary financing needs.

T-Bill Quotes and Yield Calculations

Dealers buy and sell T-Bills in a secondary market and use a bid-ask quote framework. Bid is the discount at which the dealer will buy and the Ask if the discount at which the dealer will sell the T-Bill. These quotes are based on the 360-day year because they are given in terms of a discount.

Unsecured Line of Credit

Does not require any collateral as part of the borrowing arrangement. The availability under some secured lines is limited by a borrowing base (also referred to as loan value) that is negotiated as a % of the value of the collateral securing the line.

Annual Cost of CP Issuance (Calc)

Dollar Discount = Discount Rate * Par Value * (Days to Maturity/360) Usable Funds = Par Value - Dollar Discount

Tax Based Strategy

For corporate investors in high tax brackets that want to minimize income taxes on investment return. Success for this strategy depends on the investor's location and tax regulations. Yield benefit of a tax-advantaged investment is related to directly to an investor's marginal tax rate. Tax-advantaged investments can be used in both passive and active investment strategies Global organizations may have advantages from developing a globally-based investment strategy. There are often tax-advantages to investing in one location or currency vs another and an organization operating in many different countries and currencies must often maintain liquidity in many locations and currencies. Example: In India, companies can earn higher yields by investing in tax-free infrastructure bonds. In US, tax-advantaged strategies include investing in tax-exempt municipal securities and buying shares in tax-advantaged mutual funds tailored to their location. Firms with a mix of income from US states, portfolios of municipal securities or bond funds can be used to match this income mix closely, minimizing state taxation. Dividend Capture is another tax-motivated, ST investment strategy available to corporations that pay taxes. A firm may exclude 70-80% from its taxable income of the dividends received from stock owned in another corporation as long as it owns the stock for at least 46 days of the 91-day period starting 45 days prior to the ex-dividend date. Requires an equity investment, but still considered ST because the stock is held only long enough to capture the dividend and qualify for the dividend exclusion Example: Firm purchases common stock in another firm after dividend announcement, and then sell is after the ex-dividend date (at least 46 days after). The investing firm has then captured the dividend and will receive it on the payment date. There is little risk that the dividend will not be paid because only stock in large, reputable firms is purchased for this purpose. There is a risk that the stock may have to be sold at a loss but firms using this strategy do so often enough hat gains and losses offset each other over the many transactions. This strategy should be avoided when the market is in a downward trend or there is a sense that the market may be impacted adversely in the near future by a macroeconomic shock or political event.

Ask Yield

Given in addition to the bid-ask discounts and is the yield to an investor purchasing T-Bill at the ask discount. This is calculated using a 365-day year because it is quoted as BEY.

Loan Agreements and Covenants

Impose restrictions known as restrictive or negative covenants and/or obligations, known as affirmative or positive covenants. Covenants protect the lender by preventing management from increasing the borrowing entity's credit risk and reducing the value of existing debt securities. For bonds, covenants are determined from negotiations with the rating agency as part of the ratings process. They may impost significant restrictions on the entity's financing decision making, including: 1. Ability to sell certain assets 2. Right to issue addl bonds 3. Use of 2nd or junior mortgages 4. Key ratios 5. Payments made by the firm

Loan Participation

In a loan participation, a financial institution purchases an interest in another lender's credit facility. Purchaser is a "participant" and the seller is the "lead institution". The participant does not have a separate note and has only an indirect relationship with the borrow. A participation agreement specifies that the participant and lead institution's rights and obligations. In the case of a blind participation, the participation is not disclosed to the borrower, and the participant may not contact the borrow directly or disclose their role in the credit facility. Rationale for these arrangements it that they allow banks to offer larger loans than they could on their own, due to capital requirements, and to expand their loan portfolio beyond their usual market, creating a more diversified mix of loans.

Loan Syndication

In a loan syndications multiple banks share the funding in a single credit facility. The syndicate is led by an agency who acts as the intermediary between the firm and the syndicate to negotiate credit terms and documentation, make advances, collect payments on the loans, and disseminate information. The lead usually receives a fee for administrating the efforts. The syndicate members share common documentation, but each lender has a promissory note, making it a direct lending relationship. The individual lenders in the syndicate are usually able to sell their shares with or without consent from the borrower.

Base Rate

Includes adjustments for inflation and maturity premiums, while the spread will factor in adjustments for the default and liquidity premiums. The difference between common base rates and the T-Bill rate is that the rates are interbank rates.

Mark-to-Market reporting

Investment reporting also requires that unrealized gains or losses be reported. Because market values for money market and other fixed-income securities may fluctuate throughout their lives until maturity, any difference between the current market value of holding and its adjusted cost basis must be reported Under the FASB and IASB rules, security is deemed impaired if the fair market value is less than its adjusted cost basis. This difference is an unrealized loss unless the security is liquidated at the current price, in which case it becomes a realized loss. In some cases, unrealized and realized losses are reported the same way. If a security is deemed impaired and it is not expected to be cured in the near future, then it must be further classified as "other than temporary impairment" (OTTI). If this is the case, then the investment's carrying value must be reduced by the amount of the unrealized loss, and the loss amount must be subtracted from net earnings. Must be accounted for on the firm's balance sheet, rather than the income statement.

Pricing & Costs of CP and Credit Lines

Loans represent an investment by the counterparty and the factors that influence investment yield also are the determinants for credit pricing. Factors that are included in the borrowing cost but do not impact an investor's yield include dealer and placement fees, credit enhancement, backup credit costs.

LT Bond Ratings

Moody's = A to C S&P = AAA to D Fitch = AAA to D DBRS = AAA to D JCR = AAA to D

ST Bond Ratings

Moody's = A-1 to D S&P = Prime-1 to NP Fitch = F1 to D JCR = J1 to NJ

Credit Rating Agencies

Most publicly issued debt by firms and municipalities is rated by one or more of the credit rating agencies. They assign ratings for issuers of ST and LT debt. Can be solicited when a borrower asks one or more agencies to rate the borrower and may work with the agency to ensure an appropriate rating in anticipation of a future debt offering. With an unsolicited rating, an agency would rate an entity based on publicly available information even when the firm has not requested a rating. This may result in a poor rating based on incomplete information. Credit ratings are not investment recommendations, rather they are an assessment of the potential loss on the investment. Agencies generally have access to a borrower's internal info and the subsequent ratings are widely accepted by market participants and regulators. Agencies have access to confidential, nonpublic information that is provided for the determination of ratings. The information is not released without the issuer's permission. FIs use these credit ratings when required by regulators to hold investment-grade bonds. Part of US Dodd-Frank addresses conflicts of interest for agencies, given that their primary revenues come from the entities that they rate, not from the investors who use the information. Dodd-Frank requires that agencies provide greater disclosure of their rating models and methods, subjecting them to greater liability.

Holding Period Yield (Calc)

One of the basic types of yield; return earned by an investor during the period in which the investment is held; can be calculated over different periods (daily, weekly, monthly); HPY = (Cash Received at Maturity - Amount Invested) / (Amount Invested)

Pricing

Pricing is usually negotiable. 3 cost components for a line of credit 1. All-in rate of interest (spread + LIBOR, US Prime Rate, or Fed Funds rate) 2. Commitment fees, on used/unused balances 3. Compensating balances Rates on lines are variable and adjust immediately to changes in the base rate. Actual rate on the loan will vary with the market it is not unusual for a credit agreement to have a floor rate, which provides a bottom limit on how l ow the total interest rate can go.

Reporting

Proper investment reporting is important to ensure all risk performance and risk mgmt goals are met and should include composition of the portfolio according to: 1. Maturity Distribution 2. Quality Ratings 3. Security Classes Reporting is especially important for publicly traded firms due to regulatory and exchange requirements. Periodic filings require firms to account for investment returns as allocated to a specific reporting period. For Money Market and other fixed-income investment portfolios this means reporting interest income on an accrual basis rather than a cash basis. For investment vehicles that pay interest on days that do not coincide with a reporting period's beginning or ending dates, interest accrual reports must be prepared by the firm, and by its investment managers or brokers that accurately shows interest earned (even if unpaid) on for any relevant reporting period.

Interbank Rates

Rate at which banks lend to each other. Interbank rates will be slightly higher than the T-Bill rate at any given time due to a small amount of default risk inherent in bank-to-bank borrowing arrangements

US Prime Rate

Rate commercial banks charge their best corporate customers, although strong creditworthy borrowers an usually obtain rates better than Prime from their financial partners. Unlike LIBOR, which fluctuates daily, the US prime rate is set 3% above the Fed Funds Rate and an remain fixed for a period of time.

Ratings Process

Ratings Process includes quantitative and qualitative analysis of the issuer being assessed. Quantitative Analysis from financial reports of issuer. Qualitative Analysis is concerned with quality of management, firm's competitiveness in industry, expected growth of industry, vulnerability to business cycles, technology changes, regulatory changes, labor relations For govt issues (both sovereign and sub-sovereign) the typical analysis is based on factors relating to govt finance, including economy, debt levels, tax revenues, expenses, financial statements, admin/mgmt strategies. Collateral for debt, primary source for repayment. Each factor is evaluated individually and in aggregate with respect to the total effect of the govt's ability to repay debt.

Selling of Receivables

Receivables may be sold or discounted to raise cash in 2 ways: 1. They may be sold at a discount from face value to a 3rd party called a factor. The factor then collects on the receivable, in a process called factoring. 2. Receivables can be securitized. Through securitization, a firm issues debt securities back by a pool of receivables. Receivables that are suitable for debt securitization have a predictable cash flow stream adequate to retire the issue and a historical record of low losses.

ST Investment Policies

Recognition that priority is to preserve capital and also to determine the risk tolerance of the firm 1. Investment objectives for risk/return 2. Permitted and banned investment vehicles or investment classes 3. Min acceptable security ratings 4. Max maturity for individual securities 5. Max weighted average maturity or duration for the portfolio 6. Max amounts or concentration limits (by %, $, or both) of the portfolio that may be invested in securities, companies, instrument classes, geographic areas, industries. 7. Guidelines for investments in foreign securities 8. Specific responsibilities for implementing the policy 9. Method of monitoring compliance 10. Provisions for performance measurement, evaluation, reporting 11. Responsibilities and reporting requirements for custodians, external investment managers, broker-dealers, others 12. Exception management and related approval process.

Reviews of Ratings

Reviewed annually based on new financial report, business information, review meetings with mgmt

Outsourced Management/External Mgmt

ST investment portfolio duties are assigned to a 3rd party, MMF manager or outside money manager (investment bank or registered investment advisor). Charge fees. Use may be dictated by the size of the company's portfolio. External money managers have more resources and experience, including access to securities research. Inhouse treasury managers can ask broker-dealer for this info they may be required to pay for it. Disadvantage is that investment policies and guidelines must be communicated clearly to the outside manager who then must be able to make an investment decisions within the policy guidelines. May be an issue with MMFs, as the manager's investment choices may not line up with the firm's preferences. Other issues can include compliance monitoring and due diligence. Another disadvantage is that the incentive structure faced by the outside investment manager may not line up with the firm's goals. If a broker-dealer is hired to manage a firm's ST investment portfolio, then the firm must realize that the manager does not have a fiduciary duty to act in their best financial interest. The broker-dealer trades securities for its own account and its investment recommendations may be influenced by securities it has for sale, which may not meet the client's needs. A firm may use a registered investment advisor who has a fiduciary responsibility to the clients that the broker-dealer does not.

ST Interest Rates vs. LT Interest Rates

ST rates are usually lower than LT rates (when the yield curve is normal). This implies that there is a cost advantage to using ST credit. ST Borrowing carries two types of risks: 1. Interest rate risk: If company borrows on a ST, floating-rate basis, it will borrow at the prevailing interest rate and risk dramatic rate swings in either direction. ST borrowing risks can b reduced via interest rate caps, collars, swaps, floors 2. Funds availability: If a company relies heavily on ST borrowing, then the ST funds may not be available at some future point due to tightening credit standards on the part of lenders. If a firm's credit quality declines, then that could endanger renewal of the credit agreement. Some companies counter this risk by negotiating multi-year agreements. In contrast, LT borrowing on a fixed-rate basis stabilizes interest costs and provide funds for a longer period of time.

ST Funding Alternatives

St debt instruments mature within one year and are used by firms to finance current assets, such as AR and inventory.

Tax Status; Taxable Equivalent Yield (Calc)

Tax-exempt securities (US T-Bill or Indian Infrastructure bonds) provide a lower pre-tax yield than taxable securities of similar maturity and default risk because of their tax advantage. When comparing taxable and tax-exempt instruments, the tax-exempt yield should be converted to its taxable equivalent. Taxable Equivalent Yield = Tax Exempt Yield / (1 - Marginal Tax Rate)

Actively Managed Portfolio Strategy

Total-return strategy; pursues enhanced returns by capturing capital gains that may arise on relatively longer-dated instruments. Requires that an investor is prepared to sell holdings when prices rise and is dependent on interest rates falling or on the creditworthiness of an issue improving. Used by investors to meet specific needs or earn higher returns. Advantage is as long as the yield curve is positively sloped (ST interest rates are lower than LT interest rates) capital gains are possible. As time passes and longer-dated purchases approach maturity, their value in the secondary market increase because while their maturities are shortening, their interest rates remain at levels associated with longer-dated instruments. When this increase in value occurs, these securities can be sold for a premium because they now pay above market rates for ST investment instruments of identical maturity. Capital gains do no materialize when time passes and prices do not rise and the investor's portfolio has a longer duration than intended due to the lac of capital gains. This investment strategy is only appropriate for amounts of cash that are likely to be required no earlier than the longest-maturity security that might be purchased. An active ST investment strategy requires that the inhouse or outside investment manager forecast the course of interest rates over the very short term.

Buy and Hold to Maturity Strategy (Matching Strategy)

Traditional strategy for investing excess cash and preserving capital is to: 1. Invest only in securities whose maturities can be expected to sufficiently fund any potential cash needs 2. Hold them until maturity 3. Reinvest only if maturity proceeds are not needed for expenditures. This is a passive investment approach that is favorable to conservative investors. Advantage is that funding needs are always met as long as securities are structured properly to meet cash needs and interim price fluctuations can be ignored since the maturity will also fulfill the investment's initial return expectation. Disadvantage is that the firm may forego potentially lucrative alternative investments Called matching strategy because cash flows from maturing investments can be matched to future expenditures. Matching of cash flows allows for investing over longer maturities and increased yields. This strategy requires careful forecasting of future cash flows and capital requirements. If cash is needed soon than expected and sooner than the maturity date, then the securities may need to be sold prematurely and at a loss. Firms that use matching strategy do so conservatively, covering only a portion of the expected capital need.

Yield Curves

Yield curve is a plot of the yields to maturity on the same investment or class of investments but with varying maturities as of a specific date. The curves in the graphs of the various yields to maturity generate the "term structure" of interest rates. Upward sloping yield curve is a normal yield curve. The liquidity preference theory holds that investors demand a higher yield for the lower liquidity associated with a longer maturity. LT rates are higher than ST rates. Downward sloping yield curve is referred to as an inverted yield curve. If investors shift their preferences to LT securities or issuers are switching to ST borrowing, then the LT prices increase and the LT yields decline. Inverted yield curve is a sign that the market is expecting a recession in the near future and investing in LT securities to lock in LT interest rates or avoid any reduced interest rates that may occur in the ST. Inverted yield curve is also a sign of low expectations for future inflation. High expectations of inflation would automatically increase the yields required on LT securities and lead to an upward sloping yield curve to offset the expected inflation. Inverted yield curve may also be a result of the Federal Open Market Committee (FOMC) open market operations in the US. If the Fed is attempting to raise interest rates, and the target rate is a ST interest rate, the ST rates will tend to increase before the actions affect LT interest rates, which may result in a downward sloping yield curve.

Factors Influencing Investment Pricing

Yield is a measure of the return an investor receives from a financial instrument and is stated an an annual percentage rate of return. Factors affecting yield include default, liquidity, price risk, shape of the yield curve and the tax status of the investment.

Money Market Yield (Calc)

Yield that is commonly used for ST investments and annualizes the holding period yield and uses the 360-day year = HPY * (360/Days to Maturity) = BEY * (365/360)

Bond Equivalent Yield (Calc)

Yield that is commonly used for ST investments and annualizes the holding period yield and uses the 365-day year = HPY * (365/Days to Maturity) = MMY * (360/365)

Lines of Credit

agreement in which the lender gives the borrower access to funds up to a maximum amount for a specified period of time. Lines of credit are usually revolving, meaning the borrower may borrow, repay, and borrow again. Lines of credit provide ST financing, back up a commercial paper program, or provide temporary liquidity. Conditions & Covenants: Requirements and conditions associated with lines of credit include clean up periods, credit sub-limits, covenants, and material adverse change (MAC) clauses. Sometimes a clean up period stating that the credit facility balance must be $0 for a specified period of time is included to ensure that the facility is only being used for ST needs, not LT. This is especially true for small to middle-market sized firms. Lender may also establish sub-limits under the line for specific uses (LC issuance, drafts under banker's acceptance).Covenants used in ST financing usually focus on maintaining minimum liquidity and coverage ratios, or max debt ratios. Finally, a MAC clause allows the lender to prohibit further funding or even declare the loan to be in default if there has been an adverse change in the borrower's credit profile. Sound internal reporting protocols and implementing improvements in cash forecasting help to ensure that the firm remains complaint with the loan covenants. Even though reporting is normal covenant requirement, it is also an effective management tool. It is much easier to negotiate covenant violations before they occur and since covenants apply to the entire organization, timely and accurate reporting is from subs is an important part of this issue.

Uncommitted Line of Credit (Discretionary Line of Credit)

agreement with a lender where the lender offers to make funds available in the future but is not obligated to provide a specific amount. Usually made available for a one year period but the lender can refuse funding or cancel it, due to changes in the borrower's financial condition. No fee unless funds are borrowed

Compensating Balances

balances maintained in the deposit accounts at the bank for the purpose of increasing the bank's overall revenue on the account. They do not earn interest for offset depository service charges. Expressed as one of the following: 1. Total line commitment 2. Unused amount of commitment 3. Outstanding borrowings The effect of compensating balances it to reduce the amount of borrowed fundns that are available to be used by the borrower, and increasing the loan's annual interest rate.

ICE Benchmark Administration & LIBOR

compiles LIBOR daily by averaging the interest rate quotes of at least 8 banks chosen to reflect a balance by country, type of institution, reputation, scale of marketing activity. LIBOR is quoted in numerous currencies and released to the market in London every day.

Discount Rate (Calc)

concept related to the dollar discount; dollar discount/par value and then annualized using a 360 day year = (Dollar Discount / Par Value) * (360/Days to Maturity) The MMY and BEY will always exceed the discount rate because the holding period yield is calculated with the purchase price, which is less than par value and the discount rate uses par value

Impairment Policy

documents actions that will be taken when a particular investment may be impaired. Policy should clearly define the severity and duration of an unrealized loss that will cause an impairment review and identify the specific securities that need to be reviewed. Doesn't necessarily require a write-down but leads to a quantitative analysis of the securities involved. Having a well written impairment policy will help avoid unnecessary write downs of securities that might otherwise be classified by the auditors as impaired.

ST Investment Yield

function of the 1. cash flows received from the investment 2. Amount paid for the investment 3. maturity or holding period

Singe Payment Notes

granted for a short period of time and specific purpose with both interest and principal amounts paid at maturity. Limited duration and precise maturity mean that a specific cash flow event is identified as the repayment source at the time the funds are advanced. Know where payment is coming from before loan is given.

Commercial Bank Credit

important source of working capital for middle-market and smaller firms. Larger publicly traded companies find bank credit attractive because they can customize debt structures and use information not disclosed to the public to justify underwriting the debt. Bank loans are offered on a secured and unsecured basis. Security in the form of collateral or guarantees may be used to obtain more favorable rates by some borrowers or to make credit available to businesses that cannot access unsecured credit facilities. In addition, a lender's use of private information may reduce borrowing costs.

Fed Funds Rate

interest rate US banks charge to borrow reserve balances from each other. Target fed funds rate is set by the Federal Open Market Committee. (FOMC) 8x/yr. Actual rate charged is negotiated by the banks. This is known as the Fed Funds Effective Rate.

ST Investment Valuation Policy

lays out the methodology used to determine the fairmarket value of the securities. This is a routine process for the actively traded securities in the portfolio that have publicly quoted prices but it may not be as clear for securities that are not actively traded and do not have publicly quoted market prices.

Cost of Credit line

lender will charge interest on funds borrowed and a fee on the line on an annual basis on entire line or unused portion)

Intercompany Loans

low-cost source of funds. subs of firms may borrow and lend among themselves through an inhouse bank or other internal borrowing mechanism. These arrangements are formal and usually involve promissory notes or a memorandum of understanding. They are normally priced at market rates (or arm's length rates) to comply with tax and regulatory requirements. The entity as a whole retains the money. The length of time of an outstanding intercompany loan can affect whether the return on principal is treated as a return of capital or a dividend. There are significant losses pertaining to transfer pricing (which necessitates the use of market rates) and capitalization requirements. Many jurisdictions examine these loan payments very closely and even a minor compliance issue can result in a large fine. As a result, policies and documentation related to intercompany lending transactions should be comprehensive and designed based on advice from legal, audit and tax to avoid possible problems.

Combination of inhouse and external management

management of the portfolio may be split among inhouse manager and external ones, which allows the firm to compare the cost and performance of the different managers. The added cost of multiple managers may exceed the expected value of comparing the various managers. One approach is to compare fund managers against industry indices, Bank of America Merrill Lynch 3 Month T-bill Index or Barclays Capital 1-3 Year Global treasury ex US Capped Index. This approach is helpful if the funds are allocated to the various managers based on investment type or duration, which would make it difficult tocompare managers directly.

Revolver

most common types of credit lines; committed line of credit, established for a period of time (usually multiyear basis). Revolving credit lines are formal, contractual commitments with loan agreements, including covenants. Commitment fee on the unused portion and a fee for use of the funds in the facility. Even though it is used for ST funding, the commitment term ranges from 2-5 years and may be followed by a period in which the principal is repaid systematically. If more than one year remains on a multiyear revolver, accounting guidelines usually allow balances to be carried as LT liabilities on the balance sheet. Often feature ST fixed-rate funding options that offer fixed-rate loans for specified periods with penalties imposed for prepayment. Example: Funding option for 90-day advances fixed at a rate equal to a pre-established spread over LIBOR.

Basis Points

one basis point = one-hundredth of 1% 50 bps = 0.50%

Repurchase Agreements

repo; another source of ST funds. Securities are sol , providing the seller with cash until the securities are repurchased. Repos let firms tap into the liquidity of their investment portfolio without having to permanently dispose of their ST investments. An equivalent transaction may be structured by using a single payment note secured by marketable securities

Advantages of Fee-Based 3rd party

reporting is consolidated and control over the investors' entire group of holdings is established. This is important when a firm uses multiple investment managers, who might otherwise execute trades through their own brokerage. Since all of the portfolio's trades are handled by a single custodian, it is much easier to monitor compliance with policy and operating guidelines, and identify any irregularities in trading or undue concentration. This process also requires that trades be made through the custodian rather than their own facilities, which is an important separation of duties control feature. While some firms may be able to take advantage of complimentary custody services extended by brokerage firms to reduce expenses, 3rd party custodians are often required for investors using outsourced investment management.

Secured Line of Credit

requires the borrower to pledge collateral, most often current assets such as receivables or inventory.

Commercial Paper

source of ST financing and is unsecured promissory notes of highly rated corporations, FIs, and sovereigns. Most CP markets are modeled after the US, which is the oldest and largest in the world. Two types of CP named in the Securities Act of 1933: 1. Issuer under 3(a)(3) program can issue CP up to 270 days in min amounts of $100K. Proceeds may only be used for working capital purposes. Public. Price is spread to LIBOR. Accredited Investors. 2. Issuer under the 4(2) program can issue CP up to 397 days in min amounts of $250K. No restriction on how proceeds of 4(2) CP is used. Private. Price is spread to LIBOR (no premium). Investors: Institutional Investors and QIBs. Most CP has a maturity less than 30 days, but issuers continually roll over the CP into new issue at maturity. CP programs are rated by the major credit rating agencies, which require each program to have liquidity backup in the event the market would not be available to issue or reissue CP for any reason. Backup facilities include revolving credit facility or a letter of credit issued by a highly rated bank. Not every CP issuer has to have backup; Some firms with high liquidity and strong credit rating are able to issue CP based solely on their own resources. CP can be issued directly by firms (sold directly to investors), but most CP is placed through dealers (selected by the issuer) who market the CP to investors for a nominal fee. CP is sold at a discount. The interest paid by the issuer on the CP is deducted from its face value when determining the proceeds that are available for use by the issuing firm. Discount rate is always calculated on 360-day basis. Other costs include dealer fees, backup credit facility fees, rating agency charges, credit enhancement costs. Because of the effort and high fixed costs involved in establishing a CP program, CP financing is desirable only when ongoing funding needs are large. Firms with the highest credit rating rarely issue CP for amounts below $50M. Firms without excellent credit ratings often find commercial bank credit more attractive because banks have more flexibility in structuring credit to mitigate risk and this lowers the cost of borrowing.

Supply Chain Finance

supplier receives loans based upon the credit rating and financial capabilities of its customer (buying firm). Supply chain finance is typically arranged for by the buying firm rather than the supplier and allows the buying firm to extend its payables while providing lower-cost financing for its supplier. Example: if a customer has historically paid a supplier 30 days after the receipt of invoices, using supply chain finance, the firm may negotiate longer payment terms of 90 days. The new payment terms will increase the buyer's AP and increase the supplier's AR. The invoices are approved by the buyer when received. Suppliers may wait the full 90 days to receive the full amount of the invoice, but they also have the option to receive a discounted amount prior to maturity. The primary advantage fort he suppliers is that the invoices are discounted at a rate tied to the buyer's cost of capital, and this rate may be much lower than the supplier's cost of capital, providing relative low-cost financing for the supplier's AR.

Guidance Line or Operating Risk Exposure Limit

used by banks to accommodate credit exposure created from operating activities such as sending ACHs, daylight overdrafts, returned deposits, FX exposure. Banks initiate this type of type instead of the customer in order to determine the level of exposure the bank has relative to the activities that the customer has with the bank. The bank does not normally disclose this type of line of or credit limit, but treasury professionals need to know about it actively manage it in order to send payments or obtain addl borrowing. This is especially true during periods of high growth or acquisitions, which may stretch or break limits that are not being managed. Important to note that while the guidance line is typically treated by the bank as a credit exposure, it does not represent any kind of commitment from the bank to lend funds to the firm.

Trade Credit

when a customer receives good or services but payment is not made to the supplier until a later date. This is the primary source of ST funding used by many firms, trade trade credit lets a buyer use the supplier's goods while simultaneously using the cash it would have otherwise paid to the seller in advance or upon delivery. Provides a tangible economic benefit as a source of financing because the buyer may avoid liquidating investments or incurring debt over the credit period. A firm that pays its suppliers before the invoice due date (assuming no discount for early credit) is foregoing an inexpensive form of ST financing.