Page 46 - DBP5043

MARKETABLE SECURITIES

Are assets that be converted into cash quickly. Ex. Treasury bills,
commercial papers, negotiable certificates of deposit and money
market mutual fund.

Rationale for holding marketable securities

As a substitute to cash. When cash outflow exceeds cash inflows at
any point in time, a firm will sell the marketable securities.

As a temporary investment: held as temporary investment for the
purpose of meeting the known financial requirements. Ex: to pay tax.

Selection criteria for marketable securities

1. Financial risk/ default risk – this is the risk of the borrower not
being able to pay interest/ principle on the security traded.

2. Interest rate risk – Financial instruments with longer terms to
maturity are more sensitive to changes in interest rate and therefore
have higher interest rate risk

3. Inflation risk – inflation will reduce purchasing power and those
financial instruments whose returns rise with inflation will experience
lower inflation risk, whereas those financial instruments whose returns
fall with inflation , will experienced higher inflation risk.

4. Marketable/ liquidity – financial instrument which can be sold
immediately at a price close to their market price are more
marketable and liquid as compared to those that cannot be sold

immediately.

5. Rates of return/yield – the return on marketable securities are
dependent on the four factors described above. The higher the risk,
the higher the return. However it must be said that safety/ liquidity
should not be sacrificed for higher returns.