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Commercial Paper
A Commercial Paper, also widely called CP, is a short-term promissory note, issued by a corporation to evidence its borrowing from the public. When a company is in need of short-term money to support its operations - usually to cover a short-term working capital gap such as funds to finance stock purchases or meet some maturing obligations - it has the option of borrowing from its bankers. However, raising a bank loan is not always the most feasible or cheapest option, depending on circumstances. For a reputable company with market credit-worthiness, a convenient alternative is to issue and sell CPs to raise the required funding.
Unlike a BA, a CP is not "accepted" by any bank. It consequently represents the direct indebtedness of the issuing company and can only be repaid by that company. It is therefore an unsecured lending to a company, based on the assessment of its credit standing. It's quality is dependent on the standing of the company. This higher risk profile than, say, for a T-Bill or BA, reflects in higher rate of return which you should expect from a CP. As short-term securities, they are generally considered liquid. So, you have liquidity and relatively higher yield as attractions.
CPs are issued at a discount, as with BAs and T-Bills. You invest the discounted value and receive the full amount at maturity. If, for instance, you are investing N1,000,000 in a 6-month's paper with a rate of 15%, you actually pay N850,000 but will receive a Note with face value of N1,000,000, which is what gets paid back to you at maturity. In effect, you receive 'interest' now, since it is like investing N850,000 now and earning interest of N150,000 to receive N1,000,000 at maturity. As stated previously, receiving up-front income leaves you with a higher effective yield. Also, as a discounted instrument, CPs are not liable to withholding tax.
CPs are not just issued by any company. Subprime issuers are unlikely to attract good patronage, except from speculators who want very high yield. For the safety of your investment, you need to balance returns and safety. When issued by blue-chips and creditworthy companies, they are reasonably safe. You can evaluate the default potential of a 6-months' maturity paper issued by MTN Nigeria, UACN, Guinness Nigeria, Nigerian Bottling Company, to mention these few. Are they likely to default in repayment? Certainly not, making the risk-profile of such investment quite acceptable.
CPs are therefore a profitable way to invest short, since they pay higher returns than the other securities and bank deposits, but are still relatively safe, given that you are not expected to throw money into a paper issued by an unrated company. So, instead of leaving money in a bank deposit, if your stomach accepts a little additional risk for better returns, you may seek out opportunities to invest in CPs. Your bank is the best source for accessing information on such opportunities.
Bank CDs
Leaving your money with a bank for a period and taking a certificate evidencing the bank's indebtedness to you is generally a familiar way to invest money and you've probably done it before. You are actually lending to the bank for the period of that deposit. A bank certificate of deposit (CD), is therefore a time deposit made with a bank, usually for such tenors as 30, 60 120, 90, 180 or 365 days.
Now, you can expect the normal interest payment, receivable at maturity. A CD is not expected to be withdrawn before maturity. It is, however, not impossible for your bank to pay, should you seriously require the money, except that some penal charge can be made on the interest your deposit has already earned. Fixed deposits are easily used as collateral if you need to cover a temporary funding gap and choose not to break your deposit at a cost.
Generally, bank deposits will pay lower returns than CPs and BAs, though you should have a better rate than from a T-Bill. All that reflects their perceived risk profiles. T-Bills are considered safest, being Federal Government indebtedness, bank CDs come next as direct debts of banks, BAs, because they are "accepted" (guaranteed) by a bank, rank next, while CPs, representing the direct indebtedness of corporations, come last. In all, however, these are reasonably safe investments. Interest rates on deposits will depend on factors like the bank you are dealing with, the amount and tenor. The current market rates trend is also a factor. If your investment is significant, you can negotiate the rate, irrespective of what is posted on the rates board. So, shop around and also negotiate to get the best rate for your investment.
Bank CDs, like all interest earning investments, suffer the withholding tax on deposit interest, currently charged at 10%. Also, like other money market investments, you can only hope to receive you principal (along with accrued interest), but nothing in the nature of capital appreciation. So, these fall within the section of your investment portfolio for largely liquid and relatively safe investments, where some potential for returns (capital gains) is sacrificed for these equally important investment objectives.
Bank Call Deposits
This is another useful way to leave money with the bank and comes in handy when you have idle funds for a short while. Another important situation is when there is an impending need to disburse, but that has not crystallized and could happen shortly. The best way to invest such money, whether by a business or individual, is to take a call deposit, where your money earns some returns while waiting briefly for the purpose to which you intend to apply it.
In an extreme case - especially when big values are involved - an overnight call placement could be made, especially by banks with one another. The earnings from such call investment, even for short periods and not to large amounts, can still settle some of your bills.
Sweeping your account balances into a call account - which can be arranged with your bank - is one of the smart ways to manage money.
Call deposits can be withdrawn with a short notice to your bank, making them exceedingly liquid. They suffer for that liquidity by commanding the lowest interest rates, payable at maturity. Their interest is also subject to withholding tax. Depending on the amount, it may earn interest at higher than bank savings rate.
Money Market Funds
A money market fund refers to a managed fund - unit trust fund, for instance - that invests exclusively in the money market. This is a cool way to go about short-term investing - you let the fund seek out opportunities to invest and to manage the fund. In that case, instead of looking for specific options of money market investments, you buy units of the fund and leave the rest to them. Riding on the same principle of professional management (see section on unit trusts), you expect that some expertise goes into the process, giving you room to breathe easy. The fund will choose what BAs, CPs, T-Bills or bank deposits to hold and when and hopefully generate good returns for you, its investors.
If you will like a money market fund, check with a fund manager whether they have one.
Putting it Together
The money market, as you can see, has quite some options that can help you make the best of investing money for the short-term. You invest short to manage fund balances, diversify your portfolio (and reduce its risk profile) and build more liquidity into your investment. If you understand what not putting all one's eggs in one basket means, you will see the need not to invest all your portfolio in stocks or bonds or even the money market. Some diversification, properly planned, gives your portfolio more resilience, while ensuring that the returns objective is also very much protected.
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