What Are the Criteria for Corporate Money Market Investment?
Money market instruments are short-term financial obligations with durations of less than 12 months. These instruments are typically highly liquid and generally considered lower-risk investments. A number of investment instruments may fall under the umbrella of money market instruments, including domestic checkable deposits (checking, savings), foreign deposits, bankers' acceptances, currency, repurchase agreements, government treasury bills and commercial paper. Money market managers examine a number of criteria when evaluating money market investments.
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Duration
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Duration represents the weighted-average time to maturity on an investment. Since many money market securities do not make regular coupon or interest payments, the duration of money market instruments is often the term of the security. For example, a 30-day Certificate of Deposit has a duration equal to 30 days. Money market managers seek securities with low durations. Duration on fixed rate instruments serves a measure of the amount of interest risk rate the holder endures. Since a lower duration means a lower interest rate risk, low duration securities are preferable for inclusion in money market holdings.
Risk and Volatility
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Another key criteria for corporate money market investment is the risk and volatility inherent in a security. Risk and volatility relates not only to the interest rate risk previously discussed, but, often more significantly, to individual company risk. For most non-equity, fixed money market investments, individual company risk refers to the risk a company will default or go bankrupt. A money market manager holding a short-term 30-day company bond may have to wait years to recoup the majority of the investment if the bond issuer files for bankruptcy protection.
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Liquidity
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Liquidity deals with the ability to turn investment instruments in a money market portfolio into cash holdings. Some instruments, such as demand deposits, may have little or no restrictions on how and when the investment may be converted into cash. Other instruments, such as United States Treasury bills or notes may have restrictions, but are still highly liquid because of a strong secondary market. Still, other instruments, such as Certificates of Deposit, may be relatively non-liquid, with significant restrictions on the ability to convert the investment to cash.
Hedges
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Money market managers look at hedges as a way to reduce risk, while maintaining expected returns within a portfolio. Since some investment instruments by their very nature carry high levels of risk, such as foreign currency deposits, which are subject to exchange rate fluctuations, money market managers look toward hedges to offset and reduce this risk. Hedges may be negatively correlated investments or they may be derivatives: options, futures and forward contracts.
Return
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Last, but certainly not least, money market managers are extremely concerned with the return on their investments. The money market exists because it is possible to generate short-term returns (as opposed to simply holding cash, which will generate no return). Money market managers carefully examine the anticipated return on the investment versus the other key criteria. Typically, the criteria are correlated -- as risk and duration increase, the expected return does as well.
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