Characteristics, Uses and Taxation of Investments - Cash and Equivalents


These are characterized by liquidity, safety of principal and inflation risk. Each one has unique features which are discussed below.


A. Certificates of deposit (CD): A CD is a special type of deposit account with a bank or thrift institution that typically offers a higher rate of interest than a regular savings account. Unlike other investments, CDs feature federal deposit insurance up to $100,000. Because federal deposit insurance is limited to a total aggregate amount of $100,000 for each depositor in each bank or thrift institution, it is very important that you know which bank or thrift issued your CD. CDs work in this way: When you purchase a CD, you invest a fixed sum of money for a fixed period of time - six months, one year, five years, or more - and, in exchange, the issuing bank pays you interest, typically at regular intervals. When you cash in or redeem your CD, you receive the money you originally invested along with any accrued interest. But if you redeem your CD before it matures, you may have to pay an "early withdrawal" penalty or forfeit a portion of the interest you earned. The issuing bank may choose to waive the penalty. CDs have become more complex over time. Investors may now choose among variable rate CDs, long-term CDs and CDs with other special features. Some long-term, high-yield CDs have "call" features, meaning that the issuing bank may choose to terminate - or call - the CD after only one year or some other fixed period of time. Only the issuing bank may call a CD, not the investor. For example, a bank might decide to call its high-yield CDs if interest rates fall, subjecting existing investors to reinvestment risk. But if you have invested in a long-term CD and interest rates subsequently rise, you will be locked in at the lower rate. Investors need to research and understand the various CD provisions in order that they choose the CD most appropriate for their circumstances. CDs are useful to obtain a competitive yield with relatively easy access to funds.

Look Out!
There may be a question on the extent of FDIC coverage with a fact patter of a couple holding several accounts.

B. Money Market Funds: A money market fund is a type of mutual fund that is required by law to invest in low-risk securities. Such funds have relatively few risks compared to other mutual funds and pay dividends that generally reflect short-term interest rates. Unlike a "money market deposit account" at a bank, money market funds are not federally insured. Money market funds typically invest in government securities, certificates of deposits, commercial paper of companies, and other highly liquid and low-risk securities. They attempt to keep their net asset value (NAV) at a constant $1.00 per shareonly the dividend yield goes up and down. But a money market's per share NAV may fall below $1.00 if the investments perform poorly. While investor losses in money market funds have been rare, they are possible. Like other short-term paper, such funds are subject to inflation risk. These types of mutual funds provide liquidity without typing up investor's funds. Investors often use money market mutual funds to park cash while awaiting the right investment opportunity.

Cash and Equivalents (Contd.)
Related Articles
  1. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  2. Products and Investments

    How to Create a New Financial Product in 10 Steps

    The 10 steps outlined here are essential to the creation of a new financial product.
  3. Professionals

    A Day In The Life Of A Public Accountant

    Here's an inside look at the workdays of two experienced CPAs, to give you an idea of what it might be like to pursue a career as a public accountant.
  4. Professionals

    A Day in the Life of a Public Accountant

    There’s no typical day in the life of a public accountant, but one accountant’s experience may shed some light on what the career entails.
  5. Saving and Spending

    A Key Tip for Making Your Nest Egg Last Longer

    Retirees who don't want to deplete their nest eggs during a bear market should make sure to do the following.
  6. Mutual Funds & ETFs

    Fidelity Target Risk Funds Overview

    Get a brief overview of Fidelity's seven target risk funds, with a description of each fund's asset allocation and expense ratio.
  7. Investing News

    Is it the Right Time to Raise Interest Rates?

    Warning signs have started to emerge that point to a potentially dismal 2016 for the U.S. economy.
  8. Markets

    Four Big Risks of Algorithmic High-Frequency Trading

    Algorithmic HFT has a number of risks, and it also can amplify systemic risk because of its propensity to intensify market volatility.
  9. Mutual Funds & ETFs

    The Top 3 Invesco Funds for Retirement Diversification in 2016

    Explore analyses of the top three Invesco mutual funds for retirement diversification in 2016, and learn about the characteristics of these target-date funds.
  10. Investing Basics

    Hedging Risk for Beginners: How and When to Do It

    Hedging risk is always a good idea. Here is how sophisticated investors go about it.
RELATED TERMS
  1. Sortino Ratio

    A modification of the Sharpe ratio that differentiates harmful ...
  2. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  3. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  4. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  5. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  6. Gross Exposure

    The absolute level of a fund's investments.
RELATED FAQS
  1. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  2. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  3. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  4. Why are mutual funds subject to market risk?

    Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
  5. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  6. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center