CHAPTER 4:INVESTING SURPLUS FUND

SURPLUS FUND

Definition:

May arise when a company’s cash inflows exceed its cash outflows during a period of time.

OR

Extra cash after all the expenditure.

Keynes Theory

Why company should hold surplus cash rather than investing it:

1. Transaction motive- Hold cash to meet regular commitments.

2. Precautionary motive- For emergency purpose.

3. Speculative motive- For good opportunity to invest.

FACTORS TO BE CONSIDEREDRISK• Variability of return & potential loss of principal• High risk, high return

LIQUIDITY• Cash must be available when needed• High liquidity, low return

MATURITY• Length of time an investment must be held• Longer maturity, high risk, high return

RETURN• Income & capital gain from the investment

TYPES OF RISKS

YSTEM

ATIC

R

ISK • Non-

diversifiable / market risk

• Can’t be eliminated through diversification

• Affect large number of companies in the stock market

UN

SYS

TEM

ATIC

R

ISK • Diversifiable

risk• Can be

eliminated through diversification

• Affect a specific company or small group of companies

TYPES OF RISK

TYPES OF INVESTMENTRetail Bank & Building

Society Accounts

Marketable Securities

Bill of Exchange

Local Authority Stock

Gilt-Edged Securities

(GILTs)

Certificates of Deposit

Investment with a bank

Deposit account

RETAIL BANK & BUILDING SOCIETY ACCOUNTS

Deposit Account• Instant access

accounts• Notice accounts• High interest

accounts

Other Investment• Money market

deposit• Option deposit• Specialist bonds

Deposit Account

Instant access account• Allow its customers to gain access at any time

to their deposits simply by making use of the ATM card.

Notice accounts• Account holder is required to give a notice of

withdrawal a specified no. of days before making withdrawal to avoid penalties

High interest accounts• Suitable when have large sum of money• Give higher rate of interest

Other investment

Money Market Deposit• Deposit account offered by the bank which

invest in government of corporate securities• Guaranteed by Federal Government• Higher rate of return compared to simple

checking accountOption deposits• Predetermined periods of investment - 2 to 7

years• Interest rate linked to base rate• Restricted access

CERTIFICATES OF DEPOSIT

Generally issued by bank & building society

Indicating that a sum of money has been deposited with a bank & will be repaid

at a later date

Duration – 7 days to 5 yearsNegotiable – can be bought & sold at any time before

maturity

Low credit risk High liquidity

GILT-EDGED SECURITIES (GILTs)Issued by the UK

Government

Reason – to finance

government spending & to

control MSFace value of

$100

Promises to buy back on a

specific date in the future

Usually have fixed interest

rates

Index-linked – interest & redemption value are linked to

inflationCategories of Gilts:

Short-dated: lives up to 5 yearsMedium-dated: lives from 5 to

15 yearsLong-dated: lives of more than

15 yearsPerpetual: irredeemable

Yield

Coupon yield – expressed as a % of

face valueInterest yield –

expressed as a % of the mkt $Redemption yield –

coupon yield +/- (difference between mkt $ & redemption

value)

GILT-EDGED SECURITIES (GILTs)

LOCAL AUTHORITY STOCK

Issued by local government authorities

Maturity period (2 days to 10/15 years)• Longer-dated stock – local authority bond• Shorter-dated stock – local authority bills

Fixed coupon rate of interest – paid every 6 months

Minimum investment $1,000.

Yield slightly higher than gilts:• Security of a local authority is NOT considered good as GILTs• Market for local authority stock much THINNER than for GILTs –

smaller amounts & few institutions

BILLS OF EXCHANGE

TYPES OF BILL

TREASURY BILLS

BILLS OF EXCHANGE• Trade bills• Bank bills

BILLS OF EXCHANGETrade bills• Used in

commerce as a mechanism of payment

• Drawn by 1 non-bank company on another company

Bank bills• Exchange

drawn on a bank

• Lower credit risk than trade bills

BOE• An unconditional order in

writing from 1 person / company to another, requiring the person / company to whom it addressed to pay a sum of specified amount of money• Immediately – sight bill• Future date (2 weeks to

6 months) – term bill

TRADE BILLS

BANK BILLSACCEPTING

BANK’S CUSTOMER

ACCEPTING BANK

DRAWER

INVESTOR

1) Draw bill at bank

2) Bank accepts & returns

3) Drawer discounts the bills (using its bank to arrange the sale

Discounted payment

4) Pays the bill at maturity

5) Pays for bill (+ charges) at maturity

TREASURY BILLS

Issued by the

central governme

nt

Maturity period – 91 days

Sell at discount –

lower than face

value

Issued through

competitive

bidding process

Buyers – large

financial institutio

ns

Active ‘second hand’

market.

Return to investor

– differenc

e between buying price &

face value.

RISK & RETURN RELATIONSHIP