Accounting implications: The cash position on financial statements includes cash (cash on hand and overnight deposits) as well as cash equivalent holdings. The investment objectives and parameters of most short-term MMFs should enable them to be considered as a cash equivalent for the purposes of preparing a cashflow statement. Financial statements should also disclose information about the fair value of all assets and liabilities. This should be determined according to a three-tier hierarchy. As most short-term MMFs have prices that are declared and published daily, investment in these funds should be classified in level one of the fair value measurement hierarchy.
Amortized cost/value: Measure of the cost of a security, whereby the cost value will change over time as the discount or premium paid for the security is gradually incorporated into the principal value as interest payments are received. This involves valuing a security at its cost initially and thereafter assuming a constant amortization to maturity of any discounts or premium, regardless of the impact of fluctuating interest.
Amortized cost method of valuation: Means of valuing securities in a money market fund, based on the acquisition price and the return at maturity rather than daily market prices so the fund’s net asset value can remain constant
Bid-ask spread: The difference between the highest price a buyer is willing to pay for an asset and the lowest price the seller is willing to accept
Cash equivalent: Instruments of such high liquidity and safety that they are virtually as good as cash. This is typically any highly liquid security with a known market value and a maturity, when acquired, of less than three months
Counterparty risk: The risk to each party of a contract that the other party (counterparty) will not live up to its contractual obligations. In most financial contracts, counterparty risk is known as ‘default risk.’
Credit rating agency: Independent organization that rates companies, banks and other financial institutions on their ability to meet their financial commitments. This includes Nationally Recognized Statistical Rating Organization (NRSROs).
Daily liquid assets (DLA): Cash, government bonds or securities maturing within one business day.
Dividends: As shareholders in the fund, investors receive a distribution in the form of a dividend. The dividend is calculated from the fund’s net yield on a daily basis, accumulated and either paid out or reinvested on the first business day of the following month.
Duration: A measure of the sensitivity in the price of a bond (or other fixed income security) to a change in interest rates.
Exchange traded fund (ETF): A basket of securities, often tracking an index or a fund, that trades on an exchange. An ultra-short ETF is an ETF that holds short-duration debt securities.
Ladder: Strategy of building a portfolio of instruments with varying maturities to create more predictable income streams and manage interest rate risk.
Mark to market: The practice of valuing a financial asset based on current daily prices. See Amortized cost method of valuation.
Mark to model: The practice of pricing financial assets using financial models, rather than normal market prices. See Amortized cost method of valuation.
Maturity: The maximum time that a bond can be outstanding; the date when principal capital will be repaid.
Medium-term note: A note that usually matures in five to ten years.
Net asset value (NAV) : The value of the underlying holdings in an investment fund less liabilities and some costs. The share price of a money market fund tracks its NAV.
Prime MMF: A US term for money market funds that mainly invests in non-government securities.
Repurchase agreement (REPO): A form of short-term borrowing backed by collateral. The owner sells the securities to another party and then buys them back at a specified time. The buyer earns a rate of interest for this transaction and is said to engage in a reverse repo. While repo transactions are primarily overnight, they can be for any duration. In a tri-party repurchase agreement, a custodial bank is added as a third party to the transaction. By acting as an agent to both the owner and seller of the securities, the custodian bank is responsible to safeguard the securities before the repurchase happens. In the event of default by one party, this protects the interest of the other party. Non-traditional repos can include a wide array of investment types used as collateral.
Rule 2A-7: Regulation that governs how U.S. money market funds can invest.
Tenor: The length of time a security has until maturity.
T+0 or T+1: Refers to the time it takes to settle a trade, such that ‘T’ is the trade date, ‘+0’ means it is settled on the same day and ‘+1’ means it takes one additional day until the trade is settled.
Weekly liquid assets (WLA): Assets must be in cash or in securities that convert into cash within five business days. Additionally, high quality issuers such as government securities may be counted towards this measure, though rules regarding maximum maturity and percentage vary by region.
Weighted average life (WAL): Average of the legal final maturity of all securities held in the portfolio, weighted by each security’s percentage of net assets.
Weighted average maturity (WAM): The average maturity of all instruments, taken to the next interest reset date, by each security‘s percentage of total assets.