## 1.1. Calculation of Comparable Yields

a. There are basically two types of securities, i.e. the interest-bearing securities and the discount securities.

b. The interest-bearing securities are those securities that pay the interest to the security holders at the pre-specified rate, at regular intervals. These securities sell at par throughout their maturity life and mature at par plus the interest.

c. The discount securities are those securities that are issued at discount but mature at par. The difference between the discounted price and the par value represents the interest.

d. There are three different kinds of yields, i.e. money market yield, bond equivalent yield, and discount basis yield.

e. Money market yield can be calculated using the following formula:

Money Market Yield= [(Face Value-Purchase Price)/(Purchase Price)]×[360/(No.of days)] |

f. Bond equivalent yield is calculated using the following formula:

Bond Equivalent Yield= [(Face Value-Purchase Price)/(Purchase Price)] × [365/(No.of days)] |

g. Discount Basis yield is calculated using the following formula:

Discount Basis Yield = [(Face Value-Purchase Price)/(Face Value)] × [360/(No.of days)] |

__Example 1:__

Suppose a 90-day U.S. T-Bill is selling at a discount of 8% having the face value of $ 100.

We can find its purchase price using the formula:

Discount Basis Yield= [(Face Value-Purchase Price)/(Face Value)] × [360/(No.of days)]

0.08=[(100-Purchase Price)/100] × (360/90)

Purchase Price = $ 98

Having found the purchase price, we can now find the other comparable yields, i.e. money market yield and bond equivalent yield, as follows:

Money Market Yield= [(Face Value-Purchase Price)/(Purchase Price)] × [360/(No.of days)]

= [(100-98)/98] × [360/90] = 8.16%

Similarly,

Bond Equivalent Yield= [(Face Value-Purchase Price)/(Purchase Price)] × [365/(No.of days)]

= [(100-98)/98] × [365/90] = 8.28%

## 1.2. Comparison of Portfolio Returns Against a Benchmark

a. For the comparison purpose, the returns should be expressed as a bond equivalent yield.

b. The overall return is calculated as a weighted average of the yields of different assets in a portfolio.

## 1.3. Evaluation of a Company’s Short-Term Investment Policy Guidelines

The company’s guidelines may call for a **passive **investment policy. Such policy is characterized by:

a. A limited number of transactions,

b. Very few rules,

c. Roll-over maturities, and

d. Benchmark against T-bill rates

The main purpose of the passive strategy is safety and liquidity.

A company may also have a more **active **strategy. Such strategy involves:

a.** Matching approach**, where the timings of cash outflow are matched with investment maturities. This strategy is also known as a self-liquidating approach. Here, both fixed assets as well as the permanent portion of non-operating working capital are financed using the long-term debt and equity.

b.** Mismatching approach, **where we do not match the levels of fixed assets and the permanent levels of nonoperating working capital with the level of fixed capital (consisting of long-term debts and equity). There are two possibilities here:

i. The total equity, as well as long-term debt, maybe less than the fixed assets as well as the permanent portion of non-operating working capital. The permanent capital may also be somewhat financed by short-term debt. This is the aggressive approach of capital management.

ii. The total equity, as well as long-term debt, may be more than the fixed assets as well as the permanent portion of non-operating working capital. Some portion of temporary capital may also be somewhat financed by long-term debt. This is a conservative approach to capital management.

c.** Laddering Approach**, where the maturity of debt is scheduled equally in a systematic manner over the term of the ladder.

While evaluating the cash management investment policy, we must evaluate the:

a.** Purpose**, i.e. the reason why the portfolio was created, the investment strategies followed, and the securities that qualify as a result.

b.** Authorities, **e. the persons responsible and accountable for the portfolio management, and consequences if the investment strategies are not followed.

c.** Limitations/Restriction** on the types of securities maximum positions and minimum credit ratings required.