Cash Equivalents

Investment instruments with high credit quality and high liquidity

Author: Austin Anderson
Austin Anderson
Austin Anderson
Consulting | Data Analysis

Austin has been working with Ernst & Young for over four years, starting as a senior consultant before being promoted to a manager. At EY, he focuses on strategy, process and operations improvement, and business transformation consulting services focused on health provider, payer, and public health organizations. Austin specializes in the health industry but supports clients across multiple industries.

Austin has a Bachelor of Science in Engineering and a Masters of Business Administration in Strategy, Management and Organization, both from the University of Michigan.

Reviewed By: Osman Ahmed
Osman Ahmed
Osman Ahmed
Investment Banking | Private Equity

Osman started his career as an investment banking analyst at Thomas Weisel Partners where he spent just over two years before moving into a growth equity investing role at Scale Venture Partners, focused on technology. He's currently a VP at KCK Group, the private equity arm of a middle eastern family office. Osman has a generalist industry focus on lower middle market growth equity and buyout transactions.

Osman holds a Bachelor of Science in Computer Science from the University of Southern California and a Master of Business Administration with concentrations in Finance, Entrepreneurship, and Economics from the University of Chicago Booth School of Business.

Last Updated:September 30, 2023

What is a Cash Equivalent?

Cash equivalents are investment instruments with high credit quality and high liquidity that are designed for short-term investing. Along with stocks and bonds, cash equivalents, sometimes known as "cash and equivalents," are one of the three primary asset types in financial investing.

Treasury bills (T-Bills), bank certificates of deposit, bankers' acceptances, corporate commercial paper, and other money market instruments are examples of low-risk, low-return assets. 

Cash equivalents are the total worth of cash on hand that includes similar goods to cash; cash and cash equivalents must be in the current assets section on the balance sheet.

Because cash and cash equivalents are the most liquid assets, they are always listed on the top line of a company's balance sheet.

T-bills issued by the US government, bank CDs, bankers' acceptances, corporate commercial paper, and other money market instruments are examples of low-risk securities. 

Cash and cash equivalents on hand are indicative of a company's health since they show the company's ability to service short-term debt.

Cash equivalents are also one of the most crucial financial system health indicators for a corporation. 

Analysts can use a firm's ability to generate cash and cash equivalents to determine whether it is a solid investment because it represents how well a company can pay its bills over a short period. Organizations with a lot of cash and cash equivalents are a prime target for larger companies looking to buy smaller businesses.

Cash Equivalents: Treasury bills

The Treasury Department of the United States is the primary issuer of T-bills. When given to businesses, these bonds effectively act as a loan to the government. T-bills are sold in denominations ranging from $100 to $5 million.

They do not charge interest and are available at a reduced rate. The difference between the purchase price and the redemption value is the yield on T-bills.

A T-Bill is a U.S. government debt obligation that matures in one year or less and is backed by the Treasury Department.

Typically, Treasury bills are sold in $1,000 denominations. Non-competitive bids, on the other hand, can be as large as $5 million. These securities are widely regarded as risk-free investments.

The Treasury Department auctions off T-Bills using both competitive and non-competitive bidding. Non-competitive bids, also known as non-competitive tenders, have a price determined by averaging all competitive bids received.

T-Bills have a high monetary value. The United States government issues T-bills with funding various public projects, such as the construction of schools and highways.

When an investor purchases a T-Bill, the US government effectively issues an IOU to the investor. Because they are backed by the US government, T-bills are considered a safe and conservative investment.


T-Bills are usually held until they mature. However, some holders may wish to cash out before maturity in order to realize short-term interest gains by reselling the investment in the secondary market.

Components of T-Bills

The components of T-Bills are:

  1. 1. Maturities of T-Bills: T-bill maturities can range from a few days to 52 weeks, but the most common maturities are 4, 8, 13, 26, and 52 weeks. The longer the maturity date, the higher the interest rate paid to the investor by the T-Bill.
  2. 2. Tax considerations for T-Bills: T-bill interest income is exempt from state and local income taxes. However, interest income is taxed at the federal level. For more tax information, investors can visit the Treasury Direct website's research division.
  3. 3. Getting T-Bills: T-bills that have previously been issued can be purchased on the secondary market through a broker.T-Bills can be purchased at government auctions held on the TreasuryDirect website. T-bills purchased at auction are valued using a bidding process.

Bids are classified as either competitive or non-competitive. Indirect bidders, such as banks or dealers, can be further bidders. 

Direct bidders may also purchase on their behalf. Individual investors, hedge funds, banks, and primary dealers are among the bidders.

A competitive bid establishes a price at a discount to the T-par bill's value, allowing you to specify the yield you want from the T-Bill. 

Non-competitive bid auctions allow investors to place a bid for a specific dollar amount of bills. The yield received by investors is based on the average auction price from all bidders.

Competitive bids are submitted via a local bank or a licensed broker. Individual investors can submit non-competitive bids through the TreasuryDirect website. 

Once completed, the purchase of the T-Bill serves as a government statement stating that you are owed the money you invested under the terms of the bid.

Pros and Cons of T-Bill Investing

Treasury Bills are among the most secure investments available to investors. However, this security may come at a cost. 

T-bills pay a fixed rate of interest and can provide a consistent source of income. However, as interest rates rise, existing T-bills lose appeal because their rates are less attractive in comparison to the overall market.

As a result, T-bills are subject to interest rate risk, which means that existing bondholders may miss out on higher rates in the future. Even though T-bills have no default risk, their returns are typically lower than those of corporate bonds and some certificates of deposit.

Treasury bills are sold at a discount to the face value of the bond because they do not pay periodic interest payments. When the bond matures, the difference between the purchase price and the face value is realized.

However, if they are sold before maturity, there may be a gain or loss depending on where bond prices are trading at the time of sale. In other words, if the T-bill is sold early, the sale price may be lower than the original purchase price.

The pros of investing in T-bill are:

  • Because T-bills are guaranteed by the US government, there is no default risk

  • T-bills have a low minimum investment requirement of $100

  • Interest income is exempt from state and local income taxes but subject to federal income taxes

  • T-bills can be bought and sold easily in the secondary bond market

The cons of investing in T-bill are:

  • T-Bills provide low returns when compared to other debt instruments and certificates of deposit (CDs)

  • The T-Bill has no coupon payments (interest payments) until it matures

  • T-bills can stifle cash flow for investors who need consistent income

  • T-bills are subject to interest rate risk, so their yield may become less appealing in a rising-rate environment

What factors influence T-Bill prices?

T-Bill prices fluctuate in the same way that other debt securities do. T-Bill prices can be influenced by various factors, including macroeconomic conditions, monetary policy, and the overall supply and demand for Treasuries. 

1. Dates of maturity

T-Bills with longer maturities typically yield higher returns than T-Bills with shorter maturities. In other words, short-term T-bills receive a lower discount than longer-term T-bills.

Longer-dated maturities pay higher returns than short-dated bills because there is more risk priced into the instruments, implying that interest rates may rise. Fixed-rate T-bills become less appealing as market interest rates rise.

2. Market danger

Prices are influenced by investors' risk tolerance. T-Bill prices typically fall when other investments, such as equities, appear less risky and the US economy is expanding.

During recessions, on the other hand, investors tend to invest in T-Bills as a haven for their money, driving up demand for these safe products. T-bills are considered the market's closest approach to a risk-free return since they are guaranteed by the full confidence and credit of the United States government.

3. The Federal Reserve System

The Federal Reserve's monetary policy, as expressed by the federal funds rate, significantly impacts T-Bill prices. 

The federal funds rate is the interest rate banks charge other banks for lending them money overnight from their reserve balances.

The Fed will raise or lower the fed funds rate to tighten or loosen monetary policy and the availability of money in the economy. 

A lower rate allows banks to lend more money, whereas a higher rate reduces the amount of money in the system for banks to lend.

As a result, the Fed's activities affect short-term interest rates, including T-bill rates. A rising federal funds rate attracts investors away from Treasuries and toward higher-yielding investments. Because T-bill rates are fixed, investors tend to sell T-bills when the Fed raises rates because T-bill rates become less appealing.

If the Fed lowers interest rates, money flows into existing T-bills, driving up prices as investors purchase higher-yielding T-bills. The Federal Reserve is also a major buyer of government debt securities.

When the Fed purchases US government bonds, bond prices rise while the money supply expands throughout the economy as sellers receive funds to spend or invest. Deposited funds are used by financial institutions to lend to businesses and individuals, thereby stimulating economic activity.

4. Inflation

Treasuries must also compete with inflation, which measures the rate at which prices in the economy rise. Even though T-Bills are the most liquid and safe debt security on the market, when inflation surpasses the T-bill yield, fewer investors buy them.

For example, if an investor purchased a T-Bill with a 2% yield while inflation was at 3%, the investor would have a net loss on the investment in real terms. As a result, during inflationary periods, T-bill prices tend to fall as investors sell them in favor of higher-yielding investments.


As an example, suppose an investor pays $950 for a $1,000 T-Bill with a par value of $1,000. When the T-Bill matures, the investor receives $1,000, earning $50 in interest on his or her investment. 

The investor is guaranteed to recoup at least the purchase price, but because T-bills are backed by the US Treasury, interest should be earned as well.

As previously stated, the Treasury Department conducts auctions of new T-bills throughout the year. On March 28, 2019, the Treasury issued a 52-week T-bill with a face value of $100 at a discounted price of $97.613778. In other words, a $1,000 T-bill would cost approximately $970.

Cash Equivalents: Commercial papers

Commercial paper is an unsecured, short-term debt instrument issued by corporations that are commonly used to finance payroll, accounts payable, inventories, and other short-term liabilities.

Commercial paper maturities typically last a few days and rarely exceed 270 days. Commercial paper is typically issued at a discount to face value, reflecting current market interest rates.

Commercial paper was invented more than 150 years ago when New York merchants began to sell their short-term obligations to dealers who acted as middlemen to free up capital to cover near-term obligations.

As a result, these dealers would buy the notes at a discount from their par value and then sell them to banks or other investors. The borrower would then repay the investor an amount equal to the note's par value.

Commercial paper is unsecured debt because it is not typically backed by any form of collateral. It is not the same as asset-backed commercial paper (ABCP), a type of debt instrument backed by assets chosen by the issuer. 

In either case, commercial paper is only issued by companies with high credit ratings. Only these types of companies will be able to easily find buyers without having to offer a significant discount (higher cost) for the debt issue.

Because commercial paper is issued by large institutions, the denominations of commercial paper offerings are typically $100,000 or higher. 

Commercial paper is typically purchased by other corporations, financial institutions, wealthy individuals, and money market funds.

The Benefits of commercial paper are:

  • The commercial paper does not require registration with the Securities and Exchange Commission (SEC) as long as it matures within nine months or 270 days, making it a very cost-effective means of financing.

  • Although maturities can be as long as 270 days before coming under the purview of the SEC, commercial paper maturities average around 30 days, rarely exceeding that threshold.

  • The proceeds from this type of financing can only be used on current assets, such as inventories, and cannot be used on fixed assets, such as a new plant, without the approval of the SEC.

Commercial paper during the 2007 financial crisis

The commercial paper market played a significant role in the 2007 financial crisis. The commercial paper market froze as investors began to question the financial health and liquidity of firms such as Lehman Brothers, and firms could no longer access easy and affordable funding.

Another effect of the commercial paper market freeze was that some money market funds—significant commercial paper investors—were "breaking the buck."

This meant that the affected funds had net asset values of less than $1, reflecting the declining value of their outstanding commercial paper issued by questionable financial institutions.

As a result of the credit crunch faced by financial intermediaries in the commercial paper market, the Federal Reserve Bank of New York established the Commercial Paper Funding Facility (CPFF) on October 7, 2008. After the financial sector and the broader economy recovered, the Federal Reserve Bank of New York closed the CPFF in February 2010.

Commercial Paper Example

Commercial paper is used when a retailer needs short-term funding to finance new inventory for the upcoming holiday season. The company requires $10 million and offers investors $10.1 million in commercial paper face value in exchange for $10 million in cash, based on current interest rates.

In effect, a $0.1 million interest payment would be made upon the maturity of the commercial paper in exchange for the $10 million in cash, equating to a 1% interest rate. This interest rate can be time-adjusted based on the number of days the commercial paper is outstanding.

Cash Equivalents: Marketable securities

Marketable securities are liquid financial instruments that can be converted into cash quickly and affordably. Marketable securities are liquid because their maturities are typically less than one year, and the rates at which they can be bought or sold have little effect on prices.

Businesses typically keep cash in reserve to prepare for situations in which they may need to act quickly, such as seizing an acquisition opportunity or making contingent payments. 

Instead of keeping all of its cash in its coffers, which provides no opportunity for interest, a business will invest a portion of its cash in short-term liquid securities.

Instead of sitting on cash, the company can earn returns on it. If the company suddenly needs cash, it can easily liquidate these securities. A group of assets classified as marketable securities is an example of a short-term investment product.

Any unrestricted financial instrument that can be bought or sold on a public stock exchange or a public bond exchange is defined as marketable security. As a result, marketable securities are either marketable equity securities or marketable debt securities.

Other requirements for marketable securities include a strong secondary market that allows for quick buy and sells transactions and a secondary market that provides accurate price quotes to investors.

Because marketable securities are highly liquid and considered safe investments, the return on these types of securities is low. Common stock, commercial paper, banker's acceptances, Treasury bills, and other money market instruments are examples of marketable securities.

Analysts evaluate marketable securities when performing liquidity ratio analysis on a company or sector. 

Liquidity ratios assess a company's ability to meet its immediate financial obligations. In other words, this ratio determines whether a company's most liquid assets can be used to pay off its short-term debts. Among the liquidity ratios are

1. Cash-to-Cash Ratio

MCS/ Current Liabilities = Cash Ratio,

Where MCS stands for Market Value of Cash and Marketable Securities.

The cash ratio is calculated by dividing the market value of cash and marketable securities by a company's current liabilities. Creditors prefer a ratio greater than one because it indicates that a company would be able to cover all of its short-term debts if they became due today.

However, most businesses have a low cash ratio because holding too much cash or heavily investing in marketable securities is not a profitable strategy.

2. Current Ratio

Current Assets/Current Liabilities = Current Ratio

The current ratio assesses a company's ability to repay its short-term debts using all of its current assets, including marketable securities. Current assets are divided by current liabilities to arrive at this figure.

3. Quick Ratio

Quick Assets/Current Liabilities = Quick Ratio

The quick ratio considers only short-term assets when determining a company's liquidity. Quick assets are securities that can be converted into cash more easily than current assets. 

Marketable securities are classified as short-term assets. The quick ratio is calculated as quick assets / current liabilities.

Marketable security types

Various types of marketable securities are:

1. Equity investments

Common stock and preferred stock are two types of marketable equity securities. They are equity securities of a public company held by another corporation and are listed on the holding company's balance sheet.

If the stock is expected to be liquidated or traded within a year, it will be classified as a current asset by the holding company. 

If the company expects to keep the stock for more than a year, the equity will be classified as a non-current asset. All current and non-current marketable equity securities are listed at the lower cost or market.

If, on the other hand, a company invests in the equity of another company to acquire or control that company, the securities are not considered marketable equity securities. On its balance sheet, the company instead classifies them as long-term investments.

2. Debt securities

Any short-term bond issued by a public company and held by another company is considered marketable debt security. Marketable debt securities are typically held by a company instead of cash, making an established secondary market even more important.

All marketable debt securities are held at cost on a company's balance sheet as a current asset until the debt instrument is sold and a gain or loss is realized.

Marketable debt securities are short-term investments that will be sold within a year. If a debt security is expected to be held for more than a year, it should be classified on the company's balance sheet as a long-term investment.

Cash Equivalents: Money market funds

A money market fund is a mutual fund that invests in short-term, highly liquid assets. These instruments include cash, cash equivalent securities, and short-term debt-based securities with a high credit rating (such as U.S. Treasuries).

Money market funds are designed to provide investors with high liquidity at low risk. Money market mutual funds are another name for money market funds.

A money market fund is not the same as a money market account, despite their similar names (MMA). A money market fund is an investment sponsored by a mutual fund company. As a result, there is no principal guarantee.

A money market account is a type of savings account that pays interest. Financial institutions provide money market accounts. They are insured by Federal Deposit Insurance Corporation (FDIC) and typically have limited transaction privileges.

How a money market fund works

Money market funds function similarly to mutual funds. They sell redeemable units or shares to investors and are required to follow financial regulators' guidelines (for example, those set by the U.S. Securities and Exchange Commission).

A money market fund may invest in the debt-based financial instruments listed below:

  • Bankers' Acceptances (BA) are short-term debt obligations that are guaranteed by a commercial bank

  • Certificates of deposit (CDs) are short-term savings certificates issued by banks

  • Commercial paper is short-term unsecured corporate debt

  • Short-term government securities are referred to as repurchase agreements (Repos)

  • US Treasuries are short-term government debt securities issued by the United States

Because the returns on these instruments are determined by the applicable market interest rates, the overall returns on money market funds are also determined by interest rates.

Types of money market funds

Money market funds are classified into several types based on the type of assets invested, the maturity period, and other factors.

1. Prime investment fund

A prime money fund invests in non-Treasury floating-rate debt and commercial paper, such as those issued by corporations, US government agencies, and government-sponsored enterprises (GSEs).

2. Tax-exempt investment fund

A tax-exempt money fund provides earnings that are not subject to federal income tax in the United States. A tax-exempt money fund may also be exempt from state income taxes, depending on the specific securities it invests in. Municipal bonds and other debt securities are the most common types of money market funds.

Some money market funds are designed to attract institutional money by requiring a large minimum investment (often $1 million). Other money market funds, however, are retail money funds and are available to individual investors due to their low minimums.

3. Government short-term bonds

Governments issue short-term government bonds to fund government projects. These are issued in the domestic currency of the country. When investing in government bonds, investors consider political risks, interest rate risks, and inflation.

The benefits of investing in government bonds

The following are some of the benefits of investing in government bonds.

1. Risk-Free

Government bonds provide investors with guaranteed returns as well as fund stability. They have consistently set the bar for risk-free security. Government bonds are thus appropriate for investors looking for a low-risk investment.

2. Rate of return 

In general, government bond returns are comparable to bank deposits. There is also a principal and fixed interest guarantee. Unlike bank deposits, these bonds are available for a longer period of time.

3. Liquidity

Government bonds can be bought and sold just like stocks. These bonds have the same liquidity as banks and financial institutions.

4. Diversification of a portfolio

Government bonds provide an investor with a well-diversified portfolio. Because government bonds are risk-free investments, it reduces the overall portfolio risk.

5. Regular earnings

According to RBI guidelines in India, interest on government bonds must be paid to bondholders every six months. As a result, it allows bondholders to earn a consistent income by investing their idle funds.

The disadvantages of investing in government bonds are:

The following are some of the drawbacks of investing in government bonds.

1. Low profits

Government bonds have a lower yield or interest rate than other investment options such as equity, real estate, corporate bonds, and so on.

2. Interest rate risk

Government bonds are long-term investment bonds with maturities ranging from five to forty years. As a result, the bond's value may decline during this time. When inflation rises, interest rates become less appealing.

Furthermore, as the bond period lengthens, the market's risk rises alongside the interest rate risk. This means that the investor is stuck with an investment that pays less than the market value.

Who should buy government bonds?

Government bonds are among the most secure investments in India. It is appropriate for investors who prefer security in their investments and have a low-risk tolerance. Investing in market-linked instruments typically involves the risk of capital appreciation.

As a result, they also serve as a long-term investment option for investors who are new to the stock market. Investors can also purchase government bonds to reduce overall market risk in their investment portfolio.

Recently, the government of India has taken several steps to increase the understanding and popularity of government securities among retail investors. Furthermore, they have simplified the subscription process for retail investors.

The bottom line

Cash equivalents are investment instruments with high credit quality and high liquidity. They are designed for short-term investing. Cash and cash equivalents on hand are indicative of a company's financial health.

Analysts use them to determine whether a company is a solid investment or not. A T-Bill is a U.S. government debt obligation that matures in one year or less.

They are backed by the Treasury Department and do not charge interest. The United States issues T-bills funding various public projects, such as schools and highways.

Researched and authored by Javed Saifi | LinkedIn

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