WCM/U2 Topic 8 Marketable Securities: Concept, Types
Marketable Securities are the financial instruments that one can easily buy or sell in the market. The maturities of these financial instruments are usually less than a year. Since they have high liquidity, these investments are good for businesses that need quick cash. Some examples of these financial instruments are government bonds, common stock or certificates of deposit.
Businesses keep their cash in reserves. Such reserves help them in situations when they require cash, like for acquisitions or any unforeseen payment. However, companies do not put all their cash in the reserves. Instead, they invest some in short-term liquid securities to earn interest. This way, the cash not only earns an interest income, but a company can also easily liquidate the investment to meet any future cash need.
The returns on such securities are relatively lower due to their liquidity and the fact that we see them as safe investments. Apple holds a major portion of its wealth in the form of such securities.
WHY INVEST IN THEM?
BETTER THAN IDLE CASH
Cash lying idle does not give any return and cash in the bank account offers meager returns. Therefore, investing in such securities not just offer a better return, but the safety of investment as well.
PAYING SHORT-TERM LIABILITIES
Short-term liabilities are payable within a year. So, marketable securities, which also liquidate after a year, are the best way to pay such liabilities as they are highly liquid and earn some income in the meantime as well.
To borrow funds from financial institutions, companies have to follow some guidelines. These guidelines could be in the form of maintaining a certain level of working capital and investing in cash. Moreover, these requirements are often in the form of ratios. So, marketable securities help a company meet such guidelines with liquidity and solvency ratios.
Marketable securities broadly have two groups – Marketable debt securities and Marketable equity securities.
Marketable debt securities are government bonds and corporate bonds. One can trade these on the public exchange and their market price is also readily available. In the balance sheet, all marketable debt securities are shown as current at the cost, until a company realizes a gain or loss on the sale of the debt instrument.
Marketable equity securities are common stock and most preferred stock as well. One can also easily trade them on the public exchanges and their market price information is easily available. All marketable equity securities are shown in the balance sheet at either cost or market whichever is lower.
There is also a third type of marketable securities classified further into three categories – money market instruments, derivatives, and indirect investments. Indirect investments include money put into hedge funds and unit trusts.
Derivatives are the investments that are dependent on another security for their value, like futures, options, and warrants.
Money market securities are short-term bonds, like Treasury bills (T-bills), banker’s acceptances and commercial paper. Big financial entities purchase these in massive quantities.