Debt Securities: Instruments, Yield Conventions, and Portfolio Rules
The Debt Securities domain tests how a cash manager evaluates and uses short-term debt instruments in a corporate liquidity portfolio: instrument mechanics, yield quotation conventions, settlement, credit and liquidity analysis, tax treatment, and compliance with a written investment policy that typically caps maturities, minimum ratings, issuer concentration, and eligible instrument types.
Eligible instruments and their structure
- Treasury bills are pure discount securities of 52 weeks or less, backed by the full faith and credit of the U.S., exempt from state and local income tax, and traded in the deepest secondary market.
- Treasury notes and bonds pay semiannual coupons; notes run to 10 years, bonds beyond.
- Agency discount notes are GSE obligations: strong credit, but not the government's full faith and credit.
- Commercial paper is an unsecured discount promissory note, capped at 270 days so the issuer keeps its SEC registration exemption; programs are supported by committed backup lines.
- Negotiable CDs are bank liabilities, typically $1 million and up, tradeable before maturity; Eurodollar CDs add sovereign and settlement risk.
- Bankers' acceptances are time drafts guaranteed by a bank to finance trade.
- Repurchase agreements are collateralized borrowings, overnight or term, with a haircut protecting the cash lender.
- Municipal securities pay federally tax-exempt interest, but gains, market discount accretion, and AMT private-activity bonds need separate treatment.
Yield conventions
Discount instruments quote a discount yield = (discount / par) x (360 / days). The buyer's return is better measured by money market yield = (discount / price) x (360 / days), and bond equivalent yield = (discount / price) x (365 / days).
Worked example
A 182-day T-bill with $1,000,000 par is bought at $989,000, a discount of $11,000.
- Discount yield: 11,000 / 1,000,000 x 360 / 182 = 2.18%
- Money market yield: 11,000 / 989,000 x 360 / 182 = 2.20%
- BEY: 11,000 / 989,000 x 365 / 182 = 2.23%
The quoted discount yield is always the lowest because it divides by par, not by the cash actually invested.
Traps that cost marks
- Comparing a discount yield with a CD rate without converting to a common basis.
- Assuming agency paper carries Treasury credit.
- Forgetting the 270-day commercial paper limit and backup-line requirement.
- Treating repo as a deposit rather than a collateralized loan.
- Ignoring the state tax exemption on Treasuries and the tax quirks of municipals.