Treasury Bill Versus Prime Money Fund for a 45-Day Cash Reserve
A corporate treasurer must invest $10 million of operating cash for exactly 45 days and cannot tolerate principal loss. A prime institutional money market fund advertises a 7-day yield of 5.28%, with a weighted average maturity of 38 days, a weighted average life of 75 days, weekly liquid assets of 32%, and daily liquid assets of 18%. A Treasury-only money market fund yields 5.05% with a 20-day weighted average maturity and 100% weekly liquid assets. A 45-day Treasury bill is quoted at a 5.10% discount rate on a $10 million face amount. Overnight Treasury repo is available at 5.20% with 102% collateral, but it must be rolled daily. A 45-day bank CD pays 5.15%, but FDIC insurance covers only $250,000. The treasurer says, 'The prime fund has the highest yield, so it wins.'
1. Calculate the Treasury bill's purchase price and bond-equivalent yield, and compare it with the other alternatives.
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The Treasury bill's discount is $10,000,000 x 5.10% x 45/360 = $63,750. The purchase price is $10,000,000 - $63,750 = $9,936,250. The bill pays $10,000,000 at maturity, so the investor earns $63,750 over 45 days.
The bond-equivalent yield, using a 365-day year, is ($63,750 / $9,936,250) x (365 / 45). The first term is 0.006416, and 365/45 is 8.1111, so the bond-equivalent yield is approximately 5.205%. That is higher than the quoted 5.10% discount rate because the discount is based on face value and a 360-day year, while the bond-equivalent yield is based on the actual purchase price and a 365-day year.
The prime fund's 5.28% is about 7.5 basis points above the T-bill's 5.205%, and the Treasury-only fund's 5.05% is about 15.5 basis points below the T-bill. Overnight repo at 5.20% is close to the T-bill yield but requires daily rollover and counterparty management. The CD at 5.15% is higher than the T-bill, but only $250,000 is insured, leaving $9.75 million exposed to bank credit risk. On a pure yield basis, the prime fund is highest, but yield is not the only relevant variable for a 45-day principal-safe reserve.
2. Explain the liquidity and structural risks in the prime money market fund that are relevant to a 45-day horizon.
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The prime fund's weekly liquid assets are 32%, only two percentage points above the 30% threshold that is commonly associated with heightened liquidity risk. Its weighted average life of 75 days is longer than the 45-day investment horizon, and its daily liquid assets are 18%. If large redemptions occur, the fund could fall below its internal or regulatory liquidity thresholds, and the board could impose a liquidity fee or suspend redemptions under the fund's stated procedures. A money market fund seeks a stable $1.00 net asset value, but it is not insured and can break the buck.
The Treasury-only fund holds government securities and has 100% weekly liquid assets, so its liquidity risk is much lower. It yields 5.05%, about 23 basis points less than the prime fund. For $10 million over 45 days, 23 basis points is roughly $2,875 of additional income from the prime fund, before any fee or delay. That is a small amount relative to the liquidity risk and the treasurer's stated inability to tolerate principal loss.
The T-bill has a defined maturity that matches the 45-day horizon, so it eliminates reinvestment risk and liquidity uncertainty. The repo alternative is secured by 102% Treasury collateral, but daily rollover creates operational and counterparty risk. The CD's $250,000 insurance limit makes it unsuitable for the full $10 million unless the bank's credit is separately acceptable.
3. What should the treasurer recommend, and how should the recommendation be documented?
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The treasurer should recommend the 45-day Treasury bill or the Treasury-only money market fund, not the prime fund. The T-bill locks in a 5.205% bond-equivalent yield for the exact horizon and carries no credit or liquidity risk beyond the full faith and credit of the U.S. government. The Treasury-only fund offers daily liquidity at 5.05%, which is appropriate if the cash may be needed before day 45.
If yield enhancement is important, the treasurer could split the $10 million between the T-bill and the Treasury-only fund, or use repo with a well-capitalized counterparty and conservative collateral. The prime fund should be used only if the firm's investment policy permits liquidity fees and gates and the treasurer can tolerate a delay in access. The 7.5 basis point yield advantage is not adequate compensation for the liquidity mismatch.
The recommendation should be documented in the investment policy and trade rationale: the 45-day horizon, the principal-safety constraint, the comparison of bond-equivalent yields, the liquidity thresholds, the lack of FDIC insurance, and the counterparty analysis for repo. The treasurer should also state that money market fund yields are variable and not guaranteed, and that the Treasury-only fund's yield can change daily.