Cash Equivalents
Cash equivalents are securities that are meant for short-term investing. Normally, they have solid credit quality and are highly liquid. True to their name, they are considered equivalent to cash because they can be converted to actual cash quickly.The phrase "cash and cash equivalents" is found on balance sheets in the current assets section. Cash equivalents are one of three main asset classes in investing. The other two are stocks and bonds.Cash equivalent securities have a low-risk, low-return profile.
Definition: Cash equivalents are short-term investment securities with high credit quality and high liquidity. As the name suggests, they are considered equivalent to cash because they can be quickly converted into actual cash. The term "cash and cash equivalents" can be found in the current assets section of the balance sheet. Cash equivalents are one of the three main types of investments, the other two being stocks and bonds. Cash equivalent securities are characterized by low risk and low return.
Origin: The concept of cash equivalents originated from the need for corporate financial management. As companies grew in size and financial management became more complex, there was a need for investment tools that could ensure liquidity while providing some returns. In the mid-20th century, with the development of financial markets, short-term investment tools such as Treasury bills and commercial paper gradually became representative of cash equivalents.
Categories and Characteristics: Cash equivalents mainly include the following categories:
- Treasury Bills: Issued by the government, usually with a maturity of less than one year, offering very high safety and liquidity.
- Commercial Paper: Short-term unsecured debt instruments issued by large corporations, typically with a maturity of up to 270 days, and high credit quality.
- Money Market Funds: Mutual funds that invest in short-term, highly liquid assets, providing high liquidity and safety.
Specific Cases:
- Case One: A company has a large cash inflow at the end of the quarter but no specific investment plans in the short term. To avoid idle funds, the company purchases three-month Treasury bills. These Treasury bills not only ensure the safety of the funds but also provide some interest income.
- Case Two: A large corporation, while waiting for a large receivable, purchases commercial paper. Due to the short maturity and high liquidity of commercial paper, the corporation can quickly convert it into cash when needed.
Common Questions:
- Question One: Are cash equivalents completely risk-free?
Answer: Although cash equivalents have low risk, they are not entirely risk-free. For example, if the issuing company of commercial paper faces financial problems, it may affect its repayment ability. - Question Two: What is the return rate of cash equivalents?
Answer: The return rate of cash equivalents is usually low because their primary purpose is to ensure liquidity and safety of funds, rather than high returns.
