Investing Surplus Funds

Treasury Bills:

The treasury bills are issued by RBI on behalf of the Central Government. Earlier they were issued on the basis of tenders floated regularly but now are available on tap system, i.e., on rates announced by RBI every week. These bills are issued only in bearer form. Name of the purchaser is not mentioned on the bills, rather they are easily transferable from one investor to another.

No interest is paid on the bills but the return is the difference between the purchase price and face (par) value of the bill. Since there is a backing of the Central Government, these are risk free securities. A very active secondary market exists for these bills so it has made them highly liquid. Treasury bills are one of the popular marketable securities even though the yield on them may be low.

Negotiable Certificates of Deposit (CD’s):

The money is deposited in a bank for a fixed period of time and marketable receipt is issued. The receipt may be registered or bearer, the latter facilitates transactions in the secondary market. The denominations and maturity periods are decided as per the needs of the investor.

On maturity the amount deposited and interests are paid. The CD’s are different from the treasury bills which are issued on discount. The short-term surplus funds can be used to earn interest in this method. The investment is secure unless the bank fails, the chances of which are remote.

Unit 1964 Scheme:

The Unit Trust of India’s unit 1964 scheme is very popular for making short-term investments. It is an open ended scheme which allows investors to withdraw their funds on a continuing basis. The units have a face value of Rs10. The purchase and sale value of units is not based on net assets value but it is determined administratively in such a manner that they rise gradually over time.

The unit scheme offers a good avenue for investing short-term funds and has the following advantages:

(i) The dividend income from unit received by companies is treated as inter-corporate dividend, it qualifies for tax exemption up to 80 per cent under Sec. 80M of the Income Tax Act. Many Companies purchase cum-dividend units in May, collect dividend in July and then sell the units.

(ii) The yield can be increased by a careful synchronizing of the purchase and sale of units because the capital loss on sale of units would qualify for a tax set-off, of which 80 per cent of the dividend income would be tax free.

(iii) There is an active secondary- market for units, there will be no liquidity problem.

Ready Forwards:

A commercial bank or some other organisation may enter into a ready forward deal with a company willing to invest funds for a short period of time. Under this system the bank sells and repurchases the same security (that means that company purchases and sells securities in turn) at pre­determined prices.

The difference between the purchase and sale price is the income of the company. Ready forwards are generally done in units, public sector bonds or government securities. Ready forward deals are linked with the position of the money market. The investor can hope to earn more if money market is tight during busy season and at closing of the year.

Badla Financing:

Badla financing is used in stock exchange transactions when a broker wants to carry forward his transactions from one settlement period to another. Badla financing is done through operators in stock exchange. It is the financing of transactions of a broker who wants to carry forward this deal to the other settlement period. The badla rates are decided on the day of settlement.

Badla transaction is financed on the security of shares purchased whose settlement is to be carried forward. Sometime this financing facility may be extended for a particular share only. For example, a company may provide badla finance to a broker X 10 crores for purchasing ACC shares in forward market. Badla rates vary with demand and supply position of funds.

Badla financing offers attractive interest rates. However, it becomes risky if the broker defaults in his commitment. Even the wide fluctuation in prices of shares may also affect the value of security.

An investor in this type of financing should be careful about following things:

(i) The selection of a broker should be on the basis of reputation.

(ii) The shares with a sound intrinsic value should be selected.

(iii) The margin should be adequate.

(iv) The possession of securities should be taken.

Inter-Corporate Deposits:

These are short term deposits with other companies which attract a good rate of return.

Inter-corporate deposits are of three types:

(i) Call Deposits:

It is a deposit which a lender can withdraw on one day’s notice. In practice it takes three days to get this money. The rate of interest at present is 14 per cent on these deposits.

(ii) Three Months Deposits:

These deposits are popular and are used by borrowers to tide over short- term inadequacy of funds. The interest rate on such deposits is influenced by bank overdraft interest rate and at present the borrowing rate is 22 per cent per annum.

(iii) Six-month Deposits:

The lenders may not have surplus funds for a very long period. Six-month period is normally the maximum which lenders may prefer. The current interest rate on these deposits is 24 per cent per annum.

Since inter-corporate deposits are unsecured loans, the creditworthiness of the borrower should be ascertained. Section 370 of the Company’s Act has placed certain restriction on inter-company deposits, so these provisions should be adhered to, these provisions are:

(a) A company cannot lend more than 10 per cent of its net worth (equity plus free reserves) to any single company.

(b) The total lending of a company cannot exceed 30 per cent of its net worth without the prior approval of the central government and a special resolution should permit such a lending.

Bill Discounting:

A bill arises out of credit sales. The buyer will accept a bill drawn on him by the seller. In order to raise funds the seller may get the bill discounted with his bank. The bank will charge discount and release the balance amount to the drawer. These bills normally do not exceed 90 days.

A company may also discount the bills as a bank does thus using its surplus funds. The bill discounting is considered superior to inter-corporate deposits.

The company should ensure that the discounted bills are:

(a) Trade bills (resulting from a trade transaction) and not accommodation bills (helping each other),

(b) The bills backed by the letter of credit of a bank will be most secure as these are guaranteed by the drawee’s bank.

Investment in Marketable Securities:

A firm has to maintain a reasonable balance of cash. This is necessary because there is no perfect balancing of inflows and outflows of cash. Sometimes more cash is received than required for quick payments. Instead of keeping the surplus cash as idle, the firm tries to invest it in marketable securities.

It will bring some income to the business. The cash surpluses will be available during slack seasons and will be required when demand picks up again. The investment of this cash in securities needs a prudent and cautious approach. The selection of securities for investment should be carefully made so that the amount is raised quickly on demand.

In choosing among alternative securities, the firm should examine three basic features of a security: safety, maturity and marketability. The security element deals with the absence of any type of risk. The securities with risk may give higher returns but these should be avoided. There should not be any default in payment when the securities are redeemed. The maturity periods will give higher returns.

The short-period securities will carry lower rates of interest but these should be preferred. The surplus cash can be invested only for smaller periods because the amount may be required for meeting operating cash needs in the short periods.

The securities should have a ready market. These investments can be made only in near cash securities. If the securities selected are such which require some time for realisation then there may be payment problems. So, the securities should have a ready market and may be realizable in a very short period.

Money Market Mutual Funds (MMMF):

‘Money market mutual fund’ means a scheme of a mutual fund which has been set up with the objective of investing exclusively in money market instruments. These instruments include treasury bills, dated Government securities with an expired maturity of upto one year, call and notice money, commercial paper, commercial bills accepted by banks and certificates of deposits.

Till recently, only commercial banks and public financial institutions were allowed to set up MMMFs. But in November 1995, the Government has permitted private sector mutual funds also to set up money market mutual fund. MMMFs are wholesale markets for low risk, high liquidity and short-term securities. The main feature of this fund is the access to persons of small savings.