Negotiable Certificates of Deposit
A negotiable certificate of deposit (NCD) is a debt security issued by financial institutions to obtain short-term funds. The minimum denomination is typically $100,000, but the $1 million denomination is more common. Common maturities of NCDs are 10 days to 1 year. Unlike the other money market securities we have mentioned, NCDs do provide interest payments. There is a secondary market for NCDs, but it is not so active as the secondary market for Treasury bills. Because there is a slight risk that the financial institution issuing an NCD will default on its payment at maturity, investors require a return that is slightly above the return on Treasury bills with a similar maturity.
Foreign Money Market Securities
Firms and investors can also use foreign money markets to borrow or invest funds for short-term periods. Firms can issue short-term securities such as commercial paper in foreign markets, assuming that they are perceived as creditworthy in those markets. They may even attempt to borrow short-term funds in other currencies by issuing short-term securities denominated in foreign currencies. The most common reason for a firm to borrow in foreign money markets is to obtain funds in a currency that matches its cash flows. For example, IBM's European subsidiary may borrow euros (the currency for 11 different European countries) either from a bank or by issuing commercial paper to support its European operations, and it will use future cash inflows in euros to pay off this debt at maturity.
Investors may invest in foreign short-term securities because they have future cash outflows in those currencies. For example, say a firm has excess funds that it can invest for three months. If it needs Canadian dollars to purchase exports in 3 months, it may invest in a 3-month Canadian money market security (such as Canadian Treasury bills) and then use the proceeds at maturity to pay for its exports.
Alternatively, an investor may purchase a foreign money market security to capitalize on a high interest rate. Interest rates vary among countries, which causes some foreign money market securities to have a much higher interest rate than others. However, investors are subject to exchange rate risk when investing in securities denominated in a different currency from what they need once the investment period ends. If the currency denominating the investment weakens over the investment period, then the actual return that investors earn may be less than what they could have earned from domestic money market securities.
The currency for 11 different European countries.