In the investment arena, funds held in readily accessible transactional accounts are described as cash assets. Marketable investment instruments that have a high degree of liquidity are referred to as cash equivalents. Investors keep their assets in cash and cash equivalents to minimize principal risk during periods of stock market volatility.
Checking accounts are a type of cash account on which people can transact on a daily basis without restriction. Account holders typically receive little or no interest on funds deposited in checking accounts. Banks and investment firms generally pay the highest rates of interest on the most illiquid investments, and consequently checking accounts pay the lowest returns. Savings accounts are another type of cash account, although most savings accounts have monthly or quarterly withdrawal restrictions.
Certificates of deposits (CDs) are short-term debt instruments that are issued by banks. CDs have principal guarantees, but normally have term times of six months or more during which investors cannot access funds without paying a penalty. When a CD matures, the CD account holder receives a return of premium as well as any interest that accrued during the CD term. Due to the lack of principal fluctuation, CDs with a term time of six months or less are commonly referred to as cash equivalents. Longer term CDs are viewed as illiquid since account holders have to wait for extended periods of time to access funds, and although all CDs have principal protections, the illiquidity of longer term CDs prevents such accounts from being classified as cash equivalents.
Government bonds with terms of six months or less are viewed as cash equivalents, although most investment analysts only use this term to describe bonds issued by governments with high credit ratings. Bonds issued by governments with poor credit ratings pose a high level of default risk and are therefore not comparable with cash investments. Commercial paper, which is a type of unsecured debt issued by corporations, is another type of cash equivalent. Conservative money market mutual funds contain cash and cash equivalents, and many investors park money in these funds during stock market downturns due to the relative stability offered by these funds.
Brokerage accounts are securities accounts offered by investment firms in which investors can hold both cash and cash equivalents. Account holders deposit cash in brokerage accounts and then use the cash proceeds to buy securities, including cash equivalents such as CDs. In most countries, both cash and cash equivalents held in brokerage accounts are subject to principal risk because accounts that hold securities, unlike many bank accounts, are not insured.
