Money Market Instruments: T-Bills, Commercial Paper, CDs

1. Why This Topic Matters for the CTP Exam

Money market instruments sit at the heart of Corporate Liquidity Management, one of the most heavily tested areas of the AFP Certified Treasury Professional (CTP) exam. Treasury professionals are responsible for investing excess operating cash so that it earns a return while remaining safe and available when needed. Treasury bills, commercial paper, and certificates of deposit are the three workhorse instruments of the short-term investment portfolio, and the exam expects you to know their features, risks, yield conventions, and how they fit within a corporate investment policy.

On the exam, this topic shows up in several ways: definitional questions (which instrument is unsecured? which is issued at a discount?), comparison questions (rank by credit risk or liquidity), calculation questions (compute price, discount yield, money market yield, or bond-equivalent yield), and judgment questions (which instrument best fits a given liquidity need or policy constraint). Mastering these instruments also supports other CTP domains such as cash forecasting, investment policy design, and working capital management.

2. What Are Money Market Instruments?

Money market instruments are short-term debt securities with original maturities of one year or less. They are characterized by:
- Short maturities – typically overnight to 365 days.
- High liquidity – active secondary markets (for most) or very short holding periods.
- Low credit risk – issued by governments, highly rated corporations, and banks.
- Large denominations – generally traded in round lots of $1 million or more, though minimums vary.
- Two pricing conventions – some trade on a discount basis (sold below face value, redeemed at par) and others are interest-bearing (sold at par, pay principal plus interest at maturity).

The core trade-off every treasurer faces is the classic hierarchy of short-term investment objectives: safety first, liquidity second, yield third. The exam repeatedly tests whether you understand that yield is never the primary objective for operating cash.

3. U.S. Treasury Bills (T-Bills)

What they are: Short-term obligations of the U.S. government issued by the Treasury Department and backed by its full faith and credit. They are considered the benchmark risk-free rate in dollar markets.

Key features:
- Maturities: 4, 8, 13, 17, 26, and 52 weeks (often expressed as 1, 2, 3, 4, 6, and 12 months). Cash management bills are issued irregularly to meet Treasury cash needs.
- Pricing: Sold at a discount to face (par) value; the investor receives full face value at maturity. The difference is the interest income. No coupon payments.
- Issuance: Sold through regular auctions. Competitive bids specify a yield; noncompetitive bids accept the yield determined at auction and are guaranteed a fill (up to a limit). All winning bidders pay the same price (single-price or Dutch auction).
- Minimum denomination: $100, with $100 increments, though institutional trades are far larger.
- Credit risk: Effectively zero default risk.
- Liquidity: Deepest and most liquid secondary market of any money market instrument.
- Taxation: Interest is subject to federal income tax but exempt from state and local income taxes.
- Yield quotation: Quoted on a bank discount basis using a 360-day year, which understates the true return. This is why the exam asks you to convert to money market yield or bond-equivalent yield.

Role in corporate liquidity: T-bills are the safest parking place for operating cash and the reference point against which all other money market yields are compared. The spread between a corporate instrument and the comparable T-bill reflects credit and liquidity premiums.

4. Commercial Paper (CP)

What it is: An unsecured, short-term promissory note issued by corporations, financial institutions, and other large borrowers to fund working capital, receivables, and inventory, or to bridge longer-term financing.

Key features:
- Maturities: From 1 to 270 days. Most CP is issued with maturities of 30 days or less, and much of it is overnight to one week. The 270-day cap exists because paper with a maturity of 270 days or less used for current transactions is exempt from SEC registration under Section 3(a)(3) of the Securities Act of 1933.
- Pricing: Usually issued at a discount to face value, like T-bills, though some CP is interest-bearing.
- Denominations: Typically $100,000 minimum, commonly traded in $1 million blocks.
- Credit quality: Rated by the major agencies. Top short-term ratings are A-1+ / A-1 (S&P), P-1 (Moody), and F1+ / F1 (Fitch). Tier 1 paper carries the highest ratings; Tier 2 is one notch lower. Corporate investment policies often restrict purchases to Tier 1 paper.
- Backup liquidity: Issuers are expected to maintain backup lines of credit from banks covering most or all outstanding paper. This protects against rollover risk – the possibility that maturing paper cannot be refinanced with new issues.
- Distribution: Direct paper is sold by the issuer (common for large finance companies) directly to investors; dealer paper is placed through investment banks or commercial banks acting as dealers for a fee.
- Asset-backed commercial paper (ABCP): Issued by special-purpose conduits and secured by pools of receivables or other assets; it carries different risks than traditional unsecured CP, as the 2007–2008 crisis demonstrated.
- Secondary market: Limited. Most investors hold CP to maturity, although dealers will generally repurchase paper they placed.
- Taxation: Fully taxable at federal, state, and local levels.

Role in corporate liquidity: For the issuer, CP is typically the lowest-cost source of short-term borrowing available to highly rated companies, cheaper than bank loans. For the investor, CP offers a yield pickup over T-bills in exchange for taking corporate credit risk and accepting less liquidity.

5. Certificates of Deposit (CDs)

What they are: Time deposits issued by banks and thrift institutions that pay a stated rate of interest for a specified term. Unlike T-bills and CP, most CDs are interest-bearing: the investor deposits the face amount and receives principal plus interest at maturity (or periodically for longer-term CDs).

Key varieties:
- Negotiable CDs: Large-denomination CDs (usually $100,000 minimum, typically $1 million or more) that can be sold in a secondary market before maturity. These are the institutional money market instrument. Maturities range from a few weeks to one year or more, with most under six months.
- Non-negotiable (retail or time) CDs: Cannot be sold; early withdrawal is permitted only with an interest penalty.
- Jumbo CDs: CDs of $100,000 or more.
- Yankee CDs: Dollar-denominated CDs issued in the U.S. by branches of foreign banks.
- Eurodollar CDs: Dollar-denominated CDs issued by banks outside the United States (including foreign branches of U.S. banks). Not subject to U.S. reserve requirements or FDIC insurance, so they typically yield slightly more.
- Brokered CDs: Sold through brokers who may split large deposits among many banks to stay under insurance limits.
- Variable-rate CDs: Rate resets periodically against a benchmark.

Key features:
- FDIC insurance: Deposits are insured up to $250,000 per depositor, per insured bank, per ownership category. Amounts above this limit carry the credit risk of the issuing bank, which is why corporate investors evaluate bank credit quality carefully.
- Pricing: Issued at par; interest accrues on an actual/360 basis for most negotiable CDs.
- Credit risk: Depends on the issuing bank; generally higher than T-bills, comparable to or slightly different from top-tier CP depending on the bank.
- Liquidity: Negotiable CDs have a reasonable secondary market, though less liquid than T-bills.
- Taxation: Fully taxable.

Role in corporate liquidity: CDs let a company earn a bank deposit rate with a known maturity, support relationship banking, and (through brokered or laddered structures) obtain insurance coverage on larger balances.

6. Side-by-Side Comparison

Issuer: T-bills – U.S. Treasury; CP – corporations and financial institutions; CDs – banks and thrifts.
Security: T-bills – full faith and credit of the U.S. government; CP – unsecured (except ABCP); CDs – bank obligation, FDIC insured to $250,000.
Pricing: T-bills – discount; CP – usually discount; CDs – interest-bearing (issued at par).
Typical maturity: T-bills – 4 to 52 weeks; CP – 1 to 270 days, mostly under 30 days; CDs – 7 days to 1 year or more.
Credit risk: T-bills – lowest; CP – depends on issuer rating; CDs – depends on bank, insured portion is risk-free.
Liquidity: T-bills – highest; negotiable CDs – moderate; CP – lowest (hold to maturity).
Yield: T-bills – lowest (benchmark); CDs – higher; CP – generally highest of the three for comparable maturity and quality.
Tax: T-bills – exempt from state and local tax; CP and CDs – fully taxable.
Day-count: All typically quoted on a 360-day basis; conversion to a 365-day basis gives bond-equivalent yield.

7. How Pricing and Yield Calculations Work

The CTP exam loves yield conversions. Memorize these formulas, where F = face value, P = purchase price, D = dollar discount (F – P), and t = days to maturity.

Discount yield (bank discount basis):
DY = (D / F) × (360 / t)

Price from discount rate:
P = F × [1 – (DY × t / 360)]

Money market yield (CD-equivalent yield):
MMY = (D / P) × (360 / t)

Bond-equivalent yield (investment yield):
BEY = (D / P) × (365 / t)

Interest on an interest-bearing CD:
Interest = Principal × Rate × (t / 360)

Worked example: A $1,000,000 T-bill with 91 days to maturity is quoted at a 5.00% discount rate.
- Price = 1,000,000 × [1 – (0.05 × 91 / 360)] = 1,000,000 × (1 – 0.012639) = $987,361.11
- Dollar discount = 1,000,000 – 987,361.11 = $12,638.89
- MMY = (12,638.89 / 987,361.11) × (360 / 91) = 0.012801 × 3.956 = 5.06%
- BEY = (12,638.89 / 987,361.11) × (365 / 91) = 0.012801 × 4.011 = 5.13%

Notice the ordering, which is always the same: Discount Yield < Money Market Yield < Bond-Equivalent Yield. The discount yield understates return because it divides by face value instead of the smaller purchase price; the BEY is highest because it uses a 365-day year.

CD example: A $1,000,000 negotiable CD pays 5.10% for 90 days. Interest = 1,000,000 × 0.051 × 90/360 = $12,750. The investor receives $1,012,750 at maturity. To compare this CD with the T-bill above, convert the T-bill discount yield to money market yield (5.06%) – the CD at 5.10% offers a modest pickup for taking bank credit risk.

8. How These Instruments Fit Into Corporate Liquidity Management

- Investment policy: A written short-term investment policy defines permitted instruments, minimum ratings (for example, A-1/P-1 only), maximum maturity, maximum exposure per issuer, and diversification rules. T-bills, Tier 1 CP, and CDs from approved banks are standard permitted investments.
- Matching cash flows: Treasurers match instrument maturities to forecasted cash needs. Overnight and one-week CP covers near-term disbursements; 13-week T-bills or 90-day CDs cover quarterly tax or dividend payments.
- Laddering: Staggering maturities smooths reinvestment risk and ensures regular liquidity.
- Risk management: Key risks include credit (default) risk, liquidity risk, interest rate (price) risk if sold before maturity, reinvestment risk, and rollover risk for CP issuers. Concentration limits and ratings screens mitigate credit risk; holding to maturity eliminates price risk.
- Benchmarking: Portfolio performance is measured against a T-bill index or similar benchmark.
- Money market funds: Many corporations access these instruments indirectly through SEC Rule 2a-7 money market mutual funds, which are themselves restricted to high-quality, short-maturity paper of exactly these types.

9. Exam Tips: Answering Questions on Money Market Instruments: T-Bills, Commercial Paper, CDs

Tip 1 – Know the pricing convention cold. T-bills and most CP are discount instruments; CDs are interest-bearing. If a question says a security was purchased for $985,000 and matures at $1,000,000, it is a discount instrument. If it says the investor deposited $1,000,000 and will receive $1,012,750, it is interest-bearing.

Tip 2 – Remember the 270-day rule. If a question asks why CP maturities do not exceed 270 days, the answer is the SEC registration exemption. Also remember that most CP is far shorter – 30 days or less.

Tip 3 – Unsecured means CP. When the exam describes an unsecured promissory note issued by a highly rated corporation, think commercial paper. If it mentions backup lines of credit, that is also a CP clue.

Tip 4 – Tax treatment is a differentiator. Only T-bills (and other Treasuries) are exempt from state and local taxes. Questions comparing after-tax yields for a company in a high-tax state often hinge on this point.

Tip 5 – FDIC limit. Know that insurance covers $250,000 per depositor, per bank, per ownership category. A $1 million CD at one bank has $750,000 of uninsured exposure.

Tip 6 – Rank by risk and liquidity. Expect questions asking you to order instruments. Credit risk from lowest to highest: T-bills, then CDs (insured portion) and top-tier CP. Liquidity from highest to lowest: T-bills, negotiable CDs, CP. Yield from lowest to highest generally follows the reverse of safety.

Tip 7 – Watch the day-count basis. Discount yield and money market yield use 360 days; bond-equivalent yield uses 365. If an answer choice is slightly higher than another, check whether the difference is just the 365/360 conversion.

Tip 8 – Identify what the question is asking. Calculation questions typically ask for one of four things: price, discount yield, money market yield, or bond-equivalent yield. Write down F, P, D, and t before touching the calculator, then pick the formula. Divide by F for discount yield; divide by P for the other two.

Tip 9 – Use the yield ordering as a sanity check. If your computed BEY is lower than your discount yield, you made an error. DY is always the smallest of the three for the same instrument.

Tip 10 – Think like a treasurer on judgment questions. When asked which instrument is most appropriate, apply safety-liquidity-yield in that order. Cash needed in ten days should not go into a 90-day non-negotiable CD. A policy that permits only government securities excludes CP and CDs.

Tip 11 – Distinguish Yankee, Eurodollar, and domestic CDs. Yankee = foreign bank, issued in the U.S. Eurodollar = dollar-denominated, issued outside the U.S. Eurodollar CDs are not FDIC insured and not subject to U.S. reserve requirements.

Tip 12 – Know the rating labels. A-1+/A-1, P-1, and F1+/F1 are top-tier short-term ratings. A question referencing Tier 1 versus Tier 2 paper is testing your understanding of investment policy quality screens and Rule 2a-7 constraints.

10. Practice Questions

Question 1: Which of the following is an unsecured promissory note with a maturity that generally does not exceed 270 days?
A. Treasury bill B. Negotiable CD C. Commercial paper D. Banker acceptance
Answer: C. CP is unsecured and stays within 270 days to qualify for the SEC registration exemption.

Question 2: A $1,000,000 T-bill with 182 days to maturity is quoted at a 4.80% discount rate. What is the purchase price?
Answer: P = 1,000,000 × [1 – (0.048 × 182/360)] = 1,000,000 × (1 – 0.024267) = $975,733.33.

Question 3: Which instrument is exempt from state and local income tax?
Answer: Treasury bills.

Question 4: An investor buys a 60-day discount instrument for $991,500 with face value of $1,000,000. What is the money market yield?
Answer: D = 8,500. MMY = (8,500 / 991,500) × (360 / 60) = 0.008573 × 6 = 5.14%.

Question 5: A treasurer places $1,500,000 in a single CD at one bank. How much is uninsured?
Answer: $1,500,000 – $250,000 = $1,250,000 uninsured.

Question 6: Which of the following best explains why commercial paper issuers maintain backup bank lines?
Answer: To protect against rollover risk – the inability to refinance maturing paper – and to support the credit rating required by investors.

11. Key Takeaways

- T-bills are the risk-free, most liquid, state-tax-exempt benchmark, sold at a discount via auction.
- Commercial paper is unsecured corporate debt, usually discount-priced, capped at 270 days, rated A-1/P-1 at the top tier, and supported by backup credit lines.
- CDs are interest-bearing bank deposits; negotiable CDs trade in a secondary market; FDIC insurance covers $250,000 per depositor per bank.
- Discount yield < money market yield < bond-equivalent yield, always.
- In corporate liquidity management, the objectives are safety, then liquidity, then yield – and every exam question about choosing an instrument should be answered through that lens.