Money Market Securities and More
There are a number of bond categories that are primarily traded by professional or experienced investors and differ from Treasuries, munis, corporates, agencies and mortgage-backed securities. They include money market securities, asset-backed and preferred securities, as well as auction rate and event-linked securities.
Money Market Securities
Money market securities are often considered a good place to invest funds that are needed in a shorter time period—usually one year or less. Money market instruments include bankers' acceptances, certificates of deposit and commercial paper. Bankers' acceptances are typically used to finance international transactions in goods and services, while certificates of deposit (CDs) are large-denomination, negotiable time deposits issued by commercial banks and thrift institutions. Commercial paper takes the form of short-term, unsecured promissory notes issued by both financial and non-financial corporations.
Some combination of these products makes up a money market fund. All money market funds are required to have a dollar-weighted average portfolio maturity that cannot exceed 90 days. While money market securities are highly liquid (you can usually receive your money in a few days, compared to months or years with a CD), the interest you earn on your money tends to be quite low and may not keep pace with inflation.
Asset-backed securities are certificates that represent an interest in a pool of assets such as credit card receivables, auto loans and leases, home equity loans, and even the future royalties of a musician (for instance, Bowie bonds). Once you get beyond mortgage-backed securities, which are a type of asset-backed security, investing and trading in the asset-backed market is almost exclusively done by more sophisticated investors; like mortgage-backed securities, there can be significant risks associated with any asset-based security.
There are two common types of preferred securities: equity preferred stock and debt preferred stock.
- Equity preferred stock is much like common stock in that it never matures, and it declares dividends rather than awarding regular interest payments.
- Debt preferreds pay interest like traditional bonds, and since they are corporate debt, they stand ahead of equity preferred securities in the payout hierarchy should the company default. However, many preferreds are hybrids—they contain a combination of debt and equity features, and it is not always clear which type of security they are.
Unlike traditional bonds, preferreds generally have a par value of $25 instead of the traditional $1,000. They also tend to pay interest quarterly, rather than the traditional semiannual payment associated with most bonds. Most preferreds are listed just like stocks, with the majority trading on the New York Stock Exchange. Like traditional bonds, preferreds tend to have credit ratings, and upgrades and downgrades often play an important role in the price a preferred can command in the secondary market.
Auction Rate Securities
Auction rate securities (ARS) are often debt instruments (corporate or municipal bonds) with long-term maturities, but their interest rates can be regularly reset through Dutch auctions. For many years, investors purchased ARS seeking cash-like investments that paid a higher yield than money market mutual funds or certificates of deposit. Those expectations changed in early 2008 when credit market turbulence led many ARS auctions to fail. For more information, see FINRA’s Investor Alert, Auction Rate Securities: What Happens When Auctions Fail.
Event-linked bonds—also called insurance-linked, or “catastrophe” bonds—are financial instruments that allow investors to speculate on a variety of events, including catastrophes such as hurricanes, earthquakes and pandemics. These products are not offered directly to individual investors. But various funds, including mutual funds and closed-end funds, have purchased or are authorized to purchase them on behalf of individual investors. While not widespread, holdings of event-linked securities in these funds—especially high income funds—are also not unusual. Event-linked securities currently offer higher interest rates than similarly rated corporate bonds. But, if a triggering catastrophic event occurs, holders can lose most or all of their principal and unpaid interest payments.
For more information, see Insurance-Linked Securities.