Types and Characteristics of Cash and Cash Equivalents

Start with the definition the rest of the chapter hangs on: cash equivalents are short-term, highly liquid investments that convert to a known amount of cash on short notice, with almost no risk that their value moves while you hold them. That last part — stable value — is what separates them from everything else a portfolio owns.

What counts as a cash equivalent

"Cash equivalent" is a defined category, not a loose synonym for "anything liquid." To earn the label, an instrument has to clear all three of these at once:

Pass all three and you can turn the instrument into a known amount of cash on short notice without taking a haircut. Miss even one and it's out: a 5-year Treasury note is top credit quality but fails on maturity (and carries real price risk if rates move), while a high-yield corporate bond is short-dated but fails on credit quality. Only the instruments that clear all three properties make the cut.

Why clients hold cash equivalents

Cash equivalents earn a modest yield by design, and clients accept that low return for five very practical benefits:

1. Emergency reserve. Three to six months of living expenses available immediately, without touching long-term investments at potentially bad times.
2. Transactional liquidity. Settling trades, paying tax bills, funding planned large purchases, covering month-to-month cash flow gaps.
3. Tactical dry powder. Holding cash while waiting for a specific investment opportunity (a market drawdown, a planned IPO, a real estate purchase).
4. Capital preservation in down markets. When equity and longer-duration bond markets fall, cash equivalents hold their principal — sometimes the only positive line on a year-end statement.
5. Floor on bear-market drawdowns. A portfolio with 20% cash will fall less than one with 0% cash, even if the cash portion earned nothing — its absence of decline cushions the overall drawdown.

Notice how the Series 66 frames all of this — in suitability terms. How much cash, of which type, given the client's time horizon and known cash-flow needs? Yield comparisons do matter, but only as a tiebreaker once suitability is already satisfied.

Bank deposits — checking, savings, CDs

This is the cash-equivalent category clients already know. Everything in it is a bank deposit product, which means two things at once: it's FDIC-insured up to the standard limit, and it is emphatically not a security — a distinction the exam leans on hard.

• Demand deposits — checking and savings accounts at FDIC-insured banks. Funds are available on demand, no withdrawal restrictions, typically the lowest-yielding option because of that flexibility.
• Certificates of Deposit (CDs) — time deposits with a fixed maturity date and a stated interest rate. Money is locked up until maturity; early withdrawal triggers an interest penalty. Yields are higher than demand deposits in exchange for the lockup.
• Negotiable CDs (jumbo CDs) — large-denomination CDs ($100,000 or more) that can be traded in the secondary market before maturity rather than being redeemed at the issuing bank. The negotiability adds liquidity but also exposes the holder to secondary-market price fluctuation if rates move.
• Brokered CDs — CDs issued by FDIC-insured banks but sold through broker-dealers (often in $1,000 denominations to match retail demand). Still FDIC-insured up to the per-bank limit, but may carry call features that traditional bank CDs don't.

FDIC coverage — the per-depositor, per-bank, per-category rule

The FDIC's standard coverage limit is $250,000 per depositor, per insured bank, per ownership category — and the trick is that all three dimensions stack independently:

• Per depositor — each person's deposits at one bank are aggregated for limit purposes. Two CDs and a checking account, all in the same name at one bank, share a single $250,000 cap.
• Per insured bank — deposits at different FDIC-insured institutions get separate $250,000 limits. A client with $250K at Bank A and $250K at Bank B has $500K of coverage.
• Per ownership category — different ownership categories at the same bank each get their own $250K. Categories include single account, joint account, IRA/retirement, revocable trust, irrevocable trust, employee benefit plan, and business/corporate.

Work the example. A client at one FDIC-insured bank holds a $250K individual CD, a $250K joint CD with their spouse, and a $250K IRA. All three are fully insured — three different ownership categories, three separate $250K coverages. Now add a fourth: another $50K in the client's own name (a checking account). That $50K is not separately covered, because the individual-name bucket is already full at $250K — the new deposit pushes that category to $300K, leaving $50K uninsured.

Bank deposit products at a glance

Treasury bills (T-bills)

If the Series 66 has a flagship money market instrument, this is it. T-bills are short-term U.S. government obligations issued in maturities of 4, 8, 13, 17, 26, and 52 weeks. The characteristics worth knowing:

• Sold at a discount; redeemed at face value. An investor pays less than $10,000 today and receives $10,000 at maturity. The difference is the return — no coupon payments, no reinvestment risk.
• Backed by the full faith and credit of the United States. Effectively zero credit risk; the "risk-free rate" benchmark referenced throughout the Series 66 curriculum is the T-bill yield.
• Interest is exempt from state and local income taxes (but is taxable at the federal level). This makes T-bills more attractive than commercial paper or CDs for high-tax-state residents on an after-tax basis.
• Not FDIC-insured — they don't need to be. The government backing is stronger than FDIC insurance (FDIC itself is backed by the U.S. government). The Series 66 tests this distinction.

T-bill yield conventions — bank discount vs. investment yield

T-bills are quoted on a bank discount yield basis — and that is not the investor's true return. The gap between the two is exactly what the Series 66 likes to test.

Two quirks in the formulas open up that gap, and both push the same way:

• Denominator. Bank discount yield divides by face value (the larger number); investment yield divides by purchase price (the smaller number paid). Using the smaller denominator produces a higher quoted yield, which is the honest measure.
• Day-count. Bank discount uses a 360-day year; investment yield uses 365. Multiplying by 365/360 raises the figure by ~1.4%.

So the investment yield is always higher than the bank discount yield. A 91-day T-bill quoted at a 4.0% bank discount yield works out to a true investment yield of roughly 4.10% — a modest gap, but the exam cares about the direction and the reasoning, not the exact decimal.

Commercial paper

Commercial paper is short-term, unsecured promissory notes that corporations issue to cover working-capital needs — payroll, inventory, receivables, the day-to-day cost of running a business.

• Maximum maturity: 270 days. Under Section 3(a)(3) of the Securities Act of 1933, commercial paper with a maturity of 270 days or less, used for current transactions and sold to institutional or accredited investors, is exempt from SEC registration. Issuers stay at or below this threshold to avoid the registration cost and timeline.
• Sold at a discount; redeemed at face value. Like T-bills mechanically, but issued by corporations rather than the government.
• Unsecured. No collateral backs commercial paper, so issuers must have strong credit. The market is effectively closed to issuers without investment-grade ratings; defaults are rare but historically devastating (Lehman 2008).
• Not FDIC-insured; not government-backed. Credit risk lives entirely with the issuing corporation.

That 270-day cap is one of the most-tested numbers in the whole cash-equivalents topic. Whenever a Series 66 question asks why commercial paper is structured the way it is, the registration exemption is the answer it's fishing for.

Banker's acceptances

A banker's acceptance is a short-term debt instrument issued by a company but guaranteed (accepted) by a commercial bank. It's born in international trade: an importer wants to put off paying until the goods arrive, an exporter wants certainty of payment, and a bank bridges the gap by accepting — guaranteeing — the importer's promise to pay.

• Maximum maturity: typically 180 days (regulatory cap; market practice rarely goes that long).
• Sold at a discount; redeemed at face value — same mechanical structure as T-bills and commercial paper.
• Backed by two layers of credit — the issuing company's promise plus the accepting bank's guarantee. This typically makes BAs higher-quality than ordinary commercial paper from a similar-sized issuer.
• Used almost exclusively for international trade financing. Domestic transactions don't typically need the structure.

The Series 66 mostly tests recognition here, not mechanics — what a BA is and who stands behind it. Anchor on the two features that define it: the bank guarantee, and the international-trade context.

Money market instruments at a glance

Federal funds — the interbank overnight market

Federal funds are short-term loans between banks — institutions with surplus reserves lending overnight to institutions that are short. The federal funds rate is the interest on those loans, and here's the subtlety the exam wants: it isn't a number the Federal Reserve dictates. It's a market rate, set by supply and demand, that floats within a target range the Federal Open Market Committee (FOMC) lays down.

The exam's favorite distinction: the federal funds rate is bank-to-bank, set by the market; the discount rate is what the Federal Reserve itself charges banks for direct loans through the discount window. These two get mixed up constantly. The federal funds rate is the one financial news quotes as "the Fed rate"; the discount rate sits a notch above it as a backstop.

The Fed steers the federal funds rate mainly through open market operations — buying or selling Treasury securities to add or drain reserves from the banking system. More reserves push the rate down; fewer reserves push it up.

Repurchase agreements (repos)

A repurchase agreement is a short-term loan dressed up as a sale: the borrower sells a security to the lender and contractually agrees to repurchase that same security at a slightly higher price on a set future date. The price difference is, in effect, the interest on the loan — and the security itself is the collateral.

• Typical maturities: overnight to a few weeks. "Overnight repo" is the dominant variant.
• Typical collateral: U.S. Treasury and agency securities — high quality, easy to value, broadly accepted.
• From the lender's perspective it's called a reverse repo. From the borrower's it's a repo. Same transaction, opposite sides.

Why the Series 66 cares: repos are a front-line monetary-policy tool. To drain reserves and tighten policy, the Federal Reserve sells securities under a reverse repo, pulling cash out of the system temporarily; to add reserves and ease, it does the reverse. The repo market is also the early-warning system for funding stress — the 2008 crisis first showed up as strain in the repo market, well before broader equity markets caught on.

Eurodollars

Despite the name, Eurodollars have nothing to do with the euro. The term means U.S. dollar–denominated deposits held outside the United States — in foreign banks or in foreign branches of U.S. banks. The "Euro" prefix is a leftover from the 1950s, when the market lived in European banks; the geography spread out, but the name stuck.

• Not FDIC-insured. Deposits sit outside U.S. regulatory jurisdiction.
• Typically higher yields than equivalent U.S.-domiciled deposits — compensation for the absence of FDIC backing and added political/regulatory risk.
• Eurodollar CDs are time deposits denominated in U.S. dollars and issued by banks outside the United States. They're a major institutional money-market instrument; retail exposure is rare.
• Used heavily in international trade financing where parties on both sides want to transact in U.S. dollars but neither is U.S.-domiciled.

Again the Series 66 is mostly testing recognition: what Eurodollars are (U.S. dollars deposited offshore), what they're not (FDIC-insured, or anything to do with the euro currency), and that their yields tend to run a bit higher than equivalent domestic deposits to compensate for the offshore risk.

Money market fund mechanics — NAV and "breaking the buck"

A money market mutual fund pools investors' money into short-term, high-quality money market instruments. Its defining feature is operational: the fund's net asset value (NAV) is managed to hold at exactly $1.00 per share — you put in a dollar, you expect a dollar back, and the return reaches you as monthly dividends rather than a rising share price.

When the portfolio takes losses big enough that the fund can't hold that $1.00 NAV, it's said to be "breaking the buck." This is genuinely rare — only a handful of cases in the entire history of the U.S. money market fund industry, the famous one being the Reserve Primary Fund in September 2008, after its Lehman Brothers commercial paper went to zero. The shock fed into the broader 2008 crisis and triggered a round of SEC rule changes.

Those post-2014 reforms now require institutional prime money market funds to use a floating NAV instead of the stable $1.00 share price; retail and government funds may still hold the $1.00 NAV. For the exam, carry three things: "breaking the buck" means NAV slips below $1, it's rare but possible, and a money market fund is never government-guaranteed the way a bank deposit is.

Money market fund taxonomy

The SEC and Federal Reserve sort money market funds into three categories by what they're allowed to hold — and the Series 66 expects you to know the taxonomy: