A bank uses securities to earn income, diversify credit exposures and supply cash when deposits leave or loans are drawn. Those purposes can conflict. A bond with an attractive yield may be difficult to sell during the same stress that creates a funding need. Securities selection therefore starts with expected cash needs, risk limits and the ability to absorb losses.
Money-market instruments normally mature within one year. Treasury bills offer low credit risk and deep secondary markets. Negotiable certificates of deposit and commercial paper can offer higher yields but introduce issuer risk and less reliable secondary-market liquidity. Federal funds sold are unsecured interbank loans. A reverse repurchase agreement supplies cash against collateral, adding collateral valuation and counterparty considerations. Short maturity reduces price sensitivity; it does not guarantee saleability before maturity.
Capital-market instruments include Treasury notes and bonds, municipal and corporate bonds, and mortgage-backed securities (MBS). Longer fixed-rate bonds usually have greater duration. Corporate bonds add default and spread risk. Municipal securities may offer tax advantages under the applicable tax treatment.
Common mistakes
- Equating short maturity with guaranteed liquidity. Commercial paper can be hard to sell before maturity even when only a few weeks remain.
- Automatically tainting the HTM book. The reason for a sale and permitted exceptions matter. Borrowing against eligible HTM collateral is different from selling it.
- Reversing reinvestment risk. Short maturities return principal sooner, increasing exposure to reinvesting at lower rates.
Bottom line
- Securities selection balances return, credit, liquidity, duration, optionality and accounting constraints.
- HTM sales require a facts-based assessment; eligible holdings may still support borrowing.
- Short maturities increase reinvestment exposure; ladders spread timing risk.
- Net liquidity is supply less demand; opening cash converts the flow forecast into a balance.
Exam shortcut
Mark each amount as a stock, period flow or required reserve before adding it. For intraday questions, calculate the cumulative balance after each timestamp. Check the lowest balance before using the closing balance to judge adequacy.
The full lesson (about 3,120 words, 21 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
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