12 May 2020

Pricing options on cash investments

Sean Jackson

Head of Business Cash Solutions

Fixed rates, prime rates, money market rates – what do they all mean, and how do they relate to your long and short term cash investments?

When it comes to cash investment products, there are a broad range of rates you may be offered as a return. From fixed rates and prime rates to money market rates, all of these are used to determine the return you will get on cash deposits, but they behave differently as market conditions change – which means you get a different outcome.

 

In this article, we break down the different types of pricing options available on cash investments, whether it’s a business call account, a notice product or a fixed deposit account. 

Prime rate

A prime lending rate is closely tied with the Reserve Bank’s repo rate.

The repo rate is the rate at which commercial banks can borrow funds from the South African Reserve Bank. A prime rate is a marked-up version of the repo rate that banks use as a base rate for calculating interest on both loans and cash deposits.

This means that when the repo rate is changed by the South African Reserve Bank (either up or down), the prime rate will mirror that change and adjust by the same amount. Note that the prime rate is not set at a fixed differential to the repo rate, so there may be extreme circumstances where prime is not adjusted.

 

 

In terms of the rate of return you’ll get on your cash investment, a prime rate will automatically be repriced by the increase or decrease in the repo rate. The fact that the prime rate reprices automatically and follows the repo rate means that there is always a degree of volatility. This is the biggest differentiator with a prime rate vs a fixed rate or money market rate. It is important to do some research and determine if the market is pricing in rate increases or rate decreases over the next 12 months.

5 ways the repo rate can affect you

A rise or fall in the repo rate can affect your debt repayments, savings and investment – the volatility can even affect your ability to buy a property. We demystify the complexity behind interest and lending rates.

Fixed rate

With a fixed interest rate, you’re offered a guaranteed rate of return for the specific investment term you choose.

Fixed deposit rates are typically priced by all banks from 7 days all the way out to 60 months. Should you require a different term that is not a standard term that bank publish rates daily, you can request a rate for that term.

As opposed to a prime lending rate, a fixed rate has no volatility attached to it, as it won’t change over your investment period.

This is an option investors will take if they need to budget accurately, or if they require a fixed return monthly that will not fluctuate.

As a general rule, the longer the term you chose to invest for, the higher the return should be. In other words, a one month fixed deposit will earn you less interest than a 12 month fixed deposit. It’s important to note that the difference between a one month fixed rate and a 12 month rate can vary. This is because all banks will take into consideration all market conditions and price those conditions into the 12 month rate, including any expected increases or decreases in the repo rate.

 

READ MORE: Don’t sacrifice high returns for accessibility

Money market rate

The third pricing metric you are likely to find with cash investment products is a money market rate. You can invest directly in a money market product or you can invest in a cash deposit that is priced from a money market product. A money fund is a short-term, low risk investment that purchases low-risk securities such as government bonds and commercial paper that reach maturity in under a year.

Most money market savings accounts require the investor to deposit their funds into a specific money fund, which will then earn the return of that particular money fund. At Investec, our money market products work slightly differently. Our money fund products are actually cash deposit products that derive their rate from a “set” or “basket” of money funds. Depending on which product you invest in, you could earn the average of the top 4 money market funds on any given day, or the average of the entire basket of around 20 money market funds.

 

Every single day, the averages are applied to our money fund linked products, which guarantees that you are always benefiting from the best returns across the money market funds.

 

It is important to understand that due to the purchasing of low-risk assets within money funds, money fund products do not reprice immediately like prime linked products, nor do they offer a guaranteed rate like a fixed rate. A money market product takes between 30 to 90 days to reprice any changes in the repo rate.

The rate you choose for a cash investment product will depend heavily your business’s unique cash flow requirements and how long you want to invest your money for. It is important to ensure you look at all options that ensure you maximise the return on any cash, taking into consideration the market conditions and your investment horizon.

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