What are cash equivalents?

Cash equivalents are short-term, highly liquid investments that are easily convertible to a known amount of cash and have an insignificant risk of changes in value. They are typically characterized by a maturity of three months or less at the time of acquisition.

In this context, Treasury bills (T-bills) and money market funds fit the definition of cash equivalents perfectly. T-bills are short-term government securities with maturities ranging from a few days to one year, while money market funds invest in short-term debt instruments. Both of these investments are easily liquidated, have low risk, and maintain value close to their face amount, making them suitable for cash equivalents.

On the other hand, long-term stock investments, real estate properties, and investment-grade bonds do not meet these criteria. Long-term stock investments are subject to market fluctuations and are not easily converted to cash. Real estate properties typically require significant time and transactional costs to sell, which makes them illiquid in comparison to cash equivalents. Investment-grade bonds, although relatively stable, usually have longer maturities that exceed the three-month threshold and may involve risks associated with interest rate changes. Therefore, T-bills and money market funds represent the nature of cash equivalents accurately.