Lesson 3 of 25 · 7 min
Why cash and short-duration government paper sit at the top
Top-of-schedule assets are not the safest issuers; they are the ones whose price cannot travel far before a sale settles.
The top of a schedule looks like a ranking of credit quality. It is not. It is a ranking of how far a price can move during the days between a decision to sell and the cash arriving.
Cash wins that ranking trivially, because its price does not move at all. Short-duration government paper wins it for a different reason: its price responds to interest rates, and the size of that response is a measurable property called duration. Duration says, approximately, how many percent the price falls for each percentage point rise in yields.
price change = - duration × yield change
- price change
- The percentage move in the instrument's price, negative when yields rise.
- duration
- Sensitivity to interest rates, quoted in years. A larger number means a larger price move for the same yield move.
- yield change
- The move in market yields, in percentage points.
That single relationship orders the whole fixed-income part of the schedule. A fund with a duration of 1.9 years loses about 0.76 percent when yields jump 0.40 of a point. One with a duration of 17.2 years loses 6.88 percent on the same move. Both may hold identical credit quality; the second is simply carrying nine times the price risk over the lender's selling window.
Depth reinforces the ordering. Government paper trades in sizes that make a pledged retail position invisible, so the lender assumes no meaningful impact from selling it. That combination — a small, calculable price move and no market impact — is what a 90 or 95 percent row is actually describing. Cash is the limiting case of both properties at once, which is why it sits at 95 percent or above rather than at 100. The few points withheld there are not a price forecast; they cover accrued fees, settlement timing, and the possibility that the balance is not quite where the system believes it is.
Key terms
- Duration
- How much a bond or bond fund's price moves for a given move in yields, quoted in years. The main input to where fixed income sits on a schedule.
- Market impact
- The price movement caused by your own selling. Negligible in government paper, material in a thin stock, and priced into the haircut either way.
- Settlement window
- The gap between deciding to sell and holding the cash. Everything the lender withholds is a provision for what can happen inside it.
Worked example
Three bond funds, one yield move
Yields rise 0.40 of a percentage point overnight. Illustrative durations and schedule rows.
- Short fund, duration 1.9 years
- -0.76%
- Intermediate fund, duration 6.3 years
- -2.52%
- Long fund, duration 17.2 years
- -6.88%
- Illustrative advance rates assigned
- 92% / 85% / 70%
- Spread in the schedule across the three
- 22 points
1.9 × 0.40.
6.3 × 0.40.
17.2 × 0.40.
Produced by duration alone.
Same issuer, same credit, three rows of the schedule twenty-two points apart. Duration did all of it.
Check yourself
A bond fund has a duration of 4.7 years. Yields rise 0.65 of a percentage point during the week a lender is liquidating it. Roughly how much does the price fall, and how does that compare with a fund of duration 12.0?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.