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Amortized net asset value

What Is Amortized Net Asset Value?

Amortized Net Asset Value (Amortized NAV) is an accounting method predominantly used by certain types of Money Market Funds to maintain a stable share price, typically $1.00 per share. This valuation approach falls under the broader category of investment management, particularly relevant to fund accounting and regulation. Instead of valuing portfolio securities at their current market price (mark-to-market), amortized cost accounting values them at their acquisition cost, which is then adjusted for the accretion of any discount (finance) or amortization of any premium (finance) over the life of the security until maturity. This method aims to provide investors with a consistent Net Asset Value (NAV), making these funds appear very stable and akin to bank deposits.

History and Origin

The concept of amortized cost for valuing certain fund assets has roots in the early development of money market funds. These funds emerged in the 1970s as a response to Federal Reserve Regulation Q, which limited interest rates banks could pay on savings accounts. The Securities and Exchange Commission (SEC) first approved the use of amortized cost for money market funds in May 1977, provided that the securities held had remaining maturities of 60 days or less. This regulatory allowance helped money market funds offer a stable $1.00 share price, which was crucial for their widespread adoption as a cash management vehicle17.

This valuation method was formally codified and regulated under Rule 2a-7 of the Investment Company Act of 1940, which governs mutual funds. Rule 2a-7 specifies the conditions under which money market funds can use amortized cost, including strict limits on portfolio maturity, credit quality, and diversification16. Despite its long history, the reliance on amortized cost faced significant scrutiny following the 2008 financial crisis, particularly after the Reserve Primary Fund "broke the buck" (i.e., its NAV fell below $1.00) due to its holdings of Lehman Brothers commercial paper,15. This event triggered significant investor redemptions across the money market fund industry and led to substantial regulatory reforms by the SEC in 2010 and 201414,13.

Key Takeaways

  • Amortized Net Asset Value (Amortized NAV) is an accounting method used by certain money market funds to maintain a stable $1.00 share price.
  • It values securities at their acquisition cost, adjusted for amortization of premiums or accretion of discounts, rather than current market value.
  • This method is permitted under the SEC's Rule 2a-7, which imposes strict portfolio quality, maturity, and liquidity requirements.
  • While promoting stability, the amortized cost method can mask slight fluctuations in the market value of underlying assets.
  • Regulatory reforms after 2008 introduced stricter rules and, for some funds, a move to floating NAVs to mitigate systemic risk.

Formula and Calculation

The calculation of amortized cost for a single security involves adjusting its original purchase price by the portion of any premium or discount that has been earned or amortized over time.

For a security purchased at a discount:
Amortized Cost=Purchase Price+(DiscountDays to Maturity at Purchase×Days Held)\text{Amortized Cost} = \text{Purchase Price} + \left( \frac{\text{Discount}}{\text{Days to Maturity at Purchase}} \times \text{Days Held} \right)

For a security purchased at a premium:
Amortized Cost=Purchase Price−(PremiumDays to Maturity at Purchase×Days Held)\text{Amortized Cost} = \text{Purchase Price} - \left( \frac{\text{Premium}}{\text{Days to Maturity at Purchase}} \times \text{Days Held} \right)

The fund's overall Amortized NAV per share is then calculated as:
Amortized NAV per Share=Total Amortized Cost of Portfolio Assets+Accrued Interest−LiabilitiesNumber of Shares Outstanding\text{Amortized NAV per Share} = \frac{\text{Total Amortized Cost of Portfolio Assets} + \text{Accrued Interest} - \text{Liabilities}}{\text{Number of Shares Outstanding}}

The goal of funds using this method is to maintain the Amortized NAV per share at $1.00. Accrued Interest on the underlying debt securities is also factored into the amortized cost calculation, ensuring that the daily income is recognized.

Interpreting the Amortized NAV

The primary interpretation of a fund's Amortized NAV is its stability. When an investor sees a constant $1.00 price per share, it signifies that the fund aims to return the original principal (finance) invested plus any earned income, similar to a bank account. This provides a sense of capital preservation and easy cash management.

However, it is important to note that while the reported amortized NAV remains stable, the underlying market value of the securities held by the fund can fluctuate. Funds using amortized cost are typically required to "shadow price" their portfolios daily using market-based valuations to ensure that the difference between the amortized cost and the market-based NAV does not exceed a de minimis amount, typically one-half of one cent ($0.005)12. If this deviation becomes significant, the fund's board may be required to take action, which could include repricing shares to a floating NAV or imposing fees or gates. This ensures that the amortized NAV provides a reliable representation of the fund's underlying fair value for its short-term, high-quality investments.

Hypothetical Example

Consider a money market fund that purchases a $100,000 Government Security with a 90-day maturity for $99,800 (a $200 discount).

  • Purchase Price: $99,800
  • Face Value (Maturity Value): $100,000
  • Discount: $200
  • Days to Maturity at Purchase: 90 days

Using the amortized cost method, the fund would accrete the $200 discount into the asset's value evenly over the 90 days.

  • Daily Accretion: $200 / 90 days = $2.22 per day (approximately)

After 30 days, the amortized cost of this security would be:
Amortized Cost (after 30 days)=$99,800+($2.22×30)=$99,800+$66.60=$99,866.60\text{Amortized Cost (after 30 days)} = \$99,800 + (\$2.22 \times 30) = \$99,800 + \$66.60 = \$99,866.60
If the fund holds 100,000 shares outstanding and this is its only asset (ignoring liabilities for simplicity), its amortized NAV per share would be:
Amortized NAV per Share=$99,866.60100,000=$0.998666\text{Amortized NAV per Share} = \frac{\$99,866.60}{100,000} = \$0.998666
However, because money market funds using amortized cost aim to maintain a stable value of $1.00, this slight deviation would typically be managed internally to ensure the public NAV remains at $1.00, provided it stays within the permissible penny-rounding limits.

Practical Applications

Amortized Net Asset Value is primarily a foundational accounting practice for eligible money market funds. Its practical applications are centered on providing investors with a stable, liquid cash management tool.