HomeMy WebLinkAbout2023-05-09; City Council; ; Annual Report of Investments for the Fiscal Year 2021-22CA Review CKM
Meeting Date: May 9, 2023
To: Mayor and City Council
From: Scott Chadwick, City Manager
Staff Contact: Craig Lindholm, City Treasurer
craig.lindholm@carlsbadca.gov, 442-339-2473
Subject: Annual Report of Investments for the Fiscal Year 2021-22
District: All
Recommended Action
Accept and file Annual Report of Investments for the Fiscal Year 2021-22.
Executive Summary
The City Treasurer is tasked with overseeing cash and investment activities for the city and its
agencies by managing the funds in excess of day-to-day operating needs focusing on the values
of safety, liquidity, and return on investment. The cash and investments managed by the City
Treasurer represent 38.9% of the total assets reported by the city. The annual report of
investments presents the market environment and trends relative to the reporting fiscal year,
analysis of the portfolio in a year-over-year comparison perspective and comments on the
global and domestic financial environment.
Explanation & Fiscal Analysis
City investments are pooled and invested to meet the Treasurer’s objectives of maintaining
safety of principal, maintaining liquidity to meet the operating requirements of the city and
realizing the best return on investment.
The foremost objective is the preservation of city capital. The Treasurer makes prudent
investment decisions that are projected to protect the capital of the city and its agencies, and
therefore of the citizens. All investments are made within the scope of the city’s investment
policy, and current investment details are provided monthly for full transparency and review.
The investment portfolio increased $17.9 million in book value from the previous fiscal year.
Book value represents the amount for which an investment is recorded by the city. Book value
is driven by interest earned, loan payments received and revenues in excess of expenses.
Second to safety is liquidity. The City Treasurer monitors and maintains the portfolio below the
maximum maturity limits and maximum modified duration limits of the investments. The
maximum maturity limit is calculated to be cash and maturities at a minimum of two-thirds of
the approved operating budget. During the fiscal year, the treasurer monitored and maintained
not less than $221.2 million maturing within one year, and the total of maturities occurring
within five years. Modified duration was 2.14 years as of the close of the fiscal year,
May 9, 2023 Item #1 Page 1 of 25
competently below the maximum allowed of 2.2 years. The City Treasurer has remained within
the limits of the modified duration restrictions throughout the year. Maintaining liquidity
ensures that operational needs will be met and avoids circumstances that could result in selling
at a loss.
Once safety and liquidity objectives have been met, the City Treasurer aims to realize a return
on investments. For the entire fiscal year, the portfolio averaged a return of 1.15%. The market
value of the investment portfolio increased $30.9 million in the last fiscal year. Gains in market
value result from judicious investment decisions focusing on current market rates and
anticipated future rates.
Next Steps
The City Treasurer’s monthly reports will be brought to the City Council for the remainder of
fiscal year 2022-23. The fiscal year 2022-23 annual investment report will be brought to the City
Council following the issuance of the city’s Annual Comprehensive Financial Report.
Environmental Evaluation
This action does not require environmental review because it does not constitute a project
within the meaning of the California Environmental Quality Act under California Public
Resources Code Section 21065 in that it has no potential to cause either a direct physical
change or a reasonably foreseeable indirect physical change in the environment.
Exhibits
1. Annual Report of Investments for the Fiscal Year 2021-22
May 9, 2023 Item #1 Page 2 of 25
1
Exhibit 1
May 9, 2023 Item #1 Page 3 of 25
2
CITY
TREASURER
ANNUAL
REPORT OF
INVESTMENTS
Fiscal year ended June 30, 2022
Prepared by
Craig Lindholm, City Treasurer
May 9, 2023
May 9, 2023 Item #1 Page 4 of 25
{ City of
Carlsbad
3
TABLE OF CONTENTS
Letter of Transmittal
Annual Report of Investment Portfolio
Fiscal Year 2021-22 Market Review
Portfolio Analysis
Fiscal Year 2021-22 Review
Appendices to Annual Report of Investment Portfolio
Appendix A: Risk Management
Appendix B: Disclosures
Appendix C: Portfolio Activities
May 9, 2023 Item #1 Page 5 of 25
4
CITY TREASURER LETTER OF TRANSMITTAL
Fiscal Year 2021-22 Annual Report of Investment Portfolio
May 9, 2023
Honorable Mayor, City Council and residents of the City of Carlsbad,
I am pleased to present the Annual Report of Investments for the City of Carlsbad for
the fiscal year 2021-22 which ended June 30, 2022. The report is intended to provide
reliable information as a basis for reviewing portfolio performance and making
management decisions. It also provides an archival reference.
The City Treasurer is charged with the design of an effective cash management and
investment program for the City of Carlsbad and all its agencies. Among other
activities, this includes arranging banking services; forecasting all cash receipts and
expenditures; investing inactive cash; managing investment risk exposures; and
reporting all investment activities.
This report summarizes and analyzes the activities of the investment portfolio over
fiscal year 2021-22. Total portfolio assets, investment portfolio relative to total city
assets, source of portfolio assets, asset allocations, yield achieved, unrealized gains
and losses, and cash revenues are presented. To provide perspective to this data a
summary of observations is provided about global and domestic markets for the
fiscal year ended June 30, 2022. Comparisons are also made with the preceding
fiscal years. Finally, a statement is offered regarding the prospects for the fiscal year
2022-23.
Sincerely,
Craig J. Lindholm,
City Treasurer
May 9, 2023 Item #1 Page 6 of 25
5
FISCAL YEAR 2021-22 MARKET REVIEW
Federal funds target rate
The federal funds target rate is a key money market rate that correlates with rates
of other short-term credit arrangements. It is the interest rate that banks charge
each other for overnight loans and influences many aspects of the U.S. economy.
This rate is set by the Federal Open Market Committee (FOMC), the policy making
body of the Federal Reserve System. The FOMC meet to discuss and set the federal
funds target rate eight times a year. Their goal is to help promote economic growth.
In fiscal year 2021-22, the FOMC began increasing rates to slow the rate of inflation.
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Federal funds target rate
May 9, 2023 Item #1 Page 7 of 25
6
Short-Term Interest Rates
The rates for U.S. Treasury bonds are important to all investors, but especially to
bond investors. These bonds are issued by the Department of the Treasury and are a
good look at how the U.S. government predicts inflation and the overall economy to
move. Changes in short-term market interest rates are usually affected by the
actions of the Federal Reserve.
Short-term interest rates in the three exhibited trends of five-year market, two-year
market, and six-month market had substanial increases during the fiscal year.
0.000.501.001.502.002.503.003.50
Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun
Five year 0.69 0.77 0.98 1.18 1.14 1.26 1.62 1.71 2.42 2.92 2.81 3.01
Two year 0.19 0.20 0.28 0.48 0.52 0.73 1.18 1.44 2.28 2.70 2.53 2.92
Six month 0.05 0.06 0.05 0.07 0.10 0.19 0.49 0.69 1.06 1.41 1.64 2.51
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Short-term investment rates
US Treasury instruments
fiscal year 2021-22
May 9, 2023 Item #1 Page 8 of 25
-
---
7
Market Yield Curve
The yield curve is a graphic presentation of the difference between short-term and
longer-term interest rates of U.S. Treasury instruments on a given day. Financial
analysts use it to assess the market’s expectation of recession or inflation. The
normal shape of the yield curve is mostly flat with a small upward slope, with short-
term rates lower than longer-term rates. A normal yield curve occurs when short-
term market rates are less than longer-term market rates. Normal yield curves point
toward economic expansion.
Rates have remained steady for shorter and longer term investments, with an
increase in two-year rates.
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Three month Two year Five year Ten year
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Market yield curve
6/30/2020 6/30/2021 6/30/2022
May 9, 2023 Item #1 Page 9 of 25
8
PORTFOLIO ANALYSIS
Portfolio Assets
Total assets in the investment portfolio, based on market value, stood at $852.2
million at the end of the fiscal year; an increase of 3.76% from the prior year. This
increase includes interest earned, loan payments received, and revenues in excess of
expenses.
These assets are invested by the City Treasurer with the objectives of maintaining
safety of principal, maintaining liquidity to meet the operating requirements of the
city, and realizing the best return on investment. Safety of principal is the foremost
objective of all investments made by the City Treasurer.
By pooling assets and investing a laddered portfolio the city is able to ensure funds
are available as required by obligations while earning the highest possible amount of
interest.
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22
As
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Investment portfolio
total market value of assets
May 9, 2023 Item #1 Page 10 of 25
9
Total City Assets
The city publishes an Annual Comprehensive Financial Report at the end of each
fiscal year as required by California state law and in conformity with Generally
Accepted Accounting Principles and requirements prescribed by the Governmental
Accounting Standards Board.
Among other information, the Annual Comprehensive Financial Report presents a
statement of net position showing the total assets owned by the city and all its
agencies. At the end of fiscal year 2021-22, cash and investments managed by the
City Treasurer represented 38.9% of all assets reported by the city and its agencies.
622 649 686 699 703 729 777 806 821 808
1,192 1,178 1,182 1,210 1,222 1,225 1,213 1,219 1,238 1,267
$1,814 $1,827 $1,868 $1,909 $1,925 $1,954 $1,990 $2,025 $2,059 $2,074
0
500
1,000
1,500
2,000
2,500
2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22As
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Cash & investments relative to total assets
Fair market value
Cash & investments Other assets
May 9, 2023 Item #1 Page 11 of 25
■ ■
10
Sources of Assets
The portfolio is an internal investment pool that invests the available cash from
various funds of all city agencies, city owned and fiduciary assets. The top three
sources of portfolio assets calculated at book value are: capital project funds at
45.8%; enterprise funds at 23.4%; and the general fund at 19.4%. Together, these
three fund types account for 88.7% of total portfolio assets.
The capital project fund includes funds for the general capital construction, traffic
impact fees, public facilities fees, park development, TransNet taxes, drainage fees,
special districts, infrastructure replacement and gas tax funds. Enterprise funds
consist of the Carlsbad Municipal Water District, wastewater, solid waste, storm
water and golf course funds.
General
$166 Capital Projects
$391
Enterprise
$200
Fiduciary & Internal
$61
Special & Other
$35
Fiscal year 2021-22
General
$146 Capital Projects
$381
Enterprise
$187
Agency & Internal
$66
Special & Other
$33
Fiscal year 2020-21
Source of pooled assets by fund type, in millions, at book value
May 9, 2023 Item #1 Page 12 of 25
11
Allocation of Assets
Investments are made in financial instruments as authorized by the City of Carlsbad
Investment Policy and the California Government Code. With the exception of bank
deposits and deposits in the California state Local Agency Investment Fund (LAIF), all
investments are in fixed-income instruments with known maturity dates.
Federal
Agency
$346 Corporate
$205
PMIA & Cash
$105
US Treasury
$82
CD
$22
Agency
backed
securities
$26
Municipal
$56
Fiscal year 2021-22
Federal Agency$308
Corporate
$197
PMIA & Cash$151
US Treasury
$71
CD
$21
Agency
backed
securities
$16
Municipal
$26
Fiscal year 2020-21
Asset allocation, in millions, at book value
May 9, 2023 Item #1 Page 13 of 25
12
Federal agency breakdown by percentage of total portfolio
Federal Farm Credit Bank 9.99%
Federal Home Loan Bank 13.91%
Federal Home Loan Mortgage Corporation 5.46%
Supranational 3.41%
Federal National Mortgage Association 5.46%
Federal Agricultural Mortgage Corporation 2.56%
Tennessee Valley Authority 0.13%
Private Export Funding Corporation 0.31%
On June 30, 2022, 37.8% of portfolio assets were invested in federal agency bonds,
24.4% in corporate notes, 9.7% in U.S. Treasuries, 3.4% in supranational bonds, 6.6%
in municipal bonds, 2.6% in certificates of deposit, 3.0% in mortgage-backed
securities, and 12.5% in cash and cash equivelents.
May 9, 2023 Item #1 Page 14 of 25
13
Yield
The average return of the portfolio increased from 1.17% during the prior fiscal year
to 1.28% during the current fiscal year. The portfolio yield is heavily influenced by
changes in short-term market interest rates. The average interest rate for six-month
U.S. Treasury Bills increased in the last quarter of the fiscal year to 2.51% from
0.06% in the previous fiscal year. This graph shows the change in percentage of the
portfolio over the last several fiscal years.
Investments gain and lose market value subsequent to purchase because of changes
in market interest rates. When market interest rates decrease, investments made
previously at higher rates will gain value. The reverse is true when market interest
rates increase. These changes in value are referred to as unrealized gains and
unrealized losses (commonly referred to as paper gains and paper losses). The gain
or loss is not recognized until the investment is sold. Changes in value due to
changes in market interest rates are normal and are to be expected.
With a buy and hold policy, an objective of the city’s investment policy is to achieve
an average market rate of return over the economic cycle. The success in achieving
this objective can be approximated with having unrealized gains and losses that are
relatively equal over time. Tracking and measuring unrealized gains and losses could
also reveal any presence of high-risk investments in the portfolio.
2012-
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2013-
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2014-
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2015-
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2016-
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2018-
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2019-
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2020-
21
2021-
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Portfolio 1.14 1.05 1.09 1.16 1.25 1.57 1.96 1.69 1.17 1.28
Treasury Bills 0.11 0.06 0.07 0.34 0.71 1.61 2.38 0.18 0.06 2.51
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Portfolio yields
Compared to six month treasury yields
May 9, 2023 Item #1 Page 15 of 25
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Historical unrealized gains & losses
May 9, 2023 Item #1 Page 16 of 25
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Annuity Stream
Interest income from portfolio investments represents an annual stream of
revenues. This annual stream totaled $12 million, a decrease of $2 million from the
previous fiscal year. The rest of the interest revenue is allocated to other city funds
based on their value. Cash income is a function of assets in the portfolio, the market
interest rates at the time of the investments, and interest payment schedules of the
portfolio holdings.
$12.40
$9.57 $8.10 $7.90 $8.70 $9.30
$11.25
$14.84
$17.03
$14.03
$12.05
$0
$2
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$18
2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22In
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Annuity stream from treasury
cash interest revenue
May 9, 2023 Item #1 Page 17 of 25
16
FISCAL YEAR 2021-22 REVIEW
Now let’s take a look at some of the global events impacting interest rates and
returns available to investors and the City of Carlsbad. Inflation has been unleashed
and the impact on payrolls and supply chains has been significant. With China’s
manufacturing (assembling) such a large percentage of finished goods for the world,
the country’s Zero COVID-19 policy hurt its ability to keep assembly lines operating.
Numerous factory closures and internal protests in China erupted in November of
2022. This resulted in the relaxation of the Zero COVID-19 policy along with a
decision to eliminate the continued lockdowns. China is slowly reopening its
factories.
What has not turned around in China is the real estate market. The CChinese
Communist Party directed massive amounts into real estate development and the
result is an oversupply, inflated apartments and homes that represent a significant
misallocation of land and raw materials.
Meanwhile, back in the United States, Jay Powell, chairman of the U.S. Federal
Reserve Board of Governors initiated a series of rate increases through 2022 that
imply a terminal rate of 5.00-5.25%. The projected date for this to be reached is Q3
of 2023.
Interest rate objectives that Powell shared with the markets are beginning to have
an effect on reducing inflation. He has confirmed in a number of recent speeches
that his No. 1 priority is containing inflation with a target rate of 2.0%. His second
priority is to maximize employment.
Globally and within the USA, liquidity concerns are building. Historically an inverted
yield curve has accurately predicted an economic slowdown – recall the 2008 global
financial crisis. This describes a situation where longer dated maturities have a lower
yield to maturity and shorter term maturities have a higher coupon. Currently
Treasury notes with maturities of 2 years are yielding 4.22%. Attractive indeed but
the question still to be asked is, where to invest proceeds at maturity? The City of
Carlsbad has numerous approved fixed income investments to safely invest our
resources.
May 9, 2023 Item #1 Page 18 of 25
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May 9, 2023 Item #1 Page 19 of 25
18
CITY TREASURER
ANNUAL REPORT
OF INVESTEMENTS
APPENDICES
May 9, 2023 Item #1 Page 20 of 25
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APPENDIX A: RISK MANAGEMENT
Risk Management
All investments are exposed to risk of some type. The objective of risk management
is to identify the risks involved and establish acceptable levels of risks that are
consistent with the city’s investment objectives. Risk management includes
managing, measuring, monitoring and reporting the various risks to which portfolio
investments are exposed.
Portfolio investments are exposed to the following types of risks:
• Credit risk
- Custodial credit risk
• Investments
• Deposits
- Default credit risk
- Concentration credit risk
• Interest rate risk
• Event risk
As of June 30, 2022, the portfolio had the following investments and cash in its
internal investment pool.
Investment Maturities Market Value Gain (Loss)*
U.S. agencies Jul 2022 - Mar 2028 $ 390,043,546 $ (20,311,533)
Supranational Oct 2022 - May 2026 27,133,111 (1,168,121)
Agency-backed MBS Nov 2022 - Nov 2027 27,719,558 (1,736,602)
Municipal bonds Mar 2023 - Aug 2027 58,336,841 (3,577,118)
Corporate notes Jul 2022 - Jan 2028 194,443,619 (7,784,377)
Certificates of deposit Jul 2022 - Mar 2028 20,470,981 (105,244)
CAMP 1,008,071 -
LAIF 77,534,573 -
Cash accounts 22,754,725 -
$ 819,445,026 (34,682,995)
*Market value less amortized cost.
May 9, 2023 Item #1 Page 21 of 25
20
APPENDIX B: DISCLOSURES
Custodial Credit Risk (Investments)
The city uses a third-party custody and safekeeping service for its investment
securities. Principal Custody Solutions is under contract to provide these custodial
services. Custodial credit risk is the risk that the city will not be able to recover the
value of its investments in the event of a Principal Custody Solutions failure. All city
investments held in custody and safekeeping by Principal Custody Solutions are held
in the name of the city and are segregated from securities owned by the firm. This is
the lowest level of custodial credit risk exposure.
Custodial Credit Risk (Deposits)
The city maintains cash accounts at Wells Fargo Bank. At the conclusion of each
business day, balances in these accounts are “swept” into overnight investments.
These overnight investments are pooled and collateralized with either U.S.
government securities or U.S. agency securities. The California Code authorizes this
type of investment. A small amount of cash is not swept from the Wells Fargo Bank
checking accounts to cover checks that may be presented for payment. Amounts up
to $250,000 are FDIC insured.
Default Credit Risk
Default credit risk is the risk that the issuer of the security does not pay either the
interest or the principal when due. The debts of most U.S. agencies are not backed
by the full faith and credit of the federal government; however, because the
agencies are U.S. Government-sponsored, they carry double A (AA) credit ratings.
The default credit risk of these investments is minimal.
Unless otherwise exempted, the California Government Code limits investments, at
the time of purchase, to the top three credit ratings: AAA, AA and A. It is the city’s
policy, however, to limit investments, at the time of purchase, to the top two credit
ratings (AAA and AA). As of June 30, 2022, five investments in corporate notes had a
credit rating below the AA limit. These investments were made when the credit
ratings were either AAA or AA and a subsequent change in rating has occured. The
California Government Code and the city’s investment policy allow the City
Treasurer to determine the course of action to correct exceptions to the policy. It is
the intent of the City Treasurer to hold these investments in the portfolio until
maturity unless events indicate a sale should be made.
May 9, 2023 Item #1 Page 22 of 25
21
The default credit risk for corporate notes with a credit rating of single A (A) is
considered by the City Treasurer to be within acceptable limits for purposes of
holding to maturity and is within the California Government Code limitations.
LAIF is an investment pool managed by the California state treasurer. Its investments
are short-term and follow the investment requirements of the state. As of June 30,
2022, the average maturity of the LAIF investments was 311 days. The state
treasurer is not required to contract for a credit rating to be assessed for LAIF.
California Government Code Section 16429.3 excludes LAIF deposits from being
transferred, loaned, impounded or seized by any state agency or official.
Concentration Credit Risk
Concentration credit risk is the heightened risk of potential loss when investments
are concentrated in one issuer. The California Government Code does not identify a
specific percentage that indicates when concentration risk is present for any one
issuer.
California Government Code Section 53601(k) requires that total investments in
medium-term corporate notes of all issuers not exceed 30% of the portfolio. As of
June 30, 2022, approximately 27.86% of the city’s total portfolio investments were in
medium-term corporate notes.
California Government Code Section 53601(o) requires that mortgage passthrough
securities shall not exceed 20% of of the portfolio. As of June 30, 2022,
approximately 3.47% of the city’s total portfolio investments were in mortgage
passthrough securities.
For concentration of investments in any one issuer, the city’s investment policy
requires that no more than 5% of investments in corporate notes, mortgage
passthrough securities and municipal bonds be in any one issuer. There is no similar
requirement in either the California Government Code or the city’s investment
policy for U.S. agencies. As of June 30, 2022, no investments in any one of the
aforementioned securities has an issuer that exceeded 5% of total portfolio
investments.
Interest Rate Risk
Interest rate risk is the risk that investments will lose market value because of
increases in market interest rates. A rise in market interest rates will cause the
May 9, 2023 Item #1 Page 23 of 25
22
market value of investments made earlier at lower interest rates to lose value. The
reverse will cause a gain in market value. As of June 30, 2022, the portfolio had a
4.173% unrealized loss in market value based on amortized cost.
The city’s investment policy has adopted two means of limiting its exposure to
market value losses caused by rising market interest rates: (1) limiting total portfolio
investments to a maximum modified duration of 2.2, and (2) requiring maturing
investments within one year to be equal to an amount that is not less than two
thirds of the current year operating budget of $316,997,231. As of June 30, 2022,
the modified duration of the portfolio was 2.03, within the required maximum of
2.2. Investments maturing within one year were $220,585,000, exceeding the
required minimum of $211,331,487. The city’s exposure to interest rate risk is within
acceptable limits.
Event Risk
Event risks include the chance that something unexpected will impede the ability of
an issuer of a security to meet its obligations. These types of risks are usually short in
duration, but can impair the city’s ability to communicate with or use banking
services. Such an event could cause a delay in collecting securities which have
matured. Security risks are also within this category.
May 9, 2023 Item #1 Page 24 of 25
23
APPENDIX C: PORTFOLIO ACTIVITIES - FISCAL YEAR
2021-22
The city’s portfolio balance increased 3.76% from $821.3 million to $852.2 million
based on book value in fiscal year 2021-22. The increase of $30.9 million does little to
show the volume of cash that flows in and out of the portfolio during one fiscal year.
The following table illustrates that the City Treasurer managed over $537 million of
cash inflows and cash outflows which prompted investment decisions during fiscal
year.
Cash Inflows and Outflows
Bond calls $ 43,250,000
Bond maturities 102,350,000
Bond purchases 233,310,000
Interest income 14,020,000
LAIF investments 41,000,000
LAIF withdrawals 104,000,000
$ 537,930,000
May 9, 2023 Item #1 Page 25 of 25