How can I determine the safety of a bank, savings-and-loan, mutual fund, or commercial paper? -- H. B.
Safety is a judgmental decision that someone makes after examining numerous facts. There is no such thing as absolute safety. However, you can judge the relative safety of a bank by examining its balance sheet. Look at its loan-to-capital ratio and examine how much of its reserves are in US Treasury certificates and cash and the method it uses for evaluating any bonds it holds. If bonds are valued at cost, for example, their value may be overstated, as high interest rates have discounted the value of bonds -- even US Treasury issues.
Similar values affect the safety of savings-and-loan associations. Here, the relative cost of money to average yield from investments is important. you should also look at recent income statements, as many S&Ls have been losing money because their costs of funds have been higher than yields from old mortgages. Capital remaining relative to stated losses, if any, can give you a clue as to an S&L's safety.
Evaluate the safety of a mutual fund by examining its income statement for past quarters and years. Also, examine the detailed statement of its portfolio listed in a recent prospectus or annual report. Note the difference between cost and current value and how much of the portfolio is in cash or cash equivalents.
Commercial paper will usually carry a rating, such as prime or some lesser rating. Since commercial paper is the noncollateralized debt of a specific company, evaluate the credit worthiness of the company issuing the paper. A rating of the company's bonds outstanding is one good clue.