Paychex 2016 Annual Report Download - page 47

Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Factors
Changes in interest rates and interest rate risk: Funds held for clients are primarily comprised of short-
term funds and available-for-sale securities. Corporate investments are primarily comprised of available-for-sale
securities. As a result of our investing activities, we are exposed to changes in interest rates that may materially
affect our results of operations and financial position. Changes in interest rates will impact the earnings potential
of future investments and will cause fluctuations in the fair value of our longer-term available-for-sale securities.
We follow an investment strategy of protecting principal and optimizing liquidity. A substantial portion of our
portfolios is invested in high credit quality securities with AAA and AA ratings and A-1/P-1 ratings on short-
term securities. We invest predominately in municipal bonds including general obligation bonds, pre-refunded
bonds that are secured by a U.S. government escrow, and essential services revenue bonds, along with U.S.
government agency securities and corporate bonds. We limit the amounts that can be invested in any single issuer
and invest primarily in short- to intermediate-term instruments whose fair value is less sensitive to interest rate
changes. We manage the available-for-sale securities to a benchmark duration of two and one-half to three and
three-quarters years.
During fiscal 2016, our primary short-term investment vehicles were bank demand deposit accounts,
VRDNs, high-quality commercial paper, and government agency discount notes. We have no exposure to high-
risk or illiquid investments. We have insignificant exposure to European investments. We have not and do not
utilize derivative financial instruments to manage our interest rate risk.
During fiscal 2016, the average interest rate earned on our combined funds held for clients and corporate
investment portfolios was 1.1%, compared to 1.0% for fiscal years 2015 and 2014. When interest rates are rising,
the full impact of higher interest rates will not immediately be reflected in net income due to the interaction of
short- and long-term interest rate changes. During a rising interest rate environment, earnings increase from our
short-term investments, and over time increase earnings from our longer-term available-for-sale securities.
Earnings from the available-for-sale securities, which as of May 31, 2016 had an average duration of 3.1 years,
would not reflect increases in interest rates until the investments are sold or mature and the proceeds are
reinvested at higher rates.
The amortized cost and fair value of available-for-sale securities that had stated maturities as of May 31,
2016 are shown below by contractual maturity. Expected maturities can differ from contractual maturities
because borrowers may have the right to prepay obligations without prepayment penalties.
May 31, 2016
In millions
Amortized
cost
Fair
value
Maturity date:
Due in one year or less ........................................... $ 359.6 $ 360.7
Due after one year through three years ............................... 742.7 749.4
Due after three years through five years .............................. 918.5 935.7
Due after five years .............................................. 2,073.5 2,096.1
Total ......................................................... $4,094.3 $4,141.9
VRDNs are primarily categorized as due after five years in the table above as the contractual maturities on
these securities are typically 20 to 30 years. Although these securities are issued as long-term securities, they are
priced and traded as short-term instruments because of the liquidity provided through the tender feature.
The Federal Funds rate was raised by 25 basis points in December 2015 and has been in the range of 0.25%
to 0.50% since then. Previously the Federal Funds rate had remained at a range of zero to 0.25% since December
2008.
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