Money Market and Money Market Funds

What is the money market? What are money market funds?

The money market is the market for short-term debt instruments. (Source: CFTC)

A money market fund is a type of mutual fund that is required by law to invest in low-risk securities. These funds have relatively low risks compared to other mutual funds and pay dividends that generally reflect short-term interest rates. Unlike a "money market deposit account" at a bank, money market funds are not federally insured.

Money market funds typically invest in government securities, certificates of deposits, commercial paper of companies, and other highly liquid and low-risk securities. They attempt to keep their net asset value (NAV) at a constant $1.00 per share—only the dividend yield goes up and down. But a money market’s per share NAV may fall below $1.00 if the investments perform poorly. While investor losses in money market funds have been rare, they are possible. (Source: SEC)

A money market is a financial market for short-term borrowing and lending, typically up to thirteen months. This contrasts with the capital market for longer-term funds. In the money markets, banks lend to and borrow from each other, short-term financial instruments such as certificates of deposit (CDs) or enter into agreements such as repurchase agreements (repos). It provides short to medium term liquidity in the global financial system. Money market derivatives include forward rate agreements (FRAs) and short-term interest rate futures.

Trading takes place between banks in the "money centers" (New York and London primarily, also Chicago, Frankfurt, Paris, Singapore, Hong Kong, Tokyo, Toronto, Sydney, Mumbai, San Francisco).

Money funds (or money market funds, money market mutual funds) are mutual funds that invest in short-term debt instruments. Money market mutual funds are restricted by quality, maturity and diversity guidelines. They must buy only the highest rated debt with maturies under 13 months and with a weighted average maturity of 90 days or less. They are only allowed to invest up to 5% in any one issuer, with the exception of the government. No individual investors may lose money in a money fund, which keep a stable $1.00 NAV (net asset value), but it is possible for these funds to "break the buck" and decline to $0.99 or less.

Institutional Money Funds

Institutional money funds are high minimum, low expense share classes which are marketed to corporations, governments, or fiduciaries. They are often set up so that money is swept to them overnight from a company's main operating accounts. Large national chains often have many accounts with banks all across the country, but electronically pull a majority of funds on deposit with them to a concentrated money market fund.

The largest institutional money fund is the JPMorgan Prime Money Market Fund, with almost $100 billion in assets as of Dec. 31, 2006. Among the largest companies offering institutional money funds are BlackRock, Federated, Columbia (Bank of America), Dreyfus, AIM and Evergreen (Wachovia).

Retail Money Funds

Retail money funds are offered primarily to individuals with moderate-sized accounts. Their primary use is as temporary holding funds at stock brokerage firms. Retail money market funds hold roughly 40% of all money market fund assets.

Retail money funds invest in short-term debt, such as US Treasury bills and commercial paper, come in a few different breeds: government-only funds, non-government funds and tax-free funds. You will get a slightly higher yield in the non-government variety, which will invest in high-quality commercial paper and other instruments. Money funds for individuals are currently yielding just under 5.0%. However, instruments of the United States Government are usually exempt from state income taxes.

The largest money market mutual fund is Fidelity Investments' Cash Reserves, with assets exceeding $88 billion. The largest retail money fund providers include: Fidelity, Vanguard, and Schwab. (Source: Wikipedia)