What Purpose Do Money Market Instruments Serve?
Money markets are the securities that allow borrowers to connect with lenders to borrow money for very short periods of time. Money market instruments are the underlying securities that comprise money market investment accounts that are available through a bank, investment broker, or mutual fund company.
What makes the money markets attractive is that large sums of money are available for quick and efficient loans at a relatively low cost. These instruments are used to finance the short term needs of the borrower. In exchange for the use of the funds, interest is paid to the lender (you).
Money Market Participants
Each of the participants serves different roles in the money markets. Some being borrowers, others lenders, some serving in the role of borrower and lender, while others make guarantees and provide liquidity.
- Federal Reserve Bank
- Banks
- Securities dealers
- Corporations
- The U.S. Government
- State and Local Governments
- Government Sponsored Entities
- Money Market Funds
Money Market Instruments
There are several types of money market instruments serving different needs for each of the market participants. Listed below are some of the common types of securities found within a money market fund:
- Treasury Bills: U.S. Government guaranteed securities that will mature in one year or less. These securities are issued at a discount to their face value and upon maturity the investor is paid the face value of the Treasury bill.
- Certificate of Deposits: Commonly referred to as CD’s, they are time deposits that are issued by banks paying a fixed rate of interest.
- Commercial Paper: An unsecured promissory note that is issued by banks and corporations with maturities ranging from 1 to 270 days. It is issued at a discount and upon maturity will pay the investor the face amount of the note.
- Repurchase Agreements: A sale and purchase agreement in which the borrower sells a security to the lender for cash while at the same time agreeing to buy back the security from the lender at a greater price in the future. The difference between the sell price and the buy price is the interest rate.
- Discounted Notes: Issued by government sponsored entities or very credit worthy corporate borrowers, these notes are issued at a discount and will mature at the face value of the note. This security may be issued with maturities up to one year.
Why Are Money Market Accounts Attractive to Investors?
Money market accounts are attractive to investors for a number of reasons. Among them:
- Stable share value, not subject to market fluctuation
- Easy to value; usually measured in unit values equaling one dollar for each unit or share
- Good place to maintain liquidity while waiting for the next investment opportunity
- Competitive short term interest rate which adjusts and compounds daily
- Money not locked up with withdrawal penalties
Money market accounts offer many features that make investing more convenient too. Some of the financial arrangements available within money market accounts include:
- Electronic deposits and withdrawals linked to your checking account
- Wire transfers to and from your checking account
- Check writing privileges
- Links with your brokerage account to make it easy to invest
- Payroll deposit
When all is said and done it seems like money market instruments make sense for investors seeking liquidity and stability without having to lock up their money. The rates offered are better than what you would earn in a passbook savings account in the bank, or a shorter term CD for that matter. Consulting a financial manager in regards to how money market instruments can fit your investment strategy is the best way to find success.
