The Money Market: Getting to Know It
The money market is a term you’ve probably heard before, but what exactly is it? It is a regulated marketplace where participants can lend and borrow significant quantities of money for a year or less. While the money market is a highly efficient venue for enterprises, governments, banks, and other major entities to transact cash, it also serves a vital purpose for people who want to invest small amounts while enjoying the best liquidity and security available.
We’ll take a look at some of the most common money market instruments and the advantages they provide to individual investors.
Important Points to Remember
- The money market is a regulated marketplace where people lend and borrow huge sums of money for a period of one year or less.
- Short-term money market securities appeal to investors because of their improved safety and liquidity.
- Money market mutual funds, local government investment pools, and bank trust departments’ short-term investment funds are all examples of short-term investment pools.
- Individuals have the most access to money market mutual funds.
- The US Treasury releases Treasury bills on a regular basis to refinance older T-bill issues that have reached maturity and to assist finance federal government deficits.
The Money Market’s Goals
Individuals invest in the money market for the same reasons that businesses and governments do: to lend or borrow money. Having money does not always equate to having a need for it. If you have a lump sum of money that you don’t need right away—say, to pay down debt—you may invest it temporarily until you need it for longer-term investments or a purchase.
The opportunity cost you suffer if you elect to keep these funds in cash is the interest you could have earned by investing them. If you decide to put your money in the money market, you can get this interest promptly and conveniently.
You will not earn interest if you keep your money in cash. However, if you invest your money in the money market, you may easily and rapidly ensure this interest.
Superior safety and liquidity are the main factors that attract investors to short-term money market securities. Money market instruments have maturities ranging from one day to one year, with the majority of them being three months or less. Because these assets are linked to large and active secondary markets, you can nearly always sell them before they mature, albeit at the cost of missing out on the money you would have earned if you had waited until maturity.
There is no single site for the secondary money market. Even though the money market is available via telephone or the internet from everywhere, the closest thing it has to a physical presence is an arbitrary identification with the city of New York. The majority of individual investors use their financial advisor, accountant, or banking institution to help them invest in the money market.
Money Market Instruments: What Are They and How Do They Work?
For the goal of short-term lending and borrowing, a significant number of financial instruments have been developed. Many of these money market instruments are very specialized, and they are normally traded primarily by banks and large financial organizations with extensive expertise of the money market.
Federal funds, the discount window, negotiable certificates of deposit (NCDs), eurodollar time deposits, repurchase agreements, government-sponsored enterprise securities, shares in money market instruments, futures contracts, futures options, and swaps are some examples of these specialized instruments.
Individual investors will be more familiar with investment vehicles such as short-term investment pools (STIPs) and money market mutual funds, Treasury bills, short-term municipal securities, commercial paper, and bankers’ acceptances, in addition to these specialized instruments on the money market. STIPs, money market mutual funds, and Treasury bills are all discussed in depth here.
Money Market Mutual Funds and Short-Term Investment Pools
Money market mutual funds, local government investment pools, and bank trust departments’ short-term investment funds are all examples of short-term investment pools (STIPs). All STIPs are marketed as shares in very large pools of money market instruments, which could include any or all of the above-mentioned money market products. In other words, much as an equity or fixed income mutual fund brings together a variety of equities, bonds, and other assets, STIPs offer a practical way of combining numerous money market products into one package.
Individual investors can access specialist money market products through STIPs, which do not require extensive understanding of the numerous instruments contained inside the pool. The enormous minimum investment amounts required to purchase most money market instruments, which typically equal or surpass $100,000, are also alleviated by STIPs.
Individuals have the most access to money market mutual funds among the three basic categories of STIPs. Brokerage firms and mutual fund companies sell shares in these funds to individual, corporate, and institutional investors. Bank trust departments manage short-term investment funds for their various trust accounts.
State governments establish local government investment pools on behalf of local governments, allowing investors to buy shares in local government investment funds.
Taxable and Non-Taxable Funds
Taxable and tax-exempt money market mutual funds are the two types of money market mutual funds. Taxable funds invest in securities like Treasury bills and commercial papers, which provide interest income that is subject to federal taxation after it is paid to the fund buyer. Tax-exempt funds invest in federally tax-exempt securities issued by state and municipal governments. These two types of money market mutual funds have diverse growth patterns, thus they appeal to various types of investors.
Treasury Bills (Treasury Bills)
Treasury bills, or T-bills, are short-term securities issued by the United States Treasury on a regular basis to refinance maturing T-bill issuance and to assist finance federal budget deficits.
T-bills have the most trading volume and liquidity due to their short maturities, with the Fed issuing $326 billion in notional value as of mid-2021.
2 In addition to selling T-Bills on a regular basis, the Treasury sells cash management bills on an ad hoc basis by restarting sales of bills that maturity on the same day as an outstanding issuance of bills.
When T-bills were first introduced, they were only available in three-month maturities. Following that, bills with six-month and one-year maturities were added. 3 Three-month and six-month bills are sold at regular weekly auctions, and one-year bills are sold at a bill auction every four weeks.
T-bills are sold to large investors and institutions through the commercial book-entry system, who subsequently distribute the bills to their own clientele, which may include private investors. Treasury Direct, a non-competitive holding system for small investors who aim to retain their assets until maturity, provides an option.
Individual bidders on Treasury Direct have their ownership directly documented in the Department of the Treasury’s book-entry accounts. T-bills purchased through the Treasury Direct system must be transferred to the commercial book-entry system if they are to be sold before maturity. The transfer can only be made through a depository institution with a Federal Reserve Bank account, and the person making the transfer is responsible for any transfer fees.
Investing in Money Market Accounts
It’s impossible to write about the money market without mentioning money market accounts. These are deposit accounts that are insured by the Federal Deposit Insurance Corporation (FDIC), similar to checking and traditional savings accounts, but they are not money market funds. They may grant the account holder some checking account-like features, such as the ability to issue checks and/or conduct debit card transactions. However, they operate in the same way as a savings account, with a minimum balance requirement and some limitations.
The number of debit transactions for this type of account is limited to six per month by federal laws. Anything exceeding that is normally subject to a charge. Interest is paid to account holders. The return is frequently higher than a regular savings account because many accounts have a minimum balance requirement.
Money market accounts are low-risk investments that are safe. They’re a fantastic place to put your money in general, particularly if you require rapid access to it while earning interest. Institutions pay higher interest rates because, as previously stated, they invest money market account funds in short-term securities with short-term maturities.
When an individual investor puts together a portfolio of financial instruments and securities, they usually set aside a portion of their capital for the safest and most liquid asset available: cash. This cash may be held in completely liquid funds in their investing account, just as it would be in a bank savings or checking account. Investors, on the other hand, would be far better suited putting their cash in the money market, which pays interest while maintaining the safety and liquidity of cash.
Investors can choose from a variety of money market vehicles, the most common of which are well-diversified money market mutual funds. Other money market investing options, such as purchasing T-bills through Treasury Direct, are available to individuals who are ready to go it alone.