So what is the money market? By Darrell Eaden
Darrell Mark Eaden Discusses the Money Market: The financial market is a rich landscape, with an array of investment opportunities to choose from. Some, like stocks and shares, are relatively well known by the general public, with websites offering people with little financial knowledge to invest in minutes.
Other markets — like the money market — are a little more complex, and not so well-known or understood by those who don’t work in business or finance.
So what is the money market? And who is it for? Here’s what you need to know.
The money market is a term that refers to short-term debt investments, like overnight reserves, of typically a year or less. It’s characterised by a high degree of safety, and low rates of return.
It involves the trade of large sums of money between banks and the government. Most transactions that happen are wholesale (large volume sales) between institutions such as banks; companies in the eurocurrency and time deposit markets; businesses that raise funds through commercial paper; and investors who purchase bank CDs as a safe place to park money in the short term.
Some of these transactions make their way into the consumer market in the form of mutual funds and other investments: A person can invest by buying mutual funds, treasury bills, certificates of deposit, commercial papers, or opening a money market account.
Another benefit to money markets is that they’re easier to withdraw from. They also offer mortgage lenders protection against fallout risk, because they can enter an agreement with an agency — or create a route for an operational delivery of a mortgage, as opposed to a mandatory one. In this scenario, the mortgage provider buys an option that gives the lender the right to deliver the mortgage.
While generally being considered a safe place to invest, it’s not without its risks. It’s an unregulated market and doesn’t have the same structures in place as capital markets do, where things are more formal and organised. While safer, and with a wide variety of products to choose from, returns are far lower.
“Money market funds seek stability and security with the goal of never losing money and keeping net asset value (NAV) at $1. This one-buck NAV baseline gives rise to the phrase “break the buck,” meaning that if the value falls below the $1 NAV level, some of the original investment is gone and investors will lose money. However, this scenario only happens very rarely, but because many money market funds are not FDIC-insured, meaning that money market funds can nevertheless lose money.” (source: Investopedia)
Who Uses the Money Market?
Governments, financial institutions and companies all use the money market. It can also be used by individuals (usually with the help of a financial advisor), who invest the money by purchasing money market funds. short-term certificates of deposit (CDs), municipal notes, or treasury bills.
Types of Investments
The money market funds typically have shares that are always priced at $1. Money market instruments vary. The three most popular types include the following:
This market is for purchasing and selling unsecured loads for corporations that need a short-term cash boost. Only companies with good credit participate, so risk is low.
A banker’s acceptance is a short-term loan that’s guaranteed by a bank. It’s used for foreign trade, and acts as a guarantee against an importer paying for goods.
These are dollar-denominated deposits that are held in foreign banks. Large deposits are held in tax-free locations, including the Cayman Islands.
A repo agreement is part of the overnight lending market.
Money Markets vs. Capital Markets: what’s the difference?
The money market deals with debts that last a year or less. It’s mostly used by financial institutions, governments, and corporations as a way to keep cash flow steady and make a small, low-risk profit.
The capital market, on the other hand, is focused on the sale and purchase of long-term debt and enquiry. It refers to all stock and bonds markets — and while anyone can buy and sell a stock, companies that issue them do so to raise money for growth and long-term operations. The stock’s value might rise and fall (unlike money market investments), it doesn’t come with an expiration date. The only way a stock expires is if the company itself ceases trading.
Why is the money market important?
It plays an important role in the financial economy. It makes it easy for savers to lend money to people, companies, or governments that need short-term loans to meet near-term needs. It also allows those with spare cash to invest and earn a little interest in a safe market.
Is it possible to lose money on the money market?
Money market funds are generally considered among the safest out there. Most are insured by the FDIC up to $250,000 per company or institution. Ultimately, there’s low to no risk that you’ll lose money. When there’s a period of financial stress, some money market funds have been known to make losses — but this was quickly fixed. So in short: no. Money loss is nearly impossible.
What are the disadvantages of money markets?
Because they’re almost risk-free, money market investments have very low interest rates — usually little more than the risk-free rate of return. They’re not the best option for financial gains or capital growth compared to, say, certain stocks and bonds — but they do offer a safe place to store money for the short-term.
Want to find out more about the money market? Darrell Mark Eaden is a financial advisor who can talk you through the different options and help you grow your wealth. Get in touch today to find out about our different services.
Originally published at https://darrellmarkeaden.co.uk on September 11, 2021.
