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The Money Market: Liquid
The Money Market: Liquid
The Money Market: Liquid
The money market refers to the market for short-term, high quality debt
securities issued by government and corporate borrowers. Maturities can range
from overnight to up to a year.
The money market creates liquidity for these borrowers to fund their
short-term cash flow needs.
Common money market instruments include Treasury bills (T-bills),
certificates of deposit (CDs), commercial paper, bankers acceptances,
eurodollars and repurchase agreements (repos) among others.
The money market is best known as a place for large institutions and
governments to manage their short-term cash needs. However, individual
investors have access to the market through a variety of different securities. In
this tutorial, we'll cover various types of money market securities and how they
can work in your portfolio.
Money market securities are short-term IOUs issued by governments,
financial institutions and large corporations. These instruments are
very liquid and considered extremely safe. Defaults on money market
instruments have been extremely rare. Because of this relative safety, money
market securities offer significantly lower returns than most other securities.
There is no formal money market, rather it is an informal network of
banks, brokers, dealer and financial institutions that are linked electronically.
One of the most important functions of the money market is providing an
outlet for large companies with temporary excess cash to invest that cash in
short-term money market instruments.
Corporations with short-term cash needs can sell securities such as
commercial paper, or borrow funds on a short-term basis.
Larger corporations will generally participate directly via their dealer,
while smaller companies with excess cash might just park it in a money market
mutual fund, a professionally managed fund that invests in various money
market instruments. The best way for individual investors to access the money
market is also via a money market mutual fund, or a money market account with
a bank. These funds pool together the assets of thousands of investors in order to
buy the money market securities on their behalf. However, some money market
instruments, like Treasury bills, may be purchased directly from the Treasury.
Money market funds seek to maintain a stable $1 net asset value while paying a
yield. Although these funds have traditionally held their price at $1 per share,
some recent regulations allow certain funds to break the buck when needed.
Other than T-Bills, money market instruments are not riskless, but the risks are
low. There have been defaults over the years, but they are not common.
Money Market: Treasury Bills (T-Bills)
Treasury bills, or T-bills, are short-term debt instruments issued by the U.S
Treasury. T-bills are issued for a term of one year of less. T-bills are considered
the worlds safest debt as they are backed by the full faith and credit of the
United States government.
The T-bill rate is a key barometer of short-term interest rates. Treasury
bills are sold with maturities of four, thirteen, twenty-six and fifty-two weeks.
They do not pay interest, but rather are sold a discount to their face value. The
full-face value is paid at maturity, and the difference between the discounted
purchase price and the full-face value equates to the interest rate.