Money Market Funds (MMFs): What they are, How they work

Money market fund is a form of mutual fund which invests in liquid instruments. Such instruments consist of cash and cash equivalents, debt securities that have a short-term maturity, and securities. The fund allows investors high liquidity with a low-risk level. They are designed to offer investors a liquid and safe investment option that gives them a competitive return compared to traditional savings accounts or certificates of deposit.

A money market fund is different from a money market account. Money market fund investments are supported by investment fund companies and, therefore, have no guarantee for a principal amount. A money market account, on the other hand, is a form of a savings account that earns interest. These accounts are provided by financial institutions and insured under the Federal Deposit Insurance Corporation.

How money market funds work

Money market funds work like mutual funds. They involve investments in various debt-based financial instruments to earn income while providing liquidity and preserving capital. Investments in money market funds will involve any of the following instruments:

· Certificate of deposits (CDs) – These are time deposits issued by banks and thrift institutions with a short-term maturity and a predetermined interest rate.

· Commercial papers – These are short-term debts, which can be in the form of promissory notes, that corporations issue to raise short-term funds. The maturity period of commercial papers is usually less than 270 days and corporations usually issue them to cater for the daily operational costs.

· Bankers’ acceptances – These are short-term debt instruments that come from the acceptance of a bill of exchange or a draft. They are usually used in transactions involving international trade to facilitate payment and financing. Their maturity duration is usually less than 6 months and they are regarded as safe investments.

· Repurchase agreements – These are short-term agreements whereby one party sells securities to another party with an agreement to repurchase them later at a higher price.

· Treasury bills – They are short-term debt securities issued by the US Treasury Department with their maturity period ranging from a few days to one year.

Overall, money market funds give investors low-risk investment plans offering liquidity, competitive plans, and stability. They have become popular options for individuals and institutions who want to have cash reserves or have a conservative allocation in their investment portfolios. Presently, they are one of the pillars of the capital markets.

More insights on Money market funds in the next article.