Types of Money Market Instruments and Accounts Explained

Money market instruments and accounts are a type of low-risk investment used by individuals and institutions to earn returns on their excess funds.

High-yield savings accounts are a popular type of money market account that typically earns a higher interest rate than a traditional savings account.

Certificates of Deposit (CDs) are a type of money market instrument that offers a fixed interest rate for a specified period of time, usually ranging from a few months to several years.

Commercial paper is a short-term debt security issued by large corporations to raise funds for their operations, often used as a money market instrument.

Treasury bills are a type of short-term government debt security that is issued by a country's central bank to finance its government's spending, offering a low-risk investment option.

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Money market instruments are designed to provide liquidity and low-risk investments. They are typically short-term in nature, which is why you often see them used as a way to park cash temporarily.

T-bills, or short-term Treasuries, are a type of money market instrument. They're issued by the government to raise funds for a short period.

Certificates of deposit, or CDs, are another type of money market instrument. They're time deposits offered by banks with a fixed interest rate and maturity date.

Commercial paper is a money market instrument used by companies to raise funds for short-term needs. It's essentially a short-term loan from investors.

Money market mutual funds invest in these instruments, including T-bills, CDs, and commercial paper. They typically have shares priced at $1, making them a convenient and affordable option for investors.

Repurchase agreements, or repos, are a type of money market instrument used by banks and other financial institutions. They involve selling securities with the agreement to buy them back at a later date.

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Money market accounts are a type of savings account that pay slightly higher interest rates than regular savings accounts, but often come with restrictions on withdrawing money or writing checks.

Banks typically calculate interest on a money market account daily and make a monthly credit to the account. The best-paying money market account advertised online as of July 2024 was offered by Brilliant Bank at 5.35% with a $1,000 minimum deposit.

Funds in money market accounts are insured by the Federal Deposit Insurance Corporation (FDIC) when they're held at banks and the National Credit Union Administration (NCUA) when they're held in credit unions.

Certificates of Deposit are a type of investment that can be a good option for those looking for a safe and relatively high-yielding alternative to traditional savings accounts.

Most CDs aren't strictly money market funds because they're sold with terms of up to 10 years. They do have shorter terms available, ranging from three months to six months.

Larger deposits and longer terms can yield better interest rates, similar to money market accounts. Rates in early July 2024 ranged from about 5.35% to 6.00%.

The rates offered on a CD remain constant for the deposit period, which is a key benefit. There's usually a penalty associated with an early withdrawal of funds from a CD.

U.S. Treasury Bills are a type of savings account that offers a low-risk option for investing existing funds.

They are issued by the U.S. Treasury regularly to refinance Treasury bills reaching maturity and to finance the federal government’s deficits.

Individual investors can buy U.S. Treasury Bills directly from the government through the TreasuryDirect website or a bank or a broker.

They come with a maturity of one, three, six, or twelve months.

The interest rate on Treasury Bills is represented by the difference between the discounted purchase price and face value.

You can earn interest on your savings with a low-risk option like U.S. Treasury Bills.

Money market funds invest in low-risk and high-credit quality securities, ensuring high security.

They offer a low interest rate, credit, and liquidity risk due to their short-term nature.

This makes them a great option for those who want to maximize their savings potential.

You can buy U.S. Treasury Bills directly from the government or through a bank or broker.

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State, county, and municipal governments also issue short-term notes that can be a good option for savings.

Repos, or repurchase agreements, are another type of savings account that offers a low-risk option.

They involve selling Treasury bills or other government securities with an agreement to repurchase them at a set price on a set date.

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Commercial banks can invest their excess reserves in the money market to earn interest while maintaining liquidity. This is a ready market for them to do so.

The money market provides a short-term investment option for commercial banks, such as bills of exchange, which can easily be converted to cash to support customer withdrawals. This is a convenient way for them to manage their liquidity.

Commercial banks can also borrow from the money market on a short-term basis as an alternative to borrowing from the central bank. The money market may charge lower interest rates on short-term loans than the central bank typically does.

This flexibility helps commercial banks to manage their liquidity and avoid relying on the central bank for short-term loans. By doing so, they can maintain their independence and self-sufficiency.

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A banker's acceptance is a type of short-term loan that's guaranteed by a bank, often used in foreign trade.

It's essentially a post-dated check that guarantees an importer can pay for goods they've ordered.

Banker's acceptances are created by a drawer, providing the bearer the rights to the money indicated on its face at a specified date.

The maturity date typically lies between one month and six months from the issuing date.

The holder of the acceptance can sell it on a secondary market, where investors can profit from the short-term investment at a discount.

There's a secondary market for buying and selling banker's acceptances, allowing investors to buy and sell them at a discount.

Eurodollars are dollar-denominated deposits held in foreign banks, which means they're not subject to Federal Reserve regulations.

They're often held in banks in the Cayman Islands and the Bahamas, and very large deposits of eurodollars are kept in these institutions.

Money market funds, foreign banks, and large corporations invest in eurodollars because they pay a slightly higher interest rate than U.S. government debt.

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Cash accounts are a type of money market account that offers easy access to your money, making it a great option for short-term savings or emergency funds. You can link a cash account to a checking account, allowing you to access your funds quickly and easily.

Money market funds in cash accounts typically have a low risk profile, making them a great option for those with a low tolerance for volatility. They also often offer a competitive yield compared to traditional bank savings accounts.

The redemption process for cash accounts is generally quick, taking less than two business days. This is because money market funds are designed to provide liquidity to investors, ensuring that your money is available when you need it.

Here are some common uses for cash accounts:

It's worth noting that cash accounts may not offer the highest returns, but they do provide stability and can play an important role in your overall investment portfolio.

Prime money market funds are a type of money market fund that invests in short-term corporate debt instruments, such as commercial paper, corporate notes, and short-term bank securities.

These funds also include repurchase and reverse repurchase agreements. Prime money market funds typically offer a floating net asset value (NAV) and are available to both retail and institutional investors.

Retail prime and retail municipal money market mutual funds have policies to limit beneficial owners to natural persons, or individual investors. They seek to maintain a stable $1.00 NAV.

Institutional prime and institutional municipal money market mutual funds, on the other hand, do not qualify as retail funds and may be held by institutional investors. They price and transact at a floating NAV, which may fluctuate from time to time.

A discretionary liquidity fee, not to exceed 2% of the value of the shares redeemed, may be imposed if the fund's board determines it's in the fund's best interests.

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Tax exemption is a significant benefit of investing in money market funds. It's a way to earn interest on your money while minimizing your tax liability.

Taxable money market funds, also known as prime money market funds, usually offer higher yields than tax-exempt funds, but any income is subject to taxes. This means you'll have to pay taxes on the interest you earn.

Tax-exempt funds, on the other hand, usually don't pay as much, but their earnings are federally tax-free, making them a better option for investors in a high tax bracket. This can be a significant advantage, especially for those who earn a high income.

Municipal issues in which money market funds invest are federal and often state income tax-exempt; hence they provide tax-efficient income. This means you can earn interest on your money without having to pay taxes on it.

Here are some types of tax-exempt money market funds:

Some tax-exempt funds invest only in bonds issued by a specific state, which makes them both federal and state tax-free for residents of that state. This can be a good option for those who live in a state with high taxes.

Overall, tax exemption is an important consideration when choosing a money market fund. It's essential to weigh the benefits of tax exemption against the potential returns on investment.

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The central bank plays a crucial role in guiding the monetary policy of a country and ensuring a healthy financial system.

The central bank uses the money market to make policy decisions, taking into account the prevailing short-term interest rates that reflect the banking industry's conditions.

These interest rates serve as a guide for the central bank to develop an appropriate interest rate policy.

The integrated money markets also enable the central bank to influence sub-markets and implement its monetary policy objectives.

The money market provides a convenient way for businesses to obtain short-term loans to finance their working capital needs, such as buying raw materials or paying employees.

This is especially helpful for businesses that may experience cash shortages due to the large volume of transactions.

Through commercial paper and finance bills, businesses can easily borrow money on a short-term basis.

The money market's influence on the capital market can also help businesses obtain long-term financing, as the capital market benchmarks its interest rates based on the prevailing interest rate in the money market.

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Credit risk is a real consideration when investing in money market securities.

The potential to not lose money, however low, is not guaranteed, as these securities are susceptible to volatility.

There is a probability of loss, although it is generally quite small.

You won't have the same protection as you would with a traditional bank account, as money market securities are not FDIC-insured.

This means that investors may not receive $1.00 per share on the redemption of their shares.

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Foreign exchange exposure can be a significant risk for investors who put their money in money market instruments across borders.

Changes in economic policies and government regulations can affect the price of money market securities and the financial standing of their issuers.

Funds that invest in money market instruments denominated in other currencies than the home currency are particularly vulnerable to this type of risk.

An adverse impact on the price of money market securities can result from changes in interest rates and money supply.

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Money market funds are known for their stability, with low volatility investments that make them a great option for those looking for a safe and secure place to put their money. This is because they're required by SEC regulations to invest in short-maturity, low-risk investments.

One of the biggest advantages of money market mutual funds is their liquidity. You can settle your brokerage account trades in other investments or retrieve funds from a money market mutual fund with ease, as assets are typically available daily.

Money market funds are also a great option for those looking for security. They're required to invest in short-maturity, low-risk investments, making them less prone to market fluctuations than many other types of investments.

The duration of money market mutual funds is typically short, at maximum a few months, which means they're subject to less interest rate risk than longer-maturing bond fund investments. This is great news for those who want to minimize their risk.

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Money market mutual funds tend to hold many different securities, with limited exposure outside U.S. Treasury funds to any single issuer. This diversification can help spread risk and increase potential returns.

Some money market funds invest in securities whose interest payments are typically exempt from federal, and in some cases, state income taxes. This can be a potential source of stable, tax-efficient income.

Here are some key benefits and features of money market funds:

Investing in money markets can be a great way to balance out your investment portfolio.

Money market funds are designed for customers with a short time horizon, low tolerance for volatility, or those who need extreme liquidity.

They offer stability and can help offset the typically greater volatility of bond and equity investments.

Money market funds can also be used as short-duration investments for assets needed in the near term, such as emergency savings.

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You can use them as a holding place for assets while waiting for other investment opportunities to arise, like in the core position for your brokerage account.

Here are some ways money market funds can be used: