Money market funds

Definition

Money market funds are a type of mutual fund that invests in short-term, high-quality debt securities, providing investors with a safe and liquid investment option. These funds aim to offer better returns than traditional savings accounts while maintaining a stable net asset value, typically $1 per share. Investors use money market funds to preserve capital and earn interest, making them popular cash equivalents.

5 Must Know Facts For Your Next Test

1. Money market funds are regulated by the Securities and Exchange Commission (SEC) and must adhere to strict investment guidelines.
2. These funds typically invest in highly liquid and low-risk instruments such as Treasury bills, commercial paper, and certificates of deposit.
3. While money market funds aim to maintain a stable $1 per share price, there is still a small risk that the value could fluctuate during extreme market conditions.
4. Investors can usually access their money market fund investments quickly, making them an attractive option for those seeking both yield and liquidity.
5. The yields on money market funds are generally lower than stocks or longer-term bonds, but they provide greater safety and ease of access.

Review Questions

• How do money market funds serve as a cash equivalent in financial management?
  • Money market funds are considered cash equivalents because they provide high liquidity and low risk, making them suitable for short-term investment strategies. They allow investors to earn a return on their cash while maintaining easy access to their funds. This combination of stability and liquidity aligns with the definition of cash equivalents, making them an essential tool for effective financial management.
• Discuss the regulatory framework governing money market funds and how it impacts investor confidence.
  • Money market funds are governed by regulations set by the Securities and Exchange Commission (SEC), which imposes strict rules regarding the types of securities these funds can invest in and the maturity of those investments. This regulatory framework enhances investor confidence by ensuring that these funds maintain a level of safety and liquidity. It also helps prevent large-scale defaults that could affect the stability of these investments, fostering trust among investors who seek to preserve capital.
• Evaluate the impact of interest rate changes on the performance of money market funds and their attractiveness as an investment option.
  • Interest rate changes significantly affect the performance of money market funds, as these funds primarily invest in short-term debt securities whose yields are closely tied to prevailing interest rates. When rates rise, new investments within money market funds typically yield higher returns, making them more attractive to investors looking for income. Conversely, in a declining interest rate environment, the yields on these funds may drop, leading investors to seek higher returns elsewhere. This dynamic highlights how shifts in monetary policy can influence investor behavior and the overall attractiveness of money market funds as an investment option.

Related terms

Liquidity:

The ease with which an asset can be converted into cash without significantly affecting its price.

Net Asset Value (NAV): The total value of a fund's assets minus its liabilities, often expressed on a per-share basis.

Treasury Bills: Short-term government securities issued by the U.S. Treasury, commonly held within money market funds for their safety and liquidity.