Finance

Money Market Funds

Money Market Funds

Money market funds are short-term debt funds that invest in highly liquid,  near-term instruments such as cash and cash equivalent securities, high credit rating debt-based securities with short-term maturities. These include debt funds that lend up to a period of 1 year. Money market funds are proposed so that financial advisors can generate high returns and liquidity while taking the low risk. A high loan period generally comes with higher returns. They are also referred to as market mutual funds.

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How does it work?

Money market funds are debt funds with a maturity of one year. These are used to manage short-term cash needs and deal only in cash & cash equivalents. They offer good returns over a short period while maintaining high liquidity levels. The main objective of these funds is to minimize the fluctuations of the Net Asset Value of the fund. They are like typical mutual funds. They invest in financial instruments like Certificates of Deposits, Commerical papers, Treasury bills, etc. Returns from These types of funds are dependent on interest rates.

Types of money market fund:

  • Prime money fund: This fund invests in floating rate debt and commercial paper of non-treasury assets. They include assets issued by corporations, government agencies, and GSEs.
  • Government money fund: It invests most of its total assets in cash, government securities, and repurchase agreements collateralized by cash or government securities.
  • Treasury fund: As the name suggests it invests in Treasury-issued debt securities like treasury bills, bonds, and notes.
  • Tax-exempt money fund: It offers earnings that are exempt from income tax. It can also have an exemption from state income tax depending upon the securities it invests in.

Examples:

  • Aditya Birla Sun Life Money Manager Fund
  • HDFC Money Market Fund
  • L&T Money Market Fund

Benefits:

  • The main and primary function of these funds is to give investors a safe road to investing in the secure and highly liquid market, debt-based assets utilizing more modest venture funds.
  • In the domain of mutual funds like speculations, money market funds are portrayed as low risk and low return ventures.
  • They seem to be appealing to investors because of no entry and exit charges.
  • Many market funds also give tax-advantaged gains by putting resources into municipal securities that are tax-exempt at the federal level (sometimes at the state level also).

Risks involved:

Money market funds face various risks:

  • Interest rate risks: this risk comes into picture upon the maturity. When the yield goes down market fund also declines. This makes up for the opportunity cost for holding these rather high, especially in a bullish market.
  • Credit risks: dissimilar to certificates of deposits (CDs) or savings accounts, these funds are not safeguarded by the Federal Deposit Insurance Corporation (FDIC). While these funds are generally invested into high-quality assets but then also there’s no assurance that you won’t lose your money.
  • Price risks: on account of prime and municipal money market funds, there’s a fundamental danger attached to price changes. As share costs vary quite possibly, they will be worth short of what you paid for them when you choose to sell.
  • Liquidity risk: putting resources into prime and city market funds conveys liquidity risk, which can affect the redemption plan. These assets may incidentally suspend your capacity to sell shares if liquidity dips under a base limit.

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Key Takeaways:

In an unpredictable market, market funds surely have their place. Notwithstanding, investing in them isn’t without its traps. Evaluating the dangers and the opportunity cost of holding money market funds should be normal practice, paying little heed to how much risk-averse you are. Money market funds are ideal for investors who have lower risk tolerance. Investors who have idle cash in their savings account can earn good returns by investing in these funds instead.

 

Authors: Priyanshu Ahuja and Abha Shetty

About the Authors :

Priyanshu is a first-year student from City Premier College, Nagpur, pursuing BBA. My interest includes financial markets and the investment domain.

Abha is a second-year BMS student and FRM level 1 candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.

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