Money Market Mutual Funds

Definition

Money market mutual funds are investment vehicles that pool money from investors and invest in short-term, low-risk securities such as government bonds, certificates of deposit, and commercial paper. They provide a safe and liquid option for investors seeking to preserve capital while earning a modest return.

5 Must Know Facts For Your Next Test

1. Money market mutual funds are considered low-risk investments due to the short-term, high-quality nature of the securities they hold.
2. These funds aim to maintain a stable net asset value (NAV) of $1 per share, making them a popular cash management tool for investors.
3. Money market mutual funds are included in the M2 money supply measure, as they can be easily converted into cash.
4. The primary objective of money market mutual funds is to provide investors with current income and preserve the value of their investment.
5. Strict regulations govern the types of securities money market mutual funds can invest in, ensuring a high degree of safety and stability.

Review Questions

• Explain how money market mutual funds are related to the M2 money supply measure.
  • Money market mutual funds are included in the M2 money supply measure because they are highly liquid investments that can be easily converted into cash. As part of the M2 aggregate, money market mutual funds represent a readily available source of funds that can be used for transactions and other economic activities. Their inclusion in M2 reflects their role in the broader money supply and their ability to serve as a substitute for other liquid assets.
• Describe the key features that make money market mutual funds a low-risk investment option.
  • Money market mutual funds invest in a diversified portfolio of short-term, high-quality securities such as government bonds, certificates of deposit, and commercial paper. This conservative investment strategy, along with strict regulatory requirements, helps to minimize the risk of default and preserve the stability of the fund's net asset value. Additionally, the short-term nature of the underlying securities ensures a high degree of liquidity, allowing investors to readily access their funds when needed.
• Analyze the role of money market mutual funds in the broader financial system and their impact on the measurement of the money supply.
  • Money market mutual funds play a crucial role in the financial system by providing a safe and liquid investment option for both individual and institutional investors. By channeling funds into short-term, high-quality securities, these funds help to facilitate the efficient functioning of the money market and support the broader economy. Their inclusion in the M2 money supply measure reflects their ability to serve as a substitute for cash and other liquid assets, influencing the overall size and composition of the money supply. As such, changes in the size and composition of money market mutual funds can have implications for monetary policy and the management of the money supply by central banks.

Related terms

Money Market: The money market is a financial market where short-term, highly liquid financial instruments with high credit quality are traded.

Commercial Paper: Commercial paper is a short-term debt instrument issued by corporations to meet their short-term financing needs.

Liquidity: Liquidity refers to the ease with which an asset can be converted into cash without a significant loss in value.