Money Market Funds

Definition

Money market funds are a type of mutual fund that invests in short-term, low-risk securities such as government bonds, commercial paper, and certificates of deposit. They are designed to provide investors with a safe and liquid place to park their cash while earning a modest return.

5 Must Know Facts For Your Next Test

1. Money market funds are required to maintain a stable net asset value (NAV) of $1 per share, which helps to preserve the principal investment.
2. These funds typically have very low expense ratios, making them a cost-effective option for short-term cash management.
3. Money market funds are considered to be one of the safest investment options, with a focus on preserving capital rather than generating high returns.
4. Investors can easily access their money in money market funds, as they offer same-day liquidity, allowing for quick withdrawals or transfers.
5. The returns on money market funds are generally higher than those of traditional savings accounts, but lower than those of longer-term investments.

Review Questions

• Explain the key features of money market funds that make them suitable for cash management purposes.
  • Money market funds are designed to provide a safe and liquid place to store cash while earning a modest return. They invest in short-term, low-risk securities like government bonds and commercial paper, which helps to preserve the principal investment. Additionally, money market funds maintain a stable net asset value of $1 per share, and they offer same-day liquidity, allowing investors to easily access their money when needed. These features make money market funds an attractive option for individuals and businesses looking to manage their short-term cash needs.
• Analyze the role of money market funds in the broader context of cash management strategies.
  • Within the context of cash management, money market funds play a crucial role in providing a safe and efficient way to store and manage excess cash. By investing in short-term, low-risk securities, money market funds offer investors the opportunity to earn a higher return than traditional savings accounts while maintaining a high degree of liquidity. This makes them an important tool for businesses and individuals who need to keep a portion of their assets in a readily accessible form, such as for meeting short-term obligations or taking advantage of investment opportunities. Additionally, the low expense ratios and stable net asset value of money market funds make them a cost-effective and reliable component of a comprehensive cash management strategy.
• Evaluate the potential risks and benefits of investing in money market funds as part of a cash management plan.
  • When considering the use of money market funds as part of a cash management plan, it is important to weigh both the potential risks and benefits. On the benefit side, money market funds offer a high degree of safety and liquidity, with a focus on preserving capital rather than generating high returns. They provide a convenient way to store excess cash and earn a modest return, which can be useful for meeting short-term financial obligations or taking advantage of investment opportunities. However, the potential risks include the possibility of the fund's net asset value falling below $1 per share (known as 'breaking the buck'), as well as the risk of the fund's investments underperforming due to changes in interest rates or other market conditions. Ultimately, the decision to invest in money market funds as part of a cash management plan should be based on the investor's specific needs, risk tolerance, and overall financial goals.

Related terms

Mutual Fund: A type of investment vehicle that pools money from multiple investors and invests in a diversified portfolio of securities, such as stocks, bonds, or money market instruments.

Commercial Paper: Short-term, unsecured debt instruments issued by corporations to finance their short-term operational needs.

Liquidity: The ability to quickly convert an asset into cash without significant loss in value.