The Money Market Explained

The stock market is a hazardous place for people to put their savings. The volatility can wipe out much of the value of their assets. In bear markets, most investors are rudely awakened to this fact and seek alternative investments. Enter the money market, which is actually a subset of the fixed income market. Fixed income and bonds are not synonymous. The money market deals in short-term debt securities, with maturities of less than a year. Often the maturity dates are only a few months long.

Money market instruments are IOUs issued by governments, financial institutions and corporations. These entities issue these debt securities to keep one another funded for the short-term. The money market is designed to provide liquidity to the participants whenever needed. Since the terms are so short and the risk so low, the interest rates are also low. This makes them less attractive in terms of returns, but the safety of the market is very attractive to savers and conservative investors.

The major difference between the money market and the stock market is that the debt securities are traded in large amounts. This makes getting into the market difficult for small investors. Another difference is that the money market is entirely dealer-made. This means the funds are lent and borrowed at the participants' own risk, using their own accounts. The easiest way to gain access to this market is through money market bank accounts or money market mutual funds. These accounts and funds pool the assets of thousands of investors in order to participate.

The instruments traded in the money market carry their own risk and return characteristics. Treasury bills, certificates of deposit, commercial paper, banker's acceptances, eurodollars and repurchase agreements are all traded. Each of these securities represents a variation on the concept of an IOU. For example, commercial paper is an unsecured loan issued by a corporation with a short term. Commercial paper is issued to finance accounts receivable and the purchase of additional inventory.

Investors can access the money market through mutual funds and savings accounts. Money market deposit accounts are opened at banks. The difference between these accounts and regular savings accounts are the Money Market Rates and the number of allowed withdrawals per month. The bank limits the number of withdrawals that can be made. Usually the bank allows only five or six withdrawals to be made each month. The biggest advantage is the fact that money market deposit accounts are insured by the Federal Deposit Insurance Corporation.

Money market mutual funds are not insured by the FDIC, but the Securities and Exchange Commission keeps a careful eye on them. Most funds invest in securities with maturity dates of 120 days or less. The fund must only invest in reliable securities from trusted entities. Some money market mutual funds are tax-exempt depending on the types of securities they purchase. The interest paid by these funds is almost entirely dependent on current monetary policy. The Fed sets the bar for these mutual funds.