Money Market

The money market is the segment of the financial system that handles short-term borrowing and lending—typically instruments that mature in one year or less. It provides highly liquid, low-risk places for governments, banks, corporations, and individual investors to park cash temporarily and meet near-term funding needs.

How it works

• Mostly a wholesale market where banks, institutions, and corporations lend and borrow large sums (often overnight or for a few days/weeks).
• Transactions include interbank lending, repurchase agreements (repos), and the sale of short-term debt issued by governments and corporations.
• Retail investors participate indirectly through money market mutual funds, money market accounts at banks or credit unions, short-term CDs, and Treasury bills purchased via brokerages or government platforms.

Who can invest

• Individual investors via money market mutual funds, money market accounts, certificates of deposit (CDs), and Treasury bills.
• Institutions and large corporations directly in the wholesale market (commercial paper, repos, interbank deposits).

Money market funds and the $1 NAV

• Many money market mutual funds aim to keep a stable net asset value (NAV) of $1 per share.
• “Breaking the buck” means the NAV falls below $1; it is rare but can happen during severe market stress. Some funds are not FDIC- or NCUA-insured, so losses are possible in extreme situations.

Types of money market instruments

• Money Market Funds: Pooled funds that invest in short-term instruments; intended to offer liquidity and stability.
• Money Market Accounts: Bank or credit-union savings accounts with check-writing or limited withdrawal privileges; typically pay higher rates than basic savings accounts and are insured up to applicable insurance limits.
• Certificates of Deposit (CDs): Time deposits with fixed terms and rates; early withdrawal usually incurs penalties.
• Treasury Bills (T‑bills): Short-term U.S. government securities with maturities from a few days up to one year.
• Commercial Paper: Unsecured short-term corporate debt issued by highly rated companies to meet immediate funding needs.
• Bankers’ Acceptances: Bank-guaranteed short-term instruments commonly used in trade finance.
• Eurodollars: Dollar-denominated deposits held in banks outside the issuing country, typically offering slightly higher yields than domestic government debt.
• Repurchase Agreements (Repos): Short-term loans collateralized by securities, used widely in overnight funding markets.

Money markets vs. capital markets

• Money Market: Focuses on short-term debt (maturities ≤ 1 year); priority is liquidity and safety.
• Capital Market: Deals with long-term debt and equity (bonds and stocks); aim is growth and long-term financing.

Advantages

• Very low credit risk for many instruments (especially government-backed or FDIC/NCUA-insured products).
• High liquidity—easy to convert to cash at short notice.
• Useful for preserving capital and managing short-term cash needs.

Disadvantages

• Low returns relative to stocks, bonds, and other longer-term investments.
• Often do not keep pace with inflation over time.
• Some money market funds are not insured and can lose value in extreme events.
• Accounts may have minimum balances, withdrawal limits, or fees that reduce net return.

Explain Like I’m Five

The money market is like a place where people and companies lend each other very short loans—just long enough to cover tomorrow’s needs. Because these loans are so short and usually backed by trustworthy borrowers, they pay only a little interest but are very safe.

Real-life uses

• Parking cash in a brokerage sweep account that moves idle cash into a money market fund.
• Keeping emergency or short-term funds in a money market account or short-term CD for a slightly better return than a checking account.
• Corporations and governments use the money market to manage payroll, taxes, and short-term obligations.

Can you lose money?

• Bank and credit-union money market accounts and CDs are generally protected up to applicable federal insurance limits.
• Government securities carry very low default risk.
• Money market mutual funds and some wholesale instruments are not insured and can lose value in exceptional market stress (though such events are uncommon).

Bottom line

Money market instruments offer high liquidity and low risk, making them suitable for short-term cash management and a conservative place to hold reserves. The tradeoff is lower returns that may not outpace inflation, so they are best used for temporary parking of funds rather than long-term growth.