Investors who seek highly liquid short-term investments turn to the money markets. The choices available in this market are diverse, but a common aspect of these investments is that they are extremely safe and ideal for conservative investors.
Typically, large organizations participate in these markets to raise money. These instruments offer a sound investment avenue, which investors can buy to gain many unique advantages.
Financial institutions, the government, and large companies offer short-term investment options through the money market to different kinds of buyers. This market allows borrowers to make use of funds from lenders at lower rates than other options. The transactions in the money market add to the overall liquidity of the economy and lend strength to economic activity.
For the lender, the money market is a safe haven for funds that are not being used at present. The money market investment is a form of fixed income investment and the lender gets the advantage of almost risk free investing with predictable returns.
The participants of the money market are:
Borrowers: Financial institutions, government or blue chip companies in need of funds.
Lenders: Institutional or retail investors.
Dealers: Intermediaries who facilitate distribution.
A money market instrument is a very short-term investment and maturity dates can range from a day up to a maximum of a year. The average term of a money market instrument is 3 months. This makes these instruments highly liquid and ideal for lenders who need a place to park funds before they are invested in long-term opportunities.
Money market investments are similar to bonds in that they generate fixed returns but they have a much shorter life span and they are much more liquid than bonds. Typically, funds raised from money markets, also called ‘papers’, are used to fund short term expenses while bonds usually help raise funds for capital expenditure.
These investments are considered very safe and this low risk also means low returns in comparison with other investment options like stocks. The choice of money market investments includes Treasury bills, bankers’ acceptances, commercial paper, CDs, federal funds, and some other short-term securities. For an investor, these instruments add liquidity, stability, and diversification to his portfolio.
There are some significant differences between money market investments and traditional stock market investing.
Money market funds are short term and come with expiry dates. The life of a stock market investment is left to the discretion of the investor, as long as the company that has issued the stock remains solvent.
Unlike the stock market, money market funds typically trade in very high denominations, which makes it difficult for small investors to participate in them directly.
There is no exchange where these instruments need to be traded. Unlike stocks, money market instruments are primarily traded by the borrowers directly or through their agents.
Next Chapter: How to Invest in Money Market Accounts