Money Market Investing
Many people today are choosing to invest in the money market
due to the lack of risk that is involved. However, before you invest any money, you should
know how the money market works.
In the money market, the assets that are traded are papers that
evidence indebtedness of large corporations. An illustration follows.
John borrows $1,000 from Peter and writes down on a piece of paper, “IOU $1,000 payable in 6 months with 2%
interest”. That paper is evidence of John’s indebtedness to Peter. If Peter wants to make early money out of John’s
IOU, he can go to the money market and sell the IOU at a discount in order to attract a buyer. When sold to Paul at
a selling price of $950, the discount is 5%. After 6 months Paul sells the IOU to Matthew for $980, and makes $30
from the sale. Finally, Matthew collects the $1,000 face value plus interest from John and makes a profit of $20
plus the interest on the IOU.
The money market works somewhat that way but in a much more complex setting and a
staggering volume of transactions. Combined earnings of all money market transactions are expressed in APY. If
on a certain trading day IOUs earned 2% APY, treasury bills earned 1.2%, and certificates of deposit earned
1.35%, the winner of the highest money market rates award (so to speak) is IOUs.
The money poured into this market comes from wholesale MMFs pooled from
numerous retail investors and entrusted to the custody of big-time institutional financial players that
participate in the money market. Having no direct access to MMFs, individual investors deal with a
professional fund manager. The fund manager, in turn, deals with brokers.
The fund manager tries to secure for his clients the highest money
market rates possible in his portfolio.
Individual investors can also access the
money market indirectly through the MMA service sold by banks. Since banks have more conservative portfolios
than independent professional fund managers, the highest money market
rates on MMAs are often less than those of MMFs.