Money markets are accounts designed to be secure savings or holding accounts. Money markets come in two very distinct varieties, an insured bank account or a mutual fund money market account. The structures of the accounts are different, but the investment instruments that generate the moderate rate of return are similar. Contrary to normal standards of investment, a bank can invest in riskier instruments than brokerage firms to get higher rates.
U.S. Treasury Securities
The primary instrument of money market investing is United States Government Securities. These include Treasury bills, Treasury notes and Treasury bonds. Mutual fund money markets may invest substantial amounts of the fund assets into treasuries, but they generally look at short-term bills and notes. Since the fund needs to maintain liquidity, it is at risk of principal value fluctuation. Keeping debt short term reduces the risk that the mutual fund money market will drop below a $1 per share value--known as breaking the buck. Bank funds may invest in longer term treasuries with less exposure to this interest rate risk.
Banks and money market mutual funds may also use AAA-rated corporate debt (bonds) to get higher rates that they pass on to investors. An AAA-rating is a debt measurement created by research firms such as AM Best or Standard and Poors. Debt with a rating of an BB or higher is considered investment grade. While the bank or a fund may add BB-, BBB-, A-, AA- or AAA-rated debt to the underlying assets, the lower investments may increase risk. Funds are limited to no more than 5 percent of the fund's holding to be with any one debt issuer. This mitigates the exposure to any one non-Treasury investment.
Corporations offer commercial paper to investors as a way to obtain needed capital without using assets as collateral or filing for SEC public registrations. These are considered debt instruments destined for short-term financing needs. To avoid SEC filing requirements, the paper must mature within nine months. Unlike a loan, there is no interest on the commercial paper. It is offered at a discount and redeemed for full value when the term is due. For example, a corporation may receive only $90,000 in the loan but repay the bank $100,000 after the nine months.
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