Money market instruments are used by corporations, governments, and individual investors seeking short-term funding or short-term places to invest money. There are several different varieties of money market instruments, but all have a few things in common.
What is the money market?
There are two types of financial markets. The capital markets, which consist of stocks and bonds, allow institutions to raise capital for long-term purposes, which is generally defined as more than one year. For example, a company may issue bonds in order to acquire another business, and will set the maturity date of those bonds for 10 years in the future.
On the other hand, the money market is for funding over short time periods of one year or less. Instead of obtaining funding for operating expenses or capital investment as they would with the capital markets, the money markets are often used to fund immediate operating expenses or to provide working capital.
From an investors point of view, the money market provides a safe place to invest without losing ready access to ones money. For example, an investor who needs liquidity and has little risk tolerance may put some of their money into Treasury bills.
Types of money market instruments
There are several different varieties of money market instruments, issued by both companies and governments. This isnt an exhaustive list, but some of the more common types of money market instruments include:
- Short-term CDs
- Bankers acceptances
- Treasury bills
- Commercial paper
- Municipal notes
- Federal funds
- Repurchase agreements (repos)
Money market instruments have a few things in common. For starters, we already mentioned that they have short maturities, defined as one year or less. So, a six-month CD would qualify as a money market instrument, but a two-year CD would not. Money market instruments maturities can last from one day to one year, with three months or less being the most common.
In addition, money market instruments generally have the following two characteristics:
- Liquidity -- Money market instruments are liquid investments, which means that they can readily be bought and sold for stable prices. There are active secondary markets for most money market instruments, so they can be easily sold before maturity.
- Safety -- Because of their liquidity and the nature of the lenders, money market instruments are safer than many other types. For example, Treasury bills are backed by the credit of the US government. Money market deposit accounts are federally insured for up to $250,000. However, its important to mention that low-risk and risk-free are two different things. Some types of money market instruments do have some risk. Commercial paper, for instance, is only as safe as the company that issued it.
To sum it up, money market instruments are seen as a safe place to put money because of their high liquidity, short maturities, and safety relative to other types of investments.