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Table of Contents
What Is the Money Market?
How It Works
Who Can Invest?
The One-Buck Baseline
Types of Instruments
Money Markets vs. Capital Markets
Pros and Cons
Money Market FAQs
The Bottom Line
BONDS FIXED INCOME
Money Markets: What They Are, How They Work, and Who Uses Them
By ADAM HAYES Updated July 04, 2024
Reviewed by MICHAEL J BOYLE
Fact checked by YARILET PEREZ
What Is the Money Market?
The money market refers to trading in very short-term debt investments. It involves
continuous large-volume trades between institutions and traders at the wholesale
level. It includes money market mutual funds bought by individual investors and
money market accounts opened at banks at the retail level.

The money market is characterized by a high degree of safety and relatively low
rates of return on investment.

KEY TAKEAWAYS
The money market involves the purchase and sale of large volumes of very short-term
debt products such as overnight reserves or commercial paper.
An individual can invest in the money market by purchasing a money market mutual
fund, buying a Treasury bill, or by opening a money market account at a bank.
Money market investments are characterized by safety and liquidity with money
market fund shares targeted at $1.
Money market accounts offer higher interest rates than normal savings accounts but
they have higher account minimums and limits on withdrawals.
Understanding the Money Market
The money market is one of the pillars of the global financial system. It involves
overnight swaps of vast amounts of money between banks and the U.S. government. The
majority of money market transactions are wholesale transactions that take place
between financial institutions and companies.

Institutions that participate in the money market include banks that lend to each
other and to large companies in the euro currency and time deposit markets. They
also include companies that raise money by selling commercial paper into the market
and investors who purchase bank CDs as a safe place to park money in the short
term.

Some of those wholesale transactions eventually make their way into the hands of
consumers as components of money market mutual funds and other investments.
Who Can Invest in the Money Market?
Individuals can invest in the money market by buying money market funds, short-term
certificates of deposit (CDs), municipal notes, or U.S. Treasury bills. The money
market has retail locations for individual investors. They include local banks, the
U.S. government's TreasuryDirect website, and brokerages.

The One-Buck Baseline

Money market funds seek stability and security with the goal of never losing money
and keeping net asset value (NAV) at $1. This one-buck NAV baseline gave rise to
the phrase "break the buck." Some of the original investment is gone and investors
will lose money if the value falls below the $1 level.

This scenario happens very rarely, however. It last occurred in 2008 and involved a
fund that held assets of the bankrupt Lehman Brothers investment company. Its
investors eventually received 98 cents on the dollar.
1

Many money market funds aren't FDIC-insured so they can nonetheless lose money.
2

Types of Money Market Instruments

Money Market Funds
The wholesale money market is limited to companies and financial institutions that
lend and borrow in amounts ranging from $5 million to well over $1 billion per
transaction. Mutual funds offer baskets of these products to individual investors.
The net asset value (NAV) of such funds is intended to stay at $1.

Money Market Accounts

Money market accounts are a type of savings account. They pay slightly higher
interest rates than regular savings accounts but they often come with restrictions
on withdrawing money or writing checks. Withdrawals are limited by federal
regulations. The bank will promptly convert the money market account to a checking
account if the limits are exceeded.

Banks typically calculate interest on a money market account daily and make a
monthly credit to the account.

Average interest rates for money market accounts can vary based on the amount
deposited. The best-paying money market account advertised online as of July 2024
was offered by Brilliant Bank at 5.35% with a $1,000 minimum deposit.
3

Money market accounts have become more popular because of their perceived safety
compared to more volatile investments given a high interest rate market.

Funds in money market accounts are insured by the Federal Deposit Insurance
Corporation (FDIC) when they're held at banks and the National Credit Union
Administration (NCUA) when they're held in credit unions.
2
4

Certificates of Deposit (CDs)

Most certificates of deposit (CDs) aren't strictly money market funds because
they're sold with terms of up to 10 years. CDs with terms as short as three months
to six months are available, however.

Larger deposits and longer terms yield better interest rates just as they do with
money market accounts. Rates in early July 2024 ranged from about 5.35% to 6.00%.
The rates offered on a CD remain constant for the deposit period, unlike with a
money market account. There's usually a penalty associated with an early withdrawal
of funds from a CD. They've gained in popularity due to their safety and the
relatively high rates available, however.

U.S. Treasury Bills

The U.S. government issues Treasury bills in the money market with maturities
ranging from a few days to one year. Cash management bills come with maturities of
a few days to one year.
5
6

Primary dealers buy these bills in large amounts directly from the government to
trade between themselves or to sell to individual investors. Individual investors
can buy them directly from the government through the TreasuryDirect website or a
bank or a broker. State, county, and municipal governments also issue short-term
notes.

Commercial Paper
The commercial paper market is for buying and selling unsecured loans for
corporations in need of a short-term cash infusion. Only highly creditworthy
companies participate in this market so the risks remain low.

Commercial paper is a popular borrowing mechanism in the wholesale market because

the interest rates are higher than for bank time deposits or Treasury bills. A
greater range of maturities is available as well, averaging about 30 days and
extending up to nine months.
7
The risk of default is significantly higher for commercial paper than for bank or
government instruments, however.

Banker's Acceptances
A banker's acceptance is a short-term loan that's guaranteed by a bank. Used
extensively in foreign trade, a banker's acceptance is like a post-dated check. It
serves as a guarantee that an importer who has ordered goods can pay for them.

There's a secondary market for buying and selling banker's acceptances at a

discount.

Eurodollars
Eurodollars are dollar-denominated deposits held in foreign banks so they're not
subject to Federal Reserve regulations. Very large deposits of eurodollars are held
in banks in the Cayman Islands and the Bahamas.

Money market funds, foreign banks, and large corporations invest in them because
they pay a slightly higher interest rate than U.S. government debt.

Repos
The repo or repurchase agreement is part of the overnight lending money market.
Treasury bills or other government securities are sold to another party with an
agreement to repurchase them at a set price on a set date.

Money Markets vs. Capital Markets

The money market is defined as dealing in debt of less than one year. It's used
primarily by governments and corporations to keep their cash flows steady and by
investors to make a modest profit.

The capital market is dedicated to the sale and purchase of long-term debt and
equity instruments.
The term "capital markets" refers to the entirety of the stock and bond markets.
Stocks have no expiration date unless the company itself ceases to operate, unlike
many money market products,

Advantages and Disadvantages of Money Markets

Most money market securities are considered extremely low-risk due to the
protection of FDIC insurance, backing by a government or bank, or the high
creditworthiness of the borrowers. They're also very liquid. They can readily be
exchanged for cash at short notice.
The tradeoff is that these investments have low returns. Money markets generally
underperform other asset classes and often don't even keep pace with inflation. Any
fees associated with an account can easily eat into these slim returns. And these
advantages don't extend to all money market securities. Some aren't FDIC insured
and there's a chance that even the most trustworthy borrowers may default.

Some money market accounts have minimum balance requirements or restrictions on

withdrawals.

Pros and Cons of Money Market Accounts

Pros
Extremely low risk

May be insured by FDIC

Highly liquid

Higher returns than most bank accounts

Cons
Low returns that may not keep pace with inflation

Not all money market securities are insured

May have high minimum investments or withdrawal restrictions

Why Is It Called the Money Market?

The money market deals in highly liquid, very safe, short-term debt securities and
these attributes make them virtual cash equivalents. They can be exchanged for cash
at short notice.

Why Is the Money Market Important?

The money market keeps the financial economy running smoothly. It allows savers to
lend money to those in need of short-term loans and it allocates capital toward its
most productive use.

These loans are often made overnight or for a matter of days or weeks. They're
needed by governments, corporations, and banks to meet their near-term obligations
or regulatory requirements. And they allow those with some excess cash on hand to
earn a small amount of interest.

What Are Some Examples of Money Market Instruments?

The money market is composed of several types of securities including short-term
Treasuries (T-bills), certificates of deposit (CDs), commercial paper, repurchase
agreements (repos), and money market mutual funds that invest in these instruments.
The money market funds typically have shares priced at $1.

Can You Lose Money in the Money Market?

Most money market accounts are insured by the FDIC up to $250,000 per institution,
just like bank deposits. There's virtually no chance you'll lose your money by
owning a CD or T-bill because money market instruments are very low risk.

Some money market funds can "break the buck" and briefly incur losses during
periods of extreme financial stress such as at the height of the 2008 financial
crisis. This was quickly corrected, however.

What Are the Downsides of Money Markets?

Money market investments pay very low returns because they're virtually risk-free.
They can't provide substantial capital gains or investment growth compared to
riskier assets like stocks or even bonds.

Some types of money market accounts like CDs lock your money up until a future date
that can be months or even years ahead.

Individual investors should also look carefully at the fees they'll be charged for
money market accounts. They can eat into the already modest rates of return on
these investments.

The Bottom Line

Money market accounts and money market funds are among the safest ways to invest
money. They also have much lower returns than other investments and they may even
fail to keep up with inflation.

Many individuals and businesses use money markets as a short-term investment for
their cash reserves. These investments are virtually risk-free and offer at least a
modest return on savings.
ARTICLE SOURCES
Related Terms
Cash and Cash Equivalents (CCE): Definition, Types, and Examples
Cash and cash equivalents are company assets that are either cash or can be
converted into cash immediately. more
Money Market Yield: Definition, Calculation, and Example
The money market yield is the interest rate earned by investing in securities with
high liquidity and maturities of less than one year. more
Commercial Paper: Definition, Advantages, and Example
Commercial paper is a short-term, unsecured debt instrument issued by corporations
typically for the financing of short-term liabilities. more
Money Market Funds: What They Are, How They Work, Pros and Cons
A money market fund is a type of mutual fund that invests in high-quality, short-
term debt instruments and cash equivalents. more
Banker's Acceptance (BA): Definition, Meaning, and Types
A banker's acceptance (BA) is like a post-dated check but a bank rather than an
account holder guarantees payment. BAs are sold at a discount in money markets.
more
Negotiable Certificate of Deposit (NCD): Definition and Risk
A negotiable certificate of deposit is a CD with a minimum face value of $100,000.
more
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Cash and Cash Equivalents (CCE): Definition, Types, and Examples
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Money Market Yield: Definition, Calculation, and Example
Money Market Accounts vs. Certificates of Deposit
Money Market Accounts or CDs: Which Investment Is Better?
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Besides a Savings Account, Where Is the Safest Place To Keep My Money?
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