On Money and Markets Research Paper Starter

Henry Kaufman

On Money and Markets

For businesses seeking to find asset security in between their investments, there are two general choices. The first is a long-term capital investment strategy, such as the acquisition of bonds. The second is more short-term investment strategy, one that provides shorter term financial return with more liquid assets available. It is to the latter of these concepts, money markets, which this paper focuses on with the aim of defining an important part of any strong economy.

Keywords: CD; First Tier Security; Institutional Market Fund; Money Market Fund; Retail Market Fund; Treasury Bill; Yield

Money Markets


Calvin Coolidge once said that the "chief business of the American people is business," adding that Americans are "profoundly concerned with producing, buying, selling, investing and prospering in the world" ("Coolidge," 1996). Indeed, the backbone of a strong capitalist economy like that of the United States is an extensive marketplace that offers its patrons the opportunity to maximize profits and minimize losses.

At the core of any business or commercial enterprise is financial solvency. A business relies on an ability to protect its assets by placing them in savings, hoping to see growth and expecting to avoid losses. This simple concept is in fact an extremely complex one; dependent on the preferences and decisions of the individual business owner. Some experience modest gains upon their savings but benefit from the protection by conservative investment strategies. Others seek a higher yield, while accepting the potential for sudden loss. Depending upon the specific case, long-term or short-term growth can be a focal point for a business and its funds.

For businesses seeking to find asset security in between their investments, there are two general choices. The first is a long-term investment strategy, such as the acquisition of bonds. The second is a more short-term investment strategy, one that provides shorter term financial return with an availability of more liquid assets. It is to the latter of these concepts, money markets, that this paper focuses with the aim of defining an important part of any strong economy.

Money Markets — An Introduction

A marketplace is an entity wherein items are bought or sold. In the stock market, for example, individuals invest in interests in publicly traded companies, seeking to profit from their positive performance and to avoid losses when the stocks they hold wane in value. Money markets are similar to the stock market concept, except for the fact that in a money market (as its name suggests), it is money that is traded rather than stocks.

The basic premise of a money market is that individuals invest monies into money market funds (which, like mutual funds, spread investment monies around to various market members in order to foster stability and maximum opportunity). The funds return, usually on a monthly basis, a portion of the earnings on the investor's money in the form of dividends. The targets of investment, known as "instruments," are typically government sponsored (Treasury issues, known as "T-Bills") accounts, bank-sponsored accounts (so-called "CDs, or Certificates of Deposit) or short-term corporate paper (Pritchard, 2009).

Money markets are constructed for the purpose of strengthening investments on short-term borrowing and lending relationships. A corporation, for example, might sell paper (unsecured obligation such as accounts receivable or inventory ("Commercial paper," 2009)) on the market to meet its financial needs. On the other hand, an investor who profited from another investment might deposit some of those funds into a CD as a safe way to earn more money on interest and dividends ("The money market," 2009).

Money market funds were first introduced to Wall Street in 1971, when investment entrepreneur Bruce R. Bent created the Reserve Fund. Bent's idea was not the first money market fund in history, however. Several years earlier, in 1968, John Oswin Schroy introduced the Conta Garantia to the Brazilian marketplace. 31 years after Conta Garantia was floated to investors in Rio de Janeiro and 28 years after Bruce Bent took the money market fund to a much grander scale, there are approximately 2,000 money market funds in operation worth $2.3 trillion in assets.

Types of Money Market Funds

There are two basic types of money market funds in operation. The first of these money market funds are "retail" accounts. These funds are typically offered to high-net worth investors who tend to use the accounts in between investment actions. In other words, an investor may sell a given share or asset on the stock market, and take his or her liquid earnings from the sale and "park the cash" into a retail account, where it can further generate modest interest while the investor looks for another intermediate- or long-term investment opportunity. Such funds comprise about 40 percent of all money market assets, and are offered primarily by brokerage houses. Retail accounts also prove useful for people who are simply seeking a safe, risk-free investment for their liquid assets. The largest of the retail accounts is the Fidelity Cash Reserve, which boasts about $120 billion in assets and a seven-day yield rate of 3.4 percent (Kosnett, 2008).

The second form of money market fund is the "institutional" fund. This type of money market fund is offered to large corporations, government agencies and other sizable organizations. These entities collect free-floating cash within their programs and deposit them, in many instances on an automatic, nightly basis, into the institutional fund. Like retail accounts, they are offered largely by brokerage houses and are useful for the purposes of putting a good use to idle funds ("Money market funds," 2009).

Recent Surges in Money Market Use

In both of these cases, money markets typically represent safe havens for liquid assets during particularly unsteady economic times. By 2008, money market mutual fund assets reached an all-time high, having increased by more than $19 billion to a total of $3.43 trillion, according to one watchdog group. In 2008 alone, the increase in money market assets was staggering — a 43 percent jump worth $1.1 trillion. The causes for this surge in money market participation were two-fold. First, signs of a deteriorating economic landscape led a much larger percentage of the population to install their liquid assets in less volatile markets. Second, the Federal Reserve was wary at the time to cut interest rates, which meant that entities paying back on loans within the money market did so at higher interest rates, thereby ensuring a stronger return for market investors ("Money fund asset gains," 2008).

In 2008, the money market again came to a critical use when Wall Street giant American International Group (AIG) was close to complete closure. The federal government, deciding that AIG's influence was too important to allow the company to collapse, lent nearly $85 billion to AIG through US Treasury securities, effectively giving the federal government almost 80 percent of equity holdings. A British bank, Libor, bolstered the loan (Karnitschnig, et al, 2008).

Money markets are considered relatively safe and secure institutions for investors. At a typical $1 per share, money market funds are short-term in nature (the maturity of such investments are between one day and one year), which helps prevent severe impacts should the companies involved encounter rough waters. Additionally, money market funds are liquid-based, which means an investor's money is easily accessed like that of a checking account. During times of stock market volatility, investors often pour their money into money accounts to help weather the storm.

In 2008, for example, two of The Vanguard Group's money market funds, the Vanguard Admiral Treasury Money Market Fund and the Vanguard Treasury Money Market, saw enormous surges in money market investment activity. While the stock markets saw increased unpredictability and assets began suffering as a result, these two money market funds saw extremely large growth over a one-year period — the former saw an increase of $5.4 billion and the latter saw $1.7 billion more — as investors poured their money into the typically safe, conservative funds (Sullivan, 2009).

Despite this relative safety; however, it is important to remember that with any investment, there are both benefits and risks to the investor. This paper next turns to an overview of the positive and negative aspects of money markets.

The Benefits of a Money Market

Money markets exist for the purposes of borrowing and lending. In light of this fact, any investment into a money market must be expected to provide conservative returns.

In an average or bull market (a period in which investment...

(The entire section is 3920 words.)