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Basics of Investing: Money Market Securities

What it is

The Money Market, despite its name, does not trade in currencies.

Rather, it trades in low-risk, highly liquid, short term debt instruments issued by governments, financial institutions and corporations. The maturities of these securities range from one day to one year, but are often less than 90 days.

Money market securities comprise of Treasury bills, Commercial Papers (CPs), negotiable Certificates of Deposits (CDs) and repurchase agreements.

How it works

Generally, money market instruments work on the principle of 'discount'. For example, a RBI Treasury Bill with 90 days left to maturity may have a face value of Rs. 100,000, but is selling in the money market at Rs. 98,500. If you buy it at this price, all you have to do is wait 90 days, and you can redeem this note from the RBI for Rs. 100,000, and pocket the profit of Rs. 1,500. (Rs. 1,500 out of an investment of Rs.98,500 over 90 days is a return of about 6% per annum).

A large corporation, or a bank, can also issue something similar. These are referred to as Commercial Papers (CPs), and are traded in the money markets using the same principle of discount (ie., they promise to pay a fixed price at specified time, but sell at a slightly lower price in the money market).

Money market securities are considered very low risk. RBI Treasury Bills (T-Bills), which are guaranteed by the RBI, are practically default free. The 'discount rate' of these T-Bills, (in our above example, 6%), is usually used as the proxy for the 'risk-free' rate of return. This is the rate which financiers use in their calculation of returns to their investments (other investment instruments have to give returns higher than this rate, or else investors might as well buy the guaranteed T-bills).

Debt notes issued by corporations or banks and traded in the money markets are often with high quality, and the default rate is usually very low.

How to invest

Unfortunately, most money markets cater to institutional investors and are not accessible to retail investors. The only way to participate is to buy a money market mutual fund. (Here, at Fundsupermart.com, you might want to check out the mutual funds listed under ‘Debt’ fund category and ‘Liquid’ fund class as well, because most of these mutual funds participate in the money market quite actively).

You will find that most of these mutual funds have performed very consistently, returning 7% to 10% annually.

Money market mutual funds are great for investors who are risk averse. Investors who are thinking of taking money out of their fixed deposits and investing in mutual funds might find that money market mutual funds are a great way to start because of their low risk nature.

Even for investors who are familiar with mutual funds, most experts recommend that some portion of their investment portfolios should comprise of money market instruments for stability and liquidity. In case you need some emergency cash, you can redeem your money market mutual funds with very rare instances of loss to capital.

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