What do we mean by the money market?
Short-term financial assets with a liquidity of one year or less can be exchanged on stock exchanges and these kinds of assets are popular as money market instruments. These money market instruments are highly liquid.
The money market creates a perfect opportunity for those investors who are looking to invest their money in the short-term (less than a year) and organizations that issue the money market instruments also gain from it by receiving emergency funds from the investors. Banks, significant institutional investors, and retail investors are frequent players in this financial sector.
Both the NSE and BSE stock exchanges support money markets to trade a wide range of instruments. These include treasury bills, commercial paper, certificates of deposit and repurchase agreements. The money market is seen as a secure location to invest since the securities being exchanged are very liquid in nature.
The Reserve Bank regulates the interest rates on a variety of financial products including money market instruments. The money market has lower levels of risk due to the fact that the majority of the instruments have a maturity period of a maximum of one year or less. As a result, there is little chance of default.
Many consumers and corporations utilize money markets as short-term investments for their cash reserves since they possess low risk.
Investing in Money Market Funds
Securities for the money market often have maturities of less than a year. The securities’ short-term nature helps to lower risk and uncertainty. A fund manager makes the choice of money market investments, taking into account the type of money market fund.
Income from money market mutual funds often comes in the form of dividends, which can either be taxable or tax-exempt depending on the type of securities that were purchased by the fund. Due to the funds’ liquidity and adaptability, businesses may utilize them as a cash management tool, which accounts for their appeal.
Minors risks associated with money market instruments
Often high liquidity fees are applicable
High liquidity costs, or charges assessed on the selling of shares, are imposed by money market instruments. Redemption gates, which often prevent runs on funds during times of market stress, impose prior authorization before returning profits from money market funds.
There is a credit risk involved
The likelihood of not losing money, however remote, is not guaranteed since money market assets are volatile and not FDIC-insured. There is a chance of losing, but it is often quite minimal. Investors should note that there is no assurance they will get the exact amount per share when they redeem their shares.
Foreign influence on the assets
Funds that invest internationally in money market instruments that are priced in currencies other than their home currency bear the risk of getting influenced by the foreign currency market.
Political or economic changes
Changes in government rules and economic policies, such as those that affect the money supply and interest rates, may have a negative effect on the price of money market instruments and the financial health of their issuers.
Returns are comparatively low
Money market funds often offer lower returns than other funds that invest in assets like stocks and real estate. There is a danger that money market returns may also decline below the rate of inflation, giving investors negative real returns (inflation risk). Further declines in interest rates would mean lower money market investment returns.
How to mitigate the involved risk in the money market
Here is how you can reduce the risk of money market instruments:
- The money market is governed by the RBI and it subsequently aids in controlling the economy’s level of liquidity. Therefore, investing in Indian money market instruments is much safer.
- You can certainly invest in money market instruments issued by banks and other reputable financial organizations to make your money more secure. Due to the short duration of the assets in the money market, lenders will also benefit from liquidity.
- You can also diversify your investment portfolio by investing in the Indian money market. It also helps lenders to effectively invest their idle cash, as a result, both the investor and the borrower profit in this fashion.
- Also before investing in any particular money market instrument you should research its potential risks and know your risk tolerance limit before investing in the same.
Limitations of money market instruments
Although money market instruments have very low-interest rates it simultaneously offers a risk-free rate of return. As a result, in comparison to risky assets like bonds or equities, they won’t provide significant capital gains or investment growth. Additionally, you may lock your money in some money market instruments, such as CDs, until they mature, which might take months or years.
One of the safest methods to invest money for a short amount of time and gain significant returns is through money market instruments. Although these money market instruments may sometimes yield returns that are even lower than the current inflation, nevertheless it is better than any kind of high-risk investments.