Characteristics of Money Market

Question 1

money market instruments are generally sold in large denominations

Answer 1

First, money market instruments are generally sold in large denominations (often in units of $1 million to $10 million). Most money market participants want or need to borrow large amounts of cash, so that transactions costs are low relative to the interest paid. The size of these initial transactions prohibits most individual investors from investing directly in money market securities. Rather, individuals generally invest in money market securities indirectly, with the help of financial institutions such as money market mutual funds.

Question 2

money market securities have low default risk;

Answer 2

Second, money market securities have low default risk; the risk of late or nonpayment of principal and/or interest is generally small. Since cash lent in the money markets must be available for a quick return to the lender, money market instruments can generally be issued only by high-quality borrowers with little risk of default.

Question 3

money market securities must have an original maturity of one year or less.

Answer 3

Finally, money market securities must have an original maturity of one year or less. The longer the maturity of debt security, the greater is its interest rate risk and the higher its required rate of return. Given that adverse price movements resulting from interest rate changes are smaller for short term securities, the short term maturity of money market instruments helps lower the risk that interest rate changes will significantly affect the security’s market value and price.