Money Market Funds

Money Market FundsDefinition: Money markets refer to money market mutual funds, which invest only in low-risk securities such as government securities, certificates of deposit, or commercial paper of companies. For that reason, they are usually considered very low risk. Since they are low risk, and they generally invest in short-term securities, they pay very low dividends or interest that usually reflects short-term interest rates.

Unlike mutual funds that are invested in stocks, money market funds usually try to keep the net asset value of (NAV) of each share at a dollar. Therefore, the value of the money market fund is dependent on the yield or interest rate, which does vary. It is very rare for the NAV to fall below a dollar, called breaking the buck, but it can happen if the investments do poorly.

This is what happened on September 16, 2008, to the $62 billion Reserve Primary Fund, the nation's oldest money market fund. The money market had invested in Lehman Brothers short-term debt, and when that investment bank went bankrupt, Reserves NAV dropped to 97 cents. Since it was first money fund in 14 years to break the buck, it caused panicked investors to withdraw $139 billion out of money market funds in the next two days, according to IMoneyNet.

As a result, on September 19, 2008, the Treasury Department stepped in to guarantee money market funds. This run on money market funds made Treasury Secretary Henry Paulson realize that credit markets were shutting down, and he needed to submit the $700 billion bailout bill to Congress. On October 21, the Federal Reserve agreed to buy assets from money market funds who needed cash to pay for redemptions. (Source: SEC, Money Market Funds)
Also Known As: Short term debt funds