What are money markets?
Money markets are regulated markets specifically designed to provide investment or liquidity in the short term: typically from the business day (so-called 'overnight' deposits) to periods not exceeding twelve to eighteen months. It is often referred to as a fundamental component of financial markets, for two reasons: first, because of the liquidity it provides to traders, and second, because of the possibility of exploiting excess liquidity. As can be seen in Britannica Money's money market entry, the most relevant segment of this market is the interbank market.
Money market products
The financial products bought there are therefore, on average, safe and liquid. Here are some of the most typical: bank deposits, which are not securities; repurchase agreements; government bonds with annual maturities; and certificates of deposit, which, as the International Monetary Fund also explains, can sometimes be traded as securities. The most typical money market investment instruments are, of course, mutual funds, whose portfolio consists of a basket of money market securities.
The advantages of money market investments
The advantages of money market investments include the following
- Liquidity and low risk. This is made possible by the fact that these instruments are usually issued by companies with a high credit rating, by banks (often subject to certain capital requirements) or by public authorities, as in the case of government bonds.
- A short-term refuge for cash. The safety and liquidity of money market products make it easy to withdraw your investment quickly while limiting the risk of capital loss; they are therefore often chosen by investors for short-term liquidity management.
- Safe havens for investments. Investing in the money markets is generally risk-free, all the more so when one considers what happens in other financial market segments characterised by high volatility; the capital invested is paid back little, but rather steadily. From the point of view of portfolio diversification, an investment in the money market can therefore act as an anchor for the value of portfolios, especially in times of greater market turbulence.
Disadvantages of money market investments
Investing in money markets also involves risks, which we list below.
- Interest rate risk. The monetary policy of central banks, especially when it is reflected in changes in interest rates, affects the money market.
- Negative real returns. The security that characterises money market investments can become a risk when we consider those levels of investment returns that do not exceed the rate of inflation: in this case, we speak of negative real returns, i.e. the risk that an investment portfolio will not be able to achieve its return objective.
- Credit risk. Although limited, the possibility of an issuer becoming insolvent is a risk that not only cannot be completely ruled out, but is also an important (not remote, in short) feature of certain areas of the money market.
See also
What are financial markets?
