The Money Market
Before finding out what are the top money market funds, one should try to understand the definition of this class of securities and why they exist. They are in fact quite different from mutual funds of stocks, commodity mutual funds or anything the average investor thinks of.
The money market is the name for the component of the financial market engaged in the trade of assets associated with very short term loans (less than one year and more than 90 days). The participants of the markets, sellers and buyers include but are not limited to financial institutions, individuals, and companies.
Types Of Securities In A Money Market
What exactly do these individuals trade? They trade securities that include Treasury bills, bankers' acceptances, certificates of deposit, federal funds, and short-lived mortgage- and asset-backed securities. But the most important component may be commercial paper. That is a fancy name for uncollateralized loans made from financiers to companies with extremely high credit ratings.
An Example: Company 'A'
For example, Company A is a company with high credit ratings so is believed to be extremely trustworthy, willing and able to repay their debts. But Company A turns over a lot of money in short periods of time. At the end of the month they must make pay roll, handing out to every employee a paycheck. Such an amount can run into tens of millions of dollars. Company A does not have much cash on hand, most of it is locked up in accounts receivables, assets, manufactured stocks of goods, etc.
Company A Borrows Money
Therefore in order to make pay roll Company A decides to use its good reputation and credit to borrow a large sum. They do this by basically issuing what is called a "promissory note", a very fancy word for what is basically an I.O.U. To entice buyers (or lenders) they may discount the purchase price of the I.O.U. or pay a commensurate interest rate. After all no one wants to buy an I.O.U. or lend money with no potential for pay off. Interested financiers hand over money to Company A and pick up the promissory note. The promissory note is a promise to pay back the money within a specified time period, which ends at the maturity date.
A Sample Transaction
Here is an example. Company A needs to borrow $1 million dollars. It issues a promissory note onto the commercial paper or money market for the value of $1,010,000 maturing in 90 days. It costs $1 million to get the promissory note. A financier decides that lending to Company A is a good deal so forks over $1 million and gets the note. Now two things may happen. The financier may at the end of 90 days head back to Company A and ask for the $1,010,000. If they do so, they pocket $10,000 profit which if calculated over 90 days represents a 1% gain or a 4% annualized profit.
Selling To A Third Party
But the second option is that the financier may be impatient or wish to unload the note for cash. So before the 90 days is up, the financier sells the promissory note off to a third party who is equally interested in such debt. Thus the commercial paper market or money market was born. Now you may look into buying mutual funds in the money market rather than sticking to just large cap mutual funds.