A money market fund is essentially a mutual fund that invests in low-risk securities. However, it's important not to get money market funds confused with money market deposit accounts. The FDIC insures money market deposit accounts but not money market funds. The main components of a money market fund are the quality of its investments and its liquidity, investment diversity and investment length. Money market funds strive to keep their net-asset value at $1.00 per share with a fluctuating yield.
By law, money market funds must invest in low-risk securities. This translates into high-credit rated securities. For example, money market funds typically invest in government securities, CDs and commercial paper of first tier securities. Additionally, 97 percent of a money market fund’s assets must get invested in these first tier securities. In most cases these securities must receive top ratings from two nationally-recognized statistical rating organizations such as Moody’s, Standard and Poor’s or Dominion Bond Rating Service Limited.
Money market funds must maintain high levels of liquidity. In order to do that, a certain percentage of their assets must remain in cash, U.S. Treasuries, other government securities, or securities that mature and can get cashed out in one to five business days. All money market funds must maintain 30 percent of their assets in investments that can be made liquid within five business days; or in investments that take 60 days or less to mature if they are government securities. In addition, if a fund is taxable it must maintain 10 percent of its assets in investments it can make liquid on a daily basis. Now that’s some serious pressure.
Money market funds cannot put too many eggs in one basket. Federal regulations require that a money market fund have no more than 5 percent of its assets tied up in any single issuer. Like most things, that rule gets bent when it comes to the federal government. Exceptions exist for some government agencies and other securities. Also, if a security falls into the second tier category of investments, a money market fund can only invest 0.5 percent of its total assets with that security’s company.
By nature, money market funds invest in short-term securities products. A money market fund cannot invest in a security that has more than 397 days left to mature. Plus, there’s a weighted-average maturity scale that takes into account the average maturity of all of the portfolio’s securities, weighted by each security’s percentage of net assets. When calculated, the weighted average maturity can’t surpass either 60 or 120 days, depending on the investment.
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