What is the money market? A financial exchange where companies trade loans, and investors can earn interest on their savings

• The money market is a financial exchange where banks and companies buy and sell short-term debt securities.
• Money market investments like T-bills and CDs are safe and very liquid, paying reliable interest.
• Money market accounts and money market funds are common ways that individuals can invest in the market.

Money market accounts and money market funds are common investments: Odds are you've often seen them advertised by banks or financial services companies.

But did you ever wonder what precisely the "money market" itself is?

The money market is a financial exchange, an informal, electronically linked network of banks, brokerages, and dealers. These institutions come together to lend and borrow money for short periods of time - anywhere from one night to one year.

Let's look more closely at how the money market works, what sort of investments it involves, and how individual investors can participate in it.

What is the money market?

The money market is a section of the financial market where highly liquid, short-term debt securities are created, bought, and sold. Borrowers tap the money market for their immediate financial needs and to fund their day-to-day operations. Lenders, on the other hand, use the money market so their spare cash can earn interest instead of sitting idly in a vault.

Every nation has its own money market. Nearly 200 financial institutions participate in the US money market, which has one of the largest volumes of daily transactions in the world, totaling nearly $1 trillion. As of May 2020, the value of the US total assets in money markets was approximately $4.77 trillion.

What does the money market do?

In the realm of global finance, the money market serves several functions.

• It maintains a balance in the supply and demand by keeping a constant cash flow in the market.
• It stimulates economic growth by making money available to small-scale industries and giant corporations alike.
• It guides central banks, like the Federal Reserve, in implementing appropriate interest rate policies and monetary policies by presenting prevailing conditions in the banking industry.
• It promotes self-sufficiency by ensuring that banks and companies maintain a sustainable level of liquid reserves on a daily basis, without falling short and needing more expensive loans to get by.
• It supports the government sector for both national and international trade by providing a good place to park surplus funds until future use.

What are examples of money market instruments?

A variety of different financial assets are bought and sold in the money market. Basically, they are all different sorts of debt, loans packaged in different ways.

The most common money market instruments include:

• Treasury bills are issued by the US government - like a bond, only with a very brief lifespan. They mature in either 1, 3, 6, or 12 months.
• Certificates of deposit (CDs) are issued directly by a commercial bank, insured by the Federal Deposit Insurance Corporation (FDIC), and offered in any denomination. They mature within 3 months to 5 years.
• Commercial paper is issued by large, high-credit rating corporations who are borrowing to finance immediate cash flow needs, like inventory and accounts payables. Its maturity date falls between 1 to 9 months.
• Banker's acceptances are also issued by companies but guaranteed by a bank. They are often used in international trade. Their maturity period starts at 1 month and peaks at 6 months.
• Repurchase agreements or "repos" involve selling a security (usually Treasury bills) with an agreement of buying it back at a later date, at a higher price. A repo's maturity period stretches from overnight to 30 days.

How individuals can invest in the money market

Although some of the individual assets traded in the money market are available to individuals, like CDs, most are designed for institutions and companies - the wholesale market. But the money market has financial instruments specifically designed for individual investors, too - the retail market.

These are funds or accounts that invest in individual money market assets. They fall into two basic types:

• Money market accounts
• Money market funds

What is a money market account?

A money market account is a deposit account offered by banks and credit unions. Like a savings account, it is a place to park funds, or to keep as an emergency stash. But unlike a savings account, a money market account gives you more access to your funds by allowing you to withdraw with an ATM card and write checks.

It also offers a higher interest rate than a savings account. While the US' national average interest rate for savings accounts is 0.05% APY, according to the FDIC, the average bank interest rate for money market accounts is 0.07 to 0.12% APY. And some pay much higher.

A money market account limits your number of withdrawals and bank transfers, and you'll need to maintain a certain balance. If you're interested in opening a money market account, a minimum deposit of $5 to $5,000 is required.

Like other bank accounts, money market accounts are insured by either the FDIC or the National Credit Union Administration (NCUA). That guarantees you'll be reimbursed, up to $250,000 in the unfortunate event the financial institution shuts down.

What is a money market fund?

A money market fund is a mutual fund offered by investment companies and financial services firms. It is an income-oriented investment, offering a return based on the interest from the short-term debt securities it holds.

Unlike a money market account, a money market fund is not backed by the FDIC or the NCUA - it is an investment product, not a bank depository product. But it makes up for it by providing a steady, low-risk return on your cash.

In comparing money market funds, look for one that offers a positive yield combined with a low expense ratio. Some examples include:

• Vanguard Treasury Money Market Fund, with an expense ratio of 0.09%, and a 0.04% 7-day yield.
• Schwab Value Advantage Money Fund, which has a 0.34% expense ratio, and a yield of 0.03%.
• Fidelity Investments Money Market Fund with an expense ratio of 0.31%, and a 0.01% yield.

Money market fund minimums vary, from zero to several thousand dollars. Usually, they're the same as the requirements for other funds offered by the investment company or financial services firm.

Why invest in money market funds and accounts?

Money market funds and accounts are considered highly safe vehicles, ones you can easily transfer money in and out of. Money market funds and accounts can serve several purposes:

• store a windfall or serve as an emergency fund
• bring some diversification into your financial portfolio
• act as a place to park cash until you find another investment - one offering growth or appreciation

Think of money market vehicles as cash with benefits - the benefits being the low but steady interest income they provide. They are highly liquid, mirroring the short-term debt they invest in. Because these debt assets are so short-term - the loans ranging from overnight to one year - they are considered pretty low-risk, and highly liquid (easy to sell).

The financial takeaway

The money market is of the financial system. On the institutional or wholesale level, it involves the trading of short-term debt - things like US Treasury bills, commercial paper, banker's acceptances, and other instruments - between established commercial and investment banks, brokerages, and corporations.

At first glance, the money market comes off as a professionals' financial arena reserved only for the big institutional players and financial pros. But individual, or retail investors, can also participate in it, via money market mutual funds and bank accounts.

In doing so, they get a safe place to park their cash, and even earn a little interest on it. Money market funds and accounts don't offer the highest yields, but that's the trade-off for their convenience and reliability.

Related Coverage in Investing:

Bonds vs. CDs: The key differences and how to decide which income-producing option is better for you

A corporate bond provides companies with cash and investors with income - here's how to evaluate the risks and rewards

Fixed-income investing is a strategy that focuses on low-risk investments paying a reliable return

The key differences between a money market account and a money market fund, and how they each serve different financial needs

What are liquid assets? A guide to the investments that are easiest to cash in, and why they're important