All you wanted to know about Money Market Funds

What is money market fund?

Money market funds are debt mutual fund schemes which invest in money market instruments with maturities of up to 1 year. These funds have low to moderately low interest rate risk and suitable for investment tenures of 1 – 2 years. In this article we will discuss about money market funds and whether they are suitable investment options for you.

What are money market instruments?

Money market instruments are short term debt instruments which have maturities of less than 1 year. Money market instruments are issued at discounts to face value depending on the yield of the instrument. For example, if the face value of a 1 year money market instrument is Rs 100 and its yield is 6%, then the paper will be issued at Rs 94 and the investor will get Rs 100 on maturity. Money market instruments are highly liquid instruments. These instruments mature within 1 day to 1 year. These instruments are sometimes known as cash-equivalents because they can be alternative to cash; hence the name money market.

Suggested reading: Role of fixed income in your financial plan

What are different types of money market instruments?

Money market instruments are issued by the Government, Financial Institutions and companies. These instruments are issued to meet the short term financing needs of the issuer. The most common type of money market instruments are as follows:-

• Repurchase agreements (Repo): Repurchase agreements or repo is an agreement, whereby the borrower (issuer) sells securities (primarily G-Secs) to the lender (investor) with an agreement to repurchase the securities on a certain date and at a certain price. The buying and selling prices are based on the implied yield of the instrument. You can think of Repo as secured loan because the lender (investor) can keep the securities if the borrower (issuer) defaults. The collateral securities are usually G-Secs; so there is no credit risk.


• Tri-party Repos (TREPs): Tri-party ReposorTREPs is a type of repurchase agreement (repo), which includes a third party (called Tri-party agents) whichacts as an intermediary between the two parties to the repo to facilitate services like collateral selection, payment and settlement, custody and management during the life of the transaction. In India, Clearing Corporation of India Limited acts as the Tri-party agent. All TREPs are settled on T+1 basis (i.e. 1 day maturity); hence they are also known as overnight securities. CCIL requires the collateral / securities involved in TREPs transactions to be in the form of G-Secs; so there is no credit risk.


• Treasury Bills (T-Bills): Treasury Bills or T-Bills are issued by the Central Government to meet the short term obligations of the Government. The T-Bills are issued at discount to face value and the investor gets the face value on maturity. The yields of T-Bills depend on the prevailing interest rates and market yields. At present, the Government of India issues four types of T-Bills, namely, 14-day, 91-day, 182-day and 364-day. Since T-Bills are issued by the Government, they have sovereign status; hence there is no credit risk.


• Certificates of Deposits (CDs): Certificates of Deposits (CDs) is a money market instrument issued by scheduled commercial banks and financial institutions. These instruments are issued at discount to face value and you will get an assured amount at maturity. CDs are regulated by the RBI. CDs are in Demat form; they can be traded in OTC (over the counter) market or stock exchanges with the approval of RBI. CDs are very similar to your bank FDs, except that you can buy / sell your CDs in OTC market or stock exchanges. Since you get the assured principal amount on maturity, credit risk is usually low in CDs.


• Commercial Papers (CPs): Commercial Papers are short term debt instruments issued by companies for their working capital or their short term obligations. Like CDs, commercial papers are issued at discount to face value. Commercial papers have a minimum maturity of seven days and a maximum of up to one year from the date of issue. However, the maturity date of the instrument should typically not go beyond the date up to which the credit rating of the issuer is valid.Yields of commercial papers are usually higher than yields on certificates of deposit of similar maturities. Commercial papers are subject to credit risks.

Yields of money market funds

The yield curve (yields for different maturities) of fixed income securities is usually upward shaping i.e. bonds of longer maturity / durations give higher yields than bonds of shorter durations. As such, money market funds have the potential of giving higher returns than liquid and ultra-short duration funds because money market funds can invest in instruments having maturity of up to 1 year, whereas liquid funds and ultra-short duration funds invest in securities which mature much sooner.

What are the risks in money market funds?

There are two kinds of risk in debt funds:-

• Interest Rate Risk: Price of money market instruments has an inverse relationship with interest rates. If interest rates go up, prices decrease and vice versa. The interest rate sensitivity (i.e. impact of interest rate changes on prices) of money market instruments depends on the maturity or duration of the instrument. Longer maturity or duration instruments are more sensitive to interest rate changes. Since money market funds invest in instruments with maximum maturity of 1 year, the interest rate risk is moderately low. However, money market funds can be more volatile than overnight and liquid funds.


• Credit risk: Credit risk refers to the risk of the issuer failing to fulfil its interest and / or principal payment obligations, exposing the investor to potential loss of income and / or capital. Money market instruments like TREPs, T-Bills etc have no credit risk but papers issued by private issuers are subject to credit risk. Among the different types of money market instruments commercial papers have higher credit risk. Credit rating agencies assign ratings to commercial papers. Higher the credit rating, lower the credit risk. You should look at the credit quality of the portfolio of your money market scheme and make informed investment decisions.

Should you invest in money market funds in the current interest rate environments?

Interest rates have been rising as the RBI aims to rein in inflation. The RBI has already increased interest rates by 150 bps till date (as on 19^th August 2022). The RBI Governor has indicated that further rate hikes are likely since inflation is still on the higher side. Rise in interest rates have been pushing short term yields higher. The yield of the 91 day T-Bill is 5.59%, while yields of the 182 and 364 day T-Bills are 5.96% and 6.26% (source: RBI, August 12). Higher short term yields make money market funds more attractive investment options for investors with 1 – 2 year investment tenures compared to traditional fixed income investments like FDs; money market yields are significantly higher the FD interest rates of 1 – 2 year term deposits of leading public and private sector banks. Furthermore, in a rising interest rate environment, money markets funds can re-invest the maturity proceeds of maturing instruments at higher yields. This can increase your returns.

You may also like to read a related topic: Should you invest in ultra-short duration funds

Who should invest in money market funds?

• Investors looking for income over short investment tenures (minimum 1 year).


• Investors with low to moderately low risk appetites.


• Investors with 1 – 2 year investment tenures.


• Investors looking to invest in equity funds through STP can park their lump sum funds in money market funds as the source fund of the STP.

You should look at the credit quality of the scheme before investing. Schemes investing in lower rated papers may give higher returns but will be subject to higher credit risks. You should invest according to your risk appetite and should consult your financial advisor or mutual fund distributors, if money market funds are suitable for your investment needs.