Question

Unlike a normal mutual fund (MF) that holds a portfolio of stocks, a money market mutual fund (MMMF) holds a portfolio of money market instruments like Treasury Bills, highly rated commercial paper, and overnight repo agreements. Explain why the MMMF choses to hold the money market instruments rather than stocks.

Answer 1

Answer:-

The mutual funds invest money in stocks and bonds which are highly volatile and risky. Money market mutual funds (MMMF) are considered to be less risky than the stocks and bonds issued in the market. This is because MMMF'S are less-riskier vehicles such as the certificate of deposits, treasury bills, short-term debt securities, short-term commercial papers and overnight repo agreements.

MMMF's are suitable for retail low-income investors and has been proved to be the safest investment. The assets in a money market fund are invested in safe and stable instruments of investment. Such instruments are issued by governments, banks, and corporations.They are highly liquid and the maturity period is less than a year.

The MMMF's give returns higher than the bank deposits and are not subjected to market volatility. The investments in MMMF's do not have lock in periods, not subjected to fees for managing the fund and no dilution of principal at the stake of diversification unlike mutual funds. MMMF's have surplus cash and earns higher post-tax returns with a reasonable degree of safety for the principal amount.

Due to the high certainty of the principal amount and returns higher than bank deposits the MMMF's are suitable to small retail investors who can park their money in these funds instead of depositing in banks.