Money Market Funds Invest Primarily In Foreign Currency

Mutual Funds, Insurance, and Pension Funds

Rajesh Kumar , in Strategies of Banks and Other Financial Institutions, 2014

8.1.9.3 Money market funds

A money market fund is an open-ended fund that invests in short-term fixed-income securities such as US Treasury bills and commercial papers. Money market funds seek to limit exposure to losses from credit, market, and liquidity risks. Money market funds aim to maintain a stable value of $1 per share. In 2011, according to the ICI Fact Book, there were 632 money market funds in operation with total assets of nearly US $2.7 trillion. Money market funds consist of institutional money funds and retail money funds. Institutional money funds are marketed to corporations and government bodies. These funds are characterized by high minimum investment and low-expense share classes. The largest institutional money market fund is the JPMorgan Prime Money Market Fund with over $100 billion in assets. Retail money funds are offered to individuals and exist in the form of government-only funds, nongovernment funds, and tax-free funds. The largest money market mutual fund is Fidelity Investments Cash Reserves with assets exceeding US $110 billion. Safety and liquidity are the most important advantages of the money market funds.

Ultrashort bond funds are mutual funds, similar to money market funds, that invest in bonds with extremely short maturities. Money market funds consist of retail money market funds and institutional money market funds. Institutional money market funds are used by businesses, pension funds, state and local governments, and large account investors.

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Indices and the Construction of Benchmarks

Bernd R. Fischer , Russ Wermers , in Performance Evaluation and Attribution of Security Portfolios, 2013

11.4 Money Market Indices

Money market funds are investment funds which invest primarily in term deposits and very short-dated bonds. The benchmarks used for these funds are therefore based on the reference interest rates for the money market.

Example 11.8 EONIA, EURIBOR, and LIBOR indices, eb.rexx Money Market

a.: Every day, a group of so-called panel banks report data (total volume, weighted average lending rate) on their overnight unsecured lending transactions in the interbank market to the European Central Bank. EONIA (Euro Overnight Index Average) is then computed by the ECB as the average of these overnight lending rates ⁴³ weighted by the respective transaction volumes.
b.: The same panel banks which quote for EONIA also report daily quotes of the rate that each panel bank believes one prime bank is quoting to another prime bank for interbank term deposits within the euro zone. The maturity spectrum covers one, two and three weeks as well as the twelve maturities from one to twelve months. The EURIBOR (Euro Interbank Offered Rate) for each maturity is calculated as the equal weighted average of the bank quotes, after eliminating the highest and lowest 15% of these quotes. ⁴⁴ The so-called EURIBID (Euro Interbank Bid Rate) is a reference rate which is not officially published but often used in practice. It is calculated by subtracting a specifically chosen cost charge from EURIBOR (e.g. EURIBOR – 20 bps ⁴⁵ ) and may be interpreted as the interest rate at which a bank is willing to borrow from other banks.
c.: LIBOR ⁴⁶ may be regarded as the counterpart to EURIBOR. LIBOR (London Interbank Offered Rate) is the average interest rate offered by several commercial banks in the London interbank market. It is calculated for ten currencies (e.g. EUR, USD, JPY). The panel banks are chosen individually for each currency. Maturities include one day (overnight), one and two weeks, as well as one to twelve months. Like EURIBID, LIBID (London Interbank Bid Rate) is calculated in practice by subtracting an appropriate cost charge from LIBOR.
d.: Besides the above-mentioned bond indices, Deutsche Börse calculates the money market index eb.rexx Money Market, which includes highly liquid German government bonds. Eligible bonds must have a maturity between one month and one year and an amount outstanding of at least EUR 4 billion. The bonds are market capitalization-weighted, with a maximum weight of 30 percent.

Unlike their equity and bond market counterparts, money market benchmarks are initially given only in terms of interests (Figure 11.5). Therefore, the interest rate series needs to be transformed into a performance series to obtain an index which can be compared with the share price series of a portfolio. For that purpose, a given base value (e.g. 100) is compounded with the one-day interest rates resulting from the interest rate series. In doing so, the applicable interest rate conventions have to be taken into account (Figure 11.6). ⁴⁷

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Cases on Investment Management Companies

Rajesh Kumar , in Strategies of Banks and Other Financial Institutions, 2014

4.2.1.1 Money market mutual funds

The Vanguard Admiral Treasury Money Market Fund is a conservative investment option offered by Vanguard that invests in US Treasury securities. The fund maintains a share price of $1 and the strategic objective is to provide current income to investors. The income received by shareholders depends on the current interest rate environment.

The Vanguard California Tax-Exempt Money Market Fund is designed only for California residents and seeks to provide federal and California State tax-exempt income and preserve shareholders' principal investment by maintaining a share price of $1. This fund is considered one of the most conservative investment options offered by Vanguard. Although the fund invests in short-term, high-quality securities, the amount of income that shareholders may receive is largely dependent on the current interest rate environment and the availability of eligible California municipal securities. Investors in a higher tax bracket who have a short-term savings goal and seek a competitive tax-free yield may wish to consider this option.

The Vanguard Federal Money Market Fund and Vanguard New Jersey Tax-Exempt Money Market Fund in US government securities are also conservative Vanguard investment options.

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Caps/Floors and Swaptions with an Application to Mortgages

Salih N. Neftci , in Principles of Financial Engineering (Second Edition), 2008

Reading 2

This reading refers to Part II of the case study.

Dynamic funds eye dislocation opportunities

With short-term yields continuing to fall across Europe, money market funds are increasingly targeting higher yields through structured products. Generally, they are lifting returns by selling volatility through corridor structures. (1) More specifically, they are taking advantage of hedge fund-induced market dislocations in Danish mortgage markets and sterling swap spread markets. „In the last few weeks funds have substituted a little credit risk for a bit more market risk" said one market professional at a major European bank. He added that funds saw the increasing confidence in financial markets as an opportunity to generate higher yields from market dislocations.

In particular dealers said funds were looking to buy Danish mortgage bonds together with balance-protected swaps (2). The balance-protected swap guarantees the bond buyer the coupons but still leaves the holder with duration risk—the risk that the instrument will have a shorter duration if prepayment increases. With unswapped Danish mortgage bonds, the holder is exposed to the risk that prepayment rates increase and that coupons levels are reduced.

In addition to specific dislocation-related trades (3), market professionals said there was a general trend for funds to move away from standard commercial paper and asset-swap investments towards higher-returning, more structured products. Whereas traditional funds buy floating-rate instruments and are only exposed to the credit risk of the instrument, dynamic money market funds buy instruments that are exposed to interest rate and volatility risks.

One structurer last week said the dynamic fund sector had been growing for some time, and added that some European funds had more funds under management in dynamic instruments than traditional instruments. „There's lots of excitement surrounding money market funds and their attempts to churn yield," he said.

Typical dynamic money market fund trades are corridors, (4) with popular recent trades being based on two Libor rates remaining within the band. One bank structurer said he had recently traded a note that offered higher coupons, provided both US dollar Libor and French franc Libor remained within set limits. Capital repayment was guaranteed, but coupon payments were contingent. By buying structures such as these, funds are in effect going short Libor volatility and using the earned premium to enhance their received coupon levels. (5) The size of the enhanced coupon typically depends on the width of the corridor, with extra yields of up to 200 bp generated by a tight corridor and additional yields of around 50 bp delivered by a wider corridor. Dealers said funds preferred to be more cautious and favored the wider corridor, lower yield products.

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Household Finance: An Emerging Field

Luigi Guiso , Paolo Sodini , in Handbook of the Economics of Finance, 2013

A.1 Definitions of Variables in the 2007 Wave of the SCF

Pension Savings: retirement savings

Current Savings: all savings that are not pension savings

Cash , current savings in, checking accounts, money market and savings accounts, money market funds, cash and call accounts at brokerages, certificates of deposits, treasuries, cash n.e.c.

Fixed Income Instruments: current savings in, directly held bonds apart from treasuries, bonds held in non-pension annuities (annuities not purchased using settlements from pension accounts), bonds held in trust and managed accounts, bond funds apart from treasuries, 50% balanced funds

Directly Held Equity: current savings directly held in equity (stocks)

Indirectly held equity, current savings held in equity through mutual funds, non-pension annuities, and trust or managed accounts, 50% of balanced funds

Cash Value Life Insurance: Current liquidation value of life insurance policies that build up a cash value. These are sometimes called "whole life", "straight life", or "universal life" policies. They are different from traditional "term" policies which instead pay a claim only upon early premature death.

Pension Fixed Income: pension savings in retirement accounts and pension annuities held directly or indirectly in fixed income instruments

Pension equity, pension savings in retirement accounts and pension annuities held directly or indirectly in equity

Other Financial Wealth: other pension savings and other non-pension annuities, other trust and managed investment accounts, futures contracts, stock options, derivatives, oil/mineral/gas leases, or other land leases, loans and debts owed to the household, deferred compensation, etc.,

Primary Residence: own house, lot, apartment, farm, ranch, and parts of condo, co-op, townhouse association. The category also includes mobile homes and their sites as well as the part of the ranch that is not used for business purposes

Investment in Real Estate: residential and non-residential real estate which is not a part of the primary residence and that is not owned by a business

Other Real Estate: artworks, precious metals, jewelry, antiques, coin collections, etc.

Vehicles: all types of vehicles including motor homes (that are not primary residence), boats, airplanes, etc.

Business Wealth: net equity in all kinds of privately owned businesses, limited partnerships, and corporations that are not publicly traded. The value of the part of the farm or ranch that is used for business less associated debt is also included

Credit Card Debt: outstanding balance after the last payment was made on general purpose cards, bank-type cards, store, gasoline cards, etc.

Consumer Debt: vehicle loans, other installment loans, lines of credit other than home equity, loans against pension and life insurance, loans made for home improvements that are not collateralized by real estate

Mortgages: mortgages on primary residence, other real estate, other loans using property as collateral, or home equity lines of credit, land contracts

Student Debt: loans for education attainment

Other debt, margin loans and other debt not recorded earlier

Financial Investment: pension and current fixed income instruments, pension and current directly and indirectly held equity, cash value life insurance, other trusts, and managed investment accounts, other pension savings, and pension and non-pension annuities

Current gross Financial Wealth: cash, fixed income instruments, directly and indirectly held equity, other financial assets

Retirement Wealth: pension fixed income and pension equity, other pension wealth

Total Gross Financial Wealth: current gross financial wealth plus retirement wealth

Gross Real Estate: primary residence, investment in real estate, other real estate

Gross Real Wealth: gross real estate, business wealth, vehicles

Total Gross Wealth: total gross financial wealth, gross real wealth

Total Debt: credit card, consumer and student debt, mortgages

Net Wealth Measures: gross wealth measures minus total debt

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The Behavior of Individual Online Investors Before and After the 2007 Financial Crisis: Lessons From the French Case

Daniel Haguet , in Handbook of Investors' Behavior During Financial Crises, 2017

20.4.2 General Behavior

Our file contains each individual trade per day. The total of the trades was summarized on a daily basis in order to have, for each day: the number of purchases, the number of sales, the volume of the purchases, and the volume of the sales. We have 766 daily observations from which we excluded Saturdays and Sundays and got 634 observations. We also have the breakdown between French stocks and money market mutual funds. Those could be of interest to look at the breakdown between the flows in risky assets and in nonrisky assets.

In the first part, we will look at the general behavior of our sample, then the breakdown between stocks and money market funds. The third part will present the buy and sell transactions by number.

1.

General volume and number of transactions: Fig. 20.4 shows the volume of the purchases and sales on a monthly basis. The volume of purchases and the volume of sales are strongly correlated (correlation coefficient = 0.84) and the volume of buys is greater than the volume of sells each month.

2.

Breakdown between risky assets and nonrisky assets: In this section, we also took the volume of purchases and sales in money market funds (as a proxy of nonrisky asset) to compare with the volume of purchases and sales in stocks (as a proxy of risky assets). We present in Figs. 20.4 and 20.5, the percentage of each asset class in the total flow of sales (Fig. 20.5) and purchases (Fig. 20.6).

On average, money market funds represent 10.18% of the purchase flows and 11.14% of the sale flows (the difference is nonsignificant) and a correlation coefficient equal to 0.39.

We regressed the percentage of money market fund in purchase transactions and in sale transactions with two explaining variables. The first one is the daily change of the CAC 40 and the second one is a dummy variable equal to "one" after the financial crisis and "zero" before. Table 20.8 displays the coefficients.

Table 20.8. Regression of flows of money market funds.

Explained Variable	Percent Money Market Fund in Purchase Transactions	Percent Money Market Fund in Sale Transactions
Explaining variables
Constant (t-stat)	0.100 (24.331)	0.098 (24.938)
Daily changes of the CAC 40 (t-stat)	0.341 (1.253)	−0.709*** (−2.742)
Binary variable "crisis" (t-stat)	0.015 (2.394)	0.020*** (3.391)

** and *** denote significant at the 5% and 10% levels, respectively.

The main result of Table 20.8 is that the flow of sales in money market funds is influenced by the binary variable "financial crisis" but we did not find a significant coefficient with the daily performance of the French market.

3.

Number of sales and number of purchases: We use the number of purchases and the number of sales to measure the trading behavior of our sample (Fig. 20.7).

The two series are strongly correlated (correlation coefficient equal to 0.90) but we see that the number of purchases is always greater than the number of sales. We use the ratio between the number of purchases and the number of sales to measure the trading behavior compared to the market returns. Our two proxies for the French domestic stock market are the return of the CAC 40 on a daily basis and the same return of the CAC 40 on a continuous 12-months period (annual basis). The first one gives the influence of the short-term return of the market and the second one gives the influence of the long-term return of the market.

Our regression is as follows:

$y_{i} = a_{1} X_{1} + a_{2} X_{2} + a_{3} X_{3} + ɛ_{i}$

Where y _i is the ratio between the number of purchases and the number of sales, X ₁ is the daily return of the CAC 40, X ₂ the yearly return of the CAC 40, and X ₃ is a binary variable equal to 1 after June 2007 ("bear" period) and equal to 0 before June 2007 ("bull" period). Results are displayed in Table 20.9.

Table 20.9. Regression on the sample as a whole.

Explained Variable	Number of Purchases/Number of Sales
Explaining variables
Constant (t-stat)	1.116 (23.799)
CAC 40 daily (t-stat)	−14.258 (−9.097)***
CAC 40 12 months (t-stat)	49.598 (1.324)
Binary variable "crisis" (t-stat)	0.120 (2.209)**
Number of observations	634

** and *** denote significant at the 5% and 10% levels, respectively.

Only one coefficient of the regression is significant; it shows a negative correlation between the buying and selling behavior of the whole sample and the daily changes of the CAC 40 index. It means that when the return of the market increases, the number of sales increases compared to the number of purchases. When the market return decreases, we have more purchases than sales.

The long-term return of the CAC 40 is nonsignificant for the whole sample; the binary variable "crisis" is nonsignificant as well.

We will now look more closely at the selling behavior of our sample in the context of the financial crisis.

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Investment Banks and Finance Companies

Rajesh Kumar , in Strategies of Banks and Other Financial Institutions, 2014

7.1.4 Investment Bank Participation in Financial Markets

Investment banks have active participation in the money, bond, mortgage stock, and derivatives markets. Many investment banks through money market mutual funds invest in money market securities. Investment banks also underwrite commercial papers. Investment banks actively participate in the bond market through underwriting bond issues in the primary market and provide advisory services for clients for bond purchases and sales. Investment banks also play a role in the bond market by facilitating the raising of funds for corporate restructuring activities such as mergers and acquisitions, leveraged buyouts, and other activities. Investment or securities firms also play a role in the mortgage market by underwriting securities that are backed by mortgages for various financial institutions. In stock markets, the investment banks play the major roles of underwriters in the primary market, advisors and brokers in the secondary market. In derivatives markets of futures, options and swaps, investment banks act as financial intermediaries or brokers.

Commercial banks and thrift institutions are major competitors for investment banks in providing brokerage and merger advisory services. Some investment banks own mutual funds. Mutual funds also depend on securities firms such as investment banks for advisory services related to the execution of stock trades. Investment banks provides advisory services to insurance companies for executing securities transactions and hedging risks. Pension funds also receive advisory services from investment banks with respect to securities transactions related to buying and selling securities. Pension funds and insurance funds invest in new issues, which are underwritten by securities firms.

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Foreword

Dr. Jeffrey R. Bohn , in Credit Engineering for Bankers (Second Edition), 2011

As the credit markets have evolved, nonbank financial institutions have become an important part of credit markets. Sometimes these institutions (e.g., AIG, large insurance companies, large money market funds, etc.) are said to constitute a shadow banking system. In the previous edition's foreword, I wrote, "Technology and deregulation have enabled nonbank financial institutions to enter the credit markets in unprecedented ways." The good news is that shadow banks add to the market's liquidity. The bad news is that shadow banks—with AIG at the center—are also not immune to failure arising from concentration risk. Shadow banks suffer from the same kinds of systemic ailments as the regular banking system. We discovered in this latest crisis that concentration risk can develop anywhere banking-type activities are undertaken. We now understand how important it is for analysts and regulators to track nonbank financial institutions. Executives of these institutions will also benefit from learning and implementing the tools discussed in this book.

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The Nature and Variety of Financial Intermediation

In Contemporary Financial Intermediation (Fourth Edition), 2019

Mutual Funds

Along with pension funds, mutual funds have been major market-share winners over the past 40 years. Essentially a post-World War II phenomenon, mutual funds (including money market funds) have risen from an inconsequential share of the intermediation market in 1950 to achieve a 6% market share in 1990, and a 25% market share in 2010 (measured based on total assets). Its significant growth can also be gleaned from the penetration of mutual funds among U.S. households, which increased from 25% in 1990 to 44% in 2012 (see Table 2.2).

Mutual funds come in two basic varieties: open- and closed-end. Closed-end funds have a preestablished number of shares and the fund's initial resources typically are not augmented with the subsequent sale of shares. A closed-end fund is typically traded as a single security on organized exchanges, for example, the New York Stock Exchange, and its shares are priced directly in the market like the shares of any other company. As a consequence, the market price of closed-end fund shares can deviate, often widely, from the liquidation value of the securities they hold. Open-end funds operate on very different rules. Their shares are continuously liquidated and augmented by a specialized management company that offers shares for cash, and cash for shares at net asset value (NAV). NAV is the estimated liquidation or market value of the fund's assets divided by the number of shares the fund has outstanding. Thus, unlike closed-end fund shares, the prices of open-end fund shares cannot deviate from the value of underlying assets.

The open-end funds have given rise to large specialized fund management companies, like Fidelity, DWS Scudder, Vanguard, and Dreyfus. Each of these manages and markets a wide range of different funds, each of which is defined in terms of specific investment objectives. These investment companies earn their keep by levying fees against the funds it manages. The funds, of course, are owned by their investors. Were you to consult the financial pages of any major newspaper, you would find a section headed mutual funds wherein you could find the NAV of any of the numerous mutual funds managed by Merrill Lynch, or any of the very large number managed by Fidelity. These larger mutual fund companies typically have tens of billions of dollars under management. The key financial intermediation services provided by mutual funds include transactions services, screening, and certification.

There is nothing terribly new about mutual funds, except their explosive growth in recent decades. There are at least three reasons for the current popularity of the funds. First, money-market mutual funds, which were introduced in the 1960s, rapidly became the instrument of choice for circumventing Regulation Q deposit interest rate ceilings. As inflation accelerated in the 1970s and market interest rates soared, the spread between these rates and deposit rates gaped ever wider. The bloated opportunity cost of holding bank deposits increased the appeal of money-market funds. The rest is history! Despite the competitive disadvantage of operating without a government guarantee, the mutual funds grew spectacularly, underscoring that there are limits to what the public is willing to pay for governmental deposit insurance.

By and large, the money-market funds were managed conservatively, and some even restricted themselves to holding direct debt of the U.S. government. More commonly, the funds held negotiable large-denomination certificates of deposit of banks, commercial paper, bankers' acceptances, mortgage, and other asset-backed securities, and government agency debt. Almost all of these assets were less than 1 year to maturity, and the funds traded at a constant one dollar per share.

Moreover, the money-market funds are sustained by implicit guarantees of their managers. In at least three cases, management companies made good on asset losses in order to protect their own reputations and the viability of the money funds they managed. For example, Value Line manages a money-market fund that held the commercial paper of Integrated Resources, a company that defaulted on its debt. Rather than reflect this loss in its money-market fund, which almost certainly would have meant the fund's demise, Value Line management bought the Integrated Resources commercial paper from its money-market fund at par. Notably, there was no legal or even moral obligation to protect the fund's investors, but the action was presumably motivated by the desire to maintain and build upon Value Line's reputation in managing money-market funds. Clearly, the money-market funds offered a compelling package of substitutes for the governmental deposit guarantee. Low-risk investment strategies, combined with implicit guarantees of reputable management companies, and substantially higher yields permitted the money-market funds to ravage the bank and thrift deposit markets and enjoy meteoric growth. As we will see in Chapter 14, the low (or no) risk image got battered during the 2007–2009 financial crisis. Explicit government guarantees were needed to ensure the survival of money market mutual funds.

The second and third reasons for the recent growth of mutual funds are less dramatic, but nevertheless noteworthy. In recent decades, the public has gradually become persuaded of the improbability of consistently "beating" the stock market. A sea of research, much of it academic, has demonstrated that over most extended spans of time asset managers do less well than the widely watched stock market indices, for example, Dow Jones, and Standard and Poor's. The reasons are numerous and complex, but the facts seem plain. The widespread acceptance of this idea has had a profound effect on investment behavior, and in particular it has led to the idea that if you cannot beat the averages, you can do no better than to buy the averages. Buying the averages is known as passive investment. This is done by purchasing a portfolio of securities that behave like (clone) the averages. Since this strategy typically requires holding a substantial number of securities, it is often infeasible for smaller wealth holders, and uneconomic for most. However, mutual funds can provide such a service at low cost. Thus, the popularity of passive investment strategies provides a second reason for the recent growth of mutual funds.

Finally, the past six decades have witnessed the much-heralded globalization of financial markets. Many investors believe it is as important to diversify across economies (currencies) as it is to diversify across industries. Furthermore, diversification across economies has been massively simplified in recent decades, as regulatory and tax barriers have been dismantled. However, information about foreign investment opportunities is still relatively expensive. Hence, the mutual fund has become the instrument of choice for investing abroad. Many "country funds" are closed-end and listed on the New York Stock Exchange, but there are also many open-end funds that specialize in countries and regions of the world. To mix a metaphor, as the pie of foreign indirect investment has grown larger, the bologna of specialization among funds has been sliced ever thinner.

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The Deposit Contract, Deposit Insurance, and Shadow Banking

In Contemporary Financial Intermediation (Fourth Edition), 2019

The Role of Commercial Banks in Shadow Banking

Commercial banks get involved in shadow banking in various ways. The most obvious is that commercial banks are owned by bank holding companies (BHCs). A BHC might own a wealth management unit with a money market mutual fund, that is, a shadow bank within the BHC. Another example is triparty repo funding by the broker–dealer subsidiary of a BHC. Similarly, a BHC might have an ABCP conduit, which would be off-balance-sheet to the BHC, but may be supported by a commercial bank subsidiary of the BHC through loan commitments. ⁴⁸ Another connection is that commercial banks originate the loans whose securitization creates the securities that shadow banks hold and then borrow against these securities which are used as collateral in repo transactions.

In the future, as BHCs are subjected to more stringent and liquidity requirements, some shadow-banking activities may migrate out of BHCs into the shadow-banking system.

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