(This post is a part of the series on Basics of Finance and Investing.)

A money market, or “cash”, is a low-risk, short-term, liquid, debt type security. Reading from left to right, the italicized words mean – the risk of losing the principal (money you paid for the security) is low, it matures typically in a year or less, you can sell it quick, and corporations (and the government) issue these securities to borrow funds. Because of the low risk and fixed returns, a money market is an example of a fixed-income security. Following are the three major types of money markets.

Treasury bill

“T-bill” or just “bill” for short, these are securities that the US government sells to borrow fund. They are issued weekly at a minimum denomination of $1000 for 4-week, 13-week and 26-week maturation periods. You can either buy them directly from Treasury, or at a secondary market from a government securities dealer. Because they are backed by the government itself, there is almost no risk.

The way this works is that you buy T-bills at a discount from the face-value, and get back the face-value price at maturity. The discounted amount is your earning over that period (this is different from periodic earnings until maturity). For example, if you pay $9800 for a $10000 T-bill that has a 13-week maturity, you get $10000 back after 13 weeks, and therefore earn a 2.04%(=200×100/9800) interest over this period.

Certificate of Deposit

A certificate of deposit, or “CD”, is a debt instrument issued by banks. Your principal is locked for a fixed time period, which can be a few months to a few years. You get both the accrued interests and your principal back at maturity, and cannot withdraw any money until then. In this sense, a CD is different from a bank savings account (another difference is that the interest paid on a CD is usually higher than what you can get from a savings account). Bank CDs up to $100,000 are insured with FDIC, and so your investment is safe.

Commercial paper

Commercial papers are short-term debt instruments issued by large corporations to finance their businesses. They are not secure unlike bank deposits, and therefore only firms with high credit ratings can find investors without having to offer large discounts. Maturity of a commercial paper ranges up to 270 days (9 months); longer maturities require approval from SEC. Denominations are in multiples of $100,000, which makes these securities inaccessible to small investors (they can invest indirectly via money market mutual funds, which we will discuss in a later post).

Besides these three common types, other money markets are bankers’ acceptance, eurodollar, and repos.

Next we look at a Bond.

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