Browse Analysis of Managed and Structured Products

18.2.1 Money Market Funds

Understand Money Market Funds, their investment strategies, benefits, risks, and taxation aspects for Canadian investors. Learn how these funds provide liquidity, safety, and income stream.

Overview

What are Money Market Funds?

Money market funds, as the name suggests, invest in assets that trade in the money markets. These funds primarily consist of investments in cash, cash-equivalent securities, and short-term debt securities that possess a high credit rating. Typical instruments within money market funds include:

  • Treasury Bills (T-Bills)
  • Bankers’ Acceptances
  • High-Quality Corporate Paper
  • Short-Term Bonds

Money market funds can involve both Canadian and U.S. funds, providing a degree of flexibility to investors.

Purpose and Importance

Money market funds add significant liquidity to an investment portfolio. Their low-risk profile along with providing a small stream of income makes them attractive for risk-averse investors. These funds are considered to have the least risk among mutual funds because of their investment in short-term, high-quality securities.

Compliance and Regulation

To comply with Canada’s National Instrument 81-102, money market funds must ensure that at least 95% of their total net assets are invested in cash or cash-equivalent securities, maintaining a regulatory standard designed to prioritize liquidity and risk management.

Key Features

Stable Net Asset Value Per Share (NAVPS)

A distinctive feature of money market funds is their constant share (or unit) value, commonly fixed at $10. To ensure this stability, the fund’s net income is calculated daily and credited to unitholders. Earned interest is either disbursed as cash or reinvested into additional shares on a regular—typically monthly or quarterly—basis.

Safety with Minimal Risk

Money market funds are known for their relative safety and minimal risk due to investment in highly liquid and securely rated securities. However, despite low risk, money market funds are not guaranteed investments. The main risk associated with these funds is interest rate risk. Fund managers strive to maintain a stable NAVPS, yet rapid increases in interest rates could potentially reduce the value of the shares.

Taxation

Distributions from a money market fund, when held outside a registered plan, are taxable as interest income. As investors, one must add these distributions to their total income and pay tax on that portion at their applicable marginal tax rate.

Key Takeaways

  • Money market funds provide high liquidity and are considered the least risky type of mutual funds.
  • Investments primarily include T-Bills, bankers’ acceptances, high-quality corporate paper, and short-term bonds.
  • To comply with regulatory standards, they must keep at least 95% of their assets in cash or cash-equivalent securities.
  • They aim to keep a constant share value of $10, with net income calculated daily.
  • The main risk is interest rate risk which can affect fund value if rates increase rapidly.
  • Interest income from funds is taxable if held outside registered plans.

Frequently Asked Questions

Q: What types of securities are included in a money market fund? A: Money market funds typically include Treasury bills, bankers’ acceptances, high-quality corporate paper, and short-term bonds.

Q: Are money market funds a safe investment? A: Yes, money market funds are considered the least risky type of mutual funds because they invest in high-quality, short-term securities. However, they are not entirely risk-free.

Q: How often is interest credited to unitholders? A: Interest is usually credited monthly or quarterly, either disbursed as cash or reinvested into additional shares.

Q: What is the main risk associated with money market funds? A: The primary risk is interest rate risk which can affect the value of the fund if rates increase rapidly.

Q: Are distributions from money market funds taxable? A: Yes, distributions received from a money market fund are taxable as interest income when held outside a registered plan such as RRSP or TFSA.

Glossary

  • Cash-Equivalent Securities: Highly liquid securities that are considered equivalent to cash due to their safety and short-term nature.
  • High-Quality Corporate Paper: Short-term obligations issued by companies with high credit ratings, also known as commercial paper.
  • Treasury Bills (T-Bills): Short-term government securities issued at a discount and maturing at face value.
  • Net Asset Value Per Share (NAVPS): The value per share of a mutual fund, calculated by dividing the total net assets of the fund by the number of outstanding shares.

Charts and Diagrams

    pie title Component Allocation in a Money Market Fund
	    "Cash and Cash Equivalents" : 50
	    "High-Quality Corporate Paper" : 25
	    "Treasury Bills" : 15
	    "Short-Term Bonds" : 10

CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## What type of securities do money market funds primarily invest in? - [ ] Long-term bonds - [ ] Equities - [x] Cash-equivalent securities and short-term debt - [ ] Real estate holdings > **Explanation:** Money market funds invest in cash, cash-equivalent securities, and short-term debt securities such as Treasury bills and high-quality corporate paper. ## Which of the following describes a common feature of money market funds? - [x] Constant unit value, often $10 - [ ] High risk and high return - [ ] Daily changes in NAVPS - [ ] Primarily invested in long-term debt > **Explanation:** Money market funds often have a constant unit value, typically set at $10, and the net income is credited to unitholders daily. ## What is the main risk associated with money market funds? - [ ] Foreign exchange risk - [ ] Political risk - [ ] Credit/counterparty risk - [x] Interest rate risk > **Explanation:** The main risk to money market funds is interest rate risk, especially during periods of rapid increases in interest rates, which can affect the value of the fund's shares. ## How much of a money market fund’s total net assets must be held in cash or cash-equivalent securities to comply with National Instrument 81-102? - [ ] 80% - [ ] 90% - [x] 95% - [ ] 100% > **Explanation:** To comply with National Instrument 81-102, money market funds must maintain at least 95% of their total net assets in cash or cash-equivalent securities. ## How is the net income of money market funds typically managed to keep the NAVPS constant? - [ ] It is distributed as dividends quarterly - [x] It is calculated daily and credited to unitholders - [ ] It is reinvested annually - [ ] It is not calculated > **Explanation:** The net income of the fund is calculated daily and credited to unitholders to keep the NAVPS constant. ## Distributions received from a money market fund when held outside of a registered plan are taxable as: - [ ] Capital gains - [ ] Dividends - [ ] Foreign income - [x] Interest income > **Explanation:** Distributions from a money market fund are taxable as interest income when held outside of a registered plan and must be added to the investor's income and taxed at their marginal rate. ## Which of the following is NOT typically included in a money market fund’s investments? - [ ] Treasury bills - [ ] Bankers’ acceptances - [x] Long-term corporate bonds - [ ] High-quality corporate paper > **Explanation:** Money market funds do not invest in long-term corporate bonds; they focus on cash, cash-equivalent securities, and short-term debt. ## What primary benefit do money market funds add to a portfolio? - [ ] High growth potential - [ ] Foreign diversification - [x] Liquidity - [ ] High dividend yield > **Explanation:** Money market funds add liquidity to a portfolio and provide a small stream of income while maintaining relative safety of principal. ## Which regulatory instrument must money market funds comply with? - [ ] Basel III - [ ] Dodd-Frank Act - [ ] MiFID II - [x] National Instrument 81-102 > **Explanation:** Money market funds in Canada must comply with National Instrument 81-102, which mandates specific guidelines for mutual funds, including money market funds. ## Why are money market funds considered the least risky type of mutual fund? - [ ] They invest in volatile high-growth stocks - [x] They invest in cash, cash-equivalent securities, and short-term debt - [ ] They guarantee high returns - [ ] They are not subject to interest rate risk > **Explanation:** Money market funds invest in cash, cash-equivalent securities, and short-term debt, making them the least risky type of mutual fund due to the safety and liquidity of their investments.

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Sunday, July 21, 2024