Breaking the Buck - Explained
What is Breaking the Buck?
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Table of ContentsWhat is Breaking the Buck?How Does Breaking the Buck Work?Money Market Fund HistoryMoney Market Fund InvestingAcademic Research on Breaking the Buck
What is Breaking the Buck?
Breaking the buck is described as when the money market funds investment income can not cover operating expenses or investment losses. In other words, breaking the buck occurs when the net asset value of a money market fund indicates lower than $1. Interest rates drops can cause this fall, likewise, the fund's investment in other investments can also cause this fall.
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How Does Breaking the Buck Work?
Money Market funds are quite considered to be risk-free, with breaking the buck occurring, it probably depicts economic breakdown. Money market funds have several benefits asides from paying regular interests. These benefits include: it allows money to be transferred at ease from the fund to a bank account, it offers a high return than standard-interest checking and savings accounts. They are not insured by the Federal Deposit Insurance Corp. (FDIC). The money market is a type of open-end mutual fund that invests in short-term debt securities such as U.S. Treasury bills and commercial paper. It is often used with checkable deposit accounts as an additional source of liquid savings by investors. It also has a standard, the NAV of a money market fund is fixed at $1. This is a market regulation limit. Market regulations allow a fund to value its investments at the amortized cost other than market value. This gives the fund a regular $1 value. With this, investors identify it as an alternative to checking and savings accounts. By using an amortized pricing structure, the fund can manage the activities of the fund and provide for redemptions.
Money Market Fund History
Money market funds came into existence in 1970, shortly after its introduction, there was asset flows to increase and high demand for mutual funds. This led to naming the first money market mutual fund 'the Reserve Fund' and there was a fixed standard $1 NAV. In the long run, the Money market fund started facing losses in 1994, with Community Bankers U.S. Government's Money Market Fund liquidated at 94 cents, reasons due to large losses in derivatives. While in 2008, the losses encountered by the Lehman brothers impacted negatively on the Reserve funds. The fund had assets with Lehman brothers, this eventually caused the Reserve Funds price to fall below $1. This caused panic for investors and generally the market as a whole. As a result of this, the government legislated that Money market funds cannot have an average dollar-weighted portfolio maturity exceeding 60 days and also, now limited on asset investments. This is encompassed in the rule 2a-7.
Money Market Fund Investing
Vanguard is ranked as the most successful in money market fund products, with one of its funds rated as the best. This is the Vanguard Prime Money Market Fund. It had a Return of 0.97 percent within a year till Nov. 30, 2017. Vanguard offers three taxable money market funds and its various tax-exempt funds are usually all priced at $1.