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.
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.
Academic Research on Breaking the Buck
- US dollarmoneymarketfundsand non-US banks, Baba, N., McCauley, R. N., & Ramaswamy, S. (2009). US dollar money market funds and non-US banks.BIS Quarterly Review, March. The Lehman Brothers failure stressed global interbank and foreign exchange markets because it led to a run on money market funds, the largest suppliers of dollar funding to non-US banks. Policy stopped the run and replaced private with public funding.
- How effective were the Federal Reserve emergency liquidity facilities? Evidence from the assetbacked commercial papermoneymarketmutual fundliquidity facility, DuyganBump, B., Parkinson, P., Rosengren, E., Suarez, G. A., & Willen, P. (2013). How effective were the Federal Reserve emergency liquidity facilities? Evidence from the assetbacked commercial paper money market mutual fund liquidity facility.The Journal of Finance,68(2), 715-737. The events following Lehman's failure in 2008 and the current turmoil emanating from Europe highlight the structural vulnerabilities of shortterm credit markets and the role of central banks as backstop liquidity providers. The Federal Reserve's response to financial disruptions in the United States importantly included the creation of liquidity facilities. Using a differencesindifferences approach, we evaluate one of the most unusual of these interventionsthe AssetBacked Commercial Paper Money Market Mutual Fund Liquidity Facility. We find that this facility helped stabilize asset outflows from money market funds and reduced assetbacked commercial paper yields significantly.
- The stability of primemoneymarketmutual funds: sponsor support from 2007 to 2011, Brady, S., Anadu, K., & Cooper, N. (2012). The stability of prime money market mutual funds: sponsor support from 2007 to 2011.Available at SSRN 3015986. It is commonly noted that in the history of the Money Market Mutual Fund (MMMF) industry only two MMMFs have broken the buck, or had the net asset value per share (NAV) at which they transact fall below $1. While this statement is true, it is useful to consider the role that non-contractual support has played in the maintenance of this strong track record. Such support, which has served to obscure the credit risk taken by these funds, has been a common occurrence over the history of MMMFs. This paper presents a detailed view of the non-contractual support provided to MMMFs by their sponsors1 during the recent financial crisis based on an in depth review of public MMMF annual SEC financial statement filings (form N-CSR) with fiscal year-end dates falling between 2007 and 2011. According to our conservative interpretation of this data, we find that at least 21 prime MMMFs would have broken the buck absent a single identified support instance during the most recent financial crisis.2 Further, we identify repeat instances of support (or significant outflows) for some MMMFs during this period such that a total of at least 31 prime MMMFs would have broken the buck when considering the entirety of support activity over the full period.
- Runs onmoneymarketmutual funds, Schmidt, L., Timmermann, A., & Wermers, R. (2016). Runs on money market mutual funds.American Economic Review,106(9), 2625-57. We study daily money market mutual fund flows at the individual share class level during September 2008. This fine granularity of data allows new insights into investor and portfolio holding characteristics conducive to run risk in cash-like asset pools. We find that cross-sectional flow data observed during the week of the Lehman failure are consistent with key implications of a simple model of coordination with incomplete information and strategic complementarities. Similar conclusions follow from daily models fitted to capture dynamic interactions between investors with differing levels of sophistication within the same money fund, holding constant the underlying portfolio.
- Why domoney fundmanagers voluntarily waive their fees?, Christoffersen, S. E. (2001). Why do money fund managers voluntarily waive their fees?.The Journal of Finance,56(3), 1117-1140. Over half of money fund managers voluntarily waive fees they have a contractual right to claim. Moreover, as a consequence of fee waivers, funds on average collect one half of reported expense ratios. Variation in fee waivers is significant and relates to differences in relative performance. Both lowperforming retail and institutional funds waive fees to improve their net performance. More interestingly, highperforming retail, but not institutional, funds use fee waivers to strategically adjust net performance to increase expected fund flows. Despite fund flow incentives, highperforming institutional funds do not waive more because they cannot significantly improve their relative performance.