From How Well Do You Know...Money-Market Funds?
by Leslie Scism
1) When were the first money-market mutual funds for small investors launched?
ANSWER: C. The funds "were born of a Black Swan moment -- the explosive inflation of the 1970s," when investors were craving higher rates than were then possible in bank accounts, says Paul Schott Stevens, president of trade group Investment Company Institute.
By most accounts, the first fund was offered by Reserve Management Co. -- the New York firm whose fund in September broke the buck.
2) Fidelity Investments was one of the first big mutual-fund firms to launch a money-market fund. What perk came with its new fund?
A. A matching contribution of up to $100
B. Check-writing privileges
C. A toaster
ANSWER: B. Because few investors were buying stocks in the bear market of the 1970s, Fidelity searched for another way to bring in business. In 1974 it introduced Fidelity Daily Income Trust, and to distinguish it from other money-market funds, the president of the firm, Ned Johnson, added check writing.
"He reasoned that if it was easy for investors to get money out, they'd be more likely to put money in," a Fidelity history brochure reads. "The idea worked, and assets poured into the fund."
3) Fidelity says the launch of Fidelity Daily Income Trust led directly to another key innovation at the Boston firm. Which is it?
A. A toll-free telephone line through which individuals could make fund purchases directly
B. A computerized telephone system to provide yield quotes 24 hours a day
C. A discount brokerage service to sell funds as well as stocks, allowing small investors to bypass pricey Wall Street brokers
ANSWER: A. At the time, Fidelity sold its funds through brokers. But Fidelity couldn't pay brokers to sell the money fund without losing its yield advantage, the history reads. So Fidelity set up a dedicated phone line and ran a few ads. The move proved popular, and by 1979 Fidelity removed the 8% sales charge from almost all its funds to sell directly to the public. Later came the firm's computerized phone system and discount brokerage.
4) Before the Reserve fund's problems, there was just one prior occasion when a fund broke the buck. When was that?
ANSWER: C, when tiny Community Bankers U.S. Government Money Market Fund incurred losses in financial "derivatives." There have been many other close calls over the years, but fund companies have stepped in on all those other occasions to bail out their funds. That is, the fund company either bought out the debt at par value or took other steps to back up the fund so that the shares stayed at $1. The Community Bankers fund was aimed at institutions, and no small investors lost money in it.
5) Which of the following was true of money funds as of this past June?
A. They held almost one-fifth of municipal securities outstanding.
B. They held one-fifth of marketable Treasury bills.
C. They held more than 40% of the outstanding short-term borrowings of U.S. corporations known as commercial paper.
D. All of the above.
ANSWER: D, according to the ICI. Assets in money funds quadrupled from 1984 to 1987, when they reached $1 trillion, and they tripled again, to $3 trillion, by 2007.
Securities and Exchange Commission rules, known as the quality, maturity and diversity standards, govern what money-market mutual funds can hold. What this translates to, in general, is a very wide range of highly rated securities that mature in 90 days or less.
6) What investment got the Reserve fund in trouble?
A. Russian debt
B. Lehman Brothers debt
C. Fannie Mae preferred stock
D. CDs from failed IndyMac Bancorp
ANSWER: B. The Reserve fund, which stood at $65 billion in early September, held $785 million of Lehman debt when the investment bank filed for bankruptcy on Sept. 15. The fund said it would write the debt down to zero, reducing the fund's net asset value to 97 cents a share.
7) True or false: The Reserve is the only money-market fund that has had large-scale soured investments since the subprime-mortgage crisis erupted in 2007.
ANSWER: False. At least 20 fund companies have stepped in this year to support their money funds or to prevent them from breaking the buck, according to Peter Crane, president of Crane Data, which tracks money-market activity. They bought out the money-losing debt at face value, or took other steps to make the fund whole.
Fund firms do this to prevent devastating runs. "It's like fixing your roof," he says. "You either fix your roof or the whole house ultimately will be destroyed." Fund operators repairing the roof, so to speak, include Bank of America Corp., Northern Trust Corp. and Wells Fargo & Co. And this leads to some advice from fund analysts: Invest where there is a well-capitalized company committed to the fund business.
8) True or false: The U.S. Treasury's new money-market guaranty program has caps on the amount covered identical to those at bank accounts covered by the Federal Deposit Insurance Corp.
ANSWER: False. The program, in place for three months with the possibility of extension, covers whatever sum investors had in their money-market mutual funds as of Sept. 19. FDIC coverage for consumers' bank deposits, by contrast, was recently raised to $250,000 from $100,000.
Officials at first weren't going to put any limits on the money-market guarantee, but community bankers complained that the change would fuel a flight of money out of their vaults into higher-yielding funds. So the Treasury on Sept. 21 clarified that the program applied to amounts in accounts as of Sept. 19, the date the program was announced.
9) What was the average 12-month yield as of Sept. 30 of a consumer-oriented, taxable money-market mutual fund?
ANSWER: B, according to Money Fund Report. And beware: Yield-chasing can get you into trouble. The Reserve Primary Fund's 12-month yield as of Aug. 31 was 4.04%, the highest of more than 2,100 money-market funds tracked by Morningstar Inc. The average at the time: 2.75%. A fund yielding more than others may be charting a risky course to deliver the extra income.
10) What is the average annual expense ratio of a money-market fund?
ANSWER: C, according to Morningstar. While the average of all money-market funds is 0.58% of assets, the average for the 25 largest is 0.24%. Take note: The funds with the lowest costs have the least need to take on risk to deliver a competitive yield.