Definition
Breaking the Buck is a term used in the financial industry to describe a situation where the net asset value (NAV) of a money market fund falls below $1 per share. Money market funds are typically considered safe investments, as they aim to maintain a stable NAV of $1. However, factors such as severe investment losses or when a fund’s investment income fails to meet operating expenses can cause the NAV to drop below this mark, indicating the fund is “breaking the buck.”
Examples
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Historical Example (2008 Financial Crisis): A prominent example of breaking the buck occurred in September 2008, during the financial crisis, when the Reserve Primary Fund’s NAV fell to $0.97 due to losses on Lehman Brothers commercial paper.
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Hypothetical Example: Suppose a money market fund primarily invests in corporate debt instruments. If several companies in the fund’s portfolio default on their obligations, causing significant losses, the fund’s NAV may drop below $1.
Frequently Asked Questions
What happens when a money market fund breaks the buck?
When a money market fund breaks the buck, the value of its shares falls below $1. Investors may lose confidence, leading to massive redemptions and potential liquidity issues for the fund. The fund may also have to liquidate assets at a loss to meet redemption requests.
How do money market funds typically maintain a stable NAV of $1?
Money market funds typically maintain a stable NAV of $1 by investing in high-quality, short-term debt instruments with low default risk. They also aim to match the maturities of their investments with their liabilities.
Has breaking the buck happened often in history?
Breaking the buck is relatively rare. The most notable occurrence was during the 2008 financial crisis. However, fund managers and regulatory improvements have aimed to strengthen the resilience of money market funds since then.
What measures can a money market fund take to avoid breaking the buck?
A money market fund can adopt several measures to avoid breaking the buck, such as diversifying investments, maintaining high credit quality, and actively managing liquidity and interest rate risks. Regulatory stress tests also help identify potential vulnerabilities.
Are investors protected if a money market fund breaks the buck?
No federal insurance protects investors in money market funds if they break the buck. However, in some cases, sponsoring organizations or fund managers may step in to provide support and stabilize the NAV.
Related Terms
- Net Asset Value (NAV): The value per share of a mutual fund or exchange-traded fund (ETF), calculated by dividing the total value of the fund’s assets by the number of shares outstanding.
- Money Market Fund: A type of mutual fund that invests in high-quality, short-term debt securities and aims to offer a stable NAV of $1 per share.
- Commercial Paper: An unsecured, short-term debt instrument issued by a corporation, typically for financing accounts receivable and inventories.
- Liquidity: The ability to quickly convert an asset or investment into cash without significantly affecting its price.
- Redemption: The process through which investors sell their shares back to the mutual fund.
Online References
Suggested Books for Further Studies
- “The Bogleheads’ Guide to Investing” by Taylor Larimore, Mel Lindauer, Michael LeBoeuf - Discusses various investment vehicles, including money market funds.
- “The Little Book of Common Sense Investing” by John C. Bogle - Offers insights into mutual funds and investing principles.
- “A Random Walk Down Wall Street” by Burton G. Malkiel - Provides an in-depth look at various types of investments, including money market funds.
Fundamentals of Breaking the Buck: Finance Basics Quiz
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