Invest them in shortterm safe financial instruments

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Reference no: EM131081519

a) Money market mutual funds take in your dollars (like deposits) and invest them in shortterm “safe” financial instruments to earn you interest. In essence, you buy 1 share for $1. They take your $1 and buy $1 in corporate paper, earning, say, $0.0027 for you overnight. If you then “cash out” your shares, you get $1.0027. True or False EXPLAIN WHY: This system is not vulnerable to runs like banks.

b) Now assume there is a rule stating that MMMF’s could cash people out at $1 if (for instance) the value of the MMMF’s assets were not less than $0.99 per dollar. True or False EXPLAIN WHY: This makes a run on MMMF’s possible.

hint for b: in September 15 2008, an MMMF called “Reserve Primary Fund” was invested in Lehman Brothers corporate paper when it declared bankruptcy, and it “broke the buck,” meaning assets were worth less than the original deposit, $1. This caused a run on MMMF’s, which is inexplicable to many economists who don’t know about this rule.

Reference no: EM131081519

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