Commercial Paper: A Primer
February 12, 2025
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From the previous articles, we already know that money markets form an integral part of the overall financial system. Also because of their large volumes and high ratio of demand deposits, the money market funds are always at the risk of a run. It is for this reason that the Securities and Exchange Commission has made it mandatory for money market funds to conduct periodic stress tests. This helps safeguard the interests of investors as well as of the entire financial system in general.
In this article, we will have a closer look at the details of the stress testing process in money market mutual funds.
Money market funds need to be stress-tested since they face a lot of different types of pressures. Some of these have been listed below:
Another important outcome of the exercise is that the interest rate can be identified at which the money market fund might start facing solvency issues. This helps the management to continuously monitor their solvency in the light of the latest information
The impact at different levels is mapped in order to understand the point where such redemptions will lead to the insolvency of the fund. This analysis is used by money market funds to determine when the rights to redeem funds needs to be suspended
The fact of the matter is that stress testing was used by many sponsors and financial corporations in the money market.
It was always a best practice for the sponsors to be aware of how the changes in the external environment will impact the value of the portfolio. However, now, this best practice is no longer voluntary. Instead, it is mandatory for all money market funds to conduct these tests because:
The bottom line is that stress testing in money markets is not only required from a regulatory point of view but is also desired by investors. This is the reason that the practice has been quickly adopted by all players in the money market.
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