Before we dive into specific money market instruments or mechanics, let's first define what we mean by the money market. The money market is a particular segment of the financial markets which facilitates the flow of capital from those who have a surplus and wish to invest it to those who need it.

We often split the financial market into two broad categories, the capital market and the money market.

The capital market deals with long-term instruments like stocks and bonds covering both equity and debt. On the other hand, the money market exclusively deals with debt instruments. More specifically, it involves debt instruments with maturities ranging from just one day up to one year. Most money market instruments pay interest at maturity. For instance, if you invest $100 million in a money market instrument for six months, you get your principle back along with interest at the end of the six month period. It's straightforward, no interim coupon payments or reinvestments to worry about. As a result, only simple interest calculations apply. Here's the formula to calculate the interest you will receive, and it's very simple. You just need to multiply the notional amount being invested or borrowed by the interest rates. Since interest rates are always quoted on a yearly basis, you then multiply by the day count fraction. This fraction adjusts the interest to account for the fact that you aren't investing for a full 12 month period. So if you are investing for six months, the day count fraction ensures you receive interest only for that period, not for a full year. Different conventions are used to calculate this day count fraction, which are referred to as day count conventions. In money markets, the two most common day count conventions are actual over 360 and actual over 365.

With actual 360, the actual number of days between the starts and maturity of the investment is just divided by 360.

This convention is common in US and European money markets.

Actual 365 divides the actual days by 365, which is often used in British and domestic Japanese money markets. Here's a quick example to show why choosing the correct day count convention matters when evaluating different investment options. If you invest $100 million for one month, as shown in the example here, which covers 31 days under actual 360, you would earn significantly more than under actual 365, even though the interest rate and investment amounts are the same.