Money Market Yield
What Is the Money Market Yield?
The money market yield is the interest rate earned by investing in securities with high liquidity and maturities of short of what one year, for example, negotiable certificates of deposit, U.S. Treasury bills, and municipal notes. Money market yield is calculated by taking the holding period yield and multiplying it by a 360-day bank year partitioned by days to maturity. It can likewise be calculated utilizing a bank discount yield.
The money market yield is closely related to the CD-equivalent yield and bond equivalent yield (BEY).
Understanding the Money Market Yield
The money market is the part of the more extensive financial markets that arrangements with highly liquid and short-term financial securities. The market joins borrowers and lenders who are hoping to transact in short-term instruments overnight or for certain days, weeks, or months, but in every case under a year.
Active participants in this market incorporate banks, money market funds, brokers, and dealers. Instances of money market securities incorporate Certificates of Deposit (CD), Treasury bills (T-bills), commercial paper, municipal notes, short-term asset-backed securities, Eurodollar deposits, and repurchase agreements. To earn a money market yield, it is thus important to have a money market account. Banks, for instance, offer money market accounts since they need to borrow funds on a short-term basis to meet reserve requirements and to participate in interbank lending.
Money market investors receive compensation for lending funds to entities that need to satisfy their short-term debt obligations. This compensation is typically as variable interest rates determined by the current interest rate in the economy. Since money market securities are considered to have low default risk, the money market yield will be lower than the yield on stocks and bonds but higher than the interest rates on standard savings accounts.
Calculating the Money Market Yield
Although interest rates are quoted annually, the quoted interest may actually be accumulated semi-annually, quarterly, monthly, or even daily. The money market yield is calculated utilizing the bond equivalent yield (BEY) in light of a 360-day year, which assists an investor with contrasting the return of a bond that pays a coupon on an annual basis with a bond that pays semi-annual, quarterly, or some other coupons.
The formula for the money market yield is:
Money market yield = Holding period yield x (360/Time to maturity)
Money market yield = [(Face value - Purchase price)/Purchase price] x (360/Time to maturity)
For instance, a T-bill with $100,000 face value is issued for $98,000 and due to mature in 180 days. The money market yield is:
- = ($100,000 - $98,000/$98,000) x 360/180
- = 0.0204 x 2
- = 0.0408, or 4.08%
The money market yield contrasts slightly from the bank discount yield, which is computed on the face value, not the purchase price. Nonetheless, the money market yield can likewise be calculated utilizing the bank discount yield as found in this formula:
Money market yield = Bank discount yield x (Face value/Purchase price)
Money market yield = Bank discount yield/[1 - (Face value - Purchase price/Face value)]
Where bank discount yield = (Face value - Purchase price)/Face value x (360/Time to maturity)
Highlights
- The money market yield is what money market instruments are expected to return to investors.
- The money market includes the purchase and sale of large volumes of extremely short-term debt products, like overnight reserves or commercial paper.
- An individual might invest in the money market by purchasing a money market mutual fund, buying a Treasury bill, or opening a money market account at a bank.
