The money market yield is the interest rate earned by investing in high liquidity securities with maturities of less than one year. Typical instruments include negotiable certificates of deposit, U.S. Treasury bills, and municipal notes. The yield is calculated by taking the holding period yield and multiplying it by 360 (the bank year) divided by the number of days to maturity. Another common calculation utilizes the bank discount yield.
Key Takeaways
- Money market instruments offer predictable returns to investors.
- The money market is focused on the trading of large volumes of short-term debt products, such as overnight reserves or commercial paper.
- Investors can engage with the money market by purchasing a money market mutual fund, acquiring a Treasury bill, or opening a money market account at a bank.
Exploring Money Market Yields
The money market combines highly liquid and short-term financial securities, providing a crucial link between borrowers and lenders eager to engage in short-term transactions ranging from overnight deals to less-than-a-year commitments.
Key participants include banks, money market funds, brokers, and dealers. Popular securities comprise Certificates of Deposit (CD), Treasury bills (T-bills), commercial papers, municipal notes, short-term asset-backed securities, Eurodollar deposits, and repurchase agreements.
A money market account is necessary to earn money market yields. Banks often offer these accounts as they need to borrow funds short-term for meeting reserve requirements and facilitating interbank lending.
Money market investors are compensated for lending funds to meet others’ short-term debt obligations, typically via variable interest rates reflecting current economic interest rates.
Due to the low default risks associated with money market securities, yields are generally lower than those of stocks and bonds but exceed standard savings account interests.
Calculating Money Market Yields
Despite being quoted annually, interest rates might actually be compounded semi-annually, quarterly, monthly, or daily. The money market yield can be gauged using the bond equivalent yield (BEY), which is calculated on a 360-day basis, offering a means to juxtapose the returns from bonds with various coupon payment schedules.
The formula for the money market yield is:
1Money market yield = [Holding period yield] x (360/Time to maturity)
2Money market yield = [(Face value - Purchase price)/Purchase price] x (360/Time to maturity)
For instance, consider a T-bill with a $100,000 face value, issued at $98,000, maturing in 180 days. The money market yield can be computed as follows:
1= ($100,000 - $98,000) / $98,000) x (360/180)
2= 0.0204 x 2
3= 0.0408, or 4.08%
The money market yield is distinct from the bank discount yield, which calculates based on face value rather than purchase price. Yet the yield can also be delved using this alternate method:
1Money market yield = Bank discount yield x (Face value / Purchase price)
2Money market yield = Bank discount yield / [1 - (Face value - Purchase price) / Face value)]
Typical Money Market Yields
Typically, money market accounts and instruments yield between 0.01% and 4%. This varies depending on the deposited amount, where higher deposits often attract higher interest rates.
Understanding the 7-Day Yield on Money Markets
The 7-day yield on the money market offers an annualized estimate of returns on money market instruments. It calculates the difference between today’s price and the price seven days earlier, multiplied by an annualization factor.
Disadvantages of Money Market Accounts
Some drawbacks include lower yields than certain investment accounts, limits on the number of allowable transactions over a period, and the necessity for minimum account balances.
The Bottom Line
Investing in money market instruments provides an effective use of short-term funds by generating interest income, making it a worthwhile alternative to non-interest-bearing or low-interest savings accounts.
Related Terms: Certificates of Deposit, Treasury bills, money market accounts, financial markets.
