Money Market Yield

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21 Aug, 2024

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Money Market Yield (MMY) refers to the interest or profit generated using investment into short-term debt for a short term, such as Treasury Notes. It provides short-term investment opportunities with low risks, low returns, and a high degree of liquidity to investors. All money market instruments, such as Treasury bills (T-bills), fall under this category.

Money market securities provide the best option for portfolio stability and diversification. In addition, they supply liquidity to the government and consumers, stimulating the economy toward growth. However, if all the money markets fail, long-term borrowings get badly affected and may also spell trouble for capital markets.

What Is Money Market Yield?

Money market yield refers to the money earned by investors when they invest in debt assets with maturities of less than one year, which tends to be highly liquid.
It tends to provide investors with the safest investment opportunity but has lower returns compared to riskier investments and the highest level of liquidity.
It can be calculated by getting 360 divided by the time taken for the maturity of security and multiplied by the holding period (HPY).

Money Market Yield Explained

Money market yield is explained as the net estimated profit by investment into extremely liquid securities. These securities, such as municipal notes and treasury bills, tend to be highly liquid and yield low. These short-term assets with high liquidity features have the characteristics of getting bought, sold, and turned into cash easily.

These securities have a maturity of less than one year as they have a safety feature, so their yield remains low. However, investors who are focused on making the most money could look for possibilities with the highest money market yield.

The money market plays a crucial role in the financial system by facilitating the trading of highly liquid, short-duration financial instruments. It serves as a platform where lenders and borrowers can engage in transactions involving instruments with durations ranging from a few days to less than a year.

These participants engage in transactions involving various short-term instruments, including the following:

Certificates of Deposit (CD)
Treasury bills (T-bills)
Short-term guaranteed investment certificates (GICs)
Short-term asset-backed securities
Banker's acceptance
Municipal notes
Commercial paper
Eurodollar deposits
Repurchase agreements
Short-term mortgages

To engage in money market transactions, one must have a money market account. Financial institutions borrow money from this market for a short duration to maintain the level of reserves and manage interbank lending. In return, they give the investors a variable rate of interest as per the current prevailing interest rate in the economy. As these instruments have safety in return, they give a lower rate of return on investment, which is higher than normal savings account interest rates.

The fidelity money market yield tends to be more than savings accounts but less than capital markets. This is because Vanguard money market yield gets invested in high-quality cash equivalents, cash, and short-term debt securities, which offer a balance between safety and yield.

Formula

The interest rate of these instruments gets quoted either daily, monthly, quarterly, half-yearly, or even annually. Let us derive the formula for MMY. For this purpose, one needs to know the expression of :

Holding period yield (HPY) = (Interest payments + Face value -Purchase price)/Face value

Where HPY means the amount of return from security up to its maturity.

Once we have the HPY, we can calculate the MMY using the following formula:

MMY = HPY *(360/maturity period)

One must note that MMY is calculated based on the equivalent bond yield (BEY) on a 360-day basis every year. Therefore, MMY calculations are often performed using specialized tools like money market yield calculators available on various financial websites.

Examples

Let's look at some calculation examples to grasp the topic better.

Example #1

Let us assume Noah bought a CD from a broker at $1,000. The CDs have a face value of $1,100 and a maturity period of six months starting from the buying date. CDs, too, have a zero-coupon feature, which means they will not pay the interest amount to Noah. However, Noah could sell these at a discount on their face value and earn profits as below:

Yield during Holding period = (0+1,100-1,000)/1,100 *100= 100/1100 *100 = 0.0909 = 9.09%

MMY = .0909*(360/180) = 0.1818 = 18.18%

Example #2

Suppose ABC bank approves a short-term credit to Alex as a mortgage of $2 million, having $2000 equated monthly installments. Alex would return $2 million to the bank when the term completes nine months. Let us calculate the MMY for Alex:

One can notice that the above resembles a coupon-bearing security with a face value of the same price as the purchase price.

Therefore, yield on holding period = ((9*2000) + 2,000,000 - 2,000,000)/ 2,000,000 *100

= 18,000/2,000,000*100=0.9%

MMY= 0.009 (360/270) = 1.2 %

Money Market Yield vs Bond Equivalent Yield vs Bank Discount Yield

Let's go through the table below to understand the difference between these three concepts:

Concept	Money Market Yield	Bond Equivalent Yield	Bank Discount Yield
Definition	It gives out lower rate interest rate	It accounts for the actual dollar amount invested.	It accounts for expected return while selling a bond at a discount on its face value.
Application	It forms the safest instrument for investment with assured returns.	It determines the total yield on investments in bonds.	It determines the yield given by municipal notes, commercial paper & treasury bills.
Importance	It forms the core of short-term investments.	The simple interest gets calculated on an actual or actual day-count basis.	The US Treasury Department mostly uses this term for yield quoted on US T-bills.
Calculation	It has the nature of being highly liquid.	It helps one compare bonds that have the same maturity date.	It has a simple interest as its base without compounding.

Frequently Asked Questions (FAQs)

Are money market yields net of fees?

MMY is expressed as the total net income of fees for the fund divided by the total quantity of outstanding shares in the portfolio.

Why are money market yields so low?

The yields remain low because the money obtained from investors from these instruments gets lent out to consumers in the shape of loans and credit cards bearing higher risk and little return.

Do money market yields stay constant?

MMY does not remain constant over time. Investors do not receive a fixed return on the invested amount. Instead, the yields from these instruments fluctuate due to a variable interest rate, making the earnings on these investments fluctuate over time for the consumers.

Can there be a negative money market yield during a financial crisis?

During times of financial crisis or significant market disruption, investors may choose to accept negative rates. They make this decision as they seek the protection of highly liquid assets like Treasury bills. This phenomenon, known as the flight to quality, has the potential to cause money market rates to decline momentarily.