The money market yield is the yield earned from investing in liquid, short-term debt securities with less than one year maturity. Money market instruments include Treasury bills (T-bills), short-term guaranteed investment certificates (GICs), banker’s acceptances, commercial papers, short-term mortgages, and more.
The money market yield is the yield earned from investing in liquid, short-term debt securities with less than one year maturity.
Money market securities are debt instruments with maturities of less than one year. They are characterized by high levels of liquidity and safety, resulting in low risks and low returns.
The money market yield is 360 divided by the time to maturity, multiplied by the holding period yield (HPY).
Understanding Money Market Yield
The diagram above illustrates the structure of the major asset classes. All debt securities under one year are money market securities. Those with maturity periods less than 90 days are categorized as cash and equivalents, while those with less than one year in maturity are short-term fixed income. Money market securities are characterized by high levels of liquidity and safety, resulting in low risks and low returns.
On the other hand, fixed income with maturities longer than one year (long-term debt) and equity (stocks) are under capital markets. Such securities come with higher risks and returns than the money market. Thus, money market securities are among the safest forms of investment and are a good addition to provide diversification and stability to portfolios.
The money market is an integral section of the financial market. It provides liquidity for consumer and government spending, which, in turn, spurs the economy. If the money market falters, it could spell trouble for the capital markets because short-term borrowing influences long-term borrowing.
Money Market Terms
Interest – The monetary compensation given by the borrower to the lender for lending money
Face Value – The lump-sum amount given by the borrower to the lender at the maturity date
Maturity Date – The date on which all debt obligations end, given that the borrower pays the face value and all interest payments
How Debt instruments Pay Interest
1. Coupon-Bearing Securities
Coupon-bearing securities pay periodic interest payments over the life of the security. At inception, the lender loans out an amount equivalent to or close to the security’s face value. Between inception and the maturity date, the borrower pays out period interest payments, and at maturity, they pay out the face value plus one last interest payment.
2. Zero-Coupon (Accrued Interest) Securities
With zero-coupon securities, interest payments are accrued or “deferred” until maturity instead of being paid out at periodic intervals. Investors make money from the securities because they are bought at a discount to their face value. The longer the investor holds the security, the more it is worth.
Money market securities can be sold on the secondary market, meaning that once an investor buys the security from the borrower, they can sell the security to another party before it matures. The price they can sell for on the market depends on the current market interest rate.
In calculating the money market yield, we can break the formula into two sections. The holding period yield (HPY) is the return earned from holding the security from purchase until maturity. By plugging the HPY into the money market yield formula, it accounts for the amount of holding time, with 360 representing one financial year.
Money Market Yield Examples
An investor purchased a Treasury bill from the secondary market for $990. The T-bill comes with a maturity of six months from purchase and a face value of $1,000. What is the money market yield?
Treasury bills are zero-coupon, so they do not make interest payments. Instead, they are sold at a discount to the face value.
A lender approves a short-term mortgage of $1M to a borrower with $1,000 monthly interest payments. At the maturity date eight months from now, the borrower will return $1M. What is the money market yield?
The above is a coupon-bearing security with a face value equal to the purchase price.
Holding Period Yield = ((8 x 1,000) + 1M – 1M)/1M = 0.008= 0.8%