The money market yield is the interest rate earned by investing in securities with high liquidity and maturities of less than one year such as 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 divided by days to maturity. It can also be calculated using a bank discount yield.
The money market yield is also known as the CD-equivalent yield or bond equivalent yield.
Breaking Down Money Market Yield
The money market is the part of the broader financial markets that deals with highly liquid and short term financial securities. The market links borrowers and lenders who are looking to transact in short-term instruments overnight or for some days, weeks, or months, but always less than a year. Active participants in this market include banks, money market funds, brokers, and dealers. Examples of money market securities include Certificates of Deposit (CD), Treasury bills (T-bills), commercial paper, municipal notes, short-term asset-backed securities, Eurodollar deposits, and repurchase agreements.
Money market investors receive compensation for lending funds to entities that need to fulfill their short-term debt obligations. This compensation is typically in the form of 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.
Although interest rates are quoted annually, the quoted interest may actually be compounded semi-annually, quarterly, monthly, or even daily. The money market yield is calculated using the bond equivalent yield (BEY) based on a 360-day year, which helps an investor compare the return of a bond that pays a coupon on an annual basis with a bond that pays semi-annual, quarterly, or any 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 example, 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 differs slightly from the bank discount yield, which is computed on the face value, not the purchase price. However, the money market yield can also be calculated using the bank discount yield as seen 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)
To earn a money market yield, it is necessary to have a money market account. Banks, for example, offer money market accounts because they need to borrow funds on a short-term basis to meet reserve requirements and to participate in interbank lending.