What Is the Money Market Yield?

Money market yield provides investors with a measure of return from highly liquid securities and short-term investments like U.S. Treasury bills, CDs, and municipal notes. It involves calculating the holding period yield adjusted for a 360-day bank year. This yield is closely tied to CD-equivalent and bond equivalent yields, offering insights into short-term financial securities' performance.

How the Money Market Yield Works

Themoney 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 includeCertificates of Deposit (CDs),Treasury bills (T-bills), commercial paper, municipal notes, short-term asset-backed securities, Eurodollar deposits, andrepurchase agreements.

To earn a money market yield, it is thus necessary to have amoney market account. Banks, for example, offer money market accounts because they need to borrow funds on a short-term basis to meetreserve requirements and to participate in interbank lending.

Investors in the money market earn money by lending to entities needing short-term debt solutions. This compensation is typically in the form of variable interest rates, which are determined by the current interest rate in the economy.

Money market securities, with low default risk, usually yield less than stocks and bonds but more than regular savings accounts.

Calculating Money Market Yield: Formulas and Examples

Interest rates are quoted annually, but they might be compounded semi-annually, quarterly, monthly, or daily. The money market yield uses thebond equivalent yield (BEY) and a 360-day year. This helps investors compare returns from bonds paying annual coupons with those paying semi-annual, quarterly, or other frequencies.

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 a $100,000face value is sold for $98,000 and matures 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 thebank 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)

The Bottom Line

Investing in money market instruments offers a strategic way to use short-term funds, providing interest income while maintaining liquidity. These investments, such as Treasury bills and commercial paper, generally offer a lower default risk compared to other securities. Money market yields range between 0.01% and 4%, depending on factors like deposit amounts or account types.

For investors seeking to maximize returns on short-term liquid assets, money market investments provide an accessible, lower-risk option compared to standard savings accounts.