The world of investment and financial markets can seem daunting and complicated. For the uninitiated, it can feel akin to learning a new language – one which is spoken purely in numbers, percentages and decimal points rather than words and sentences.
You can trade many different markets such as foreign exchange, commodities, stocks and shares, indices and more. And you can do so in different ways – spread betting and contracts for difference are just two examples.
Then there are money market products, which are seen as low-risk and low-reward instruments that can be a useful place for investors to keep their funds until they have another use for the capital. But what exactly is the money market yield? How does it work? And what does it mean for investors around the world? Read on to find out more.
What is the money market yield?
The money market yield is the interest rate you receive when you invest in high-liquidity debt securities with maturities of less than one year. Examples of these short-term products include certificates for deposit and Treasury bills. It essentially offers an indication of the returns you can expect to see on your investment. Brokers, dealers and funds are all likely users of these types of markets and any securities with maturity periods of 90 days or less are sometimes referred to as cash equivalents.
How does the money market yield work?
To explain this further, we need to understand a few key terms.
- Maturity period: The length of time before the borrower is obligated to repay the debt.
- Face value: The amount paid by the borrower to the lender once the maturity period is up.
- Interest: Additional funds paid to the lender by the borrower, in return for being able to borrow the money. This is usually charged as a percentage.
- Holding period yield (HPY): This is worked out as the interest plus the face value minus the purchase price, which is then divided by the face value.
Once we have the HPY, we can use it to calculate the money market yield. This is done by dividing 360 (one financial year) by the maturity period and multiplying that by the holding period yield.
What does it mean for individual investors?
As the world tackles a difficult economic landscape, lots of capital is being invested into money market products. In some places, this trend is developing to the extent that fund managers have had to restrict the amount of investment flowing into these products. The attraction for investors is that money markets are low-risk, representing something of a safe haven in an otherwise uncertain financial climate. And because they’re high-liquidity, it makes it easier for investors to take their money out if they spot an opportunity elsewhere.