Question

You find two investments:

1) a T-BILL with a Face value of 10.000 $ and 120 day until maturity with a current price of 96.5 and

2) 260 days to maturity a price of 92.8 and a Face Value of 10,000 $.

Questions:

Calculate the 4 different money market yields for both instruments.

Which of the two money market instruments will you choose? Justify your decision

Answer 1

Four different types of money market yields are :

1. Bank Discount Yield (BDY)

Formula: (D/F)*(360/t) Where D=Amount of discount, F= Face Value, t= No. of days till maturity

2. Holding Period Yield (HPY)

Formula: (P₁-P₀+D₁)/P₀ Where P₁= Amount received on maturity, P₀ = Purchase price and D₁= Interest received on maturity

3. Effective Annual Yield (EAY)

Formula: [(1+HPY)^(365/t])-1

4. Money Market Yield (MMY)

Formula: (Face Value-Purchase Price)*360/time to maturity

1. Security: T Bill with Face Value $10,000. Time to maturity 120 days. Current Price 96.5

Current Price @96.5= (96.5/100)*10,000= $9,650. Amount of discount= $10,000-$9,650= $350

Annualized Bank Discount Yield= (350/10,000)*(360/120)= 0.105= 15.5% (Rounded)

Holding Period Yield= (10000-9650+0)/9650= 350/9650= 0.03626943 = 3.62% (Rounded)

Effective Annual Yield= [(1+0.3627)^(365/120)]-1= (1.3627^3.041667)-1= 0.114457= 11.45% (Rounded)

Money Market Yield= (10000-9650)/9650*360/120=350/9650*360/120=0.108808=10.88% (Rounded)

2. Security: Face Value $10,000. Time to maturity 260 days. Current Price 92.80

Current Price @92.80= (92.8/100)*10,000= $9,280. Amount of discount= $10,000-$9,280= $720

Annualized Bank Discount Yield= (720/10,000)*(360/260)= 0.099692 =9.97% (Rounded)

Holding Period Yield= (10000-9280+0)/9280= 720/9280= 0.077586 = 7.76% (Rounded)

Effective Annual Yield= [(1+0.0776)^(365/260)]-1= (1.11062)-1= 0.11062= 11.06% (Rounded)

Money Market Yield= (10000-9280)/92800*360/260= 720/9280*360/280= 0.099754=9.98% (Rounded)

Selection of security:

Holding period yield pertain to the holding period and does not take care of annualized effect. Except that, all other measures indicate higher yield on security 1 (T Bill). Hence the same will be chosen.