Question

In class, we discussed different ways to calculate the return or yield on a money market financial instrument. We started with Holding Period Return (simple interest) and worked through Bank Discount Yield, Money Market 360-day Yield, Money Market 365-day Yield, and APY. (Formulae provided, below.) We showed that using the same inputs for current price and maturity value, you could get different answers for each quotation method. Explain the three issues behind why the quotation methods yield different results.

            Money Market interest rate quotations:

                        Simple interest rate = (Pn - Po) / Po

Bank Discount Yield (BDY) = {(Pn - Po) / Pn}*{360/n}

    

Money Market 360 day yield = {(Pn - Po) / Po}*{360/n}

     

Money Market 365 day yield = {(Pn - Po) / Po}*{365/n}

    

True (effective) yield (APY) = {1 + [(Pn - Po) / Po]}^365/n - 1

Answer 1

ISSUES WITH DIFFERENT YIELDS ARE

1. BANK DISCOUNT YIELD this yield uses a 360-day year to calculate the return an investor would receive. But this doesn't take into account the potential for compounded returns.

2.MONEY MARKET YIELD -The money market yield (MMY) (also known as the CD-equivalent yield), relies on a calculation allowing the quoted yield (which is on a T-Bill) to be compared to an interest-bearing money market instrument.

3.EFFECTIVE ANNUAL YIELD -  This Includes Holding period and problem with it is ,  return differs from most return calculations that show returns on a yearly basis. Also, is it assumed that the interest or cash disbursement will be paid at the time of maturity.