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Money Market Yield

Understanding Money Market Yield

The money market is a part of the financial system that allows participants to essentially trade large amounts of liquid funds for short periods, usually one year or less. The money market is actually part of the fixed income market. The money market is different from the bond market in that, for purposes of liquidity, the debt instruments traded in the money market never go above a one-year term. Within that framework, there is room for a great deal of flexibility, and investors can take advantage of the security and safety offered by this market by investing in money market accounts at banks and brokerages.

A money market account can either be a savings or checking account. The advantage is that money market accounts pay higher interest rates than regular savings or checking accounts, although these rates are usually lower than the bond and stock markets. The interest rate is typically compounded daily and paid into the account on a monthly basis. Banks make their profits from these accounts by lending the money that customers deposit into a money market account at a higher interest rate than the one they pay the depositor.

Banks do not only lend the money out to customers in the form of mortgages, constructions loans, etc. Banks need depositors money in order to buy and sell funds on the interbank lending market in order to stay above reserve requirements. Banks can sell their excess reserves to banks with deficient reserves; likewise banks with deficient reserves can buy excess reserves from larger or wealthier banks. The money market plays an integral role in this market, which is why liquidity is so important to maintain and the funds are always kept in pure cash.

Obviously, the interbank lending market revolves around selling and buying debt instruments, since the loans made in such a way are only for very short periods. This affects the interest rate, also known as the yield or rate of return. The shorter the time period, the lower the rate of return due to less risk, and vice versa. The relationship between money market yield and time is often graphically expressed as a curve. This curve allows all possible money market yield positions to be plotted and therefore analyzed by quantitative mathematical methods.

Money market yield is the price that banks pay to depositors for essentially lending them the money they need in order to meet their reserve requirements as well as to fulfill any remaining interbank obligations that they have. The money market helps banks stay liquid and therefore helps the customers make sure that they have access to their funds. Money market yield is the factor that can tell banks and customers the state of the market and thus the state of their money.

Additional topics

Financial Dictionary: Accounting, Business & International FinancePersonal Finance - Savings Accounts, CDs, the Stock Market, and Other Investments