6e Where do they use money market yield rates in real life?

CFA Level I Quant
#1

this section covers Holding Period Yield, Bank Yield Discounts, Effective Annual Yield, and Money Market Yield

The book lists an example of a fixed income instrument with a normal face value of 100,000 being sold at a discounted price of 98,500, with 120 days left to maturity.

HPR is easy to understand for me. 1500/98,500 = 1.5228%

But the BYD , I don’t understand. The book states it at (1500/100000) * (360/120) =4.5%

A) Why are we using 360 days instead of 365? What happens if an asset is held for 361 days?

B) Why are we using $100,000 when our capital commitment was only 98,500?

So then I’m looking at EAY , which is (1+0.015228) ^ (365/120 days) -1 = 4.72%. That makes sense, bc it takes into effect compounding

Finally, the book covers Money Market rate , which is defined as HPR*(360/120 days) = 4.568%

When would I ever use MM rate instead of EAY in real life? Or is this just stuff we have to learn for the test?

#2

All the banks use MMY to calculate interest on deposits and on loans. At least commercial loans.

The 360 days’ year is just a convention. This is how they calculate (just to make it trickier for the non-finance bank customers :-))

BDY is a discount yield. You compare what you earned to the FV and not to the PV. And 360 days. And simple yield, not compounded.

MMY is an add-on yield (hence they use PV in the denominator when calculating HPY). And 360 days. And simple yield, not compounded.

BEY is 365 days, and compounded. Hence you not multiply with 365/days but you use the power

(1+HPY)^365/days - 1 to account for compounding for the period (days).

#3

I now see how to calculate BDY and HPY.

The author says that if he gets BDY, he can calculate HPY. How does he do that without knowing what T (days to maturity) equals?

#4

Here’s an article I wrote on exactly this topic: http://financialexamhelp123.com/comparing-yield-measures-quant/.

You’re correct: you cannot convert from BDY to HPY without knowing t.

#5

Using the $100,000 is some what of a convention as well. It’s becuase these securities are usually issued on a discount basis, so you would use the total discount over the face value. Its only important to remember for this specific calculation. I dont think its used for any other asset.