A Proposal for Quoting Money Market Rates

Miles Livingston and Lei Zhou

Financial Analysts Journal, 2002, vol. 58, issue 2, 38-42

Abstract: U.S. money market interest rates may be quoted in many different ways. Regardless of the method, however, the amount of the loan, the coupon, and the par value of the loan are the same. The only difference in the methods is how the interest rate is quoted. This multiplicity of ways of quoting interest rates is a cause of constant confusion for novices attempting to analyze money market instruments and has no value for experts. We propose a single way to quote money market interest rates regardless of the type of money market instrument. The proposed method is not only consistent for the various instruments; it is also consistent with the Truth in Lending Law. Any observer of the U.S. market for money market instruments must be struck by the great number of ways of quoting money market interest rates. At least five different ways are frequently used to quote interest rates on zero-coupon money market instruments with maturities of less than six months. And additional methods are used to quote coupon-bearing money market instruments or money market instruments with maturities of between six months and one year.Two instruments may have the same price or amount of loan, same coupon, and same par value, but the calculation of the interest rate differs. For example, suppose a 90-day noncoupon money market instrument has a par value of $100 and a price of $99. The quoted discount rate on the instrument is 4 percent, the add-on rate is 4.04 percent, the bond-equivalent yield is 4.10 percent, the semiannual yield is 4.12 percent, and the annual yield to maturity is 4.16 percent. This multiplicity of ways of quoting interest rates is a cause of constant confusion for novice analysts in the field of money market instruments and has no value for experts.The reason for the multiplicity of interest rates appears to be historical accident. Before hand-held calculators, various money markets developed separately over time, but the ability to calculate rates easily was important, so each market developed an easy calculation. With the advent of hand-held calculators, calculation of any of these interest rates is no longer a problem.Because long-term bonds in the United States are quoted in terms of semiannual yield to maturity (i.e., annualized semiannually compounded yield to maturity), the world of fixed-income analysis would be greatly simplified if all interest rates were stated this way. There would be no need to state interest rates on a particular debt instrument in different ways, and given the ease of calculating the semiannual yield to maturity, there is no reason to have any other interest rate. Therefore, we propose that the bond market use the semiannual yield for all bonds and money market instruments.

Date: 2002
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DOI: 10.2469/faj.v58.n2.2521

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