Compounding effect and Money market: Difference between pages

From ACT Wiki
(Difference between pages)
Jump to navigationJump to search
imported>Doug Williamson
(Add link.)
 
imported>Doug Williamson
(Linked to The Treasurers Handbook - Money market fund reform: a light at the end of the tunnel?)
 
Line 1: Line 1:
The additional growth or additional interest, resulting from the compounding effects of - for example - interest on interest.
Money markets trade short-term financial instruments, generally with a life up to one year.  


Another example is the compounding effect of growth on growth.  
Securities are generally quoted on the basis of a simple nominal annual interest rate (or yield) or a simple nominal annual discount rate.


Important short term interest conventions are:


'''Example'''


Interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is:
1. For GBP yield instruments: Actual/365 days


= (1.06 x 1.06) - 1
So Simple periodic interest = Quoted nominal annual rate x [Actual days]/365


= 12.36% for the two year period.
For example a 272 day sterling yield instrument quoted at 4% would pay periodic interest of:


= 4% x 272/365


Without the additional interest on interest, the total interest would have been simply
= 2.9808% per 272 day period


6% per annum x 2 years


= 12.00%.
2. For EUR, USD and most other currencies yield instruments: Actual/360 days


So Simple periodic interest = Quoted nominal annual rate x [Actual days]/360


So the compounding effect of interest on interest here
For example a 272 day USD yield instrument quoted at 4% pays periodic interest of:


= 12.36% - 12.00%  
= 4% x 272/360


= 0.36% over the two year period (= 6% x 6%).
= 3.0222% per 272 day period.
 
 
When both the number of periods and the rate of growth/interest are low, compounding effects are relatively small.
 
When either the number of periods or the rate of growth/interest - or both - are greater, compounding effects quickly become very much larger.




== See also ==
== See also ==
* [[Compound]]
* [[Capital market]]
* [[Compound interest]]
* [[Depo market]]
* [[Compounding factor]]
* [[International money market]]
* [[Continuously compounded rate of return]]
* [[Market]]
* [[Discount]]
* [[Money market fund]]
* [[Money market fund reform: a light at the end of the tunnel?]]
* [[Money market lines]]
* [[Nominal annual rate]]
* [[Simple interest]]
* [[Wholesale markets]]


[[Category:Manage_risks]]
[[Category:Long_term_funding]]

Revision as of 11:27, 1 December 2014

Money markets trade short-term financial instruments, generally with a life up to one year.

Securities are generally quoted on the basis of a simple nominal annual interest rate (or yield) or a simple nominal annual discount rate.

Important short term interest conventions are:


1. For GBP yield instruments: Actual/365 days

So Simple periodic interest = Quoted nominal annual rate x [Actual days]/365

For example a 272 day sterling yield instrument quoted at 4% would pay periodic interest of:

= 4% x 272/365

= 2.9808% per 272 day period


2. For EUR, USD and most other currencies yield instruments: Actual/360 days

So Simple periodic interest = Quoted nominal annual rate x [Actual days]/360

For example a 272 day USD yield instrument quoted at 4% pays periodic interest of:

= 4% x 272/360

= 3.0222% per 272 day period.


See also