Investors trading in different types of securities including money markets and high yield mutual funds often use a mathematical construct known as a yield curve. Novice investors would benefit greatly from understanding this mysterious concept. As a starting point, let us think about the meaning of the word yield. To the buyer of a security, it simply reflects how much return on investment he or she expects. To the seller it is a very different thing: it is the cost of borrowing in issuing the security.
Did you know that the yield is a function of the length of time to maturity of the security. As the maturity date gets set further and further into the future, the yield increases to higher values. The increase is asymptotic, meaning that there are less gains as the maturity date goes further one. One famous theory for why yields behave this way is the “risk to liquidity” idea that states investors demand to be compensated more as they are forced to tie up money further into the future.
The ultimate effect is that yield values change as the maturity period increases, up to a point where it starts to plateau out. Put another way, the yield rises quickly as the maturity date shifts from a few months to a few years. But as the date gets pushed to the one, two and three decade range, the yield only increases slightly. In the rare occasions a yield curve shows falling behavior, investors have noted that a recession was likely imminent.
The dynamic nature of yields has an impact on many financial instruments.
Personal investors who are curious about receiving a higher yield than a checking account might consider the money market account. Such accounts are invested in mostly very short term financial instruments. Money market accounts are everywhere, easily found in a local branch of a national bank. Just obtain details on yields and deposit minimums before completing any forms. Accounts are likewise insured by the FDIC. Because money markets are always short term, the highest money market rates do not differ much from short term bonds according to yield curve theory.
The yield on mutual funds depends on the types of securities invested. A type of fund that has quite a low profile is the GNMA mutual fund, in contrast to the similar Fannie Mae and Freddie Mac. The three manage to land consumers and profit handsomely from the interest payments. At the time of the housing collapse of 2007-2008, when the duo Fannie Mae and Freddie Mac were criticized due to their part in financing underfunded mortgage seekers, Ginnie Mae found itself largely unscathed because of their low-risk investments. Because Ginnie Mae funds are longer term, they have higher yields than the short term securities.
Finally, what does the yield curve imply for government bonds? When the government conducts its operations it is required to somehow pay for it until tax revenue is collected to pay the workers. The borrowed financing is formalized as a bond which is basically a promise to repay the borrowed money in addition to some extra interest. Therefore treasury bills that mature in less than a year have much lower yields than treasury bonds that mature in decades.
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Antonopolous, Leo . "Understanding High Yield Mutual Funds And Highest Money Market Rates." Understanding High Yield Mutual Funds And Highest Money Market Rates. 2 Jul. 2010. uberarticles.com. 7 Apr 2015 <http://uberarticles.com/finance/assessing-high-yield-mutual-funds-and-best-money-market-yields/>.
APA Style Citation:
Antonopolous, L (2010, July 2). Understanding High Yield Mutual Funds And Highest Money Market Rates. Retrieved April 7, 2015, from http://uberarticles.com/finance/assessing-high-yield-mutual-funds-and-best-money-market-yields/
Chicago Style Citation:
Antonopolous, Leo . "Understanding High Yield Mutual Funds And Highest Money Market Rates" uberarticles.com. http://uberarticles.com/finance/assessing-high-yield-mutual-funds-and-best-money-market-yields/
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