Transcript Document
Chapter 6
Managing Your Money Copyright ©2004 Pearson Education, Inc. All rights reserved.
Chapter Objectives
• Provide a background on money management • Describe the most popular money market investments • Identify the risk associated with money market investments • Explain how to manage the risk of your money market investments Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Background on Money Management
• • Money management: a series of decisions made over a short-term period regarding cash inflows and outflows Liquidity: your ability to cover any cash deficiencies that you may experience – Related to your personal cash flow statement Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Background on Money Management
• Adequate return – Dependent upon the risk-free rate and the level of risk you are willing to tolerate – Usually should consider multiple investments with varied returns and levels of liquidity Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
• Checking account • NOW account • Savings deposits • Certificate of deposit • Money market deposit account (MMDA) • Treasury bills • Money market fund • Asset management account Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
• Checking Account — also called demand deposit account – Enables you to track spending – Overdraft protection: an arrangement that protects a customer who writes a check for an amount that exceeds the checking account balance • Saves overdraft fees and bounced checks • Results in high interest rate on borrowed amount Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
– Stop payment: a financial institution’s notice that it will not honor a check if someone tries to cash it – Fees such as monthly service charges, per check charges – No interest — regular checking accounts don’t pay interest Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
• NOW (negotiable order of withdrawal) account: a type of deposit offered by depository institutions that provides checking services and pays interest – Requires a minimum balance, lowering liquidity • Savings deposits pay interest and are slightly less liquid than checking accounts
Money Market Investments
• Certificate of Deposit – Retail CDs: certificates of deposit that have small denominations – Return — CDs pay higher interest rates than savings deposits – Liquidity — penalties are imposed for early withdrawal – Choice among CD maturities Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Financial Planning Online: Deposit Rates Offered by Banks
• Go to: http://www.bankrate.com/brm/rate/dep_home.asp
• This Web site provides information on the highest interest rates offered on deposits by banks across the United States as well as in you specific city.
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Money Market Investments
• Focus on Ethics: Risky Deposit Rates – While CDs with especially high deposit rates sound appealing, they probably carry greater risk – Ask if they are insured by the FDIC – If an investment sounds too good to be true, it probably is!
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Money Market Investments
• Money Market Deposit Account (MMDA): number of checks to be written each month a deposit offered by a depository institution that requires a minimum balance, has no maturity date, pays interest, and allows a limited – Less liquid than checking, but pays a higher interest rate Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
• Treasury securities: debt securities issued by the U.S. Treasury – Treasury bills (T-bills): Treasury securities with maturities of one year or less – Return — purchased at a discount; result in capital gains – Secondary market: a market where existing securities such as Treasury bills can be purchased or sold Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
• Money Market Funds (MMFs): accounts that pool money by individuals and invest in securities that have a short term maturity – Typically less than 90 days – Commercial paper: short-term debt securities issued by large corporations that typically offer a slightly higher return than T-bills Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
Exhibit 6.1: Weekly Money Market Fund Yields Copyright © 2001 Dow Jones & Company, Inc. All Rights Reserved.
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Money Market Investments
• Asset Management Account: an account that combines deposit accounts with a brokerage account and provides a single consolidated statement • Comparison of money market investments – Tradeoff between expected return and degree of liquidity Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
Exhibit 6.2 Comparison of Money Market Investments Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Money Market Investments
Exhibit 6.3: Comparison of the Liquidity and Returns of Money Market Instruments Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Financial Planning Online: Impact of Different Deposit Rates on Your Wealth • Go to: http://www.financenter.com/products/ sellingtools/calculators • Click on: “Savings,” then “How much of a difference will the rate make?” • This Web site provides estimates of future savings at different deposit rates.
Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Risk of Money Market Investments
• Credit risk: the risk that a borrower may not repay on a timely basis (default risk) • Interest rate risk: the risk that the value of an investment could decline as a result of a change in interest rates • Liquidity risk: the potential loss that could occur as a result of converting an investment into cash Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Risk Management of Money Market Investments
• Risk assessment of money market investments – Most money market investments are federally insured – Treasury securities are nearly risk free – Remember the relationship between risk and return Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Financial Planning Online: Identifying Insured Investments
• Go to: http://www.chicagofed.org
• Click on: Project Money $mart, then “Different Bank Products-What’s Insured and What’s Not” • This Web site identifies the investments that are backed by the U.S. government.
Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Risk Management of Money Market Investments
• Determining the optimal allocation of money market investments – Anticipate upcoming bills and have adequate funds in your checking account – Estimate additional funds needed in near future and invest in a liquid investment – Use remaining funds in a way that will maximize your return, considering your risk tolerance Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Optimal Allocation of Money Market Investments
Exhibit 6.4: How Liquidity Is Affected by Anticipated Expenses Copyright ©2004 Pearson Education, Inc. All rights reserved.
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How Money Management Fits Within Your Financial Plan
• Key money management decisions for your financial plan are: – How can you ensure that you can pay your anticipated bills on time?
– How can you maintain adequate liquidity in case you incur unanticipated expenses?
– How should you invest any remaining funds among money market investments?
Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Integrating Key Concepts
Copyright ©2004 Pearson Education, Inc. All rights reserved.
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Integrating Key Concepts
• Part 1: Financial Planning Tools • Part 2: Liquidity Management – In Chapter 5 we learned about banking and interest rates – In Chapter 6 we learned about managing your money – Chapter 7 teaches about managing your credit • Part 3: Financing • Part 4: Protecting Your Wealth • Part 5: Investing • Part 6: Retirement and Estate Planning Copyright ©2004 Pearson Education, Inc. All rights reserved.
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