Post on 16-Dec-2015
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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
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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
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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
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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
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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
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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
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
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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
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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): a deposit offered by a depository institution that requires a minimum balance, has no maturity date, pays interest, and allows a limited number of checks to be written each month
– Less liquid than checking, but pays a higher interest rate
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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
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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
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Money Market Investments
Exhibit 6.1: Weekly Money Market Fund YieldsCopyright © 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
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Money Market Investments
Exhibit 6.2 Comparison of Money Market Investments
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Money Market Investments
Exhibit 6.3: Comparison of the Liquidity and Returns of Money Market Instruments
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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.
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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
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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
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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.
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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
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Optimal Allocation of Money Market Investments
Exhibit 6.4: How Liquidity Is Affected by Anticipated Expenses
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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?
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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