Ch06

Copyright ©2004 Pearson Education, Inc. All rights reserved.

Chapter 6

Managing Your Money

Copyright ©2004 Pearson Education, Inc. All rights reserved. 6-2

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


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


Background on Money Management

• Adequate return – Dependent upon the risk-free rate the the

level of risk you are willing to tolerate

– Usually should consider multiple investments with varied returns and levels of liquidity


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



– 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


• 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



• 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


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.

http://www.bankrate.com/brm/rate/dep_home.asp



• 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!



• 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



• 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



• 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



• 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



Exhibit 6.2 Comparison of Money Market Investments



Exhibit 6.3: Comparison of the Liquidity and Returns of Money Market Instruments


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.

http://www.financenter.com/products/sellingtools/calculators




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


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


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.

http://www.chicagofed.org/


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


Optimal Allocation of Money Market Investments

Exhibit 6.4: How Liquidity Is Affected by Anticipated Expenses


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?


Integrating Key Concepts


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

Ch06

Economy & Finance

Transcript of Ch06