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3.3 Money and Financial Products
GCSE Economics 3.3 Money and Financial Products
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Money Definition: Money can be defined as a collection of notes and coins which, when taken together, form a medium of exchange (often referred to as cash). This allows individuals to exchange cash in return for goods and services.
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Functions of Money Unit of Account – this function allows an individual to measure the value of goods/services, since they are usually stated in money terms, e.g. comparing prices of an Apple iPhone across retailers – one retailer may sell it at £409.00, whereas another sells it for £399.99 Store of Value – this function means that money must hold its value over time, so that an individual can use the money to buy goods/services at a later date, rather than in the short term, e.g. an individual might book a summer holiday costing £1,000 in October, but only pay the travel agent £1,000 in June
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Functions of Money Medium of Exchange – individuals can easily access a common way of exchanging goods in return for a cash payment, e.g. Caterpillar produces and sells excavators and items of clothing – paid for by customers, using cash. Standard for Deferred Payment – purchases can be made on credit, being paid for at a later date using money, e.g. a store card used to purchase a mobile phone immediately, paid for at a later date
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Means of Payment Individuals can choose to pay for goods/services using a variety of payment methods. Two categories are commonly found: Cash-based methods Non Cash-based methods
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Cash-based methods Cash - notes/coins used to complete a transaction, e.g. a voucher costing £10 to top-up a mobile phone purchased at a local retailer paid using coins. This method is convenient, however it means that cash must be carried at all times. Cheques Paper documents, stating a promise to pay the holder the amount stated on the cheque when presented to a bank for payment.
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Non-cash based methods
Debit Cards - A plastic card containing key information which when presented for use at an automated terminal, allow the user to transfer funds to/from a bank account immediately Credit Cards - A plastic card related to an individual’s credit account containing information which when presented for use at an automated terminal, allow the user to transfer funds to/from a credit account immediately
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Non-cash based methods
Store Cards - A plastic card related to an individual’s credit account (loan facility provided by a retailer), containing key information which when presented for use at the specific retailer’s automated terminal, allows the user to transfer funds to/from a credit account immediately to purchase goods, e.g. purchase of a laptop pc from Argos Electronic Funds Transfer A system of automated payments/receipts operated by many banks facilitating the electronic transfer of funds between bank accounts, e.g. monthly direct debit from an individual’s account to Ford Motor Co. to pay for a car
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Financial Products A range of financial products/services are available to allow individuals/ businesses to meet their financial needs. Examples Include: Savings Loans Mortgages Insurance products Pension products Shares Risk/Return Relationship: General concept – the higher the risk of a financial product, the higher the return that is expected by the investor; e.g. deposits/savings typically pay 1% interest p.a. (at best), whereas a dividend on a share might pay 10%; but savings must be guaranteed (up to £85,000), i.e. low risk; whereas shares are not guaranteed, i.e. high risk
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Savings This is money which an individual has which remains unspent – i.e. a situation where the income is greater than the financial outgoings Bank Deposits/Credit Union savings – safe form of investment, guaranteed up to £85,000, low risk, low return – low interest rates payable National Savings – e.g. premium bonds, government bonds; safe form of investment, low risk, low return – low interest rates payable
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Loans Money provided to an individual from a bank/financial services provider to enable a person to pay for something immediately, however, it is repaid in smaller amounts (with interest) over a period of time in the future Secured – debt attached to an asset, e.g. mortgage to buy a property or a loan – low risk, low rate of interest Unsecured – debt not attached to an asset, e.g. credit card, store card – high risk, higher rate of interest
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Mortgages A mortgage is a long term loan, normally granted to allow an individual to purchase property Types: Fixed Rate – householder charged a fixed rate of interest over an agreed period Variable Rate – householder charged a variable rate of interest over an agreed period Tracker – householder charged a rate of interest which varies in the same direction once interest rate changes
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Insurance Products An insurance policy is a legal contract which enables the policy-holder to pay a fee (premium) in return for being protected against financial loss in the future. Examples include: house/contents insurance car insurance travel insurance life assurance
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Pension Products A pension is a source of income payable to individuals of retirement age. It is basically a long-term savings plan (over years linked a person’s job), which can be used to provide an income to pensioners Stakeholder Pension – a basic pension which all employees/employers/government must participate in Private/Company Pension – an enhanced pension which all employees/employers participate in State Pension – a pension paid by government to all individuals of pension age, if no other pension is payable
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Shares A share is a certificate documenting part-ownership of the share capital in a limited company; shares are a risky investment, since dividends are not guaranteed, shares prices can go down as well as up A high risk investment compared to savings Dividend – return on a share, paid at a variable rate Capital Income – received on disposal of shares
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Interest Rate Definition:
An interest rate is a yearly charge levied by a financial institution or bank as follows: Savings – a bank will pay interest to savers who deposit money with it, over a long period of time. Credit – a bank will charge customers interest in return for lending money to them – e.g. for a loan, overdraft or credit card.
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Interest Rate Annual Percentage Rate (APR %) – applies to borrowings and is the rate of interest applied by the financial institution on the funds advanced. The purpose of an APR is to allow individuals to compare the cost of credit across different types of borrowings Annual Equivalent Rate (AER %) – applies to savings and is the rate of interest applied by the financial institution on the money deposited by individuals. The purpose of an AER is to allow individuals to compare the expected rates of return on different savings products
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Role of an Interest Rate
To encourage saving – an interest rate might encourage individuals to save money – the higher the interest rate, the more attractive saving becomes. To encourage borrowing – an interest rate might encourage individuals to borrow money – the lower the interest rate, the cheaper and thus more attractive it is to borrow money.
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Role of an Interest Rate
Income – the interest rate is the main way in which a financial institution makes money. The general concept is that: Savers will be given a low rate of interest on their savings, e.g. 3% p.a. Borrowers will be charged a higher rate of interest on their outstanding borrowings, e.g. 10% p.a. Government – government will change the interest rate as a way of either stimulating or discouraging consumer spending in the economy
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Interest Rate Changes/Differences
Interest rates change for various reasons: Savings: Base Rate Changes – the Base Rate of interest in the economy is determined by the Bank of England. Interest rates given by financial providers based on savings are linked to the base rate (usually a few percentage points lower than the base rate). Therefore, interest rates can change in line with national economic decisions.
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Interest Rate Changes/Differences
Amount Deposited – financial institutions/banks often set an interest rate linked to the actual amount saved by an individual, e.g. savings totalling £1 - £100,000 might attract an AER of 0.5% p.a., whereas amounts deposited over £100,000 might attract an AER of 0.75% p.a. – this has the effect of making saving more attractive.
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Interest Rate Changes/Differences
Length of Term – the length of time for which sums of money are deposited with financial institutions also influences the interest rate received. The general concept is that, the longer the monies are deposited, the higher the interest rate Competition – financial institutions very often compete for investors funds in order to attract customers and make a profit
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Interest Rate Changes/Differences
Interest rates change for various reasons Borrowings: Base Rate Changes – the Base Rate of interest in the economy is determined by the Bank of England. Interest rates levied by financial providers based on borrowings are linked to the base rate (usually a few percentage points higher than the base rate). Therefore, interest rates can change in line with national economic decisions.
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Interest Rate Changes/Differences
Purpose of Borrowings – a lender will often set an interest rate in relation to the funds advanced based on the purpose of the borrowings. Amount Borrowed - financial institutions/banks often set an interest rate linked to the actual amount borrowed by an individual Length of Term - the length of time for which sums of money are borrowed from financial institutions also influences the interest rate charged
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Interest Rate Changes/Differences
Credit Score – the interest rate levied by a financial institution will in part be dependent on the credit status of an individual Competition – financial institutions very often compete with each other in order to attract customers, provide borrowing facilities
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Questions Q1. Explain the term ‘money’. Q2. Explain the term ‘financial products/services’ Q3. Explain the functions of money. Q4. Explain the terms ‘saving’ and ‘borrowing’. Q5. Explain the term ‘interest rate’. Q6. Explain two ‘cash based’ and two ‘non-cash based’ methods of payment that you might currently use to meet your financial needs.
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Group Activities Prepare notes summarising one advantage and one disadvantage each of the following financial products/services: Savings Loans Mortgages Insurance products Pension products Shares (Note: You should research the internet to provide two examples of each financial product/service).
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Money and Financial Products
During the last 10 years, many investors have invested money in shares quoted on the Stock Exchange rather than deposit the money in a bank account. Shareholders recognise the profits to be made from increases in share prices. However, share prices do go down, as well as up, over time.
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Questions A friend in your class has asked you to help prepare revision notes for a class test next week: Explain the function of the stock exchange. Explain the factors that are likely to affect the share price of a public limited company listed on the stock exchange. Sam is 18 and has just won £250,000 on a national lottery scratchcard. Sam is considering investing all of the money in either: (a) shares of a company quoted on the stock exchange (e.g. Rolls Royce plc or Diageo plc); or (b) in a 1-year fixed term deposit account paying 1% interest p.a. What would you advise Sam to invest the money in, and why? State 2 benefits/drawbacks of each form of investment. (Note: you should undertake research using ‘live’ data to prepare your answers)
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Money and Financial Products
Notes:
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