1. Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 6 Managing Your Money

2. 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

3. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-3 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

4. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-4 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

5. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-5 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

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

7. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-7 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

8. 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

9. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-9 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

10. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-10 Financial Planning Online: Deposit Rates Offered by Banks Go to: http://www.bankrate.com/brm/rate/dep_home.asp 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.

11. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-11 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!

12. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-12 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

13. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-13 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

14. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-14 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

15. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-15 Money Market Investments Exhibit 6.1: Weekly Money Market Fund Yields Copyright © 2001 Dow Jones & Company, Inc. All Rights Reserved.

16. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-16 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

17. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-17 Money Market Investments Exhibit 6.2 Comparison of Money Market Investments

18. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-18 Money Market Investments Exhibit 6.3: Comparison of the Liquidity and Returns of Money Market Instruments

19. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-19 Financial Planning Online: Impact of Different Deposit Rates on Your Wealth Go to: http://www.financenter.com/products/ sellingtools/calculators 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.

20. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-20 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

21. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-21 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

22. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-22 Financial Planning Online: Identifying Insured Investments Go to: http://www.chicagofed.orghttp://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.

23. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-23 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

24. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-24 Optimal Allocation of Money Market Investments Exhibit 6.4: How Liquidity Is Affected by Anticipated Expenses

25. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-25 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?

26. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-26 Integrating Key Concepts

27. Copyright ©2004 Pearson Education, Inc. All rights reserved.6-27 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