Pesonal finance 6th madura chapter 06 mananing your money

Personal Finance
SIXTH EDITION

Chapter 6
Managing Your
Money

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Chapter Objective
6.1 Provide a background on money management
6.2 Describe the most popular money market
investments
6.3 Identify the risk associated with money market
investments
6.4 Explain how to manage the risk of your money
market investments
6.5 Explain how money management fits within your
financial plan
Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Background on Money Management (1 of 2)
• 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 © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Background on Money Management (2 of 2)
– Using credit cards for liquidity
 Interest rate usually high
 Maintaining adequate liquid assets allows you to avoid using
credit cards and paying high finance charges

– Adequate return
 Try to achieve highest possible returns on short-term
investments

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (1 of 11)
• Checking Account
– Very liquid investment
– Overdraft protection: an arrangement that protects a
customer who writes a check for an amount that
exceeds the checking account balance; it is a shortterm loan from the depository institution where the
checking account is maintained
 Saves overdraft fees and bounced checks
 Results in high interest rate on borrowed amount

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (2 of 11)

– Stop payment: a financial institution’s notice that it will
not honor a check if someone tries to cash it; usually
occurs in response to a request by the writer of the
check
– Direct deposit – paychecks go directly to your financial
institution
– Fees – vary from institution to institution
– No interest on most checking accounts

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (3 of 11)
• 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
– Automatic transfer feature can help saving

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (4 of 11)
• 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 © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (5 of 11)
• 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
– Many people keep a checking or NOW account for
day-to-day and a money market for other funds

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (6 of 11)
• 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
– Quotations – prices online and in financial news

publications

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (7 of 11)
• Money Market Funds (MMFs): accounts that pool
money from 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 Treasury bills
– Money market fund quotations
 Found in financial newspapers and online

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (8 of 11)
EXHIBIT 6.1 Weekly Money Market Fund Yields
Fund
Star Fund

Average Maturity
43

7-Day Yield

Assets (millions of $)

3.28%

496

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Financial Planning Online (1 of 3)
• Go to the data section of http://
www.federalreserve.gov
• This Web site provides historical interest rate data

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (9 of 11)
• Asset Management Account: an account that
combines deposit accounts with a brokerage
account and provides a single consolidated
statement
– Sweep account: an asset management account that
sweeps any unused balance in the brokerage account
into a money market investment at the end of each
business day

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Money Market Investments (10 of 11)

EXHIBIT 6.2 Comparison of Money Market Investments
Money Market Investment

Advantages

Disadvantages

Checking account

Very liquid

No interest

NOW account

Very liquid

Low interest rate; minimum balance
required

MMDA

Liquid

Low interest rate

Savings account

Liquid

Low interest rate

Certificate of deposit (CD)

Relatively high interest rate

Less liquid

Treasury bill

Relatively high interest rate

High minimum purchase

Money market fund (MMF)

Liquid

Not as liquid as checking or NOW accounts

Asset management
account

Convenient

High minimum balance required

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Money Market Investments (11 of 11)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Risk of Money Market Investments (1 of 3)
• Credit risk (or default risk): the risk that a borrower
may not repay on a timely basis
• 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 © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Financial Planning Online (2 of 3)
• Go to the money section of CNN.com and go to
the personal finance section containing calculators
• This site provides estimates of future savings that
you can accumulate over time with different
interest rates in taxable or nontaxable accounts
adjusted for inflation.

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Risk of Money Market Investments (2 of 3)
• Impact of expected economic conditions on

liquidity needs
– Weak economic conditions can create liquidity
problems
 Job loss
 Fewer hours worked
 Poor returns on investments

– This could be a time to allocate more funds to liquid
investments

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Risk of Money Market Investments (3 of 3)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Risk Management (1 of 3)
• Always consider the risk-return tradeoff before
making investment decisions
• Most money market instruments are largely free
from credit risk
• Money Market Funds (MMFs) do carry some
credit risk since they may hold commercial paper

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Risk Management (2 of 3)

• 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 © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Risk Management (3 of 3)
• Recently, interest rates on money market
investments have been low
– Resist temptation of reduce these investments in favor
of stocks
– Money market investments have a specific purpose –
to provide easy access to funds

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved


Financial Planning Online (3 of 3)
• Go to www.fdic.gov
• This Web site provides information on what types
of investments are insured and what types are not.

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Optimal Allocation of Money Market
Investments

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved