© 2008 Thomson South-Western

CHAPTER 4CHAPTER 4

MANAGING YOUR MANAGING YOUR CASH AND SAVINGSCASH AND SAVINGS

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Role of Cash Management in Personal Financial Planning

Cash management deals with the routine, day-to-day use of liquid assets.

– Liquid assets consist of cash and other assets that can be converted easily to cash with little or no loss in value.

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Examples of Liquid Assets

Cash Checking Accounts Savings Accounts Money Market Deposit Accounts Money Market Mutual Funds U.S. Treasury Bills EE Savings Bonds Certificates of Deposit (shorter-

term)

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The Financial Services Marketplace

Financial products– checking and

savings accounts

– credit cards

– loans and mortgages

– insurance

– mutual funds

Financial services– financial planning

– tax preparation

– brokerage services

– real estate

– trusts

– retirement

– estate planning

The financial services industry markets:

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Types of Financial Institutions

Depository Nondepository

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Types of Depository Financial Institutions

Commercial Banks

– Largest type of traditional financial institution.

– Offer full array of financial services.

– Only type of financial institution that can offer noninterest-paying checking accounts.

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Savings and Loan Associations

– Offer many of the same services as commercial banks.

– Typically pay slightly more on savings deposits.

– Channel depositors’ savings into mortgage loans for purchasing and improving homes.

– Some are mutual associations.

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Credit Unions

– Provide financial products and services to specific groups of people who have a common tie.

– Qualified persons become members by purchasing a share of ownership.

– All are mutual associations; owned and sometimes operated by members.

– Typically pay interest rates higher than those of other financial institutions.

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Internet Banks

– Offer online banking services.

– Feature lower fees and higher yields than “brick-and-mortar banks.”

– Suitable for people who do not need to physically go to a bank.

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Types of Nondepository Financial Institutions

– Stockbrokerage firms—offer cash management accounts, money market mutual funds, wrap accounts, credit cards

– Mutual funds—offer money market mutual funds

– Life insurance companies

– Finance companies

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How Safe is Your Money?

Almost all financial institutions are federally insured by either:

Federal Deposit Insurance Corporation (FDIC) insures accounts at banks, savings banks, and S&Ls.

National Credit Union Administration (NCUA) insures accounts at credit unions.

Both provide government insurance up to $100,000 per depositor.

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Truth-in-Savings Act of 1993

Helps consumers evaluate terms and costs of banking products.

Fees, interest rates, and terms of both checking and savings accounts must be fully and clearly disclosed.

Places strict controls on advertising and what constitutes a free account.

Standard formula for annual percentage yield (APY) must used.

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Cash Management Products

With sufficient funds, banks must immediately pay the amount of your check or ATM withdrawal.

1. Checking Accounts =

Demand Deposits

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Funds are expected to remain on deposit for a longer time period than are demand deposits.

Generally pay higher interest rates than demand deposits.

At many institutions, the larger the balance, the higher the interest rate offered.

2. Savings Accounts =

Time Deposits

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Types of Checking Accounts

Regular checking accounts – Offered by commercial banks– Pay no interest

Interest-bearing checking accounts– Examples include NOW, share draft,

and money market deposit accounts– Offered by banks, savings banks,

S&Ls, and credit unions

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– Offered by investment (mutual fund) companies

– Not federally insured; trade on open market

– Interest bearing; limited checks

Money Market Mutual Funds

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– Primarily offered by brokerage firms; consolidate financial activities

– Not covered by deposit insurance (protected by SIPC); open market

– Interest bearing; check writing privileges

Asset Management Accounts

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Other Money Management Services

Electronic Banking Services

Electronic Funds Transfer Systems (EFTS) make possible– ATM service– Debit cards—linked to your checking

account– Pre-authorized deposits and payments– Banking by phone– Online banking and bill payment services

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– Regulates EFTS Services.

– States that errors must be reported within 60 days.

Electronic Funds Transfer Act of 1978

Limit your losses by immediately reporting theft, loss, or unauthorized use of your card or account!

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Other Bank Services

Safe Deposit Boxes

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Maintaining a Checking Account

Determine services needed. Consider costs involved. Keep track of checks written, automatic

deposits, and ATM withdrawals. Don’t write checks for more than you

have in the account. Arrange for overdraft protection. Know how to stop a payment. Reconcile your account monthly.

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Special Types of Checks

When personal checks are not accepted, special checks can be used to guarantee payment.

Cashier’s—drawn on the bank.

Certified—drawn on your account but guaranteed by the bank.

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Establishing A Savings Program

PAY YOURSELF FIRST: On payday, write yourself a check and deposit it into a savings account, or transfer a set amount to savings through your debit card.

Establish an emergency fund. Regularly set aside funds for financial

goals. Utilize direct deposits and automatic

transfers. Choose instruments best suited to your

goals and time horizon.

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Simple Interest—interest paid only on initial amount of deposit.

Compound Interest—interest paid at set intervals and added back to principal.

Earning Interest on Your Money

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If simple interest is used, there is no compounding:Interest = Principal x rate x time

= $1000 x .05 x 1

= $50

How Is Interest Calculated?

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If compound interest is used and the compounding occurs semiannually—

First 6 months' interest:

$1000 x .05 x 6/12 = $25.00

Second 6 months' interest: +

$1025 x .05 x 6/12 = $25.63

Total annual interest = $50.63

How Is Interest Calculated?

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Amount of interest earned depends onFrequency of compoundingBalance on which interest is paidInterest rate applied

How Much Interest Will You Earn?

Time value of money concepts are used in compounding to find interest earned.

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A Variety of Ways to Save

Certificates of Deposit (CDs) – Funds are to remain on account for a

given time period.– Early withdrawals incur an interest

penalty.

U.S. Treasury Bills– Debt securities issued by the U.S.

Treasury.– Sold at a discount; $1000 minimum.– Mature in 1 year or less.

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A Variety of Ways to Save

Series EE Bonds– Purchased at 1/2 face value.– Interest paid when bonds redeemed.– Newly purchased bonds must be held at

least 12 months; actual maturity date unspecified.

– Taxes not paid until bonds redeemed.– Exempt from state and local taxes.– If redeemed for educational purposes,

income taxes may be avoided.