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13

MONEY, FINANCIAL INSTITUTIONS, AND SECURITIES MARKETS

Other Teaching Tools 13.3

Video Notes 13.4

Brief Chapter Outline and Learning Goals 13.5

Lecture Outline and Lecture Notes 13.6

Career and Study Skills Notes 13.11

CAREER DEVELOPMENT: Job Interviewing—Make It Count 13.11

STUDY SKILLS: Time to Grow Up 13.13

Lecture Links 13.15

LECTURE LINK 13-1 Fixed Assets, or Why a Loan in Yap Is Hard to 13.15Roll Over

LECTURE LINK 13-2 Goldsmith Banking 13.16

LECTURE LINK 13-3 History of Banking 13.16

LECTURE LINK 13-4 The Fate of the Penny 13.17

LECTURE LINK 13-5 Currency for Visually Impaired Consumers? 13.18

LECTURE LINK 13-6 Toward a Cashless Society? 13.18

LECTURE LINK 13-7 Wrenching Inflation out of the Economy 13.19

LECTURE LINK 13-8 Protecting Your Money 13.20

LECTURE LINK 13-9 Stock Market Indicators 13.21

LECTURE LINK 13-10 The Dominican Nuns’ Stock Portfolio 13.23

LECTURE LINK 13-11 The Tokyo Exchange Typing Error 13.24

LECTURE LINK 13-12 The Day They Call “Black Tuesday” 13.24

Bonus Internet Exercises 13.26

BONUS INTERNET EXERCISE 13-1 Money Facts 13.26

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BONUS INTERNET EXERCISE 13-2 Researching the Federal Reserve 13.27Tools

BONUS INTERNET EXERCISE 13-3 Currency Trading 13.28

BONUS INTERNET EXERCISE 13-4 Dow Jones Components 13.29

BONUS INTERNET EXERCISE 13-5 Exploring Mutual Funds 13.31

Critical Thinking Exercises 13.33

CRITICAL THINKING EXERCISE 13-1 Bartering: Buying a Pair of Jeans 13.33

CRITICAL THINKING EXERCISE 13-2 Test Your Knowledge of Money 13.35

CRITICAL THINKING EXERCISE 13-3 Financing Options 13.39

CRITICAL THINKING EXERCISE 13-4 Understanding Stock Quotations 13.41

Bonus Cases 13.43

BONUS CASE 13-1 Keeping Ahead of Counterfeiters 13.43

BONUS CASE 13-2 When Money Loses its Meaning 13.45

BONUS CASE 13-3 State Farm Bank: Would You Like Banking with 13.47that Insurance? (Video Case)

BONUS CASE 13-4 Making Dreams Come True 13.49

BONUS CASE 13-5 The Rebuilding Decision 13.51

BONUS CASE 13-6 The Motley Food: Fooling Around with the 13.54Stock Market (Video Case)

BONUS CASE 13-7 The Sage of Omaha 13.56

13.2 INTRODUCTION TO BUSINESS: Instructor’s Resource Manual

OTHER TEACHING TOOLS

For a description of each of these valuable teaching tools, please see the Preface in this manual.

Student Learning ToolsStudent Online Learning Center (OLC) www.mhhe.com/diasbusinessStudent Study GuideSpanish Translation Glossary (OLC)Spanish Translation Quizzes (OLC)

Instructor Teaching ToolsAnnotated Instructor’s Resource ManualIRCD (Instructor’s Resource Manual, Test Bank, PowerPoints, EZtest)Asset Map Online Learning Center (OLC) www.mhhe.com/diasbusinessPageOutPowerPoint Presentations (on IRCD and OLC)Test Bank Business Videos on DVD Enhanced Cartridge optionSpanish Translation Glossary (OLC)

CHAPTER 13: Money, Financial Institutions, and Securities Markets 13.3

http://www.mhhe.com/diasbusiness

http://www.mhhe.com/diasbusiness

VIDEO NOTES

Twenty videos are available, geared to individual chapter topics. The teaching notes for these videos are also included in the Video Notes section of this Instructor’s Resource Manual, beginning on page V.1.

VIDEO 13: “State Farm Bank: Would You Like Banking with that Insurance?”

State Farm Insurance has an established network of 16,000 independent agents. Deregulation of the banking in the 1990s opened the way for insurance companies to en-ter the banking industry. This video shows how State Farm’s agent network has made it possible to create a successful “virtual” bank.

(BONUS CASE 13-3, “State Farm Bank: Would You Like Banking with that Insurance?” on page 13.47 of this manual relates to this video.)

ALTERNATIVE: “The Motley Fool: A Fool and His Money”

Matthew Emmers, a writer and humorist for The Motley Fool, explains the mis-sion and purpose of their website and many of the fundamental principles of investing in the securities market.

(BONUS CASE 13-6, “The Motley Fool: Fooling Around with the Stock Market,” on page 13.54 of this manual relates to this video.)


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BRIEF CHAPTER OUTLINE AND LEARNING GOALS

CHAPTER 13

Money, Financial Institutions, and Securities Markets

I. THE IMPORTANCE OF MONEYLEARNING OBJECTIVE 1Understand the importance of money and its ba-sic characteristics.

II. MONEY SUPPLYLEARNING OBJECTIVE 2Describe how the Federal Reserve controls the money supply.

A. Basics about the Federal ReserveLEARNING OBJECTIVE 3Explain the functions of the Federal Reserve.

1. Reserve Requirement2. Open-Market Operations3. The Discount Rate

B. Global Exchange of Money

III. THE FUNCTION OF SECURITIES MARKETSLEARNING OBJECTIVE 4Understand how securities markets work.

A. BondsLEARNING OBJECTIVE 5Explain the differences among stocks, bonds, and mutual funds.

B. Stocks1. Preferred Stock2. Common Stock

C. Mutual FundsD. Stock Exchanges

1. Securities Exchange RegulationE. Investing in SecuritiesF. Reading Stock, Bond, and Mutual Fund Quotes


LECTURE OUTLINE AND LECTURE NOTES

CHAPTER OPENING PROFILEThe Motley Fool (Text pages 418-419)

Brothers David and Tom Gardner founded the Motley Fool with a self-imposed mission “to edu-cate, amuse, and enlighten everyday people about the power of investing.” The company has become one of the most successful multimedia financial-education firms in the nation. Though they sometimes use jester hats and humor in their analysis, the brothers are intense in their passion to spread the message that securities markets can offer financial opportunity to all.


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LECTURE OUTLINE LECTURE NOTES

I. THE IMPORTANCE OF MONEYLEARNING OBJECTIVE 1Understand the importance of money and its ba-sic characteristics (Text pages 420-422)

A. The U.S. economy depends upon money—its availability and its value relative to other currencies.

1. Many institutions have evolved to manage money and to make it avail-able when it is needed.

2. This free flow of money involves a complex system of banking.

B. What Is Money? 1. MONEY is anything that people gener-

ally accept as payment for goods and services.

2. BARTER is the trading of goods and services for other goods and services directly.

a. Many people have discovered the benefits of bartering online.

b. Today people still barter goods and services, but transactions are difficult.

3. People need some form of currency that is portable, divisible, durable, and stable so that they can trade without having to carry the actual goods.

4. Coins meet all the standards for a more useful money:

a. Portability: Coins are easier to take to market than goods.

b. Divisibility: Different-sized coins can be made to represent different values.

POWERPOINT 13-1Chapter Title(Refers to text page 418)

POWERPOINT 13-2Learning Objectives(Refers to text page 419)

POWERPOINT 13-3The Importance of Money(Refers to text pages 420-422)

TEXT REFERENCE Real World Business Apps(Box in text on page 421) Alan Wong just inherited $25,000 from her grand-mother. He is weighing his choices—to use the money for new furniture or to invest the money, perhaps starting a retirement savings account.

LECTURE LINK 13-1Fixed Assets, or Why a Loan in Yap Is Hard to Roll OverThe traditional money supply in the Yap Islands consists of enormous stone wheels. (See complete lecture link on page 13.15 of this manual.)

CRITICAL THINKING EXERCISE 13-1Bartering: Buying a Pair of JeansThis exercise explores how bartering would work using the example of a pair of jeans. (See complete exercise on page 13.33 of this man-ual.)

CRITICAL THINKING EXERCISE 13-2


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II. MONEY SUPPLYLEARNING OBJECTIVE 2Describe how the Federal Reserve controls the money supply. (Text pages 422-427)

A. Because currency is so important, the gov-ernment, through the Federal Reserve System, manages the money supply.

1. The MONEY SUPPLY is the amount of money the Federal Reserve Bank makes available for people to buy goods and services.

2. There are several classifications of the money supply (M-1, M-2, and so on.)

a. M-1 includes coins and paper bills, money that’s available by writing checks, and money that’s held in traveler’s checks.

b. M-1 is money that can be ac-cessed quickly and easily.

c. M-2 is everything in M-1 plus money in savings accounts, money market accounts, mutual funds, and certificates of deposit.

d. This definition of money includes items that may take a little more time to obtain.

e. M-3 is M-2 plus big deposits, which would include agreements among banks.

3. Why does the money supply need to be controlled?

a. If too much money is available, prices go up: inflation (too much money chasing too few goods).

b. If too little money is available, prices would go down: deflation.

LECTURE LINK 13-6Toward a Cashless Society The long-predicted “cashless society” has quietly arrived. (See complete lecture link on page 13.18 of this manual.)

POWERPOINT 13-4Money Supply (Refers to text pages 422-423)

TEXT REFERENCE Study Skills: Time to Grow Up! (Box in text on page 423) An additional exercise and discussion is available on page 13.13 of this chapter.

BONUS INTERNETEXERCISE 13-1Money FactsWhy do some coins have grooved edges? How much gold is in Fort Knox? (See complete exercise on page 13.26 of this manual.)

BONUS CASE 13-2


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III. THE FUNCTION OF SECURITIES MARKETS

LEARNING OBJECTIVE 4Understand how securities markets work. (Text pages 429-447)

A. The SECURITIES MARKET is a financial marketplace where stocks and bonds are traded.

1. SECURITIES are stocks and bonds that are traded.

2. The NEW YORK STOCK EXCHANGE (NYSE) and the NASDAQ (a com-pletely electronic exchange) are secu-rities markets.

3. Securities markets serve two major functions:

a. To help businesses find long-term funding;

b. To provide a place for private in-vestors to buy and sell securities (investments) such as stocks, bonds, and mutual funds.

4. Securities markets are divided into two markets:

a. Primary markets handle the sale of new securities.i. Corporations make money on

the sale of their securities only once, when they are first sold on the primary market.

ii. An INITIAL PUBLIC OFFER-ING (IPO) is the first public of-fering of a corporation’s stock.

b. Secondary markets handle the trading of securities between in-vestors; the proceeds of the sale

POWERPOINT 13-7The Function of Securities Markets (Refers to text pages 429-431)

LECTURE LINK 13-9Stock Market IndicatorsStock market indicators such as the Dow Jones Industrial Average give investors an in-dication of the direction of the broader market. (See complete lecture link on page 13.21 of this manual.)

TEXT FIGURE 13.4What Is the Dow? (Box in text on page 430)

BONUS INTERNETEXERCISE 13-4Dow Jones ComponentsThis Internet exercise asks students to visit the Web site for the Dow Jones Indexes and research the historical components of the index and its performance over time. (See complete exercise on page 13.29 of this manual.)



IV. SUMMARY


CAREER AND STUDY SKILLS NOTES

CAREER DEVELOPMENT BOX:

Job Interviewing – Make It Count (Text page 440)

Instructor’s Notes for Text Box Thirteen:(Objectives to consider and implement to increase stu-dents’ knowledge, usage, and understanding of the concepts).

Job interviews are times of nervous energy that can be channeled into productive results if the time before the interview is used productively. From a student’s perspective, a job interview is much like a college test. Showing up for a test without reading the course materials, taking notes and doing pretest reviews will not result in a passing grade; it is.much the same for a job interview. As a result, a job inter-view has to follow a similar format so that a sense of confidence about the interviewing process is estab-lished before the interview takes place.

STUDENT EXERCISES:

1. Review with the students the importance of preparation and due diligence as a learned, normal practice they conduct prior to a job interview. In class, begin the discussion about what might be good interview preparation and execution practices for achieving good results. Make the list on the board and discuss the list. Make sure that each class member contributes at least one item and that all items are discussed in some length. Be careful not to accept all suggestions and make sure each good suggestion is backed with why it would contribute to successful interviewing.

2. If possible, find a tape on job interviewing that allows students to watch an interview take place. Let students soak in the entire interview process as thought they are being interviewed. Have them take notes regarding what they observe as good interview techniques and what might be common mistakes that are also made.

3. Set up the classroom for a job interview allowing students to interview potential new hires and to have students being interviewed for a potential job. Create various scenarios regarding interviews for specific jobs. Make sure the points of basic interview habits are noted and carried out, no mat-ter what level the job is. These habits are:

(a) good posture

(b) strong eye contact

(c) good use of words and correct pronunciation (no slang)

(d) research and general knowledge about the company hiring

(e) well written résumé describing your skills, education, and accomplishments

(f) taking notes

(g) asking good questions

(h) expressing thanks for the interview opportunity

(i) asking about the hiring timelines (when they expect to hire someone and have that person in place)


(j) follow up after the interview with a letter of thanks and restate your desire for the job and your abilities

*Remember, the majority of job candidates will not complete the tasks listed above…with practice and self evaluation of the interviewing process, you can become very well-versed and confident when you go to job interviews.


STUDY SKILLS BOX:Time to Grow Up(Text page 423)

Instructor’s Notes for Text Box Thirteen:(Objectives to consider and implement to increase stu-dents’ knowledge, usage, and understanding of the concepts).

The transition from high school to college can be almost seamless for some students but a long journey for others. Some students have great maturity during their high school years and are well pre-pared for the decisions and commitments necessary to be successful as a college student. For others, high school has its ups and downs, and the idea of moving on to college holds feelings of excitement but also fills the student with anticipation, doubt, and fears. Young adults need to make a serious assessment of where they are now and what changes must occur for them to handle the responsibility of college.

STUDENT EXERCISES:

1. Have students do some writing and self evaluation about the term maturity. Give them the follow-ing questions and let them explain the answers in their own terms:(a) Define maturity (in your own terms):(b) Give examples of how you have achieved maturity.(c) If you could change three things about yourself as they apply to maturity, what would they

be?(d) If you could keep three things you have done to demonstrate higher levels of maturity, what

would they be?(e) How do you feel about your ability to handle college responsibilities?(f) What successes have you had so far?(g) What problems or setbacks have you had so far?(h) What can you do to accelerate your maturity level?(i) What help do you think you need to help you with maturity?(j) How do you think your college experience would change if you increase your level of ma-

turity?

*Upon completion of this assignment, have students discuss their answers in the classroom. Al-low ample time for extensive discussion about this subject.

2. Two important elements of maturity are preparation and execution. Explain to students the differ-ence between preparation and execution. Ask students to describe how they have prepared for something they felt was important which required a certain amount of preparation to be success-ful. Ask students to also describe an event where they had to perform or execute as well as they felt they could to succeed. Discuss the two activities and how it felt when good preparation lead to desired results. Discuss when the two activities occurred and desired results were not achieved. Ask the students what might have lead to the less than desirable outcome.Study preparation involves all the activities that can help you in improving the many things that

you need to be a successful student: getting the most out of reading, note taking and the concentration re-quired to learn and master the materials your are going to be tested on.

Study execution involves the actions you take to stay on course to make sure you succeed. Just like the athlete that practices his sport, he also knows he will be asked to use the same techniques when in competition to assure success. Often, athletes (just like students) have good practice skills but are not


mentally tough enough or ready to perform when it counts. Good students understand preparation and the concept of being “battle ready.” They know that both are required for success. Both skills are necessary to be considered a good athlete, a good student, a good teacher, etc. Often, students feel assured they are putting in the time necessary to do well in their classes but somehow this does not translate to consistently good grades. Learning the techniques to test taking is a process and mastering it can help achieve better results.


LECTURE LINKS

LECTURE LINK 13-1

Fixed Assets, or Why a Loan in Yap Is Hard to Roll Over

On the tiny South Pacific island of Yap, Micronesia, life is easy and the currency is hard. Else-where, the world’s troubled monetary system creaks along, and devaluations are commonplace. But on Yap, the currency is as solid as a rock. In fact, it is rock—limestone, to be precise.

For nearly 2,000 years, the Yapese have used large stone wheels to pay for major purchases, such as land, canoes, and permission to marry. Yap is a U.S. trust territory, and the dollar is used in grocery stores and gas stations. But reliance on stone money, called rai stones, continues.

The people of Yap have been using stone money ever since a Yapese warrior named Anagumang first brought the huge stones over from limestone caverns on neighboring Palau, some 1,500 to 2,000 years ago. Inspired by the moon, he fashioned the stones into large circles. The residents of Palau re-quired Yapese to pay in beads, coconuts, and copra for the privilege of quarrying. Yap has no limestone, and it was viewed by the Yapese as an exotic luxury, much like gold and diamonds are to the rest of the world. Every village chief wanted a bigger stone than his rivals.

The discs took years to carve, and the journey to bring such massive objects back to Yap, in wooden canoes through rough seas, was an extremely dangerous one. Many boats sank. Sailors drowned, and hundreds of enormous rocks sunk to the ocean floor.

Human nature being what it is, the danger only increased the demand. The worth of stone money doesn’t depend on size. Instead, the pieces are valued by how hard it was to get them to the island. The earliest stones, brought by war canoe by Anagumang and his descendants, are the most precious because they cost so many lives to bring in. Although the heavily laden Yapese canoes were fitted with outriggers, they often capsized during the 280-mile ocean voyage from Palau.

Next in value are some stones cut on Palau in the 1870s by David Dean O’Keffe, a shipwrecked American sailor who escaped from the island and returned later with a Chinese junk. Mr. O’Keffe, who helped transport the boulders in return for Yapese help in processing dried coconut, ultimately ran the is-land as a self-styled emperor. Finally, there are a few mechanically chiseled stone wheels brought in with-out problems by German traders in the late 1800s and early 1900s. But the value of these is much lower than the older stones. The Yapese can tell the difference—many of the stones had (and still have) individ-ual names.

Rai stones are used in social transactions like marriages, inheritance, political deals, even ransom in battle. The largest are 10 feet in diameter and weigh 4 tons. Some of the smaller stones are about the size of a saucer. These smaller “coins” are everyday money, used to buy fish and pigs.

Yapese lean the stone wheels against their houses or prop up rows of them in village “banks.” Each has a hole in the center so it can be slipped onto a tree trunk and carried. It takes 20 men to lift some wheels.

By custom, the stones are worthless when broken. Rather than risk a broken stone, Yapese tend to leave the larger stones where they are and make a mental accounting that the ownership has been trans-ferred—much as gold bars used in international transactions change hands without leaving the vault of the New York Federal Reserve Bank.

There are some decided advantages to using massive stones for money. They are immune to black-market trading, are impossible to counterfeit, and pose formidable obstacles to pickpockets. With


only about 6,600 stone wheels remaining on the island, the money supply stays level. Stone wheels don’t make good pocket money, so for small transactions, Yapese use other forms of currency. In addition to U.S. dollars, beer is widely used for trading.

Stone money has its limits. Most of the island’s few retail stores won’t accept it for general mer-chandise. But stone money remains and important part of Yapese traditions. There are instances in Yap where you cannot use U.S. money. One is the settling of disputes. If a Yapese wants to settle an argu-ment, he brings his adversary stone money as a token. The apology is accepted without question.

Stone money even figured in international diplomacy. Micronesia president Tosiho Nakayama brought a stone disk when he visited the U.S. in 1984. Officials say Mr. Nakayama intended the stone as Micronesia’s symbolic contribution toward reducing the U.S. budget deficit.

LECTURE LINK 13-2

Goldsmith Banking

Many economists believe that modern money and banking have their roots in medieval Europe. Toward the end of the middle ages, Europe was a dangerous place to live, especially if one had gold and silver coins so attractive to bandits. Most villages had only one institution that could safely store precious metal—the village goldsmith. The goldsmiths, makers and sellers of plate and jewelry, flourished in the 1500s after the monasteries were dissolved, increasing the available supplies of gold.

Many goldsmiths developed strong connections with the monarchy, and most began to take in valuables for safekeeping in their vaults. The locals also brought their gold and silver to the goldsmith’s vault. In exchange, the goldsmith would write a receipt stating that Joe Nobleman had fifteen gold coins on deposit. When local sales transactions were made, the villager and merchant would go to the goldsmith shop and withdraw the needed amount of coins. Often, the merchant would turn around and leave the same coins with the goldsmith for safety.

Inevitably, the inconvenience of meeting and physically exchanging gold coins led villagers to trade not coins, but rather the receipts for coins from the goldsmith. These receipts circulated in the area, with all buyers and sellers aware that the paper could be traded at any time for the underlying precious metal. Some enterprising goldsmith eventually noticed that the gold he had in storage rarely left the vault, and one gold coin was like every other gold coin. From that point, it was a simple step to loan part of the gold in storage to others, for a fee. In its earliest form, we have the first paper money and the first bank loan with interest.

By 1677, there were forty-four goldsmith bankers in London. Two of the oldest surviving banks, Coutts & Co. and Child & Co., which originated as goldsmith bankers, continue to operate as part of The Royal Bank of Scotland Group today.

Incidentally, paper money was not developed first in Europe, but in China, probably during the 600s A.D. The Italian trader Marco Polo traveled to China in the 1200s and was amazed to see the Chi-nese using paper money instead of coins.i

LECTURE LINK 13-3

The History of Banking

i Sources: “A History of British Banking,” The Royal Bank of Scotland Group, www.rbs.com, and “The Goldsmith Era of Banking,” The Federal Debt Relief System, www.fdrs.org


http://www.fdrs.org/

http://www.rbs.com/

The history of banking in the U.S. shows the importance of controlling the money supply. At first, there were no banks. Strict laws in Europe limited the number of coins that could be brought to the colonies in the New World. Thus, colonists were forced to barter for goods; for example, cotton and to-bacco may have been traded for shoes and lumber.

The demand for money was so great that Massachusetts issued its own paper money in 1690, and other colonies soon followed suit. But continental money, the first paper money printed in the United States, became worthless after a few years because people didn’t trust its value.

Land banks were established to lend money to farmers. But Great Britain, still in charge of the colonies at that point, ended land banks by 1741. The colonies rebelled against these and other restrictions on their freedom, and a new bank was formed in Pennsylvania during the American Revolution to finance the war against England.

In 1791, after the United States gained independence, Alexander Hamilton persuaded Congress to form a central bank (a bank at which other banks could keep their funds and borrow funds if needed), over the objections of Thomas Jefferson and others.ii This first version of a federal bank closed in 1811, only to be replaced in 1816 because state-chartered banks couldn’t support the War of 1812. The battle between the Second (Central) Bank of the United States and state banks got hot in the 1830s. The fight ended when the bank was closed in 1836. You can see that there was great resistance to a central bank through much of U.S. history.

By the time of the Civil War, the banking system was a mess. Different banks issued different kinds of currencies. During the Civil War, coins were hoarded because they were worth more as gold and silver than as coins. The chaos continued long after the war ended, reaching something of a climax in 1907, when many banks failed. People got nervous about the safety of banks and attempted to withdraw their funds. This is now known as “a run on the banks.” Soon the cash was depleted and some banks had to refuse money to depositors. This caused people to distrust the banking system in general.

Despite the long history of opposition to a central bank, the cash shortage problems of 1907 led to the formation of an organization that could lend money to banks—the Federal Reserve System. It was to be a “lender of last resort” in such emergencies. Under the Federal Reserve Act of 1913, all federally chartered banks had to join the Federal Reserve. State banks could also join. The Federal Reserve became the bankers’ bank. If banks had excess funds, they could deposit them in the Fed; if they needed extra money, they could borrow it from the Fed. The Federal Reserve System has been intimately related to banking ever since.

The Federal Reserve System was designed to prevent a repeat of the 1907 panic. Nevertheless, the stock market crash of 1929 led to bank failures in the early 1930s. When the stock market began tum-bling, people hurried to banks to make withdrawals. In spite of the Federal Reserve System, the banks ran out of money and states were forced to close banks. President Franklin D. Roosevelt extended the period of the bank closings in 1933 to gain time to come up with some solution to the problem.

During the Great Depression, in 1933 and in 1935, Congress passed legislation to strengthen the banking system. The most important move was to establish federal deposit insurance, a program to further protect the public from bank failures.

LECTURE LINK 13-4

The Fate of the Penny

The lowly penny gets no respect. In early American, a penny bought a loaf of bread, but it is now sliding into obsolescence due to inflation. Fifty-eight percent of Americans say they stash pennies in piggy banks, jars, and drawers instead of spending them like other coins. Stray pennies turn up every-where: in streets, cars, sofas, beaches, even landfills.


The U.S. Mint is the money-making government operation in more ways than one. Pennies have traditionally been moneymakers for the government. In 2005, the Mint made $730 million in profits. However, it now costs the U.S. Mint more than 1 cent to make a penny. Higher prices for component met-als have raised the basic cost of a penny to 1.4 cents. Multiply that by 7 or 8 billion pennies made each year, and it comes to a $20 million loss. This imbalance is a milestone for the Mint because coins have historically cost less to produce than the face value. (www.usmint.gov)

Some people think this expense is ridiculous and are petitioning the government to retire the penny. However, Gallop polling has shown that two-thirds of Americans want to keep the penny coin. There’s even a pro-penny lobby called Americans for Common Cents. The push to retire the penny gained traction in 1989 with a bill in Congress to round off purchases to the nearest nickel. Although that bill failed, there is again pressure to eliminate the money-losing coin. The same Gallop poll found that 2% of Americans admit to just throwing pennies out.iii

Others view the penny as a reassuring symbol of tradition and hesitate to abandon it. Some also argue that eliminating the penny would hurt the poor. A study by a former Federal Reserve economist shows that rounding hurts lower income citizens most because only cash transactions would have to be rounded up.

LECTURE LINK 13-5

Currency for Visually Impaired Consumers?

The American Council of the Blind scored a victory in 2006 when a federal district judge ruled that American currency violates the Federal Rehabilitation Act because denominations are not easily dis-tinguishable by blind people. Since 1983 the advocacy group has been urging U.S. Treasury officials to make paper money easier for the blind to use.

Blind people typically determine the denominations of paper money by using bill-reading ma-chines or by asking sighted people a bill’s value and then folding the various denominations in different ways. The November 2006 District court decision ruled that if blind people “cannot accurately identify paper money without assistance” they are being illegally denied “meaningful access” to the currency, in violation of the law.

Fixing the U.S. currency could be expensive. The costliest option—adopting different-sized bills for different denominations—would require an initial investment of about $225 million for new presses and plates, according to the U.S. Treasury. Other options suggested include microperforations in the bills or raised intaglio printing. Advocates for the blind point out that the Treasury’s budget of $4.2 billion over the past ten years has incorporated major currency revisions—color-shifting ink, microprinting, and plastic security threads—in 1996 and 2004.

Of the 180 nations using paper currency today, the U.S. is the only one currently taking no steps to make denominations legible to the blind.iv

LECTURE LINK 13-6

Toward a Cashless Society

For decades economists have predicted that technology and plastic would make the U.S. a “cash-less” society. And now, quietly, it has arrived. Coins, currency, and checks are gradually being replaced by digital transactions.

The U.S. Bureau of Engraving and Printing printed over 9 billion individual bills in 2007. How-ever, 95% of these are printed to replace worn currency, not to expand the money supply. Signs near the


http://www.usmint.gov/

printing presses declare “The buck starts here,” but today the “buck” may be a debit card or electronic de-posit.

You can use a credit card almost anywhere. From 1999 to 2005, the number of credit card termi-nals tripled to 6.8 million. In 1990, most Americans regarded paying for groceries by credit card as unnat-ural. Now credit cards cover about 65% of food sales. Eighty-three percent of Social Security beneficia-ries receive their monthly payments by automatic deposit. Then there’s the money floating around in pre-paid cards, gift certificates, Internet buying, and automatic payment for tool booths.

In 2006, U.S. currency (dollar bills of all denominations) totaled $784 billion, but probably half or more is held outside the U.S. by foreigners. In other countries, the $100 bill is prized as a store of value. That would indicate that less than $400 billion in currency supports a $13 trillion economy. In 1970, the economy’s relative need for cash was almost twice as high.

In 2005 Americans held 1.7 billion credit and debit cards (about seven for everyone over 15). In the past decade debit-card use has exploded. In 1996, checks and cash represented almost 80% of con-sumer payments. Now cash and checks account for less than half.

From a peak of almost 50 billion in 1995, the number of checks written in the U.S. fell to 36.6 billion in 2003. In the same time period, the number of electronic payments tripled from 15 billion to 44 billion.

The acceptance of electronic money reflects both technology and economics. The Federal Re-serve says that processing an electronic payment costs about a fifth as much as a check.

For consumers, electronic cash is a mixed blessing. E-cash is more convenient—fewer trips to the bank or ATM for cash. But credit card companies impose stiff monthly fees on retailers and charge high interest rates. Supermarkets and other stores argue that these fees then finance wasteful marketing cam-paigns and “rewards” programs, costs that are passed on to everyday consumers in the form of higher prices.

Cash use has not disappeared. Some populations, the poor and recent immigrants, are unable to or choose not to use banks. A remarkable 9% of families don’t have a bank account.v

LECTURE LINK 13-7

Wrenching Inflation Out of the Economy

The Federal Reserve’s primary function is to control the money supply. It uses its tools to in-crease or decrease the money supply in response to changing economic conditions. When the economy is slowing, the Fed increases the money supply, which results in lower interest rates and more investment. When the economy is overheated, the Fed takes money out of circulation, driving up interest rates.

But during the late 1970s, the economic conditions were more complicated. The economy was less than robust—the decade saw a series of economic dips—but at the same time, inflation was driving up prices at an alarming rate. The combination became known as “stagflation.” In 1979, the inflation rate was 14.6%. A dollar at the beginning of the year would be worth less than 85¢ by the end of the year. Prices increased rapidly, followed by wages. Because of the declining value of money, consumers rushed out to buy products before prices increased. More money chasing a fixed amount of goods drove inflation up still further.

During the 1970s, the Fed managed the economy with an eye on interest rates. If interest rates in-creased, the Fed put more money into circulation. The goal was a stable interest rate to provide equilib-rium in nation’s economy.


In 1980, President Jimmy Carter appointed Paul Volcker as Chairman of the Federal Reserve with a mandate to stabilize inflation. Volcker brought a radical new philosophy to the Fed leadership. In-stead of using interest rates to control the economy, he believed that the only hope for stopping inflation was to control inflation’s fuel—the money in circulation.

The Fed immediately put the brakes on the money supply, and then it relied on basic laws of sup-ply and demand to set the price of the fixed amount of money in circulation. With less money created, the existing money in circulation became more valuable. In order to secure financing, businesses had to pay more for the money they needed and the cost of money (the interest rate) soared.

By 1981, the prime interest rate peaked at 21.5%. The high interest rate dramatically affected all businesses activity, but the housing market was hit especially hard. The difference between a mortgage at 8% and a mortgage at 14% amounted to hundreds of dollars a month in increased mortgage expense. Re-altors and homeowners scrambled to find creative financing options to move property. The high interest rates also brought business expansion to a halt, throwing the economy into recession.

Volcker’s Fed held fast to its fixed money philosophy. By 1982, it succeeded in reducing the in-flation rate to 3.9%, but the cost was high. The U.S. unemployment rate that year climbed to 9.7%. Al-most one in ten workers was out of a job.

The economy gradually stabilized, and interest rates dropped steadily. The public had learned the lesson—they no longer expected prices to soar, and pressure on wages gradually decreased. Although President Reagan has been credited with reining in inflation, the true credit goes to Fed Chairman Paul Volcker, appointed by the previous Democratic President.

The Fed continues to fine-tune the economy, tweaking the money supply through changes in the discount rate. The risky sub-prime mortgage industry collapsed in 2007, sending economic indicators tumbling. The Fed reacted in January 2008 by twice cut the discount rate—once by 75 basis points (3/4 of one percent) then by another 50 points two weeks later. Wholesale changes in the money supply, how-ever, are a thing of the past.

LECTURE LINK 13-8

Protecting Your Money

The American economic system learned a valuable lesson from the depression of the 1930s. To prevent investors from being completely wiped out during an economic downturn, several organizations evolved to protect your money. The three major sources of financial protection are the Federal Deposit In-surance Corporation (FDIC); the Savings Association Insurance Fund (SAIF), originally called the Fed-eral Savings and Loan Insurance Corporation (FSLIC); and the National Credit Union Administration (NCUA). All three insure deposits in individual accounts up to $100,000.

The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the U.S. gov-ernment that insures bank deposits. If a bank were to fail, the FDIC would arrange to have that bank’s ac-counts transferred to another bank or pay off depositors up to a certain amount ($100,000 per account). The FDIC covers about 13,000 institutions, mostly commercial banks. What would happen if one of the top 10 banks in the United States were to fail? The FDIC has a contingency plan to nationalize the bank so that it wouldn’t fail. The idea is to maintain confidence in banks so that others do not fail if one hap-pens to falter.

The Savings Association Insurance Fund (SAIF) insures holders of accounts in savings and loan associations. It’s now part of the FDIC. It was originally called the Federal Savings and Loan Insur-ance Corporation (FSLIC) and was an independent agency. A brief history will show why the association was created.


Both the FDIC and the FSLIC were started during the Great Depression. The FDIC was begun in 1933, and the FSLIC in 1934. Some 1,700 bank and thrift institutions had failed during the previous few years, and people were losing confidence in them. The FDIC and FSLIC were designed to create more confidence in banking institutions. In the 1980s, to get more control over the banking system in general, the government placed the FSLIC under the Federal Deposit Insurance Corporation (FDIC) and gave it a new name: the Savings Association Insurance Fund. Like the FDIC, it insures accounts for up to $100,000.

The National Credit Union Administration (NCUA) provides up to $100,000 coverage per in-dividual depositor per institution. This coverage includes all accounts, including checking, savings or money market accounts, and certificates of deposit. Additional protection can be obtained by holding ac-counts jointly or in trust. Individual retirement accounts (IRAs) are also separately insured. The Legal Briefcase box looks at identity theft and other issues regarding self-protection of your money.

LECTURE LINK 13-9

Stock Market Indicators

When you see news reports on television or on the Internet, you often read say things like “The Dow Industrials are up 90 points today in active trading.” Wonder what’s going on? The Dow Jones In-dustrial Average (the Dow) is the average cost of 30 selected industrial stocks, used to give an indication of the direction (up or down) of the stock market over time. A man named Charles Dow began the prac-tice of measuring stock averages in 1884, using the prices of 12 important stocks. The 30 current stocks in the Dow are illustrated in Figure 13.4 in the text. The original 12 stocks were:

American Cotton OilAmerican Sugar Refining Co.American TobaccoChicago GasDistilling & Cattle Feeding Co.General Electric Co.Laclede Gas Light Co.National LeadNorth American Co.Tennessee Coal, Iron & Railroad Co.U.S. LeatherU.S. Rubber Co.

New stocks are substituted on the Dow when it’s deemed appropriate. For example, the Dow was broadened in 1982 to include 30 stocks. In 1991, Disney was added to the Dow to reflect the increased importance of the service sector. In 1997, the list was again altered with Hewlett-Packard, Johnson & Johnson, Wal-Mart, and Citigroup replacing Texaco, Woolworth, Bethlehem Steel, and Westinghouse. In 1999, the Dow added Home Depot and SBC Communications along with its first NASDAQ stocks, Intel and Microsoft. Chevron, Sears Roebuck, Union Carbide, and Goodyear were eliminated. In 2004, Ameri-can International Group, Pfizer, and Verizon replaced AT&T, International Paper, and Eastman Kodak. In 2005, AT&T rejoined the Dow when it merged with SBC. The 30 current stocks in the Dow Jones Indus-trial Average also include such long-standing notables as General Electric, IBM, and Coca-Cola.

(BONUS INTERNET EXERCISE 13-4, “Dow Jones Components,” asks students to research the historical components and performance of the DJIA.)


Critics argue that if the purpose of the Dow is to give an indication of the direction of the broader market over time, the 30-company sample is too small to get a good statistical representation. Many in-vestors and market analysts therefore prefer to follow stock indexes like the Standard & Poor’s 500 (S&P 500), which tracks the performance of 400 industrial, 40 financial, 40 public utility, and 20 transportation stocks. Investors also closely follow the NASDAQ average, which is quoted each trading day to show the trends that are occurring in this important exchange. vi


LECTURE LINK 13-10

The Dominican Nuns’ Stock Portfolio

The Adrian Dominican Sisters want to make good corporate citizens out of corporations like American Electric Power, Cinergy Corporation, and TXU Corporation. When government environmental agencies fail to keep corporations from spewing out more and more pollution, the Dominican Sisters take their fight into the inner circles of power. The Sisters purchase stock in companies, and then introduce shareholder resolutions that demand corporate reform from within. It doesn’t hurt their cause that the or-der packs a massive portfolio: the Interfaith Center on Corporate Responsibility, which the Sisters repre-sent, has 275 faith-based institutional investors with combined holdings of about $90 billion.

Sister Patricia Daly, executive director of the organization representing the Dominican Order, has introduced shareholder resolutions aimed at the “filthy five,” five U.S. utilities viewed as the biggest emitters of carbon dioxide in their business. The resolutions asked investors to agree that the board of di-rectors report to shareholders on “the greenhouse-gas emissions from our company’s operations including steps the company can take to reduce emissions of greenhouse gases substantially.”

Even if Sister Patricia doesn’t win a majority, she’ll make her mark. Over the years, her efforts have forced corporations to address many environmental and labor concerns. She stood her ground against some of the biggest egos in business.

The Adrian Dominicans have now spent 30 years as shareholder activists, using their investment portfolio as a means of achieving social change. The move toward “socially responsible investing” in the U.S. started in the 1960s, as people began to shun companies like Dow Chemical that were profiting from the manufacturer of napalm for the Vietnam War. Some investors sold off their “sin stocks,” while others used annual shareholder meetings to submit resolutions that called on these companies to stop what they saw as immoral business practices. The Interfaith Center on Corporate Responsibility was founded during this era.

One of its notable efforts was against the textile manufacturer, J. P. Stevens, a flagrant labor-rights violator in the South made infamous by the 1979 film Norma Rae. The nuns’ decision in 1975 to become activist shareholders came from a need to do more than their direct work in underprivileged com-munities around the world. So they went behind company lines, using their standing as stockholders and moral authority as nuns to try to shape policy at some of America’s biggest corporations.

A division of the National Council of Churches, the group helps coordinate efforts for religious investors. Adrians are revered as much for their willingness to tackle controversial questions as for the many fronts on which they fight social injustice.

The congregation has used its pocketbook to pursue change in many other ways. For example, they developed a $2 million revolving-door fund from which they grant low-interest loans to social ser-vice groups. They have also instructed the managers of their multimillion-dollar stock portfolio not to buy shares in tobacco companies. If no women are candidates for the board of directors, the Dominicans refuse to cast a vote.

It is rare that a shareholder resolution they offer passes when voted on by other stockholders. But their concerns generate publicity, which along with dialogue and negotiation have become their most ef-fective tools. They rarely confront an issue—or company—without linking with other groups, usually though ICCR.

The Sisters don’t see themselves as enemies of corporations. They are, after all, owner-investors and have a stake in the corporation’s success. Most of the money they invest comes from funds set aside for the sisters’ retirement, the rest from the congregation’s general budget.


Religious investors in the United States have a combined portfolio of about $45 billion. Although they include Protestant churches and their pension funds, most are Roman Catholic groups. Each year re-ligious investors sponsor dozens of shareholder resolutions. In most years, none pass when voted on, and about one-third are withdrawn before annual meetings because negotiations with the companies produced results.

A few months after filing resolutions with the “filthy five” utilities, Sister Daly also filed resolu-tions with two of the Big Three: General Motors and Ford. They are asking the carmakers to commit to reducing greenhouse gas emissions. According to Sister Daly “this is not only about what is good for the environment, it is about what is good for GM and Ford shareholders,” by nudging the car giants to focus on their hybrid (gas/electric vehicle) strategy to regain their competitive edge in the U.S.vii

LECTURE LINK 13-11

The Tokyo Exchange Typing Error

Computerized trading systems common on stock exchanges these days have reduced the trade er-ror rate significantly. Yet the computers’ infallibility is only as good as the accuracy of the person enter-ing the information.

In December 2005, The Tokyo Stock Exchange was rocked by an erroneous trade that caused Mizuho Securities to lose at least 27 billion yen ($225 million). The cause of the turmoil was eventually traced to a trader at Mizuho Securities, who meant to sell 1 share of stock in J-Com Co., a job recruiting company, for 610,000 yen ($5,041.) The trader instead entered a trade of 610,000 shares at 1 yen (less than a penny).

The enormity of the error should have raised red flags through the exchange. The number of shares in the order was 41 times greater than the number of J-Com’s shares actually outstanding, but the Tokyo Stock Exchange processed the order anyway. Mizuho says another trader tried to cancel the order three times, but the exchange’s policy is not to cancel transactions even if they are executed on erroneous orders. By the end of the day, Mizuho Financial Group had lost at least 27 billion yen.viii

LECTURE LINK 13-12

The Day They Call “Black Tuesday”

October 29, 1929, “Black Tuesday”—the day the boom of the 1920’s ended. The market slides of 1987 and 1997 are often compared with this historical watershed.

Few suspected that the go-go era would end so abruptly. Between the spring of 1926 and the spring of 1929, the Dow Jones Industrial Average had more than doubled. During the summer of 1929, it increased another 25%. The national economy, while showing signs of weakness, did not discourage the speculation boom. Investors with as little as 10% cash margin flocked into the market, lured by news of steadily increasing prices. The DJIA reached a peak of 381 on September 3, 1929.

vii Sources: Marilyn Berlin Snell, “Sister Action: The Almighty Dollar Meets its March in a Dominican Nun,” Sierra, May 1, 2003; Tom Murphy, “Lilly Faction Seeks Split of Exec Roles,” Indianapolis Business Journal, March 21, 2005; and Sarah A. Webster, “Stockholders Support Ford Leadership: Few at Annual Meeting Criticize Chairman’s Work,” Detroit Free Press, May 12, 2006

viii Source: “Typing Error Causes Japan Stock Confusion,” The Clarion Ledger, The Associated Press, December 10, 2005


The Federal Reserve Board made a half-hearted attempt to slow down the expansion, jolting prices down briefly during September, but it was not until October 24, a Thursday, that the slide became a crash. On that day, nearly 13 million shares changed hands, 56% more than the previous record. As prices dropped, brokers called investors for more margin, fueling more selling. Only when the nation’s top five banks agreed to pool their resources to support the market did the hysteria lessen temporarily.

Monday the selling began again, dropping the Dow by a one-day record 38 points, fully 13% of the total market value. There was nothing the banks could do. The next day, Tuesday, October 29, the bottom dropped out. The Dow dropped 31 more points, on a volume of 16.4 million shares. In two days, the market lost almost 25% of its value. Tuesday’s volume record stood for nearly four decades. In five trading days, the gains of the previous sixteen months were wiped out.

By July, 1932, the DJIA had bottomed out at 41, a reduction of nearly 90% from its peak three years previously. Investors lost more than $74 billion in the collapse. It was not until 1954 that the stock market managed to regain the ground it lost in those three years.


BONUS INTERNET EXERCISESIX

BONUS INTERNET EXERCISE 13-1

Money Facts

The U.S. Mint is a great source of information about money and currency. Go to the U.S. Mint website, www.usmint.gov. (Sometimes the web address for a location changes. You might need to search to find the exact location mentioned.)

1. What are pennies made of?

2. Why do some coins have grooves on the edges?

3. Why are certain presidents chosen for certain coins?

4. For the latest complete year, record the number of coins minted for each denomination.

(a) 1¢ ________________________________

(b) 5¢ ________________________________

(c) 10¢ ________________________________

(d) 25¢ ________________________________

(e) 50¢ ________________________________

(f) $1 ________________________________

5. How much gold is stored in Fort Knox?

ix The Internet is a dynamic, changing information source. Web links noted in this manual were checked at the time of publication, but content may change over time. Please review the website before recommending it to your stu-dents.




Researching the Federal Reserve Tools

PURPOSE:The purpose of this exercise is to encourage students to find up-to-date information about the

money management tools used by the Federal Reserve System. The information can be obtained by visit-ing the Federal Reserve Board website at www.federalreserve.gov. (Sometimes the web address for a lo-cation changes. You might need to search to find the exact location mentioned.)

EXERCISE:

1. What is the current federal funds rate in percent? How has this rate changed in the past year?

2. What is the current reserve requirement for banks? Is the reserve requirement the same for all banks (“depository institutions”)?

3. What is the primary concern of the Fed Open Market Committee now? Inflation or recession?

4. Look back at the Open Market Committee actions for previous years. Compare the actions of the Federal Reserve today with those two years ago. How has the emphasis changed?


http://www.federalreserve.gov/


Currency Trading

Currencies of various nations are valued by the market in relation to other currencies. The rates are available daily in The Wall Street Journal (in the “Currency Markets” chart in the “Money and Invest-ing” section). They are also available on many websites, such as Yahoo Finance (www.finance.yahoo.-com), the Universal Currency Converter (www.xe.com/uss), or CNNMoney (http://money.cnn.com/mar-kets/currencies/). (Sometimes the web address for a location changes. You might need to search to find the exact location mentioned.) Using one of these sources, determine the following:

1. What is the value in United Kingdom pounds of 100 U.S. dollars?

2. How many Canadian dollars will 20 U.S. dollars buy?

3. What is the value in Euros of 100 (United Kingdom pounds)?

4. How many Euros will 1000 Japanese yen buy?

5. What is the value in Mexican pesos of 100 Canadian dollars?

6. How many Japanese yen will 500 United Kingdom pounds buy?

7. How many U.S. dollars would it take to buy $1000 in Canadian dollars?

8. What is the value in Japanese yen of 1,000 Deutsche marks?


http://money.cnn.com/markets/currencies/

http://money.cnn.com/markets/currencies/

http://www.xe.com/uss

http://www.finance.yahoo.com/

http://www.finance.yahoo.com/


Dow Jones Components

PURPOSE:To research the historical components and performance of the Dow Jones Industrial Average by

visiting the Dow Jones Indexes website. (www.djindexes.com/jsp/industrialaverages.) (Sometimes the web address for a location changes. You might need to search to find the exact location mentioned.)

EXERCISE:Using the information about the Dow Jones Industrial Average given on the website, answer the

following questions.

1. What is the Dow Jones Industrial Average Index value at the end of yesterday’s trading?

2. What is the percentage change in the index in the year to date?

3. The website contains information about the composition of the DJIA index. Use this information to answer the following questions:(a) In what year was the DJIA index expanded to twelve stocks?

(b) In what year was General Motors added to the index?

(c) In what year was Microsoft added to the index?

4. Choose one of the stocks included in the DJIA today and trace its history.


http://www.djindexes.com/jsp/industrialaverages

BONUS INTERNET EXERCISE 13-4 (continued)

5. The website includes a chart showing what happened to the Dow Jones Industrial Average after major world events.

(a) After the Oklahoma City bombing in 1995, what was the one-day effect on the Dow Jones Industrial Average? What was the effect one year later?

(b) After the September 11, 2001 terrorist attacks, what was the one-day effect on the Dow Jones Industrial Average? What was the effect one year later?

(c) After Hurricane Katrina hit the Gulf Coast in August 2005, what was the one-day effect on the Dow Jones Industrial Average? What was the effect one year later?



Exploring Mutual Fund Families

PURPOSE:To explore the types of mutual funds available within a fund family and understand the risk/re-

turn relationship.

EXERCISE:Text Figure 13.12 gives a sample mutual fund quotation such as you might find in The Wall

Street Journal. The company highlighted is American Century, a mutual fund company with a variety of individual funds. Go to the company’s website www.americancentury.com/funds/index.jsp. (Sometimes the web address for a location changes. You might need to search to find the exact location mentioned.)

Using the information on that site, explore the three individual funds given below.

1. Equity Income fund.(a) What is the investment strategy for this fund?

(b) What is the level of risk?

(c) Would this fund be more suitable for a young investor or an investor nearing retirement? Why?

(d) What is the net asset value of this fund at the end of yesterday’s trading?

(e) Go back to the quotation in Text Figure 13.12. What is the change in NAV from that day’s value?

(f) What is the total value of the fund’s assets?

(g) How has the value of the fund changed in the past five years?

2. Select fund(a) What is the investment strategy for this fund?




BONUS INTERNET EXERCISE 13-5 (continued)





3. Ultra fund.

(a) What is the investment strategy for this fund?








CRITICAL THINKING EXERCISES


Bartering: Buying a Pair of Jeans

As the text notes, bartering was used rather than money in early commerce. In fact, countries suf-fering from hyperinflation have resorted to bartering in more recent years. Let’s see how cumbersome bartering can become and how difficult it is to get your needs met in a barter economy.

Suppose you live in a barter economy and you need to buy pair of jeans. Listed below are six people who live in your community. Each person has goods or services that he or she can trade to satisfy a particular need. You must figure out how to barter so that you get that pair of jeans. Be sure to indicate how much of each good or service is traded. Does everyone get his or her need met? Why? (This exercise is more fun if it is done in groups, with each person playing a specific role.)

You:

Have - Artistic talent and advertising experienceNeed - Pair of jeans

Great Value Store:Has - Pair of jeans

Needs - Shelves stockedBubbles and Bows:

Has - Facilities to clean and mend clothesNeeds - Flyers to advertise opening of new store

Sly Sliverbottom:Has - Two tickets to the Falling Rock concert

Needs - Music video by the Royal PaynesMac Cannick:

Has - A gas stationNeeds - Clothes cleaned

Clark Clerk:Has - Time and ability to stock shelves

Needs - Gas for his pickup truck


NOTES ON CRITICAL THINKING EXERCISE 13-1

Students must decide how much of each good or service (represented by the Xs below) is in-volved in each transaction. Students will disagree on the worth of each good or service. This disagree-ment is one of the problems of a barter economy.

The solution is:

First, you must trade X number of flyers for X loads of clothes cleaning with Bubbles and Bows.

Second, you must trade X loads of clothes cleaning for X gallons of gas with Mac Cannick.

Third, you must trade X gallons of gas for X hours of stock shelving with Clark Clerk.

Fourth, you must trade X hours of stock shelving for X pairs of jeans with Great Value Store

Sly Sliverbottom doesn’t seem to get his video since no one needs his concert tickets. That’s one of the problems in a barter economy: some people have nothing to trade.

This exercise emphasizes how awkward and cumbersome a barter economy is and how important money is in facilitating exchange of goods and services. Ask your students to identify the problems of a barter economy.



Test Your Knowledge of Money

Answer the following questions about money.

1. Where is the U.S. stock of gold and silver bullion stored? What is the value of these assets?

2. Whose signature appears on U.S. currency?

3. What is the largest denomination bill issued today?

4. When is it legal to reproduce a U.S. dollar note?

5. How many commercial banks are there in the U.S.?

Match the portrait that appears on the front of U.S. currency with the denomination of that bill.

_______ 6. Benjamin Franklin

_______ 7. Ulysses S. Grant

_______ 8. Andrew Jackson

_______ 9. George Washington

_______ 10. Abraham Lincoln

_______ 11. Thomas Jefferson

_______ 12. Alexander Hamilton

a. $1

b. $2

c. $5

d. $10

e. $20

f. $50

g. $100


CRITICAL THINKING EXERCISE 13-2 (continued)

Match the name of the currency with the country that issues it.

_______ 13. Dollar

_______ 14. Rupee

_______ 15. Peso

_______ 16. Dinar

_______ 17. Pound

_______ 18. Bhat

_______ 19. Rand

_______ 20. Franc

_______ 21. Yen

_______ 22. Kronor

a. Sweden

b. Japan

c. South Africa

d. Iraq

e. New Zealand

f. Thailand

g. Pakistan

h. United Kingdom

i. Switzerland

j Argentina

True or False:

_______ 23. A retailer is required by law to accept any U.S. coins in payment for goods.

_______ 24. U.S. dollars are backed by the country’s gold and silver assets.

_______ 24. U.S. quarters and dimes have no silver content.

_______ 26. The U.S. government plans to recall all currency and replace it with the newly designed currency.

_______ 27. It costs the U.S. Mint more than 1¢ to mint a penny.

_______ 28. The $1 bill makes up 20% of the currency printed by the U.S. Mint.



1. Where is the U.S. stock of gold and silver bullion stored? What is the value of these assets?

The U.S.’s stock of gold and silver is stored at Fort Knox, Kentucky. The second part of this question is harder to answer. As of 2008, the U.S. had 147.7 million ounces of bullion stored at Fort Knox. The U.S. gold stock is listed at a “standard value” set at $42.2222 per ounce. Using this price, the value of the bullion is over $6 trillion. However, gold on the open market trades at significantly higher prices. Recently, an ounce of gold traded at a historic high of $928. If the U.S. gold stock were stated at market value, the total valuation would be over $137 trillion. (Interestingly, the gold stored in Fort Knox has not been inventoried since the 1950s, so the actual amount of bullion is the subject of some contro-versy.)

2. Whose signature appears on U.S. currency?

The signature on all U.S. currency is that of the Secretary of the Treasury. From 2003 to 2006, the Secretary of the Treasury was John W. Snow. In 2006, Henry M. Paulson became Treasury Secretary. The Secretary of the Treasury will again change after the 2009 Presidential Inauguration.

3. What is the largest denomination bill issued today?

Today the largest denomination bill is $100. There have been $500 notes, $1,000 notes, even $100,000 notes, but they were phased out beginning in 1946 as checks became more widely used for large debts.

4. When is it legal to reproduce a U.S. dollar note?

It is illegal to reproduce a U.S. dollar note at 100% of its size. It is not illegal to reproduce a note if it is less than three-fourths or more than one and one-half the size of the original.

5. How many commercial banks are there in the U.S.?In 2005, there were 7,527 commercial banks.

Matching

6. Benjamin Franklin – g. ($100)

7. Ulysses S. Grant – f. ($50)

8. Andrew Jackson – e. ($20)

9. George Washington – a. ($1)

10. Abraham Lincoln – c. ($5)

11. Thomas Jefferson – b. ($2)

12. Alexander Hamilton d. ($10)

13. Dollar


14. Rupee

15. Peso

16. Dinar

17. Pound

18. Bhat

19. Rand

20. Franc

21. Yen

22. Kronor

True or False

23. A retailer is required by law to accept any U.S. coins in payment for goods.

False. There is no federal law that mandates that a person must accept currency or coins as pay-ment for goods or services not yet provided. For example, a bus line may prohibit payment of fares in pennies or dollar bills. Some gas stations as a matter of policy may refuse to accept currency of a large denomination, such as notes above $20, as long as the notice is posted and a transaction has not already been completed.

24. U.S. dollars are backed by the country’s gold and silver assets.

False. In the past, the U.S. Treasury issued notes backed by precious metals. You can still occa-sionally find a “silver certificate” that is backed by silver. Today’s currency is almost exclusively “Fed-eral Reserve Notes,” backed only by our faith in the U.S. economy.

25. U.S. quarters and dimes have no silver content.

True. U.S. quarters and dimes are now minted using 75% copper and 25% nickel.

26. The U.S. government plans to recall all currency and replace it with the newly designed cur-rency.

False. The new currency will gradually replace older bills in circulation, but the U.S. Government will NOT recall older currency.

27. It costs the U.S. Mint more than 1¢ to mint a penny.

True. In 2006, it cost 1.4¢ to produce one penny.

28. The $1 bill makes up 20% of the currency printed by the U.S. Mint.

False. The $1 bill makes up about 47% of our currency. (It costs only 4¢ to produce a dollar bill.)



Financing Options

You’ve owned a tool and die company for the last five years. Even during the recession, you have been earning a net profit of 30% on your investment and have been able to pay yourself a reasonable salary. You are feeling so confident that you are considering expanding. You believe that your profit po-tential can improve greatly if you could expand your product line with newer high-tech equipment. You estimate that you will need $1,000,000 for the expansion.

1. What are your financing alternatives?

2. Would you consider selling bonds if you had to pay 12% interest? Why or why not?

3. What are the major advantages of using issuing bonds?

4. What are the major disadvantages of using issuing bonds?

5. A venture capital firm has agreed to invest the money you need. In return, the venture capital firm will own 75% of the business. You will be replaced as board chairman and CEO, through you’ll retain the title of company founder and president. The venture capital firm will hire a new CEO. Would you be willing to take the money but lose control of your business? Why or why not?



1. What are your financing alternatives?You could raise the money by selling more stock or by borrowing money through the sale of

bonds.

2. Would you consider selling bonds if you had to pay 12% interest? Why or why not?Probably not. You have been realizing a return higher than that, but 12% is simply too much to

pay in the long run. Business could slow and you would be stuck paying 12% to bond holders for a long time.

3. What are the major advantages of using issuing bonds?

You maintain control over the firm and you don’t dilute the ownership.

4. What are the major disadvantages of using issuing bonds?You have to pay back the debt even if you don’t have the revenues to do so. Debt weakens the fi-

nancial base of the firm and makes it harder to sell stock.

5. A venture capital firm has agreed to invest the money you need. In return, the venture capital firm will own 75% of the business. You will be replaced as board chairman and CEO, through you’ll retain the title of company founder and president. The venture capital firm will hire a new CEO. Would you be willing to take the money but lose control of your business? Why or why not?

Is losing control of your business worth the infusion of cash? Interesting discussion.



Understanding Stock Quotations

Using the stock quotation given in Text Figure 13.11, answer the questions below:

1. What is the PE for:

(a) McDonalds?

(b) Medicis Pharmaceuticals?

2. What is the change in Maxtor’s closing price from yesterday (in dollars and cents)?

3. If you bought 100 shares of Maytag at 20.25 last year:

(a) How much could you sell these shares for today (using the closing stock price)?

(b) How much profit/loss would you have?

4. If you had $1000, how many shares of Media General could you buy today using the closing price?

5. How many shares of McGraw-Hill were traded today?

6. What is the stock symbol for McDonalds?

7. What is the highest price paid for Media Arts in the past year?

8. How much would your latest dividend payment be on your 100 shares of Maytag?



1. What is the PE for:(a) McDonalds? 14

(b) Medicis Pharmaceuticals? 31

2. What is the change in Maxtor’s closing price from yesterday (in dollars and cents)? -5¢.

3. If you bought 100 shares of Maytag at 20.25 last year:

(a) How much could you sell these shares for today (using the closing stock price)?The closing price today is $27.66. Your 100 shares would yield $2,766.

(b) How much profit/loss would you have?

The initial total price was $2,052 (100 x $20.52). Thus:Sale price $2,766Purchase price –$2,025Profit $741 (a 36.6% increase for the year)

4. If you had $1000, how many shares of Media General could you buy today using the closing price?The closing price today is $57.80. $1,000 ÷ $57.80 = 17.3. Because there are not fractional

shares, our $1,000 would buy 17 shares.

5. How many shares of McGraw-Hill were traded today? 629,600 shares

6. What is the stock symbol for McDonalds? MCD

7. What is the highest price paid for Media Arts in the past year? $4.50

8. How much would your latest dividend payment be on your 100 shares of Maytag?Each share of your stock would earn $0.72 in dividends. The total dividend payment would be

$72.00.

(BONUS EXERCISE: Update the exercise questions by finding the current stock price quotations for the companies featured.)


BONUS CASES

BONUS CASE 13-1

Keeping Ahead of Counterfeiters

Counterfeiting used to be very straightforward. Crooks just found the best engraver who painstak-ingly attempted to reproduce the details in U.S. currency notes. The Department of Treasury tried to keep one step ahead by adding anti-counterfeit measures to the currency. A sweeping change to the appearance of all paper money occurred in 1929. All currency was reduced in size by about 30%, and designs were standardized for each denomination, making it easier for the public to distinguish between genuine and counterfeit notes.

In the 1990s, advanced reprographic technology made it possible to reproduce the colors and de-tails of security documents and currency. In the face of digital scanners, sophisticated copiers, and com-puter software, the security of the U.S. currency became inadequate. In 1990, a security thread and micro-printing were introduced to deter counterfeiting by this advanced equipment. The note’s denomination is printed on the threads in bills larger than $1. Since it is visible to transmitted light, not reflected light, the thread is difficult to copy with a color copier. Each denomination has a unique thread position to guard against counterfeit techniques such as bleaching a lower denomination bill and using the paper to “re-print” the bill as a higher valuation. The thread in each denomination glows a different color under ultra-violet light. The $5 note glows blue, the $10 note glows orange, the $20 note glows green, the $50 note glows yellow, and the $100 note glows red.

Microprinting appears as a thin line to the naked eye, but the lettering is easily read using a low-power magnifier. The resolution of most current copiers is not adequate to copy such fine print.

The first sweeping design change in 67 years occurred in 1996 when U.S. currency was re-designed to further deter counterfeiting. Color-shifting inks were added. The ink appears green when viewed directly and changes to black when the note is tilted. A watermark was added by varying paper density in a small area during the papermaking process. The image is visible as darker and lighter areas when held to the light. Since the watermark does not copy on color copiers or scanners, it is a good way to authenticate the note. The note’s portrait was also shifted off-center and enlarged. The larger portrait incorporated more detail, making it easier to recognize and harder to counterfeit.

In 2003, the currency was again changed to make it harder to fake. Subtle green, peach, and blue colors were added to the background. Different colors are used for different denominations. These addi-tions added complexity to the notes, making counterfeiting even more difficult.

It is impossible to completely prevent ingenious crooks from attempting to counterfeit U.S. cur-rency. The U.S. Treasury is continually evaluating new reproduction technology to identify future threats. Digital technology represents the greatest threat. In 1995, less than 1% of counterfeit notes detected in the U.S. were digitally produced. By 2005, that number was nearly 40%.

DISCUSSION QUESTIONS FOR BONUS CASE 13-1

1. Coins are more durable than bills and cost less to produce. But in recent years the Treasury has twice introduced one-dollar coins—the Susan B. Anthony coin and the Sacagawea coin—that have not been accepted by the public. Why do you think people resist using these dollar coins?


2. Some European currencies use bright colored inks for different denominations. Do you think the American consumer would accept “orangebacks” or “bluebacks” as replacements for today’s “greenbacks”? Why or why not?

3. To make different denominations of currency easier to identify, some people have suggested that each denomination’s size be different. What changes in the economy would be necessary if higher denomination bills were physically larger?

ANSWERS TO DISCUSSION QUESTIONS FOR BONUS CASE 13-1

1. Coins are more durable than bills and cost less to produce. But in recent years the Treasury has twice introduced one-dollar coins—the Susan B. Anthony coin and the Sacagawea coin—that have not been accepted by the public. Why do you think people resist using these dollar coins?One reason the coins were not accepted was their size—only slightly larger than a quarter. Many

complained that the dollar coin and the quarter were easily confused. There is also something inherently reassuring about a dollar bill—the symbol of the American economy. If students have any insights on this issue, the Treasury would be interested.

2. Some European currencies use bright colored inks for different denominations. Do you think the American consumer would accept “orangebacks” or “bluebacks” as replacements for today’s “greenbacks”? Why or why not?Americans seem to have accepted the new multicolor $10, $20, and $100 bills. Students can ex-

press their opinions one way or the other.

3. To make different denominations of currency easier to identify, some people have suggested that each denomination’s size be different. What changes in the economy would be necessary if higher denomination bills were physically larger?Vending machines would have to be adapted to accept different sizes. Wallets would need to be

larger. Bank teller cash drawers and ATM machines would have to be redesigned. (But, as discussed in LECTURE LINK 13-5, “Currency for Visually Impaired Consumers?” different size denominations for bills would make using currency easier for visually-impaired consumers.)


BONUS CASE 13-2

When Money Loses its Meaning

When money decreases in value because of inflation, people tend to place less trust in it as a method of storing value, and look for alternative means of storing their wealth that would be more effi-cient. Hyperinflation—extremely high inflation that can range from 100% to 10,000% annually—makes money particularly unstable. In fact, hyperinflation makes money meaningless. That is what happened in Germany during the 1920s. A pack of cigarettes, for example, had a price tag of 200 trillion marks. As a result, people ceased to use the official, but worthless, currency and resorted to using other objects as money (such as clothes, appliances, jewelry, antiques, diamonds, silver, and gold). These objects effec-tively became money. Subsequently, the German economy collapsed, setting the stage for the rise of Nazism.

Hyperinflation in post-World War I Germany is one of the worst such cases in this century. Nev-ertheless, there are numerous recent examples of hyperinflation. In the South American country of Bo-livia, for example, prices during 1984 rose at an annual rate of 10,000%. A hamburger cost 1 million pe-sos, a loaf of bread sold for 300,000 pesos, and one night’s lodging in a good hotel cost 35 million pesos. Hyperinflation in Bolivia skyrocketed to the point where the peso was virtually worthless.

The most severe known incident of inflation was in Hungary after the end of World War II when prices rose at a rate of 4.19 x 1016.% per month. (Prices doubled every 15 hours.) More recently, Yu-goslavia suffered 5 x 1015% inflation per month (prices doubled every 16 hours) between October 1993 and January 1994. x


1. Why did official money lose its meaning in Germany during the 1920s?

2. Do you believe that the United States could be facing a hyperinflation problem in the foreseeable future? Why or why not?

3. How can we deal with hyperinflation? What is the role of the Federal Reserve in controlling infla-tion? How does it perform this function?


1. Why did official money lose its meaning in Germany during the 1920s?When a government gets into financial trouble, one of the ways to finance those problems is

through inflation. If the government owes people money, that debt is lessened considerably if money is worth less and less. A government can also print money to pay its bills. The more money pumped into an economy, though, the higher inflation becomes. The principle, again, is too much money chasing too few goods. When a government is preparing for war, it often prints lots of money to pay for war materials. This is very inflationary, and has resulted in inflation in many countries.

2. Do you believe that the United States could be facing a hyperinflation problem in the foreseeable future? Why or why not?

x Source: http://en.wikipedia.org


http://en.wikipedia.org/

The economy of the United States steadily grew throughout the early 2000s, and inflation was down from double-digit levels of a decade ago. Many felt that inflation was under control. But by early 2008, producer prices shot up rapidly, raising inflation fears. Any threat of war or collapse in the banking system could further fuel inflationary pressure. The Federal Reserve plays a pivotal role in all this by con-trolling the money supply.

3. How can we deal with hyperinflation? What is the role of the Federal Reserve in controlling in-flation? How does it perform this function?The Fed has three tools for managing the money supply: (1) reserve requirements, which keeps

money out of circulation, (2) open-market operations that manage the money supply by the purchase and sale of securities, and (3) the discount rate (the rate charged banks for borrowing funds from the Fed). By keeping the money supply in balance, the Fed can lessen pressures for inflation. Too tight a policy can re-sult in another depression, too loose a policy could result in hyperinflation.


BONUS CASE 13-3

State Farm Bank: Would You Like Banking with That Insurance? (Video Case)

(NOTE: This case can be used with the Video on DVD for this chapter.)

It’s not unusual to hear employees at a fast-food restaurant ask, “Would you like fries with that?” But you don’t expect your insurance agent to ask, “Would you like banking services with your insurance coverage.” Nonetheless that’s exactly what is happening at State Farm. This chapter is all about money and banking, and the latest trends in banking. One of those trends is to combine banking with insurance, as you’ll see in this video.

You won’t see a State Farm bank in your neighborhood shopping center or downtown. And you won’t see any State Farm ATMs in your local grocery store or on the corner. That’s because State Farm is a virtual bank; that is, an online bank. As you read in this chapter, recent legislation made it possible for financial institutions to provide services they couldn’t provide before. For example, stock brokers can of-fer insurance, and insurance companies can offer banking. At State Farm Bank, you can get regular bank-ing services such as checking accounts, loans, CDs, credit cards, IRAs, and more.

So, how do you get such services? State Farm Insurance agents will handle any of your banking needs. But, like most online banks, you can do most of your banking online via the Internet. Customer service is available 24 hours a day. Any remaining questions can be directed at your State Farm agent.

This chapter talked about banks and savings and loans (thrift agencies). State Farm falls into the thrift category. Its deposits are insured by the Federal Deposit Insurance Corporation, like banks and other thrifts. State Farm, however, does not have strategic partnerships with car dealerships or other firms like General Motors Acceptance Corporation does.

Because it is in the health and banking business, State Farm offers products like health insurance plans that are low cost and high deductible. Although State Farm’s insurance and banking operations have been integrated, that integration was not as easy as might be imagined. Two different corporate cultures had to be merged, but that merger has gone relatively smoothly. Now, when a customer suffers a major loss because of a flood or hurricane or something similar, the bank can easily respond and adjust insur-ance payments and house payments accordingly.

Like all corporations, State Farm has ethical issues to confront. For example, agents make sure that customers understand that they can buy insurance and not get involved in banking and vice versa. The whole idea is to listen to customers to determine their wants and needs. If they want to buy a new car, financing can be made available—and insurance. Because of their good products and good service, State Farm mostly relies on word of mouth to promote their products. Of course, they have highly trained sales-people to help customers as well.


1. What advantages and disadvantages do you see with doing both insurance and banking with the same company?

2. Are you as comfortable doing banking online as with a clerk in a brick and mortar bank? Would it help to be able to work with your insurance agent instead of a banking clerk?

3. What kind of services do you get from a brick and mortar bank (such as ATMs) that you might not get as easily from an online bank?



1. What advantages and disadvantages do you see with doing both insurance and banking with the same company?

There are many advantages: ease of transactions, simpler, fewer bills. However, there are disad-vantages: less specialization, maybe less desirable services? Good discussion starter.

2. Are you as comfortable doing banking online as with a clerk in a brick and mortar bank? Would it help to be able to work with your insurance agent instead of a banking clerk?

Most people are not as comfortable doing banking online as they are in person. It seems more risky—not as personal as in person. Identity theft can also be an issue.

3. What kind of services do you get from a brick and mortar bank (such as ATMs) that you might not get as easily from an online bank?

The brick-and-mortar bank would provide personal care and better understanding of questions. With online banking, speed of Internet issues arise. Flexibility of answers. Good discussion question.


BONUS CASE 13-4

Making Dreams Come True

Carlos Galendez had big dreams but very little money. He had worked more than 10 years wash-ing dishes and then as a cook for two major restaurants. Finally, his dream to save enough money to start his own Mexican restaurant came true. Galendez opened his restaurant, Casa de Carlos, with a guaranteed loan from the Small Business Administration. His old family recipes and appealing Hispanic decor helped the business gain immediate success. He repaid his small business loan within 14 months and immedi-ately opened a second, and then a third, location. Casa de Carlos became one of the largest Mexican restaurant chains in the nation.

Galendez decided the company needed to go public to help finance a nationwide expansion. He believed that continued growth was beneficial to the company, and that offering ownership was the way to bring in loyal investors. Nevertheless, he wanted to make certain his family maintained a controlling interest in the firm’s stock. Therefore, in its initial public offering (IPO), Casa de Carlos offered to sell only 40% of the company’s available shares to investors. The Galendez family kept control of the remain-ing 60%.

As the public’s craving for Mexican food grew, so did the fortunes of Casa de Carlos, Inc. By early 2001, the company enjoyed the enviable position of being light on debt and heavy on cash. But the firm’s debt position changed dramatically when it bought out Captain Ahab’s Seafood Restaurants and, two years later, expanded into full service wholesale distribution of seafood products with the purchase of Ancient Mariner Wholesalers. The firm’s debt increased, but the price of its stock was up and all its busi-ness operations were booming.

Then tragedy struck the firm when Carlos Galendez died suddenly from a heart attack. His oldest child, Maria, was selected to take control as chief executive officer. Maria Galendez had learned the busi-ness from her father, who had taught her to keep an eye out for opportunities that seemed fiscally respon-sible. Even so, the fortunes of the firm began to shift. Two major competitors were taking market share from Casa de Carlos, and the seafood venture began to flounder (pun intended). Also, consumer shifts in eating habits and the slight recession in 2002 encouraged consumers to spend less, causing the company some severe cash flow problems. It was up to Maria Galendez as CEO to decide how to get the funds the firm needed for improvements and other expenses. Unfortunately, several local banks wouldn’t expand the firm’s credit line, so she considered the possibility of a bond or stock offering to raise capital for the business. Her decision could be crucial to the future of the firm.


1. What advantages do bonds offer a company such as Casa de Carlos? What disadvantages do bonds impose?

2. What would be the advantages and disadvantages of the company’s offering new stock to in-vestors?

3. Are any other options available to Maria Galendez?

4. What choice would you make and why?



1. What advantages do bonds offer a company such as Casa de Carlos? What disadvantages do bonds impose?

Bonds offer the advantage of not losing full ownership of the company. One can borrow money and pay it back without losing control of management. The disadvantage of bonds is that they have to be paid back at a certain time, with interest. They add to a company’s debt, making them look less attractive to stockholders.

2. What would be the advantages and disadvantages of the company’s offering new stock to in-vestors?The advantage to selling stock is that lots of money becomes available for expansion, moderniza-

tion, and other such projects. The disadvantage is that additional stock dilutes ownership and control over the firm.

3. Are any other options available to Maria Galendez?

Other options include going to friends and relatives and asking to borrow money. She could also pile up credit card debt. But none of these options is superior to stocks or bonds. Going to an “angel,” a person who lends money for such purposes, has no real benefit because they demand ownership rights too.

4. What choice would you make and why?

She could try some bonds and try to raise money internally with the investments made possible with the bond money. If that fails, she should turn to stock.


BONUS CASE 13-5

The Rebuilding Decision

After Rob and Janet Colton finished veterinary school in the early 1990, they spent several years working for other veterinary clinics. By 1997, they felt it was time for them to start their own practice. They considered several towns in the south central U.S., visiting local chambers of commerce and study-ing each town’s demographics. They finally settled in Wardston, a small city in Arkansas. Wardston is a regional center for the surrounding counties, located at the intersection of two major cross-state highways. The industry rule of thumb is that it takes a population of 1,500 pet owners to support one veterinarian. Wardston appeared to be an underserved area, and no other veterinarian in the area was treating large ani-mals. A big factor in their decision also was the fact that Janet’s parents and three brothers lived in Ward-ston. “If we failed, at least we knew we could get a good homemade meal,” said Rob.

They bought an abandoned veterinary clinic with a three-quarter acre plot of land on the major thoroughfare. The clinic, a sturdy 2,000 square foot cinderblock structure, had been constructed in 1950 and needed major renovations. Rob and Janet were still paying off $45,000 in student loans and had no savings to draw on. However, Janet’s parents agreed to deed them a house and tract of land to get started. Now a property owner, Rob was able to borrow $165,000 from a local bank. Rob’s family took out a home equity loan to help them complete the renovations. When the clinic opened in May of 1998, the small concrete building had been transformed into the Wardston Animal Hospital, a 4,000 square foot veterinary clinic, complete with treatment room, surgery, kennels, and offices.

As they had anticipated, the area badly needed another vet clinic, and business began to boom. They were able to pay off the loan from Rob’s parents and make improvements to the clinic’s parking area. By 2000, the Wardston Animal Hospital had grown large enough to need another vet, and Dr. Wayne Harper joined the practice. He soon became an equal partner with Rob and Janet.

The clinic building, while adequate for a small practice, was still half a century old with an incon-venient traffic flow. The building was designed around a single center hallway going from north to south. Clients going to exam rooms, animals being weighed, vets heading to treatment rooms, staff going to break room all had to go down same central hallway. The partners always knew that they eventually wanted to build a new “ideal” clinic. Janet kept a notebook full of ideas and possible floor plans that they dubbed their “five year plan.”

Then one April afternoon in 2005, a line of severe thunderstorms passed through the city. It was a Wednesday afternoon, the clinic’s early closure day, and the staff—with the exception of the office man-ager—had left the building. At 3:00 p.m., a tornado dropped out of the squall line and plowed through the northern part of the city, tearing the roof off the Wardston Animal Hospital and wrapping it around sev-eral nearby pine trees. For three hours, a steady downpour flooded the damaged building, leaving six inches of water on the treatment room floor. Worse still, the rainwater soaked into the insulation in the walls, the sheetrock on the walls, and the ceiling tiles. Volunteers, staff, even other veterinarians flocked to the clinic to help ferry the boarded animals to temporary homes and clean up the shredded interior. None of the animals was hurt, and no one was injured, although the clinic office manager was in shock for a few days.

Within two weeks, the partners were back in business, operating out of a doublewide trailer set up on the north side of the parking lot. They hired a clean-up service to start the long process of recovery. The cleaning crew soon realized the extent of the damage and told the partners that the clean-up would be very costly. They also warned that the soggy walls and ceiling would probably have mildew problems in the future no matter how thoroughly the building was cleaned.

Rob, Janet, and Wayne had to make a decision about how to proceed. As Rob saw it, there were four options to consider:


Plan A: Restore the building to its existing condition before the tornado. The $150,000 insurance settlement would just cover the renovation costs. This option would be the least costly, but they would still have the same 55-year-old building with the same bad traffic flow.

Plan B: Gut the old building and create the “ideal” building within the old shell, total cost ap-proximately $400,000.

Plan C: Level the old building and rebuild on the site. This option was almost immediately elimi-nated for several reasons. First, the cost just to demolish the building would be $50,000. Also, the clinic staff was using undamaged parts of the old building for kennel space and storage. The doublewide trailer alone would be inadequate to support the practice if the old building were immediately demolished.

Plan D: Build the clinic of their dreams on land the partners owned adjacent to the clinic. The clinic would take almost a year to complete at a cost of $650,000.


1. Are there other options that have not been considered? Explain.

2. What would you advise Drs. Colton and Harper to do? Why?

3. If the Wardston area suffered a major economic blow, what risks would the partnership face?


1. Are there other options that have not been considered? Explain.

Students can develop other options. The veterinary partners did not consider moving to another location, for example.

2. What would you advise Drs. Colton and Harper to do? Why?

This case is based on a real incident. The partners decided to go with plan D, financing the new clinic entirely with a bank loan. “Rob” believed that the growing practice and influx of Katrina pet own-ers into the area would enable him pay off the loan without problems.

Right after the tornado, “Rob” put an inexpensive roof on the old building to protect it from fur-ther damage. He decided to donate the old clinic to the local animal rescue league, which badly needed the kennels and the office space. Generous and ethical behavior….and a nice tax deduction.

3. If the Wardston area suffered a major economic blow, what risks would the partnership face?

Borrowing funds to build the new clinic creates a legal obligation to repay the loan. If a major economic blow occurred, the partners would run the risk that revenues generated will not cover the monthly loan payment.

This case is an actual situation. For months, I listened to my friend Bob (“Rob”) go through the all the angst and indecision about the veterinary clinic’s future. At some point, I pulled out a pencil and started taking notes. A few weeks later, I sat down with him to get more information for the case. He spent two hours giving me all the details, some very private, about financing the clinic. It was an incredi-ble opportunity to create a decision-based case.


The outcome: The partners decided to go with plan D, financing the new clinic entirely with a bank loan. Bob’s choice was partly based on an industry study that found that a new veterinary facility causes an average revenue bump of 20%.

The new building was built quickly, and they moved into the new clinic facility 16 weeks after the storm, The revenues for the new clinic were a little less than anticipated in the year after the move. The clinic is operating profitably, however, and paying down the bank loan.


BONUS CASE 13-6

The Motley Fool: Fooling Around with the Stock Market (Video Case)

(NOTE: This case can be used with the Video on DVD for this chapter.)

You can’t help but be impressed when you first visit the offices of Motley Fool. The building is modern and imposing, and is located in Alexandria, a very attractive suburb of Washington, D.C. The re-ception area is modern as well. A statue of a jester greets you by the elevator. You get the impression that this isn’t your typical up-tight finance firm. That impression is heightened when you meet the employees. None of the men and women is wearing a suit or tie or fancy outfit, and all of them seem young.

One of those employees is Matt Emmers. Matt was a finance major in school. His friends called him “the stock doctor” because he was so interested in telling people about stock and guiding them into the right stocks. It naturally followed that Emmers would become a broker. He thought that such a job would be great—he would be helping people select the right stocks at the right time. Instead, he found himself making hundreds of phone calls a day trying to sell stock to people. That simply wasn’t the kind of job Emmers wanted.

Happily, Emmers eventually found himself working at Motley Fool. Of course, the name of the company was a little shocking at first. Do I really want to be a “fool?” The answer was a resounding “Yes!” You see, a fool is actually a jester; that is, the person who was honest with the King and Queen and could be trusted. But a jester is also light hearted and enjoys his work. And that’s what it’s like to work at Motley Fool. You earn peoples’ trust. You teach them how to invest. You do that, at the begin-ning, by making a newsletter that informs people about stocks. Over time, that leads to five books, a radio show, a website and more.

David and Tom Garner are brothers and the founders of Motley Fool. They started the company when they were young and surrounded themselves with smart, young finance types. They all shared a passion for helping people to make the right kind of investments and for having a good time doing so. Of course, that would include a room next to the offices where you can see the latest sports on a giant TV screen or play a new video game.

Hey, making money can be fun! First you have to learn about securities (stocks and bonds). Stock represents ownership in the company, and it’s the owners who make big money when the company grows. Bonds represent debt. Companies borrow money from people or organizations and then have to pay that money back at a certain time and pay interest on the money. Motley Fool focuses more on stocks than bonds because, in the long run, you usually make more money investing in stock rather than bonds.

You buy those stocks on the various exchanges, like the New York Stock Exchange or the Ameri-can Exchange. If you want your trades done totally electronically, you can go to the NASDAQ. Not all stocks are traded on all the exchanges, so you have to buy the stocks you want from the exchange that sells them. You can learn a lot about stocks and bonds and stock exchanges in this text. But you can learn a lot more details by going to Fool.com and clicking on stock research. There you’ll find the kind of in-formation you can get by singing up.


1. What kind of impression did the founders of Motley Fool want to convey by choosing the name of the company the way they did? Did they succeed?

2. What characteristics are you looking for when choosing a broker? Does it make a difference how old he or she is? What gender? How much experience he or she has had? Or are you just as com-fortable making your own decisions and then using a low-cost Internet broker?


3. Does working for Motley Fool seem like more fun than the typical brokerage firm? Are you will-ing to work as an intern for a broker to see what the job entails?


1. What kind of impression did the founders of Motley Fool want to convey by choosing the name of the company the way they did? Did they succeed?

They wanted to convey the fact that investing can be interesting and fun and not scary. Students may want to give their impressions of the name and the overall goals of the company as they see them.

2. What characteristics are you looking for when choosing a broker? Does it make a difference how old he or she is? What gender? How much experience he or she has had? Or are you just as com-fortable making your own decisions and then using a low-cost Internet broker?

Most students have not gotten involved with a broker yet. This is as good a time as ever to dis-cuss the various options they have: buying directly from a mutual fund, finding a regular broker or a dis-count broker, or simply putting their money into a saving account at a bank or a CD.

3. Does working for Motley Fool seem like more fun than the typical brokerage firm? Are you will-ing to work as an intern for a broker to see what the job entails?

Brokerage firms hire interns all the time—especially in the summer. Often those jobs are in New York or Atlanta or some other big city. You may want to talk about internships in general and finance in-ternships in particular. Some firms, like Motley Fool, are more fun. How would students learn which firms best meet their needs?


BONUS CASE 13-7

The Sage of Omaha

Warren Buffett is the world’s most famous investor and its second richest person. He is the only U. S. billionaire to have made his money entirely through investing. As CEO of Berkshire Hathaway, Buffett’s net worth in 2007 was $52 billion. Called the Omaha Oracle or the Sage of Omaha, his down-to-earth, insightful annual letters to Berkshire shareholders are eagerly awaited by investors and executives in the financial world.

The legend is that young Warren Buffett made his first trade at the age of 11, buying 3 shares of a company for $38 each in 1941. The shares dropped to $27 but then rose to $40, when Buffet sold, making a small profit. Later, when the stock price climbed to $200 and young Buffet missed out on a huge killing, he formed the basis of his investing philosophy that share-buying is for the long term.”

In 1962, Buffett found a Massachusetts textile business called Berkshire Hathaway. He used the assets of the rundown company to buy into other businesses. Berkshire now owns Geico Insurance and General Re, an insurance and financial company. The premiums gained from those insurance companies enabled Buffett to invest and build Berkshire Hathaway into the huge financial conglomerate it is today. For example, in 1973, Buffett began investing in The Washington Post; the $11 million stake grew to $1.2 billion. In 1988, he bought $1.3 billion worth of shares of Coca-Cola, an investment that is now worth $8 billion. In addition to those investments, other holdings include furniture and jewelry stores, apparel man-ufacturers, building materials, and carpeting. Dairy Queen and See’s Candies are Berkshire Hathaway companies, as is Garan, the manufacturer of Garanimals, the children’s clothing line. Berkshire also owns stock in such companies as H&R Block, Moody’s, The Gap, and Nike.

Part of the Buffett investment legend is the fact that $10,000 invested in Berkshire in 1965 would be worth $50 million today. The same money invested in the general stock market index would be worth $500,000. Unfortunately, Berkshire’s share price is out of range for most investors. Berkshire-Hathaway “A” shares trade at more than $136,000 apiece. Even its “B” stock, “Baby Berks”, sell at approximately $4,500 per share.

Buffett claims that he “came wired at birth with a talent for capital allocation.” He also credits his mentor and former professor Benjamin Graham with developing that talent to the fullest. Considering that Berkshire generates about $5 billion in cash flow annually from its investments, insurance and operating companies, that means Buffett has $100 million a week that he has to figure out what to do with.

In 2006, Buffett announced that he’d found a new use for his Berkshire holdings. He committed to donate Berkshire stock, currently valued at about $30 billion, to the Bill and Melinda Gates Founda-tion, and about $6 billion more to four Buffett family foundations. That’s about 85% of his Berkshire stake, and is the biggest single gift every announced by anyone.

Even in his philanthropy, Buffett is still a shrewd investor. His gift, which is being given away over a period of years, is 12.05 million Berkshire B shares rather than a fixed amount of money. The higher Berkshire’s stock is over time, the more his gift will be worth—or the lower if it goes down.

His choice of the Gates Foundation also shows his genius touch. The Foundation is the world’s biggest charity and has spent years establishing an infrastructure to be able to effectively give away huge amounts of money. Buffett’s gift specifies that the Gates Foundation give away the value of Buffett’s an-nual contribution each year. Instead of creating his own foundation to channel his gift, which he would have to set up and monitor, he chose to funnel it through an established, and efficient, distribution system.

Buffett has also structured his gift to protect Berkshire investors. If Buffett had included the char-itable bequest in his will, the designated charities would have to sell large portions of the bequest quickly, which would clobber Berkshire’s stock price.


The Gates Foundation, however, won’t have to sell its 500,000 shares the day it gets them. The foundation has $30 billion of other assets and can dispose of its Berkshire stock in small pieces and still make the required gifts. That minimizes the downward pressure on the stock.

In crafting his donation, Buffett also cleverly protected his control of Berkshire. The donation will be in Berkshire “B” shares, not the closely-owned A shares. One Berkshire “A” share has one vote, while a “B” share has only 1/200th of a vote.

Buffett really does know how to profit while giving money away.xi


1. Should persons like Warren Buffett be expected to share their vast wealth with persons who are in need?

2. Can philanthropy make good business sense? Why or why not?

3. Buffett chose to give his donation to the Gates Foundation, the largest charity in the world. Do you think large charities are better able to help those in need than small charities?


1. Should persons like Warren Buffett be expected to share their vast wealth with persons who are in need?

This question gives students a chance to debate the social responsibilities of wealthy individuals. Should they be held to a higher standard than others? What are their obligations to their families? To soci-ety?

2. Can philanthropy make good business sense? Why or why not?

Does doing good translate into doing well? This is a question that can be debated endlessly.

3. Buffett chose to give his donation to the Gates Foundation, the largest charity in the world. Do you think large charities are better able to help those in need than small charities?

Larger foundations have a more efficient distribution network than smaller charities. However, small charities usually maintain closer ties to communities they serve. These smaller groups may be more in touch with local needs. Good discussion material.

xi Sources: Rupert Conwell, “Profile: Warren Buffett—The One True Sage in a World of Market,” Independent, July 27, 2002, p. 17; Andy Serwer and Julia Boorstin, “The Oracle of Everything,” Fortune, November 11, 2002, p. 68; Warren Buffett, “Dividend Voodoo,” The Washington Post, May 20, 2003, p. A19; Daniel Kadlec and Julia Rawe, “Comeback Crusader,” Time, March 10, 2003, p. 42; and Allan Sloan, “Buffett’s Generosity Benefits Both Charity, Berkshire Investors,” The Washington Post, June 27, 2006


ENDNOTES

ii Source: Editorial called “Hamilton and Jefferson,” St. Croix Review, January 2005, pp. 2-6. iii

? Sources: The Associated Press, “Is the Penny Worth It? Rising Cost May Mean End to Coin,” The Clarion-Ledger, July 2, 2006; Brian Wilson, “Bad Penny! Lawmakers Consider Elimination of Least-Valued U.S. Currency,” Fox News, July 20, 2006; and “The Composition of the Cent,” The United States Mint, www.usmint.gov

iv Source: Robert Parloff, “The Blind Undercutting the Blind,” Fortune, January 22, 2007.

v Sources: Robert J. Samuelson, “The Vanishing Greenback,” Newsweek, June 24, 2007; and “R.I.P. for the Check,” ConsumerReports.com, December 17, 2007

vi Source: www.djindexes.com.


http://www.djindexes.com/


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