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Finance: Chapter 5 Notes

by: Lindsay Fialli

Finance: Chapter 5 Notes FIN 100

Marketplace > Salem State University > Finance > FIN 100 > Finance Chapter 5 Notes
Lindsay Fialli

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About this Document

These are my notes on Chapter 5 of Personal Finance by Jeff Madura.
Personal Finance
Terrance Doyle
Class Notes
Personal, finance
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This 5 page Class Notes was uploaded by Lindsay Fialli on Friday October 7, 2016. The Class Notes belongs to FIN 100 at Salem State University taught by Terrance Doyle in Fall 2016. Since its upload, it has received 4 views. For similar materials see Personal Finance in Finance at Salem State University.


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Date Created: 10/07/16
Chapter 5: Banking and Interest Rates  Individuals rely on financial institutions when they wish to invest or borrow funds Depository Institutions  Depository Institutions: financial institutions that accept deposits (which are insured up to a maximum level) from individuals and provide loans o Pay interest on savings deposits & charge interest on loans o Skilled in assessing the ability of potential borrowers to repay loans o Three types: commercial banks, savings institutions, & credit unions  Commercial Banks: financial institutions that accept deposits and use the funds to provide commercial (business) and personal loans o Savings accounts pay interest o Up to $250,000 per depositor is insured by FDIC  Federal Deposit Insurance Corporation(FDIC): a government owned insurance agency that ensures the safety of bank deposits o Provide personal loans for big purchases o Offer mortgage loans  Savings Institutions (thrift institutions): financial institutions that accept deposits and provide mortgage and personal loans to individuals o Offer checking & savings accounts o Up to $250,000 per depositor is insured by FDIC o Less focus on commercial  Credit Unions: nonprofit depository institutions that serve members who have a common affiliation (such as the same employer or the same community) o Created to serve the employees of specific hospitals, universities, & some corporations o Insured by National Credit Union Share Insurance Fund (NCUSIF) o Provide mortgage & personal loans o Some issue credit cards  Commercial banks & savings institutions suffered during the financial crisis Nondepository Institutions  Nondepository Institutions: financial institutions that do not offer federally insured deposit accounts, but provide various other financial services o Finance companies, insurance companies, securities firms, & investment companies  Financial Companies: nondepository institutions that specialize in providing personal loans to individuals o Charge high rates on loans  They lend to individuals who they perceive as to have a higher risk of defaulting on their loans o Experienced defaults on personal loans during the financial crisis  Securities Firms: nondepository institutions that facilitate the purchase or sale of securities by firms or individuals by providing investment banking services and brokerage services o Placing securities that are issued by firms, meaning that the securities firm finds investors who wish to purchase those securities o Advising firms regarding the sale of securities, which involves determining the price at which the securities may be sold & the quantity of securities that should be sold o Advising firms that are considering mergers about the valuation of a firm, the potential benefits of being acquired or of acquiring another firm, and the financing necessary for a merger o Brokerage services: facilitate the trading of existing securities  Create a market for stocks and bonds by matching willing buyers and sellers  Insurance Companies: nondepository institutions that provide insurance to protect individuals or firms from the financial consequences of possible adverse events o Include life, auto, home, property & casualty, and health insurance o Insurance serves a crucial function for individuals because it compensates the (or their beneficiaries) in the event of adverse conditions that otherwise ruin their financial institution  Investment Companies: nondepository institutions that sell shares to individuals and use the proceeds to invest in securities to create mutual funds o Minimum amount to invest is between $500-$3,000 o Individuals who invests in mutual fund is part owner of the portfolio o Mutual funds provide a means by which investors with a small amount of money can invest in a portfolio of securities Financial Conglomerates  Financial Conglomerates: financial institutions that offer a diverse set of financial services to individuals or firms o Accepts deposits & provides personal loans o Offers credit cards o May execute stock transactions for individuals o May also offer insurance services o Aims to serve as a place where individuals can conduct all their financial activities Banking Services Offered Checking Services  You use a checking account to draw funds by using a debit card, making online payments, or writing checks against your account  Used to pay bills and avoid carrying a lot of cash on your person  Debit Card: a card that is used to make purchases that are charged against a checking account o Does not create debt o If stolen, your account can be emptied if you don't act fast enough o Could possible overdraw your account o Convenient for parents to provide their children with funds  Parents can transfer funds into their child's account and set spending limits  Mobile banking allows you to view your transactions and balance from anywhere o Can pay with you smartphone  Automatic payments help avoid being late on bills and the resulting late fees  How to avoid checking account fees: o Maintain a minimum balance o Authorize direct deposits to your account each month o Do your transactions online o Some banks don't charge fees for students or veterans o Make sure you have sufficient funds in your account before writing checks, some banks charge bounce check fees  To reconcile the balance in your register with the balance on the bank statement, subtract any uncleared checks or unprocessed transactions  Why reconcile your account balance? o Banks can make errors o Make sure no one is using your card without your permission o Enables you to see where your money is going  Check Float: the time from when you write a check until your checking account balance is reduced when the check is cashed o Check clearing for the 21st Century Act (2004) has made the process faster  Can transfer money from savings to checking within the monthly limit  Safety Deposit Boxes: a box at a financial institution where a customer can store documents, jewelry, or other valuable o An annual fee is charged for this service  Automated Teller Machine (ATM): a machine where individuals can deposit and withdraw funds at any time of the day  Cashier's Check: a check that is written on behalf of a person to a specific payee and will be charged against a financial institutions account  Money Order: a check that is written on behalf of a person for a fixed amount that is paid in advance  Traveler's Check: a check that is written on behalf of an individual and will charged against a large well-known financial institution or credit card sponsor's account o No payee is designated o Accepted around the world  Your base of a financial institution should be based on convenience, the ability to pay bills online, deposit rates and insurance, and fees  The return you receive from your deposits at a financial institution and the cost of borrowing money from a financial institution are dependent on the interest rates  Certificate of Deposit (CD): an instrument that is issued by a depository institution and specifies a minimum investment, an interest rate, and a maturity date( backed by government insurance) o Money invested cannot be withdrawn until the maturity date or there is a penalty for early withdrawal  Risk-Free Rate: a return on an investment that is guaranteed for a specified period  Risk Premium: an additional return beyond the risk-free rate that can be earned from a deposit guaranteed by the government o Higher potential default risk of an investment, the higher the risk premium  Equation: RP= R- Rf  RP= risk premium  R= specific return  Rf= risk-free rate  When economic conditions weaken, firms that issue various types of debt securities must pay higher risk premiums to sell their securities  Consider a risky investment only if the risk premium on the term structure compensates you for the risk  Term Structure of Interest Rates: the relationship between the maturities of risk-free debt securities and the annualized yields offered on those securities o Provides risk-free interest rates for various maturities  Yield curve allows you to easily see how the returns from investing in debt securities with different maturities have changed over time  A shift of supply or demand in funds cause a shift in interest rates  Money Supply: demand deposits (checking accounts) and currency held by the public o Indicator of the amount of funds that financial institutions can provide consumers or businesses as loans  Monetary Policy: the actions taken by the Federal Reserve to control the money supply o The Federal Reserve is the central bank of the US  Federal Reserve has funds that are not deposited in any commercial bank or other financial institutions  Open Market Operations: the Federal Reserve's buying and selling of Treasury securities  When the Fed. Reserve wishes to reduce interest rates, it increases the amount of funds at commercial banks by using some of its reserves to purchase Treasury securities held by investors  In the financial crisis, the Fed. Reserve responded by lowering interest rates o The goal was to encourage firms and individuals to borrow money and spend money to increase economic growth  When economic conditions change, businesses review their spending plans and adjust their demand for funds


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