Finance: Chapter 6
Finance: Chapter 6 FIN 100
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This 3 page Class Notes was uploaded by Lindsay Fialli on Saturday October 8, 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: 10/08/16
Chapter 6: Managing Your Money Money Management: a series of decisions made over a short-term period regarding cash inflows and outflows o Focuses on maintaining short-term investments to achieve both liquidity and an adequate return on your investments o Determines how to use excess funds or how to obtain funds if your cash inflows are insufficient Liquidity: your ability to cover any cash deficiencies that you may experience o Necessary because there will be periods when your cash inflows are not adequate to cover your cash outflows Some individuals rely on a credit card as a source of liquidity rather than maintaining liquid investments o There is a danger to using credit cards as a permanent source of financing The return on your short-term investments is dependent on the prevailing risk-free rate and the level of risk you are willing to tolerate To achieve both liquidity and an adequate return, you should consider investing in multiple money market investments with varied returns and levels of liquidity Common investments for short-term funds: o Checking Account o NOW Account o Savings Deposit o Certificate of Deposit (CD) o Treasury Bills o Money Market Fund o Money Market Deposit Account (MMDA) o Asset Management Fund Overdraft Protection: an arrangement that protects a customer who uses a debit card or writes a check for an amount that exceeds the checking account balance, it is a short-term loan from the depository institution where the checking account is maintained o Essentially a short-term loan o Prevents checks from bouncing Stop Payment: a financial institution's notice that it will not honor a check if someone tries to cash it; usually occurs in response to a request by the writer of the check o A fee is charged Funds do not gain interest in a checking account NOW (Negotiable Order of Withdrawal) Account: a type of deposit offered by depository institutions that provides checking services and pays interest o Required to maintain a minimum balance o Not as liquid Savings account is less liquid Automatic transfer ensures that you save a portion of your paycheck Retail CDs: certificates of deposit that have small denominations o Such as $5,000 or $10,000 Consider a CD only if you are certain that you will not need the funds until after it matures CDs with longer terms to maturity typically offer higher annualized interest rates o The length of time depends in your need for liquidity Money Market Deposit Account: a deposit offered by a depository institution that requires a minimum balance, has no maturity date, pays interest, and allows a limited number of checks to be written each month o Provides only limited checking services while paying higher interest rates Treasury Securities: debt securities issued by the US Treasury o Purchased through a brokerage firm Treasury Bills (T-Bills): Treasury securities with maturities of one year or less o In multiples of 100 (100, 200, 300, etc.) o Earns capital gain o More liquid than CDs o Quotations: prices can be found online and in finance newspapers Secondary Market: a market where existing securities such as Treasury Bills can be purchased or sold Money Market Funds (MMF): accounts that pool money from individuals and invest in securities that have a short-term maturity , such as one year or less o Typically less than 90 days o Not insured o Invest mainly in commercial paper o Can write checks against the fund/account o Financial papers commonly publish MMF yields Commercial Paper: short-term debt securities issued by the large corporations that typically offer a slightly higher return than Treasury Bills Asset Management Account: an account that combines deposit accounts with a brokerage account and provides a single consolidated statement Sweep Account: an asset management account that sweeps any unused balance in the brokerage account into a money market investment at the end of each business day o Unused balance earns interest and remains available to write checks Money market investments are vulnerable to credit risk, interest rate risk, and liquidity risk Credit Risk (Default Risk): the risk that a borrower may not repay on a timely basis o You receive only a portion if this happens o Insured by the FDIC up to $250,000 Interest Rate Risk: the risk that the value of an investment could decline as a result of a change in interest rates o Invest in debt securities that fit your time frame Liquidity Risk: the potential loss that could occur as a result of converting an investment into cash o Influenced by its second market When economic conditions weaken, it can create some liquidity problems Risk Management of Money 1 Assessing the risk exhibited by the investments 2 Using your assessment of risk and your unique financial situation to determine the optimal allocation of your short-term funds among money market investments Consider the risk-return trade off before making investment decisions Yields are higher for securities that are more exposed to liquidity risk Anticipate your upcoming bills and ensure you have sufficient funds in your checking account Estimate the additional funds that you might need in the near future, and consider investing them in an investment that offers sufficient liquidity; also keep an extra reserve Use remaining funds in a manner that will earn you a higher return, within your level of risk tolerance
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