Finance Chapter 5 - Part 5
Chapter 5 Notes Three general reasons for holding onto cash: 1 - Finance Chapter 5 introduction. managing transaction needs 2. preparing for cash emergencies 3. making a temporary investment -very conservative advice suggest you should have enough liquid assets to cover 5 to 8 months of regular expenses -others suggest 2 months is more than enough Four rules to help better cash management outcomes: 1. keep track of your cash by balancing your checkbook every month 2. develop a system to ensure that you pay your bills on time 3. tick to your financial plan by paying yourself first 4. use sound criteria to evaluate financial institutions and select products or services Depository institutions include commercial banks, several types of savings institutions, and credit unions. All these types of firms are similar in two major ways: * their primary source of funds comes from customer deposits * their primary source of income is interest earned on loans S&Ls were first limited to offering savings accounts and making home and personal loans to individuals.
More recently, however, savings institutions have been able to offer a more competitive selection of checking and savings accounts; they can even offer credit cards, business loans, and financial planning services. An important distinction between credit unions and other depository institutions is that credit unions have non-profit status and often make use of a partially volunteer labor force, allowing them a low-cost advantage over other institutions Nondepository firms include mutual fund companies, life insurance companies, brokerage firms, and other financial services firms. No accounts offered are federally insured
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Since demand deposits are easily converted to cash, they are less risky to you. Key Terms: Annual percentage yield (APY): the amount of interest paid each year, given as a percentage of the investment; the APY makes it possible to compare interest rates across accounts with different compounding periods. Automated teller machines (ATMs): computer terminals used to complete certain financial transactions, including obtaining account balances, making deposits and withdrawals. Brokerage firm: a nondepository financial institution that helps its customers to buy and sell financial securities.
Cash management: management of cash payments and liquid investments Cash reserve: liquid assets held to meet emergency cash needs Certificate of deposit (CD): an account that pays a fixed rate of interest on funds left on deposit for a stated period of time Commercial bank: a depository institution offering a wide variety of cash management services to business and individual customers. Credit union: a nonprofit depository institution owned by its depositors Debit card: a plastic card that effects immediate electronic withdrawal of funds from a bank account
Demand deposits: deposit accounts, such as checking accounts, from which money can be withdrawn with little or no notice to the financial institution Depository institutions: financial institutions that obtain funds from customer deposits Discount bonds: bonds that sell for less than their face value Federal Deposit Insurance Corporation (FDIC): a government-sponsored agency that insures customer accounts in banks and savings institutions Life insurance company: a nondepository financial institution that obtains funds from premiums paid for life insurance, invests in stock and bonds, and makes mortgage loans
Maturity date: for a CD, the date on which the depositor can withdraw the invested amount and receive the stated interest Money market account: a savings account which pays interest that fluctuates with market rates on money market securities Money market mutual fund: a mutual fund that holds a portfolio of short-term, low risk, securities issued by the federal government, its agencies and large corporations and pays investors a rate of return that fluctuates with the interest earned on the portfolio
Mutual fund: a nondepository financial institution that sells shares to investors and then invests the money in financial assets Mutual savings institution: a savings institution owned by its depositors Negotiated order of withdrawal (NOW) account: a type of checking account that pays interest Overdraft protection: an arrangement by which a financial institution places funds in a depositor’s checking account to cover overdrafts Regular checking account: checking account that does not pay interest and requires the payment of a monthly service charge unless a minimum balance is maintained in the account
Rule of 72: method of calculating the time for a sum of money to double by dividing 72 by the rate of interest earned on the funds Savings and loan associations (S&Ls): a depository institution that receives funds primarily from household deposits and uses most of its funds to make home mortgage loans Stock-held savings institution: a savings institution owned by stockholders. Stop payment order: an order by which a financial institution promises not to honor a check that a depositor has written
Time deposit account: a savings account from which the depositor may not withdraw money, without penalty, until after a certain amount of time has passed US savings bonds: bonds issued by the US treasury that pay interest that fluctuates with current Treasury security rates and are exempt from state and local taxes Wire transfer: electronic transmittal of cash from an account in another location; requires payment of a fee Summary 1. Apply the objectives of cash management to assessing your need for cash management products and services.
Cash management includes all your decisions related to cash payments and short-term liquid investments. People hold cash for three general reasons: to manage transaction needs, to prepare for cash emergencies, and to make temporary investments. 2. Explain the rules of effective cash management and why it is important to regularly balance your checkbook. Following several rules will result in better cash management outcomes: (1) Keep track of your cash by balancing your checkbook every month. (2) Develop a system to ensure that you pay your bills on time. (3) Stick to your financial plan by paying yourself first.
This means you should allocate funds to your financial goals at the beginning of the month rather than waiting to see how much is left at the end. (4) Use sound criteria to evaluate financial institutions and select cash management products and services. 3. Understand the differences among providers of cash management products and services. Cash management services are offered by many financial institutions. Some, called depository institutions, obtain the funds they invest from customer deposits; these institutions include commercial banks, savings institutions, and credit unions.
Others, called nondepository institutions, get their investment funds from other sources; these institutions include insurance companies, mutual funds, and brokerage firms. Financial institutions can also be distinguished by whether they are organized as mutual companies, which are owned by customers, or stock companies, which are owned by outside stockholders. Recent deregulation has made it possible for most types of financial institutions to offer a diverse menu of financial products and services.
In deciding among different financial institutions, you should consider whether they have what you need (product), whether they are competitive in costs imposed and interest rates paid (price), whether they provide high-quality customer service (people), and how convenient their locations are (place). 4. Identify cash management products and services that are important to your financial plan. The cash management services offered by particular financial institutions include checking and savings accounts, as well as electronic banking.
Regular checking accounts pay no interest on the account balance; NOW accounts (which go by various names) do pay interest, although the rates are fairly low. Accounts also differ in monthly service charges, minimum balances required, and fees for additional services. Savings accounts generally differ in their liquidity and risk, with higher rates of interest paid on riskier accounts and those with more restrictions on withdrawals. The most common types of savings vehicles include regular savings accounts, CDs, U. S. savings bonds, money market mutual funds, and money market accounts. . Compare cash management account options based on liquidity, safety, costs, and after-tax annual percentage yield (APY). Since the primary purpose of cash management accounts is to provide a liquid source of funds to meet cash emergencies, liquidity and safety are of utmost importance in selecting a cash management account. When evaluating comparably safe account alternatives, you should consider the differences in costs, such as monthly fees and penalties for early withdrawal, and the taxability of the interest earned.
Annual percentage yield (APY) makes it possible to compare interest rates across accounts with different compounding periods. 6. Select appropriate tools for dealing with cash management errors. Cash management problems can result from your own errors, as in the case of overdrafts and late payments, or they can be due to the carelessness or intentional actions of others. In either case, you’ll probably incur some costs, so it’s important to resolve these problems as quickly as possible.