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Questions and Answers
What is one key disadvantage of a NOW account?
Which type of investment typically pays higher interest rates than savings deposits?
Which feature makes savings deposits slightly less liquid than checking accounts?
What is a characteristic of Money Market Deposit Accounts (MMDA)?
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How do penalties for early withdrawal of a Certificate of Deposit (CD) affect investors?
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Which of the following is NOT a feature of Treasury securities?
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Which investment option typically offers no interest payments?
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What is a main reason individuals might choose to keep both a checking account and a money market account?
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What is a significant advantage of Treasury bills (T-bills) over other money market investments?
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Which of the following is a characteristic of money market funds (MMFs)?
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How do changes in economic conditions impact money market fund liquidity?
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What is a common risk management strategy associated with investing in money market funds?
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How do Treasury bills compare to commercial paper in terms of security and return?
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What is the primary disadvantage of a Certificate of Deposit (CD)?
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Which of the following accurately describes the credit risk associated with money market investments?
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In weak economic conditions, what is a suggested strategy regarding investments?
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What is a common characteristic of a Money Market Fund (MMF)?
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Which of the following accounts has the highest liquidity?
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What type of risk involves potential losses when converting an investment into cash?
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What factor is NOT considered a disadvantage of a NOW account?
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Which money market investment typically offers a relatively high interest rate but may require a high minimum purchase?
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Study Notes
Personal Finance - Chapter 6: Managing Your Money
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Chapter Objectives:
- Provide background on money management
- Describe popular money market investments
- Identify risks associated with money market investments
- Explain how to manage money market investment risk
Background on Money Management
- Money management: A series of decisions regarding cash inflows and outflows over a short timeframe.
- Liquidity: The ability to cover cash shortages. This is related to your personal cash flow statement.
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Using credit cards for liquidity:
- Interest rates are typically high
- Maintaining liquid assets helps avoid credit card use and high finance charges
- Aim for optimal returns on short-term investments
Money Market Investments
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Checking Account:
- Very liquid investment: Easy to access funds
- Overdraft protection: Short-term loan from the bank if you write a check for more than your account balance. This avoids fees for overdrafts or bounced checks and results in higher interest rates on borrowed amounts
- Stop payment: Bank's notice to not honor a check if someone tries to cash it (usually at the check writer's request)
- Direct deposit: Paychecks are directly deposited into your account.
- Fees: Vary by institution
- Interest: Usually no interest
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NOW (Negotiable Order of Withdrawal) account:
- Checking account that pays interest
- Requires a minimum balance, lowering liquidity
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Savings account:
- Pays interest
- Less liquid than checking accounts
- Often features automatic transfer to different accounts
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Certificate of Deposit (CD):
- Retail CDs: Small denomination CDs
- May pay higher interest rates than savings accounts
- Penalties for early withdrawal
- Different terms/maturity options available
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Money Market Deposit Account (MMDA):
- Requires a minimum balance
- No maturity date
- Pays interest
- Allows a limited number of checks per month
- Less liquid than checking accounts
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Treasury securities: Government debt securities
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Treasury Bills (T-bills): Treasury securities with maturities of one year or less.
- Purchased at a discount, resulting in capital gains
- Secondary market: You can buy and sell existing T-bills.
- Prices are available online and in financial publications
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Money Market Funds (MMFs):
- Pool money from investors and invest in short-term securities.
- Typically less than 90 days in maturity
- Commercial paper: Short-term debt issued by large corporations (often with slightly higher returns than Treasury bills).
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Asset Management Account: Combines deposit and brokerage accounts.
- Sweep Account: Any unused balance in brokerage account is automatically transferred into a money market investment at the end of each business day
Money Market Investment Comparison (Advantages & Disadvantages)
- See the details in the provided table.
Risks of Money Market Investments
- Credit risk: Risk that a borrower may not repay on time.
- Interest rate risk: Risk of investment value declining due to changes in interest rates.
- Liquidity risk: Potential loss when converting investments into cash.
Risk Management
- Consider the risk-return tradeoff before making investment decisions.
- Many money market instruments are not subject to credit risk.
- Money Market Funds carry some credit risk because they may hold commercial paper.
- Optimal allocation: Anticipate upcoming bills, estimate future fund needs, invest remaining funds that maximize returns.
Risk Management (Continued)
- Recent lower interest rates: Resist urge to shift money from money market investments to stocks given lower risk.
- Money market investments have a distinct function which is easy access to funds.
Optimal Allocation of Money Market Investments
- Need for much liquidity: Allocate funds to extremely liquid investments.
- Need for little liquidity: Allocate funds to non-liquid investments.
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Description
This quiz covers key concepts from Chapter 6 of Personal Finance, focusing on effective money management and popular money market investments. You'll learn about liquidity, risks associated with investments, and strategies to manage investment risks efficiently.
