Personal Finance Chapter 6 Quiz & Flashcards

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Questions and Answers

What is one key disadvantage of a NOW account?

It has no interest payments.

It allows unlimited check writing.

It requires a minimum balance. (correct)

It offers higher liquidity than checking accounts.

Which type of investment typically pays higher interest rates than savings deposits?

Certificate of Deposit (CD) (correct)

Money Market Deposit Account (MMDA)

NOW account

Checking account

Which feature makes savings deposits slightly less liquid than checking accounts?

Higher interest rates

Restrictions on withdrawals (correct)

Minimum balance requirements

Automatic transfer feature

What is a characteristic of Money Market Deposit Accounts (MMDA)?

They require a minimum balance. Signup and view all the answers

How do penalties for early withdrawal of a Certificate of Deposit (CD) affect investors?

They encourage longer investment periods. Signup and view all the answers

Which of the following is NOT a feature of Treasury securities?

Include a requirement for minimum balance Signup and view all the answers

Which investment option typically offers no interest payments?

Checking accounts Signup and view all the answers

What is a main reason individuals might choose to keep both a checking account and a money market account?

To achieve higher interest rates on savings Signup and view all the answers

What is a significant advantage of Treasury bills (T-bills) over other money market investments?

They are typically purchased at a discount resulting in capital gains Signup and view all the answers

Which of the following is a characteristic of money market funds (MMFs)?

They typically have maturities of less than 90 days Signup and view all the answers

How do changes in economic conditions impact money market fund liquidity?

Increased economic stability results in higher liquidity Signup and view all the answers

What is a common risk management strategy associated with investing in money market funds?

Diversifying across various fund types and sectors Signup and view all the answers

How do Treasury bills compare to commercial paper in terms of security and return?

Treasury bills are considered safer than commercial paper while providing lower returns Signup and view all the answers

What is the primary disadvantage of a Certificate of Deposit (CD)?

Less liquid Signup and view all the answers

Which of the following accurately describes the credit risk associated with money market investments?

The risk that the borrower may not repay on time Signup and view all the answers

In weak economic conditions, what is a suggested strategy regarding investments?

Increase allocations to liquid investments Signup and view all the answers

What is a common characteristic of a Money Market Fund (MMF)?

Less liquid compared to checking or NOW accounts Signup and view all the answers

Which of the following accounts has the highest liquidity?

Checking account Signup and view all the answers

What type of risk involves potential losses when converting an investment into cash?

Liquidity risk Signup and view all the answers

What factor is NOT considered a disadvantage of a NOW account?

Very liquid Signup and view all the answers

Which money market investment typically offers a relatively high interest rate but may require a high minimum purchase?

Treasury bill Signup and view all the answers

Study Notes

Personal Finance - Chapter 6: Managing Your Money

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.
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

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
NOW (Negotiable Order of Withdrawal) account:
- Checking account that pays interest
- Requires a minimum balance, lowering liquidity
Savings account:
- Pays interest
- Less liquid than checking accounts
- Often features automatic transfer to different accounts
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
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
Treasury securities: Government debt securities
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
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).
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.

Personal Finance Chapter 6: Managing Your Money

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