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FIN 200: Personal Finance

FIN 200: Personal Finance. Topic 16-Short-Term Investments Lawrence Schrenk, Instructor. Learning Objectives. Explain the importance and costs of liquidity. ▪ Describe the financial instruments available for short-term investing.

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FIN 200: Personal Finance

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  1. FIN 200: Personal Finance Topic 16-Short-Term Investments Lawrence Schrenk, Instructor

  2. Learning Objectives • Explain the importance and costs of liquidity. ▪ • Describe the financial instruments available for short-term investing. • Discuss the role of short-term investments in financial planning. ▪

  3. Asset Types

  4. Liquidity

  5. Liquidity • The ability to quickly convert an asset into cash without incurring substantial transactions costs or loss in value. • It measures the person’s ability to meet cash obligations–financial flexibility. • Transactions costs: brokerage fees, etc. • Increased liquidity denotes a decrease in risk.

  6. Motives for and Cost of Liquidity • Motives • Transactions–bill paying • Precautionary–unpredictability of needs, emergencies, “what-if” scenarios • Speculative–investment opportunities • Cost • Opportunity costs

  7. Sources of Liquidity • Cash on Hand • Deposit Accounts • Short-Term Borrowing, e.g. Credit Cards • Short-Term Investment, e.g. CDs

  8. Costs of Illiquidity • Delayed Payments • Cost of Lost Opportunities • Additional Interest Costs • Transactions Costs • Risk to Credit Rating

  9. Short-Term Investments

  10. Yield Curve

  11. Assets • Checking Account • Interest-Bearing Checking Account • Savings Account • Money Market Account • Certificate of Deposit

  12. Checking Accounts • Payments Made via Check, Online Banking and Debit Card • Low or No Interest • High Transaction Volume

  13. Interest Earning Checking Accounts • Less interest than certificates of deposits or money-market deposit accounts. • Convenient • Hidden Costs • Service Charges, • Minimum Balances, • Fees for Checks, • Etc.

  14. Regular Savings Accounts • Low Transaction Volume • Minimal Interest Earnings • Cannot be used directly as money, i.e., cannot write a check on a savings account. • Not a Demand Account.

  15. Money Market Accounts and Funds • Money market account is a deposit account with a relatively high rate of interest • To earn a higher interest on these accounts, you may need to leave as much as $2,500 in the account (depending on the financial institution) • They may limit the number of monthly withdrawals and usually set a minimum amount for each withdrawal • Some are not insured by the FDIC.

  16. U.S. Treasury Securities • Treasury Bills • Money Market • Discount Instrument • Minimum $1,000 • Treasury Notes • 2, 5, 7 & 10 Years • Semi-Annual Coupon • Treasury Bonds • 30 Years • Semi-Annual Coupon

  17. U.S. Savings Bonds. • U.S. Savings Bonds • Series EE sold at half of face value, with potential tax advantages if used to pay tuition and fees. • Series HH pays interest every six months. • I bonds which earns a fixed rate plus an inflation rate which changes twice a year • Seewww.savingsbonds.gov for rates. • Advantages • Exempt from state and local income taxes. • You don’t have to pay federal income tax on earnings until you redeem the bonds.

  18. Certificates of Deposit (CDs) • Certificates of Deposit earn higher interest rate than money market accounts. • Time-based fixed income: 6 months, 1, 2, 3 years, etc. • Early cash-out has interest and possible principal implications. • Interest payments may be withdrawn as they are received. • FDIC insured • Available at banks and online. • CDs are good when you have a specific time frame to meet a specific goal.

  19. Certificates of Deposit (CDs) Rates Time Now Last Year 6 month CD 3.03% 3.04% 1 yr CD 3.50% 3.56% 5 yr CD 3.89% 3.86% Source: BankRate.com

  20. CD Rate Trend

  21. CD Variations • Traditional • Bump-Up • Liquid • Zero-Coupon • Callable

  22. CD Strategies • Laddering: $20,000 to invest; $4,000 in each rung • $4,000 in a one-year CD, $4,000 in a two-year CD…$4,000 in a five-year CD. • As each matures, roll over into new five-year CD. • Strategy Bullets • Staggered purchases with same maturity. • Good strategy when saving money for a specific goal .

  23. Return Comparison • Checking Account • Interest-Bearing Checking Account • Savings Account • Money Market Account • Certificate of Deposit

  24. Project Note

  25. Ethical Dilemma Ernie is in his mid 50s and was raised by parents of the Depression era. As a result, he is very risk adverse. Ernie recently came into a very large amount of money and he wants to put it where it will be safe, but where it will earn him some return. His banker tells him that he should put the money in a five-year CD. Ernie asks if there is any way he can lose his money and he is told that the federal government insures the deposit and will give him a higher return than a passbook savings account. Ernie purchases a CD and goes home happy knowing that his money is safe and available whenever he needs it. Four months later; the roof on Ernie's barn collapses and he needs the money to make repairs, but finds that he can only withdraw it at a substantial penalty. a. Comment on the ethics of the banker in not fully discussing all risks of money market investments. b. Is Ernie correct in his thinking that he can find a totally risk-free investment?

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