Economics: Chapter 8

1. Economics: Chapter 8 Money, Banking, Saving, and Investing

2. All about Money • Functions of money • Characteristics of money • Types of Money • US Money supply

3. Functions of Money • Medium of Exchange • Can use it in exchange for an item of value • Unit of Account • Used as a means to measure the value of goods and services • Store of Value • Maintains its value over time

4. Characteristics of money • Generally accepted • Divisibility • Portability • Durability • Uniformity • Scarce

5. Types of Money • Commodity Money • An item used as money that has value on its own, but is also used as money • Example: Cigarettes in prisons • Commodity Backed Money • Money that has value because it is representative of a commodity held in a nation’s treasury • Example: Gold Standard • Fiat Money • Money that has value because the government has decreed that what is used as money has value as a medium of exchange

6. US Money System • US Money Supply is monitored by the Federal Reserve System (our central bank) • Money supply is divided up into two categories: • M1 – includes currency and checkable deposits (demand depositis) • Most liquid • M2 – includes M1 and savings accounts and time deposits • Less liquid • Savings accounts are called “near money”

7. US Money System • What about Credit Cards? • What about Debit Cards? • Are they money?

8. The Banking System • Important part of our economy. • Why?

10. Financial Institutions • Must have a charter from state or federal government • Why must banks be regulated? • What do you remember about the Causes of the Great Depression? • What do you know about the reason we recently had a Great Recession?

11. Types of Banks • Commercial Banks • businesses • Savings and Loans • Mutual Savings Banks • Credit Unions • They used to be different, but now most have very similar functions

12. What are the functions of financial institutions?

13. Functions of financial institutions • Cash Checks • Issue Credit Cards • Exchange foreign currency for US money and vice versa • Safe-Deposit Boxes • E-Banking • Main function: financial intermediary

14. Financial Intermediary • Brings savers and borrowers together in a financial market • Savers deposit their money • Banks use their depositors money to make loans to borrowers

16. Liquidity • Liquidity – how fast can an assets be converted into cash • Currency is the most liquid • Banks offer many types of deposit accounts to savers • Vary in liquidity • Some accounts require a certain period of time to pass before a saver can access their money

17. How do savings accounts benefit us?

18. Interest Rates: • Rates are higher for savings accounts than for checking accounts (checkable deposits) • Rates are higher for time deposits than for a “regular • Interesting link • Think risk vs. reward • Higher the “risk” the higher the reward • What is the risk of putting your money in the bank?

19. FDIC insures deposits of up to $250,000 • What is the cause of this law? • So rather than “risk”, it’s really about the tradeoffs that you make when you make your decision.

20. Loans • Commercial Loans • Purpose? • Consumer Loans • Purpose? • Mortgages • Purpose? • Includes • Principal – amount actually borrowed • Interest – amount • Other fees: points, fees • 15 Year or 30 Year? • Fixed or variable? • Example: $220,000 home, 30-Year fixed mortgage with a rate of 5 percent • Credit Rating: Be careful, Banks will do a credit history

21. “A credit report includes information on where you live, how you pay your bills, and whether you’ve been sued or have filed for bankruptcy. “

22. Banks create money • How? • They use fractional reserve banking • They are required to keep a certain percentage of each deposit in the bank (reserve requirement) • Now 10% • Then they loan out the rest • If I deposit $100 in the bank, how much can the bank loan out? • How much “additional” money did my savings create?

26. Role of the Federal Reserve • Holding Reserves • Banks must keep a fraction of all deposits in reserve • “Banker’s Bank” • Providing Cash and Loans • Fed lends money to banks (discount rate) • Clearing Checks • Transfers funds from one bank to another when someone writes a check • Linking Banks electronically • Controls nation’s money supply • This is called Monetary policy and it plays an important role in stabilizing our economic system • Too much money – inflation • Too little money – deflation

27. How do savers help the Economy? • Remember the most important role of a financial institution is acting as a financial intermediary between savers and borrowers. • Would banks be able to make loans without the funds that savers deposit? • What would happen to economic growth if people could not borrow money?

28. Things to think about • What is the interest that you will earn by depositing your money in the bank • How is the interest calculated? • Simple interest • Interest earn in principal only • Compound interest • Interest earned on both principal and interest previously earned

29. Things to think about.. • What is the interest that you will have to pay for a loan? • Are there any other fees associated with obtaining the loan? • Remember: Banks are a business out to make profit. The largest source of income for banks is the interest charged on loans.

30. Planning for the future • Personal Savings Rate • % of our income that we keep in savings. • Had fallen in the last 30 years • But statistics indicate that it is now rising again • Nov. 2013 rate was 4.9%

31. Savings Helps our Economy Grow • Banks loan out a fraction of depositors money • This benefits banks because they earn interest • But these loans also enable new businesses to start. • New businesses stimulate the economy when they purchase physical capital and hire new workers • There is a rippl effect throughout the whole economy. (multiplier effect)

32. Savings Helps You Reach Your Goals • What are you saving for? • Car • College • Independent Life

33. Savings Helps You When You Need Money for Emergencies • “Poop” Happens, right? • Rule of Thumb – Keep savings in the bank worth as much as you would need for a six-month period of time • “Rainy Day” fund

34. You need to save for your retirement • What are your retirement goals? • When do you want to retire? • What lifestyle do you want to have? • Where do you want to live? • Need to plan now for your retirement because if you wait too long, you may not have enough. • I plan to live past the age of 100!

35. Need to plan now for your retirement because if you wait too long, you may not have enough. • I plan to live past the age of 100! • Other events will make demands on your income • College • Wedding • Travel • Car • Home • Kids – • Day Care cost me $13,000 per year when my boys were young! • Kids’ college fund

36. Social Security will not be much when you retire • It is a pay as you go system. What we contribute today pays for current retirees. • When I retire you will fund my social security. So you better get really good jobs!!!!

37. Retirement – Three Legged Stool • Social Security • Age 65 • FICA (This is your contribution. You will see it as a category on your paycheck) • Company Retirement Plans • 401(k), Pension Plans • Personal savings and investment • Savings accounts, IRAs, Stocks and bonds

38. Company Retirement Plans • Company Pension Plan • Employer makes a contribution to your pension plan • 401(k) • Named after the section of the IRS tax code where it is located • Money is not taxed now so you can adjust your contribution to get into a lower tax bracket and lower your federal income taxes

39. Personal Savings and Investments • Not employer sponsored • Variety of options • Most common – IRA (Individual Retirement Account) • Sponsored by federal government • Tax benefits are offered • Two types • Traditional IRA – Money put into account is not taxed until it is withdrawn • Roth IRA – Money is taxed before it is put into your account. It is not taxed when it is withdrawn. • Meet with an advisor trained in personal finance to help you make the right decision

40. Investing Your Savings • Make money with your money • What can you invest your money in? • Real Estate • Collections (like stamps, antiques, baseball cards, etc…) • Securities • Stocks • Bonds • Relationship between risk and reward. • High risk can be highly rewarded

41. The Power of Compounded Interest • Rule of 72. how long will it take to double your money when your interested is compounded. Divide 72 by the interest rate. • Compound Interest calculator

42. Bonds • Relatively Low risk • Represents a loan. Owner of the bond is the lender. Seller of the bond is the borrower. • Bond are bought and sold in a bond market • Types: • Government Bonds • Municipal Bonds • Corporate bonds • Junk Bonds

43. Stock Market • Represents the highest risk • Beware the Bear!