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Personal Finance
Money Markets
Bill Klinger
Personal Finance
• Review
– Commercial banks
– Savings institutions
– Credit unions
– Interest rates
• Risk-free rate
• Risk premium
• Factors affecting risk
Money Management
• Liquidity
– Ability to sell assets without losing value
– Need for funds to cover shortfall in cash flow
• Emergencies
• Unexpected expenses, e.g. car repair
• Unexpected ‘opportunities’, e.g. refrigerator on saleCredit cards
– Dangerous
– Don’t use if can’t pay off
• Investing for liquidity
– Be safe
– Get highest interest rate
Cash Investments
• Text calls all these “money market” investments
• Checking
Very liquid
Overdraft protection available
Stop payment
Direct deposit
• Why doesn’t everyone do this?
– Fees
• Like negative interest
– No interest
• Now accounts
– Similar to checking
– Pays interest
– Requires minimum balance
Cash Investments
• Savings account
Higher rates than NOW accounts
No check writing
Less liquid
Automatic transfer from checking
• Pay yourself first
• CD – certificate of deposit
– Require money to be invested for period of time
• E.g. one month, three months, six months, year, 3 years
– The longer the period, the higher the interest
– Higher rates than savings accounts
– Less liquid than savings accounts
• Penalty for early withdrawal
• Consider a CD ladder
Cash Investments
• U.S. Treasury Bills
Risk-free asset
Mature in less than one year
Minimum $10,000
• Can be sold on secondary market
• Money market funds
– Fund – investors pool their money to buy cash investments
• T-Bills
• Large CDs
• Commercial paper
– Liquidity
• Limited number of checks each month
– Get rates online
Cash Investments
• Asset Management Account
Offered by investment firms
Combine deposit and brokerage accounts
“Sweep” unused money into money market
High minimum balances required, e.g. $15,000
Cash Risks
• Default (credit) risk
• Interest rate risk
– Interest rates go up, value goes down
• Liquidity risk
– Can it be sold quickly for its value?
– Do you have to pay a penalty?
• Inflation risk
– Cash investments pay less than rate of inflation
Cash Allocation
• Need for short-term goals
• Need for emergencies
– Loss of job
– Medical needs
– Unexpected expenses (e.g. repairs)
• Common advice
Keep 3+ months of expenses in cash investments
In Class
• In groups of two
– Do the Financial Planning Problems at the end of Chapter 6