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Managing your Cash and Saving

Managing your Cash and Saving. In this chapter the authors want you to think about the liquid assets mentioned back in the context of the balance sheet. The ideas presented are often given the general title cash management. I start by asking some questions.

jennifer-rodriquez
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Managing your Cash and Saving

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  1. Managing your Cash and Saving

  2. In this chapter the authors want you to think about the liquid assets mentioned back in the context of the balance sheet. The ideas presented are often given the general title cash management. I start by asking some questions. When you get paid from work should you just cash the check? Where should you put the funds? Will the funds be secure? Can you write checks? Will interest be earned? Do you have to keep a minimum balance? How often is compounding?

  3. Should you cash the check? First off, if you just cash the check you will have funds ready to spend. This can be a good thing – burgers, fries, books and bars! You would be ready! Two potential problems arise. One, you would not be looking to the future. Rainy days may come and you might need some funds then. Two, if you have a lot of cash around folks might beat you up and take all your money. The situation you face is really one of balancing the liquidity – ready to spend – and the problems that could arise. So, what are your alternatives? Put the money into a liquid asset at a financial institution! The options here include commercial banks, savings and loan associations, savings banks, credit unions and nondepository financial institutions (stock brokers and the like).

  4. Will the funds be secure? You don’t want to put your money into a bank or other place if they just beat you up and take your money there. Make sure you put your funds in a place that has deposit insurance. Deposit insurance means an insuring agency stands behind the financial institution and guarantees the safety of your deposits. FDIC – The Federal Deposit Insurance Corporation The FDIC will insure up to $100,000 of deposits in accounts like checking, savings and even CD’s. What if you have $1,000,000 and want it all to be secure? Spread it around in 10 different banks! Let’s go to http://www.fdic.gov/deposit/deposits/insured/index.html and then look at FAQ #6.

  5. Can you write checks? Not all accounts at the financial institutions that deal with liquid assets have check writing ability. But many of them do and we like this because of needs and desires to spend. Remember to save for a rainy day. Will interest be earned? Many times the answer is yes! Note that commercial banks are the only type of institution here that can legally pay no interest on a checking account. Do you have to keep a minimum balance? This varies from account to account. Note that there is a correlation between the amount of the minimum balance and the interest rate earned and the correlation is positive.

  6. How often is compounding? Compounding, again, refers to the notion that interest earned (or charged) in one period can earn interest in future periods. This is a relatively new innovation in the history of mankind. In this class, unless otherwise stated, interest will be compounded annually. But, different financial instruments have different compounding periods and you need to pay attention to the compounding period. The compounding period could be less than one year. Examples include compounded daily, monthly, quarterly and semi-annually. In this class up to this time we have for the most part dealt with annual compounding. And we mentioned the interest rate and the time frame as annual amounts.

  7. If compounding is more than once a year – annual compounding – then you divide the annual interest rate by the number of compounding periods in one year and you multiply the time frame by the number of compounding periods in one year. Example Using appendix A, we know that $1 earning 12% interest per year will grow to $1.974 in 6 years. But, if interest is 12% compounded semi-annually, the account will grow to $2.010. Note the yearly rate is divided by 2 – 6% per half year – and the time frame is multiplied by 2 – 12 periods. Appendix A can still be used but we use 6% for 12 periods. The years column really stands for periods.

  8. Some terminology used with compounding Nominal rate of interest – the stated rate by the bank, ignoring any compounding. Effective rate of interest – the real rate earned per year when incorporating the notion of compounding. Example The interest will be calculated at 12% compounded semi-annually. Nominal rate – .12 or 12% Effective rate – (1 + .12/2)2 – 1 = .1236 or 12.36%. In general, the effective rate = (1 + [nominal rate/m])m – 1, where m = the number of compounding periods in 1 year.

  9. The effective rate is often called the annual percentage rate, annual percentage yield or the effective yield. Under the Truth-in-Savings Act of 1993, financial institutions have to be clear on the compounding.

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