Managing your Cash and Saving

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Managing your Cash and Saving
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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?
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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).
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Will the funds be secure? You dont 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 CDs. What if you have 1,000,000 and
want it all to be secure? Spread it around in 10
different banks! Lets go to http//www.fdic.gov/d
eposit/deposits/insured/index.html and then look
at FAQ 6.
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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.
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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.
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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.
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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.
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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.