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Chapter 5

Cash or Liquid Asset Management

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The Need for Liquidity

Liquidity offers protection– enables you to have immediate access to funds– keeps you from tapping into investments

The reservoir effect Risks associated with liquid assets

– risk-return trade-off -- higher liquidity means lower returns

– spending risk -- cash on hand is easier to spend

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Automate Savings: Pay Yourself First, Just Do It!

Payroll deductions Account alternatives Time value of

money Automatic deposit

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Financial Institutions

“Banks” or deposit-type financial institutions

Non-deposit-type financial institutions

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“Banks” or Deposit-type Financial Institutions

Commercial banksSavings and loan associationsSavings banksCredit unions

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On-Line Banking and “Net” Banks

On-line banking offers account access via personal computer; convenience at a fee.

“Net” banks are electronic banks that pay more for deposits, but have no local branch.

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Non-deposit-type Financial Institutions

Mutual funds Stockbrokerage

firms

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What to Look for in a Financial Institution

Kind of services provided.Safety of your money.Cost of achieving your financial goals.Type of personal relationship provided.Note: You should probably use more

than one financial institution to take advantage of each one’s strengths.

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Cash Management Alternatives

Checking accountsSavings accountsMoney market deposit accounts Certificates of depositMoney market mutual funds

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Cash Management Alternatives (cont’d)

Asset management accounts

U.S. Treasury bills U.S. Series EE

bonds

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Checking Accounts

Demand deposits -- non-interest bearing accounts

Negotiable order of withdrawal (NOW) accounts -- interest bearing accounts

Forced balances and opportunity costsFees associated with checking

accounts

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Savings Accounts

Passbook accountsStatement accounts“Passbook” versus statementLow return, reduced further by forced

balances or service charges

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Money Market Deposit Accounts (MMDA)

Alternative to a commercial bank’s savings account

Advantages– higher rates of interest– limited check writing

Disadvantages– higher minimum balance requirements– variable rate of interest

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Certificates of Deposits (CDs) Pay a fixed rate of

interest for a fixed period of time

Offer higher rates, but sacrifice liquidity

Have early withdrawal penalties

Very competitive marketing tool

Shop nationally

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Money Market Mutual Funds (MMMFs)

Pool funds from many investors to buy higher priced securities

Offer return rates from 2% to 17%Charge an administration feeAre bought by the shareMost require a $500 to $2,000 minimum

investmentHave limited check writing privileges

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Asset Management AccountsOffer comprehensive financial services

– checking accounts and credit cards– money market mutual funds– loans– brokerage services– overdraft protection

Automatically control cash flowsHave higher annual fees ($50 to $125)

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U.S. Treasury Bills

Are short-term, less-than 12 months, notes of debt

Are purchased at a discountDon’t accrue periodic interest paymentsAre extremely liquidAre state and local income tax exempt

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U.S. Series EE Bonds

Denominations from $25 to $10,000Are purchased at half their face valueLiquid, but early withdrawal reduces the

returnRate of interest varies with the market

rateOffer several tax advantages

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Comparing Cash Management Alternatives

Use comparable interest ratesConsider tax advantages and after-tax

returnConsider safety

– Federal Deposit Insurance Corporation (FDIC)

– National Credit Union Association (NCUA)– Money market mutual funds and safety

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Choosing a Financial Institution

The Three Cs of Banking– The cost factor– The convenience

factor– The consideration

factor

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The Cost Factor

Monthly feesMinimum balanceCharge per checkBalance-dependent scaled fees

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The Convenience Factor

Location (branches, ATMs)Safety deposit boxesOverdraft protectionStop-payment ability

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The Consideration Factor

Personal attention Financial advice

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Balancing Your Checking Account

Just Do It! Follow Worksheet

12

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Other Types of Checks

– Cashier’s check– Certified check– Money order– Traveler’s check

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Electronic Fund Transfers (EFTs)

Automated bill paymentAutomated teller machinesDebit cardsSmart cards

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Automated Teller Machines

Be careful with your PINFees -- $1.00 to $5.00 per transactionSecurityLiability -- limited to $50 if you notify the

holding institution within 24 hours

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Debit Cards

The plastic check Avoid carrying cash Avoid carrying a big

credit card balance

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Smart Cards

Money is stored electronically on the card

Have similar usage as debit cardsLimit owner liability if stolen because

the card doesn’t access an accountExamples -- Kinkos, some universities,

some grocery stores

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Fixing ErrorsBe alert to human and computer errors.Never deposit cash in an ATM.Call the institution that made the error.Write the institution within 60 days of

receiving your statement.Write the Federal Reserve Board’s

Division of Consumer and Community Affairs.

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Summary

Cash management balances the need for liquid assets and emergency funds with the potential for greater return from other investments.

Automate savings to meet your goals.

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Summary (cont’d)

Types of financial institutions– “banks” or deposit-type financial institutions– non-deposit-type financial institutions

Compare liquid investment alternatives using– return– safety– compounding methods– tax advantages

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Summary (cont’d)

Cash management accounts– checking accounts– savings accounts– money market deposit accounts – certificates of deposit– money market mutual funds– asset management accounts– U.S. Treasury bills– U.S. Series EE bonds

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Summary (cont’d)

The three C’s of banking– cost– convenience– consideration

Electronic fund transfers– automated teller machines– debit cards– smart cards– automated bill payment