Lesson standards. E.6.3 Explain the roles of financial institutions. E.6.6 Explain how interest rates act as an incentive for savers and borrowers.

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1 Lesson standards E.6.3 Explain the roles of financial institutions. E.6.6 Explain how interest rates act as an incentive for savers and borrowers. E.6.7 Compare and contrast different types of financial investments.

2 How many of you have as much money as you could ever want? How many of you want to live with your parents for the rest of your life? How many of you want to work until you re 80 years old? Most people don t have complete financial freedom and so they have to save to get what they want

3 Why save? I. Deciding to save Saving & Investing A. Economists define savings as the nonuse of income for a period of time so that it can be used later B. People save for purchases that require more funds that are available at one time, for emergencies & for retirement C. Savings done by an individual provides money for others to invest or spend and allows businesses to expand which provides more income for consumers & raises the standard of living

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5 D. When people put their money in some kind of savings program, they receive interest. 1. Interest payment people receive when they lend money or allow someone else to use their money 2. People will receive interest on their savings plan for as long as they keep their money in the plan E. When choosing a place to save, think about trade offs 1. Some savings plans allow immediate access to your money but pay lower interest rates 2. Others pay a higher interest & allow immediate access to your money but require a large minimum balance 3. Other plans offer high interest but you do not have easy access to your money

6 II. Savings accounts A. Passbook savings account ( regular savings account) The depositor receives a booklet in which deposits, withdrawals, and interest are recorded, and a customer must present the passbook each time one of these transactions take place B. Statement savings account basically the same as a passbook savings account, but instead of a passbook you receive a monthly statement showing all transactions. Key pt = Passbook & statement savings accounts offer easy availability of funds. You can usually withdraw funds at anytime without paying a penalty (forfeiting any money), but the interest paid on these types of savings accounts is low compared to the interest on other savings plans

7 C. Money Market Deposit Account (MMDA) pays relatively high rates of interest and allows immediate access to your money through checks, but there are trade offs 1. These accounts usually have a $1,000 to $2,500 minimum balance requirement 2. You can usually make withdrawals in person at any time, but you are allowed to write only a few checks a month against the account

8 III. Time deposits Time deposits refers to a wide group of savings plans or certificates of deposit (CDs) with a high interest rate that increases over time, but a person can t remove funds before a certain time period (maturity = which can range from 7 days to 8 years or more) without paying a penalty A. CDs state the amount of the deposit, the maturity, and the rate of interest being paid. B. The longer the maturity, the higher the interest rate being paid. Ex = CD with a 90 day maturity pays less than a CD with a 2 year maturity C. Savers who cash a time deposit (CD) before maturity must pay a penalty

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10 IV. Insuring deposits A. Before the 1930 s, people could lose all the money in their accounts if the bank failed (Stock market collapse of 1929) B. Today, there are several federal agencies that insure most banks and savings institutions 1. FDIC (Federal Deposit Insurance Corporation) Insures each depositor s money (up to $250,000) in commercial banks and savings banks. If an insured institution fails, each depositor will be paid the full amount of the savings up to $250,000 for each legally separate account

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12 Investing: taking risks with your savings. People have savings plans because they want a safe rate of interest. If people are willing to take a chance on earning a higher rate of return, they can invest their savings in stocks & bonds I. Stocks & bonds A. Corporations are formed by selling shares of stock (aka securities). By issuing stock, a company obtains money for expanding (or starting) a business in the hopes of making a large profit 1. Shares of stock entitle the buyer to a certain part of the future profits & assets of the corporation (company). 2. Buying shares of stock makes a person part owner and as proof of ownership, the corporation issues stock certificates

13 What is a typical minimum balance for a Money Market Deposit Account? A. $100 B. $500 C. $1,000 D. $10,000 [Default] [MC Any] [MC All]

14 How much money will the FDIC protect? A. $100,000 B. $250,000 C. $500,000 D. $1,000,000 [Default] [MC Any] [MC All]

15 Owners of a CD may withdraw their money for free at any time A. True B. False

16 Written response Given your current financial situation; explain why a long term time deposit could be a good thing and explain why it might be bad.

17 B. Stock returns 1. Stockholders make money through dividends money a stockbroker receives on the amount he/she originally invested in the corporation 2. A corporation may declare a dividend at 1 or more times during a year, but dividends are usually paid only when the corporation makes a profit 3. Another way people make money on stocks is by selling it for more than they paid for it 4. Some people buy stock to speculate buying stock hoping it will increase in price so they can sell it for a profit C. Capital gains and losses 1. Capital gain money earned by selling stock for more than you paid for it 2. Capital loss money lost by selling stock for less than you paid for it

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19 D. Bonds 1. Instead of buying stocks, people with money to invest can buy bonds a. Bond is a certificate issued by a corporation or the Gov t. in exchange for borrowed money b. It promises to pay a stated rate of interest, over a stated period of time, and then to repay the borrowed amount in full at the end of that time 2. Unlike buying stock, buying a bond does not make a bondholder part owner of the corp or Gov t that issued the bond a. The bond becomes part of the debt of the corp or Gov t and the bondholder becomes a creditor E. Tax-exempt bonds 1. These bonds (sold by local & state Gov ts), unlike bonds sold by corps, the interest is not taxed by the federal gov t 2. Interest earned on bonds your own city or state sells is also exempt from city and state income taxes 3. These types of bonds are good investments for wealthier people who would otherwise pay high taxes on interest earned from investments

20 F. Savings bonds 1. Issued by the US Gov t as one of the ways the Gov t borrows money 2. Face value can range from $50 up to $10, A very safe form of investment very attractive to people with limited money to invest. Also, the interest earned is not taxed until the bond is turned in for cash 4. You buy a savings bond by paying ½ the bonds face value ex = a $50 bond costs $25. The bond increases in value every 6 months until its full value is reached a. Rule of 72 tells how long it takes for a bond to mature: divide 72 by the interest rate 5. If you redeem a U.S. savings bond before it matures, you are guaranteed a certain rate of interest

21 G. T-bills, T-notes & T-bonds These are gov t bonds exempt from state & local taxes and are mainly for large investments 1. T Bills (Treasury bills)- mature in 3 months to a year 2. T Notes (Treasury notes) Mature in 1 to 10 years 3. T Bonds (Treasury bonds) mature in 10 or more years a. The minimum amount of investment for any of these is $1,000 b. The interest on all 3 of the Gov t securities is exempt from state and local income taxes, but not from federal tax

22 II. Stock and bond markets A. Stocks are bought and sold through Brokers a person who acts as a go between for buyers and sellers B. Investors interested in buying or trading company shares can contact a brokerage firm which will perform the service for a fee (fees depend on the dollar amounts invested or traded). Also, may be done on internet web sites C. Stock exchanges and the stock market 1. Stocks are bought or traded at stock exchanges 2. The largest in the New York Stock Exchange (NYSE). You also have supplemental stock exchanges and regional exchanges like the Midwest Stock in Chicago and exchanges in other countries like the London and Tokyo stock exchanges 3. To be listed on these exchanges, a company offering stock must show proof that it is in good financial condition. 4. Most of the companies traded on stock exchanges are among the largest, most profitable companies in the U.S.

23 How long does it take a T Bond to mature? A. 6 months B. 1 year C. 5 years D. 10 years [Default] [MC Any] [MC All]

24 The largest stock market in the world is in A. London B. New York C. Tokyo D. Geneva [Default] [MC Any] [MC All]

25 D. Over the counter markets 1. This is an electronic marketplace for stocks not listed on the organized exchanges (these are usually smaller, new companies) 2. NASDAQ (National Association of Securities Dealers Automated Quotations) has the largest volume of over the counter stocks 3. Over the counter stocks are not traded in any specific place. Brokerage firms hold shares of stocks that they buy and sell for investors. 4. Usually stocks are sold in amounts of 100 shares, but some brokers will handle smaller amounts. E. Bond markets 1. Bonds are sold on exchanges and over the counter markets and on the internet. 2. The New York Exchange bond market and the American exchange bond market are the two largest bond exchanges

26 F. Mutual funds 1. Investment companies that combine many investor s funds to buy stocks, bonds and other investments. 2. Most mutual funds hold a variety of stocks and bonds, and losses in 1 area are likely to be made up by gains in another 3. Some mutual funds mirror index funds a. Index = is a measuring system that tracks stock prices over the long run i. The Dow Jones Industrial Average (DJIA) tracks the stocks of 30 of the largest American companies to measure the well being of the stock market as a whole ii. Standard and Poor s (S&P) the S&P 500 tracks 500 companies 4. Managed mutual funds have managers who adjust and mix the stocks bought, attempting to generate the highest yield

27 G. Money market funds 1. Type of mutual fund that uses investors money to make short term loans to businesses and banks 2. Usually allows investors to write checks against their money in the fund. Any check must be above some minimum amount, usually $500, and the investor then earns money only on the amount left in the account. 3. Banks, Savings & Loan Associations, and savings banks offer a similar service called money market deposit account. MMDAs are insured by the Fed Gov t against loss. 4. Mutual funds and money market funds are not insured by the Fed

28 III. Government regulations A. The stock market is heavily regulated today, both at the state and federal levels. B. The Securities and Exchange Commission (SEC) regulates brokerage firms, stock exchanges, and most businesses that issue stocks. C. It also investigates any dealings among corporations, such as mergers, that affect the value of stocks.

29 D. Congress passes the Securities Exchange Act of 1934 to avoid another stock market crash 1. The act requires that all essential information concerning the issuing of stocks and bonds be made available to investors a. A registration statement must be filed with the Federal government b. A prospectus = must be given to each potential buyer of stocks or bonds. It lists the amount offered, the price, and the company s projected use for the money raised by the stocks and bonds c. Mutual funds must distribute a prospectus describing the fund and the way in which the money will be invested E. States also have securities laws designed mostly to prevent schemes that would take advantage of small investors.

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31 Special savings plans and goals I. Investing for retirement A. Most companies have pension plans, such as 401K, that provide retirement income K You allow a certain portion of your paycheck to be withheld, and the company matches the amount B. Most people will combine a retirement plan with their social security checks because Social Security alone isn t enough

32 C. Personal or private pension plans have the benefit of tax savings 1. The Keogh plan = allows people who are self employed to set aside a maximum of 15% of their income up to a specified amount each year, and then deduct that amount from their yearly taxable income a. You pay the tax only when you take out the funds, usually after retirement when you are in a lower tax bracket 2. Traditional IRAs (Individual Retirement account) = allows a single person earning less than $30,000 per year (as of 2002) and deduct those contributions from taxable income a. There are other limits for married couples and those covered by employer plans. b. The contribution is not taxed when put in, and any earnings and interest are not taxed until money is withdrawn, usually after retirement. 3. Roth IRAs = allows you to save up to $3,000 a year, which is taxed when put in, but interest and earnings are never taxed, and money is not taxed when withdrawn.

33 D. Buying real estate is another form of investing for your retirement, but it carries a much higher risk. 1. Housing generally increases in value over time (owning a home, condominium, or co-op) 2. Buying undeveloped land is a more risky investment no guarantee that there will be a demand in the future for a particular piece of land. It may be the same for housing, but most people don t buy housing for the purpose of reselling it. 3. It s usually hard to turn real estate into cash on short notice

34 II. How much to save and invest A. There are many factors involved in deciding how much to save versus how much to invest such as 1. How much do you spend on fixed expenses? 2. What are your reasons for saving? 3. How much interest can you earn on your savings? 4. How much income will you make in the future? 5. What degree of risk are you willing to take? 6. How important is it that your savings be readily available in case you need immediate cash? 7. Will your standard of living at retirement depend largely on your accumulated savings?

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36 B. It s best to invest in several different types of accounts to lower your overall risk (aka diversification = don t put all your eggs in one basket) C. If you can t afford any losses, put your savings in insured accounts in a local bank or savings and loan, or buy U.S. savings bonds. D. The greater your income and the more savings you have, the more you can diversify into stocks, corporate bonds, etc. E. Your values may affect your investment choices. ex = protect the environment invest in companies that have shown a commitment to protecting the environment. ex = equal rights invest in companies that have fair and equal opportunities

37 Given your risk and reward interests, what do you believe is the best investment plan for you? Why?