Personal Finance SIXTH EDITION Chapter 5 Banking and

Chapter Objectives (1 of 2) 5. 1 Describe the types and functions of financial institutions 5. 2 Describe the banking services offered by financial institutions 5. 3 Explain how to select a financial institution for personal use 5. 4 Identify the components of interest rates Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Chapter Objectives (2 of 2) 5. 5 Explain why interest rates change over time 5. 6 Explain how banking services fit within your financial plan Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Types of Financial Institutions (1 of 6) • Depository institutions: Financial institutions that accept deposits from individuals and provide loans – Commercial banks: financial institutions that accept deposits and use the funds to provide commercial and personal loans § Deposits insured by Federal Deposit Insurance Corporation (FDIC) up to $250, 000 per depositor Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Types of Financial Institutions (2 of 6) – Savings institutions (or thrift institutions): financial institutions that accept deposits and provide mortgage and personal loans to individuals – Credit unions: nonprofit depository institutions that serve members who have a common affiliation Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Types of Financial Institutions (3 of 6) • Nondepository institutions: financial institutions that do not offer federally insured deposit accounts, but provide various other financial services – Finance companies: nondepository institutions that specialize in providing personal loans to individuals Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Types of Financial Institutions (4 of 6) – Securities firms: nondepository institutions that facilitate the purchase or sale of securities by providing investment banking and brokerage services – Insurance companies: nondepository institutions that provide insurance to protect individuals or firms against possible adverse events Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Types of Financial Institutions (5 of 6) – Investment companies: nondepository institutions that sell shares to individuals and use the proceeds to invest in securities to create mutual funds • Financial conglomerates: financial institutions that offer a diverse set of financial services to individuals or firms – Examples include Bank of America and Citigroup Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Types of Financial Institutions (6 of 6) Copyright © 2017, 2014, 2011 Pearson Education,

Banking Services Offered by Financial Institutions (1 of 7) • Checking services – Checking accounts allow you to draw on funds by writing checks – Paying Bills on Time § Fees are charged for – Paying bills after the deadline – Making loan payments after the deadline – Ignoring the rules of a car lease contract, such as maximum mileage allowed Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Banking Services Offered by Financial Institutions (2 of 7) • Checking accounts – Banks commonly issue debit cards tied to your checking account – Mobile banking using smartphone apps is now common – Online banking is also gaining popularity § Online bill pay § Online account transfers § Electronic deposits Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Banking Services Offered by Financial Institutions (3 of 7) – Monitoring Your Account Balance § Record checks in your checkbook as you write them – Reconciling Your Account Balance § Make sure the bank statement agrees with your check register Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Banking Services Offered by Financial Institutions (4 of 7) EXHIBIT 5. 2 Example of a Worksheet to Reconcile Your Bank Statement Beginning balance Deposits = $1, 500 $100 $400 $500 Withdrawals → + $500 → - $200 → - $800 → - $200 $50 $150 $200 Checks that have cleared $700 $100 $800 Debit card transactions $25 $50 $125 $200 Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Banking Services Offered by Financial Institutions (5 of 7) EXHIBIT 5. 2 Example of a Worksheet to Reconcile Your Bank Statement Automatic bill payments $100 Bank fees $200 → - $200 $0 → -$0 Balance shown on bank statement Checks that have not yet cleared $600 $100 $200 Adjusted bank balance (your prevailing bank balance) Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved → - $200 $400

Banking Services Offered by Financial Institutions (6 of 7) • Check float—the time from when you write a check until your checking account balance is reduced – Check Clearing for the 21 st Century Act (Oct. 2004) allows banks to transmit electronic images of checks, virtually eliminating float – Electronic checking deters fraud Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Banking Services Offered by Financial Institutions (7 of 7) • Credit card financing such as Visa and Mastercard • Debit card: a card that is used to make purchases that are charged against a checking account – Debit cards for Teenagers § Convenient way for parents to transfer funds to children, but may encourage overspending Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Additional Services Financial Institutions Offer (1 of 3) • Safety deposit box: a box at a financial institution where a customer can store documents, jewelry, or other valuables • Automated teller machines (ATMs): a machine where individuals can deposit and withdraw funds any time of the day – Fees can be charged for using another financial institution’s ATM Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Additional Services Financial Institutions Offer (2 of 3) • Cashier’s check: a check that is written on behalf of a person to a specific payee and will be charged against a financial institution’s account • Money order: a check that is written on behalf of a person for a fixed amount that is paid in advance Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Additional Services Financial Institutions Offer (3 of 3) • Traveler’s check: a check that is written on behalf of an individual and will be charged against a large well-known financial institution or credit card sponsor’s account Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Selecting a Financial Institution • Criteria Used to Select a Financial Institution – Convenience § Close to where you live or work, convenient ATM locations, online banking – Paying bills online – Deposit rates and insurance § Comparison shop for best interest rates – Fees § Some consumers using Wal-Mart to avoid fees Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Financial Planning Online (1 of 3) • Go to http: //www. fdic. gov/ • Go to the site’s search engine and search for “Safe Internet Banking” • This Web site provides tips for safe banking over the Internet Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (1 of 10) • Interest rates on deposits and loans affect your cash inflows and outflows • Certificate of deposit: an instrument that is issued by a depository institution and specifies a minimum investment, an interest rate, and a maturity • Risk-free rate: a return on an investment that is guaranteed for a specified period Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (2 of 10) • Risk premium: an additional return beyond the riskfree rate that can be earned from a deposit guaranteed by the government • Loan rate—financial institutions loan money at a rate higher than they pay depositors – Individuals with a poor credit history pay higher rates Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (3 of 10) • Impact of the economy of the risk premium – When economic conditions weaken, firms issuing securities must pay a higher risk premium to sell their securities, resulting in investors reluctance to purchase the securities for fear the firm might go bankrupt and not repay their debt – Investors more willing to invest in a favorable economic climate Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Financial Planning Online (2 of 3) • Go to www. bloomberg. com • Go to the “Markets” section and then go to “Rate + Bonds” to find interest rate data • This Web site provides some information about individual financial institutions and their relevant interest rates Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (4 of 10) • Twisted perception of the risk premium – Some investors attracted to investments for the wrong reasons – They pursue risky investments to make up for limited income – This is faulty reasoning as those with limited incomes can less afford losses Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (5 of 10) • Comparing interest rates and risks – Choice depends on risk tolerance § If you will need your money within a year, you should take no risk § If you will need a portion of your money when your investment matures, you can afford to take some risk § No choice is right for all investors Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (6 of 10) • Term structure of interest rates: the relationship between the maturities of risk-free debt securities and the annualized yields offered on those securities – Often based on rates of return offered by U. S. Treasury securities with different maturities Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (7 of 10) • Shifts in the yield curve - Graphs such as the on the previous slide can be found in financial publications such as the Wall Street Journal and illustrate how returns change over time • Loan Rates - Financial institutions obtain funds by accepting deposits and providing loans to individuals and firms. They make a profit on the spread between the two rates Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Financial Planning Online (3 of 3) • Go to www. bankrate. com • Search this site for “federal reserve” • This search will provide updated information about the Fed’s recent actions and upcoming meetings, as well as forecasts of future policy decisions and the potential impact of these decisions. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (8 of 10) EXHIBIT 5. 3 Annualized Deposit Rates Offered on Deposits with Various Maturities Maturity Annualized Deposit Rate (%) 1 month 0. 20 3 months 0. 24 6 months 0. 45 1 year 0. 70 2 years 1. 00 3 years 1. 25 4 years 1. 60 5 years 1. 70 10 years 3. 80 Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Interest Rates on Deposits and Loans (9 of 10) Copyright © 2017, 2014, 2011

Interest Rates on Deposits and Loans (10 of 10) Copyright © 2017, 2014, 2011

Why Interest Rates Change (1 of 3) • Monetary policy: the actions taken by the Federal Reserve to control the money supply – Money supply: demand deposits (checking accounts) and currency held by the public – Open market operations: the Fed’s buying and selling of Treasury securities Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

Why Interest Rates Change (2 of 3) Copyright © 2017, 2014, 2011 Pearson Education,

Why Interest Rates Change (3 of 3) • Shift in the government demand for funds – Any change in the government’s borrowing behavior can affect the demand for funds and affect interest rates • Shift in the business demand for funds – When firms adjust their borrowing and spending plans, this affects demand interest rates Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

How Banking Services Fit within Your Financial Plan (1 of 4) • The key banking decisions for your financial plan are: – What banking service characteristics are most important to you? – What financial institution provides the best banking service characteristic for you? Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

How Banking Services Fit within Your Financial Plan (2 of 4) EXHIBIT 5. 7 How Banking Services Fit Within Stephanie Spratt’s Financial Plan GOALS FOR BANKING SERVICES 1. Identify the most important banking services. 2. Determine which financial institution will provide me with the best banking services. ANALYSIS Characteristic How It Affects Me Interest rate offered on deposits This will affect the amount of interest income I earn on deposits. Interest rate charged on mortgages I could use the same financial institution if I buy a home in the future. Interest rate charged on personal loans I could use the same financial institution if I obtain a personal loan in the future. Fees charged for checking services I will be writing many checks, so I would prefer not to pay fees on a checking account if I maintain the minimum balance. Location The ideal financial institution would have a branch near my apartment building and near where I work. Online and mobile services available This would make my banking more convenient. ATMs Check locations for convenience and whether any fees are charged for using ATMs. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

How Banking Services Fit within Your Financial Plan (3 of 4) EXHIBIT 5. 7 How Banking Services Fit Within Stephanie Spratt’s Financial Plan DECISIONS Decision Regarding Important Characteristics of a Financial Institution: My most important banking service is the checking account because I will write many checks every month. I prefer a bank that does not charge fees for check writing if I maintain a minimum balance. I also value convenience, which I measure by the location of the financial institution’s branches, and its online and mobile banking services. I would prefer a financial institution that offers reasonable rates on its deposit accounts, but convenience is more important to me than the deposit rate. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved

How Banking Services Fit within Your Financial Plan (4 of 4) EXHIBIT 5. 7 How Banking Services Fit Within Stephanie Spratt’s Financial Plan Decision Regarding the Optimal Financial Institution: After screening financial institutions according to my criteria, I found three financial institutions that are desirable. I selected Quality Savings, Inc. because it does not charge for check writing if I maintain a minimum balance, has branches in convenient locations, and offers online and mobile banking. It also pays relatively high interest rates on its deposits and charges relatively low interest rates (compared to other financial institutions) on its loans. I may consider obtaining a mortgage there someday if I buy a home, as its mortgage rate was comparable to those of other financial institutions. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved