5 FINANCIAL SERVICES: SAVINGS PLANS AND PAYMENT ACCOUNTS CHAPTER OVERVIEW Using savings plans, checking accounts, and other financial services is a primary personal financial planning activity. This chapter starts with an overview of these services followed by a discussion of the changing environment of financial services caused by technology and economic conditions. Next, discussion of the different types of financial institutions is offered along with the factors to consider when selecting one. Coverage of choosing and using savings plans includes material on the types of accounts that are available. Finally, selection and use of checking accounts other payment methods is presented. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: LO 5-1 Analyze factors that affect selection and use of financial services. Financial products such as savings plans, checking accounts, loans, and trust services are used for managing daily financial activities. Technology, opportunity costs, and economic conditions affect the selection and use of financial services. LO 5-2 Compare the types of financial institutions. Commercial banks, savings and loan associations, mutual savings banks, credit unions, life insurance companies, investment companies, finance companies, mortgage companies, pawnshops, and check-cashing outlets may be compared on the basis of services offered, rates and fees, safety, convenience, and special programs available to customers. LO 5-3 Compare the costs and benefits of various savings plans Commonly used savings plans include regular savings accounts, club accounts, certificates of deposit, interest-earning checking accounts, money market accounts, money market funds, and U.S. savings bonds. LO 5-4 Identify the factors used to evaluate different savings plans. Savings plans may be evaluated on the basis of rate of return, inflation, tax considerations, liquidity, safety, restrictions, and fees. LO 5-5 Compare the costs and benefits of different types of payment accounts. Electronic payment methods include debit card transactions, online payments, stored-value cards, and smart cards. Regular checking accounts, activity accounts, and interest-earning checking accounts can be compared with regard to restrictions (such as a minimum balance), fees and charges, interest, and special services. Other payment alternatives include certified checks, cashier’s checks, money orders, and traveler’s checks. 5-1 INTRODUCTORY ACTIVITIES • Ask students to comment on their responses to the “My Life” chapter opening exercise (pp. 155- 156). • Point out the learning objectives (p. 155) in an effort to highlight the key points in the chapter. • Ask students to provide examples of financial services that could be used to achieve various goals. • Point out the opportunity costs associated with using various financial services (see text page 160). • Obtain sample advertisements, brochures, or website printouts from financial institutions with information on their services, rates, and fees. WHAT'S NEW TO THIS EDITION Topics, Features Benefits for the Teaching-Learning Environment New visual: Financial Institutions and Banking Services Presents an overview of deposit financial institutions, non-deposit institutions, non-bank financial service providers, and high-cost financial service providers. New visual: Mobile banking Details the payment, transfer, deposit, and other services available through mobile banking. New visual: Expanding Prepaid Debit Card Services Provides an overview of prepaid debit card "loading" methods, uses, and fees. Expanded content: The "Unbanked" and High-Cost Financial Services Updates coverage of pawnshops, check-cashing outlets, payday loans, rent-to-own centers, and car title loans. Updated content: Types of CDs Offers revised coverage of various types of certificates of deposit. Updated content: FDIC insurance Presents updated information on recent changes for federal deposit insurance. New content: Failing to reconcile your bank account Warns of potential dangers as a result of not preparing a bank reconciliation. New case: Evaluating Banking Services Allows students to assess alternative financial services for use in various situations. CHAPTER 5 OUTLINE I. Financial Services for Financial Planning A. Managing Daily Money Needs B. Types Financial Services 1. Savings 2. Cash Availability and Payment Services 3. Borrowing 4. Investments and Other Financial Services C. Online and Mobile Banking D. Prepaid Debit Cards E. Opportunity Costs of Financial Services F. Financial Services and Economic Conditions 5-2 II. Financial Institutions A. Deposit Institutions 1. Commercial Banks 2. Savings and Loan Associations 3. Mutual Savings Banks 4. Credit Unions B. Other Financial Institutions 1. Life Insurance Companies 2. Investment Companies 3. Brokerage Firms 4. Finance Companies 5. Credit Card Companies 6. Mortgage Companies C. Comparing Financial Institutions III. Savings Plans A. Regular Savings Accounts B. Certificates of Deposit 1. Types of CDs 2. Managing CDs C. Money Market Accounts and Funds D. U.S. Savings Bonds 1. EE Bonds 2. HH bonds 3. I Bonds IV. Evaluating Savings Plans A. Rate of Return 1. Compounding 2. Truth in Savings B. Inflation C. Tax Considerations D. Liquidity E. Safety V. Payment Methods A. Electronic Payments 1. Debit Card Transactions 2. Online Payments 3. Mobile Transfers 4. Stored-Value Cards 5. Smart Cards B. Types of Checking Accounts 1. Regular Checking Accounts 5-3 2. Activity Accounts 3. Interest-Earning Checking Accounts C. Evaluating Checking Accounts 1. Restrictions 2. Fees and Charges 3. Interest 4. Special Services D. Managing Your Checking Account 1. Opening a Checking Account 2. Making Deposits 3. Writing Checks 4. Reconciling Your Checking Account E. Other Payment Methods 5-4 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions I. FINANCIAL SERVICES FOR FINANCIAL PLANNING (p.156) • Daily buying activities require the use of financial services that facilitate business transactions as well as lead to the achievement of goals. Managing Daily Money Needs (p. 156) • Cash, check, credit card, or cash machine card are the common payment choices. • No matter how carefully you manage your money, there may be times when you will need more cash than you have currently available. To cope with that situation, you have two basic choices: liquidate savings or borrow. Types of Financial Services (p. 156) • Financial services may be viewed in four main categories: 1. Savings involves safe storage of funds for future use. 2. Payment services get you the ability to transfer money to others for conducting business. 3. Borrowing refers to credit alternatives available for short- and long-term needs. 4. Other financial services include insurance protection, investments, real estate purchases, tax assistance, and financial planning • A trust is a legal agreement that provides for the management and control of assets by one party for the benefit of another. • An asset management account, also referred to as a cash management account, provides a complete financial services program for a single fee. • Use PPT slides 5-2 to 5-9. • Current Example: When considering an asset management account, check into: What types of credit cards are involved? What is the annual fee and interest rate? What amount is swept into a money market account? What amount receives little or no interest? Where is your money invested? Are there fees for writing checks? Are canceled checks returned? Online and Mobile Banking (p. 158) • Banking online and through mobile systems (see Exhibit 5-2) provide fast, convenient, and efficient systems for financial services. • While most traditional financial institutions offer online banking services, web-only banks have also become strong competitors. • Financial service through a smartphone or tablet has three access methods: (1) text banking; (2) mobile web banking; and (3) banking apps. • An automatic teller machine (ATM), or simply cash machine, is a computer terminal that allows customers to conduct banking transactions. • Use PPT slides 5-10 and 5-11. • Text Highlight: Exhibit 5-2 (p. 158) provides an overview of mobile banking services. • Current Example: To reduce ATM fees: (1) compare ATM fees at different financial institutions before opening an account; (2) use your own bank’s ATM whenever possible to avoid surcharges of another financial institution; (3) withdraw larger cash amounts, as needed, to avoid fees on several small transactions; (4) use credit cards when away from home. 5-5 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions • A debit card, or cash card, activates ATM transactions and is linked to a bank account. ATM convenience can be expensive. • A lost or stolen debit card can be expensive. If you notify the financial institution within two days of losing the card, your liability for authorized use is $50. If you wait any longer, you can be liable for up to $500 of unauthorized use for up to 60 days. Beyond that time, your liability is unlimited. Prepaid Debit Cards (p. 159) • Prepaid debit cards have become the fastest growing payment method. For many consumers, these cards (see Exhibit 5-3 ) are being used instead of traditional banking services. Prepaid debit cards are issued by many financial service providers including traditional financial institutions, retailers (such as Walmart), and non-bank companies specifically created to provide this financial service. • A major concern with prepaid debit cards can be the extensive fees that a user encounters due to few current regulations for these financial products. • With credit cards you “pay later,” with debit cards you “pay now,” and with prepaid cards you “pay before.” • Current Example: Face- recognition and voice- recognition software are being tested to activate ATM transactions. This same software is being used for border crossings and airport security. • Use PPT slide 5-12. • Text Highlight: Exhibit 5-3 (p. 159) provides an overview of prepaid debit card services. Opportunity Costs of Financial Services (p. 160) • As in all decisions, opportunity cost is what you give up when evaluating, selecting, and using financial services. • Opportunity costs associated with financial services may include higher return with low liquidity, higher costs for convenience of 24-hour electronic banking, or lost interest when a “free” checking account requires that you maintain a minimum balance. • Use PPT slide 5-13. • PPT slides 5-14 and 5-15 (based on Exhibit 5-4) shows how changing interest rates should be considered when using financial services. • Assignment: Using The Wall Street Journal or www.federalreserve.gov, have students update the interest rates on page 162. Financial Services and Economic Conditions (p. 160) • Changing interest rates, fluctuating consumer prices, and other economic factors influence the availability and use of financial services. • Practice Quiz 5-1 (p. 161) 5-6 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions II. FINANCIAL INSTITUTIONS (p. 161) • Financial institutions may be viewed in two major categories. Deposit Institutions (p. 161) • Traditionally, commercial banks have offered the widest range of financial services. • Savings and loan associations traditionally specialized in savings accounts and loans for mortgages; today most offer a complete range of financial services. • Mutual savings banks, which are owned by depositors, specialize in savings and mortgage loans. • Credit unions are user-owner, nonprofit, cooperative financial institutions that offer a wide range of services. Other Financial Institutions (p. 163) • Many life insurance companies offer policies that contain savings and investment features. • Investment companies, also referred to as mutual funds, have become involved in banking-type activities. A common service of these organizations is the money market fund, a combination savings- investment plan in which the investment company uses your money to purchase a variety of financial instruments. • Brokerage firm employ investment advisers and financial planners, and serve as agents between the buyer and seller for stocks, bonds, and other investment securities. Expanded financial services are available from brokerage firms, including checking accounts and online banking. • Making loans to consumers and small businesses is the main function of finance companies. • Credit card companies specialize in funding short- term retail lending. These networks, including VISA, Master-Card, and Discover, have expanded into other banking and investing services. • Mortgage companies are organized to provide loans for home purchases. The "Unbanked" and High-Cost "Shadow" Financial Services (p. 162) • Pawnshops make loans based on the value of some tangible possession, such as jewelry or other valuable items. Many low- and moderate-income families use these organizations to quickly obtain cash loans. • Use PPT slides 5-16 to 5-19. • Assignment: Have students survey three to five people to determine the main factors that influenced their selection of a financial institution with which they do business. • Current Example: Surveys of consumers consistently give credit unions the highest satisfaction rating of all financial service providers. • Use PPT slides 5-20, 5-21. 5-7 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions Pawnshops charge higher fees than other financial institutions. • Many U.S. households do not have bank accounts, and most financial institutions won’t cash a check unless you have an account. The over 6,000 check- cashing outlets (CCO) can charge anywhere from 1% to 20% of the face value of a check; the average cost is between 2% and 3%. • Payday loan companies often charge borrowers as much as 780 percent and more to obtain needed cash. In a typical payday loan, a consumer writes a personal check for $115 to borrow $100 for 14 days. The payday lender agrees to hold the check until the next payday. This $15 finance charge for the 14 days translates into an annual percentage rate of 391 percent. Some consumers “roll over” their loans, paying another$15 for the $100 loan for the next 14 days. After a few rollovers, the finance charge can exceed the amount borrowed. • Rent-to-own centers lease products to consumers who can own the item if they complete a certain number of monthly or weekly payments. A $600 computer can result in $1,900 of payments. RTO purchases can result in annual interest rates of over 300 percent. • Car title loans are used when people with poor credit ratings are in need of money; a cash advance is obtained using their automobile title as security for a high-interest loan. While the process is simple, the consequences can be devastating with the repossession of the car. Comparing Financial Institutions (p. 164) • The major factors to consider when selecting a financial institution are: services offered convenience/location safety/deposit insurance interest rates fees and charges • Use PPT slide 5-22. • Text Highlight: Exhibit 5-5 (p. 165) suggests a process for selecting a financial institution. • Practice Quiz 5-2 (p. 165) 5-8 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions III. SAVINGS PLANS (p. 155) • The basis for your attainment of financial goals is the accumulation of funds that results from an effective savings and investment program. Regular Savings Plans (p. 165) • Regular savings accounts, traditionally referred to as passbook accounts, involve a low or no minimum balance and allow savers to withdraw money as needed. At a credit union, these savings plans are called share accounts. Certificates of Deposit (p. 150) • A certificate of deposit (CD) is a savings plan that requires you to leave a certain amount on deposit for a set time period (ranging from 30 days to 5, 10 or more years) in order to earn a specified interest rate. • The main types of CDs are: 1. Rising-rate or bump-up CDs may have higher rates at various intervals, such as every six months. However, this rate may be in effect only for the last few months of an 18- or 24-month CD. 2. Liquid CDs offer an opportunity to withdraw money without a penalty; likely requires a minimum balance in the account. 3. A zero-coupon CD is purchased at a deep discount with no interest payments. Your initial small deposit ($5,000, for example) grows to the maturity value of the CD ($10,000) in 10 years. 4. Indexed CDs have earnings based on the stock market. In times of strong stock performance, your earnings can be higher than those on other CDs. At other times, however, you may earn no interest and may even lose part of your savings. 5. Callable CDs start with higher rates and usually have long maturities, as high as 10 to 15 years. With this savings option, if interest rates drop, the bank may “call” (close) the account after a set period, such as one or two years. • Current information about CD rates is available at www.bankrate.com. • Consider creating a CD portfolio with CDs maturing at different times. For example, $2,000 in a three- month CD, $2,000 in a six-month CD, $2,000 in a one-year CD, and $2,000 in a two-year CD. This will give you some degree of liquidity and flexibility when reinvesting your funds. • Use PPT slides 5-23 to 5-25. • Text Highlight: Exhibit 5-6 (p. 166) provides an overview of the main types of savings plans. 5-9 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions Money Market Accounts and Funds (p. 167) • A money market account is a savings account that requires a minimum balance and bases earnings on market interest rates. Money market accounts allow savers to write a limited number of checks to make large payments or to transfer money to other accounts. • Money market accounts at banks and credit unions are covered by federal deposit insurance. This is not true of money market funds, U.S. Savings Bonds (p. 168) • U.S. savings bonds are a low-risk savings program guaranteed by the federal government. • Series EE bonds may be purchased for any amount greater than $25, Electronic EE bonds are purchased online at face value; for example, you pay $50 for a $50 bond. • Paper savings bonds, while no longer issued at financial institutions, are still available through payroll savings plans or by using part or all of your federal tax refund. • EE bonds increase in value as interest accrues monthly and compounds semiannually. Bonds redeemed before five years, forfeit the latest three months of interest; after five years, no penalty. Series EE bonds to earn interest for 30 years. • The main tax advantages of series EE bonds are: the interest earned is exempt from state and local taxes, and federal income tax on earnings is not due until the bonds are redeemed. • Series HH bonds, are no longer sold, were current- income bonds; interest deposited every six months. • This interest was taxed as current income on a person’s federal tax return, but exempt from state and local taxes. • The I bond earns a combined rate consisting of: (1) a fixed rate for the life of the bond, and (2) an inflation rate that changes twice a year. Every six months a new, fixed base rate is set for new bonds. The additional interest payment is recalculated twice a year, based on the current annual inflation rate. • I bonds are sold in the same denominations as EE bonds, but are purchased at face value, not discount. • Additional information and value calculations for savings bonds available at www.savingsbonds.gov. Practice Quiz 5-3 (p. 169) 5-10 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions IV. EVALUATING SAVINGS PLANS (p. 170) Rate of Return (p. 170) • Rate of return, or yield, is the percentage of increase in the value of your savings due to earned interest. • Compounding refers to interest that is earned on previously earned interest. The more frequent the compounding, the higher your rate of return will be. • Text Highlight: Exhibit 5-7 (p. 170) provides an overview of the factors to consider when evaluating savings plans. • Use PPT slide 5-26. • In 1993, Truth in Savings (Federal Reserve Regulation DD) became effective. This law requires financial institutions to disclose the following information on savings account plans they offer: fees on deposit accounts the interest rate the annual percentage yield (APY) other terms and conditions of the savings plan • Truth in savings (TIS) defines annual percentage yield (APY) as the percentage rate expressing the total amount of interest that would be received on a $100 deposit based on the annual rate and frequency of compounding for a 365-day period. (See “Financial Calculations” for additional information on APY.) (p. 155) Inflation (p. 172) • The rate of return you earn on your savings should be compared with the inflation rate. • In general, as the inflation rate increases, the interest rates offered to savers also increase. This gives you an opportunity to select a savings option that will minimize the erosion of your dollars on deposit. • Use PPT slides 5-27 and 5-28. Tax Considerations (p. 172) • Taxes reduce your earnings on savings. For example, a 6.25 percent return for a saver in a 28 percent tax bracket means a real return of only 4.5 percent. Liquidity (p. 172) • Liquidity allows you to withdraw your money on short notice. • Use PPT slides 5-29 to 5-31. • Text Highlight: The “Financial Planning Calculations” feature on page 173 explains how to compute the after-tax rate of return. Safety (p. 172) • Most savings plans at banks, savings and loan associations, and credit unions are insured by agencies affiliated with the federal government. 5-11 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions • The Federal Deposit Insurance Corporation (FDIC) provides deposit insurance for banks and savings and loan associations. The FDIC administers separate insurance funds, the Bank Insurance Fund and the Savings Association Insurance Fund. Credit unions may still obtain deposit insurance through the National Credit Union Association (NCUA). The FDIC insures deposits of up to $250,000 per person per financial institution; a joint account is considered to belong proportionally to each name on the account. However, by using combinations of individual, joint, and trust ownership accounts in different financial institutions, it is possible to have federal deposit insurance cover amounts that exceed $250,000. Restrictions and Fees • Restrictions and costs may include a delay between the time interest is earned and the time it is added to your account. Also, some institutions charge a transaction fee for each deposit or withdrawal. • Practice Quiz 5-4 (p. 174) 5-12 CHAPTER 5 LECTURE OUTLINE Instructional Suggestions V. PAYMENT METHODS (p. 174) Electronic Payments (p. 174) • Use PPT slide 5-32. • While check writing still accounts for many consumer transactions, various electronic payment methods are now commonly used. • Debit Card Transactions. Most retail stores, restaurants, and other businesses accept check cards issued by Visa and MasterCard. When the debit card transaction is processed, the amount of the purchase is deducted from your checking account. • Most debit cards are used two ways: (1) with your signature, like a credit card, or (2) with your personal identification number (PIN), like an ATM card. • Online Payments. Banks and Internet companies are serving as third parties to facilitate online bill payments. Some of these include www.paypal.com, www.mycheckfree.com, www.paytrust.com, and Google Wallet. When using these services, be sure to consider the monthly charge as well as online security and customer service availability. • Mobile transfers using apps on a smart phone, tablet, and other wireless device are expanding. While mobile transactions usually occur through a bank account, in the future these payments may bypass banks with charges directly on your phone bill. • Mobile banking is increasing the availability of “person-to-person” payments with the transfer of funds by email or to a mobile phone number. • Stored-value cards are prepaid cards for telephone service, transit fares, highway tolls, laundry service, and school lunches are very common. While some of these stored-value cards are disposable, others can be reloaded with an additional amount. • Smart Cards. These “electronic wallets’ are similar to other ATM cards. However, their imbedded microchip stores prepaid amounts as well as information with account balances, transaction records, insurance information, and medical history. Types of Checking Accounts (p. 175) • With a major portion of business transactions conducted by check, a checking account is a necessity for most people. • The main types of checking accounts are: regular checking accounts with a monthly service charge or a minimum balance to avoid the fee activity accounts charge for each check written interest-earning checking accounts • Text Highlight: Exhibit 5-9 (p. 174) provides a summary of payment methods available to consumers. • Use PPT slides 5-32 and 5-33. • Transparency Master 5-1 offers a framework for assessing the costs associated with using a checking account. 5-13 CHAPTER 5 LECTURE OUTLINE Evaluating Checking Accounts (p. 176) • The most common limitation on checking accounts is the amount that must be kept on deposit to earn interest or avoid a service charge. • Nearly all financial institutions require a minimum balance or service charges for checking accounts. • The interest rate, frequency of compounding, and interest computation method will affect the earnings on your checking account. • Financial institutions may offer checking account customers such extra services as 24-hour teller machines and home banking services. • Overdraft protection is an automatic loan made to checking customers to cover the amount of checks written in excess of the available balance. Managing Your Checking Account (p. 178) • Opening a Checking Account. Start by deciding whether to open an individual account or joint account. • Making Deposits. Depositing checks may be done with a blank endorsement, a restrictive endorsement, or a special endorsement. • Writing Checks. The information needed when completing a check includes: (1) the date; (2) the name of person or organization receiving the check; (3) the amount in figures; (4) the amount in words; (5) your signature; (6) note the reason for the payment. • Maintaining a Checking Account. A bank statement is a summary of the transactions for a checking account. A bank reconciliation is prepared to determine the true checking account balance since a difference between the checkbook and bank statement balance is likely. Instructional Suggestions • Use PPT slide 5-34. • Use PPT slides 5-35, 5-36, and 5-37. • Text Highlight: The "Financial Planning Calculations" feature on page 179 presents the steps involved in reconciling a checking account. Other Payment Methods (p. 180) • A certified check is a personal check with guaranteed payment. • A cashier’s check is the check of a financial institution. • A money order is a payment device purchased from financial institutions, post offices, or stores. • Traveler’s checks allow you to make payments when away from home. • Use PPT slides 5-38 and 5-39. • Practice Quiz 5-5 (p. 164) 5-14 CONCLUDING ACTIVITIES • Point out the chapter summary (pp. 182-183) and key terms in the text margin. • Use the “My Life Stage” feature (p.182) to highlight the main financial planning activities from the chapter for various ages and life situations. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use the Chapter Quiz in the Instructor’s Manual. WORKSHEETS FROM PERSONAL FINANCIAL PLANNER FOR USE WITH CHAPTER 5 Use the “Your Personal Financial Planner in Action” (pp. 184-185) activities to encourage students to plan and implement various personal financial decisions. Sheet 23 Planning the Use of Financial Services Sheet 24 Using Savings to Achieve Financial Goals Sheet 25 Savings Plan Comparison Sheet 26 Payment Account Comparison Sheet 27 Payment Account Cost Analysis Sheet 28 Checking Account Reconciliation CHAPTER 5 QUIZ ANSWERS True-False Multiple Choice 1. T (p. 156) 6. D (p. 164) 2. F (p. 157) 7. A (p. 170) 3. F (pp. 162) 8. B (p. 166) 4. T (pp. 170) 9. C (p. 174) 5. F (pp. 166) 10. A (p. 180) 5-15 Name ________________________________________ Date____________________________ CHAPTER 5 QUIZ TRUE-FALSE _____1. A quick source of cash is to liquidate savings. _____2. Demand deposits refer to money deposited in savings accounts. _____3. A credit union usually offers a wider range of financial services than a commercial bank. _____4. A savings account with daily compounding will have higher earnings than an account with quarterly compounding. _____5. A CD account is a checking account that earns interest. MULTIPLE CHOICE _____6. The fewest financial services would probably be offered by a(n) a. credit union. b. savings and loan association. c. commercial bank. d. investment company. _____7. The rate of return on a savings account may also be referred to as a. yield. b. compounding. c. liquidity. d. equity. _____8. The savings plan that is likely to have a set rate of return is a a. money market account. b. certificate of deposit. c. debit card account. d. money market fund. _____9. Debit cards transactions are most commonly deducted from funds in a person's _______ account. a. savings b. money market c. checking d. loan _____10. A personal check with guaranteed payment is a a. certified check. b. bank draft. c. cashier’s check. d. money order. 5-16 SUPPLEMENTARY LECTURE Are You an Informed User of Financial Services? For each of the following statements indicate a “Yes” or “No” answer. Yes No _____ _____ 1. Do you know a financial institution in your community that has safe- deposit boxes? _____ _____ 2. Do you know the current rate of return on your savings account? _____ _____ 3. Do you know the frequency of compounding for your savings account? _____ _____ 4. Do you know where you can buy U.S. savings bonds? _____ _____ 5. Do you know if there is a credit union in your community? _____ _____ 6. Do you know the location of your financial institution’s 24-hour automatic teller machines? _____ _____ 7. Do you know the monthly service charge on your checking account and the fees on your ATM withdrawals? _____ _____ 8. Do you know the minimum balance on your checking account to avoid a service charge? _____ _____ 9. Do you know the charge for an overdraft on your checking account? _____ _____ 10. Do you know the annual percentage rate charged on your credit cards and charge accounts? _____ _____ 11. Do you know the annual fee for your bank credit card? _____ _____ 12. Do you know the interest rate for automobile loans at your financial institution? 5-17 ANSWERS TO PRACTICE QUIZZES, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, FINANCIAL PLANNING CASE, AND CONTINUING CASE PRACTICE QUIZZES Practice Quiz 5-1 (p. 161) 1. What is the relationship between financial services and overall financial planning? Financial services are used to manage financial activities and to achieve financial goals. See Exhibit 5-1 (p. 157) for an overview of this relationship. 2. What are the major categories of financial services? The major financial services are savings plans, payment services, credit plans, and other services such as investments, tax assistance, financial planning, and trusts. (pp. 157-158) 3. Why shouldn’t you select financial services only on the basis of monetary factors? Certain factors such as convenience and personal service may not be easily measured in terms of money. (p. 160) 4. How do changing economic conditions affect the use of financial services? As interest rates rise you are more likely to save and borrow less. When interest rates decline, spending and borrowing increase. See Exhibit 5-4 (p. 160) for additional information on the effect of interest rates on financial services use. Practice Quiz 5-2 (p. 165) 1. What are the examples of deposit financial institutions? Deposit-type financial institutions include commercial banks, savings and loan associations, mutual savings banks, and credit unions. (pp. 161-162) 2. What factors do consumers usually consider when selecting a financial institution to meet their saving and checking needs? When selecting a financial institution, a person should consider the services available, convenience (location, hours, branch offices, banking by mail, automatic teller machines), safety, personal service, rates charged, and interest paid to savers. (pp. 164-165) Practice Quiz 5-3 (p. 169) 1. What are the main types of savings plans offered by financial institutions? The main types of savings plans are regular savings accounts, certificates of deposit, money market accounts, money market funds, and U.S. savings bonds. (pp. 165-168) 2. How does a money market account differ from a money market fund? 5-18 A money market account is a savings account at a bank or other insured financial institution, usually with a minimum balance, earning a rate that varies based on current interest rates. A money market fund is a savings-investment plan with an investment company. (p. 167) 3. What are the benefits of U.S. savings bonds? One benefit of U.S. savings bonds is safety. They are guaranteed by the federal government. Also, the floating rate on I-bonds can result in higher returns as inflation increase; the interest earned is exempt from state and local taxes; federal income tax on interest earned does not have to be paid until bonds are redeemed; and bonds may be exempt from federal taxes if the funds are used for college tuition. (pp. 168-169) Practice Quiz 5-4 (p. 174) 1. When would you prefer a savings plan with high liquidity over one with a high rate of return? If a person will need to have access to savings funds in the near future, liquidity would be preferred over a high rate of return since a penalty for early withdrawal may be involved to get the higher yield. 2. What is the relationship between compounding and calculating the future value of an amount? Future value calculations can also be referred to as compounding since the process involves determining interest on the initial deposit plus any previously-earned interest. (pp. 170-171) 3. How do inflation and taxes affect earnings on savings? Inflation and taxes reduce the real rate of return earned on savings. (p. 172) Practice Quiz 5-5 (p. 180) 1. What factors are commonly considered when selecting a checking account? When selecting a checking account consider restrictions (such as minimum balance and holding period for deposited checks), fees and charges, special features, and interest earned. (pp. 176-178) 2. Are checking accounts that earn interest better than regular checking accounts? Why or why not? This depends on the minimum balance required to earn interest and the fees charged. FINANCIAL PLANNING PROBLEMS (p. 183) 1. Calculating the Cost of ATM Fees. If a person has ATM fees each month of $18 for 6 years, what would be the total cost of those banking fees? Solution: $18 × 12 months × 6 years = $1,296 LO: 5-1 Topic: Calculating the Cost of ATM Fees. LOD: Easy Bloom’s tag: Application 5-19 2. Determining an Annual Interest Rate. A payday loan company charges 4 percent interest for a two- week period. What would be the annual interest rate from that company? Solution: 52 weeks / 2-week period = 26 periods × .04 = 1.04 (annual period of 104 percent) LO: 5-2 Topic: Determining an Annual Interest Rate LOD: Medium Bloom’s tag: Application 3. Computing CD Interest. A certificate of deposit will often result in a penalty for withdrawing funds before the maturity date. If the penalty involves two months of interest, what would be the amount for early withdrawal on a $20,000, 6 percent CD? Solution: $20,000 × .06 × (2/12) = $200 LO: 5-4 Topic: Computing CD Interest. LOD: Easy Bloom’s tag: Application 4. Computing Future Value. What would be the value of a savings account started with $1,200, earning 3 percent (compounded annually) after 10 years? Solution: $1,200 1.344 = $1,612.80 LO: 5-4 Topic: Computing Future Value. LOD: Easy Bloom’s tag: Application 5. Calculating Present Value. Brenda Young desires to have $20,000 eight years from now for her daughter’s college fund. If she will earn 4 percent (compounded annually) on her money, what amount should she deposit now? Use the present value of a single amount calculation. Solution: $20,000 0.731 = $14,620 LO: 5-4 Topic: Calculating Present Value LOD: Easy Bloom’s tag: Application 6. Computing Future Value of Annual Deposits. What amount would you have if you deposited $2,500 a year for 30 years at 8 percent (compounded annually)? (Use the Chapter 1 appendix.) Solution: $2,500 113.280 = $283,200 LO: 5-4 Topic: Computing Future Value of Annual Deposits LOD: Easy Bloom’s tag: Application 7. Comparing Taxable and Tax-Free Yields. With a 28 percent marginal tax rate, would a tax-free yield of 7 percent or a taxable yield of 9.5 percent give you a better return on your savings? Why? Solution: The 7 percent tax-free yield is better since 9.5 percent after taxes comes to 6.84 percent (9.5% 0.72). LO: 5-4 Topic: Comparing Taxable and Tax-Free Yields. LOD: Hard Bloom’s tag: Application, analysis 5-20 8. Computing APY. What would be the annual percentage yield for a savings account that earned $56 in interest on $800 over the past 365 days? Solution: $56 / $800 = .07 = 7 percent LO: 5-4 Topic: Computing APY LOD: Medium Bloom’s tag: Application 9. Calculating Opportunity Cost. What is the annual opportunity cost of a checking account that requires a $400 minimum balance to avoid service charges? Assume an interest rate of 3 percent. Solution: $400 .03 = $12 LO: 5-5 Topic: Calculating Opportunity Cost LOD: Easy Bloom’s tag: Application 10. Comparing Costs of Checking Accounts. What would be the net annual cost of the following checking accounts? a. Monthly fee, $3.75; processing fee, $0.25 cents per check; checks written, an average of 22 a month. b. Interest earnings of 6 percent with a $500 minimum balance; average monthly balance, $600; monthly service charge of $15 for falling below the minimum balance, which occurs three times a year (no interest earned in these months). Solution: a. (22 checks 12 months $0.25) + ($3.75 12 months) = $111 cost b. $600 .06 = 36 9/12 = $27 less $45 services charge = $18 net cost LO: 5-5 Topic: Comparing Costs of Checking Accounts LOD: Medium Bloom’s tag: Application 11. Computing Checking Account Balance. Based on the following information, determine the true balance in your checking account (see page 179). Balance in your checkbook, $356 Interest earned on the account, $4 Balance on bank statement, $472 Total of outstanding checks, $187 Service charge and other fees, $15 Deposits in transit, $60 Solution: $345 is the reconciled balance. (Checkbook: $356 – 15 + 4 = $345; Bank statement $472 – 187 + 60 =$345) LO: 5-5 Topic: Computing Checking Account Balance LOD: Medium Bloom’s tag: Application FINANCIAL PLANNING ACTIVITIES (p. 183) 1. Researching Banking Services. Talk to several people regarding their experiences with mobile banking and prepaid debit cards. What benefits and concerns have they experienced with these services? This activity can provide students with practical insight about using various financial services. 5-21 2. Comparing Financial Institutions. Conduct a study of services offered by various financial institutions. How has technology influenced the types of services and costs of these services? While most students will use online research for this activity, also encourage them to visit the financial institutions to obtain information and to talk with staff members. 3. Researching Alternative Financial Services. Conduct research (online and by talking with people) about pawnshops, payday loans, check-cashing outlets, rent-to-own purchases, and car title loans. What actions might a person take to avoid these high-cost financial services? This activity will provide with a better understanding of these high-cost financial services that should be avoided. 4. Comparing Savings Plans. Collect information from varied financial institutions (national bank, local bank, credit union, online bank) about the savings plans they offer. Using Sheet 25 in the Personal Financial Planner, compare the features and potential earnings of two or three savings plans. Have students report on the information obtained for various savings plans. 5. Comparing Payment Accounts. Using Sheets 26 and 27 in the Personal Financial Planner, compare the features and costs of checking accounts at two financial institutions. Online searches for this information may be useful. This activity can help students better understand the costs and services associated with checking accounts in their community. FINANCIAL PLANNING CASE Evaluating Banking Services (p. 184) 1. What benefits and drawbacks might Melanie encounter when using each of these financial services? Mobile banking Prepaid debit card Check-cashing outlet Benefits convenience; usually low cost control spending available "unbanked" consumers; other service available Drawbacks privacy; technology concerns potential extensive fees high service cost 2. What factors should Melanie consider when selecting among these various banking services? Student answers will vary. They should point out factors discussed in Exhibit 5-5 (p. 165) as well as the personal factors such as household situation, income, and living location. 3. What actions might you take to better understand the concerns associated with using various banking services? Students should point out research actions involving online sources, talking to others, and visiting 5-22 financial service provider locations to assess various factors and to understand common concerns such as online security, privacy rights, identity theft, and cyber fraud. CONTINUING CASE Banking Services (p. 185) Questions 1. Given her current situation, list some suggestions on what Shelby should do to increase her emergency fund. Most financial advisors recommend an emergency fund of 3 to 6 months of living expenses ($3,630 to $7,260 in Shelby’s case). In order to overcome the decrease in her savings due to the illness and establish an adequate emergency fund, Shelby may consider reducing some of her living expenses (eating out less, spending less on gasoline, etc.) or increase her monthly income by taking on extra work. 2. Based on her current and future life situation, what other money management and financial planning activities would you recommend for Shelby? Although student responses may vary, some good answers to this question are: • Set up an automatic withdrawal from her paycheck that is deposited into a savings account • Assess the costs of her current checking account versus ones at other institutions • Compare the rate earned on her current savings account with ones at other institutions • Consider online banking to handle finances; online banking assists in tracking daily spending and helps with budgeting; online bill pay is convenient and reduces car wear and tear and gasoline expenses; online banking gives direct access to ATMs, savings accounts, loan services, etc. 3. Describe how Shelby might use the following Personal Financial Planner sheets (Payment Account Comparison and Checking Account Reconciliation). Although student responses may vary, some good answers to this question are: a. Payment Account Comparison - Shelby can use this form to compare the benefits and costs associated with different checking and payment accounts from various financial institutions (banks, savings and loan associations, or credit unions). b. Checking Account Reconciliation - Shelby can use this form to identify any differences between her checkbook and her bank statement records. DAILY SPENDING DAIRY (p. 185) This activity will help students better plan the use of various financial services as well as spending for short-term and long-term financial decisions. 5-23 Name ______________________________________ Cha pt er 5: F ina ncia l Ser v ices: Sa v ings Pla ns a nd Pa y m ent A ccount s 1. An interest-bearing checking account at a credit union. 7. A legal agreement that provides for the management and control of assets by one party for the benefit of another. 8. A savings-investment plan offered by investment companies, with earnings based on investments in various short-term financial instruments. 10. The percentage of increase in the value of savings as a result of interest earned; also called "yield." 11. An all-in-one account that includes savings, checking, borrowing, investing, and other financial services for a single fee; also called a "cash management account." 12. A process that calculates interest based on previously earned interest. 13. A plastic access card used in computerized banking transactions; also called a "cash card" or "ATM card." 14. A regular savings account at a credit union. 15. A savings account offered by banks, savings and loan associations, and credit unions that requires a minimum balance and has earnings based on market interest rates. 1. A financial institution that traditionally specialized in savings accounts and mortgage loans. 2. A financial institution that is owned by depositors and specializes in savings accounts and mortgage loans. 3. A user-owned, nonprofit, cooperative financial institution that is organized for the benefit of its members. 4. An automatic loan made to checking account customers to cover the amount of checks written in excess of the available balance in the checking account. 5. A savings plan requiring that a certain amount be left on deposit for a stated time period to earn a specified interest rate. 6. A financial institution that offers a full range of financial services to individuals, businesses, and government agencies. 9. A computer terminal used to conduct banking tranactions (abbreviated). 16. The percentage rate expressing the total amount of interest that would be received on a $100 deposit based on the annual rate and frequency of compounding for a 365-day period (abbreviated). Across Down A S S E T M A N A G E M E N T A C C O U N T S A V I N G S A N D L O A N A S S O C I A T I O N C E R T I F I C A T E O F D E P O S I T O V E R D R A F T P R O T E C T I O N M O N E Y M A R K E T A C C O U N T S H A R E D R A F T A C C O U N T M U T U A L S A V I N G S B A N K M O N E Y M A R K E T F U N D C O M M E R C I A L B A N K S H A R E A C C O U N T R A T E O F R E T U R N C R E D I T U N I O N C O M P O U N D I N G D E B I T C A R D T R U S T A T M A P Y 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Instructor Manual for Personal Finance Jack R. Kapoor, Les R. Dlabay , Robert J. Hughes, Melissa M. Hart 9780077861643, 9781260013993
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