Welcome to classWhy this class Simple questions getting passed all the way up to Finance Manager e.g. How is interest compounded? Why is my interest less this quarter?Front line should be educated enough to answer basic questions for our members.Need to serve our members better by having more knowledgeVideo IntroVideo assigned to high school IT class as year end project. Objective is to create something to put on YouTube. Subject matter and medium was completely up to them.As your are watching, make note of what statistics stand out to you.Show Video8 minutes – “Did You Know 2.0” video - http://www.youtube.com/watch?v=pMcfrLYDm2U- Stop video once the “shift” logo comes in and clicks.IcebreakerIntroduce yourself & discuss what you thought about the videoHow does this video apply to this class?Change happens all the time and exponentiallyWe need as much knowledge as possible to keep up and to feel more comfortable with changeOur members have more access to knowledge so we need to keep up and continue to be the “expert” which adds value
Ask:“So why are you here today to take Credit Union Finance?” Gain more knowledge Better serve the members Etc…Into House AnalogyBlueprints – What’s in it for the member, what’s in it for you, take always of the dayFoundation and Frame – Core Terms and Interest ConceptsFinish Construction – Investments and Financial ReportsShelter to Weather the Storm – Economic Factors and Indicators
“Ever been shopping for something and you know more than the sales person?”Use buying a TV at Best Buy exampleWhat’s In It For The Member?We gain knowledgeWe are more informed and add more value to our members when we can answer their questions in an educated mannerWe can better serve our membersWe build loyalty and rapportSo, these are member benefits for learning about finance, let’s talk about the WIFM?
WIFM? (what’s in it for me) Personal growth!Knowledge that you can take with you in promotions or other employment venturesCan’t take knowledge away from youUnderstand investing more for your personal financesRecognize health indicators in the economy and monitor the financial health of FCFCU“Now that you know the WIFM, let’s take a look at our blueprint for today”.
“Today as we build our financial knowledge house you will be able to…”
“This is the last of the “blueprint” portion… the class structure is going to start with….”
“So now, lets start laying the financial foundation by broadening your knowledge of Core Financial Terms”
So, let’s define a few terms:“Who knows what _______ are/is?”Assets:Anything a person or company owns is considered an asset. Give me some examples of the credit union’s assets.BuildingsCompany VanEquipmentNOT employees because we don’t own themLiabilities:Anything a person or company owes is considered a liability. Give me some examples of liabilitiesMortgage(talk about ACCRUED payroll) once paid it is an expense.Bills owed for equipment and supply purchasesEquity: - SingularThe true value of an object or company. Your assts minus your liabilities.If you own a home worth 100K and owe 80K, how much equity do you have in your home?Can you have negative equity?Equity can also mean the value of a person or company’s ownership in a business.Net Worth: - Plural (applies to more than 1 object)A SUM TOTAL - All equity (both positive and negative) combined for a specific unit e.g. a room, or an entire business.Capital:Any form of wealth that can be utilized to create more wealth.Money is a common form of capital. You could invest money to earn more money in the form of interest. Can also be something that makes you more efficient. Shovels for ditch-diggersSewing machines for tailors“What are some examples of Capital that a Credit Union might have?”Drive Through TubesComputersMarketing MaterialsATMsCashLiquidity:The ability of an asset to be converted into cash. Accounts with different classifications of liquidity:S0 is considered very high liquidity because a member can easily convert that account into cash. A certificate is considered moderate liquidity because the memberwould have to pay a penalty to convert the CD into cash.An IRA would be the least liquid because of tax and fee penalties.10K motorcycle vs. 100K house…which is more liquid?Interest:Money paid in return for borrowing money. Investments, loans, bonds, stocks, etc. all pay interest because one party is borrowing another party’s money. Interest paid is the “rental fee” for borrowing those funds.Compounding:Interest paid on interest previously earned. If you invest $100 for a year at 10% interest, at the end of the first year, you’ll have $110. The interest earned in the second year is earned on the initial principle, $100, and the additional $10 of interest - that means you’ll earn $11 after the second year. The extra $1 earned is due to compounding.Now that we’ve defined some core terms, let’s take a look at the time value of money.
Ask class: “What factors influence an interest rate of a loan? Of an investment?”The rate of interest on the money is based on a number of factors - The potential of being paid back (the more likely payment is, the lower the interest) - How available the funds are to call (lower liquidity means higher rate) - The duration of the loaned money (the longer the term, the higher the rate) - The amount of money borrowed (the higher the amount, the higher the rate)
This is an example of a yield curve. Notice the yield % is greater with respect to time – the effect of risk vs. reward and duration on an investment.So, now that we know what impacts an interest rate, how do we calculate interest?
Basic interest calculations include the multiplication of the principle by the rate by the amount of time. The formula for figuring simple interest is as follows (write on board):I = InterestP = Principal I = P * R * TR = RateT = TimeThis formula does not, however, address the effect of compounding. We’ll talk about that on the next slide. We can use this formula to compute interest for one cycle of an investment or loan.Member Investments are calculated and compounded based on the investment type. For example, the Christmas Club savings suffix is computed on a yearly basis, right? We can figure out how much interest a member will earn on a Christmas Club by multiplying the average balance by the yearly rate (2% or .02) by 365/365, or “1”. This gives us the interest earned for the year.In the example of a S0 suffix, interest is computed quarterly. Quarters vary in days, depending on how many days each month of the quarter has. For example, in Quarter 1, what months are included? (let class answer – should be Jan, Feb, Mar). How many days are in January? (31) How many in February? (28) How many in March? (31) What does this total? (90 days) So, in Q1, there are 90 days out of 365 days in the year. To figure out how much interest a S0 would make in the first quarter, multiply the average balance by the APR (0.30% or .0030) by 90/365.For interest computed monthly, each month has a different number of days. The same computation for quarters applies to months. In the example of a money fund suffix, multiply the average balance by the APR (.35% base rate, or 0.0035) by the days in the month divided by 365 (January would be 31/365).For interest computed daily, the same example is true. First Community only does this type of compounding on loans, but the example is the same.Now, let’s talk about compounding.
Remember back to our definitions – what is “compound interest”?Let’s use this example: a $500 Certificate invested at 2% compounded annually will render $10 per year (write “500 x .02 x 1 = 10” on board). Since the first year rendered $10 in interest, the 2nd year’s interest would be figured on the 1st year’s principle plus the 1st year’s interest, and would be calculated as this (write on board): (500+10) x .02 x 1= 10.20. The extra $0.20 came from the 2% interest we earned on the $10.The APR for an investment is the annual percentage rate, in our example 2%. Once the effect of compounding is factored in, the rate slightly changes and is referred to as APY, or annual percentage yield.A yield curve is a graph of the relationship between the interest rate (or rental cost of borrowing) and the time to maturity of the investment. We’ll see this in minute.As we said before, we cannot use the formula for computing “simple” interest to address compounding. Normally, we’d use an algebraic function to solve for compounding. We’re not going to use this function, though, since we have a Ten-Key. Here’s how we figure compound interest with the tools we have…
We can do this calculation on our ten-key by performing the following steps:Convert the APR to decimal form (0.75% = .0075)Divide the decimal rate by how many times the investment is compounded per year (.0075/4 = 0.001875 for S0)Add “1” to the effective cycle rate. (1.001875) ------- Write that # down!!Enter the principle amount in the ten-key (500) and press the “x” key.Enter the value from step 3 (1.001875) and press the “x” key. This value is the amount of the investment after one cycle.Continue to press the “x” key until all cycles are complete (in this case, 3 additional times).The final value is the investment amount after all cycles.Let’s try this!Use the example of $1000 in a 13-month Certificate, at 1.24%, compounded Quarterly.
Now, we’re going to recap what we’ve learned so far. *Hand out “Individual Challenge” *The purpose of this exercise is to test your retention of the information we’ve learned so far, and answer questions you may have after using this knowledge.
To continue with our house building, let’s go ahead with the application of the things we’ve learned and see how it applies to the real world of finance…
Now that we have a firm understanding of interest, let’s discuss different types of investments and how they differ from each other.Investments we offer here at First Community are considered to be Internal Investments. These include:Share suffixes, like savings accounts, checking accounts, money funds, and IRA’s. This also includes certificates – both traditional and IRA options. These investments are fairly moderate in interest rates – roughly 0.50% for a basic checking to 3.90% for a 48-60 month IRA CD (with the effect of MAP). The important idea to note, here, is that the more “transactional” the suffix is (i.e. the more transactions done on the account), the lower the rate. This has to do with a number of factors, including the Fed required reserves on accounts with more than 6 transactions, and the fact that the suffix tends to be a more liquid investment (for example, the $2,000 minimum deposit in a money fund to earn interest).These are all good rates, and some of the best from local credit unions, but there’s other ways to achieve higher rates.
External investment options may have higher rates than FCFCU, but the investor takes on more risk. Remember that the higher the risk associated with the investment, typically the higher the reward. If people are taking on more risk, they want a higher payoff for taking on that risk. External investments are typically the source of most confusion to our members, and the biggest opportunity for us to demonstrate our knowledge. Diversifying funds (spreading money invested into numerous types of investments) is one way to minimize risk while still investing in riskier securities.Bonds:A short-term debt security where the issuer is the borrower of the funds and the holder is the party loaning the funds. Interest is paid to the holder by the issuer – sort of like a reverse loan.Stocks:Also known as capital stock. A share of the initial capital used to start a business. Stock shares fluctuate in value as the business operates and, hopefully, increase in value as the business operates and grows. Stocks also pay dividends. Shares can be purchased, sold, and traded on stock markets, such as the NY Stock Exchange.Mutual Funds:Many owners buying into a professionally managed pre-diversified stock portfolio. Dividends and interest are then paid to all the owners.Money Market Funds:A mutual-fund type investment that seeks to invest in short-term debt securities. The goal of this investment is to never lose money – AKA, extreme consistency and low risk. But, with low risk comes low reward.Annuities:An annuity is a contract between you and an insurance company in which you pay the insurer a lump-sum payment or series of payments. Your money is invested and accumulates on a tax-deferred basis. In return, at retirement the money is returned to you either in a lump sum, through periodic withdrawals, or as a guaranteed income stream for a specified period of time. Annuities are also not insured by the government – they are based on the ability of the insurance company to make the payments. If the company dies, so do the payments.Now that we know what some investment options are, let’s go over some of the financial reports.
Financial reports are designed to assist a person or business in understanding their finances, both in a situational analysis and in a money flow analysis.An income statement is designed to show the flow of money over a certain amount of time (generally a fiscal year – 365 days). This form essentially gives the details of the money flowing into the business through sales – AKA revenue – or earned by the person in the form of a work paycheck compared to the money flowing out of the business or person through expenditures. This difference indicates whether there is a net income (a positive flow of money) or a net loss (a negative flow of money).
This is an example of what an income statement could look like. Take a look at how the sheet is laid out – income, expenses, and then net income. What items do you notice under those sections – start with “Income”… “Expenses”… What are some of the subcategories?
A balance sheet is a situational analysis – a snapshot of a person or business’s financial situation – and shows a few different figures: Assets, Liabilities, and Owner’s Equity. On one side of the balance sheet are the total assets of the company. The other side includes both Liabilities and Owner’s Equity. Both “sides” of the balance sheet need to equal out to the same amount – hence the name “balance sheet”.
A lot like the income statement, this is a good example of what a balance sheet from a member could look like. Notice how the assets are on the left side, with liabilities and equity on the right side. Both side Assets = Liabilities + Shareholder’s Equity. Notice that assets and liabilities can be “current” and “long-term”. What subcategories do you notice?Great, so what’s the connection between the two?
What’s the connection between the two? The net income or net loss from the income statement is added or subtracted from Owner’s Equity on the balance sheet. Essentially, this means that, if a business has a net loss of $10,000, Owner’s Equity has decreased by $10,000.Click on picture to pull up NCUA FRP Application: http://webapps2.ncua.gov/NCUAFPR/Lets take a few minutes to get familiar with the investments we talked about earlier and these reports through a team activity!
What’s the purpose of building a house? SHELTER!If we build a house, and build it correctly, it should protect us from the storm. The same is true of financial knowledge. If we correctly use our financial knowledge, we can see the impacts of the macro-environment, and protect ourselves from upcoming financial storms. Let’s learn some more about the grand scheme of things – mainly pertaining to the economy.
Understanding basic interest rates associated with the Federal Reserve and the average rates in the economy allows us to gain a clearer picture of what’s going on in the world of finance.The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. Basically, this is the rate at which financial institutions lend money to each other. This rate is currently 0.25%The prime rate, as reported by the Wall Street Journal's bank survey, is among the most widely used benchmark in setting lending rates. It is an average of the prime rates from the U.S.’s 30 largest banks. This rate is currently at 3.25%.Any questions, so far?Ok, let’s move on to the major rates associated with economic health: Unemployment and Inflation.
Another macro-economic rate to pay attention to is the Inflation Rate. This is basically the change in value of currency – in this case, an decrease in value (or buying power). If the American Dollar experiences an inflation of 10%, your American Dollars would buy 10% less than they would have before the inflation. For example: you buy a pack of bubble gum this year for $1.00. If we experienced 10% inflation, it would cost you $1.10 cents to purchase that pack of gum the next year. In other words, good cost more because each dollar purchases less.The rate of inflation or deflation (an increase in value of currency) is commonly measured by price indices, like the Consumer Price Index (CPI) or Employment Cost Index (ECI). These indexes measure the cost of a common “basket” of goods and services (or labor, in the case of the ECI). The actual measurement of the CPI includes samples from 8000 basic indexes, in 211 item categories, to compute the average cost of the basket. We can then compare one index to another to find out how much inflation (or deflation) has been experienced.What does this mean for our members? If the economy is experiencing a state of inflation, members need to take inflation into account in order to calculate the true value of an investment. For example, if we’re currently experiencing a 3% inflation rate, a member’s investment should return at least 3% APY in order for them to gain a return ahead of inflation. Essentially, if a member invests in a CD that has a rate of 3.25% APY, then they have an actual return of 0.25% after the effect of inflation. This is a great reason to recommend Carol Diest!!Alright, now that we’ve learned all this financial knowledge, let’s put it to the test in a skill challenge!
Pair the group into teams of 2-3. Each person gets a skill challenge “Member Scenario” they will need to role-play.
Finance for Credit Unions - Module 1
Credit Union Finance Module 1: Being the Expert
Financial Reports• Income Statement – Flow of money over time – Revenue vs. Expenses• Balance Sheet – Snapshot of financial situation – Assets vs. Liabilities• Connection – Net Income impacts Equity