This is the first of three investing modules. There is an abundance of popular literature on investing and the markets, but two suggested readings about the general workings of Wall Street are Liar's Poker and The Big Short by Michael Lewis. There is also a spreadsheet that goes with all three modules.
This module begins with a save-it-in-the-mattress joke. However, there is a sizeable portion of the population that do more or less the same thing. What percent of American households do not have banking accounts? Have the students guess. The FDIC survey of 2009 says 7.7% or 1 in 13. What might be their reasons? It turns out that the survey listed the following top 3 reasons:
The origin of the FDIC is discussed on slide 3.
It might be good to ask the students what they know about each of these four things, and whether they or their families use one or more of them.
You might make the point that savings/bonds/stock market are listed in order of increasing risk, whereas mutual funds are some combination of stocks or bonds designed to reduce risk.
Mutual funds are often a major component of retirement programs. There are two separate modules for the topics of the stock market and mutual funds.
In order to understand the FDIC and Roosevelt's comments, students need to know a little bit about the stock market crash of 1929. One option would be a few minutes of internet research and reporting back to the class, based on these questions:
After the audio you might want to discuss Roosevelt's response to the crisis. What would be the response today if the President closed the banks for a week?
How many students knew that the bank did not have their money present in its vaults? Where is it? Does anybody in the class know?
The main point here is that the bank gives you interest on your money because it is lending it to others and collecting the loan interest from them.
An interesting mathematical exploration at this time would be to compare interest rates offered by the bank (say 2%) with those required on a car loan (say 7%). Suppose the bank has a million dollars on which it pays 2% interest to customers (in a year, for simplicity, with no compounding). Say it loans out 90% of this to people buying cars and houses at a rate of 7% (again, for simplicity, over a year with no compounding and only a single rate of interest for all loans). How much do the owners of the million dollars make on their money during this time? How much does the bank make?
Class discussion on interest rates and how they vary by bank.
You might provide a worksheet that your class can use to explore the effects of compounding interest. Have students compare what happens with different interest rates over the course of 12 months. Include the rates of 1.4%, 1.2%, 1 % for the purposes of discussion in slide 6, as well as higher rates such as 3,4,5% for the purposes of slide 7.
How does the bank choose its interest rates for both paying to savers and loaning to borrowers? These rates vary but are linked to the prime rate, which you can see here
This rate is based on another, very low, rate that banks use to lend money to each other. Why are they lending money to each other? Have students suggest reasons. It is because they are required to carry a minimum percentage of their deposits as available cash for withdrawal.
So who wants to open a bank?
What is the big difference between the savings account described in the last slide and this example, the CD? No compounding. So which is better after 6 months, the money that was compounded monthly at 1.12% or the money that is compounded semi-annually at 1.4%?
The effect of compounding is that you will earn more than the stated annual percentage rate (APR) on money that is compounded (monthly, say). This new rate is called the APY, or annual percentage yield.
An interesting graphing question would be to use the class data to graph APY versus APR. What is the relationship? You can use the worksheet we suggested you create in slide 6 to explore this for the case of a savings account compounded monthly.
These are words that come up in offers from the bank, credit card companies, etc. Students should identify these values in the examples they used for the worksheet.
Can students see the difference between the bank account and the bond? It requires some thought.
The main differences are:It is best if the students use calculators and duplicate the math described here during the discussion.
The main question for the students at this point is: Is this a good deal? Or more precisely, under what circumstances is buying bonds a good investment? They should mention the relative interest rates, perhaps the cost of living and inflation, the term of the bond, whether they will need the money before the bond matures, etc.
Be sure and scroll to the bottom of the linked web page on slide 13.
After looking at the ratings system, you see that municipal bonds have about zero chance of defaulting, so that takes care of one danger. However, students could now look up rates of returns on various bonds and see that risk correlates with rates. That is, you get paid a higher rate of interest for taking a bigger risk.
An example of this phenomenon is here.
This is an example of how a fair market would price a bond. Of course, the market is not always rational, but you can be.
Here are some math questions for the students to work out in groups. Using the calculation as an example, what should you pay for this older $2000 bond at 5% if the current interest rates for bonds bought new is 6%? 7%? 8%? 9%? Etc.
As a class, you can graph the relationship between the value you place on this bond versus the current interest rate. What is the relationship? If linear, is the slope positive or negative? Why?
A T-bill that pays $100 at the end of a year has to sell for what amount to give 5% in interest?
Suppose you are bidding for a T-note that pays semiannual interest of 2% APR and returns $100 at the end of 5 years. If you believe you want a real return of 5% per year, what would you be willing to pay for this bond?
Do students understand what an auction is?
Here is an example of a car auction
and a livestock auction:
but T-notes are also auctioned online.
The inflation rate is a benchmark against which many investments are measured.
Historical US inflation rates are given here.
Have the students look at this chart and ask them if they can see why people are willing to invest in riskier things than bank accounts or safe bonds. They should be able to observe that few of these yield an interest rate that matches inflations.
What does that mean? Although your investment has increased in value, you are poorer in terms of purchasing power, due to inflation.
At this point the students should be given a task involving the spreadsheet. It would be good if the students had to research several investment options they choose for themselves. This way the class can compare. Who found the highest yielding option? Which of the possibilities seems to be the most risky? Which, if any, beats the current inflation rate?
This slide is also an invitation to consider other options, which are pursued in the module on stocks and the module on mutual funds.