ECON1200 - Money and Mind

Dr Frédérique Bracoud

Topic 7 – Savings I Bank savings account and term

deposits, future value, simple and compound
interest rates
Purposes of having bank savings and term deposits
• Ways to separate money for different purposes: bill management, Fire
extinguisher, Mojo, Smile and Growth buckets
• Helps keep records for each purpose.
• Avoids temptations to spend for other purposes as the accounts
cannot be directly used for payment
• Earns interest so way of boosting the value of the savings

Very low
interest for
the moment
Savings Account versus term deposit

Acknowledgement: Cormac Hughes worked on the

first version of these slides as student as partner
What is a savings account?
• Money can be added at any time and withdrawn at any time when
needed.
• There is no minimum amount to invest.
• Some savings accounts may also pay bonus interest when certain
conditions are met, such as growing the account balance by the end of
the month and/or not withdrawing.
• Savings accounts usually have a variable interest rate, so the amount
of interest payable is likely to fluctuate over time.
Likely each time
the RBA adjusts
the cash rate
target
 No top up
What is a term deposit? allowed before
maturity

• With a term deposit, an amount of money is locked away for an agreed

length of time (the ‘term’) – that means the money cannot be
withdrawn until the term is up.
• Most term deposits will have a minimum balance deposit required,
often between $1,000-$5,000. (for instance $5,000 for CBA or ANZ)
• In return, there is a fixed rate of interest for the term, so the return on
your money is known with certainty.
• There are a penalty and interest adjustment when withdrawing before
the term. Usually 1 month notice required to withdraw.
Which one to choose: savings account or term
deposits?
• If you are sure you will not need the money then term deposit is better as it
usually pays a better interest rate. It helps avoid the temptation to use the
money for impulsive purchases.
• If you know that the money is only saved temporarily waiting for being used
for an expected bill then better to get a savings account.
• Why not having both? You may need to accumulate enough money on
savings account first in order to reach the minimum investment amount for
a term deposit anyway.
Activity: which account is
best for bills management,
Extinguisher, Mojo, Smile
and Growth buckets?
Which one to choose: savings account or term
deposits? (cont’d)
• If you need to know for sure which value you will get after a certain term
you need to choose a term deposit as the interest rate is known in advance
for the totality of the period
• If you think the interest rate is going to go up you may prefer to not commit
your money in a term deposit so you can benefit from a higher rate

Activity: in which direction

are the interest rates
heading?
Advantages of bank saving account and term
deposits
• No capital loss as not based on prices
• deposit guarantee by government for up to $250,000 per person per bank
• Return can only be positive as interest rate is positive on these accounts
(even if low)
 Can be calculated
from the start

Future value of investment in term deposits

Our notation for interest rate

The notation 0𝑖𝑛 refers to the annual interest rate for an investment starting at t=0
for a maturity of n years (or any other measure of time like days, months, etc)
The rate 0𝑖𝑛 applies to every year during the n years of investment, even if the
market rate has changed in the meantime
It is a spot interest rate i.e. known in the market at the start of the investment at
t=0
If simple interest, it applies to the initial amount
If compound interest, it applies to the initial amount augmented by interest
already generated (paid and kept in the account)
0𝑖0.25

0𝑖0.5

0𝑖1

0𝑖 2
The future value of an investment in a term deposit

Only one t=0 t=n

withdrawal at
the end

0𝑖𝑛 0𝑖𝑛 0𝑖 𝑛 0𝑖𝑛 0𝑖𝑛

X F?

F is the future value of investing X after n-year investment at the

market annual interest rate 0𝑖𝑛 Money locked
for n years with
same interest
rate every year
Future value of a investment of $100 for one year
n=1-year investment of amount X=100 with no payments between the
investment and the maturity date. Annual interest rate 0𝑖1 =10% Interest rate
would be
t=0 actually around
t=n=1 4% even less

0𝑖1 =10%

X=100 F =110

F =100+10% x100 = 100(1+10%) =110

interests
Future value with simple interest rate
n=3-year investment of amount X=100 with no payments between the
investment and the maturity date. Annual simple interest rate 0𝑖3 =10%.
Interest rate
that applies
t=0 t=3 is the one
from the
Fixed
start
reference
0𝑖3
value =10%
0𝑖3 =10% 0𝑖3 =10%
X=100 F?
F=100 + 100 10% + 100 10% + 100 10% = 100 (1+3*10%)
=130
interests
Future value with simple interest rate –
Generalisation to n years
Future value F is the value in the future of an amount of money today X invested
at a known annual simple interest rate 0𝑖𝑛 for a maturity of n years:
Interest rate
at the start of
investment

F = X + X 0in + X 0in + .... + X 0in = X (1 + n0 i n )

Initial value of
investment
Number of
years
Future value with annual compound interest rate
Frequency n=3 year investment of amount X=100 with no payments between the
of the investment and the maturity date. Annual compound interest rate
payment of
0𝑖3 = 10%
interest
kept in the
account t=0 Reset of the
t=3 reference
every year
First
reference
100 0𝑖3 =10% 0𝑖3 =10% 0𝑖3 =10%
X=100 Second Third
F =133
reference reference
110 121
F=100 + 100*10% + 110*10% +121*10%
F=100 (1+10%) (1+10%) (1+10%) = 100 (1+10%)3 = 133
Future value with annual compound interest rate -
Generalisation

Future value F is the value in the future of an amount of money today X

invested at a known annual compound interest rate 0𝑖𝑛 (with an annual
compounding frequency) for a maturity of n years:

F = X (1+ 0 in ) (1+ 0 in )....(1+ 0 in )

Number of
F = X (1+ 0 in )
n
years

Initial value of Interest rate at the

investment start of investment
Future value with compound interest rate – with
more frequency
n=3 year investment. If the compounding is twice a year the annual
frequency is m=2 (nm=6 periods). The reference period is 6 months, so the
0𝑖3
compound interest for the reference period is .
2

t=0 t=2n

0𝑖 3 0𝑖 3 0𝑖 3 0𝑖 3 0𝑖 3 0𝑖 3
2 2 2 2
X 2 2 F?
i i i i i i i
F = X (1 + ) (1 + 0 3 )(1 + 0 3 )(1 + 0 3 )(1 + 0 3 )(1 + 0 3 ) = X (1 + 0 3 ) 6
0 3

2 2 2 2 2 2 2
Future value with compound interest rate – with m
frequency
n year investment and annual compounding frequency is m. The
reference period is 1/m fraction of a year, so the compound interest rate
𝑖
for the reference period is 0𝑚𝑛.

t=0 t=nm

0𝑖𝑛 0𝑖𝑛 0𝑖𝑛

0𝑖𝑛
𝑚 𝑚 𝑚 𝑚
X F?
Future value with compound interest rate – with m
frequency

i i i i i i
F = X (1 + ) (1 + )(1 + )(1 + )(1 + )(1 + )
0 n 0 n 0 n 0 n 0 n 0 n

m m m m m m
i Number of
F = X (1 + )
0 n nm
subperiods
m

Initial value of Interest rate for the

investment subperiod at the start
of investment
Comparison simple interest and compound interest
Compound interest means that each period the interest is calculated with a
reference to the initial investment (X) accrued by the accumulated interest.
Simple interest is calculated every year on the basis of the initial investment X
only.
→ The future value of a given investment is larger with a compound interest rate.
→ The larger the frequency of compounding m of a given investment the larger
the future value.
 Nowadays it is
more likely to
Illustration be around 4 %!

0𝑖5 =4%; X=100; n=5

t=0 Check your
t=5 calculation with
MoneySmart
interest
0 𝑖5 0 𝑖5 0 𝑖5 0 𝑖5 0 𝑖5
calculator
X F?

F=100 +100 (5 * 0.04) = 120 (simple interest)

F=100 (1+0.04)5 = 121.6653 (annual compound interest)
F=100 (1+0.04/2) 10 = 121.8994 (twice a year compounding)
Future value for a saving account
• Unlike the term deposits, saving accounts have a variable interest rate that may
change often (likely at least every time the RBA is adjusting its cash rate target)
• One cannot calculate in advance the future value at the end of the investment
period as we do not know the future values of the interest rate
• One does not need to commit to any term for the investment, therefore we do
not even know when is the end of the investment
Comparison of interest rates
Compare with ratecity or finder
https://www.ratecity.com.au/term-deposits/compare
https://www.finder.com.au

Keep in mind that not all banks will be represented as they may have to pay a fee
to be considered in the comparison rates
Visit the websites of the major 4 banks

Keep in mind that the major banks may not offer you the best deal; but that gives
you a benchmark
Thank you!