Procesamiento de Lenguaje Natural (PLN)

There are obvious reasons which can motivate or induce you to build your personal cash flows such as savings. These reasons can broadly be categorized into three main purposes such as precautionary motive, transaction motive, speculative motive, and portfolio motive. All these are discussed as follows.

3.5.1 Transaction Motive

The transactions motive for money demand involves the need for liquidity, which refers to the need to hold money for use in day-to-day transactions in the near future. This need arises when income is received only occasionally, for instance, once in every month in discrete amounts but expenditures occur continuously.

Nevertheless, the amount of money a person desires to hold for transactions is also likely to depend on the prevailing nominal interest rate, which is a strong motivating factor. This arises due the lack of synchronization in time between when purchases are desired and when salary is actually paid. In other words, while workers may get their salary paid only once a month they generally make purchases almost on daily basis, and hence need money, over the course of the entire month.

The most well-known example of an economic model that is based on such considerations is the Baumol-Tobin model. In this model, an individual receives his/her income periodically, for example, only once per month. However, the person wishes to make purchases continuously; on daily basis. The person could carry his/her entire income with his/her at all times and use it to make purchases. Nevertheless, in this case the person would be giving up the (nominal) interest rate that he/she can get by holding the income in the bank.

The optimal strategy involves holding a portion of one's income in the bank and portion as liquid money. The money portion is continuously spent (or run down) as the individual makes purchases while he/she makes periodic but costly trips to the bank to replenish the holdings of

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money. Basically, therefore, the demand for money resulting from the Baumol-Tobin model is based on the fact that the demand for real balances depends on both the income and the desired level of transactions, and on the nominal interest rate.

3.5.2 Precautionary Motive

This motive involves a desire to hold cash in order to be able to deal effectively with unexpected events that require cash outlay. In essence, it is the motive for people or firms to hold money in case of emergencies, as opposed to the transaction motive where they hold money to use for some definite transaction in the future or the speculative motive where they hold money in the form of investments because they hope to make a capital gain.

In another perspective, precautionary motive refers to the desire of individuals to keep money (or cash) for unforeseen contingencies. This implies that people wish to hold some cash with which to provide for the risk of unforeseen events such as sickness, accident, and happenstance that requires urgent financial attention. The amount of money being held under this motive depends on the nature of individual and the conditions in which he/she lives. The demand for money for precautionary purpose is also closely related to the level of income. This implies that the high the level of income, the more money (or cash balances) that will be held for contingencies by the individuals.

In case of transaction motive, money is held for ordinary transactions while in precautionary motive, cash is kept to meet unforeseen transactions for contingencies. These are commitments that are not normally envisaged by individuals. Furthermore, under transaction motive, holding money is very convenient and value of money, in terms of other goods, is relatively certain.

However, under precautionary motive, holding money depends on the degree of uncertainty, which implies that money is kept in the events of war or financial and less money during normal conditions. In general, the cash balances held for transaction and precautionary motives are directly dependent on the level of income.

3.5.3 Speculative Motive

Speculative Motive refers to the desire of individuals to keep cash balance as an alternative to financial assets such as bonds. Under this motive, it is presumed that people can hold their wealth either in form of bonds or in the form of cash balances. By implication, the decision to hold money in cash balances or bonds depend on te expectations about changes in the rate of interest or capital value of assets (bond) in future.

This reason for the demand for money is based on the fact that people can take advantage of investing their money or stock of savings in investible instruments in order to generate more money. Keynes (1923), in respect of laying out speculative reasons for holding money, stresses the choice between money and bonds. Accordingly, Keynes argues that if people expect the future nominal interest rate (the return on bonds) to be lower than the current rate they will then reduce their holdings of money and increase their holdings of bonds. Furthermore, Keynes stresses that if the future interest rate falls, then the price of bonds will increase and the investors will have realized a capital gain on the bonds they purchased.

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The above analysis implies that the demand for money, on speculative basis, in any period of time will depend on both the current nominal interest rate and the expected future interest rate.

This is in addition to the standard transaction motives which depend on income. In related terms, the fact that the current demand for money can depend on expectations of the future interest rates has implications for volatility of money demand. If these expectations eventually occur, as in Keynes' view, they are likely to change erratically and cause money demand to be quite unstable.

3.5.4 Portfolio Motive

This motive for holding cash is associated with the speculative motive but it entails more than the latter. The portfolio motive also focuses on demand for money over and above that required for carrying out transactions as espoused by Tobin (1956). He considered a situation where people decide to hold their wealth (not consumed) in a form of a low risk–low return asset (money) or high risk–high return asset such as bonds or equity shares. Basically, people desire the choice of a mix of these two types of assets (called portfolio), which is based on the risk associated with the expected return on such assets.

However, for a given expected rate of return, more risk averse individuals will prefer for money as a greater part of the assets in their portfolio. Similarly, given a person's degree of risk aversion, a higher expected return (nominal interest rate plus expected capital gains on bonds) will cause agents to shift away from safe money and into risky assets. Like in the other motivations above, this preference will create a negative relationship between the nominal interest rate and the demand for money.

This discussion is indicative of the fact that the Tobin model is based partly on the subjective rate of risk aversion as well as the objective degree of risk of other assets, which is measured by the standard deviation of capital gains and losses resulting from holding bonds and/or equity shares.

SELF ASSESSMENT EXERCISE 5

Mention and explain the three main reasons for building personal cash flows in form of saving.

4.0 CONCLUSION

This unit of the course material has provided you with the basic ideas on the nature of building personal cash flows. This is mainly related to savings whereby you set aside some amount of your income for saving in the bank. Alternatively such amount of money can be saved with thrift and credit society or a cooperative society of your choice. There are some advantages accruing from saving your money a cooperative society such earning interest and gaining access to loan or credit facility. The issue of accessing loan or credit facility from a cooperative for which you are a member is easier than obtaining loan form a commercial bank based on your savings. Building personal cash flows, as you have learned from this study unit, is also associated with motives for holding money as opposed to spending all the amount of your income. These reasons include precautionary motive, transaction motive, speculative motive, and portfolio motive.

134 5.0 SUMMARY

In this initial study unit of the course material, you have been taught the following topics:

 Meaning of Saving

 Importance of Saving

 Different Methods of Saving Money

 Differences between Saving and Savings

 Precautionary Motive for Building Personal Cash Flows;

 Transaction Motive for Building Personal Cash Flows;

 Speculative Motive for Building Personal Cash Flows; and

 Portfolio Motive for Building Personal Cash Flows.

In the next study unit, you will be taken through personal financial planning.

6.0 TUTOR MARKED ASSIGNMENT

1. Identify your personal reasons for engaging in savings.

2. What are methods of saving?

3 Identify the differences between saving and savings 4. Mention and explain the basic motives for holding cash.

Answers to Self-Assessment Exercises 1. Explain the term Saving.

Saving refers money laid or set aside for future use, which implies that saving presupposes that you try to avoid being extravagant and wasteful in spending and thereby building your personal cash reserves.