FINANCIAL LITERACY UNIT-I
CONCEPT
Financial literacy refers to the knowledge and skills required to make informed
and effective decisions about managing personal finances. It encompasses a
wide range of topics, including budgeting, saving, investing, borrowing, and
understanding financial products like insurance, credit cards, and loans. Being
financially literate means having the ability to understand how money works in
everyday life — how it is earned, managed, invested, and donated — and
applying this understanding to make responsible financial decisions.
At its core, financial literacy empowers individuals to take control of their
financial future. It enables people to set financial goals, plan for emergencies,
avoid debt traps, and build wealth over time. For example, a financially literate
person understands the importance of budgeting to track income and
expenses, which helps in preventing overspending. They also recognize the
value of saving and investing early to benefit from compound interest and to
secure a financially stable retirement.
One of the key aspects of financial literacy is budgeting. A budget is a financial
plan that helps individuals allocate their income toward expenses, savings, and
investments. It is a foundational tool that helps in avoiding unnecessary debt
and achieving financial goals. People who budget effectively are better
prepared for emergencies and can avoid living paycheck to paycheck.
Another critical area is saving and investing. Financial literacy teaches the
difference between saving money in a bank account for short-term needs and
investing money in financial instruments like stocks, mutual funds, or real
estate for long-term wealth creation. Understanding investment options, risk,
return, and the time value of money is essential to growing one’s wealth and
achieving long-term financial security.
Credit and debt management are also important components of financial
literacy. Many individuals fall into debt traps due to a lack of understanding
about interest rates, loan terms, and credit scores. A financially literate person
knows how to use credit wisely, pay off debts strategically, and maintain a
healthy credit score, which is crucial for future financial opportunities like
buying a house or starting a business.
In addition, financial literacy includes understanding taxes, insurance, and
retirement planning. Knowing how income tax works or what types of
insurance policies are essential (like health or life insurance) can help
individuals protect their assets and reduce financial risks. Retirement planning
is especially important in today’s world, where traditional pension schemes are
becoming rare. Financial literacy helps individuals plan and save for retirement
through tools like provident funds, pensions, or retirement investment plans.
The importance of financial literacy is growing in today’s digital age, where
people have easy access to credit, online banking, and investment platforms.
Without proper knowledge, individuals are vulnerable to scams, frauds, and
poor financial choices. Financial literacy is not just important for personal well-
being but also for the overall economic development of a country. Financially
informed citizens are more likely to contribute positively to the economy and
reduce the burden on social welfare systems.
Need and Scope of Financial Literacy
Need for Financial Literacy:
1. Informed Financial Decision-Making:
Financial literacy enables individuals to make smart, informed choices
regarding their money — from daily expenses to long-term investments.
It helps people understand how to manage income, avoid unnecessary
debt, and plan for future needs.
2. Debt Management:
Many people fall into debt traps due to a lack of understanding about
interest rates, credit card usage, and repayment terms. Financial literacy
teaches how to borrow responsibly, repay loans on time, and maintain a
healthy credit score.
3. Savings and Investment Awareness:
People often do not understand the importance of saving and investing
early. Financial literacy helps individuals appreciate concepts like
compound interest, diversification, and risk management, which are
essential for wealth creation and long-term financial security.
4. Protection from Frauds and Scams:
In the digital age, financial frauds, cybercrimes, and Ponzi schemes are
increasing. A financially literate person is better equipped to identify and
avoid these threats.
5. Retirement and Emergency Planning:
With limited government pension support and increasing life expectancy,
it’s crucial to plan for retirement and unforeseen emergencies. Financial
literacy helps people build an emergency fund and plan for a stable
retired life.
6. Empowerment and Independence:
Financial literacy promotes financial independence. It is especially
important for women, students, and youth who must learn to manage
their finances in a modern and competitive world.
Scope of Financial Literacy:
1. Personal Finance:
It covers everyday financial activities like budgeting, saving, investing,
borrowing, and financial planning. It helps individuals set realistic
financial goals and work toward them.
2. Banking and Digital Transactions:
Financial literacy includes knowledge of banking services, how to use
debit/credit cards, internet banking, UPI, and mobile wallets securely. It
encourages the use of digital payments and promotes transparency.
3. Insurance and Risk Management:
Understanding different types of insurance (health, life, motor, etc.)
helps individuals protect themselves and their families from unexpected
financial shocks.
4. Taxation:
A good grasp of income tax laws, deductions, and filing returns is a vital
part of financial literacy. It ensures legal compliance and helps optimize
savings.
5. Credit and Loans:
Financial literacy educates about types of loans (home, personal,
education), interest rates, EMIs, credit scores, and the impact of
borrowing on financial health.
6. Entrepreneurship and Business Finance:
For aspiring entrepreneurs, financial literacy is key to understanding
funding options, budgeting, profit/loss, and business expansion
strategies.
7. Government Schemes and Financial Inclusion:
The scope also includes knowledge of government financial schemes like
Jan Dhan Yojana, Sukanya Samriddhi Yojana, or Atal Pension Yojana,
which aim to promote inclusive growth and financial well-being for all
citizens.
Introduction to Saving and Personal Budgeting
Saving and personal budgeting are fundamental pillars of personal
finance. They play a crucial role in helping individuals take control of
their money, reduce financial stress, and build a stable financial future.
Regardless of income level, practicing saving and budgeting effectively is
essential for achieving both short-term and long-term financial goals.
What is Saving?
Saving refers to setting aside a portion of one’s income rather than
spending it all. It is the act of preserving money for future use, whether
for emergencies, planned purchases, or investments. Savings provide
financial security and prepare individuals for unforeseen circumstances
such as medical emergencies, job loss, or urgent family needs.
People save money for various reasons, including education, retirement,
buying a house, vacations, or even building a financial safety net. Saving
is a habit that requires discipline, consistency, and foresight. Developing
the habit of saving early in life can lead to long-term financial freedom
and reduced dependence on loans or credit cards.
Some common methods of saving include keeping money in a savings
bank account, recurring deposit, fixed deposit, or investing in
instruments like Public Provident Fund (PPF), mutual funds, or
government schemes. These not only help preserve money but often
provide interest or returns, helping it grow over time.
What is Personal Budgeting?
Personal budgeting is the process of planning how to spend and manage
money over a certain period — usually monthly. It involves tracking
income, monitoring expenses, and allocating funds toward needs, wants,
savings, and investments. A personal budget acts like a financial
roadmap that guides individuals in making informed spending decisions.
A widely used method for budgeting is the 50-30-20 rule:
50% of income should be spent on needs (rent, food, utilities, insurance)
30% on wants (entertainment, travel, shopping)
20% on savings and debt repayment
Budgeting helps individuals live within their means and avoid the trap of
overspending or taking on unnecessary debt. It also builds financial
discipline and ensures that money is being used for the most important
priorities.
Why Saving and Budgeting Are Important
1. Emergency Preparedness:
Life is unpredictable. Saving ensures you are financially prepared to
handle emergencies like medical crises, car repairs, or job loss.
2. Debt Prevention:
With proper budgeting and saving, you can avoid relying heavily on
credit cards or loans, thus preventing high-interest debt.
3. Goal Achievement:
Budgeting helps you set clear financial goals and track your progress.
Whether it’s buying a car or saving for a wedding, a budget aligns your
spending with your goals.
4. Peace of Mind:
Knowing that your expenses are under control and that you have savings
for the future reduces stress and improves your overall quality of life.
How to Get Started:
1. Track Your Income: Know how much you earn each month.
2. List Your Expenses: Categorize them into essentials and non-essentials.
3. Create a Budget Plan: Allocate specific amounts to each category.
4. Monitor and Adjust: Review your budget regularly and make changes as
needed.
Concept of Time Value of Money
The core concept of TVM is based on the premise that money can earn
interest. Therefore, any amount of money is worth more the earlier it is
received. For example, receiving ₹1,000 today is more valuable than
receiving ₹1,000 one year from now, because you can invest that ₹1,000
today and earn additional income over the year.
The key factors influencing TVM are:
1. Principal – The initial amount of money.
2. Interest Rate (r) – The rate at which the money grows over time.
3. Time (t) – The period for which the money is invested or borrowed.
4. Frequency of Compounding – The number of times interest is calculated
and added to the principal in a year (annually, semi-annually, quarterly,
monthly, etc.).
Techniques of Time Value of Money
Several techniques and formulas help in the calculation of TVM. The
most commonly used ones include:
1. Future Value (FV)
Future Value refers to the amount of money an investment will grow to
over a period at a given interest rate.
Formula:
FV = PV × (1 + r)ⁿ
Where:
FV = Future Value
PV = Present Value
r = Interest Rate per period
n = Number of periods
This formula assumes compound interest. For example, ₹1,000 invested
at 10% interest for 2 years will become:
FV = 1000 × (1 + 0.10)² = ₹1,210
2. Present Value (PV)
Present Value is the current value of a future amount of money,
discounted at a specific interest rate.
Formula:
PV = FV / (1 + r)ⁿ
If you expect to receive ₹1,210 in two years, and the interest rate is 10%,
its present value is:
PV = 1210 / (1 + 0.10)² = ₹1,000
3. Annuities
An annuity is a series of equal payments made at regular intervals. There
are two main types:
Ordinary Annuity: Payments are made at the end of each period.
Annuity Due: Payments are made at the beginning of each period.
Future Value of an Ordinary Annuity:
FV = P × [(1 + r)ⁿ – 1] / r
Present Value of an Ordinary Annuity:
PV = P × [1 – (1 + r)⁻ⁿ] / r
Where P is the periodic payment.
4. Perpetuity
A perpetuity is an annuity that continues forever. Its present value is
calculated as:
PV = P / r
Where P is the periodic payment and r is the interest rate.
Applications of TVM
Loan amortization schedules
Valuation of bonds and stocks
Investment appraisal (NPV, IRR)
Retirement planning
Lease and mortgage calculations
