Personal Finance Exam 1

Personal Finance process of planning, spending, financing, and investing so as to optimize your financial situation
Personal Financial Plan A plan that specifies your financial goals and plans to achieve them
Opportunity Cost What you give up as a result of a decision
Financial Plan Components 1. Budgeting and tax planning2. Managing your liquidity3. Financing your large purchases4. Protecting your assets and income (insurance)5. Investing your money6. Planning your retirement estate
Budget Planning Process of forecasting future expenses and savings
Assets What you own
Liabilities What you owe
Net Worth (Value of what you own) – (Value of what you owe)
Liquidity Access to funds to cover any short term cash deficiencies
Money Management Decisions regarding how much money to retain in a liquid form, and how to allocate the funds among short-term investments
Credit Management Decisions regarding how much credit to obtain to support your spending and which source of credit to use
Plans for Investing Any funds beyond what you need to maintain liquidity should be invested.
Estate Planning determining how your wealth will be distributed before or upon your death
Effective financial plan can… enhance net worth and build wealth
Financing focuses on… obtaining cash for large purchases or repaying loans
Steps of Developing a Financial Plan 1. Establish Your Financial Goals2. Consider Your Current Financial Position3. Identify and Evaluate Alternative Plans That Could Achieve Your Goals4. Select and Implement the Best Plan for Achieving Your Goals
Cash Inflows Salaries, interest, dividends
Cash Outflows All expenses, large and small
Personal Cash Flow Statement statement by recording your revenues and expenses over a period of time
Net Cash Flows (Cash Inflows) – (Cash Outflows)
Factors that Affect Cash Inflows -Stage in career path-Type of job-Number of income earners in your family
Factors that Affect Cash Outflows -Size of Family-Age-Personal Consumption Behavior
Budget Cash flow statement based on the forecast of cash flow for a future time period.-Helps prepare for shortages in cash
Balance Sheet -Reflects financial position at specific point in time-Allows you to determine your net worth
Types of Assets -Liquid-Household
Liquid Assets Easily sold without a loss in value
Household Assets Normally owned by a household (home, car, furniture)-Need to get market value (amount you’d receive if you sold the asset today)
Types of Investments -Bonds-Stocks-Mutual Funds-Real Estate
Bonds Certificates issued by borrower, usually firms and government agencies, to raise funds
Stocks Certificates representing partial ownership in a firm
Mutual Funds Investment companies that sell shares and invest the proceeds in investment instruments
Types of Liabilities -Current-Long-Term
Current Liabilities Debts that will be paid within a year
Long-Term Liabilities Debts that will be paid over a period longer than one year
Wealth is built by… Using NET CASH FLOWS to INVEST in assets WITHOUT increasing liabilities
Liquidity Ratio -Measures liquidity.(liquid assets) / (current liabilities)-Higher ratio=Greater Liquidity
Debt-to-Asset Ratio -Measures debt level(total liabilities) / (total assets)-Higher ratio=Higher debt relative to assets
Savings Rate -Measures savings over period in comparison to disposable income over the period(savings during the period) / (disposable income during the period)
Lump Sum single payment at one time rather than many small
Annuity A series of equal cash flow payments that occur at the end of each period -e.g. monthly deposit of $50 to savings
Compounding How money accumulates interest
To determine future value of an amount of money deposited today, must know… -Amount of deposit today-Interest rate to be earned on the deposit-Number of years it’ll be invested
Future Value Interest Factor (FVIF) A factor multiplied by todays savings to determine how the savings will accumulate over time.-As years increase so does FVIF-Calculate with Future Value Table or Calculator
Discounting The process of obtaining present values
To determine present values, must know… -Amount of money to be received in the future-Interest rate to be earned on the deposit-Number of years the money will be invested
Present Value Interest Factor (PVIF) A factor multiplied by a future value to determine present value of that amount**PVIF is lower as the number of years and interest rate increases**
Annuity Due A series of equal cash flow payments that occur at the beginning of each period
Future Value Interest Factor for an Annuity (FVIFA) A factor multiplied by the periodic savings level (annuity) to determine how the savings will accumulate over time
Present Value of Annuity is determined by… Discounting the individual cash flows of the annuity and adding them up
Present Value Interest Factor for an Annuity (PVIFA) A factor multiplied by a periodic saving level (annuity) to determine present value of the annuity

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