Personal Finance test #1 review

The Financial Planning Process 1.Determine current financial situation2. Develop your financial goals3. Identify alternative courses of action4. Evaluate alternativea) life situation, values, economic factors b) risk, tvm, opportunity cost5. Create and implement your financial action plan6. Review and revise the financial plan
Opportunity Costs What a person gives up by making a choice; trade-off of a decisionex money, time, risks
Inflation risk Rising & falling interests rates cause changes in borrowing power; this risk is based on buying something now rather than later.
Interest rate The cost of money; the cost of credit when you borrow; the return on your money when you save or invest increases make buying on credit &borrowing more expensivesaving and investing more attractive
Income risk the loss of a job; people with high risk of unemployment should keep an emergency fund
personal risk Purchasing certain brands may make it harder to find replacements or repairs
liquidity risk These investments usually have a higher rate of a return but are harder to convert to cash…
Personal opportunity costs Time, effort, energy, abilities knowledge & health that a person gives up
consumer prices The buying power of the dollar, changes with inflation; if this increases faster than your income then your purchasing power decreases
unemployment The number of people without employment who are willing and able to work ;high unemployment reduces consumer spending and job opportunities
Money Supply The dollars available for spending in our economy;Interest rates decline as more people save & invest, but reduces job opportunities
Housing starts the number of new homes being built; more job opportunities, high wages, consumer spending, and overall economic expansion
Gross Domestic Product The total value of goods and services produced within a country’s borders, including items produced with foreign resources.
Trade balance The difference between a country’s imports and exports
consumer spending The demand for goods and services; increase in this creates more jobs, higher wages, can push up interest rates and consumer prices
Dow Jones Average, S&P 500, & other stock market indexes Provides a general movement of stock prices and investments
SMART Financial goals S- SpecificM- measurable A- action-orientated R- Realistic T- time-based
Influences on personal planning Life situation, personal values, & economic factors
Economics the study of how wealth is created and distributed;business labor and government working together to satisfy our needs and wants.
Rule of 72 Take the inflation rate and divide it by 72 and that’s how long it takes to double your money. ex 72/4= 18 years to double money.
future value The amount to which current savings will increase based on a certain interest rate and a certain time period; also referred to as compounding
Present value The current value for a future amount based on a certain interest rate and a certain time period; also referred to as discounting
Components of personal financial planning 1. Planning your personal financesi.Obtainingii. planning2.Managing your personal finances i.savingii. borrowing3. Making your purchasing decisionsi spending4. Insuring your resources i managing risk5. Investing your financial resourcesi Investing6. Controlling your financial futurei. retirement and estate planning
Characteristics of financial goals for various life situations pg 25 exhibit 1-10
Money managment day-to-day financial activities necessary to manage current personal economic resources while working toward long-term financial security.
Money management activities 1. storing and maintaining personal financial records and documents2. Creating personal financial statements (balance sheets and cash flow statements of income and outflows) 3. Creating and implementing a plan for spending and saving (budgeting)
assests cash and other property with a monetary value
Liabilities Amounts owed to othersi short-term liabilityii long-term liability
Net worth The amount you would have if all assets were sold for the listed values and all debts were paid in full; gives an indication of your financial position on a given date.
Insolvency The inability to pay debts when they are due because liabilities far exceed the value of assests
Gross income total income (before taxes) after working
Net income
Take-home pay Earnings after deductions for taxes and other items; also called disposable income
Discretionary income Money left over after paying for housing, food, and other necessities
Emergency fund a savings account that a person would use for unexpected expenses such as a car repair or unemployment (usually enough for cover 6 months of fixed expenses)
Balance sheet A financial statement that reports what an individual or a family owns and owes; also called a net worth statement. What you own- what you owe = net worth Assets (1. liquid assets 2. real estate 3. personal possessions )- Liabilities ( 1. current liabilities 2. long term liabilities)
Purposes of personal financial statements 1. Report your current financial position in relation to the value of the items you own and the amounts you owe2. Measure your progress towards your financial goals3. Maintain information about your financial activities 4. provide data you can use when preparing tax forms or applying for credit
Cash flow The actual inflow and outflow of cash during a given time period;
Cash flow statements the financial statements that summarizes cash receipts and payments for a given period. 1. record income2. record outflows : Fixed & variable 3. determine net cash flow
Creating an implementing a budget 1. Assessing your current situation i measure current financial positionii determine personal needs, values & life situation2. Planning your financial directioni set goalsii estimate incomeiii budget emergency fund and savingsv budgeting fixed expensesvi budgeting variable expenses 3. Implementing your budget i recording spending amounts4. evaluation of your budgeting program
Different Types of Taxes 1. taxes on purchasesi sales taxii excise tax2. taxes on propertyi. real estate property taxii. personal property tax3. taxes on wealthi estate taxii inheritance tax4. taxes on earnings i social securityii income taxes
excise tax a tax imposed on specific goods and services such a gasoline, cigarettes, alcohlic beverages, tires, and air travel
estate tax a tax imposed on the value of a person’s property at the time of his or her death
inheritance tax a tax levied on the value of property bequeathed by a deceased person.
Types of income 1. earned income : salary bonuses, tips2. Investment income: divindends, rent, interest3. passive income: limited partnership
How to fill out a tax return 1. gross income – adjustments = adjusted gross income 2. adjusted gross income – deductions & exemptions = Taxable income3. Taxable income- tax + credits=total tax due
Tax-exempt income Income that is not subject to tax
Tax-deferred income Income that will be taxed at a later date; ex IRA
Adjusted gross income gross income after certain reductions have been made.ex. IRA, keogh, alimony payments ,
Tax deduction an amount subtracted from adjusted gross income to arrive at taxable income
Standard deductions a set amount on which no taxes are paid. ex singles $5,700
Itemized deductions Expenses that can be deducted from adjusted gross income, such as medical expenses, real estate property taxes, home mortgage interests, charitable contributions, casualty losses, and certain work-related expenses.
Exemptions a deduction from adjusted gross income for yourself, your spouse, and qualified dependents. ex $3650 for each dependent
Marginal tax rate The rate used to calculate tax on the last (and next) dollar of taxable income. After deductions and exemptions a person in the 28% tax pays .28 cents for every 1.00 in that bracket.
Average tax rate Total tax due divided by taxable income ex tax bill: $4200/ ti: $40,000 = 10.5%
Tax credit versus tax deduction $100 tax credit reduces your taxes by $100$100 tax deductions reduces taxable income by $100
Schedule A A list of itemized deductions;health care, sales tax, interest, charity contributions, theft, job expense,
Tax avoidance the use of legitimate methods to reduce one’s taxes
Tax evasion The use of illegal actions to reduce one’s taxes.
tax-exempt investments Interest from municipal bonds (given by state and local goverments)You may still pay a state tax on it..
tax-deferred investments income that is taxed at a later date;including 1. tax deferred annuities 2. Section 529 savings plan3. Retirement plans : IRA, keogh, 401k plans4. Capital gains
Capital gains Profits from the sale of a capital asset such as stocks, bonds, or real estate.-long term capital gains are taxed at a lower rate-short term capital gains are taxed as ordinary income
Debit card Spending of your own funds in an account to make purchases; If stolen you can be held liable for up to $500
Credit card borrowing additional money than what you already make. Considered safe because if it it stolen, you are only liable for $50
When interest rates are rising – use long term loans to take advantage of current rates -select short term savings instruments to take advantage of higher interest rates when they are mature.
When interest rates are falling -use short term loans to take advantage of lower rates when refinancing the loans. -select long term savings instruments to “lock in” earnings at current higher rates.
Commercial Bank/ regular savings account A financial institution that offers a full range of financial services to individuals businesses, and government agencies. have corporate investors, fed- regulated.Regular savings accounts involve low or no minimum balance, & high liquidity
Savings and loans associations a financial institution that traditionally specialized in savings accounts and mortgage loans. Today they also offer checking, expanded savings plans, loans to businesses, & financial planning services.
Mutual savings bank A financial institution that is owned by depositors and specializes in savings accounts and mortgage loans. owned by depositors
Credit unions A user owned, nonprofit, cooperative financial institution that is organized for the benefit of its members.savings accounts are called share accounts
Money market fund A savings investment plan offered by investment companies with earnings based of investments in various short term financial instruments.
Money Market Accounts a savings account offered by banks, savings & loan associations, and credit unions that requires a minimum balance- anything over can be withdrawn if desired & earnings based on the markets but they are insured.
How to choose a financial institution – services offered – rates -fees & charges -financial advice – safety (insurance) – convenience – location -online services – special programs
Certificate of deposit (CD) a savings plan requiring a certain amount be left on deposit for a stated time period to earn a specific interest rate. 1.rising-rate (bump-up) cds : higher rates at various intervals2.indexed cds: based on the stock market3. callable cds: higher rates but the bank may call the cd so you don’t actually earn that interest rate for that whole locked in period4. promotional cd: Offers gifts or promotions for people to invest
Savings bonds 1. EE bonds; purchased at face value & increases in value every month2. HH Bonds : current income bonds that were automatically deposited into your savings every month. 3. I Bonds : bonds that change with the inflation rate
Rate of return The percentage of increase in the value of savings as a result of interest earned. Also called yield. % increases with frequency of compounding
Compounding A process that calculates interest based on previously earned interest. Interest on interest.
Annual Percentage yield The percentage rate expressing the total amount of interest that would be received on a $100 deposit based on the annual rate and frequency of compounding for a 365 day period.
Liquidity Allows you to withdraw money from your account on short notice with no penalties.
Safety most banks, savings & loan associations, & credit unions are insured by fdic ( up to $250,000).
Debit card transactions Not every retailer accepts them; authorized in two waysi. your signatureii pin number
Online payments Banks and internet companies that serve as third parties to facilitate online bill payments.
Store value cards Prepaid cards such as phone cards. highway tolls, laundry services, and school lunches.
Smart cards Electronic wallets similar to ATM cards as well as account balances, transaction records, insurance information & medical history
Regular checking accounts usually have a monthly service charge that can be avoided by keeping a minimum balance
Activity accounts Charge a fee for each check written & a fee for each deposit but there is no minimum balance required
Interest earning checking accounts Require minimum balance & if one goes below that then no interest is earned on the deposit.
Restrictions of Checking accounts – minimum balance- federal deposit insurance-hours and location of branch offices-holding period for deposited checks
Fees and Charges of Checking accounts -monthly fees-fees for each check or deposit-printing of checks-fee to obtain cancelled check copy-overdraft, stop-payment order, certified check fee- fees for preauthorizes bill payment, fund transfer, or home banking activity
Special services of checking accounts -direct deposit of payroll & government checks-24 atms-overdraft protection-banking at home-discounts or free checking for certain groups-free discounted services like traveler’s checks
Checking account interests -minimum deposit to earn interest-portion of balance used to compute interest-fee charged for falling below necessary balance to earn interest
Closed-end credit You pay back loan time loans in a specifies period of time and in payments of equal amountsex mortgage loans, auto loans, installments: sales contract ( large appliances), cash credit ( vacation loan)
Open-end credit Loans are made on a continuous basis and you are billed periodically for a least a partial payment; has overdraft protectionex cards issued by department stores, bank cards, travel & entertainment cards
Installment sales credit A loan that allows you receive merchandise, usually a high- priced item such as a large appliance or furniture
Installment cash credit A direct loan of money for personal purposes, home improvements or vacation expenses
Single Lump sum credit A loan that must be repaid in total or on a specific day usually within 30 to 90 days.
incident credit A credit agreement that has no extra costs and no specific repayment plan; interest free for 30 days or at the end of the month, start making payments on the loan.
Revolving check credit a prearranged loan from a bank for a specified amount; also called a bank line of credit.
The general rules for credit capacity 1. debt payments to income ratio 2. Debt to equity ratio
Debt payments to income ratio experts say no more than 20% of your net (after-tax) income should be spent on credit card paymentsex $1068 x .2 = $213 <– this person should not spend more than this a month of credit card bills
Debt to equity ratio Dividing total liabilities by your net worth ex Liabilities: $60,000 Net worth: $150,00060,000/150,000 = .4 <– the higher this number is, the riskier the loan.
Cosigning a loan Co-signers of a loan often have to pay for the full amount plus any late fees attached to it ; Helps build credit for people who are first starting out; the loan might effect your credit score ;
Credit buereau (CRA’s) A reporting agency that assembles credit and other information about consumers; 1. Experian Information solutions2. Transunion credit information company3. Equifax Services Inc.Information stays on a file 7-10 years
Fair credit reporting act Regulates the use of credit reports, requires the deletion of obsolete information, and gives consumers access to their files and the right to have erroneous data corrected.
How do you avoid and correct mistakes? you can avoid mistakes by simply checking your credit score every few months; You can correct mistakes by writing into the bureau to have them verify and explain the transaction.
the 5 C’s of credit management 1. Character : borrower’s attitude towards credit obligations2. Capacity : financial ability to meet obligations3. Capital : refers to assets or net worth4. collateral : An asset you pledge to an institution5. conditions : general economic conditions that affect your ability to repay the loan
Sources of credit Inexpensive loansi. loans from family members ii insurance policy loansmedium-priced loansi. commercial banks, credit unions, federal savings banksExpensive Loansi finance companiesii retailers (car dealers, appliance stores, department stores)iii banks through credit cardsv cash advances
Finance charge the total dollar amount you pay to use credit
Annual percentage rate (apr) the percentage cost or relative cost of credit on a yearly basis. the APR yields a true rate of interest for comparison with other sources of credit
Warning signs of potential debt problems 1. Paying only the minimum balance2. Increasing the total balance due on credit accounts each month3. Missing payments, paying late, or paying some bills this month and others next month4. Intentionally using the overdraft or automatic loan features on checking accounts or taking frequent cash advances on credit cards 5.Using savings to pay routine bills such as groceries or utilities6. receiving second or third payment notices from creditors 7. Not talking to your spouse about money or talking only about money8. Depending on overtime, moonlighting, or bonuses to meet everyday expenses9.Using up your savings10. borrowing money to pay old debts11. Not knowing how much you owe until the bills arrive12. going over your credit limit on credit cards13. Having little or nothing in savings to handle unexpected expenses14. being denied credit because of a negative credit bureau report15. Getting a credit card revoked by the issuer16. Putting off medical or dental visits because you can’t afford them right now.
The consumer credit counseling service A local nonprofit organization that provides debt counseling services for families and individuals with serious financial problems.
establishments that help with consumer debt problems – american consumer credit counseling- Association of Independent consumer credit counseling- In charge Institute of America- Money Management International
Chapter 7 Bankruptcy One type of personal (or straight) bankruptcy in which debts are forgiven; makes a list of everything he or she owns, files it for a fee & most of the debtor’s assets are sold to pay off creditors. Some assets like your home & car are protected.
Chapter 13 bankruptcy A voluntary plan that a debtor with regular income develops and proposes to a bankruptcy court. using future earnings or property settle debts. the debtor makes regular payments to a trustee & keeps most of their personal property.
Simple Interest Interest computed on principle only and without compounding
Declining balance method A method of computing interest when more than one payment is made on a simple interest loan; the more frequent the payments the lower the interest you will pay.
add-on interest method A method of computing interest in which interest is calculated on the full amount of the original principal.
adjusted balance method the assessment of finance charges after payments made during the billing period have been subtracted
Previous balance method A method of computing finance charges that gives no credit for payments made during the billing period.
Average daily balance method A method of computing finance charges that uses a weighted average of the account balance throughout the current billing period.

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