FHCE3200 Test 1 Review

What is the equation to calculate a spending surplus?

Income minus living expenses

When you borrow money you pay ___ and when you lend money you generate ___

Interest

What is at the root of your money working for you?

Interest is at the root of making your money work for you.

What is the difference between the interior and exterior view of finance? Give some examples of what is associated with the exterior view?

Interior finance refers to your knowledge, attitudes, perceptions, and abilities. Exterior finance refers to the observable actions you take with money and the associated outcomes, such as •loan payment amounts •savings rates •cash flow management •net worth

What is the conceptual idea behind compound growth?

Investment gains earned in the 1st time period are put to work in the 2nd time period to earn more investment returns.

What are the key action steps on the Journey to Financial Well Being?

Key action items: 1. Keep good records 2. Spend less than you earn 3. Maintain appropriate insurance 4. Save money on a regular basis

Define a S-T liability and give some examples

Liabilities that are due within a year such as utility bills, credit cards, and short-term installment loans

Define expenses as they relate to a budget

Literally everything you spend money on

What is loss aversion? Where will people generally focus much of their attention regarding loss?

Most people dislike losing, especially money. In other words, people tend to be loss-averse. People generally focus much of their attention on avoiding losses because the joy of a gain is smothered by the pain of a loss.

What percent of Americans do not have $1,000 set aside to cover an unexpected emergency?

Nearly 65%

What is a hedonistic perspective?

Part of present oriented (doing things for pleasure, the experience, and excitement of the action)

What is a fatalistic perspective?

Part of present oriented unable to visualize a meaningful future

what is the investment payback period? Give the formula

Payback Period = Total Costs / Increase in Annual Income

What is the formula for APR?

Periodic Interest Rate * Number of periods in the year

What type of association is between Wealth Accumulation and Financial Risk Tolerance?

Positive

What is Self-Efficacy?

Psychologists refer to self-efficacy as how well you believe you can do something.

What is the optimism bias?

This is when some people think that they will rarely, if ever, experience painful losses during their lifetime. These people suffer from an optimism bias.

For some financial products, like U.S. savings bonds, can you cash in the bond less than 1 year from the time of purchase?

U.S. savings bonds will not let you cash in the bond for at least 1 year from the time of purchase.

How can being overly optimistic hurt your financial well-being?

While being optimistic is good, it may blind you to reality •Being overly optimistic can lead some people to discount the risks associated with a decision

What rule can you use with the APY? What does this rule provide? How do you determine how many periods it will take to double your money?

You can use the APY with the Rule of 72, which provides an estimate of how long it will take you to double your money. To determine the number of periods it will take to double, just divide 72 by the interest rate you can earn on your investment.

What is the equation for net worth?

Your assets less your liabilities equal your net worth: Assets - Liabilities = Net Worth

What do lenders always want to know about you before giving a loan?

Your net worth Positive net worth will lead to more favorable financing

What are informal networks?

are the interpersonal relationships you form with your family and close friends.

Define depreciating assets

assets such as cars and computers, fall in value over time

Define appreciating assets

assets that increase in value over time, for example, a house

What does future oriented mean?

based on a calculation of the consequences of actions in terms of a future payoff Those with a future orientation tend to be very goal-oriented. As such, they might do a better job of managing their personal financial situation in the long run but may miss out on some opportunities along the way.

What does it mean to be past oriented?

based on memories, whether good or bad

What is the status quo bias? What do you tend to overemphasize? What do you underestimate? What does it create?

bias is a personal preference for keeping things the same. •Overemphasizes the good aspects of a current situation •Underestimates the benefits that come from making a change •Creates fear of making a wrong decision regarding a new situation

For those interested in accumulating wealth over their life, being willing to take _______ risks will be essential in reaching financial goals.

calculated financial risks

Changes in assets and liabilities will result in a change of your what?

changes in your assets or liabilities will also result in changes to your net worth

What are formal networks? What might they include?

connect you with people in professional, recreational, leisure, and social communities. Formal networks include clubs, organizations, and professional associations

TVM shortcut, the rule of 72: How do you approximate number of years to double your money? How do you approximate interest rate needed to double your money?

divide 72 by the interest rate. divide 72 by the number of years in your goal time horizon.

What does it mean to be present-oriented? What is it based on?

either a hedonistic perspective or a fatalistic perspective Those who view past events negatively have the most trouble staying on their financial path.

Name the 6 total elements that fo into making an effective financial plan

financial knowledge experience feelings of control risk tolerance financial capacity time horizon

What are examples of bad debt?

happens when you borrow money to buy something that either goes down in value quickly or is consumed immediately.

Define a L-T liability and give examples

have a longer repayment schedule, over a year include student loans and money borrowed to purchase a house (i.e., a mortgage)

Define liquidity

how quickly an asset can be converted to cash

What does the total debt-to-income ratio indicate? What is the formula?

indicates what percentage of your income you are using to pay all of your debts (consumer debt plus mortgage and student loans) •Total Debt Payments/Total Income

What does the consumer debt-to-income ratio indicate? What is the formula? What should it be less than? What question does it seek to answer?

indicates what percentage of your income you are using to pay debt payments (credit cards, personal loans, car loans, boat loans, and other liabilities) •Total Consumer Debt Payments / Total Income = 15% or Less • Why am I dependent on consumer debt?

In financial markets, the only way to accumulate a certain level of wealth is to take ______ risks with your savings.

informed financial

Define Social Capital?

is how well you are able to form connections with other people.

Unlike human capital, social capital is not found where?

is not found in individuals themselves but rather in the space between individuals, or the network of connections among people

Define risk

is the uncertainty associated with any physical, social, emotional, environmental, labor market, or financial activity

Define Human Capital

is your ability and willingness to work, learn, earn, and make wise decisions about how to save and invest money.

Define Financial Risk Tolerance

is your unwillingness to engage in financial endeavors that have uncertain outcomes.

What is confirmation bias? What does it lead to? Example?

leads to overconfidence in future decisions. Let's say your friend buys stock in a company without any research. If the stock price rises, your friend may attribute success to skill rather than luck and therefore be overconfident in picking stocks.

When you deposit money into a savings account at a bank or credit union, you are _____ it to that financial institution.

lending

•A short-term time horizon is how long? •A long-term time horizon is how long?

less than 1 year is greater than 1 year

Research indicates that for individuals to be indifferent between the equal likelihood of gains and losses, the potential gains need to be nearly how large compared to that of the potential losses?

needs to be nearly twice the size of the potential losses

Define "risk-taking"

refers to doing something that involves the possibility of a gain or a loss.

What type of deposit in protected against a loss in a bank?

savings deposit

What does a balance sheet help you organize?

sheet helps to organize •what you own—assets •what you owe—liabilities

Your ____ capital will affect the value of your ____ capital, particularly how much you earn over your working life span.

social human

Define Fair Market Value

the price someone would realistically pay you to buy the asset

Define the current ratio What question does this answer? What is the formula?

the proportion of current assets to current liabilities Do I have enough in current assets to cover my current liabilities? •Current Assets / Current Liabilities = 1

Behavioral economists have concluded that if you lose, your emotional pain—your feelings of loss and the regret associated with making a bad decision—will also be how many times as great as the joy of winning?

two times

Define surplus/deficit as it relates to a budget

•A surplus means that you have planned well •A deficit indicates that your expenses exceed your income

What are heuristics? How does our mind use them?

•Based on past experiences •Automatic and rarely used with forethought •Can help you make quick decisions, however, they sometimes lead to problematic choices and outcomes Our minds use heuristics to make decisions more quickly and easily than if we were to labor over every choice.

What are three key ways to help you believe you can achieve something

•Break complex goals into objectives and tasks •Focus on things that you can control •Recognize small achievements along the way

What are the main components of the Internal View of the Financial World?

•Financial knowledge •Financial risk tolerance •Feelings of control

Define the Annual Percentage Rate, what does it not take into account?

•If interest is calculated more frequently than once per year, then the annual percentage rate (APR) becomes the annual sum of the periodic interest rates applied to the account, without considering the effect of compound growth

How do you define necessary expenses?

•Necessary expenses = all of your expenses minus taxes, savings, and nonessential expenses

What is the only way to stop interest payments?

•The only way to stop interest is to eliminate the cause—the loan principal amount accruing interest •Pay off your credit card debt in full •Wait to spend money

In addition to formal education, what other resources increase your human capital?

•Your health •Your willingness to relocate for higher-paying job markets •Continuing professional education and skill development

Relationship between human and social capital? - Early in your career: - As you continue to gain work experience: - Over time near retirement

. Early in your career, your human capital increases because you are gaining additional education, training, and experience, and likely relocating to accept better jobs. 2. As you continue to gain work experience and additional professional education, your human capital becomes increasingly valuable. 3. Over time, your human capital increase may slow because you have less time remaining before you need, or choose, to retire from paid work. However, if you plan wisely, you'll notice that as you age, your financial wealth increases.

Identify the three sections of a budget

1. Income 2. Expense 3. Surplus

1. _______ for the future is essential to achieving short-, intermediate-, and long-term financial goals. 2. _______ is placing more value on the present at the expense of the future. 3. _________ occurs when the value of future benefits is perceived to be lower than that of an alternative available right now. Match the following words with the above blanks: Procrastination Hyperbolic discounting Planning

1. Planning 2. Procrastination 3. Hyperbolic discounting

Identify the steps in using heuristics as a decision making tool

1.Identify the problem or issue 2.Gather appropriate facts and data about the situation 3.Analyze the data you have collected 4.List the viable alternatives and select the best one 5.Implement the decision 6.Monitor outcomes

Define the Six Steps to Creating a a Financial Plan

1.Set a Financial Goal 2.Know Your Starting Point 3.Determine Your Financial Score 4.Determine Your Financial Capacity 5.Know Your Time Horizon Formalize and Implement Your Financial Plan

Identify the steps in setting a personal budget

1.Use the SMART approach to goal development 2.Know where your money is coming from (income) 3.Know where your money is going (spending) 4.A budget is a financial tool that helps you regulate how quickly and in what ways your money is going to be used so that you can stay focused on accomplishing your goals 5.At the end of the month, evaluate what happened

No more than what percent of income should be used for debt payments?

36%

Determining your financial score: what does the score provide? What are the scores out of? The lower the score means what? what about higher?

A score provides a realistic understanding of your risk tolerance, financial knowledge, and feelings of control 10 - 20+ Lower (under 10) is the worst Higher (20+) os the best

What is the formula for APY

APY = ((1+Periodic Interest Rate)^(# of periods in the year)) - 1

The APY or APR is higher than the APY or APR as long as there's more than one compounding period in a year.

APY and APR

Define income as it relates to a budget

All resources that can be spent or saved, such as wages or salaries, interest earned at a bank or credit union, and allowances - Everything

SMART: Measurable

Attach a quantifiable standard for achieving the goal

SMART: Attainable

Be realistic about whether you can achieve the goal

Key question to ask yourself to determine if you actually own something...

Can I legally sell the asset?

SMART: Timely

Create a goal you can meet in a reasonable amount of time

SMART: Relevant

Develop those financial goals that are crucial to improving your financial situation

SMART: Specific

Document the when, what, where, and how aspects of the goal

What is an indicator of the value of your human capital in the labor market? What are they closely related to?

Earnings level of formal education

What are the two ways to increase the importance of a goal?

External and Internal Factors

Fact or Fiction...It can take up to 99 years to receive your federally insured money from the Federal Deposit Insurance Corporation (FDIC).

Fiction

What are some External Factors as they relate to increasing the importance of a goal

Financial bonuses if you reach your goal Sharing your goal with others (in person or via social media

What rate would a financial institution quote for a loan? What about a savings account?

Financial institutions will often quote either the APR or the APY depending on what they're trying to sell to customers APR on loans and APY on savings

_________ is one of the most important predictors of savings and investment success and overall well-being.

Financial literacy

Define Financial Literacy

Financial literacy is how well you can understand and use personal finance-related information.

What is the primary way to build wealth?

Generating a surplus is the primary way to build wealth over your lifetime.

What should you match your financial goals with (the time between creating a goal and achieving the goal)?

Goal Time Horizon

What are examples of good debt?

Going into debt to pay for your education, transportation, and other items that you need to invest in your human capital

What goes into the numerator and denominator of the savings ratio?

The numerator of the savings ratio includes the money you put aside from your income, plus any contributions your employer gives you for retirement, during a set time period. • The denominator is your total income over that same time period

What does the savings ratio indicate? What is the formula? What question are you trying to answer?

The savings ratio indicates the percentage of money that you are setting aside on a regular basis •Total Savings/Total Income = 12% or higher What is an adequate portion to save from my income?

Define the annual percentage yield...What does it take into account?

The annual percentage yield (APY) accounts for compound growth, or the additional interest that your interest earns.

Define the debt ratio What question does it answer?

The debt ratio is a broader measure of financial health How much of my lifestyle is being leveraged by debt? •Total Liabilities / Total Assets = 40%

What is the emergency fund ratio? What is the equation? Approx what should it equal?

The emergency fund ratio indicates whether you have sufficient resources available in case of an emergency •Monetary Assests / Necessary Expenses = 3 to 6 months

Financial decisions must be SMART, what does each letter stand for?

S pecific M easurable A ttainable R elevant Timely

What are some internal factors as they relate to increasing the importance of a goal

Self-improvement Visualizing attainment of your goal

Who protects accounts for up to $250,000?

The Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA)