Test 1

In general, how much of your annual income should you save in the form of liquid reserves? What portion of your investment portfolio should you keep in savings and other short-term investment vehicles? Explain.

Although opinions differ as to how much you should keep as liquid reserves, the post-crisis consensus is that most families should have an amount equal to at least 6 months of after-tax income. Many financial planning experts recommend keeping a minimum of 10 percent to 25 percent of your investment portfolio in savings-type instruments in addition to the 6 months of liquid reserves noted earlier. Many savers prefer to keep their emergency funds in a regular savings or money market deposit account at an institution with federal deposit insurance.

Discuss the various forms in which wealth can be accumulated.

An individual's wealth is the accumulated value of all items he or she owns. People accumulate wealth as either financial assets or tangible assets. Financial assets are intangible assets such as savings accounts or securities, such as stocks, bonds and mutual funds. Financial assets are expected to provide the investor with interest, dividends, or appreciated value. Tangible assets are physical items, such as real estate, automobiles, artwork, and jewelry. Such items can be held for either consumption or investment purposes or both.

Describe the steps involved in closing the purchase of a home.

An overview of these closing requirements may be found on HUD's Web site (go to the "Homes" section of http://www.hud.gov). Exhibit 5.10 provides some strategies to help you sail smoothly through the home-buying process in general. For the closing specific steps include the title check [normally performed by a title insurance company] and preparation of the closing statement. A closing statement, provided to both buyer and seller at or before the actual closing, accounts for monies that change hands during the transaction.

What is a capital gain, and how is it treated for tax purposes?

Capital gain is gain from the sale of capital assets. Capital assets is defined in the negative, that is, it is anything except receivables, inventory, real property used in a trade or business, personal property used in a trade or business, and so on. What is not not a capital asset? Investments in stocks, bonds, raw land, real estate [not used in a business], personal assets, and so on. Gains from the sale of capital assets held more than 12 months are subject to an alternative rate based upon the ordinary tax rate—the rate that applies to wages and other ordinary income. The following table reports these rates: Ordinary tax rates 10% or 12% 22%, 24%, 32%, 35% 37% Alternative tax rates 0% 15% 20% In addition, gains from the sale of collectibles are subject to an alternative rate of 28% and gain equal to depreciation allowed on real property is taxed at 25%. If the capital asset has not been held more than 12 months, the alternative rate does not apply and the gain is taxed as ordinary income. Losses are not treated favorably. Net capital losses, capital gains less all capital losses [short-term + long-term losses], are limited to $3,000 per year when deducted against ordinary income.

Discuss the need for career planning throughout the life cycle and its relationship to financial planning. What are some of your own personal career goals?

Career planning is a critical part of the life cycle of the personal financial planning process. The choice of a career affects the amount you earn. By setting both short- and long-term career goals, you can incorporate them into your financial plans. For example, if you need additional education and/or other training for a particular job, you may include a savings plan to obtain the needed funds. You should reevaluate your career decision periodically to see if it still meets your personal and financial goals. Other important considerations with regard to a specific job (and company) include the earnings potential, advancement opportunities, and benefits, plus how well the job fits your lifestyle and values. In today's rapidly changing job environment, you should expect to change careers several times. It is important to keep up with developments in your industry, acquire a broad base of experience, and continue to learn new skills, both general and technical.

What are closing costs, and what items do they include? Who pays these costs, and when?

Closing costs are all other expenses besides the down payment that borrowers ordinarily pay at the time a mortgage loan is closed and title to the purchased property is conveyed to them. The buyer typically pays the majority of the closing costs, although the seller may, by custom or contract, pay some of the costs. Closing costs are made up of such items as: (1) loan application fees, (2) loan origination fees, (3) points (if any), (4) title search and insurance, (5) attorneys' fees, (6) appraisal fees, and (7) other miscellaneous fees for things like mortgage taxes, filing fees, inspections, credit reports, and so on. Closing costs, including points, can total an amount equal to 50% or more of the down payment. When the down payment is only 10%, closing costs can run as high as 70% or more of the down payment. Exhibit 5.7 gives an example of closing costs.

Discuss briefly how the following situations affect personal financial planning: a. Being part of a dual-income couple

Couples should discuss their money attitudes and financial goals and decide how to manage joint financial affairs before they get married. Take an inventory of your financial assets and liabilities, including savings and checking accounts; credit card accounts and outstanding bills; auto, health, and life insurance policies; and investment portfolios. You may want to eliminate some credit cards. Too many cards can hurt your credit rating, and most people need only one or two. Each partner should have a card in his or her name to establish a credit record. Compare employee benefit plans to figure out the lowest-cost source of health insurance coverage, and coordinate other benefits. Change the beneficiary on your life insurance policies as desired. Adjust withholding amounts as necessary based on your new filing category.

Describe employee benefit and tax planning. How do they fit into the financial planning framework?

Employee benefits, such as insurance (life, health, and disability) and pension and other types of retirement plans, will affect your personal financial planning. You must evaluate these benefits so that you have the necessary insurance protection and retirement funds. If your employer's benefits fall short of your needs, you must supplement them. Therefore, employee benefits must be coordinated with and integrated into other insurance and retirement plans. Tax planninginvolves looking at an individual's current and projected earnings and developing strategies that will defer and/or minimize taxes. For income tax purposes, income may be classified as active income, passive income, or portfolio income. While most income is currently subject to income taxes, some may be tax free or tax deferred. Tax planning considers all these dimensions and more. Tax planning is an important element of financial planning because it guides the selection of investment vehicles and the form in which returns are to be received. This means that it is closely tied to investment plans and often dictates certain investment strategies.

Briefly describe the basic operations of—and the products and services offered by—each of the following financial institutions: (a) commercial bank, (b) savings and loan association, (c) savings bank, (d) credit union, (e) stock brokerage firm, and (f) mutual fund.

Exhibit 4.2 gives a brief description of services offered by commercial banks, savings and loan associations, savings banks, credit union. From Exhibit 4.2: Depository Financial Institutions Commercial bank Offers checking and savings accounts and a full range of financial products and services; the only institution that can offer non-interest-paying checking accounts (demand deposits). The most popular of the depository financial institutions. Most are traditional brick-and-mortar banks, but Internet banks—online commercial banks—are growing in popularity because of their convenience, lower service fees, and higher interest paid on account balances. Savings and loan association (S&L) Channels the savings of depositors primarily into mortgage loans for purchasing and improving homes. Also offers many of the same checking, saving, and lending products as commercial banks. Often pays slightly higher interest on savings than do commercial banks. Savings bank Similar to S&Ls, but located primarily in the New England states. Most are mutual associations—their depositors are their owners and thus receive a portion of the profits in the form of interest on their savings. Credit union A nonprofit, member-owned financial cooperative that provides a full range of financial products and services to its members, who must belong to a common occupation, religious or fraternal order, or residential area. Generally small institutions when compared with commercial banks and S&Ls. Offer interest-paying checking accounts—called share draft accounts—and a variety of saving and lending programs. Because they are run to benefit their members, they pay higher interest on savings and charge lower rates on loans than do other depository financial institutions. Nondepository Financial Institutions: Stock brokerage firms offer several cash management options, including money market mutual funds that invest in short-term securities and earn a higher rate of interest than bank accounts, special "wrap" accounts, and credit cards. Mutual funds, discussed in detail in Chapter 13, provide yet another alternative to bank savings accounts. Like stockbrokers, mutual fund companies offer money market mutual funds.

What types of financial planning concerns does a complete set of financial plans cover?

Financial plans provide the roadmap for achieving your financial goals. The six-step financial planning process (introduced in Exhibit 1.3) results in separate yet interrelated components covering all the important financial elements in your life. Some elements deal with the more immediate aspects of money management, such as preparing a budget to help manage spending. Others focus on acquiring major assets, controlling borrowing, reducing financial risk, providing for emergency funds and future wealth accumulation, taking advantage of and managing employer-sponsored benefits, deferring and minimizing taxes, providing for financial security when you stop working, and ensuring an orderly and cost effective transfer of assets to your heirs.

When might you use future value? Present value? Give specific examples.

Future value calculations show how much an amount will grow over a given time period. Future value is used to evaluate investments and to determine how much to save each year to accumulate a given future amount, such as the down payment on a house or for a child's college education. Present value concepts, the value today of an amount that will be received in the future, help you calculate how much a future cash receipt will be worth today, analyze investments, and determine loan payments.

Describe some of the steps home buyers can take to improve the home-buying process and increase their overall satisfaction with their purchases.

Gather all the information available about the location of the home. The standing joke: What are the three most important factors in buying a home? Answer, location, location, and location. The more you know about the area, the more you will be satisfied with your decision. You must begin your home search project by figuring out what you require for your particular lifestyle needs—in terms of living space, style, and other special features.

Are consumption patterns related to quality of life? Explain.

Generally, consumption patterns are related to quality of life, which depends on a person's socioeconomic strata. This implies that wealthy persons, who are likely to consume non-necessity items, quite often live higher quality lives than persons whose wealth permits only consumption of necessities.

Define and differentiate between gross income and AGI. Name several types of tax-exempt income. What is passive income?

Goss income is income from whatever source derived unless excluded by Congress. Examples of excluded income are interest on state and local bonds, proceeds from various insurances, and gifts. Adjusted gross income is gross income less business expenses and other adjustments allowed by law. Examples of other adjustments include contributions to IRAs, alimony paid related to divorces prior to 2019, self-employed health insurance premiums, expenses relating to serving in the National Guard or Reserves, and interest on education loans. Passive income is income from businesses and investments in which the taxpayer is a passive owner, that is, the taxpayer does not materially participant in the operation of the business. A general rule is if you spend 500 hours per year working in the business, it will be an active activity, not passive.

Discuss the following statement: "The interactions among government, business, and consumers determine the environment in which personal financial plans must be made."

Government, businesses, and consumers are the three major participants in the economic system. Government provides the structure within which businesses and consumers function. In addition, it provides a number of essential services that generally improve the quality of the society in which we live. To create this structure, various regulations are set forth, and to support its activities and provision of essential services, taxes are levied. These activities tend to constrain businesses and consumers. Businesses provide goods and services for consumers and receive money payments in return. They also employ certain inputs in producing and selling goods and services. In exchange they pay wages, rents, interest, and profit. Businesses are a key component in the circular flow of income that sustains our economy. They create the competitive environment in which consumers select from many different types of goods and services. By understanding the role and actions of businesses on the cost and availability of goods and services, consumers can better function in the economic environment and, in turn, implement more efficient personal wealth maximizing financial plans. Consumers are the focal point of the personal finance environment. Their choices ultimately determine the kinds of goods and services that businesses will provide. Also, consumer spending and saving decisions directly affect the present and future circular flows of income. Consumers must; however, operate in the financial environment created by the actions of government and business. Consumers may affect change in this environment through their elected officials, purchasing decisions and/or advocacy groups. Yet, basically, change occurs slowly and tediously, often with less than favorable results. Thus, consumers should attempt to optimize their financial plans within the existing financial environment.

Distinguish between long-term, intermediate, and short-term financial goals. Give examples of each.

Individual time horizons can vary, but in general individuals would expect to achieve their short-term financial goals in a year or less, intermediate-term goals in the next 2-5 years, and long-term financial goals in more than 5 years. Refer to Worksheet 1.1 for examples of financial goals. In making personal financial goals, individuals must first carefully consider their current financial situation and then give themselves a pathway to reach their future goals. People in the early stages of their financial planning life cycle may need more time to accomplish long-term goals than those who are already established in their careers and may also need to give themselves more flexibility with their goal dates.

What is inflation, and why should it be a concern in financial planning?

Inflation is a state of the economy in which the general price level is rising. It is important in financial planning because it affects what we pay for goods and services; it impacts how much we earn on our jobs; it directly affects interest rates and, therefore, it affects such things as mortgage and car loan payments. The most common measure of inflation is the consumer price index, which is based on the changes in the cost of a typical "market basket" of consumer goods and services. This can be used to compare changes in the cost of living over time for the typical family. Inflation is measured by the percentage change in the consumer price index from one time period to another, so that as the CPI rises, the cost of living also increases.

Explain how inflation affects the purchasing poser of money over time. What is the Fisher equation and how does it relate nominal and real interest rates to the expected rate of inflation?

Inflation is changes in the purchasing power of money. It is expressed as a percentage. Thus, if a loaf of bread costs $3.00 on January 1 of year and the inflation rate is 3%, that same bread will cost $3.09 one year later. If you are saving $3.00 in a bank account that pays 1%, at the end of the year you will not have enough to purchase the bread. For financial planning the inflation adjusted interest rate should be used. The Fisher equation allows you to compute the inflation adjusted interest rate considering the effect of compounded interest. The results will be better planning for your financial future. The equation is: (1+ in) = (1 + ireal) x (1 +einf), where in is the nominal interest rate, ireal is the real interest rate, and einf is the expected inflation rate. Solving for ireal ireal = [(1 + in) / (1 +einf)] - 1 Again, the inflation adjusted interest rate computed by the Fisher equation considers the compounding effect of interest and is a more accurate rate. For many applications simply subjecting the expected inflation rate from the nominal rate of interest will give an acceptable inflation adjusted interest rate.

What is compounding? Explain the rule of 72.

Interest is earned over a given period of time. When interest is compounded, this given period of time is broken into segments, such as months. Interest is then calculated one segment at a time, with the interest earned in one segment added back to become part of the principal for the next time segment. Thus, in compounding, your money earns interest on interest. The rule of 72 is a quick way to approximate how long it will take for an investment to double in value. Divide 72 by the percentage rate you are earning on your investment, and the answer will be approximately how many years it will take for your money to double. For example, if your investment is earning 8%, divide 72 by 8 to see that in approximately 9 years your money will double.

Is it possible to bounce a check because of insufficient funds when the checkbook ledger shows a balance available to cover it? Explain what happens when a check bounces. Can you obtain protection against overdrafts?

It is possible to bounce a check due to insufficient funds when the checkbook ledger shows a balance available to cover it if certain deposits added to the checkbook ledger have not yet been credited to the account by the bank. This situation could also arise when certain service fees are deducted from the account by the bank, but the account holder has not yet been notified and therefore has not yet deducted them from his or her checkbook ledger. When a check bounces, the bank stamps the overdrawn check with the words "insufficient balance (or funds)" and returns it to the party to whom it was written. The account holder is notified of this action, and a penalty fee of $20 to $25 or more is deducted from his or her checking account. In addition, the depositor of a "bad check" may be charged as much as $15 to $20 by its bank, which explains why merchants typically charge customers who give them bad checks $15 to $25 or more and refuse to accept future checks from them. To prevent bounced checks, you can arrange for overdraft protection through an overdraft line of credit or automatic transfer program. Here the bank will go ahead and pay a check that overdraws the account but be aware that bank charges and policies vary widely on the cost and terms of such protection. The bank may even extend such protection without prior arrangement, but in such a case it will notify the account holder of the overdraft and charge a penalty for the inconvenience.

Briefly describe the various benefits of owning a home. Which one is most important to you? Which is least important?

Major benefits of owning versus renting are: Tax shelter, that is, property taxes and mortgage interest are deductible for federal and state income tax, thus, these costs of ownership will reduce or "shelter" taxes on other income such as your salary. However, with the 2017 tax act, the increase in the standard deduction has reduce the availability of the tax savings. For many, rent and invest may be the better decisions. Costs of renting do not provide tax benefits. Inflation hedge, in general value of real estate increases over time. The major cost of ownership, mortgage interest, generally does not increase over time. Thus, the cost of ownership as a percent of the value of the house decreases over time. Within a certain time period, say a five-year period, housing value may in fact decrease, but over longer period of time, the value will increase. Currently the tax shelter attribute is least important.

Discuss briefly how the following situations affect personal financial planning: b. Major life changes, such as marriage or divorce

Major life changes such as marriage and divorce: Marriage. Finances must be merged and there may be a need for life insurance. Divorce. Financial plans based on two incomes are no longer applicable. Revised plans must reflect any property settlements, alimony, and/or child support.

If you itemize your deductions, you may include certain expenses as part of your itemized deductions. Discuss five types of itemized deductions and the general rules that apply to them.

Medical expenses—deductible if they exceed 7,5% [in 2018, 10% in 2019 and thereafter] of adjusted gross income State and local taxes—Only income taxes and property taxes where the property tax is based upon value of the property; total is limited to $10,000. [Note many in Congress do not like this limit, so it may change in 2020. Or not.] Interest paid—only applies to interest on mortgages for up to two homes and limited to $750,000 of principal. Charitable Contributions—Only contributions given to a 501(c)-3 organization. Overall limit is 60% of adjusted gross income. Any in kind contribution with a value over $5,000 must be based upon an appraisal. Also, any single contribution over $250 must have a letter from organization that states amount and that the donor received no tangible benefit from the contribution. Casualty and theft losses—limited to losses incurred in areas that have been declared a disaster area by the federal government and limited to amount in excess of 10% of adjusted gross income. Loss must be reduced by $100 before applying the 10% of AGI limit.

Explain why financial plans must be psychologically as well as economically sound. What is the best way to resolve money disputes in a relationship?

Money is not only an economic concept; it is also a psychological one that is linked through emotion and personality. Each person has a unique personality and emotional makeup that determines the importance and role of money in his or her life, as well as one's particular money management style. Personal values also affect one's attitudes to money. Money is a primary motivator of personal behavior and has a strong impact on self-image. To some, money is of primary importance, and accumulation of wealth is a dominant goal. For others, money may be less important than lifestyle considerations. Therefore, every financial plan must be developed with a view towards the wants, needs, and financial resources of the individual and must also realistically consider his or her personality, values, and money emotions. Money is frequently a source of conflict in relationships, often because the persons involved aren't comfortable discussing this emotion-laden topic. Each person may have different financial goals and personal values, leading to different opinions on how to spend/save/invest the family's money. To avoid arguments and resolve conflicts, it is essential to first become aware of each person's attitude toward money and his or her money management style, keep the lines of communication open, and be willing to listen and to compromise. It is possible to accommodate various money management styles within a relationship or family by establishing personal financial plans that take individual needs into account. Some families are able to avoid conflict by establishing separate accounts, such as yours, mine and household, with a set amount allocated to each account each pay period. This way, no one feels deprived, and enough has been set aside to pay the bills and to meet common financial goals.

What is the role of money in setting financial goals? What is the relationship of money to utility?

Money is the exchange medium used as the measure of value in our economy. Money provides the standard unit of exchange (in the case of the U.S., the dollar) by which specific personal financial plans—and progress with respect to these plans—can be measured. Money is therefore the key consideration in establishing financial plans. Utility refers to the amount of satisfaction derived from purchasing certain types or quantities of goods and services. Since money is used to purchase these goods and services, it is generally believed that greater wealth (money) permits the purchase of more and better goods and services that in turn result in greater utility (satisfaction).

The Garcia family has prepared their annual cash budget for 2021. They have divided it into 12 monthly budgets. Although only 1 monthly budget balances, they have managed to balance the overall budget for the year. What remedies are available to the Garcia family for meeting the monthly budget deficits?

Monthly deficits may be handled by shifting expenses to a later month or income to an earlier month. If that is not possible, the Garcia family may withdraw an amount from savings or borrow a short-term loan to get the months in balance. Another alternative is to increase income perhaps with a second job or move to a higher paying job.

What are mortgage points? How much would a home buyer have to pay if the lender wanted to charge 2.5 points on a $250,000 mortgage? When would this amount have to be paid? What effect do points have on the mortgage's rate of interest?

Mortgage points are fees charged by lenders at the time that they grant a mortgage loan. In appearance, points are like interest in that they are a charge for borrowing money. In fact for federal tax purposes, points are deductible as interest. 2.5 points on a $250,000 required the borrower to pay $6,250 [2.5% * 250,000] up front as part of closing costs on the mortgage. The amount would be paid at the time of the closing. Paying points will reduce the interest rate on the loan and thereby the annual cost of the loan. Some refer to points as "buying down the interest rate".

What role does a real estate agent play in the purchase of a house? What is the benefit of the MLS? How is the real estate agent compensated, and by whom?

Most home buyers rely on real estate agents because they're professionals who are in daily contact with the housing market. Once you describe your needs to an agent, he or she can begin to search for appropriate properties. Your agent will also help you negotiate with the seller, obtain satisfactory financing, and, although not empowered to give explicit legal advice, prepare the real estate sales contract. Most real estate firms belong to a local Multiple Listing Service (MLS), a comprehensive listing, updated daily, of properties for sale in a given community or metropolitan area. Buyers should remember that agents typically are employed by sellers. Unless you've agreed to pay a fee to a sales agent to act as a buyer's agent, a realtor's primary responsibility, by law, is to sell listed properties at the highest possible prices. Agents are paid only if they make a sale, so some might pressure you to "sign now or miss the chance of a lifetime."

Describe the procedure used to stop payment on a check. Why might you wish to initiate this process?

Payment on a check is stopped by notifying the bank. Normally, the account holder fills out a form with the check number and date, amount, and the name of the payee. Some banks accept stop-payment orders over the telephone or online and may ask for a written follow-up. Banks charge a fee ranging from $20 to $35 to stop payment on a check. If checks or checkbook are lost or stolen, there's no need to stop payment on them because the holder has no personal liability on that. Several reasons to issue a stop payment order include: · A good or service paid for by check is found to be faulty. · A check is issued as part of a contract that is not carried out.

What are the two types of personal financial statements? What is a budget, and how does it differ from personal financial statements? What role do these reports play in a financial plan?

Personal financial statements provide important information needed in the personal financial planning process. The balance sheet describes your financial condition [that is what assets and liabilities you have] at one point in time. The income and expense statement reports financial performance [cash surplus or deficit] over a given time period typically monthly or annually. Budgets help you plan your future spending. The budget is a statement of the future income or expenses that will result from your financial plan. By comparing the actual income and expenses to the budget you can see when your plan needs to be modified. Together these statements give you information needed for your financial planning process.

Why should you investigate mortgage loans and prequalify for a mortgage early in the home-buying process?

Prequalification can work to your advantage in several ways. You'll know ahead of time the specific mortgage amount that you qualify for—subject, of course, to changes in rates and terms—and can focus your search on homes within an affordable price range. Prequalification also provides estimates of the required down payment and closing costs for different types of mortgages. It identifies in advance any problems, such as credit report errors, that might arise from your application and allows you time to correct them. Finally, prequalification enhances your bargaining power with the seller of a house you want by letting her or him know that the deal won't fall through because you can't afford the property or obtain suitable financing. And since you will have already gone through the mortgage application process, the time required to close the sale should be relatively short.

Describe some of the areas or items you would consider when evaluating your balance sheet and income and expense statement. Cite several ratios that could help in this effort.

Ratios are used to relate items from the financial statements. These ratios provide useful information for specific decisions. From the Balance sheet: Current Ratio: Current Assets divided by Current Liabilities, useful for short term credit decisions Solvency ratio: Total net worth divided by total assets; measures the degree of exposure to insolvency Liquidity ratio: Total liquid assets divided by total current debts; measures the ability to pay current debts. From the Income Statement: Savings ratio: Cash surplus divided by income after taxes, indicates the portion of income you chose to save Debt service ratio: Total monthly loan payments divided by Monthly gross (before tax) income, provides a measure of the ability to pay debts promptly Return on Equity: Cash Surplus (a measure of net income) divided by New Worth, provides a measure of how well you managed your wealth.

Explain why it is important to set realistically attainable financial goals. Select one of your personal financial goals and develop a brief financial plan for achieving it.

Realistic goals are set with a specific focus and a reasonable time frame to achieve results. It is important to set realistically attainable financial goals because they form the basis upon which our financial plans are established. If goals are little more than "pipe dreams," then the integrity of the financial plans would be suspect as well. Students' descriptions of the steps to achieve a specific goal will, of course, vary. They should follow the general guidelines in the chapter: define financial goals, develop financial plans and strategies to achieve goals, implement financial plans and strategies, periodically develop and implement budgets to monitor and control progress toward goals, use financial statements to evaluate results of plans and budgets, and redefine goals and revise plans as personal circumstances change.

Describe the purchase transaction process, including shopping, negotiating price, and closing the deal on a car.

Shopping is all about finding the best car for you. Exhibit 5.2 lists some steps to take. The key is to compare cars and dealers. In addition to assessing reliability, talking with friends who own similar cars and reading objective assessments published by consumer magazines and buying guides such as Consumer Reports gives you great information that helps you hone in on the car for you. Negotiating price can always be done. Before making an offer, prepare a worksheet with the cost versus the list price for the exact car you want. The more information you have, the better you will be at negotiating price. You need to avoid anchoring [allowing the initial price to dominate assessment of value] and you need to be ready to walk away. There is always another car or dealer that is available to you. Closing the deal involves executing a sales contract. Whether you're buying a new or used car, to make a legally binding offer, you must sign a sales contract that specifies the offering price and all the conditions of your offer. At this point the dealer will offer a variety of add-ons that will increase the price. Again, knowing that this will happen and being prepared will help you stick to the purchase of the car and not the other services.

What information is normally included in a real estate sales contract? What is an earnest money deposit? What is a contingency clause?

State laws generally specify that, to be enforceable in court, real estate buy-sell agreements must be in writing and contain certain information, including: (1) the names of buyers and sellers, (2) a description of the property sufficient for positive identification, (3) specific price and other terms, and (4) usually the signatures of the buyers and sellers. An earnest money deposit is the money that you pledge to show good faith when you make an offer. If, after signing a sales contract, you withdraw from the transaction without a valid reason, you might have to forfeit this deposit.A valid reason for withdrawal would be stated in the contract as a contingency clause. With a contingency clause, you can condition your agreement to buy on such factors as the availability of financing, a satisfactory termite inspection or other physical inspection of the property, or the advice of a lawyer or real estate expert.

Distinguish between gross earnings and take-home pay. What does the employer do with the difference?

Take-home pay is the gross earnings less required income tax withholding, FICA taxes [Social Security and Medicare taxes], and less any fringe benefits paid for by taxpayer such as group life insurance or employee business expenses paid by taxpayer, such as a uniform. The employer remits the withholding to the IRS for crediting to the taxpayer's account. The employer also pays the vendor for the various fringe benefits.

Define estimated taxes and explain under what conditions such tax payments are required.

Taxpayers who do not work for an employer, must pay their own taxes four times a year: April 15, June 15, October 15, and January 15 of following year. Any income in excess of $600 on which taxes have not been withheld received by the taxpayer will require the taxpayer to pay estimated taxes.

Describe the features of an AMA, its advantages, and its disadvantages.

The AMA [Asset Management Account] is a comprehensive deposit account that combines checking, investing, and borrowing activities and is offered primarily by brokerage houses and mutual funds. AMAs appeal to investors because they can consolidate most of their financial transactions at one institution and on one account statement. A typical AMA account includes an MMDA [Money Market Demand Account] with unlimited free checking, a Visa or MasterCard debit card, use of ATMs, and brokerage and loan accounts. Their major advantage is that they "sweep" balances in excess of a minimum amount into a money market fund which pays a higher interest than banks. Disadvantages include a lack of "branch locations" compared to commercial banks. Also, the ATM transactions are handled through affiliates and are more costly than banks.

What role does the FDIC play in insuring financial institutions? What other federal insurance program exists? Explain.

The FDIC provides deposit insurance on accounts up to $250,000 for commercial banks and thrift institutions. The FDIC insurance requires a deposit account at the financial institution. This type of insurance is not available on money market mutual funds, which are offered by investment companies, but it is offered by credit unions which are insured by the National Credit Union Administration (NCUA). The National Credit Union Share Insurance Fund (NCUSIF) is the federal fund used by the NCUA to insure accounts at credit unions for up to $250,000 per depositor.

What types of assistance and tax preparation services does the IRS provide?

The IRS attempts to provide tax assistance on a walk-in basis at its various offices in the larger cities. The IRS also attempts to provide telephone assistance via toll free numbers. Also at irs.gov there are a large number of publications and instructions designed to help taxpayers and tax professionals prepare returns. With the budget cuts, the tax filing season has shown a sharp decline in service from the IRS.

What factors determine the amount of interest you will earn on a deposit account? Which combination provides the best return?

The amount of interest earned depends on several factors, including frequency of compounding, how the bank calculates the balances on which interest is paid, and the interest rate itself. Look for daily or continuous compounding and a balance calculation using the "day of deposit to day of withdrawal" method. This is the most accurate balance determination and gives depositors the highest interest earnings for a given period. It is also considered the fairest procedure since depositors earn interest on all funds on deposit during the period. This method is sometimes called daily interest, but it should not be confused with the daily compounding of interest, which is an entirely different concept.

What is average propensity to consume? Is it possible for two people with very different incomes to have the same average propensity to consume? Why?

The average propensity to consume is the percentage of each dollar of a person's income that is spent (rather than saved), on average, for current needs rather than savings. Yes, it is quite possible to find two persons with significantly different incomes with the same average propensity to consume. Many people will increase their level of consumption as their incomes rise, i.e., buy a nicer home or a newer car. Thus, even though they may have more money, they may still consume the same percentage (or more) of their incomes as before.

What is the balance sheet equation? Explain when a family may be viewed as technically insolvent.

The balance sheet equation is: Net Worth = Total Assets - Total Liabilities A family is technically insolvent when their net worth is less than zero. This indicates that the amount of their total liabilities is greater than the fair market value of their total assets.

Describe the balance sheet, its components, and how you would use it in personal financial planning. Differentiate between investments and real and personal property.

The balance sheet summarizes your financial position by showing your assets (what you own listed at fair market value), your liabilities (what you owe), and your net worth (the difference between assets and liabilities) at a given point in time. With a balance sheet, you know whether your assets are greater than your liabilities, and by comparing balance sheets for different time periods, you can see whether your net worth is growing. Investments are intangible assets that have market value [such as stock] and you hold in hopes of future increases in value and future income. Real property is an asset that is affixed to the ground, example is a house. Personal property is tangible property that is not real property, example is a car or furniture.

Explain what cash basis means in this statement: "An income and expense statement should be prepared on a cash basis." How and where are credit purchases shown when statements are prepared on a cash basis?

The cash basis only records income that is received in cash or expenses that are paid in cash during the period. It does not include as income any amount that you are due [receivables] or an expense that you will have to pay in the future [liabilities]. Payments on liabilities should be divided into payment of interest and payments on principle, but both are listed as expenses on a cash statement. Obviously, the cash statement does not give a complete picture of a person's income or expenses, but since most individuals do not have receivables and their liabilities are managed with monthly payments, the cash statement gives good information for financial planning.

Explain the effects that historically low interest rates have on borrowers, lenders, savers, and retirees.

The current low interest rate encourages businesses to rely on debt which increases the risk of going into business. Also, the low rate discourages saving which has negative impact for the long run financial health of the financial plan. Inflation adjusted real interest rate has been negative, which means that savers are not keeping up with inflation and will either have to tap into their principal or cut their spending. This is bad for retirees and the overall economy. The benefits of lower interest rates include the reduced costs of financing the massive federal budget deficit, which is a significant savings given that interest on the federal debt was $383 billion in 2019. And lower rates have helped support the "too big to fail" banks. Indeed, the Fed's low interest rate policy has allowed banks to pay less than 1 percent interest on savings. But the costs are equally impressive. Low interest rates reduce income to retirees and to pension funds. Some retirees will have to dip into their principal, which could put more stress on welfare programs for the elderly and may prompt the government to increase its financial support of underfunded pension funds.

Given your personal financial circumstances, if you were buying a car today, would you probably pay cash, lease, or finance it, and why? Which factors are most important to you in making this decision?

The factors referred to in 5-3 answer will apply here. Most students are concerned with down payments and getting more car than they can afford. Thus, leasing will look good. If you have the funds to pay cash, then you need to compare the amount you can earned on the funds if invested with the cost of financing the car. Some dealers offer "zero cost financing" but they may adjust price of car to make up the profit from financing. You are the buyer; make the seller give you full information.

Briefly define the five filing categories available to taxpayers. When might married taxpayers choose to file separately?

The five filing statuses are: Single taxpayer is not married on last day of year Married filing jointly—both parties to the marriage agree and take responsibility for the tax return. They must be married on the last day of the year. Married filing separate—there are two returns filed by the married couple. Each spouse is responsible for reporting his or her own income and tax. The married filing separate tax rates are the highest of the four sets of tax rates. Surviving Spouse [Qualifying widow(er)]—For the two years after death of a spouse, the surviving spouse may use the joint rates as long as they have a dependent child living with them. Head of Household—Unmarried taxpayer who provides a household for a qualified person living with them. There is an exception for abandoned spouses and for parents living in a retirement home paid for by taxpayer. It will be a rare case where a couple will decide to file married filing separately.Examples are where one spouse does not want to be liable for the other's unpaid taxes.In very unusual cases, one spouse may be able to deduct higher itemized deductions by filing separately.

Briefly describe the two basic types of mortgage loans. Which has the lowest initial rate of interest? What is negative amortization, and which type of mortgage can experience it? Discuss the advantages and disadvantages of each mortgage type.

The fixed-rate mortgage still accounts for a large portion of all home mortgages. Both the rate of interest and the monthly mortgage payment are fixed over the full term of the loan. The payments are fixed and there is no uncertainty with the loan. The adjustable-rate mortgage (ARM) provides that the rate of interest, and therefore the size of the monthly payment, is adjusted based on market interest rate movements. Typically, the ARM will have lower rated than the fixed-rate mortgage, at least initially. The rates will change as the general interest rates vary at each adjustment date, generally every five years. Some ARMs are subject to negative amortization— an increase in the principal balance resulting from monthly loan payments that are lower than the amount of monthly interest being charged. In other words, you could end up with a larger mortgage balance on the next anniversary of your loan than on the previous one.

What is an income and expense statement? What role does it serve in personal financial planning?

The income and expense statement capture the actual result of financial activities. If income exceeds expenses, your wealth increases for stated time period, a month or a year. In personal financial planning, the statement permits comparison of actual results to the budgeted values to help you evaluate your financial plan.

What does the loan-to-value ratio on a home represent? Is the down payment on a home related to its loan-to-value ratio? Explain.

The loan-to-value ratio specifies the maximum percentage of the value of a property that the lender is willing to loan. For example, if the loan-to-value ratio is 80 percent, the buyer will have to come up with a down payment equal to the remaining 20 percent.

Cooper Bryant's investments over the past several years have not lived up to his full return expectations. He is not particularly concerned, however, because his return is only about 2 percentage points below his expectations. Do you have any advice for Cooper?

The loss of two percentage points on investment returns is anything but inconsequential, particularly if the loss occurs annually over a period of several years. For example, if Cooper had invested $1,000 at an 8 percent return and subsequently had invested all earnings from the initial investment at 8 percent, in 40 years he would have accumulated $21,725 from the initial $1,000 investment. If, on the other hand, he had earned a 10 percent return on the same investment, he would have accumulated $45,259 in 40 years—more than double his return at 8 percent! Clearly, two percentage points over time can make a significant difference! Calculate various rates of return on a $1,000 investment to see that for every 2 percent increase in return, your investment results will more than double over a 40-year period. By carefully considering his investment and banking choices, it is likely that Cooper would be able to get a 2 percent greater rate of return without taking on additional risk. This can be done both by choosing investments and bank accounts that hold down expenses, as well as by finding investments of the same type that have performed better.

What are the stages of an economic cycle? Explain their significance for your personal finances.

The stages of the economic cycles are expansion, peak, contraction, and trough. Each of these stages relates to real gross domestic product (GDP), which is an important indicator of economic activity. The stronger the economy, the higher the levels of real GDP and employment. During an expansion, employment is high, the economy is active and growing, and prices tend to rise. During an expansion, real GDP increases until it hits a peak, which usually signals the end of the expansion and the beginning of a contraction. During a contraction, real GDP falls into a trough, which is the end of a contraction and the beginning of an expansion. An understanding of these four basic stages, coupled with knowledge of the stage in which the economy is presently operating, should permit individuals to adjust and implement financial actions in order to efficiently and successfully achieve their personal financial goals.

Discuss briefly how the following situations affect personal financial planning: c. Death of a spouse

The surviving spouse is typically faced with decisions on how to receive and invest life insurance proceeds and manage other assets. In families where the deceased made most of the financial decisions with little or no involvement of the surviving spouse, the survivor may be overwhelmed by the need to take on financial responsibilities. Advance planning can minimize many of these problems.

Explain two ways in which net worth could increase (or decrease) from one period to the next.

There are basically two ways to achieve an increase in net worth. First, one could prepare a budget for the pending period to specifically provide for an increase in net worth by acquiring more assets and/or paying down debts. Then you take steps to attain this budget. If you accomplished this by planning and control of income and expenses your net worth increases. A second approach would be to forecast expected increases in the market value of certain assets—primarily investment and tangible property assets. If the market value of the assets increased as expected and liabilities remained constant or decreased, an increase in net worth would result. (Note: Decreases in net worth would result from the opposite strategies/occurrences.) Of course, there is also the old fashion way, you inherit wealth.

"There's no sense in worrying about retirement until you reach middle age." Discuss this point of view.

This statement reflects a very limited and too often expressed point of view. Due to the inconsistencies and vagaries of our economic system—and of life itself!—the goals of and plans for retirement should be established early in life. If retirement goals are incorporated into an individual's financial planning objectives, short- and long-term financial plans can be coordinated. Thus, financial plans can guide present actions not only to maximize current wealth and/or utility, but also to provide for the successful fulfillment of retirement goals. Furthermore, if retirement is desired earlier than anticipated, the plans may still permit the fulfillment of retirement goals.

What is a professional financial planner? Does it make any difference whether the financial planner earns money from commissions made on products sold as opposed to the fees he or she charges?

Unlike accounting and law, the field professional financial planning field is largely unregulated, and almost anyone can call themselves a professional financial planner. Most financial planners are honest and reputable, but there have been cases of fraudulent practice. So, it's critical to thoroughly check out a potential financial advisor-preferably interview two or three. Most financial planners fall into one of two categories based on how they are paid: commissions or fees. Commission-based planners earn commissions on the financial products they sell, whereas fee-only planners charge fees based on the complexity of the plan they prepare. Many financial planners take a hybrid approach and charge fees and collect commissions on products they sell, offering lower fees if you make product transactions through them. The way a planner is paid—commissions, fees, or both—should be one of your major concerns. Obviously, you need to be aware of potential conflicts of interest when using a planner with ties to a brokerage firm, insurance company, or bank. Many planners now provide clients with disclosure forms outlining fees and commissions or various transaction costs.

What are your legal rights and responsibilities when using EFTSs?

You are responsible for your actions. To prevent unauthorized charges you must notify the issuer promptly. You must notify the bank immediately about the theft, loss, or unauthorized use of your EFTS card. Notification within 2 business days after you discover the card missing limits your loss to $50. After 2 business days, you may lose up to $500 (but never more than the amount that was withdrawn by the thief). If you don't report the loss within 60 days after your periodic statement was mailed, you can lose all the money in your account.

What type of information is found in the monthly bank statement, and how is it used? Explain the basic steps involved in reconciling an account.

Your monthly bank statement contains an itemized listing of all transactions (checks written, deposits made, electronic funds transfer transactions such as ATM withdrawals and deposits and automatic payments) within your checking account. It also includes notice of any service charges levied or interest earned in the account. Many banks also include canceled checks [or image of check] and deposit slips with the bank statement. The monthly bank statement can be used to verify the accuracy of the account records and to reconcile differences between the statement balance and the balance shown in the checkbook ledger. The monthly statement is also an important source of information needed for tax purposes. The basic steps in the account reconciliation process are: 1. Upon receipt of the bank statement, arrange all canceled checks in descending numerical order based on their sequence numbers or issuance dates. 2. Compare each check amount, from the check itself or the statement, with the corresponding entry in the checkbook ledger to make sure that no recording errors exist. Place a checkmark in the ledger alongside each entry compared. Also check off any other withdrawals, such as from ATMs or automatic payments, and make sure to add any checks written or deposits made which are shown on the bank statement, but you forgot to record in your checkbook. 3. List all checks and other deductions (ATM withdrawals, automatic payments) still outstanding (deducted in the checkbook but not returned with the statement.) 4. Repeat the process for deposits. All automatic deposits and deposits made at ATMs should be included. Determine the total amount of deposits made but not shown on the bank statement (deposits in transit). 5. Subtract the total amount of checks outstanding (from step 3) from the bank statement balance and add the amount of outstanding deposits (from step 4) to this balance. The resulting amount is the adjusted bank balance. 6. Deduct the amount of any service charges levied by the bank and add any interest earned to the checkbook ledger balance. The resulting amount is the new checkbook balance. This amount should equal the adjusted bank balance (from step 5). If not, check all of the addition and subtraction in the checkbook ledger, because there probably is a math error.

Briefly describe each of these special types of checks:

a. A cashier's check is drawn on the bank, rather than a personal or corporate account, so that the bank is actually paying the recipient. There is a service fee in addition to the face amount. b. Traveler's checks provide a safe, convenient way to carry money while traveling because they are insured against loss. They are purchased from financial institutions in certain denominations for the face value plus a fee. c. A certified check is a personal check guaranteed by the bank as to availability of funds. The bank charges minimal or no charge fee for this guarantee.

Define and discuss (a) demand deposits, (b) time deposits, (c) interest-paying checking accounts.

a. Demand deposit refers to an account held at a financial institution from which funds can be withdrawn (in check or cash) upon demand by the account holder. As long as sufficient funds are in the account, the bank must immediately pay the amount indicated when presented with a valid check or when accessed with a debit card or when the account holder appears in person. This means that money in checking accounts is liquid and can be easily used to pay bills and make purchases. b. Time deposits are expected to remain untapped for a longer period of time than demand deposits. While financial institutions generally retain the right to require a savings account holder to wait a certain number of days before receiving payment on a withdrawal, most are willing to pay withdrawals immediately. Typically, a savings account pays interest at a fixed rate, and money is held in this type of account in order to accumulate funds for known future expenditures or to meet unexpected financial needs. c. Interest-paying checking accounts are distinguished from regular checking accounts which are not required to pay interest. As a result of the changes in the laws governing financial institutions in the late 1970s and early 1980s, depositors now have the opportunity to choose among a wide variety of accounts to meet their checking and cash balance needs. Each of these accounts has its own specific characteristics. Interest-paying checking accounts include money market mutual funds (MMMFs) which are offered through investment (mutual fund) companies and are not FDIC insured, money market deposit accounts (MMDAs), and NOW accounts. MMDAs and NOW accounts are available at virtually every deposit-taking financial institution in the U.S. and are federally insured (provided the institution offers FDIC or NCUA insurance, and virtually all do).

Explain how the following are used in filing a tax return: (a) Form 1040, and (b) tax rate schedules.

a. Form 1040 is the main form used in filing federal income taxes. All individuals filing may use Form 1040 accompanied by appropriate schedules as needed to file their tax return. The form's two pages summarize all items of income, the deductions detailed on the accompanying schedules, and computes the taxable income and associated tax liability. b. Tax rate schedules provide the information for calculating the tax due after all deductions and exemptions have been taken to arrive at taxable income. There are different tax tables for the various filing categories. While the rates are the same for all filing statuses, the brackets vary according to the filing status.

Briefly describe the key characteristics of each of the following forms of interest paying checking accounts: (a) NOW account, (b) MMDA, and (c) MMMF.

a. NOW accounts (or negotiable order of withdrawal accounts) have been popular since the removal, beginning in 1986, of all interest rate restrictions. The account itself pays interest and offers unlimited check writing privileges so that investors can view the account as both a savings account and a convenience checking account. While no legal minimum account balance exists, many institutions impose at least a $500 minimum. Many banks also charge fees on the use of these accounts, such that in some cases the fees may negate the amount of interest earned. b. Money market deposit accounts (MMDAs) are vehicles offered by banks, S&Ls, and other depository institutions to compete with money market mutual funds. Unlike MMMFs, MMDAs are federally insured. Depositors have access to their funds through check-writing privileges or through automated teller machines. However, most require minimum balances, and there is usually a limit on the total number of transfers permitted during a month, with additional transfers subject to a penalty charge. This limits the flexibility of the accounts, but most people look upon them as savings accounts rather than as convenience accounts, so this is normally not a serious obstacle. c.Money market mutual funds (MMMFs)are offered by investment companies and pool the funds of many small investors to purchase high-yielding, short-term marketable securities offered by the U. S. Treasury, major corporations, large commercial banks, and various government organizations. The main advantage of these types of accounts to the small investor is that you can indirectly own these types of marketable securities by making fairly small minimum deposits, often 500; owning such securities directly may require a higher minimum investment.The interest rate earned on a MMMF depends on the returns earned on its investments, which fluctuate with overall credit conditions. Investors typically have instant access to their funds through check-writing privileges, although the checks often must be written for at least a stipulated minimum amount. In the banking system, checks written on MMMFs are treated just like those written on any other demand deposit account, and although they are considered very safe, these funds are not federally insured.

Explain each of the following strategies for reducing current taxes: (a) maximizing deductions, (b) income shifting, (c) tax-free income, and (d) tax-deferred income.

a. Taxpayers can maximize deductions by accelerating or bunching their deductions into one tax year. Examples include paying next year's property taxes early in order to be able to count both, this year's and next year's taxes on this year's return and bunching non-reimbursable elective medical procedures into one year. Such actions may make it advantageous for a taxpayer to itemize deductions for at least one year versus having to take the standard each year. b. Income shifting is a technique for reducing taxes by shifting some income to a family member in a lower tax bracket. This is done by creating trusts or custodial accounts or making outright gifts of income-producing property to family members. (Note: The age of the family member will affect the tax benefits of this strategy.) Also, you may shift income from one year to the next in order to tax advantage of lower rates expected in the next year. c. Tax-free income is income which is free from federal income taxation. For example, qualified municipal bonds pay interest income which is free from federal income taxes. However, if you live where there is a state and/or local income tax, qualified municipal bonds from other states will be subject to your state and local income taxes. Be aware that not all municipal bonds qualify for the tax-exempt status and that capital gains on the sale of municipal bonds are not tax free! d. Tax-deferred income allows you to reduce or eliminate taxes today by postponing them to sometime into the future, perhaps after retirement. The appeal of tax-deferred vehicles, such as IRAs and 401(k) plans, is their ability to allow the investor to accumulate earnings in a tax-free fashion. This will allow the investment to grow to a larger amount before it is subject to taxation, and the idea with this is that many people will be in a lower income tax bracket after retirement. Then, when income is taxed after retirement, not as much will be lost to taxes. However, many retired people are in the same or sometimes higher tax bracket than they were before retirement.

Why is it important to use time value of money concepts in setting personal financial goals?

A dollar today and a dollar in the future may enable you to purchase different amounts of goods and services, because if you have a dollar today, you can invest it and it will grow to more than a dollar in the future. At the same time, inflation works against the dollar, because rising prices erode its purchasing power. Time value of money concepts help us quantify these changes in dollar values so that we can plan the amount of money needed at certain points in time in order to fulfill our personal financial goals.

Would it be possible for an individual to have, say, six or seven checking and savings accounts at the same bank and still be fully protected under federal deposit insurance? Explain. Describe how it would be possible for a married couple to obtain as much as $1,500,000 in federal deposit insurance coverage at a single bank.

A married couple can obtain as much as $1,500,000 in coverage, apart from the coverage of CDs noted below, by setting up several accounts: • One in the name of each spouse ($500,000 in coverage) • A joint account in both names (good for $500,000, which is $250,000 per account owner) • Separate trust or self-directed retirement (IRA, Keogh, etc.) accounts in the name of each spouse (good for an additional $250,000 per spouse)

Describe a real estate short sales transaction. What are the potential benefits and costs from the perspective of the homeowner?

A real estate short sale is the sale of property in which the proceeds are less than the balance owed on a loan secured by the property sold. This procedure is an effort by mortgage lenders to come to terms with homeowners who are about to default or are defaulting on their mortgage loans. Although it certainly can reduce a lender's losses, it can also be beneficial for the homeowner. A real estate short sale will avoid having a foreclosure appear on the homeowner's credit history. Short sales should also help homeowners manage the costs that got them into trouble in the first place. Finally, a short sale is usually faster and cheaper for the homeowner than a foreclosure. Most short sales fully satisfy the debt owed, but this is not always the case, so homeowners should confirm this in the settlement.

What is the purpose of a tax audit? Describe some things you can do to be prepared if your return is audited.

A tax audit is a review of a tax return to prove its accuracy with regard to the proper reporting of income and deductions. Some taxpayers are chosen randomly for audits, while others are audited because certain income or deduction items fall outside of normal ranges. The best way to be prepared for an audit is to keep thorough records of cash receipts and expenditures and receipts from other deductible items. Especially when you have deductions that fall outside the IRS norms, be sure to have proper documentation and attach an explanation of such deductions to your return. And stay calm; it is only an audit.

Differentiate among conventional, insured, and guaranteed mortgage loans.

A conventional mortgage is a mortgage offered by a lender who assumes all the risk of loss. To protect themselves, lenders usually require a down payment of at least 20 percent of the value of the mortgaged property. To promote homeownership, the federal government, through the Federal Housing Administration (FHA), offers lenders mortgage insurance on loans with a high loan-to-value ratio. These loans usually feature low down payments, below-market interest rates, few if any points, and relaxed income or debt-ratio qualifications. Guaranteed loans are similar to insured loans, but better—if you qualify. VA loan guarantees are provided by the U.S. Veterans Administration to lenders who make qualified mortgage loans to eligible veterans of the U.S. armed forces and their unmarried surviving spouses. The VA loans are limited to veterans while the FHA insured loans are available to all citizens.

How can accurate records and control procedures be used to ensure the effectiveness of the personal financial planning process?

Before you can set realistic goals, develop your financial plans, or effectively manage your money, you must take stock of your current financial situation. Without accurate records, you do not have the needed information to make your financial decisions.

"All people who have equivalent formal education earn similar incomes." Do you agree or disagree with this statement? Explain your position.

Disagree. Although higher levels of education may result in higher levels of income, this does not mean that everyone with a given level of education will achieve a specified level of income. Factors such as age, marital status, geographical location, and career choice also impact a person's level of income. A number of other factors, such as the degree of personal motivation and the methods by which one utilizes his or her formal education, can also affect one's income level.

Distinguish between fixed and variable expenses, and give examples of each.

Fixed expenses are contractual, predetermined expenses that are made each period, such as rent, mortgage and loan payments, or insurance premiums. Once the decision to incur the expense, fixed expenses are not controllable. Variable expenses change each period. These include food, utilities, charge card bills, and entertainment. In general, you have control over a variable expense.

What are the advantages and disadvantages of leasing a car?

Leasing is another way to pay for a car. You need to first look at the cost of leasing versus buying. Note the Financial Road sign in the chapter, "When Does it make Sense to Lease a Car?" The reasons are mostly not financial. If you plan to keep the car for 150,000 miles, buying will be better for you. Worksheet 5.1 gives a form for comparing the lease versus buy option.

Why is it important to have a written lease? What should a rental contract include?

Oral agreements may be binding as to the additional services that are offered by the lessor. However, the written lease agreement will govern the use of the real estate. Most leases are written to protect the lessor, but there will be some provisions that gives the lessee rights. It is important to read the agreement even though it has a lot of legalize that is boring to read. You need to understand what you sign.

Describe the various sources of mortgage loans. What role might a mortgage broker play in obtaining mortgage financing?

The major sources of home mortgages today are commercial banks, thrift institutions, and mortgage bankers or brokers; also, some credit unions make mortgage loans available to their members. Most mortgage brokers also have ongoing relationships with different lenders, thereby increasing your chances of finding a loan even if you don't qualify at a commercial bank or thrift institution.

What are the most common guidelines used to determine the monthly mortgage payment one can afford?

The most common guidelines used to determine the amount of monthly mortgage payments one can afford are the affordability ratios that stipulate: · Monthly mortgage payments should not exceed 25 to 30% of the borrower's monthly gross (before tax) income; and · The borrower's total monthly installment loan payments (mortgage and other consumer loan payments) should not exceed 33 to 38% of monthly gross income.

What is a progressive tax structure and the economic rationale for it?

The progressive tax structure uses a progressive tax rate where the rate increases [ from 10% to 37% as taxable income increases. The economic concepts supporting the progressive tax are ability-to-pay and marginal utility of income. Those will higher income have the ability to pay a higher tax, thus a progressive rate. Also, the higher income, the less pain associated with the loss of a dollar, thus the diminishing marginal utility of income.

Briefly describe (a) debit cards, (b) banking at ATMs, (c) preauthorized deposits and payments, (d) bank-by-phone accounts, and (e) online banking and bill-paying services.

These are alternative forms of Electronic Funds Transfers systems. They provide convenience to the customers and cost savings to the banks. Security is always an issue. The customer must safeguard their passwords [PIN] and the bank must have security procedures for its system. With sophisticated hackers, the risk of electronic funds transfers is a concern. a. Debit cards are specially coded plastic cards that permit cash withdrawals at ATM machines or allow a transfer of funds from your checking account to the recipient's account. ATM cards are one form of debit card, and Visa and MasterCard also issue debit cards. They provide a convenient form of payment and are accepted at many retail and service establishments. But remember to record all debit card purchases in your checkbook ledger to avoid overdrawing your account. For some transactions, the bank will withhold an additional amount to the charge to provide for anticipated changes in the amount of the final transactions, e.g. tips at a restaurant. Such additional charges may cause overdrafts. b. An automated teller machine (ATM) is a remote computer terminal at which bank customers can make deposits, withdrawals, and other types of basic transactions. The ATM can operate 24 hours a day, seven days a week. Banks and other depository institutions locate them in places convenient to shopping, offices, and travel facilities. Most banks do not charge their customers for this service. If not a customer, they do charge. c. Another form of EFTS service is the pre-authorized deposit, an automatic deposit made directly into your checking account on a regular basis. Some examples are paychecks, social security payments, and pension checks. Similarly, preauthorized payments allow a customer to authorize the bank to automatically make monthly payments for mortgages and other loans, utilities, or mutual fund purchases. d. Bank-by-phone accounts allow customers to make many types of banking transactions using their telephones. They can either talk to a customer service representative or use a touch-tone phone to verify balances, find out whether a check has cleared, transfer funds, and, at some banks, pay bills. e. Online banking and bill payment services enable one to handle nearly all account transactions from a personal computer at any time of the day or night and on any day of the week. Basically, with an online banking setup the customer instructs the bank to pay various bills by electronically transferring funds to designated payees. One can also call up a current "statement" on the computer screen at any time to check on the status of transactions, including checks written the traditional way. However, these systems do not permit one to make deposits or cash withdrawals through the home computer. This can only be accomplished by going to the bank or an ATM. The cost of electronic home banking systems is small once the person has the computer. The cost of a full-service teller transaction is about $1, an ATM transaction is less than 30 cents, and an Internet transaction is less than 1 cent.

Is it possible to have a cash deficit on an income and expense statement? If so, how?

Yes, a cash deficit appears on a cash basis income and expense statement whenever the period's expenses exceed income. Deficit spending is made possible by using up an asset, such as taking money out of savings, selling an asset such as an investment, or incurring more debt, such as charging a purchase on a credit card.

Briefly discuss how each of these purchase considerations would affect your choice of a car:

a. Affordability This is your first step. You'll need to calculate two numbers unless you can pay cash for the entire cost of the car. • Amount of down payment: This money will come from savings, so be sure not to deplete your emergency fund. • Size of the monthly loan payment you can afford: Analyze your available resources—after considering your other expenses, including housing—and then your transportation requirements. Don't forget to include insurance. Your monthly car payment should be no more than 20 percent of your monthly net income. b. Operating costs The out-of-pocket cost of operating an automobile includes not only car payments but also insurance, license, fuel, oil, tires, and other operating and maintenance outlays. Also, consider how quickly the car will decline in value or depreciate. While, this is not an out-of-pocket or cash cost, it will impact the future value of the car. c. Gas, diesel, hybrid, or electric? Each of these options will impact the annual operating costs and the initial purchase cost. If you want to go "green" regardless of the cost, you may select a hybrid [gas and electric] or an electric car. With gas prices around $3 per gallon, the miles per gallon of gas number is important. Each option has advantages and disadvantages. Diesel can pollute more and may produce more noise. Hybrid will cost more initially and may have higher repair prices. Electric may have some performance [acceleration or power to climb hills] issues and access to charging stations especially in rural areas. d. New, used, or "nearly new"? Exhibit 5.2 list steps to consider in finding the care for you. You may be able to afford a "luxury" car by buying a used car. The cost may be about 25% less by buying a used car than a new car. If you plan to drive a car 150,000 miles, buying a car with 30,000 miles may not be a problem. Leased car are a good source, however, dealers are pricing these cars higher than they did five year ago and may not be the best source. e. Size, body style, and features Your personal choices and family status will control these features. The options that add to the cost of a new car, will have little impact on the price of a used car. While most people need a car for transportation and therefore the style may not matter, some need a car that will enhance their status either for business or personal purposes. f. Reliability and warranty protection Assess thereliabilityof a car by talking with friends who own similar cars and reading objective assessments published by consumer magazines and buying guides such asConsumer Reports. Study thewarrantyoffered by new car manufacturers, comparing those for cars that interest you.

Briefly describe the basic features of each of the following savings vehicles: (a) CDs, (b) U.S. Treasury bills, (c) Series EE bonds, and (d) I savings bonds.

a. Certificates of deposit (CDs) are savings instruments that require funds to remain on deposit for a specified period of time and can range from seven days to a year or more. Although it is possible to withdraw funds prior to maturity, an interest penalty usually makes withdrawal somewhat costly. While the bank or other depository institution can impose any penalty it wants, most result in a severely reduced rate of interest—typically a rate no greater than that paid on its most basic regular savings account. CDs are attractive for the high competitive yields they offer, the ease with which they can be purchased, and the protection offered by federal deposit insurance. In addition to purchasing CDs directly from the issuer, "brokered CDs" can be purchased from stockbrokers. b. U.S. Treasury bills (T-bills) are obligations of the U.S. Treasury issued as part of the on-going process of funding the national debt. T-bills are sold on a discount basis now in minimum denominations as low as $1,000 and are issued with 3-month (13-week), 6-month (26-week), and one-year maturities. They carry the full faith and credit of the U.S. government and pay an attractive and safe yield that is free from state and local income taxes. They are almost as liquid as cash, because they can be sold at any time in a very active secondary market without any interest penalty. If they should be sold before maturity, however, one can lose money if interest rates have risen. In addition, broker's fees have to be paid in order to sell T-bills prior to maturity. c. Series EE bonds are the well-known savings bonds that have been around for decades. They are often purchased through payroll deduction plans or at banks or other depository institutions. Though issued by the U.S. Treasury, they are very different from U.S. Treasury bills. The fixed interest rate is set every six months in May and November, and change with prevailing Treasury security market yields. They increase in value every month, and the fixed interest rate is compounded semiannually. The interest is exempt from state and local taxes and, for federal tax purposes, it does not have to be reported until the bonds are cashed. In addition, when the bond proceeds are used to pay educational expenses, such as college, the tax on bond earnings may be partially or completely avoided if the taxpayer's income falls below a certain level at the time of redemption (other restrictions apply). d. I Savings Bonds are similar to Series EE bonds in numerous ways. Both are issued by the U.S. Treasury and are accrual-type securities. I bonds are available in denominations between $25 and $10,000. Interest compounds semiannually for 30 years on both securities. Like Series EE bonds, I savings bonds' interest remains exempt from state and local income taxes but does face state and local estate, inheritance, gift, and other excises taxes. Interest earnings are subject to federal income tax but may be excluded when used to finance education with some limitations. There are some significant differences between the two savings vehicles. Whereas Series EE bonds are sold at a discount, I bonds are sold at face value. I savings bonds differ from Series EE bonds in that their annual interest rate combines a fixed rate that remains the same for the life of the bond with a semi-annual inflation rate that changes with the Consumer Price Index for all Urban Consumers (CPI-U). In contrast, the rate on Series EE bonds is based on the 6-month averages of 5-year Treasury security market yields. Thus, the key difference between Series EE bonds and I bonds is that I bond returns are adjusted for inflation. Note in particular that the earnings rate cannot go below zero and that the value of I bonds cannot drop below their redemption value. Like Series EE bonds, I bonds can be bought on the Web or via phone. I bonds offer the opportunity to "inflation-protect" your savings somewhat. I bonds cannot be bought or sold in the secondary market; transactions are only with the U.S. Treasury.

Describe the cash budget and its three parts. How does a budget deficit differ from a budget surplus?

A cash budget is a summary of estimated cash income and cash expenses for a specific time period, typically a year. The three parts of the cash budget include: the income section where all expected income is listed; the expense section where expected expenses are listed by category; and the surplus or deficit section where the cash surplus or deficit is determined both on a month-by-month basis and on a cumulative basis throughout the year. Abudget deficit occurs when the planned expenses for a period exceed the anticipated income in that same period. Abudget surplus occurs when the planned income for the period exceeds its planned expenses.

What are the advantages of using tax preparation software?

Tax software provides guidance, computation, and form preparation based upon taxpayer inputs. It works and is not expensive. There is a learning curve to the use of software. Thus, there are significant advantages of using the same software as you used the previous year.

In addition to single-family homes, what other forms of housing are available in the United States? Briefly describe each of them.

Single-family homes: They can be stand-alone homes on their own legally defined lots or row houses or townhouses that share a common wall. As a rule, single-family homes offer buyers privacy, prestige, pride of ownership, and maximum property control. Condominiums: The term condominium, or condo, describes a form of ownership rather than a type of building. Condominiums can be apartments, townhouses, or cluster housing. The condominium buyer receives title to an individual residential unit and joint ownership of common areas and facilities such as lobbies, swimming pools, lakes, and tennis courts. Cooperative apartments: In a cooperative apartment, or co-op, building, each tenant owns a share of the nonprofit corporation that owns the building. Residents lease their units from the corporation and pay a monthly assessment in proportion to ownership shares, based on the space they occupy. Rental units: Some individuals and families choose to rent or lease their place of residence rather than own it. They may be just starting out and have limited funds for housing, or they may be uncertain where they want to live. Perhaps they like the short-term commitment and limited maintenance responsibilities.

What is a standard of living? What factors affect the quality of life?

Standard of living, which varies from person to person, represents the necessities, comforts, and luxuries enjoyed by a person. It is reflected in the material items a person owns, as well as the costs and types of expenditures normally made for goods and services. Although many factors such as geographic location, public facilities, local costs of living, pollution, traffic, and population density affect one's quality of life, the main determinant of quality of life is believed to be wealth.

Differentiate between tax evasion and tax avoidance.

Tax avoidance is the practice of using various legal strategies to reduce one's tax liability. Tax evasion, on the other hand, refers to illegal means of reducing taxes, such as underreporting income or overstating deductions.

Distinguish between a checking account and a savings account.

A checking account held at a financial institution is a demand deposit, meaning, that the bank must permit these funds to be withdrawn whenever the account holder demands. Savings deposits are referred to as time deposits because they are expected to remain on deposit for longer periods of time than demand deposits. Typically saving accounts have higher interest than checking accounts.

Define and differentiate between the average tax rate and the marginal tax rate. How does a tax credit differ from an itemized deduction?

Average tax rate is the tax due divided by the taxable income. The marginal tax rate is the rate on the next dollar of income which is determined by the bracket their income falls in. With a progressive tax rate, the marginal tax rate is always greater than the average tax rate when income is over the 10% bracket amount. A tax credit is a dollar for dollar reduction in the tax due. A tax deduction reduces taxable income and is worth the marginal tax rate times the amount of the deduction to the taxpayer. A $1,000 child tax credit is worth $1,000 to a 25% [or 37%] taxpayer while a deduction of $1,000 is only worth $250 to a 25% taxpayer [$370 to a 37% taxpayer].

Why is it advisable for the prospective home buyer to investigate property taxes?

Because they're local taxes levied to fund schools, law enforcement, and other local services, the level of property taxes differs from one community to another. In addition, within a given community, individual property taxes will vary according to the assessed value of the real estate—the larger and/or more expensive the home, the higher the property taxes, and vice versa. As a rule, annual property taxes vary from less than 0.5 percent to more than 2 percent of a home's approximate market value. Thus, the property taxes on a $100,000 home could vary from about $500 to more than $2,000 a year, depending on location and geographic area.

Why is it important to analyze budget variances and their implied surpluses or deficits at the end of each month?

By examining end-of-month budget balances, and the associated surpluses or deficits for all accounts, a person can initiate any required corrective actions to assure a balanced budget for the year. Surpluses are not problematic but should be examined to insure they are not the results of shifting expenses to later periods. Deficits normally require spending adjustments during subsequent months to bring the budget into balance by year end.

What is cash management, and what are its major functions?

Cash management is an activity that involves the day-to-day administration of cash and near-cash liquid resources by an individual or family. The major functions of cash management are (1) making sure that adequate funds are available to meet both planned and unplanned expenditures and (2) establishing an ongoing savings program that cushions against financial emergencies and accumulates funds to meet financial goals.

What are the key factors to consider when opening a checking account? Discuss the advantages and disadvantages of individual versus joint accounts.

Factors that typically influence the choice of where to maintain a checking account are convenience, services, and cost. Many people choose a bank based solely on convenience factors: business hours, location, number of drive-thru windows, and number and location of branch offices and ATMs. The availability of additional services may also be important. Many banks also offer online and telephone banking and bill-paying services, safe-deposit box rental, provision for direct deposits and withdrawals, and mutual-fund sales. One advantage of the joint account over two individual accounts is lower service charges. In addition, the account has rights of survivorship: for a married couple, this means that if one spouse dies, the surviving spouse, after fulfilling a specified legal requirement, can draw checks on the account.

Give two reasons for holding liquid assets. Identify and briefly describe the popular types of liquid assets.

Liquid assets are held for two broad reasons: (1) to meet known, near-term spending needs and (2) to meet unplanned future needs. See Exhibit 4.1 for a list of liquid assets and a representative rate of return for each.

Discuss the relationship of life-cycle considerations to personal financial planning. What are some factors to consider when revising financial plans to reflect changes in the life cycle?

Personal needs and goals change as you move through different stages of your life. So, too, do financial goals and plans, because they are directly influenced by personal needs. When your personal circumstances change, your goals must reflect the new situation. Factors such as job changes, a car accident, marriage, divorce, birth of children or the need to care for elderly relatives must be considered in revising financial plans.

What two factors determine the amount of federal withholding.

Tax withholding will vary by filing status, number of withholding exemptions claimed, and amount of income. The taxpayer may have more tax withheld by reducing the number of exemptions or have less withheld by increasing the number of exemptions.

Define and distinguish between the nominal (stated) rate of interest and the effective rate of interest. Explain why a financial institution that pays a nominal rate of 4.5 percent interest, compounded daily, actually pays an effective rate of 4.6 percent.

The nominal rate of interest is the stated rate of interest, so in this instance the financial institution nominal interest rate is 4.5%. The effective rate of interest is the interest rate actually earned over the period of time that the funds are on deposit. It is found by dividing the dollar amount of interest earned over the course of one year by the amount of money on deposit. We can determine the effective rate when the financial institution has a stated rate of 4.5% by calculating how much interest is actually paid during the year. The easiest way is with a financial calculator because the financial institution compounds daily in this example. We will arbitrarily choose to calculate the interest on a $1,000 account. (The percentage rate will be the same no matter what dollar amount we choose to begin with.) Set the calculator on End Mode and 1 Payment/Year. 1,000 +/- PV 4.5 ¸ 365 I 1 × 365 N FV $1,046.03 During the year, this account earned $46.03 in interest, so we take the interest earned and divide it by the beginning principal to determine the effective interest rate. $46.03 = 4.6% effective rate of return $1,000

What type of housing would you choose for yourself now, and why? Why might you choose to rent instead of buy?

Worksheet 5.2 gives a format for analyzing the rent versus buy cost comparison. A major factor in the decision is the availability of funds for down payment and the time you expect to stay in the unit. Rule of thumb is if you will be in the unit for less than three years, rent. More than three years, buy. Real estate professionals say the three most important items in purchasing a home are Location, Location, Location. Your preferred housing will depend upon location as well as square feet in house.