Personal Finance Exam
PRESENT VALUE OF A SERIES OF DEPOSITS For example, if you want to take $400 out of an investment account each year for nine years and your money is earning an annual rate of 8 percent, you need to deposit
$2,498.80 ($400 × 6.247).
PRESENT VALUE OF A SINGLE AMOUNT if you want $1,000 five years from now and you earn 5 percent on your savings, you need to deposit
$784 ($1,000 × 0.784).
An organized financial records system provides for (5)
(1) handling daily business activities, such as bill paying, (2) measuring financial progress, (3) completing tax forms, (4) making investment decisions, and (5) determining resources for spending
Actions to increase net worth are the result of (4)
(1) increasing your savings, (2) reducing spending, (3) increasing the value of investments and other possessions, and (4) reducing amounts owed.
The main purposes of a budget are to: (5)
(1) live within your income; (2) spend money wisely; (3) reach financial goals; (4) prepare for financial emergencies; and (5) develop wise financial management habits.
Different savings methods - Single deposit at a certain interest rate, $6000 for 3% for 2,5,10 years - $200 deposited every 3 months at 4% for 2,4,6 years - $2000 a year at 8% for 10,20,30 years
- 6365, 6956, 8064 - 1657, 3452, 5395 - 28973, 91524, 226566
For money management decisions, examples of trade-off situations, or opportunity costs, include the following:
- Current spending reduces money available for long-term saving and investing. - Increased saving and investing for the future lowers what you can spend now. - Credit payments over time reduce future income available for spending and saving. - Using savings to buy things results in lost interest and not being able to use savings for other purposes. - Comparison shopping results in wiser buying but uses something of value you cannot replace: your time.
The advantages of being financially literate include:
- Increased effectiveness in obtaining, using, and protecting financial resources. - Expanded control of financial activities to avoid excessive debt, bankruptcy, and dependence on others. - Improved personal relationships with well-planned and effectively communicated financial decisions. - Enhanced freedom from financial worries achieved by looking to the future, anticipating expenses, and achieving personal economic goals.
The main purposes of personal financial statements are to:
- Report your current financial position based on the value of items you own and amounts you owe. - Measure your progress toward financial goals. - Maintain information about your financial activities. - Provide data for preparing tax forms or applying for credit.
Consumer price Measures? Influences FP?
- The buying power of a dollar; inflation - If consumer prices increase faster than income, you are not able to purchase the same amount of goods and services; higher consumer prices often cause higher interest rates.
Interest rates Measures? Influences FP?
- The cost of money; the cost of credit when you borrow; the return on your money when you save or invest. - Higher interest rates make buying on credit more expensive; higher interest rates make saving and investing more attractive and may discourage borrowing.
Consumer spending Measures? Influences FP?
- The demand for goods and services by individuals and households - Increased consumer spending usually creates more jobs and higher wages; high levels of consumer spending and borrowing may push up consumer prices and interest rates.
People invest for two primary reasons.
- Those interested in current income select investments that pay regular dividends or interest. - In contrast, investors who desire long-term growth choose stocks, mutual funds, real estate, and other investments with potential for increased value over time.
Common reasons for saving include:
- To create an emergency fund for irregular and unexpected expenses. - To pay for the replacement of expensive items, such as appliances or an automobile, or to have money for a down payment on a house - To buy expensive items such as electronics or sports equipment or to pay for a vacation. - To provide for long-term expenses such as the education of children or retirement. - To earn income from interest on savings to pay current living expenses.
Providers and users being Financial intermediaries being Financial markets being
- businesses, govs, individuals, foreign entities (savers, investors) / earn vs pay interest/dividends for the funds they provide/use - banks, credit unions, insurance/investment companies - stock/bond/money/ commodity markets
Common courses of action for alternatives include:
-Continue the same course of action -Expand the current situation -Change the current situation -Take a new course of action.
CHAPTER 1 - PERSONAL FINANCE BASICS AND THE TIME VALUE OF MONEY
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CHAPTER 3: MONEY MANAGEMENT STRATEGY- FINANCIAL STATEMENTS AND BUDGETING
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TYPES OF BUDGETING SYSTEMS
1 A mental budget 2 A physical budget - involves envelopes, folders, 3 A written budget provides a detailed plan in a notebook 4 A digital budget may be created with a spreadsheet, software
The economic conditions that most often influence personal finance are 3 things
1 Consumer prices 2 Consumer spending 3 Interest rates
Personal financial activities involve three main decision areas:
1 Spending 2 Saving 3 Sharing
Your personal financial statements and budget are designed to help you achieve financial goals with:
1. A balance sheet reporting your current financial position—where you are now. 2. A cash flow statement detailing your income and spending during a month. 3. A budget recording your plans for spending and saving for your financial goals.
The financial planning process 6 steps
1. Determine current financial situation 2. Develop financial goals (short, intermed, long term) 3. Identify alternative courses of action 4. Evaluate alternatives (Consider and Assess) 5. Create and implement your financial action plan 6. Review and revise the financial plan
Five methods are available for calculating time value of money:
1. Formula Calculation. 2. Time Value of Money Tables 3. Financial Calculator. 4. Spreadsheet Software. 5. Websites and Apps
Components of personal financial planning
1. Planning your personal finances i.Obtaining ii. planning 2.Managing your personal finances i.saving ii. borrowing 3. Making your purchasing decisions i spending 4. Insuring your resources i managing risk 5. Investing your financial resources i Investing 6. Controlling your financial future i. retirement and estate planning
Three amounts are required to calculate the time value of money for savings in the form of interest earned:
1. The amount of the savings (commonly called the principal). 2. The annual interest rate. 3. The length of time the money is on deposit
A vital success strategy is to develop financial habits for both short-term satisfaction and long-term financial security, including the following:
1. Track spending to create a spending plan to live within your income while you save and invest for the future. The main cause of financial difficulties is overspending. 2. Have appropriate insurance protection to avoid financial disasters. 3. Become informed about taxes and investments to help expand your financial resources.
Simple interest is calculated as follows:
Amount in savings x Annual interest rate x Time period = Interest Ex.) $1,000 on deposit at 3 percent for six months would earn $15 (calculated as: $1,000 × 0.03 × 6 months/12 months
Savings ratio
Amount saved each month divided by gross income Financial advisors recommend monthly savings of 5-10 percent.
Net worth formula
Assets − Liabilities = Net worth
Howard recommends the CLARK Method for money management and budgeting:
Calculate your income List your expenses Analyze your spending and set goals Record everything Knock out debt and build your savings
Liabilities usually have two categories:
Current (less than a year) and long term (over year)
Rule of 72
Divide 72 by number of annual inflation or interest rate to find when things will double in price
FUTURE VALUE OF A SERIES OF DEPOSITS FV = Annuity (1+i)^n - 1 / i Situation 1 - Do a repeated investment of 1,500 a year, earning 5% interest, for 10 years
FV = 1500(1+0.05)^10 - 1 / 0.05 FV = $18,866.84
Future value of a SINGLE AMOUNT formula FV = PV(1 + i)^n i = interest rate n = number of years Do an investment of $650 earning 8 percent for 10 years
FV = 650(1 + 0.08)^ 10 FV = $1,403.30
Personal Opportunity Costs (time, effort, health) and Financial Opportunity Costs (interest, liquidity, safety) have to be given up in order to get ______
Financial Acquisitions (car, home, college, investment, insurance, retirement)
Three major money management activities are interrelated.
First, personal financial records and documents are the foundation of systematic resource use. These records provide evidence of business transactions and ownership of property, and information on legal matters. Next, personal financial statements enable you to measure and assess your financial position and progress. Finally, your spending plan, or budget, is the basis for effective money management.
The amount available at a later date is called the ____.
Future value Ex.) $100 deposited in a 4 percent account for one year will grow to $104 Future value = $100 + ($100 × 0.04 × 1 year) + $104 The same process could continue for a second, third, and fourth year, but the computations would be time-consuming
70/20/10 Rule
Guidelines for budget allocations include the 70% rule, which allocates 70 percent of income for necessary expenses, 20 percent for savings, and 10 percent for retirement and future financial security. A variation is the 50/30/20 rule with three categories; 50 percent for necessities, 20 percent for financial goals, and 30 percent on other items.
Where to keep your financial records
Home files, home computer, online, safe deposit box
The 5 Types of Risk
Inflation Interest Rate Income Personal Liquidity
You prepare a personal balance sheet to determine your current financial position using the following process:
Items of value (what you own) − Amounts owed (what you owe) = Net worth (your weal
Debt ratio
Liabilities divided by assets $25,000/$50,000 = 0.5 - Shows relationship between debt and assets; a low debt ratio is best.
Current ratio
Liquid assets divided by current liabilities $4,000/$2,000 = 2 Indicates $2 in liquid assets for every $1 of current liabilities; a high current ratio is desirable to have cash available to pay bills.
Liquidity ratio
Liquid assets divided by monthly expenses $10,000/$4,000 = 2.5 Indicates the number of months in which living expenses can be paid if an emergency arises; a high liquidity ratio is desirable.
Financial planning information sources
Media Financial Institutions Financial Specialists
The financial system
Money in an economy flows from -providers- of funds to -users- of funds through -intermediaries and financial markets-
Debt payments ratio
Monthly credit payments divided by take home pay $540/$3,600 = 0.15 Indicates how much of a person's earnings goes for debt payments (excluding a home mortgage); financial advisors recommend a debt-payments ratio of less than 20 percent.
FUTURE VALUE OF A SERIES OF DEPOSITS Situation 2 - Don Yamada wants to have $50,000 available in 10 years as a reserve fund for his parents' retirement living expenses and health care. If he earns an average of 8 percent on his investments, what amount must he invest today to achieve this goal? Use formula PV = FV / (1 + i)^n
PV = 50,000 / (1 + 0.08)^10 PV = $23, 159.67 Don needs to invest approximately $23,160 today for 10 years at 8 percent to achieve the desired financial goal.
Creating and implementing a budget Steps (4)
Phase 1: Assess your current situation Phase 2: Plan your financial direction Phase 3: Implement your budget Phase 4: Evaluate your budget program
SMART approach
SPECIFIC MEASURABLE ACTION-ORIENTED REALISTIC TIME-BASED
THE BUDGETING PROCESS
STEP 1: SET FINANCIAL GOALS STEP 2: ESTIMATE INCOME STEP 3: BUDGET AN EMERGENCY FUND AND SAVINGS STEP 4: BUDGET FIXED EXPENSES STEP 5: BUDGET VARIABLE EXPENSES STEP 6: RECORD SPENDING AMOUNTS STEP 7: REVIEW SPENDING AND SAVING PATTERNS
Several government agencies regulate financial activities, one being
The Federal Reserve System, the central bank of the United States
Intangible-purchase goals.
These goals may relate to personal relationships, health, education, and leisure
The process for preparing a cash flow statement is
Total cash received during the time period − Cash outflows during the time period = Ca
A security
a financial instrument that represents debt or equity.
The consumer price index (CPI), published by the Bureau of Labor Statistics, is
a measure of the average change in the prices urban consumers pay for a fixed "basket" of goods and services
The difference between income and outflows can be either
a positive (surplus) or a negative (deficit) cash flow
Cash flow is the
actual inflow and outflow of cash during a time period.
The cash flow statement reports the
actual spending of a household. In contrast, a budget, with a similar format, is used to project income and spending.
Tariff
an import tax, to reduce its trade deficit
Two documents you should create, the personal _____ and the _____ statement, are called personal financial statements
balance sheet cash flow
A cash flow statement, also called a personal income and expenditure statement (Exhibit 3-4), is a summary of
cash receipts and payments for a time period, such as a month or a year
Market value =
current value
Your emergency fund can be measured with a ______, a tool used by organizations to monitor key performance indicators such as delivery time, product defects, or customer complaints. As an individual, you can use a personal finance dashboard to assess your ______
dashboard financial situation
Take-home pay, also called net pay, is a person's
earnings after deductions for taxes and other items
Divide cash outflows into two major categories:
fixed expenses and variable expenses
Investment assets are
funds set aside for long-term financial needs
Personal Risk
health, safety, buying risks
The time value of money calculates
increases in an amount of money as a result of interest earned.
Durable-product goals usually involve
infrequently purchased, expensive items such as appliances, cars, or sports equipment; these are tangible items
A financial plan
is a formalized report that summarizes your current financial situation, analyzes your financial needs, and recommends future financial activities
Opportunity cost (trade off)
is what you give up by making a choice.
Discretionary income is money
left over after paying for housing, food, and other necessities.
Opportunity fund
money set aside to expand your income and net worth
Consumable-product goals usually occur
on a periodic basis and involve items that are used up relatively quickly, such as food, clothing, and entertainment.
Insolvency is the inability to
pay debts when they are due; it occurs when a person's liabilities far exceed available assets.
The current value of an amount in the future is the ______
present value. EX. OF PRESENT VALUE.) $110 due in 12 months' time has a present value of $100 today, if invested at an annual rate of 10 percent"
The consumer price index (CPI) is a measure of the general
price level of consumer goods and services in the United States
Equity securities (stock)
represent ownership in a corporation.
inflation Risk
rising/fall prices, buy now vs later, whats better
Liquidity Risk
risk that assets cannot be easily converted to cash
Interest Rate Risk
same thing as infltion risk with interest rates, what is to your advantage
Debt securities
such as bonds, represent money borrowed by companies or governments.
A budget variance is the difference between
the amount budgeted and the actual amount received or spent.
Money management refers to
the day-to-day financial activities necessary to manage current personal economic resources while working toward longterm financial security.
Bankruptcy
the legal status of a person who is not able to pay debts owed.
Personal financial planning
the process of managing your money to achieve personal economic satisfaction
Economics
the study of how wealth is created and distributed
Financial literacy
the use of knowledge and skills for earning, saving, spending, and investing money to achieve personal, family, and community goals
People may prepare a balance sheet on a periodic basis, such as every _____. Between those times, a ____ and _____ help you plan and measure spending and saving activities
three or six months budget cash flow statement
Income Risk
unemployment risk
CHARACTERISTICS OF SUCCESSFUL BUDGETING
well planned realistic flexible clearly communicated
A Balance sheet, also called a net worth statement or statement of financial position, reports
what you own and what you owe
The adult life cycle
—the stages in the family situation and financial needs of an adult—influences financial activities and decisions
