Finance Final Study Guide Chapters 1-5
What is a standard deduction?
A blanket deduction that includes various deductible expenses that would normally be incurred by a taxpayer - For taxpayers who have little or no personal expenses (for example, property taxes or professional organization dues), the standard deduction is taken to reduce AGI
What is a Savings & Loan (S&L) association?
A financial institution that accepts both savings and checking deposits and provides home mortgage loans
If you wanted to purchase ownership interests in diversified portfolios of investments, which type of financial product provider should you contact?
A mutual fund
What is a credit union?
A nonprofit-making money cooperative whose members can borrow loans from pooled deposits at low interest rates and save with higher interest rates - Offer interest-paying checking accounts—called share draft accounts
What is an itemized deduction?
A personal expense that is subtracted from AGI - If personal expenses exceed the standard deduction amount, the taxpayer can choose to itemize deductions rather than take the standard deduction - Some itemized deductions are limited based on a taxpayer's AGI
In some cases, up to six years from when a return was filed, taxpayers can be notified that they are subject to what?
A tax audit
In general, if you expect interest rates to decrease in the near future, what should you invest in?
Invest in long-term investments so that you can lock in the higher interest rates before they decrease
In general, if you expect interest rates to increase in the near future, what should you invest in?
Invest in short-term investments so that you can reinvest quickly when interest rates increase
What does an income and expense statement do?
It takes income and subtracts expenses to determine an individual's or a family's cash surplus or deficit situation
How do you calculate net monthly income?
Net Monthly Income = Gross Monthly Income × (1-Tax Rate)
If taxpayers have been granted an automatic extension, when is their annual federal tax return due?
No later than October 15
What do financial experts recommend you spend on monthly car payments?
No more than 20% of your net monthly income
What is a capital gain?
Occurs whenever an asset (such as a stock, a bond, or real estate holding) is sold for more than its original price - Taxed at different rates
What are 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
How do you calculate the present value of the loan?
Present Value of the Loan = Monthly Payment × [1 − [1 / (1 + i)t]] / i
What tax structure does the following: as taxable income rises, the tax rate applied to additional income also increases
Progressive tax structure
Of nominal rate of return and real rate of return, which one accounts for inflation?
Real rate of return
What is an example of a non-interest-earning checking account?
Regular checking account (the most common)
What is an example of a fixed expense?
Rent; mortgage; car payment
What are some examples of interest-earning checking accounts?
Share draft accounts and Negotiable Order of Withdrawal (NOW) accounts
There are two major types of checking accounts. What is the distinguishing characteristic?
Some pay interest and some don't
What do The Federal Deposit Insurance Corporation (FDIC) and National Credit Union Share Insurance Fund (NCUSIF) provide insurance coverage for?
Specified deposit accounts held in depository institutions
For individuals in work situations where taxes are not withheld (freelance workers), how does the IRS collect their taxes?
The IRS requires that their tax liability be estimated and paid in four installments - These are due April 15, June 15, September 15, and January 15
What is an example of a variable expense?
Electricity bill; plumbing bill; groceries
Which of the following is a principal tool used by government organizations to constrain the activities of businesses and consumers?
Enacting monetary policy (control the size of the money supply)
True or False: When estimating expenses, developing an amount that one can live within is the best approach.
False
What are savings banks?
- A mutual savings ban - Only about 500 in the US - Mostly used for savings accounts and loans on property - FDIC insured up to $250,000
What is the "qualifying widow or widower with dependent child" filing status?
- A status that a person whose spouse died within two years of the tax year and who supports a dependent child uses - Individuals who qualify for this filing status are allowed to use joint return tax rates and are eligible for the highest standard deduction
What types of income are taxable?
- Active/ordinary income - Passive income - Portfolio/investment income - Tax-deferred/tax-free income
What are some advantages of purchasing a car?
- As you repay the loan, you develop equity or trade-in value on the vehicle - You can take advantage of available dealer or manufacturer rebates or other buyer incentives - Purchases also save owners big expenses by not requiring disposition, early termination, or excess wear and damage fees - There are no mileage allowances.
What is a contraction period characterized by?
- Businesses that are operating lower productive capacity - Increasing unemployment - Low retail sales - Increasing or high prices and interest rates - A declining stock market - Expectations of lower business profits
What are current and long-term liabilities?
- Current liabilities: debts that are scheduled for payments within one year - Long term liabilities: debts to be paid over a period of more than one year
What are some important steps in financial record keeping?
- Ensuring that your family and/or executor can locate your financial documents - Maintaining records for tax and insurance purposes
If the federal government wants to increase production and purchasing activity levels in the economy, what policy tools could it use?
- Increase government spending - Increase the money supply - Reduce tax rates
What are some advantages of leasing a car?
- Leases generally exhibit lower monthly payments, which allow you to get more car for your money - Low to no down payment is required in the lease transaction - The term of the lease is usually equal to the length of the vehicle's warranty = 2 to 4 years (means fewer maintenance headaches, as most big issues will be covered by the manufacturer's warranty) - The lessee doesn't have to trade in or sell a vehicle at the end of the lease term - Detractor: 12,000 miles per year mileage limit
What are short- intermediate- and long-term goals?
- Short-term goals transpire within 1 year - Intermediate-term goals transpire within 2 to 5 years - Long-term goals transpire after 6+ years
What factors should you consider when identifying appropriate savings vehicles?
- Your attitudes toward risk - The length of time you can leave your money on deposit - The liquidity, convenience and safety characteristics of the accounts being considered - The level of current and anticipated interest rates
What are the six steps of financial planning?
1. Define your financial goals 2. Develop the financial plans and strategies needed to achieve those goals 3. Implement your financial plans and strategies 4. Develop and implement budgets to control your progress toward your goals 5. Develop and use financial statements to evaluate the results of your plans and budgets 6. As your personal circumstances change, redefine your goals and revise your plans and strategies
What are the steps in determining taxable income and ultimately identifying your tax liability?
1. Determine Adjusted Gross Income (Gross Income - Adjustments) 2. Calculate taxable income (Itemized Deduction or Standard Deduction - Total Personal Exemptions) 3. Calculate tax liability ([Calculate tax using tax tables or tax rate schedules] - Tax Credits + Other Taxes)
What is the 4-step car-buying process?
1. Identify cash and non-cash rebates and low-cost financing incentives on the brands and models being considered 2. Test drive the car and meet the salesman at least once to ascertain if he or she is someone you want to do business with 3. Inspect the vehicle for damage and missing items, such as the correct sound system, missing floor mats, or damaged pieces of trim 4. Change the oil, rotate the tires, and replace the windshield wipers as needed
How much income should an emergency fund contain?
3 to 6 months' worth
What are depository institutions required to do?
Accept deposits and make loans
What are Enrolled Agents (EAs)?
Federally licensed individual tax practitioners who have passed a difficult, two-day, IRS-administered exam - They are fully qualified to handle tax preparation at various levels of complexity
What is true of low interest rates? A) stock prices tend to rise B) help purchase larger, long-term assets such as cars or houses C) indicate sluggish economic growth D) increase risk of deflation E) help federal government pay its debts F) discourages savings and penalizes those that have saved all their lives G) all of the above
All of the above
How do you determine how much money can be withdrawn annually for the next number of years?
Annual PayoutAnnual Payout = Future Value / Present Value Annuity Factor
What interest-paying checking account provides a unified and coordinated bundle of checking, savings, stock brokerage, and mutual fund accounts whose transactions are reported in a single monthly statement?
Asset Management Account (AMA)
How often should one prepare their financial statements?
At least once a year
What are commercial banks?
Financial institutions that accept deposits, provide payment services, and make loans to firms and households - The only institutions that can offer non-interest-paying checking accounts (demand deposits)
If your Debt Service Ratio moves from 15 to 30 is that good or bad? Why?
Bad; The lower the debt service ratio, the easier it is to meet loan payments as they come due
If you move from a Solvency Ratio of 40 to a ratio of 30 is that good or bad? Why?
Bad; how much "cushion" you have as a protection against insolvency has shrank
What is fair market value?
Can be the actual asset value (such as cash) or an amount that can be reasonably expected if the asset is sold in the open market (such as your car, home, or jewelry)
What is the Savings Ratio?
Cash Surplus / Income After Taxes
What exists when the net cash value equation results in a negative number?
Cash defecit
What exists when the net cash value equation results in a positive number?
Cash surplus
What does the Bank Insurance Fund (BIF) provide coverage for?
Commercial banks - Ex. mutual savings banks
What are some examples of depository institutions?
Commercial banks, savings banks, savings and loan associations (thrifts), and credit unions
Which of the following formulas would you choose to calculate the future balance on an account that earns compound interest?
Future Account Balance = Amount on Deposit × Interest Factor FV = PV × (1 + i)^n
How do you calculate future value?
Future Value = Amount Invested x Future Value Factor
If your Liquidity Ratio moves from 15 to 30 is that good or bad? Why?
Good; The higher the number, the better the ratio because it means that more months of expenses can be paid from a cash reserve
If your Savings Ratio moves from 15 to 20 is that good or bad? Why?
Good; The relative amount of cash surplus you achieved has risen
Reconciling a checking account will do what and when?
Help spot potential errors in the bank statement & will verify the account balance as of the reconciliation date
What does The National Credit Union Share Insurance Fund (NCUSIF), which is overseen and managed by the National Credit Union Administration, cover?
Deposits held in federally chartered credit unions
What are tax credits?
Dollar-for-dollar reduction in taxes
At what age is it recommended to begin tax planning?
Early 30s
What is the effectie rate of interest formula?
Effective Rate of Interest = Amount of Interest Earned / Amount of Money Invested or Deposited
What is the home equity equation?
Home Equity = Fair Market Value of House - Outstanding Mortgage Balance
How do you calculate how much you should invest today to have the amount you want in the future?
How Much to Invest = Future Value × Present Value Factor
What does the Savings Association Insurance Fund (SAIF) provide coverage for?
Insures deposits in savings associations - Ex. funds held in federally chartered credit unions
How do you calculate a lease total initial payment?
Lease Total Initial Payment = Capital Cost Reduction + Security Deposit
How do you calculate the opportunity cost of the down payment and security deposit funds on a lease?
Lease Total Opportunity Cost = (Capital Cost Reduction + Security Deposit) × Interest Rate Earned on Invested Funds × Lease Term
How do you calculate the total monthly payments made over the life of a lease?
Lease Total Payments = Monthly Lease Payment × (Years in Lease Term × 12 months per year)
How should you calculate 20% of your net monthly income to determine your maximum car payment?
Maximum Car Payment = Net Monthly Income × 20%
What interest-paying checking account has these attributes? - Although this account is not protected by deposit insurance, it is extremely safe due to the securities backing the funds - Funds invested in this account are pooled to purchase very short-term debt securities - Interest is calculated daily - Funds can be withdrawn at any time - Can be opened with minimum deposits of $500 to $1,000 - Tend to earn the highest rates of interest available to money market accounts
Money Market Mutual Funds (MMMF)
How often should you reconcile your bank account?
Monthly
What are some examples of non-depository institutions?
Mutual funds, insurance companies, brokerage firms, and financial services companies.
What is the sticker price?
The popular name given to a vehicle manufacturer's suggested retail price (MSRP), which is posted on the vehicle's window
What is marginal tax rate?
The tax rate that applies to the next dollar of taxable income
What are national and local tax services?
These include national services such as H&R Block and independent local firms - These services are best for taxpayers with relatively common types of income and expenditures
What are tax attorneys?
These individuals are bar-certified lawyers who specialize in tax planning and related legal issues
What are Certified Public Accountants (CPAs)?
These individuals have taken an exam administered by the American Institute for Certified Public Accountants - A subset focuses on taxes and specializes in preparing returns and advising taxpayers on planning
What is the balance sheet equation?
Total Assets = Total Liabilities + Net Worth
How do you determine net cash value?
Total Income - Total Expenses = Net Cash Value
What is the Liquidity Ratio?
Total Liquid Assets / Total Current Debts
What is the Debt Service Ratio?
Total Monthly Loan Payments / Monthly Gross Income
What is the Solvency Ratio?
Total Net Worth / Total Assets
True or False: A Joint account has two depositors, thus $500,000 insurance.
True
True or False: Bank errors must be reported timely, generally within 60 days. If you fail to report within time, the bank does not have to take corrective actions.
True
True or False: Compared with commercial banks and savings banks, credit unions tend to pay the highest interest rates on their deposits.
True
True or False: Demand deposit accounts created by commercial banks are usually called checking accounts or negotiable order of withdrawal (NOW) accounts, while those created by credit unions are called share draft accounts.
True
True or False: During the early stage of an economic expansion, finding a job generally tends to be easier, because manufacturers and retailers generate relatively higher levels of production and output.
True
True or False: In situations where an annual budget deficit exists, cutting expenses from the budget is optimal.
True
True or False: Internet banks—online commercial banks—are becoming more popular because of their convenience, lower service fees, and higher interest paid on account balances.
True
True or False: Regardless of the type of loan, only the latest outstanding loan balance is shown on the balance sheet.
True
True or False: To finalize the budget, compare projected income to projected expenses. When income equals or exceeds total expenses, it is considered a balanced budget.
True
True or False: Typical American families pay more than 1/3 of its gross income in taxes including federal income tax, Social Security and Medicare tax, and state income, property, and sales tax.
True
True or False: When estimating income, include amounts that you can control, like bonuses and rental income.
True
With a filing extension in hand, when must a taxpayer pay any taxes owed?
When the extension request is filed
What does it mean to be solvent?
You are worth more than you owe; You have positive net worth
What does it mean to be insolvent?
You own more than you are worth; When your net worth is less than zero
Financial goals should be stated in what terms?
monetary terms
