module 3
Some rule-of-thumb ratios are helpful in understanding how a client's debt will be assessed by lenders, which can determine interest rates. Which of these is NOT correct regarding ratio descriptions and the related benchmark? A) Monthly housing costs include principal, interest, taxes, fees, and insurance, and should be no more than 28% of the prospective borrower's net income. B) Consumer debt is all nonmortgage debt. It should be no more than 20% of monthly net income. C) The minimum required payments should be used in the calculation. D) Total monthly payment on all debts should be no more than 36% of gross monthly income.
Monthly housing costs include principal, interest, taxes, fees, and insurance, and should be no more than 36% of the prospective borrower's net income. Keeping all debt payments under 36% is important in order to qualify for reasonable rates on credit. Helping clients understand what will make future debt more costly can give them motivation to stay within the guidelines. Monthly housing costs should be no more than 28% of the prospective borrower's gross, not net, income.
Which of these are savings strategies a financial planner can recommend to clients? Forgo premium cable channels Use an overdraft feature on debit cards Choose an economical cell phone plan Decrease deductibles on automobile insurance policies A) I and III B) II and IV C) I, II, and III D) I, III, and IV
a, The answer is I and III. Using an overdraft feature on debit cards may entice individuals to spend money they do not have available in their accounts. Decreasing insurance deductibles increases premiums, which is not a savings strategy.
Allyson would like to pay off her debt, reducing the debt with the highest interest rate first. Compared to the snowball approach of debt reduction, which of the following statements are CORRECT? Compared to the snowball approach, it is relatively more difficult to pay off the first debt with a high balance quickly. This approach increases the total amount of interest paid during the debt reduction process. A) I only B) Neither I nor II C) Both I and II D) II only
a, The answer is I only. With Allyson's approach, it often takes longer to pay off the first debt when the highest interest rate has a considerable balance. Less interest paid during the debt reduction process is an advantage of paying off debt in order of interest rate.
Andy and Debbie are working with their financial planner to develop a budget. The financial planner told them to list all their discretionary and nondiscretionary expenses. Which of the following would be considered a nondiscretionary cash outflow for planning purposes? Utility bills Loan payments Mortgage payments Travel and entertainment expenses A) I, II, and III B) I, II, III, and IV C) I only D) II and III
a, The answer is I, II, and III. Utility bills, loan payments, and mortgage payments are considered nondiscretionary expenses. Travel and entertainment expenses, along with gifts, premium cable TV channels, and club dues are considered discretionary expenses.
Which of the following statements regarding the identification of financial strengths and weaknesses is CORRECT? This process is primarily objective. A planner may rely on financial ratios to assist in making this determination. A) II only B) Neither I nor II C) I only D) Both I and II
a, The answer is II only. Although a planner may rely on financial ratios to assist in identifying financial strengths and weaknesses, this analysis is generally subjective.
Which components of the FICO credit score calculation have the greatest impact on the total score? New credit Length of credit history Amounts owed Payment history A) III and IV B) II and IV C) I and III D) I and IV
a, The answer is III and IV. Payment history (35% of credit score) and amounts owed (30% of credit score) have the greatest impacts on the total FICO score.
What assets should typically NOT be used to establish an emergency fund? A) U.S. government bonds B) Cash in a basement safe C) Checking accounts D) A money market deposit account
a, The answer is U.S. government bonds. Bonds are not as liquid as other assets and are therefore not typically a good source of emergency funds. Money market deposit accounts are a good source for emergency funds. To the extent that they exceed the regular expenses of the client, checking account balances can be a good source for emergency funds.
Alex has a personal emergency requiring him to immediately access $50,000. He expects this need will last for several months. Which of the following assets shown on his statement of financial position is the best choice to pay for his emergency? A) A credit union account totaling $60,000 B) Aggressive stocks currently trading at a market value of $65,000 C) A money market mutual fund worth $35,000 D) A life insurance cash surrender value in the amount of $55,000
a, The answer is a credit union account totaling $60,000. Although both the credit union account and the money market mutual fund reflect liquid assets, the best asset to use is the credit union account because it sufficiently covers Alex's needs.
Which of the following statements regarding the identification of financial strengths and weaknesses is CORRECT? This process is primarily subjective. A planner may rely on financial ratios to assist in making this determination. A) Both I and II B) II only C) I only D) Neither I nor II
a, The answer is both I and II. During this subjective process, a planner may rely on financial ratios to assist in identifying financial strengths and weaknesses.
Which of the following has the least impact on a client's total FICO score? A) Credit mix B) Amounts owed C) Length of credit history D) Payment history
a, The answer is credit mix. These categories affect credit scores in the following percentages: credit mix, 10%; length of credit history, 15%; amounts owed, 30%; and payment history, 35%
When preparing a cash flow statement for a client, what is the correct way to indicate the period covered? A) For the period January 1, 20XX, to December 31, 20XX B) For the period January to December 20XX C) From January 20XX to December 20XX D) As of December 31, 20XX
a, The answer is for the period January 1, 20XX, to December 31, 20XX. Usually the cash flow statement is prepared for the calendar year period.
Which of the following statements regarding liabilities on the statement of financial position is CORRECT? They are categorized as fixed or variable. Any outstanding mortgage balance is reported as its original amount. A) Neither I nor II B) I only C) Both I and II D) II only
a, The answer is neither I nor II. Liabilities are categorized as current (short-term) liabilities or long-term on the statement of financial position. The current outstanding mortgage balance as of the date of the statement of financial position, not the original mortgage amount, is reported on this statement.
Joe and Mary believe in stress management. Several times each year, they take a short vacation to relax and recharge as part of their overall approach to maintaining good health. Their regularly planned vacations are an example of what type of expense? A) Variable discretionary expense B) Fixed nondiscretionary expense C) Variable nondiscretionary expense D) Fixed discretionary expense
a, The answer is variable discretionary expense. Although Joe and Mary believe the vacations to be important for good health, the vacations are considered a variable discretionary expense.
Which of the following statements regarding a client's credit score is CORRECT? Too many credit inquiries may lower a credit score, but likely not by much. Opening several new accounts in a short amount of time reflects a good use of credit and therefore can increase a credit score. A) II only B) I only C) Neither I nor II D) Both I and II
b, The answer is I only. Opening several new accounts over a short period can lower, not increase, a client's credit score. Too many credit inquiries may lower a client's credit score but will likely not have a great impact.
Which of these are reasons a client should consider purchasing a home rather than renting one? I. Mortgage interest is generally income tax deductible II. Adequate liquid assets are available for a down paymentIII. Client plans to live in the home five years or longer A) II and III B) I, II, and III C) I only D) I and III
b, The answer is I, II, and III. The deductibility of mortgage interest when a client itemizes deductions is a definite tax advantage in purchasing a home as opposed to renting one. If clients intend to live in their residences for several years (more than five) and have enough money for a down payment (without depleting the emergency fund), they should consider purchasing a home.
Which of the following items should NOT be included in an individual's statement of cash flows? Home value Mortgage balance Mortgage payment Mutual fund balance A) I and IV B) I, II, and IV C) I and II D) III only
b, The answer is I, II, and IV. The mortgage balance should be shown as a liability on the statement of financial position. The value of a home and the balance of a mutual fund should be listed as assets on the statement of financial position. Only the mortgage payment, which is considered a fixed outflow, is included in the statement of cash flows.
What is the key to successfully using the snowball technique to eliminate debt? A) Start with the debt that has the highest account balance B) Developing a plan that the client can commit to executing C) Begin with the debt that has the highest interest rate D) Begin with the debt that has the highest payment
b, The answer is developing a plan that the client can commit to executing. The key to the effectiveness of using the snowball technique is developing a plan that the client can commit to and execute. The goal is eliminating debt, and the client needs to agree to the process to make that happen. Beginning a debt reduction plan with the debt that has the highest payment is not a typical debt reduction technique.
Jake and Ashley are working with their financial planner to develop a budget. The financial planner told them to list all their fixed cash outflows and variable cash outflows on a questionnaire. Which of the following would be considered a fixed cash outflow for planning purposes? A) Utilities B) Mortgage payments C) Food D) Travel and entertainment
b, The answer is mortgage payments. Only mortgage payments are considered a fixed cash outflow. Other examples of fixed cash outflows are car payments, insurance premiums, and property taxes.
Which of the following actions would most likely decrease an individual's credit score? A) Pay off a balance on a credit card that the individual has had for 10 years B) Take advantage of several offers for new credit cards C) Have several different types of credit accounts, such as a car loan, a mortgage, and credit cards D) Make just the minimum payment on time each month
b, The answer is take advantage of several offers for new credit cards. Taking advantage of several offers for new credit cards would decrease an individual's credit score.
Which is a true statement about reducing debt? A) Increasing income is more important than reducing debt. B) The client's desires and wishes will determine which course of action to take. C) It is always better to maintain a mortgage over the normal life of the loan in order to take advantage of other investment opportunities that may arise. D) It is always better to pay off a mortgage as soon as possible.
b, The answer is the client's desires and wishes will determine which course of action to take. There are occasions when you as a planner may have a strong opinion as to which is the best course of action to pursue for a client; however, a client-first philosophy is the cornerstone to financial planning ethics. That may require you to set aside what you think is best in order to help clients achieve what they believe is best.
Before any of the transactions below, Sid had a net worth of $200,000. Took out a $24,000 loan to pay for a European vacation Paid off his student loan of $8,000 using funds from his money market deposit account Purchased an antique car valued at $18,000 for $15,000 with checking account funds What is Sid's net worth after these transactions? A) $173,000 B) $186,000 C) $179,000 D) $169,000
c, The answer is $179,000. Sid's $24,000 loan for travel increases his liabilities and does not affect his assets. Payment of his student loan will reduce debt by $8,000. However, the use of his money market deposit account to pay off the debt will reduce his assets by $8,000. The net effect of this transaction on his net worth is zero. Purchasing the antique car for $15,000 with funds from his checking account decreases assets by $15,000; however, assets are increased by $18,000 (the value of the car) for a net asset increase of $3,000. Therefore, after the transactions, his net worth decreases to $179,000 ($200,000 - $24,000 + $3,000).
Which components of the FICO credit score calculation have the greatest impact on the total score? Credit mix Payment history Amounts owed Length of credit history A) II and V B) III and IV C) II and III D) I and II
c, The answer is II and III. Payment history and amounts owed have the greatest impact on total score of the FICO credit score calculation.
Which of these is characteristic of the snowball technique of debt reduction? The debt with the lowest balance is eliminated first. Clients are encouraged by paying off the first debt quickly. A) II only B) Neither I nor II C) Both I and II D) I only
c, The answer is both I and II. The snowball technique of debt reduction involves eliminating the debt with the lowest balance first. Clients are often encouraged by paying off the first debt quickly, which motivates them to continue the process.
What is the appropriate date to identify the statement of financial position of a calendar-year client for the year 2021? A) On January 1, 2022 B) For the period beginning January 1, 2021 C) On December 31, 2021 D) For the period from January 1 to December 31, 2021
c, The answer is on December 31, 2021. The statement of financial position (personal balance sheet) is presented as of a specific date in time (i.e., a snapshot). The answer choice "For the period beginning January 1, 2022" could be correct, but the question specified the date was for a calendar-year client.
Your client, Andy, is in need of assistance in preparing his statement of financial position and statement of cash flows. He earns $150,000 annually and pays $1,000 monthly in alimony to his ex-wife, Debbie. Andy owns a condo valued at $230,000, which currently has an outstanding mortgage balance of $100,000. He pays annual property taxes of $3,000, and the condo insurance costs $180 per month. All of the following statements are CORRECT except A) the condo insurance payments would be a fixed outflow on Andy's statement of cash flows. B) the alimony Andy pays would be a cash inflow on Debbie's statement of cash flows. C) taxes paid on his property would be a liability on his statement of financial position. D) Andy's salary would be considered a cash inflow on his statement of cash flows.
c, The answer is taxes paid on his property would be a liability on his statement of financial position. The property taxes Andy pays would be considered a fixed outflow on his statement of cash flows. Such tax payments would not be an entry on a statement of financial position.
Which of the following financial statements provides a snapshot of a client's net worth at any given point in time, usually at the end of a calendar year? Statement of cash flows Statement of financial position Personal tax return Net worth statement A) II and III B) I and IV C) II only D) II and IV
d, The answer is II and IV. The statement of financial position, also known as a personal balance sheet or net worth statement, provides a snapshot of the client's net worth (wealth) at any given point in time.
Which of the following statements regarding a client's credit score is CORRECT? Using a high percentage of available credit will positively affect a credit score. Considering a client's credit history only, the longer the history, the higher credit score. A) I only B) Both I and II C) Neither I nor II D) II only
d, The answer is II only. When considering a client's credit history and no other FICO categories, in general, the longer the credit history, the higher the credit score. Using a high percentage of available credit will negatively affect a client's credit score.
Brandon and Jessica are in their mid-30s. Both are employed and they have no children. They enjoy international travel and own luxury automobiles. To afford their lifestyle, the couple has accumulated significant debt. In addition to their large car loans, Brandon and Jessica have balances on multiple credit cards and a substantial private loan used to pay for a Mediterranean cruise. Within the next few months, they intend to purchase a home. Both Brandon and Jessica are aware of their need to plan for retirement, but their current debt makes it difficult for them to consistently save money. After meeting with the couple and analyzing their financial statements, you recommend they adopt a savings plan. Assuming they accept your recommendation, which of the following steps would help Brandon and Jessica maximize their savings potential? Begin paying off their debts, giving priority to the debt with the highest interest rate Monitor their spending to ensure they are not using debt to finance a lifestyle they cannot afford A) II only B) I only C) Neither I nor II D) Both I and II
d, The answer is both I and II. Both of these steps should be implemented as part of the Brandon and Jessica's savings plan.
All of the following items should be included on an individual's statement of financial position except A) mortgage balance. B) mutual fund balance. C) fair market value of a home. D) mortgage payment.
d, The answer is mortgage payment. The mortgage payment, which is considered a fixed outflow, is included on the statement of cash flows, not the statement of financial position. The mortgage balance should be shown as a liability on the statement of financial position. The fair market value of a home and the balance of a mutual fund should be listed as assets on the statement of financial position.
