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FNCE 2820 Study Guide Review Solutions
1. Principles of Personal Finance: 1. Knowledge of Personal Finance
2. Focus on Cash Flow (discipline, tax minimization, liquidity)
3. Value in Creating Financial Plan (financial and risk management process)
4. Healthy Behavior (taking action, avoid, self-sabotage)
2. Pieces of the Financial Planning Puzzle: -cash management
-debt management -planning for educational needs -insurance and risk management -income tax strategy -retirement planning
- investments -estate planning
3. Strategic Planning Process: -understand your situation
-identify your goals and priorities analyze current plan -synthesize updated plan -implement plan -monitor and adapt
4. Stages of Life Cycle: 1. Accumulation
2. Consolidation
3. Spending and Gifting
5. Net Worth: Total Assets - total liabilities
6. Assets: cash and cash equivalents, investments, use assets
7. Liabilities: current liabilities, long-term debt
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8. cash flows: income, fixed expenses, variable-fixed expenses, taxes, discretionary expenses, surplus
9. Ratio Analysis: -liquidity funds
-housing debt payment ratio -consumer debt payment ratio -total debt payment ratio -savings ratio
10. liquidity funds ratio: 3-6 months of emergency funds
short term assets / monthly non-discretionary expenses
11. housing debt payment ratio: 2 d 8 % of gross income (more if housing is more expensive)
housing liabilities / gross income
12. consumer debt payment ratio: 10-20% of take-home pay
total consumer debt PAYMENTS / net income
13. total debt payment ratio: 36-38% of gross pay
14. savings ratio: 5-10% of gross income
total savings / gross income
15. Tax Form 1040: Gross Income - "above the line" deductions = adjusted gross income (AGI)
AGI - "below the line" deductions = taxable income taxable income x tax rate = income liability income liability - tax credits = TAX DUE
16. gross income: the total amount of income from wages before any payroll deductions, as well as capital gains
17. "above the line" deductions: -qualified student loan interest (subject to limit)
-IRA contributions (pre-tax contribution, subject to limit)
4 / 26 depository accounts liquid securities brokerage accounts
25. depository accounts: checking account NOW
account savings account money market deposit account
26. liquid securities: certificate of deposit US
treasury bills US savings bonds
27. brokerage accounts: asset management account money market
mutual fund
28. major differences between depository account types?: account balance required, interest, and number of checks allowed
per month
29. financial intermediaries: depositories non-
depositories investment intermediaries government agencies
30. depositories: banks
savings banks credit unions savings and loans
31. non-depositories: insurance companies financing
companies pension plans
32. investment intermediaries: brokerage companies mutual fund
companies venture capital firms investment banks trust institutions pooled investments
33. FDIC insurance: insures depositor accounts for up to 250,000 per FDIC bank, type of account, and per legal depositor account
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34. credit union insurance: NCUSIF insurance, works same as FDIC
35. FICO Credit Score: 350-
Higher score = less risk Calculated from: payment history (35%) amount of debt (30%) length of credit history (15%) new credit (10%) type of credit (10%)
36. consumer revolving credit (revolving debt): an "open" line of credit, available to consumer as needed.
line of credit with pre-approved credit limit. no finance charge if repaid by due date; otherwise, high finance charge with minimum payment due -higher interest rates, no collateral, and lower credit limits compared to installment debt
37. types of consumer revolving credit: credit cards store charge
cards overdraft protection bank line of credit home equity line of credit
38. credit cards (things to keep in mind): card fees characteristics
annual percentage rates types of credit cards credit limits repayment and grace periods balances
39. home equity line of credit: during draw period, your total line of credit amount is available as long as your initial withdraw amount is
below the credit. once repayment period begins, there is no further withdrawal and the balance is fully amortized. You should have fixed monthly payments of principal and interest.
40. bankruptcy: Decision of last resort.
chapter 7 chapter 9 chapter 11 chapter 12
7 / 26 to credit bureaus after 90 days. Oflcial default occurs after 270 days of no payments. -the interest continues to accrue -consolidation and repayment options are lost -no new federal loans will be issued -wages may be garnished -up to 15% of Social Security benefits garnished -Government may deduct 25% of each payment as a collection fee -negative impact on credit score -job searches negatively impacted
51. car buying process: do your homework (ex. KBB) comparison
shopping negotiate deal buy decision
52. What are sources of information about car prices, safety rating, and auto financing?: KBB, consumer reports,
edmunds, national automobile, dealers association
53. What's the difference between MSRP and dealer invoice?: MSRP--means little. Dealer invoice is the dealer's required cost to
break even. The invoice price does not reflect manufacturer discounts.
54. How do you negotiate the deal?: -knowledge of fair price
-know dealer prices -ability to walk away -never make that decision under duress
55. Car leasing: -used for business or wanting new car, if you don't think you'll exceed either mileage or lease term
cost of using vehicle/ # of payment periods Includes security deposit and monthly payments. additional fees: acquisition fee, disposition fee (to prepare for resale), early termination fee
56. Home lease: -financial terms (monthly payment, security deposit, damage deposit, late penalties)
-terms of the lease -responsibilities (utilities, landscaping, repairs)
8 / 26 -restrictions (pet restrictions, maximum occupants, sub-leasing) -eviction process -move out (notice, inspection, return deposits)
57. home rentals: legal contract between tenant and landlord
58. home buying process: -do your homework (remember online calculators for budget and type of home you want+can attord)
-search for your home (look for properties. fair resale price. appreciation potential) -negotiate the deal -obtain mortgage -closing and moving in
59. What are sources of information about home listing?: Zillow, Trulia, etc.
60. What are important neighborhood factors?: schools, safety, culture, night life, day life, etc.
61. What did you learn about negotiating the deal?: 1. property listing should be fair
2. buyer otter
3. seller response
4. ongoing negotiation
5. mutual acceptance or withdrawal of otter
62. appreciation potential: Location is most important. Buy the lowest-priced house in the best location, particularly if you can add square footage.
63. who pays for the title search?: The seller. Very important
64. Real Estate Closing: 1. Open ESCROW (title or escrow company). Should hold earnest money and transaction documents.
2. Title search. Search title insurance. (Make sure there are no liens. You should own the whole house.
3. Mortgage approval Lender conducts home assessment. Rate is locked, if not done already.
4. Estimated closing cost disclosure
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2) time value of money,
3) risk and return,
4) the importance of planning,
5) the need to manage catastrophic risk exposure,
6) the value in taking control of your cash flows,
7) the need to maintain adequate liquidity,
8) tax minimization,
9) positive financial behaviors and
10) take action.
71. An asset is financial, real or personal property that you own or control, while a liability is a debt
obligation. Which of the following would be listed as a liability on your Statement of Net Worth? Current value of your investment account Fair market value of your home Fair market value of your rental property Current balance on your credit cards Face value of life insurance policy: Answer: Current balance on your credit cards Examples of liabilities include credit card balances, balance of school debt, store credit balances, and balance of any personal loans.
72. Expenses can be categorized as fixed, variable-fixed and discretionary. Which of the following
is a discretionary expense?
(1)monthly rental payment
(2)electric and water bills
(3)travel expenses
(4)monthly auto loan payment
(5)entertainment expenses
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(6)income tax payment
(7)vacation costs: Answer: 3, 5 and 7
Examples of discretionary expenses include vacations, entertainment, capital expenditure (e.g., new car, home remodel) and gifts.
73. What is the net worth given the following information?
Bank account = $500 Credit card balance = $ Investment account = $2, Fair market value of used car = $3,400 School loan = $3, Store charge account balance = $250: Answer: $2, Net worth is equal to total assets less total liabilities. In this question, the assets include the bank account, the investment account and the fair market vale of the used car. The liabilities include the credit card balance, the school loan and the store charge account balance. The calculation follows: 500 + 2,600 + 3,400 - 360 - 3,500 - 250 = 2,390.
74. The CFP Board suggests a maximum housing ratio of 28%. Which of the following statements
best describe the following situation? Jack's gross income for the year = $84,000 Monthly mortgage and interest payment = $1, Annual premium for homeowner's insurance = $1, Annual property tax = $4,600: Answer: Jack's housing ratio is above the recommended 28% bench- mark The housing ratio is calculated by dividing the total cost of housing (principal, interest, property taxes and homeown- er's insurance) by gross income. In answering this question, you need to make sure that all of the items are stated as monthly or yearly data. Since you are given three annual data points, it is easiest to multiple the monthly mortgage payment by 12. Housing costs = (12 x 1,500) + 1,800 + 4,600 = 24, Gross income = 90, Housing ratio = 24,400 / 84,000 = 29.1%
75. What is your friend's emergency fund multiple (ratio) based on the follow- ing data:
Monthly gross income = $5,4000 Monthly fixed expenses = $2,200 Monthly variable-fixed expenses = $ Monthly discretionary expenses = $600 Short-term assets
13 / 26 positioning for long-term capital gains, maximizing the above-the-line adjustments, maximizing below-the-line deductions, positioning for tax credits and planning for the alternative minimum tax.
80. Assuming that the following tax rate schedule applies, what is your tax liability given ordinary
taxable income of $96,400? 10% ($0-$9,875) 12% ($9,875-$40,125) 22% ($40,125-$85,525) 24% ($85,525-$163,300) 32% ($163,300-$207, 35% ($207,350-$518,400) 37% (over $518,400): Answer: $17,215. The tax liability is calculated using the progressive rate schedule. In this example, the first $9,875 of taxable income is taxed at 10%. The next $30,250 ($40,125 - 9,875) of taxable income is taxed at 12%, the next $45,400 ($85,525 - 40,125) is taxed at 22% and the remaining amount of $10,875 ($96,400 - 85,525) is taxed at 24%. The tax liability equals $17,215.50 (987.50 + 3,630 + 9,988 + 2,610).
81. The IRS categorizes income as either earned income, portfolio income or passive income. Which of
the following would be considered as portfolio income? Bonus from employment Income received from a partnership in which you are a limited partner W-2 wages Interest on your bank account Scholarship: Answer: Interest on your bank account Portfolio income includes dividends (from stocks, mutual funds, etc.), interest (from bank accounts, etc.), royalties from investment property, net rent from property that you manage, annuity income and gains on the sale of property, investment securities and business interests.
82. Which of the following would be taxed as a long-term capital gain, rather than as ordinary
income or a short-term capital gain? Distribution from an employer retirement plan Sale of a mutual fund that you owned for six months and one day Sale of a stock that you owned for one year and one day Dividends from a mutual fund that you owned for five years Disability benefit received from an employer's insurance plan: Answer: Sale of a stock that you owned for one year and one day
14 / 26 Capital gains apply to the sale of capital assets, including securities, a home, car, business interest or personal property. Any sale that occurs after a holding period of one year plus one day is considered long-term. Any sale that occurs one year from purchase or shorter is taxed at the short-term capital gain rate. Note that dividends and interest from securities is considered ordinary income, not a capital gain.
83. Which of the following is considered earned income (i.e., active income)?
(1)Salary from your job
(2)Sale of your used car that represents a gain of $
(3)Sick pay
(4)Sale of a limited partnership
(5)Commission received from selling product
(6)Membership to 24/7 fitness, which is paid by your employer
(7)Gift from your parents: Answer: 1, 3, 5 and 6
Earned income includes wages, salaries, tips, bonuses, self-employment income, severance pay, sick pay, disability income, gambling winnings, unemployment income, jury duty pay, distributions from retirement plans (which represent pre-tax contributions and tax-deferred earnings), loan forgiveness, and certain employer fringe benefits. The sale of a used car is a capital gain. The sale of the limited partnership would be a capital gain or loss of a passive investment. The gift from your parents is excluded from gross income.
84. All but one of the following deductions are permitted against gross income. Which of the following is
NOT an above-the-line adjustment for Form 1040? Qualified student loan interest (subject to cap) Contributions to a health savings account (subject to limits) Charitable contributions (subject to limits) Contributions to a pre-tax individual retirement arrangement (IRA), subject to limits: Answer: Charitable contributions (subject to limits) Charitable contributions are a below-the-line deduction, not an above-the-line adjustment. Above-the-line adjustments include IRA contributions, health saving account contributions, contributions to a self-em- ployment retirement plan, premiums for health insurance when self-employed, early withdrawal penalties of financial securities and qualified student loan interest.
85. Your accountant calculates that your Federal tax liability is $2,000. If you are able to claim a
16 / 26 paycheck, you realize that your take-home pay is significantly less than that. Why is that the case?: $1,038 is the gross weekly salary; however, money will be withheld for Federal and state income taxes, FICA and unemployment insurance. Each of these items will be itemized on Form W-2. also withholdings for FICA and FUTA, plus any deferrals that you make to your 401(k) retirement plan
90. Which of the following is NOT considered a cash equivalent asset?
certificate of deposit money market deposit account bank account savings account stock mutual fund: Answer: stock mutual fund Cash and cash equivalents are assets that can easily be converted to cash without significant transaction cost. Examples of cash equivalents include checking account, savings account, money market deposit account, certificate of deposit, US Treasury bills and notes, and a money market mutual fund. A stock mutual fund is subject to market fluctuations, which impact the value received. That is not a characteristic of a cash equivalent asset.
91. Financial institutions facilitate the flow of funds between borrowers and lenders. They include
banks, savings and loans, credit unions, investment companies and insurance companies. Which of the following statements about the various institutions is INCORRECT? Mutual fund insurance is designed to provide investors with protection up to $500,000 in the event that the stock market declines in value National credit union insurance fund is designed to provide credit union depositors with protection up to $250,000, in the event of credit union insol- vency SIPC insurance is designed to provide brokerage account holders with protec- tion up to $500,000 in the event of dealer-broker bankruptcy. FDIC insurance is designed to provide bank depositors with protection up to $250,000 in the event of bank insolvency.: Answer: Mutual fund insurance is designed to provide investors with protection up to $500,000 in the event that the stock market declines in value. There is no insurance fund designed to make an investor whole due to a market decline. Even SIPC insurance would not cover loses due to market volatility. Rather, FDIC, SIPC and NCUIF insurance is designed to promote investor/depositor confidence in the financial stability of financial intermediaries (e.g., banks, credit unions, savings and loans and broker-dealers).
92. When you start employment within the US, you will be required to fill out Form W4, which
17 / 26 informs the employer about income tax withholdings. Assuming that each of the following individuals earns the same salary, which one will have the largest amount withheld from the take-home pay? Sally claims two allowances Lucy claims four allowances Joe claims one allowance Jake claims three allowances: Answer: Joe claims one allowance The lower the number of allowances claims, then the more money that is taken out to pre-pay income taxes. The higher the number of allowances claimed, then the less money that is taken out to pre-pay taxes.
93. Which of the following statements accurately describe FICA withholdings?
FICA withholdings are used to pay your income tax liability FICA withholdings are used to pay for your health care benefits
19 / 26 Employer contributions to your employer-sponsored qualified retirement plan Education assistance (capped at $5,250 per year) Use of the company car and ski lodge for a family vacation Health insurance premiums paid by the employer: Answer: Use of the company car and ski lodge for a family vacation Employer benefits that are not considered gross income include health and disability insurance premium payments, group term life insurance premiums (subject to $50, benefit cap), contributions to the employee's qualified retirement plan, qualified employer discounts, educational assistance for qualified expenses (subject to annual $5,250 cap), de minimums expenses, onsite athlete facilities and meals and lodging for the benefit of the employer. Taxable benefits include private use of the company car or properties, membership to ott-site health facilities or country clubs, and tickets to sporting events or presentations.
97. Liquid assets earn low rates of interest, as compared to capital assets. Which of the following liquid
asset accounts would typically earn the lowest interest rate? bank checking account bank certificate of deposit bank savings account bank money market deposit account: Answer: bank checking account Bank accounts are intended to facilitate financial transactions, including paying bills and withdrawing money on demand. Because the assets are considered very short- term in nature, the interest earned is quite low. In general, the more frequent the expected transaction, the lower the interest earned. As discussed in class, the checking account is designed to provide unlimited withdraws, so interest is quite low (if there is any interest at all).
98. What is meant by a credit card's grace period?
How does it impact financing charges, given: 1) no existing loan balance going into the month but credit card purchases within the month and 2) a loan balance at the beginning of the month plus monthly credit card charges?: The grace period refers to the amount of time before financing charges apply. The typical grace period is 30 days. If there is no existing balance due, then there won't be any interest charge on purchases within the month as long as the new purchases are paid ott by the end of the month. In contrast, if there are existing balances, then there will be interest assessed on the balance plus any new charges within the month. The secret to using a credit card is to pay ott the balances each and every month before the end of the grace period.
99. How does a "line of credit" work? In responding to this question, offer an example to clarify your
explanation.: A line of credit is an amount of money that is available to you at a pre-arranged interest rate for a period of time. In securing the line of credit, you will generally be assessed an upfront fee. No interest is assessed on the line of credit until you withdraw the money. Repayment of the loan is quite flexible during the draw period; however, at some point (e.g., 10 years) the draw period ends and the repayment period begins. During the repayment period, there are fixed, amortized payments.
20 / 26 Remember that the bank line of credit is a hybrid between revolving and installment credit. After the initial draw period, the loan becomes fully amortized.
100. During class you researched two financial websites, which provided de- tailed information about credit
cards. Identify the site you found to be the most useful and share two items of information that you found to be rele- vant.: The two sites were Bankrate.com and Creditcards.com
101. Two forms of consumer credit are revolving (or open) credit and install- ment (or closed credit).
All of the following characteristics are representative of revolving credit, except for one. Which of the following is generally NOT a characteristic of revolving consumer credit? higher interest rate, as compared to installment debt flexible repayment schedule smaller loan amount, as compared to installment debt pre-determined repayment date (when loan needs to be paid off): Answer: pre-de- termined repayment date Characteristics of revolving credit include smaller loan dollar amount, a flexible repayment schedule, higher cost of debt and no repayment date (as long as the loan balance is below the credit limit).
102. Which of the following elements is most heavily weighted in the FICO credit score calculation?
history for making timely debt repayments amount of credit still available and the total amount of debt owed length of credit history experience with different types of consumer credit recent applications for new credit sources: Answer: history for making timely debt repayments The borrower's history for making timely debt repayments over time is weighted at 35% of the total score. The other categories include amount of debt owned and still available (30%), length of credit history (15%), new credit applications (10%) and type of consumer credit (10%).
103. All but one of the following statements regarding Chapter 7 bankruptcy is correct. Which statement is
INCORRECT?
Chapter 7 bankruptcy is a liquidation event, in which certain property is liquidated and the proceeds are distributed among the creditors. A Chapter 7 bankruptcy is available once every eight (8) years. In order to qualify for a Chapter 7 bankruptcy, the person must attend pre-bankruptcy financial counseling and then must qualify based on financial means testing. Chapter 7 bankruptcy provides a "fresh start" as all debts are wiped clean.: -
