Transcript W!SE Financial Test Review

W!SE Financial Test Review
TEST DAY: APRIL 9, 2014
Source of income
 Earned Income: Income derived from active
participation in a trade or business, including wages,
salary, tips, commissions and bonuses.
 Unearned Income: Any income that comes from
investments and other sources unrelated to
employment services. Examples: interest from a
savings account, bond interest, alimony, and
dividends from stock
Exemptions
 If you are not claimed as a dependent on another
taxpayer's return, then you can claim one personal tax
exemption. The exemption reduces your taxable income
just like a deduction does, but has fewer restrictions to
claiming it. If you are married and file a joint tax return,
both you and your spouse each get an exemption.
 The IRS allows you to take additional exemptions for
each dependent you claim. Frequently, the source of
these exemptions are the children who live with you for
more than half the year, are under 19 years old (or under
24 if a full-time student) and who don't provide more
than half of their own financial support during the tax
year.
Liquidity
 The ability to convert an asset to cash quickly and
with minimal impact to the price.
 Examples: Cash, Most stocks, money market
instruments and government bonds.
 Money market accounts: It is the organized exchange
on which participants can lend and borrow large
sums of money for a period of one year or less.
 Bonds- It is the organized exchange on which
participants can lend and borrow large sums of
money for a period of one year or less.
Gift cards
 A gift card is a restricted monetary equivalent is issued by
retailers or banks to be used as an alternative to a nonmonetary gift.
 Prepaid cards, gift cards, and gift certificates cannot expire
within five years of activation or unless the terms of the
expiration are clearly disclosed. The law bans dormancy fees,
inactivity fees or service fees on gift cards unless there has
been no activity in a 12-month period and the issuer clearly
discloses all fees before the gift card is purchased.
 Exclusions: Prepaid phone cards , reloadable cards, loyalty or
rewards cards, cards issued for admission to special events or
venues and certificates issued in paper form only are exempt.
Discretionary income and budget surplus
 The amount of an individual's income that is left for
spending, investing or saving after taxes and
personal necessities (such as food, shelter, and
clothing) have been paid. Discretionary income
includes money spent on luxury items, vacations and
non-essential goods and services.
Money Orders
 A certificate that allows the stated
payee to receive cash on-demand,
usually issued by governments and
banking institutions. A money order
functions much like a check, in that the
person who purchased the money order
may stop payment
Why does the US currency have value
 Its value is only based on what we
can get in exchange for it. Or put it
another way, money has value as
long as other people believe the
money you give them can be
exchanged for the goods and
services they desire in the future.
Opportunity cost
 The value of the best alternative
that must be given up when scarce
resources are used for one purpose
instead of another
Inflation
 Inflation is a general increase in prices and a
corresponding decrease in money's purchasing
power.
 The economic indicator for stable prices is the
Consumer Price Index (CPI). The CPI measures
inflation in consumer goods. Inflation is an increase
in the overall price level—sometimes referred to as
an increase in the cost of living. Inflation is not
when gas prices rise or coffee prices rise—it is when
prices in general are rising.
Inflation
 The biggest losers due to inflation are those willing
to lend money. An extreme example would be during
the hyper-inflation of 1923 in Germany. If you had
loaned a friend enough money to buy a car in early
1923 and he had repaid it at the end of 1923 you
might have been able to buy a box of matches with it.
So it is easy to see that the borrower got a car and he
was able to repay it with pocket change. The lender
of course was the big loser.
Inflation
 People hurt the most: Those on fixed incomes
(retired people)
 People hurt the least: Borrowers and producers
Inflation
 When individuals, businesses, and governments
borrow, it is usually at a fixed rate of Interest that
had some expected level of inflation built into it. If
higher than expected inflation occurs, then the real
value of the borrower's debt is reduced. Assume that
banks lend billions of dollars at a fixed nominal
interest rate of 5%. If inflation were to unexpectedly
increase from 2% to 4%, then borrowers' real interest
rate paid would be reduced from 3% to 1%. In
simpler terms, the money that was lent was more
precious than the money being repaid.
Inflation
 Another group that benefits from an increase in
consumer prices in the short run is producers. When
unexpected inflation occurs, consumer prices rise
while wages paid to employees remain relatively
stable. This allows producers to experience higher
profits for a time until wages adjust to reflect the
higher prices consumers are paying.
Treasury Department
 The United States Department of the Treasury is the
government (Cabinet) department responsible for
issuing all Treasury bonds, notes and bills.
 The U.S. Treasury is responsible for the revenue of
the U.S. government, but here are some other key
functions:
Treasury Department
 Printing of bills, postage, Federal Reserve notes, and
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minting of coins
Collection of taxes and enforcement of tax laws
(through the IRS)
Management of all government accounts and debt
issues
Overseeing U.S. banks
Identifying and targeting the financial support
networks of national security threats
Banks
PAGES 6-11
Pay Yourself First
 Put money into savings each month as if it were a
bill. At least 10% of your income should go into
savings. It’s recommended you have 6-8 months of
expenses saved.
Certificate of Deposit
 Sold by financial institutions, certificates of deposit
(CDs) are low-risk –- and relatively low-return —
investments suitable for cash you don’t need for
months or years. If you leave the money alone during
the investment period (known as the “term” or
“duration”), the bank will pay you an interest rate
slightly higher than what you would have earned in a
money market or checking account. All gains from
CDs are taxable as income.
Certificate of Deposit
 CDs are among the safest investment a person can
make. The interest rate is determined ahead of time,
and you’re guaranteed to get back what you put in,
plus interest once the CD matures.
 Traditional CD: You receive a fixed interest rate over
a specific period of time. When that term ends, you
can withdraw your money or roll it into another CD.
Certificate of Deposit
 Liquid CD — This kind of account allows you to
withdraw part of your deposit without paying a
penalty. The interest rate on this CD usually is a little
lower than others, but the rate is still higher than the
rate in a money market account.
 Zero-coupon CD — This kind of CD does not pay out
annual interest, and instead re-invests the payments
so you earn interest on a higher total deposit. The
interest rate offered is slightly higher than other CDs,
but you’ll owe taxes on the re-invested interest.
Institutions that give loans
 Pawnshops: You are given a short-term loan in
exchange for leaving a personal item, such as jewelry
or an electronic device, as collateral. If you pay back
the loan, including interest, on time, you get the item
back. You may be able to renew the loan by paying
the interest. However, if you fail to repay or renew
the loan, your item can be sold. The APRs for pawn
shop loans are typically around 120-300 percent,
much higher than the rate charged on credit cards.
Many pawn shops also charge additional fees for
insurance and storage.
Institutions that give loans
 Payday lenders: A payday lender allows you to
borrow against your future income. You give them a
postdated check, which is deposited if you do not pay
back the loan. The APR (interest expressed as an
annual percent rate) is usually over 200 percent and
can go much higher if you refinance the loan instead
of paying it off as soon as it comes due.
Institutions that give loans
 Banks vs. credit unions: Credit unions generally
charge lower interest rates.
 Tax preparers: short-term consumer loans, usually
24 to 48 hours, secured by a taxpayer’s expected tax
refund, and designed to offer customers quicker
access to funds.
What is a Credit Union?
 Member-owned financial co-operative. These
institutions are created and operated by its members
and profits are shared among the owners.
 Advantages: Lower interest rates for loans, higher
interest rates for savings accounts and investments
because they are a non-profit and pass savings to
customer/owner.
Overdraft protection – how it works
 A line of credit that banks offer to their customers to
cover their overdrafts. Overdraft protection kicks in
when a customer writes a check for more than the
amount in their account. Banks usually charge
interest on the amount used to cover the overdraft.
Compound interest
 “Interest on interest,” It will make a deposit or loan
grow at a faster rate than simple interest, which is
interest calculated only on the principal amount. The
rate at which compound interest accrues depends on
the frequency of compounding; the higher the
number of compounding periods, the greater the
compound interest.
 Time value of money
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The idea that money available at the present time is worth
more than the same amount in the future due to its potential
earning capacity.
Liquid financial products
 Liquid assets: Those that can be converted to cash
easily, with little effect on value. Examples: most
stocks, money market instruments and government
bonds.
 Less liquid (Illiquid): The state of a security or other
asset that cannot easily be sold or exchanged for cash
without a substantial loss in value. Illiquid assets
also cannot be sold quickly because of a lack of ready
and willing investors or speculators to purchase the
asset. Examples: Housing, stocks that have no
buyers.
Rule of 72
 The 'Rule of 72' is a simplified way to determine how
long an investment will take to double, given a fixed
annual rate of interest. By dividing 72 by the annual
rate of return, investors can get a rough estimate of
how many years it will take for the initial investment
to duplicate itself.
Reconciling a Checking account
 A record, usually sent to the account holder once per
month, summarizing all transactions in an account
during the time from the previous statement to the
current statement. The opening balance from the prior
month combined with the net of all transactions during
the period should result in the closing balance for the
current statement.
 Consumers should carefully review their bank statements
and retain them for their own records. In reconciling
their own record of transactions with the bank's records,
account holders should be on the lookout for incorrect or
transposed numbers as well as unauthorized
transactions. Discrepancies should be reported as soon
as possible, in writing if possible.
Repayment of student loans
 You must repay a student loan even if your financial
circumstances become difficult. Your student loans
cannot be canceled because you didn’t get the
education or job you expected, or because you didn’t
complete your education (unless you couldn’t
complete your education because your school
closed).
Tax anticipation loans
 A Refund Anticipation Loan (RAL) is a loan that is
offered by many tax preparation companies to people
against their income tax return. These loans are
based on the full amount of the tax refund. Loans
can be had for the entire amount or a partial amount
of the anticipated refund. When the check arrives at
the tax preparer’s office, the loan is paid in full, with
interest, and any remaining balance is issued to the
recipient. Many people use this program for its quick
access to money without considering the high
interest rates attached.
CREDIT
PAGES 12-15 OF NOTES
Credit card cash advances
 A service provided by many credit card issuers
allowing cardholders to withdraw a certain amount
of cash, either through an ATM or directly from a
bank or other financial agency. Cash advances
typically carry a high interest rate - even higher than
credit card itself - and the interest begins to accrue
immediately. On the plus side, cash advances are
quick and easy to obtain in a pinch.
Credit
 Truth in Lending Act
 A federal law enacted in 1968 with the intention of protecting
consumers in their dealings with lenders and creditors. The
Truth in Lending Act was implemented by the Federal Reserve
through a series of regulations.
 Consequences of paying the minimum payment due
on a credit card bill or paying a bill late
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Your credit score will fall
Your monthly bills start to balloon
Your credit card costs skyrocket
Credit
 How does the degree of risk influence the interest
rate charged for credit
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Higher risk = higher interest rate
Lower risk = lower interest rate
 Debt to credit ratio
 Amount of available credit you are using
 Divide the aggregate outstanding balance of all your credit
cards by the total credit limit across all the cards
 One should try to keep that percentage to below 30%
Credit Reports
 Report detailing your use of credit
 Identifying information (name, address, etc.)
 Account information (date opened, balance, payment
history)
 Credit inquiries (companies who’ve checked your credit)
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Important because it shows if you’ve been seeking new credit
 Public record and collection information
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Such as: bankruptcies, liens, law suits, judgments and
collections
Consequences of a lost or stolen credit card
 Identity theft, use of your credit
 In the event that your credit card is stolen in the
United States, federal law limits the liability of card
holders to $50 regardless of the amount charged on
the card by the unauthorized user. In today's world
of electronic fraud, if just the credit card account
number itself is stolen, federal law guarantees that
the card holder has a zero liability to the issuer.
Consequences of a lost or stolen credit card
 As a card holder, you should notify the issuer
immediately if you notice that your credit card is
missing or stolen. This early notification will give the
issuer time to help you with the following:
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1. Verify if and where fraud has occurred.
2. Remove unauthorized charges from your credit.
3. Close down your account to prevent future fraudulent
charges.
4. Issue you a new card and account number.
Consequences of a lost or stolen credit card
 Several credit card companies have adopted a "zero
liability" policy which means the consumer is not
held responsible for any fraudulent charges. You
should also check with the three major credit
reporting agencies and obtain a copy of your credit
report to be sure that nothing else has been accessed
fraudulently.
Consequences of a lost or stolen credit card
 Be wary of credit card protection offers. This type of
insurance is unnecessary because federal law limits
your credit card fraud liability. But scam artists try to
sell $200-300 credit card insurance by falsely
claiming that cardholders face significant financial
risk if their cards are misused. According to recent
Federal Trade Commission estimates, 3.3 million
consumers have purchased unnecessary insurance to
prevent unauthorized use of their credit cards.
Credit
 The length of debt repayment and impacts on cost
 Longer you take to pay, the more you pay in total
(accumulating interest)
 What to do if a person thinks he/she is the victim of
identity theft
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Report to creditors and credit reporting agencies
Watch credit report carefully for several months
 Characteristics of predatory loans
 Giving unfair and abusive loan terms to borrowers
 Showing lower interest than actually paying, making it seem
they can afford more than they can, using collateral against
default, high fees, etc.
Credit
 Collateral (secured vs. unsecured)
 Secured = has collateral tied to it in case of default (home
mortgage, car financing)
 Unsecured = no collateral (credit cards)
 Pawnshops
 Offer collateralized loans
 Bring in item of value, get loan of percentage of value
 Pay back with interest
 If unpaid, item is forfeited to the pawnshop and considered
paid in full
 Does NOT affect credit score, doesn’t require a credit check or
bank account
Insurance, Investing, &
Financial Planning
PAGES 16-24
Insurance
 How insurance works – concept of sharing risk
 Insurance is a form of risk management in which the insured
transfers the cost of potential loss to another entity in
exchange for monetary compensation known as the premium
 Insurance deductible – what happens to the
premium when the deductible is raised or lowered
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Deductible=The amount you have to pay out-of-pocket for
expenses before the insurance company will cover the
remaining costs.
A lower deductible creates higher premiums (cost for
insurance coverage), higher deductible creates lower
premiums.
Collision coverage
 Collision Insurance will reimburse the insured for
any damage sustained to their personal automobile
that is due to the fault of the insured driver.
 People typically drop this coverage when their car’s
value is low enough that the cost of the insurance
deductible and premiums aren’t worth paying
Term life insurance
 A policy with a set duration limit on the coverage
period. Once the policy is expired, it is up to the
policy owner to decide whether to renew the term life
insurance policy or to let the coverage end.
 The policy pays out upon death only – no savings or
investment component.
Whole life insurance
 A life insurance contract with level premiums that
has both insurance and an investment component.
The insurance component pays a stated amount
upon death of the insured. The investment
component accumulates a cash value that the
policyholder can withdraw or borrow against.
Health insurance – HMO insurance and co-pays
 An HMO is a type of health insurance plan that gives
you access to certain doctors and hospitals, often
called network or contracting doctors and hospitals
(sometimes called "providers").
 Co-pays: paid by the insured person each time a
medical service is accessed.
Disability insurance
 Disability insurance offers income protection to
individuals who become disabled for a long period of
time, and as a result can no longer work during that
time period. Employees, who have paid the Federal
Insurance Contributions Act (FICA) tax for a certain
amount of time, are eligible to receive the Social
Security disability income insurance.
How to reduce the cost of auto insurance
 Increase deductible, purchase a low profile car, drop
unneeded coverage, drive less, safety discounts,
student discounts, combine policies
Securities and equities
 When you sell a capital asset, the difference between the
amounts you sell it for and what you paid for it – is a capital
gain or a capital loss.
 Historical performance of stocks: Up and down but average 910%
 Primary market: The primary market is where securities are
created. It's in this market that firms sell new stocks and
bonds to the public for the first time (IPO – Initial Public
Offering)
 Secondary market: The secondary market is what people are
talking about when they refer to the "stock market". This
includes the New York Stock Exchange (NYSE), NASDAQ and
all major exchanges around the world. The defining
characteristic of the secondary market is that investor’s trade
among themselves.
What is a bull market?
 The use of "bull" and "bear" to describe markets
comes from the way the animals attack their
opponents. A bull thrusts its horns up into the air
while a bear swipes its paws down. These actions are
metaphors for the movement of a market. If the
trend is up, it's a bull market. If the trend is down,
it's a bear market.
Bonds
 A debt investment in which an investor loans money to
an entity (corporate or governmental) that borrows the
funds for a defined period of time at a fixed interest rate.
Bonds are used by companies, municipalities, states and
U.S. and foreign governments to finance a variety of
projects and activities.
 The indebted entity (issuer) issues a bond that states the
interest rate (coupon) that will be paid and when the
loaned funds (bond principal) are to be returned
(maturity date). Interest on bonds is usually paid every
six months (semi-annually). The main categories of
bonds are corporate bonds, municipal bonds, and U.S.
Treasury bonds, notes and bills, which are collectively
referred to as simply "Treasuries."
Mutual funds
 An investment vehicle that is made up of a pool of
funds collected from many investors for the purpose
of investing in securities such as stocks, bonds,
money market instruments and similar assets.
Mutual funds are operated by money managers, who
invest the fund's capital and attempt to produce
capital gains and income for the fund's investors.
Investment Portfolio
 A grouping of financial assets such as stocks, bonds and
cash equivalents, as well as their mutual, exchangetraded and closed-fund counterparts. Portfolios are held
directly by investors and/or managed by financial
professionals.
 Investors should construct an investment portfolio in
accordance with risk tolerance and investing objectives.
Think of an investment portfolio as a pie that is divided
into pieces of varying sizes representing a variety of asset
classes and/or types of investments to accomplish an
appropriate risk-return portfolio allocation.
Investing
 Diversification
 “Don’t put all your eggs in one basket” - create a portfolio that
includes multiple investments in order to reduce risk.
 Dividends
 A distribution of a portion of a company's earnings (profits) to
a class of its shareholders. The dividend is most often quoted
in terms of the dollar amount each share receives (dividends
per share).
Treasury bills
 A short-term debt obligation backed by the U.S.
government with a maturity of less than one year. Tbills are sold in denominations of $1,000 up to a
maximum purchase of $5 million and commonly
have maturities of one month (four weeks), three
months (13 weeks) or six months (26 weeks).
Determine Net Worth
 Net worth = value of assets – amount of liabilities
 Assets: real estate, stock investments, bank
accounts, cash
 Liabilities: debts, loans (mortgage, car, student, etc.)
 Assets = Liabilities + Owner’s Equity
Retirement
 A pension is a retirement account that an employer
maintains to give you a fixed payout when you retire.
It's a kind of defined benefit plan.
 Your payout typically depends on how long you
worked for your employer and on your salary. When
you retire, you can choose between a lump-sum
payout or a monthly "annuity" payment
Retirement
 Traditional IRA: An individual retirement account
(IRA) that allows individuals to direct pretax income,
up to specific annual limits, toward investments that
can grow tax-deferred (no capital gains or dividend
income is taxed). Taxes are paid at the time of
distribution/withdrawal.
 Roth IRA: With a Roth IRA, you make contributions
with money on which you've already paid taxes. Your
money can then potentially grow tax-free, with taxfree withdrawals in retirement, provided that certain
conditions are met.
Inflation: A general increase in prices
 Purchasing power of money. Government tries to keep
it to 2-3%.
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Most hurt: lenders and those on fixed incomes (retired)
Least hurt: minimum wage earners, middle class home owners
 Deflation: Reduction in the general level of prices,
often caused by a reduction in the supply of money or
credit. Deflation can be caused also by a decrease in
government, personal or investment spending. The
opposite of inflation, deflation has the side effect of
increased unemployment since there is a lower level of
demand in the economy, which can lead to an
economic depression.
Taxes
 Income taxes: a tax that takes a larger percentage
from the income of high-income earners than it does
from low-income individuals. Taxpayers are broken
down into categories based on taxable income; the
more one earns, the more taxes they will have to pay
once they cross the benchmark cut-off points
between the different tax bracket levels.
Regulatory Agencies
 SEC (Securities and Exchange Commission): A
government commission created by Congress to regulate
the securities markets and protects investors. In addition
to regulation and protection, it also monitors the
corporate takeovers in the U.S. Role is to protect the
investing public against fraudulent and manipulative
practices in the securities markets.
 The Fed: The central bank of the United States and the
most powerful financial institution in the world.
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Roles: Conducting national monetary policy by influencing monetary
and credit conditions in the U.S. economy to ensure maximum
employment, stable prices and moderate long-term interest rates.
Regulatory Agencies
 Supervising and regulating banking institutions to
ensure safety of the U.S. banking and financial
system and to protect consumers’ credit rights.
 Maintaining financial system stability and
containing systemic risk.
 Providing financial services – including a pivotal role
in operating the national payments system – to
depository institutions, the U.S. government and
foreign official institutions.
Regulatory Agencies
 FDIC (Federal Deposit Insurance Corporation): The U.S.
Corporation insuring deposits in the U.S. against bank
failure. The FDIC was created in 1933 to maintain public
confidence and encourage stability in the financial
system through the promotion of sound banking
practices. The FDIC will insure deposits of up to
US$250,000 per institution as long as the bank is a
member firm.
 CFPB (Consumer Fraud Protection Bureau): A regulatory
agency charged with overseeing financial products and
services that are offered to consumers. Role is to protect
and educate consumers about the various types of
financial products and services that are available.