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FIN 502
Tsogbadral Galaabaatar

Chapter 1: Intro •Financial planners (four categories): Salaried employees of institutions, Commission planners, Fee-based planners, Fee-only (for service) • Financial Planners Standards Council (FPSC): mandated group to provide uniform standards for financial planners in Canada. (FPSC Core curriculum -> exam 1-> capstone course -> exam 2-> 3 year experience) •Financial Goal (at time n) = existingsavings+investmentincomeforn yearsontheexistingsavings+(Earnings−Consumptioneach year)+Investmentincomeontheannualsavings,n Chapter 2: Time Value of Money k • t = return in period t • Reinvestment rate assumption: concerns at what rate the periodic rates are reinvested • EAR assumes that the periodic payments n' are reinvested at the same rate as the original lopart of the FV equation is called the future value interest factor (FVIF),• present value periodic payments are the same, a stream of payments that grows at a constant rate •CGAD: constant growth annuity due •Pure Time Premium: the price that the we demand for waiting before we consume Discount rate: value discounted at k% k= C F1−C F 0 Rate or Return: single period C F 0 , k=rate of return, CF= cash flows n kt (1+k t) Rate of return: multi period, Arithmetic mean re(e.x. = n 1 t=1 n Rate of return: MP, Geometric mean re¿ −1= t=1 0.17+0.08+0.02+0.15 ¿ 4 ) (e.x.√(1.17x1.08x1.02x1.15)−1=1.4822 o.2=10.34 Annual Percentage Return (APR) = m , m= number of periods, ……… km= rate of return m …….or use 1.4822 as FV, -1 as PV, 4 as N, CPT I/Y Effective Annual Rate (EAR) = )−1 …. Monthly rate turned annual rate quotedrate n EAR= 1+ −1 [ ( n ) ] , 1 EPR= 1+EAR )pmt/−1 Future and Present value: Single Period,+k) , n 1 (1+k)−1 1− ( ) n FV FVIFA = k PVIFA= (1+k) PV= k 1+k t F&P value: Multi-period (compounded),(1+k) , PV= FV (1+k)t g=constant growth rate, x= first payment or cash flow of CGA n n ¿x [(1+k)−(1+g) ] Nominal rate:+k nom=(1+k )r1+i) or FVCGA { k−g } , FVCGAD knom= (+k r)(1+i)−1 ¿(1+k)(FVCGA) , knom=nominalrate,k =realrate,i=inflationrate 1+k nom n Real rate: kr= −1 1− 1+g 1+i PVCGA [1+k , PVCGAD ¿(1+k)(PVCGA) ¿x { } k−g Chapter 3: Setting Goals and the Financial Planning Process •Desires and goals (be rich, independent, security, retire, children’s education, big home) • Financial Planning Process: 1. Goal setting, 2. Action plan, 3. Take action, 4. Feedback (monitor progress) • Formal Model for Analysis: use this model to show how everything fits together in the process of meeting financial goals. •Establish Client-Planner engagement -> gather client data -> clarify your present financial status -> develop and present the financial plan -> implement the plan -> monitor the plan (1+k) −1 • W n : the financial goal, amount trying to accumulate (FV) Future value of wealthPV (1+k)+CFt ( k ) W • 0 : the amount you have today that can be dedicated to the future Formal Model: see chapter 1 goal (PV) n n n−t •k: rate of return (I/Y) W =n (1+k0 + ∑ (E tC (1t)) t=1 E • t : money you earn in year t ( tC =Pt) C • t : money you consume or spend in year t Chapter 4: Measuring and Controlling Personal Finances •Articulation: the income statement items all link directly to the balance sheet, and the net worth amount is exactly the sum of all the previous incomes minus dividends paid •Family balance sheet(statement of net worth): families financial standing. •Define the family, assets to include, liabilities to include • market value: what someone else would pay • Historic cost: the original price • depreciated cost: historic cost minus allowance for wear and obsolescence • replacement cost: price to replace in new condition •Human Capital: the earning power that a person possesses •financial statement: provides the basis for budgeting next year’s spending • envelope system: every paycheck is divided into the budget sections it has to cover. •Control spending -> checking liquidity -> planning Personal Assets: Financial assets, Personal assets, luxury assets Family is any group of people who share their wealth, revenues, and expenses. Liabilities: Current liabilities, long term liabilities Family balance sheet, family income statement Guidelines for debt management: Financial planning guidelines: 1. consumer debt should not exceed 20% of take-home 1. save 10% of take-home pay 2. pay off consumer debt as soon as possible 2. pay yourself first, analyze expenditure cuts later (savings) 3. convert consumer loan into investment loan 3. set up an emergency fund 4. check if there is negative cash-flow and ensure family can ser4.ceset short term goals, less 5.aSet long term goals, more than 3y Chapter 5: Family Law •Separation agreement: contract between spouses in which they agree to live separate lives and set various conditions (legal separation). •Divorce: granted by a court upon application by a petitioner • Ending a relationship: Separation -> Divorce •Separation agreement requires: financial disclosure of both parties, Support Obligations. • a person who marries someone with children and lives with them during marriage will have to provide child support •Fixed percent for child support over income of for first 150,000: 0.74% for one child, 1.26% for two, 1.54% for three, 1.84% for four Support: Division of Property: General Exclusions 1. Dependent children: under age 18 or full attendance of sc1.olProperty excluded explicitly in a marriage contract 2. Spouse: Spousal support (alimony) 2. Property owned by one spouse in advance of the marriage a. Recognize economic disadvantage to spouse due to mar3.agA gift, inheritance, or proceeds or settlement for damages b. Apportion between spouses and financial consequences4.uePersonal items (clothing, sporting goods) c. Relieve economic hardship due to breakdown of marria5. Proceeds from life insurance policy d. Promote economic self-sufficiency in reasonable time6. Family heirlooms and antiques 7. Property gained after separation Divorce: grounds for divorce 1. Intentional separation for one year because of ma2.talAdulterylt3.s husband or wife subjects the other to intolerable physical or mental cruelty Chapter 6: The life Cycle and Financial Intermediation •Financial life cycle: stages of differing financial positions • Likely to have a lot of debt during early stages • As you proceed through life, you start to earn more E −C >0 than you consume t t •Life Cycle Categories: 1. Younger, single 2. Younger couple, no kids 3. Couple, dependent kids 4. Single, dependent kids 5. Older couple, independent kids 6. Older, single 7. Couple, retired 8. Single, retired •CDIC: Canada Deposit Insurance Corporation Four Pillars: • Chartered banks • Trust Companies - Schedule A: Canadian controlled, offer wide range of prod/services • Life insurance companies - Schedule B: corporate/commercial sector, smaller & more numerous • Investment dealers Chapter 7: Personal Income Tax •Canadian tax system is progressive •can calculate both marginal and average tax rates •if you are in the highest tax bracket, you are deciding to invest your money •marginal tax rate is the rate that applies to one more dollar of income. • completing tax return: total income -> tax credits -> federal tax -> provincial tax -> balance owing (refund) -> everything else • Tax-free gains: sale on family’s principle residence, including one half hectare of land is not taxable.(unless used to earn business or rental income) Format for Personal Income Taxation (1−marginaltaxrte)x(interestrate) Income – Allowable deductions = taxable income t =t +t 1+t( ) Interest on ordinary income: c f p sp Taxable income x income tax rate = income tax payable before credits tc=combinedmarginalrate, income tax payable before credits – tax credits = tax payable(refund) t =marginal federalrate, f aftertaxdiscount,k =k 1−tt b ( c) tp=marginalfederal rate, tspprovincialsurtaxonmarginal provrate, DTC prop.div.taxcredit, DTC =feferal÷taxcredit , G=dividend grossup Div. CG surtax: tc dividend [1+G )tf−DT C + f] [(1+G t pDT C p](1+t sp) Chapter 8: Income Tax Planning •tax rates are progressive •governments try to achieve several objectives with tax laws • tax deferral often saves money because of TVM •income deferral: you can’t use income for consumption purposes • RPP: established by an employer to defer income payable to employees to provide retirement income •RRSP: do it yourself pension •tax is not payable on capital gains until it is realized •income splitting: from higher earning spouse to lower earning spouse (tax brackets) •Estate freezes: freezes value of property in the hands of the original owners, who place it in the freeze. •tax shelter: a lower of 0 rate of tax, without deferral. • cashsaved RRSP Contribution limit: maximum is lessor of 23,820 or 18% of previous years earned income 1−taxrate , CS(1-tax rate), i(1-tax rate) TFSA Contribution limit: starting in 2009, 2009-2012 : max of 5000/y, 2013-2014: max of 5500/yr Chapter 9: Risk Management •Five stage personal risk management process: identify, evaluate, control, finance, and monitor •speculative risk: involves loss and gain, but in uncertain amounts •speculative does not mean gambling • Step 1. Identify risks: Life & health, property, liability Step 3. Controlling risks: separation, prevention, reduction of frequency Step 2. Evaluate risks: size of potential loss, probability of occurrence Step 4. Financing risks: insurance, moral hazard are not insurable Step.5 Monitoring risk profile: risks will change as you move through life cycle. Chapter 10: Life, Health, and Disability Insurance •Life insurance: means of financing the risk of the premature death of a family member • death benefit or face value: dollar amount to be paid •policy term can range from 1 year to entire life time •insurability: qualification for the insured to be insurable, may be requirements (medical examination) •income approach: estimates the face value of the life insurance by calculating the present value of the insured’s expected future income. •Human capital: present value of insured’s expected future income. •Three issues: 1. Present discount rate of future income 2. Handling inflation 3. Income stream. • Expense approach: life insurance face-value amount that the family needs is the amount that will provide enough funds to pay for those expected expenses of the beneficiaries that are not covered. • Shortfall: income lost • Factors in insurance: age, gender, health condition, cost of selling and administering policy, duration of policy • Real rate of interest = nominal rate – expected rate of inflation Net annual premium: NAP C x 1 − 1 Step 1. Draw up balance sheet of individual at death n Net Single Premium: NSP [ i i(1+dr) ] Step 2. Determine the capital and the assets available that can be T−1 xP T−1 xP xQ invested i i x+i NAP = NSP÷ ∑ i NSP=M ∑ i+1 i=0 1+k ) i=0 (1+k ) Step 3. Government payments, survivor benefits, CPP Step 4. Estimate the expenses required for the dependents to live M=facevalueof insurance policy comfortably Step 5. Subtract step 3 from step 4 for income shortfall xP =probabilitythatanindividualaged xwillsurviceimore years i Step 6. Calculate capital (face value of life insurance) Q =x+ibabilitythatanindividualaged(x+i)willdieduringnext year k=discount rate
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