Personal Financial Management Exam Review

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Marketing and Consumer Studies
MCS 2100
Douglas Adlam

Personal Financial Management – Final Exam Study Notes Unit 1: Planning Your Personal Finances What You Should Focus on for the Exam 1. Understand why financial planning is important. -Planning is important to ensure that you achieve all of your set goals. Without planning it is easy to miss these goals. 2. Understand how the life cycle can affect financial planning. -pg 10-11 -At different points in the life cycle, and in different life situations, you will have different financial goals and priorities, and therefore have to funnel your money into different expenses at different points in your life. 3. The six steps in the financial planning process - know what they are & understand them. -pg 4 1. Determine current financial situation 2. Develop financial goals 3. Identify alternative courses of action 4. Evaluate alternatives 5. Create and implement a financial action plan 6. Re-evaluate and revise the financial plan 4. How to set financial goals. -There are many different ways to set financial goals, but here are some important guidelines to follow. -Financial goals should be realistic. They should be stated in specific, measurable terms. They should have a time frame. They should indicate the type of action to be taken. 5. Understand how the economy affects personal financial decisions (this is covered in other chapters as well) -First of all, market forces such as demand and supply can have an effect on your decisions because they will determine what you will have to pay. -Financial institutions have an influence on this due to the fact that they control the supply of money in the economy and therefore consumer spending. -Global influences have an effect, for example when there is a change in our exports and imports. -There are also many other economic conditions that have an effect on our financial decisions. These are consumer prices, consumer spending, interest rates, money supply, unemployment rate, housing starts (number of new homes being built), GDP, Trade Balance, S&P/TSX and other stock market indexes. 6. Opportunity cost (this is covered in other chapters as well) -The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. -The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages. Here's another example: if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.). 7. For each chapter make sure you know the terms given at the end of the chapter. Appendix 1B: Time Value of Money What You Should Focus on for the Exam - for Time Value of Money Since Quiz 1 will test this material there will only be a couple of exam questions from this appendix. 1. Know how to use all of the formulas and know when to use them. -Formulas will be given. Just plug in values. 2. Understand the difference between simple and compound interest. - 3. Remember how to account for more than one compounding period in a year. Chapter 2: Money Management -An important part of a budget is to have methods to help you monitor and control expenditures and savings. Methods for monitoring can be as simple as keeping a running total of expenditures as they occur in a notebook or as complex as using double entry book keeping. You need to set up a system that works for you and decide how often you will update it. If you decide to update it once a month where will you put the receipts etc? Also important are ways to control expenditures and savings. Methods include automatic bank account transfers for savings, taking $X out of your bank account once a week for entertainment etc, reporting on your expenditures to another person, leaving credit and debit cards at home, having a concrete plan to reduce certain expenditures (brown bagging it, renting movies instead of going to the show etc) and putting funds for second semester in a savings vehicle that is hard to access. Find control methods that work for you. What You Should Focus on for the Exam 1. Objective 1 -Recognize relationships among financial documents and money management activities. -understand opportunity cost and money management. -there are three main components of money management. 1. Storing and maintaining personal financial records and documents. 2. Creating personal financial statements (balance sheets and cashflow statements 3. Creating and implementing a plan for spending and saving (budgeting) 2. Be able to produce balance sheets and cash flow statements. -personal balance sheet Items of Value (what you own) – Net Worth (your wealth) = Amounts owed Assets – Liabilities= Net worth -Calculate cash surplus or deficit for a given period. 3. Be able to calculate and understand the financial ratios. 4. Understand the budgeting process. -Creating and implementing a budget can be achieved in seven steps: 1. Setting financial goals. 2. Estimating income. 3. Budgeting emergency fund and savings. 4. Budgeting fixed expenses. 5. Budgeting variable expenses. 6. Recording spending amounts. 7. Reviewing spending and savings patterns. 5. Be able to apply the theory on 2 income households. -Some suggestions for 2 income households -Pooled Income: both incomes are combined, and bills are paid from the pool. This method requires trust and shared goals and values. -Sharing the bills: Each person is responsible for paying predetermined bills. -50/50: Each person is to contribute an equal amount. -Proportionate Contributions: Amount contributed is relative to their income, this is useful when one income is higher than the other. Chapter 3: Planning Your Tax Strategy What You Should Focus on for the Exam 1. The basic process of calculating tax payable as shown on page 77 of the textbook - Exhibit 3-1. Step 1: Determining total income (employment income+ Investment Income, etc…) Step 2: Calculating Net Income (Less Deductions) Step 3: Calculating Taxable Income (Less other allowable deductions) Step 4: Calculating Federal Taxes Owing (Federal tax based on tax bracket) Step 5: Calculating Net Federal Tax (Less Tax Credits, Plus Net Provincial Taxes, Equals Total taxes due) What types of things are allowable deductions (usually related to earning income and CPP and RRSP contributions). -Contributions to deferred income plans (RRSPs, RPPs, IPPs) -Union and Professional Dues -Childcare Expenses -Disability supports deduction -Moving Expenses -Business involvement loss, capital losses -Spousal and child support payments -Interest paid on loans -employment expenses What types of things are allowable tax credits. -There are two types of tax credits that can reduce the amount of tax you owe: non-refundable tax credits and refundable tax credits. The more common are non-refundable tax credits, which are subtracted from the amount of taxes owed but can never reduce net federal tax below zero. Know the difference between marginal tax rate and average tax rate. -Marginal tax rate is the rate you pay on the next dollar of taxable income earned. For example if you earn $45,000 of taxable income, the first $35,000 will be taxed at 15%, and the remaining would be taxed at 22%. -Average tax rate is based on the total tax due divided by the total taxable income. Understand capital gains and know that only 50% of it is currently taxed. -A capital gain is the increase in value of an investment over time. Current regulations entitle individuals to a $750,000 lifetime exemption. Understand that our tax system is progressive. -the progressiveness of our tax system shows that the more you earn, the more you are going to have to pay. The tax brackets get higher and higher up to 46%. Understand the difference between tax avoidance and tax deferment. You should be able to identify examples of each and know what is legal and what is not. -First of all, Tax avoidance is illegal, tax deferment is not. Tax avoidance would be hiding income by not declaring this income to be taxed. Tax deferment would be using legal routes and tax shelters such as RRSP’s to pay less tax. Chapter 4: The Banking Services of Financial Institutions What You Should Focus on for the Exam Objectives 1 to 5 on pg. 117 of the textbook. Pick the best financial service or savings plan for a given situation. -pg 122-124 READ Bank reconciliation – know how to do Canada Deposit Insurance Corporation -The Canadian Deposit Insurance Corporation will protect eligible deposits up to a maximum of $100,000 per person, including principal and interest, for each member institution involved. Eligible deposits include chequing accounts, term deposits, GIC’s, debentures, and other obligations offered by members of the CDIC. Chapter 5: Introduction to Consumer Credit Credit Options When you need to obtain credit for consumer loans make sure you compare the available credit options. Do not just go with the most convenient credit. It can cost you in the long run. Compare the cost of credit at the retail establishment with the cost of various bank credit options. Be careful of schemes that advertise “Don’t pay a cent until …”. Make sure you read the fine print first. Most of these schemes will not charge interest if you pay the credit bill in full by the don’t pay a cent until date. If you do not pay in full by that time usually you will be charged interest starting at the purchase date. This can be a substantial amount of money because often there have been no credit payments for a full year. This means that a year’s worth of interest charges are added onto the principal owing. If you wish to take advantage of the year’s (or whatever time period) grace period then make sure you are able to pay off the full amount due on the due date. Or alternatively, use a line of credit or other loan to pay off the amount due. Some of these schemes also charge and administration fee. Make sure you take this into consideration when you are comparing credit choices. Car Loans vs Car Leases For many people comparing the costs of obtaining a car loan to renting is overwhelming. A car loan is much more straight forward than renting. With renting there are more variables and sometimes the total cost is not known until the end of the contract. Generally, it is cheaper to buy a car with a loan than to lease one. I hope that this will make the comparison easier or at least give you the knowledge to ask the right questions. Many dealerships have been advertising 0% financing. That sounds very attractive. Generally the catch is if you pay cash for the car you get a dealer rebate. The rebate is often as much as $2000. So that 0% financing is costing you $2000 more. If you need to get a loan make sure you compare the cost of the dealership financing with the financing available at your bank. The bank loan could very well be cheaper in the long run. Now for some of the ins and outs of leases. There are two types of car leases: open-end and closed-end. With an open-end lease the leasing company estimates the value of the vehicle at the end of the lease. If the vehicle actually ends up being worth less at the end of the contract the consumer is on the hook for the difference. Closed-end leases do not have this risk. Often an open-end lease will look better because the monthly payments are lower. The lease payment is based on 5 factors: 1) the cost of the car; 2) the estimated value of the vehicle at the end of the lease (residual factor); 3) lease or interest rate; 4) length of the lease; and 5) the down payment. It is important to compare the residual factors used by different dealerships. Since the monthly payment is based largely on the estimated depreciation of the vehicle over the term of the lease the best lease deals are for vehicles that have lower rates of depreciation. Many leases require a security deposit. You may also decide to put down a down payment. Lease terms are usually from 2 to 5 years. It is difficult and costly to terminate a lease agreement. Pay attention to the terms of termination. Termination applies to vehicles stolen or totalled in accidents. Gap insurance will pay lease fees for vehicles stolen or totalled. You are responsible for insuring the vehicle and maintaining the car. At the end of the lease you may be responsible for paying for any “unreasonable wear and tear”. You may also be required to pay a “disposition fee” if the vehicle is returned at the end of the lease. If you have gone over the maximum number of kilometres you will also be charged a fee based on the number of extra kilometres. At the end of a lease you have the option to purchase the vehicle. If the purchase price is below the current market price it is likely beneficial to purchase the vehicle, even if you re-sell it. A website that has an auto loan and auto lease calculator is It lets you plug in numbers to compare the costing of borrowing to buy and leasing. A website that has an excellent explanation of how leases work plus some calculators is It is also a U.S. site but does include Canada in its information. What You Should Focus on for the Exam Differentiate among various types of credit - know advantages and disadvantages of each and be able to pick best type for a given situation. -read 147-156 Objective 4 and 5 on page 144 of the textbook. -Describe the information creditors look for when you apply for credit. First of all there are the five C’s of credit management. Character (attitude towards credit obligations), Capacity (your financial ability to meet credit obligations), Capital (refers to your assets or net worth), Collateral (an asset that you pledge to obtain a load). They also judge many other things, such as previous occupations, homeowner or not, age, if you have a telephone, and your monthly income. -Identify the steps you can take to avoid and correct credit mistakes. Read pg 169 exibit 5-8 for info. Chapter 6: Choosing a Source of Credit-The Costs of Credit Alternatives What You Should Focus on for the Exam Objectives 1 to 5 on pg. 174 of the textbook. -give whole chapter a quick read through Process of personal bankruptcy -read pg 188-191 Chapter 7: The Finances of Housing Term vs Amortization Mortgage payments are calculated based on the amortization. The amortization period is the length of time it will take to pay off the mortgage at a given interest rate. Common amortization periods are 5, 10, 15, 20 and 25 years. In contrast the mortgage term is the length of the current mortgage contract. The mortgage term is often shorter than the amortization. At the end of the mortgage term the mortgage will usually be re-negotiated for another term unless the mortgage has been completely paid off. Usually there are slight differences in the mortgage interest rates for each of the different mortgage term lengths. The differences arise due to the predictions about future interest rates. New Mortgage Product Manulife One has introduced a revolutionary new way to pay off a mortgage. It combines a mortgage, savings, chequing, charge cards and loans all in one account. With this account you do not make any predetermined payments. Instead every pay day the pay cheque will be applied against the outstanding balance. As the account holder withdraws money this will in turn increase the outstanding balance. This method allows all available money to be applied to the mortgage. Interest is charged daily on the outstanding balance. In the long run it will decrease the amount of interest paid. It is estimated that on a $200,000 mortgage approximately $30,00
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