EXAM 1 Review
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This 13 page Study Guide was uploaded by Rachel Causey on Thursday October 13, 2016. The Study Guide belongs to FAM 251 at University of Kentucky taught by Dr. Kim Hyungsoo in Fall 2016. Since its upload, it has received 9 views. For similar materials see Personal/family Finance in Finance at University of Kentucky.
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Date Created: 10/13/16
EXAM review for FAM 251 September 28th, 2016 Chapter 1, 3, and 4 Chapter 1: Personal Finance o Interest rate: costs of borrowing money, when you need resources and don’t have the money, you pay the people you borrow from>>>>which is called interest. o Inflation: the general increase in prices. If only one items increases in price then it is not an overall inflation, it is just an increase for that particular item. o Time value of money: concept that addresses the way the value of money changes over a period of time Principle that money received today is worth more money than money received at some point in the future (thanks to interest^^^) Why is money today worth more than money tomorrow? Because you can invest in it to earn a compounding interest on it, see the chart for $3000 invested at 9% IR Early Late Age $ Age $ 23 3000 23 0 31 6000 31 3000 39 12000 39 6000 47 24000 47 12000 55 48000 55 24000 63 96000 63 48000 You can see how if you started investing at age 23 instead of age 31, then you will reach that peak amount of money much sooner. At age 63 you could either be earning $96,000 or $48,000. o Rule of 72: estimate the amount of time it will take to double your money by taking the % of interest and divide it by 72 72/interest rate 72/9=8 years to double your investment for $1000 at 6% it would take 12 years to double two major reasons of why money is worth more in the present and not in the future: inflation, and uncertainty of receiving future income. o 3 factors of saving/investment outcomes How much: principle Interest: rate of return How long: time period o When determining future value: FV=PV (multiply or divide) [1+r]^n So a year from today you want to have $100 at a 4% rate: 100/[1+.04]^1= you need to deposit $96.2 and then one year from today with 4% interest you will have $100 If you start out with $100 and want to know how much you will have after one year with 4% IR: 100*[1+.04]^1=$104 after one year Chapter 3: Financial Statements and Budgeting o Financial Planning; financial values, goals (specific), and strategies: Financial strategies are pre-established plans of action to be implemented in specific situation 2 Financial values provide the underlying support and rationale for your financial and lifestyle goals Goals: short term, intermediate, and long term (all goals very specific to time and amount) Short: these goals can be achieved in less than a year, such as finishing college, paying off an auto loan, increasing savings, purchasing assets, etc. Intermediate: are goals that can be achieved between one and perhaps three-five years such as creating an emergency fund amounting to at least 3 months of income within 4 years, saving for a down payment on a home, taking a $4000 vacation to Asia in two years, etc. Long term: financial targets or ends that an individual or family wants to achieve perhaps more than five years in the future, such as having a $1 million retirement fund by age 60 o Financial Statements Financial statements are compilations for personal financial data that describes an individual’s or family’s current financial situation, see following definitions. Have a balance sheet- this describes an individual’s or families financial condition on a specified date by showing assets, liabilities, and net worth. Contains what you own, what you owe, and what the net result would be if you paid off all of your debts (“where are you financially right now?”) Have cash flow statements- lists and summarizes income and expense transactions that have taken place over a specific period of time, such as a month or a year. Tells you where your money came from and where it went (“where did your money go?”) 3 In cash flow statements you need to know the income, and expenses. Expenses can be fixed or variable o Fixed expenses pretty much stay the same from month to month, for example rent o Variable expenses will change monthly and may not even be included in some months, like going out to eat, electric bill, etc. o Types of assets/liabilities: An asset includes everything you own that has monetary value Monetary assets (liquid or cash assets) include low-risk near-cash items valued at their fair market price. (what a willing buyer would pay a willing seller) not what was originally paid or what the future value is, but the present value of an item in the here and now Tangible (use/lifestyle) assets are personal property whose primary purpose is to provide maintenance of one’s everyday lifestyle. This includes furniture and vehicles and can depreciate in value over time Investment assets (capital assets) include tangible and intangible items that have relatively long life and high cost that are acquired for the monetary benefits they provide, such as generating additional income and appreciation (increasing value) these are things like stocks and bonds. Your liabilities are your debts-amounts you owe to others Short term liabilities are obligations that can be paid off within the current year, like personal 4 loans owed to other people, credit card balances, taxes, rent, etc. Long term liabilities are debts that do not have to be paid in full until more than a year from the BS as CF BS as of during of Dec Nov30 Dec 31 Asset $100 Income $100 Asset $120 (100+2 0) Liabilit$50 Expens $80 Liabilit$50 y e y Net $50 Surplus $20 Net $70 (50+20 worth worth ) current year, for example automobile loans, real estate mortgages, education/student loans, etc. Net worth is the dollar amount left when what is owed is subtracted from the dollar value of what is owned. Assets-liabilities= net worth What is owned- what is owed= net worth College students typically have more debts than assets; thus they are technically insolvent because they have a negative net worth Below will show the relationship between the Balance sheet and the Cash Flow Sheet in a net gain situation and also in a net loss situation 5 So from November to December, your net worth increased by $20. You need to spend less than you earn so that you have surplus on your cash-flow Net Loss: BS as of CF BS as of Nov30 during Dec 31 Dec Asset $100 Income $100 Asset $80 (100- 20) Liability $50 Expense $120 Liability $50 s Net $50 Deficit -$20 Net $30(50- worth worth 20) So from November to December, your net worth decreased by $20. This put you at a deficit for you Cash flow during December Past: >> Present: >> Future: -Cash flow -Balance - Budgeting statement Sheet Financial Ratios o Common ratios and questions: Do you have enough emergency funds? Liquidity ratio o The speed/ease your assets convert into cash o If you wreck a car and have no money you liquidate assets in order to have the money to pay for repairs and if needed medical bills 6 o You tend to want at least if not more 3 months of living expenses in monetary assets incase anything were to happen. You could liquefy your assets and still be able to live comfortable for 3 months. o $3000 monetary assets/$1000 monthly expenses=you could live off your assets for 3 moths before running out of money (theoretically) o some suggest at least 6 months built up Do you have enough assets compared to liability? Asset to debt ratio o Assets/all debt: more than 1 o $3000 asset/$3000 debt = you can pay off all debt by selling all your assets o $6000/$3000= you have $3000 left over after paying your debt Can you meet your total debt obligation? Debt service-to-income ratio o Annual debt repayments/annual gross income o Less than 36% o $3600/$10,000= 36% of income to pay debt/service Is your non-mortgage debt payment too stressful? Debt payment to disposable income ratio o Monthly non-mortgage debt repayment/monthly disposable income o $366.67/$5242.67= 6.99% o Should be less than 15% 7 Am I saving/investing enough? Investment Assets-to-total assets ratio o Investment assets/total assets o $167,000/$372,620=0.448 or 44.8% Budgeting o Budgeting- a process of projecting, monitoring, adjusting and controlling future income expenditures o A cash flow calendar is a budget that estimates for monthly income and expenses o A revolving savings fund is a variable budgeting tool that places funds in savings to cover emergency or higher than usual expenses o Rules for successful budgeting: Simple Personal Flexible Positive o Budgeting Action: Before Make budget estimate of Gross income (income before taxes), take home pay (disposable income), and discretionary income Revise budget estimates (earn more income, cut back expenses [best for college] and don’t forget to include your savings in your budget, keep a balanced budget Set goals: Long, intermediate, and short term These goals should be specific: What, amount, and time frame During 8 Control spending: Monitor balances in each item to prevent over spending, use a subordinate budget, pay by check to record the purchase of expenditures, try the notebook method: Food away $100 from home May 3 Lunch w/ $14 $86 mom May 11 Dinner out $27 $59 May 19 Church $18 $41 breakfast May 25 Joe’s b-day $37 $4 This keeps track of all credit card transactions and allows you to see your current balance (just like a bank statement) Budgeting continued: After: Evaluate budgeting progress Budget varies: Differences between amount budgeted and actual amount spent/received (can help you see where you’re over spending is located and where you should relocate some unused money) What to do with the left over money: Put into a revolving savings account Build a cash reserve in a savings account Pay off any credit card debt or any other debts you may have Chapter 4: Income Taxes o Major types of taxes: Income (taxed through income, in the federal/state/local jurisdiction Consumption 9 All (taxed through sale, under the state/local jurisdiction) Specific (taxed through exercise of service under the federal/state jurisdiction) Wealth Ownership (taxed through property taxes under the jurisdiction of state/local) Transfer (estate taxes through inheritance under the jurisdiction of federal) o Income taxes Taxes that are compulsory charges imposed by the government on its own citizens Internal Revenue Service’s (IRS) o Progressive Taxes The progressive nature of the federal income tax Progressive tax is one that requires a higher tax rate as income increases A regressive tax rate is one that demands a decreasing proportion of one’s income o Marginal Tax Rate The tax rate paid on any amount of income within 7 brackets Why do marginal rates matter? Because decisions get made in the margin: o Should I save, spend, what to do with the money? o Tax burden Average tax rate Proportion of total income paid in income taxes 10.1% in 2015 effective marginal tax rate sum of total marginal tax rate on income 10 federal, state, local marginal income tax rates and social security 25%+6%+2%+7.65%=40.65% basically 40 cents per dollar you earn is tax Tax liability=taxable income*marginal tax rates o 8 Steps involved in calculating federal income taxes: total income: compensation from all sources income you might receive wages commissions (tip) interest retirement scholarship bonus capital gains gross income determine and report gross income exclusions and gross income certain types of income such as gifts that do not have to be reported are exclusions o gifts (up to 4,000) o inherited money o life insurance o child support o scholarships Total income-exclusions=gross income Gross income-adjustments=adjusted gross income Adjusted gross income- deductions/exemptions=taxable income Taxable income*marginal tax rates=tax liability Tax liability – tax credits=final tax liability Tax refund if final tax liability < withholding or tax payment 11 Tax balance due if final tax liability > withholding or tax payment Tax credits, adjustments, deduction or exemptions o Exemptions are legally permitted amounts deducted from Adjusted gross income based on the number of people that the tax payer’s income supports (otherwise known as a dependent) o Tax credit is dollar for dollar decreasing in tax liability; also known as credit. o A tax credit reduces your tax liability dollar for dollar whereas a tax deduction reduces the amount of your taxable income, which is used to calculate your tax liability. o Tax credits are more valuable because they reduce your tax liability one dollar for every dollar of the credit. o Tax deductions reduce your tax liability by your tax rate for every dollar in the deduction Tax avoidance, evading, and strategies o Tax evasion involves deliberately and willfully hiding income, falsely claiming deductions, or otherwise cheating the government out of taxes owed. It is very ILLEGAL o Tax avoidance means reducing tax liability through legal techniques. It involves applying knowledge of the tax code and regulations to personal income tax planning. o Strategies: Tax-sheltered investments: reduction or elimination of taxes due. The tax laws allow certain income to be exempt from income taxes in the current year or permit an adjustment, reduction, deferral of income liability. Tax shelter: when the investor does not pay the current year tax liability on the income and 12 instead shifts the income and any tax liability to a later year. Roth IRA: Individual retirement plan that accumulates tax free and withdrawals are tax free. There is no tax break on contributions. IRA: amount contributed to the account is considered an adjustment to income, which reduces your current year income tax liability, they are tax sheltered, and income taxes are eventually owed on the withdrawals during retirement. 13
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