FHCE 3200 exam 1 Study Guide

financial literacy

How well you can understand and use personal finance-related information

one of the most important predictors of
savings and investment success
and overall well-being.

financial knowledge

the ability to understand personal finance information

financial risk tolerance

unwillingness to engage in financial endeavors that have uncertain outcomes.

key action steps to financial well-being

1. Keep good records

2. Spend less than you earn

3. Maintain appropriate insurance

4. Save money on a regular basis

human capital

ability and willingness to work, learn, earn, and make wise decisions about how to save and invest money.

social capital

how well you are able to form connections with other people

Informal Social Capital

the interpersonal relationships you form with your family and close friends

Formal Social Capital

connect you with people in professional, recreational, leisure, and social communities

Calculate the Payback period

Total Costs/Increase in annual income

Risk

uncertainty associated with any physical, social, emotional, environmental, labor market, or financial activity

risk taking

doing something that involves the possibility of a gain or a loss

wealth creation and risk tolerance

In financial markets, the only way to accumulate a certain level of wealth is to take informed financial risks with your savings.

Identify the SMART goal process

Specific
Measurable
Attainable
Relevant
Timely

Specific

Document the when, what, where, and how aspects of the goal

Measurable

Attach a quantifiable standard for achieving the goal

Attainable

Be realistic about whether you can achieve the goal

Relevant

Develop those financial goals that are crucial to improving your financial situation

Timely

Create a goal you can meet in a reasonable amount of time

Goal Time Horizons

time between creating a goal and achieving the goal

short-term time horizon

less than 1 year

long term time horizon

greater than 1 year

Past Oriented

based on memories, whether good or bad. Those who view past events negatively have the most trouble staying on their financial path

Present-Oriented

based on hedonistic perspective or fatalistic perspective

hedonistic perspective

doing things for pleasure, the experience, and excitement of the action

fatalistic perspective

unable to visualize a meaningful future

Future-Oriented

based on a calculation of the consequences of actions in terms of a future payoff

self-efficacy

how well you believe you can do something.

hyperbolic discounting

occurs when the value of future benefits is perceived to be lower than that of an alternative available right now.

Heuristics

•Based on past experiences
•Automatic and rarely used with forethought
•Can help you make quick decisions, however, they sometimes lead to problematic choices and outcomes

Status quo bias

the preference to keep things the way they are rather than change

loss-averse

characteristic of being very reluctant to do anything that might lead to loss

optimism bias

people believe that, compared with other people, they are more likely to experience positive events and less likely to experience negative events in the future

Confirmation bias

a tendency to search for information that supports our preconceptions and to ignore or distort contradictory evidence

interior finance

refers to your knowledge, attitudes, perceptions, and abilities

exterior finance

the observable actions you take with money and the associated outcomes such as
Loan payment amounts
saving rates
cash flow management
net worth

Interest

the price paid for the use of borrowed money
Borrowed money you pay back with interest (loan)
Lended money you generate interest (savings, loaning)

True/False:
It can take up to 99 years to receive your federally insured money from the Federal Deposit Insurance Corporation (FDIC).

False

BOTH Federal Deposit Insurance Corporation (FDIC) and National Credit Union Administration (NCUA) protect your deposit up to

$250,00

APR (Annual Percentage Rate)

annual sum of the periodic interest rates applied to the account, without considering the effect of compound growth.

APY (annual percentage yield)

The effective annual rate of return taking into account the effect of compounding interest.

APR Formula

periodic interest rate x number of periods in the year

APY Formula

[(1+Periodic Interest rate)^(number of periods in a year)]-1

Time Value of Money calculations

FV: Future Value
PV: Present value
N: # of periods
I/Y: Interest
PMT: a series of more than one payment or deposits

Time Vale of Money (TVM) formula

FV/(1+i)^N

future value of an annuity

the amount accumulated in the future when a series of payments is invested and accrues interest

Future value of an annuity formula

FVA=(PMT/i)[((1+i)^n)-1]

present value of an annuity

The amount at a present time that is equivalent to a series of payments and interest in the future.

Present Value of an Annuity formula

PVA=(PMT/i)(1-(1/[(1+i)^n]))

Amortized Payments

a payment of the same amount for a set number of months or years

Amortized Payments formula

Monthly Payment=PV((I × (1 + I)^N)/((1 + I)^N) - 1)

Future Value (FV)

how much current savings and investments will be worth at a certain date in the future

Present Value (PV)

Value today of a future amount

Annuity

a series of equal regular deposits

Rule of 72

The number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of interest.

balance sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date.

Net Work formula

Assets-Liabilities=Owners equity (ALOE)

liquidity

How quickly and easily an asset can be converted into cash

fair market value

the price someone would realistically pay you to buy the asset

Appreciating Assets

assets that increase in value over time, for example, a house

depreciating assets

assets such as cars and computers, fall in value over time

short term liability

liability typically expected to be paid within one year or less

long-term liability

Liabilities with longer repayment schedule and would include student loans and money borrowed to purchase a house (i.e., a mortgage)

bad debt

borrow money to buy something that either goes down in value quickly or is consumed immediately.

good debt

The concept that sometimes it is worth taking on certain types of debt in order to generate income in the long run. Common examples include college education debt and real estate.

current ratio

current assets / current liabilities=1

debt ratio

total liabilities/total assets = 40%

savings ratio formula

total savings/total income=12% or higher

targeted saving rates based on age

Emergency Fund Ratio

cash and cash equivalents (Monetary Assets) / monthly non-discretionary cash flows(Necessary Expenses); benchmark = 3-6 months

consumer debt-to-income ratio

total consumer debt payments/total income = 15% or less

total debt to income ratio

Total debt payments/Total income=no more than 36% of income being used for debt payments

surplus

Income exceeds expenses

Sections of a budget

Income, Expenses, Surplus/Deficit (Profit/Loss)

deficit

Expenses exceeds income

Save More Tomorrow

Commit to putting half of every future raise towards your saving

Present Bias

A preference for choosing short term pleasures over long term investments

Income

broad term used to describe all sources of money obtained by individuals and households and can include:
•Allowances
•Public assistance
•Interest
•Dividends
•Social Security payments

Earnings

just one form of income:
•Compensation received for services performed for an employer

Wage

•what an employer pays an employee to work
•usually based on an hourly rate

Salary

•payment for work for a set period of time
•usually an annual amount

commission

•payment based on the sale of a product or service

Bonus

•an extra payment usually based on performance

Overtime

working more than 40 hours in one week. gets paid 1.5x regular wage

Six steps for creating a financial plan

1.Set a Financial Goal
2.Know Your Starting Point
3.Determine Your Financial Score
4.Determine Your Financial Capacity
5.Know Your Time Horizon
6.Formalize and Implement Your Financial Plan

Sole Proprietorship

unlimited liability, limited access to resources, easy start-up, sole receiver of profit

General Partnership

A partnership in which all owners share in operating the business and in assuming liability for the business's debts. unlimited liability

Limited Partnership

general partner manages the business and one or more limited partners invest money in the business

Limited liability partnership

•Partners are not liable for actions of other partners, but are liable for the general obligations of the business

Limited Liability Company (LLC)

A legal entity that is not taxable itself and distributes the profits to its owners, but shields personal assets from business debt like a corporation.

Corporation

A business owned by stockholders who share in its profits but are not personally responsible for its debts.
Very effective at limiting liability, but also expensive to form and maintain

Earned Income

money from work primarily through the labor market.
•Salaries, wages, commissions, or bonuses

Unearned Income

money from non-labor sources.
•Interest from savings accounts
•Dividends
•Capital gains
•Monetary gifts
•Government benefits
•Money received by inheritance
•Proceeds from savings bonds

capital assets

almost everything you own or use for personal or investment purposes, according to the IRS
•Your home
•Your car
•Investments like stocks, bonds, and mutual funds
•Ownership interest in a small business you started
•Rental or other real estate you own

Calculate capital gain

Calculating steps: Selling Price

• Basis (Purchase price)

• Selling costs = Realized Capital Gain

Calculate capital loss

Original Price - Price Sold at