PF3 Notes

(6.1) What are some mainstream lenders and their alternatives?

• Banks → Check cashers

• Credit Unions → Payday lenders

• Auto manufacturing financing → Title loans

• Credit card issuers → Pawn shops

• Merchant credit cards → Seller - financed used car loans

(6.1) What are payday loans?

Short-term loan designed to be repaid within a few weeks when the borrower receives a paycheck (usually $500)

Process:

• Person gives $575 check

• They receive a $500 loan

• 2 weeks pass

• $575 cash given

• Initial check returned

• If not paid within 2 weeks, the lender will attempt to cash the check

(6.1) How to calculate the APR of a loan:

Loan is $500 and interest is $75

75 is 15% of 500

If rate is charged every 14 days, it would be charged 26 times in a year

365 days / 14 days = 26.07

26.07 × 15% = 3.91

3.91 × 100 = 391%

(6.1) What is collateral? Which alternative lenders use this?

Something you give the lender that they can sell if you don’t repay the loan in a timely manner

Pawn shops and title loan companies

(6.1) Pros and cons of alternative loans:

Product	Good Credit Score Required	Additional Application Requirements	Example Finance Charge $300 for 3 Months
Parents or family	No	None	Likely 0% APR, $0
Subsidized student loan	No	FAFSA form. No credit check required	2.75%  APR, deferred interest, $0**
Auto loan at bank	Yes	Must own the car and have equity in it. Complete loan application at bank.	6%  APR, $4.52
Personal loan at bank	Yes	Complete loan application at bank.	10% APR, $7.56
Credit card	Yes	Complete a loan application.	12% APR, $9.09
Credit offered by service provider	Yes	Service providers often offer loans to customers to pay for services. The loan is generally made by a national lender partnering with the local business. Complete application at store.	29.99%APR, $23.06
Pawn shop	No	Something of significant value to give the pawn shop as collateral. If the loan is) repaid, the item can be reclaimed, if not the item is sold.	200% to 400 % APR; $176.39 (at 200% APR)
Title loan	No	Must own the car without any other loans against the car. No credit check required	300% APR, $285.94
Payday loan	No	Must write a personal check for the loan amount plus a fee, usually $15 per $100 borrowed. In 2 weeks must repay the loan or renew the loan with an additional fee. No credit check required	390% APR, $393.92

(6.1) How should you avoid expensive loans?

Have an emergency fund

Other sources of funds:

• Withdraw the funds from their savings, investments, or other financial accounts

• Borrow the money from family or friends

• Obtain a loan from a bank, credit union, or other mainstream financial institution

• Work more hours to increase pay

• Sell something of value

• Use alternative financial services (payday lenders and pawn shops

(6.1) What is the Truth in Lending Act?

Federal law that protects consumers who borrow money

Important provisions of TILA include:

• Disclosure of Terms and Costs

• Right of Rescission

• Advertising Rules

• Enforcement

• Billing Statements

• High-Cost Mortgage Protection

(6.2) What is a personal loan?

Typically a small-dollar debt that can be used to pay bills or make purchases

Example:

• Someone has a consistent job that usually pays the bills, but one month they need an extra $350

• They can take a cash advance or use a credit card

• Both options are much better than payday or title loan

(6.2) What are the types of personal loans?

• Secured loan

  • Backed by collateral

  • Property (such as car or valuable item) that can be taken by the lending institution if the borrower fails to repay the loan

  • Typically includes:

    • vehicle loans

    • mortgage loans

    • deposit advances

    • car title loans

    • pawn shop loans

• Unsecured loan

  • Not backed by collateral

  • Sometimes called signature loans

  • Considered to be riskier than secured loans and therefore charge a higher interest rate

  • Typically includes:

    • lines of credit

    • credit cards

    • student loans

    • payday loans

• Installment credit

  • The borrower receives the full amount of the loan upfront in a single lump sum

  • Interest is usually fixed

  • Payback period is fixed

  • Repayment periods are generally 1-5 years

• Line of credit

  • Looks similar to credit cards; allowing the borrower to maintain a revolving balance month-to-month

  • Usually unsecured

  • The bank informs the borrower how much may be borrowed in total

  • The borrower is given a debit card or a checkbook

  • The borrower can then access the line of credit as needed

  • Interest is only paid on the money borrowed

• Deposit advance

  • Short-term loan that is automatically repaid when the next qualifying electronic deposit is made (such as next paycheck)

  • The borrower must have a checking account and a history of regular electronic deposits of paychecks, federal benefits, or other deposits

  • When a loan is needed, the borrower pays the bank approximately $10 for every $100 borrowed

  • The borrower then has 35 days to pay back the loan

• Peer-to-peer lending (P2P)

  • Allows a borrower and lender to come together via the Internet, such as Lending Club, Peerform, and Prosper

  • Allows people 18 years of age or older to enter their personal information into a database

  • Each service provider creates a “lending score” that is driven by a borrower’s credit report

  • Those who have at least a 650 credit score can then ask lenders (known as investors) for a loan

  • Loans can range from $1,000 to $50,000

  • Interest rates vary but generally do not exceed 36% APR

(6.2) What are cash advances and borrowing options?

Cash advance:

• From credit card

Ask:

• A friend or family member for loan

Request:

• An advance on a paycheck

Contact:

• The companies you owe money to, explain situation, and ask for modification to billing plan

(6.3) Options to pay for college:

• Work

• Scholarships

• Family contributions

• Savings

• Federal student loans

(6.3) Process of Obtaining Federal Financial Aid:

Application:

• Via FAFSA (Free Application for Federal Student Aid)

Award:

• From your school

  • Federal student loans

    • no credit check required

    • can be used to pay for school and living expenses

  • Federal work-study

    • school-based employment that is subsidized by the federal gov’t

    • generally on-campus job

  • Federal grants

    • cash award paid to school on behalf of student

    • grant funds in excess are paid to student

Repayment

• To the lender

(6.3) What are the different federal student loans?

• Direct subsidized loans

  • Federal student loans made to undergraduate students who demonstrate a financial need

  • If the student is enrolled in school for more than half-time, interest on these loans is paid by the federal gov’t

  • These loans are the best value for someone who needs to borrow

  • Annual amount to borrow is capped

• Direct unsubsidized loans

  • Are made to undergraduate, graduate, and professional students

  • Interest is calculated on the loan balance until payments begin (usually 6 months after graduation) and continues throughout repayment

  • The annual amount to borrow is capped

  • Students don’t need to show a financial need

• Direct PLUS loans

  • Are available to graduate and professional students

  • Also available to parents of undergraduate students

  • Interest is calculated on the loan balance until the student is no longer attending school and payments begin

  • Students don’t need to show financial need

• Direct consolidation loans

  • Allow students to consolidate all of their federal student loans into one easy-to-manage loan

(6.3) Repayment of federal student loans:

Typically must begin within 6 months of completing school or when students are at half-time status or less

• The 6-month period is referred to as the grace period

• There are several different repayment plans that can be designed to fit your needs

• One benefit associated with all types of student loans (including federal student loans) is that the interest you pay may be tax-deductible

(6.3) Types of repayment plans (1)

Repayment Plan	Eligible Loans	Monthly Payment	Eligibility
Standard Plan	All loans, including consolidation loans	•Up to 10 years (30 years for consolidation loans)	All borrowers (not eligible for PSLF program)
Graduated Repayment Plan	All loans, including consolidation loans	•Payments start lower but increase over time •Up to 10 years (30 years for consolidation loans) •Payments cannot be less than the periodic interest charge and cannot be greater than three times the standard plan payment	All borrowers (not eligible for PSLF program)
Extended Repayment Plan	All loans, including consolidation loans	•Up to 25 years	All borrowers with more than $30,000 in direct loans (not eligible for PSLF program)
Saving on a Valuable Education (SAVE) Plan	•Direct subsidized and unsubsidized loans •Direct PLUS loans to students •Direct consolidation loans that do not include PLUS loans made to parents	•Payments limited to 10% of discretionary income •Payments recalculated each year based on updated income and family size •Total family income used to determine payment •If family income increases sufficiently, payments may increase and be higher than with the Standard Plan •Any debt remaining after 20 years (if only undergraduate loans were taken) or 25 years (if graduate loans also taken) will be forgiven	Any student borrower (does not include any loans made to parents)
Pay as You Earn Repayment (PAYE) Plan	•Direct subsidized and unsubsidized loans •Direct PLUS loans to students •Direct consolidation loans that do not include PLUS loans made to parents	•Payments limited to 10% of discretionary income •Payments recalculated each year based on updated income and family size •Payments will never exceed the Standard Plan payment amount •Family income considered only if taxes are filed jointly •Any debt remaining after 20 years will be Forgiven	All student borrowers whose monthly payment using the PAYE plan would be less than that with the 10-year Standard Plan

(6.3) Types of repayment plans (2)

Repayment Plan	Eligible Loans	Monthly Payment	Eligibility
Income-Based Repayment (IBR) Plan	•Subsidized and unsubsidized loans •Direct PLUS loans to students •Direct consolidated loans that do not include PLUS loans made to parents	•Payments will be 10% of discretionary income for new borrowers after July 1, 2014 •Payments recalculated each year based on income and family size •Family income considered only if taxes are filed jointly •Any debt remaining after 20 years will be Forgiven	All student borrowers whose monthly payment using the IBR plan would be less than with the 10-year Standard Plan
Income-Contingent Repayment (ICR) Plan	•Direct subsidized and unsubsidized loans •Direct PLUS loans to students •Direct consolidation loans for students •Direct consolidation loans for parents	•Monthly payment will be lesser of: •20% of discretionary income or •Amount that would be paid on a repayment •plan with a fixed payment over 12 years, adjusted for income •Payments recalculated each year based on updated income and family size •If income increases sufficiently, monthly payment may increase above the amount specified under the Standard Plan •Family income considered only if taxes are filed jointly and direct loans are repaid jointly with spouse •Any debt remaining after 25 years will be forgiven	All student borrowers and parents who consolidate their Parent PLUS loans into a Direct Consolidation loan
Income-Sensitive Repayment Plan	•Subsidized and unsubsidized Stafford loans •Federal Family Education Loan (FFEL) Plus loans •FFEL consolidation loans	•Payment based on annual income •Up to 15 years	All borrowers (not eligible for the PSLF program)

(6.4) Payback period formula:

Payback period = total costs / increase in annual income

(6.4) What are the types of savings for college?

• Taxable savings (UGMA/UTMA)

• Savings bonds

• Roth IRA

• 529 Plan

• Coverdell Educational Savings Account

(6.4) What are taxable savings?

Includes investments in stocks, bonds, mutual funds, and exchange-traded funds held in a brokerage account and/or savings in bank

• No restrictions on how much you can save each year

• No tax benefits

• Can reduce the amount of financial aid offered

• Can be in the form of a UGMA (Uniform Gift to Minors Account) or UTMA (Uniform Transfers to Minors Account)

(6.4) What are savings bonds?

• If the bonds are used to pay for a child or grandchild’s college tuition, no tax will be paid when the bonds are cashed in

• The tax-free benefit only applies to bonds owned and cashed in by someone other than the child

• Limit on how many bonds can be purchased in a given year ($10,000 in 2024)

• Rate of interest is relatively low.

(6.4) What is a Roth IRA?

Most often used as a way to accumulate retirement savings. However, Roth rules allow an account owner to withdraw any contributions made, at any time, without paying taxes

• Will pay ordinary income tax on the earnings if withdrawn before age 59 ½, but no early withdrawal penalty will be applied if used to pay for qualified higher education expenses

• Ability to invest in a wide range of assets to achieve high rates of return

• Disregarded on the FAFSA form, meaning funds do not affect qualification for need-based student aid

(6.4) What is a 529 Plan?

A tax-favored college savings option sponsored by the state in which the account holder lives

• Most states offer a tax deduction for contributions made to the state’s plan

• Most allow the account owner to invest in mutual funds and other investments with the potential to earn high rates of return

• No taxes owed on the earnings if money is used to pay for elementary through college expenses – including tuition, room and board, and other qualified expenses

• Ability to change the beneficiary to another family member

(6.4) What is a Coverdell Educational Savings Account (CESA)?

• It allows contributions up to $2,000 per year per account beneficiary

• Contributions are not tax-deductible, but distributions of contributions and earnings are tax-free if used to pay for qualified educational expenses (from elementary school through college)

• Income restrictions for contributions

• Taxes and penalties applied on any money left in a CESA after the beneficiary turns 30

• No additional contributions allowed after beneficiary turns 18

(6.4) What are other ways to pay for college?

Nearly all grants are need-based, which include:

• Federal Pell Grant

• Federal Supplemental Educational Opportunity Grant (FSEOG)

• Teacher Education Assistance for College and Higher Education Grant (TEACH)

• Iraq and Afghanistan Service Grant

Scholarships can also need-based, but are generally merit-based

(6.5) What is an asset?

Something that is intended to support the current level of living of an individual or household

• Tend to go down in value (depreciate)

• The most popular use assets: Automobiles

• Eventually, use assets (such as automobiles) will no longer work well and will need to be replaced

(6.5) What are the steps in purchasing an automobile?

Determine your transportation needs

Calculate how much you can afford

Shop for a loan if you plan to borrow money

Research specific vehicle models

• Identify those that best meet your needs and budget

Obtain an estimate for auto insurance

• For the specific vehicle you want to purchase

Locate the specific vehicle you will purchase

• Negotiate a purchase price

(6.5) How to determine what you can afford (vehicle):

Review your monthly budget and determine your excess cash flow each month after contributing to savings and paying your bills.

Options:

• Withdraw the money directly from savings and pay cash for the car

• Use a combination of cash for a down payment and borrow the remainder with a loan

• Borrow the entire purchase price of the car with a loan

(6.5) Shopping for automobile loan:

Limit your loan shopping to a 2-week period to minimize the impact of multiple credit inquiries.

• Every time a car dealer runs a credit report on you (they often do this before allowing you to take a test drive), this shows up on your credit report

Other variables that determine the loan amount you qualify for:

• The interest rate

• The loan term or repayment period

The key variable to negotiate in an auto loan is the lowest interest rate possible.

• Obtain at least three loan offers (preapprovals) from different banks and credit unions before going to a dealer

(6.5) Calculating affordability for automobile example:

Budget: $230

Loan length: 4 years

Loan rate: 5%

Utilize PV formula:

• N (number of terms) = 48 (4 years x 12 months)

• I (interest) = 5% / 12 = 0.004167

• PMT = $230

• PV = $0

• FV = ? ($9,990 or less)

(6.5) How to negotiate prices for automobiles:

Obtain an estimate for auto insurance

• For the specific vehicle you want to purchase (covered in a later chapter in detail)

Negotiate a purchase price

• Yes, you can negotiate! The seller needs to sell the car

• Make your search area as large as possible

• Dealerships can be good places to look for used cars

• The best values generally come from private sellers

(6.5) What is the difference between buying and leasing?

Lease payments:

• much lower than loan payments

• you get to drive a new car every few years

• however, at the end of the lease period, you have not accumulated any equity in the car and you don’t own anything

Car lease:

• financial agreement between you and the dealership

• you agree to pay a certain price for the right to drive the car for a set period of time

• Typically last around 3 years

• Nearly all leases limit the miles that can be driven yearly to about 12,000

• There are lease inception fees, which include title fees, acquisition fees, security deposits, and other fees

• At the end of the lease, you can purchase the car and pay an acquisition fee, or you can return the car to the dealership and pay a disposition fee

(6.6) Renting vs. buying comparisons:

(6.6) How to file for a rental:

Determining a location:

• Safety should be a high concern

• The overall condition of the neighborhood is important: the buildings and houses should be well maintained

• Make sure that you’re close to work/school, shopping, restaurants, and fun things to do

Determine a budget:

• Generally, the U.S. Department of Housing and Urban Development (HUD), suggests that you spend no more than 30% of your pretax income on rent.

• For example, if you make $5,000 per month before taxes, you should pay no more than $1,500 of your income on rent ($5,000 × 30% = $1,500).

(6.6) What all is apart of a rental lease?

Application deposit:

• used in case your application is accepted and you decide not to move in

Security deposit:

• money paid in advance to cover the cost of excess damage

Pet deposit:

• used to help offset damages caused by any pets

Reletting fee:

• incurred if you move out before the lease termination to cover the cost of renting the apartment again

Renters’ Insurance:

• pays for any lost, damaged, or stolen property

(6.6) What is the Equal Housing Act (EHA)?

It prevents discrimination in the housing market, both for renters and purchasers.

• Illegal for landlords, sellers, real estate agents and lenders to discriminate based on race, color, religion, sex, national origin, familial status, or disability

• Housing providers must treat everyone similarly in terms of making housing available, pricing, or contractual terms

• Outlines building codes that multifamily home builders must meet

(6.7) What is housing wealth?

• Financial value accumulated through a home

• Represents more than half of many Americans’ total wealth

(6.7) What is a mortgage?

A special type of loan that is secured by land and all improvements on a piece of land, including a personal residence

• Generally, mortgages have long repayment periods, most commonly 15 or 30 years

• If the homeowner does not make the monthly mortgage payments, then the lender can take possession of the house and sell it to another buyer in a process known as foreclosure

(6.7) How to determine what housing is affordable:

Housing Payments-to-Income Ratio:

• the front-end mortgage qualification ratio

Federal Housing Authority (FHA):

• recommends homeowners spend less than 31% of their monthly income on housing expenses.

• some mortgage lenders require housing expenses to be less than 28% of household income.

(6.7) Total fixed payments-to-income ratio:

FHA recommends this ratio to be less than 43%

(monthly housing payments + other monthly debt payments) / monthly gross income = total fixed payments-to-income ratio

Some mortgage lenders require this ratio to be lower, at 36%, sometimes called the back-end mortgage qualification ratio.

(6.7) What is the difference between a real estate agent and a mortgage loan officer?

Real estate agents:

• can represent the buyer, the seller, or both

• their experience can be quite helpful, especially when making an offer on a house

Mortgage loan officer:

• specializes in mortgages and can help you get preapproved for a loan

• to be preapproved for a loan means the lender has:

  • verified your credit

  • income

  • other important facts and has indicated how much you are able to borrow

(6.7) How to shop for a mortgage:

Each lender will give you a good faith estimate (GFE) with the following details:

• Loan type

• Loan amount

• Interest rate

• Expected monthly principal and interest payment

• Closing costs, which include all of the associated loan and purchase fees associated with buying a house

  • appraisal fees

  • title insurance

  • loan origination fees and points

(6.7) What is housing equity?

The difference between what a house could sell for and the amount still owed on the mortgage

It is built in 3 ways:

• Making a large down payment, minimizing the loan

• Paying down the mortgage loan, by making extra payments on the principle

• When housing prices in the area increase, time is on your side

(7.1) What are the different types of risk?

Risk: the possibility of losing money

Pure risk: risk that results in an economic loss, such as needing to repair a car or replace a major appliance

Inflation risk: prices increase over time

Business risk: a company in which you invest closes

Interest rate risk: general interest rates increase (reduces value of most investments)

Liquidity risk: you cannot sell something you own due to a weak market

Subjective risk: perception of the riskiness associated with a behavior or decision

• based on your personally developed probabilities of potential losses

• based on expectations, fears, and worries

• varies from one person to another

Objective Risk: ranking of risk using statistics

• can be measured using probabilities

(7.1) What are the types of returns?

Return: money you can make on an investment

Nominal return: actual percentage return (1% return from bank)

Real rate of return: inflation-adjusted return (price increases by 3%, you lose 2% purchasing power)

Real rate of return = [ (1 + nominal return) / (1 + inflation rate) ] - 1

Example:
Joan makes 12% return on an investment with inflation of 3%, and a real rate of return of 8.74%

(7.1) What are savings?

Money put aside for short-term goals

(7.1) What are investments?

Assets purchased to reach long-term goals

(7.1) What is liquidity?

How quickly you can convert an asset into cash

• Cash in your pocket

• Assets held in banks and credit unions

• Usually generates lower returns

(7.1) Investment pyramid:

Level 1: Setting the Foundation

• Very liquid and often insured assets

• Savings and checking accounts and certificates of deposit

Level 2: Investments

• Assets with potential to make a higher return over time

• Mutual funds, stocks, and bonds

Level 3: High-Risk Investments

• Investments that can generate very high returns/losses

• Commodities and collectibles

(7.2) What is an emergency fund?

Emergency funds need to be very liquid

• immediately accessible in case of unexpected expenses (pure risk)

• basic guideline - between 3-6 months of living expenses

How to determine amount in emergency fund:

Estimate your monthly living expenses

• Minimum monthly dollar amount you need each month

• All your expenses minus taxes, savings, and nonessentials

• Essentials tend to be a mortgage payment or rent, insurance, and car payments

Determine your monetary assets

• Cash, savings, and checking accounts

Calculate your emergency fund ratio

• Divide monetary assets by monthly living expenses

(7.3) What is opportunity cost?

The loss of a benefit that you would have received by choosing another option

• failing to save is an opportunity cost

(7.3) Where to save your money?

Savings account

• An interest-bearing asset that allows you to earn a small return on your deposit

• Insured up to $250,000 for individuals

• Allows easy access to funds (ATM or in person withdrawals)

Money market account

• An interest-bearing asset that allows you a higher return on your deposit as the amount in the account increases

• Insured up to $250,000 for individuals

• Allows easy, but slightly more restrictive, access to funds (ATM, in person, or a check) with limited number of withdrawals each month

(7.3) What is a Certificate of Deposit (CD)?

An interest-bearing asset that allows you an even higher return on your deposit than savings or money market accounts

• Insured up to $250,000 for individuals

• Generally purchased with one lump-sum dollar amount

• Restricted access to funds with penalties for early withdrawal

Dedicated savings account

• Popular variation of a traditional CD

• Allow contributions of money to the CD until the maturity date

(7.3) Safe assets for an emergency fund or short-term savings:

(7.3) Types of accounts and costs:

Money market account:

• An account that pays higher interest rates than a savings account, with a restricted number of withdrawals.

Certificate of deposit:

• A savings account that restricts withdrawals until a specific date; in exchange for a higher interest rate.

Savings account

• An interest-bearing account providing depositors a safe and secure place for money

Opportunity cost

• The foregone benefit that you would get from doing the next best thing.

  
  

(7.4) Differences between a Traditional IRA or Roth IRA:

Traditional IRA

• Make a contribution

• Receive an income tax deduction

• Pay less tax today

• Money grows tax-deferred

• Pay taxes on money taken out of the account in the future

Roth IRA

• Make a contribution

• No income tax deduction

• Postpone tax advantage to the future

• Money grows tax-deferred

• Pay no taxes on money taken out of the account in the future (after-tax basis)

(7.4) Roth IRA advantages:

• Investments accumulate earnings tax-deferred

• Money taken out is tax-free for certain conditions

• Contributing money on an after-tax basis (does not lower taxable income)

  • No 10% penalty + tax on money

(7.4) What are the types of Roth IRA withdrawals?

• Withdrawal of principal any time after the account is initially funded

• Qualifying withdrawal of earnings

• Non-qualifying withdrawal of earnings

Principal: the amount that you deposit into the account

Earnings: generated from the different types of investments within the account

(7.4) What is a qualifying distribution?

Distribution of earnings that is tax-free if it meets 2 conditions:

• You are at least 59½ years old, disabled, or use the funds to purchase a first home (up to $10,000)

• The Roth IRA account has been open for at least 5 years

(7.4) What are Traditional IRA withdrawals?

They do not provide the same flexibility in terms of withdrawals:

• Some or all future withdrawals from traditional IRAs will be fully taxable

• Traditional IRAs are subject to early withdrawal penalties

Exceptions to the penalty include:

• Withdrawals after age 59½

• Disability

• Upon the owner’s death

• First-time home purchase (up to $10,000)

• Qualified higher education expenses

• To purchase medical insurance if you are unemployed

(7.4) Opening, Funding, and Using Your Roth IRA:

You must have earned income that is equal to or greater than the amount you contribute to the Roth IRA.

You may only contribute up to an annual limit ($7,000 for 2024).

• Keep in mind that this dollar amount changes periodically.

• This limit means that if you have more than one IRA (this includes Roth and traditional IRAs), this is the maximum you may contribute to any or all accounts.

• If you are older than age 50, you may qualify for an additional “catch-up” contribution.

It is possible to own a traditional IRA, a workplace retirement plan, and a Roth IRA at the same time. In fact, you may hold multiple retirement accounts at the same time throughout your life.

• There are restrictions based on adjusted gross income (AGI, these change every year) that limit contributions for those with high earned income.

(7.4) Roth IRA investment options:

• Bank products (CDs and money market accounts)

• Mutual funds

• Exchange-traded funds (ETFs)

• Stocks

• Bonds

(7.5) What is a U.S. Savings Bond?

A way for Americans to lend money to the U.S. government. In exchange, the federal government agrees to pay you interest.

• Interest is automatically reinvested and is compounded semiannually.

• Interest is added to the value of the bond rather than being paid out directly to the bondholder.

• U.S. savings bonds continue to earn interest for 30 years from the issue date.

• The interest rate paid on U.S. savings bonds varies, but the rates are generally higher than the savings rates paid by banks and credit unions

Benefits:

• Easy to buy

• Easy to redeem

• Tax advantaged

• Safe

  • Although bank accounts are insured by the FDIC, savings bonds are backed by the full faith of the U.S. Treasury

Limitations:

• Once you purchase a savings bond, you cannot cash in the bond for at least a year

• If you cash in your savings bond after the first year but before 5 years of ownership, then you will forfeit the last 3 months of interest earned on the bond (similar to the early withdrawal penalty for a CD).

(7.5) Types of U.S. Savings Bonds:

Bond Feature	Series EE Savings Bonds	Series I Savings Bonds
Minimum Investment	$25	$25 ($50 if purchased using a tax refund)
Maturity (stops earning interest)	30 years	30 years
Interest rate	Fixed	Variable based on inflation

(7.5) What are the 3 options for purchasing and redeeming savings bonds?

Option 1:

Directly from the Treasury Department

• $25 minimum

• Electronic record

• Set up an account through the Treasury Direct portal on the U.S. Treasury Department website

• Requires a minimum investment of $25

• The Treasury Department will send you an electronic record and reference number - these bonds are paperless

Option 2:

Directly from the federal income tax refund

• $50 minimum

• Paper bond

• Use Form 8888 when you file your federal tax return

• You will receive a paper I bond in the mail 4 to 6 weeks after filing your tax return

Option 3:

• Through payroll deductions

• $25 minimum

• Electronic record

• Establish a Treasury Direct account and set up a Payroll Services plan

  • Available from employers that offer direct-deposit to multiple accounts

(7.6) Property ownership as a minor:

Minors (< age 18) can own titled assets (such as savings, investments, and real estate) indirectly through a custodial account as follows:

• Assets can be given, transferred, or owned by a minor using the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) custodial account

• Minors may also own custodial IRA accounts

• The adult custodian may withdraw money, but the law states the custodian must use the money only for the minor’s welfare

(7.6) Taxation of Custodial and Beneficiary Accounts:

• Earnings from investments in UGMA and UTMA accounts are taxable in the year they are earned

• The minor who owns the account is responsible for paying the tax on those earnings

• Custodial IRA accounts have tax-deferred growth

(7.6) Financial benefits to transferring assets to minors:

Nearly all custodial accounts are created through gifts or transfers from an adult to a child

For example, gifting stock to a child:

• By placing the stock into the UGMA or UTMA, the child must wait until age 18, 19, or 21 (depending on the state where the child lives) before he can gain access to the stock.

• This may save the adult capital gains tax in the future.

• The adult will receive an income tax benefit.

(7.6) Other beneficiary accounts:

College savings plans: specific types of accounts set up by states that allow individuals to set money aside for a designated beneficiary’s higher education expenses

• Tax-deferred growth on earnings

• Tax-free distributions if the money is used for qualified educational expenses such as tuition, fees, books, equipment, housing, meal plans, and other necessary expenses

529 plan / qualified tuition programs: popular college saving plans for parents and grandparents as these plans allow them to:

• Save for their children’s or grandchildren’s education tax-deferred

• Have tax-free distributions

• Remain in control of the money so that it can only be used for college expenses

(7.7) What is financial fraud?

occurs whenever someone attempts to deceive you with a promise of goods, services, money, or other benefits that really do not exist, were never intended to be provided, or were misrepresented

3 well-known frauds:

• ponzi schemes

• pyramid schemes

• telemarketing fraud

(7.7) What is a ponzi scheme?

promises investors a low-risk, high rate of return, interest, or dividends:

• the fraudsters pay early investors a rate of return (such as 10%) with money raised from people who invest later

• the moment that some of the early investors demand all their money back or when no new investors can be found, the scheme falls apart

(7.7) What is a pyramid scheme?

scam typically based on selling products or recruiting new members into an organization

• Recruiters promise high commissions or a sizable share of money paid by new members.

• Members may not earn high commissions, but may earn more based on fees paid by new members.

• Can be lucrative to those on the top of the pyramid, but later members end up losing as it becomes difficult to find new network members.

• Once the number of new participants declines, the pyramid crumbles

(7.7) What is a telemarketing fraud?

occurs when a product or service is misrepresented in an unsolicited phone call, e-mail, or text message

• A common line is as follows: “I am calling to inform you that you have won a free gift.”

• The reality is that no one ever gives away something for free

• Always assume that there is a catch to the story

(7.7) How to protect yourself from fraud:

Do:

• Always ask to receive written material before sending money or providing account information

• Do not believe that a rich relative you don’t know has left you money and then pay to get the details

• A good rule is to be skeptical whenever it comes to anything that would separate you from your money!

Do Not:

• Never buy something from an unfamiliar person or business over the phone or Internet

• Never pay a processing fee to receive a prize

• Never invest in something you do not understand

• Never send money overseas to someone you do not know

(7.7) What is identity theft?

crime in which someone wrongfully obtains and uses your personal data in some way that involves fraud or deception for his or her economic gain

• before 1998, identity theft was not a federal crime

• changed when news spread that convicted felon stole identity of man and did:

  • Ran up more than $100,000 in credit card debt

  • Obtained a mortgage for a new home

  • Purchased cars, boats, motorcycles, and guns

facts:

• More than 10% of people over the age of 16—about 35 million people—have been victims of identity theft during the last 12 months;

• The misuse or attempted misuse of credit cards and bank accounts is the primary crime perpetrated against 85% of identity-theft victims;

• The total loss associated with identity theft exceeds $18 billion per year

(7.7) How to protect yourself from identity theft:

Do:

• Always reconcile your bank accounts monthly and report any problems to your bank or creditor immediately.

• Keep a list of all your credit cards, debit cards, and each account’s contact information somewhere secure, such as a safe deposit box.

• Obtain a copy of your credit report annually and report anything unusual right away

Do Not:

• never throw away ATM receipts, credit statements, credit cards, or bank statements; always shred or destroy these documents.

• Never (ever) give your credit card number over the telephone unless you made the call.

• Never (ever) respond to a phishing scheme—an unsolicited e-mail asking you to provide personal information

(8.1) What is a stock? What are the types? Why buy it?

• referred to as shares or equity

• represents a piece of ownership in a company

Publicly traded stocks:

• can be bought in the stock market.

Privately held stocks:

• available to a relatively small number of people or family members who own all the stock available

Growth stocks:

• Stocks focused on stock price appreciation

Income stocks:

• Stocks that pay out a large portion of earnings in dividends

Growth and income stocks:

• Stocks that provide shareholders a combination of stock price appreciation and dividends

After the stock is initially sold in the IPO market, investors, seeking to make a profit, can buy and sell the stock to other investors in the secondary market

(8.1) How do you make money from owning a stock?

• Buying shares of stock in a profitable firm, holding the stock for a period of months or years, and then reselling the shares at a higher price.

• Receiving earnings in the form of dividends.

(8.1) Steps for business that leads into stocks:

1. Idea for new product / service

2. Business expansion planned and budgeted (too much for business loan)

3. Continued growth w/ underwriter (investment banker)

4. Incorporation and stock valuation

5. Shares sold in an initial public offering (IPO)

(8.1) What is a bid price?

the highest price a buyer will pay to purchase a specified number of shares of a stock at a specific time

(8.1) What is an ask price?

the lowest price at which a seller will sell a share of stock

(8.1) What is the difference between investors and owners?

Investors:

• buy and sell stock through stock exchanges

  • which are organized markets where buyers and sellers conduct stock transactions

• they also appoint, through open elections, the managers of the company

Owners:

• are entitled—by law—to share in the profits of the firm

(8.1) How shareholders make money example:

Bill's Cupcakes example:

• One cupcake sells for $2

  • this is the gross sale

• All expenses ($1.70) such as ingredients, labor, rent, and taxes all reduce the gross sales value

• That one cupcake may produce a net profit of 30 cents (Gross Sales − Expenses = Net Profit)

• For 10,000,000 cupcakes at $0.30 each, the firm generates $3,000,000 (profit)

(8.1) What is earnings per share?

EPS is the net earning per share sold

• $2 gross sale - $1.70 expense = $0.30 net profit

• $0.30 × 10,000,000 units sold = $3,000,000 net profit

• $3,000,000 / 1,000,000 shares in market = $3.00 EPS

(8.2) What must you have in order to buy shares?

Brokerage account:

• account with an investment company—you deposit money and then use it to buy stock

2 Choices:

• Full-service brokers such as Merrill Lynch, Edward Jones, and UBS, provide advice before you buy and sell stocks.

• Online brokerage firms, or discount brokers such as TD Ameritrade, Fidelity, and Schwab, are used by investors who do not need or want advice.

(8.2) What is a stock exchange?

a place where buyers and sellers meet to trade stocks.

Two major stock exchanges in the United States:

• New York Stock Exchange (NYSE)

• NASDAQ

(8.2) What is the discounted dividend valuation model?

A calculation to use for companies that pay dividends regularly

Stock value = dividend x (1 + dividend growth rate) / (your required rate of return - dividend growth rate)

(8.3) What is P/E ratio?

Price-to-Earnings ratio

• shows how much you are paying for $1 of current earnings

• stocks typically trade in a P/E range between 10 and 30

stock price per share (P) / earnings per share (E)

(8.2) What is market capitalization?

• also known as market cap

• the price of a stock multiplied by the total number of shares in the marketplace

Investors classify stock by market cap as follows:

• > $10 billion is large company stock (large cap)

• $2 - $10 billion is medium company stock (mid cap)

• < $2 billion is small company stock (small cap)

(8.3) What are bonds and their advantages?

• represent contractual loans to corporations and governments

• Advantages:

  • Provide low-risk fixed income in the form of interest payments.

  • Include a tax incentive for the companies that issue them.

  • Help investors diversify a portfolio

(8.3) What is asset allocation?

an approach in which you include different investments into one portfolio

(8.3) What is diversification?

means to spread your investments across different types of assets to manage financial risk.

• this protects you against significant financial losses:

  • by spreading your investment money across more than one asset category, you can reduce risk and improve returns.

(8.3) What are bond features?

The face value (or par value):

• the amount of money that the bond issuer will pay to the bondholder on the maturity date

The maturity date:

• the length of the loan contract (a few months, years, or decades in the future)

The coupon rate:

• the interest rate that the bond issuer has agreed to pay the bondholder

The coupon payment:

• the dollar amount of interest that the bond issuer will pay the bondholder

(8.3) What is a corporate vs federal bond?

Corporate bonds:

• generally offer investors a higher coupon rate and often a longer maturity date.

Federal government bonds:

• similar to U.S. savings bonds but different in significant ways

  • Treasury securities with a maturity date of:

    • 1 year or less are Treasury bills or T-bills

    • 1 - 10 years are Treasury notes

    • 10 - 30 years are Treasury bonds

(8.3) What is a municipal bond?

Bonds issued by states and local governments

• Funds are typically used to develop and maintain infrastructure (roads, buildings, parks, schools, and police and fire departments)

• All interest earned is tax-exempt interest at the federal level

(8.3) Interest VS. Dividends:

(8.3) Composition of US Bond Market (In Trillions):

(8.3) What is a default risk?

The risk that a company or government may not be able to repay the bond

(8.3) What is a rating agency?

analyzes corporations and governments ability to repay debts

• 2 well known agencies:

  • Standard & Poor's

  • Moody's

These rating companies evaluate companies and governments as follows:

• Those with the highest probability of repaying their debts are rated as AAA (S&P) or Aaa (Moody).

• Those with low probabilities of repaying their debts are rated as C.

• Those that are unable to repay their debts are rated as D for default.

(8.3) Current interest rate/Coupon rate vs Fair market value/face value:

If current interest rate is = coupon rate, then fair market value = face value

If current interest rate is < coupon rate, then fair market value > face value

If current interest rate is > coupon rate, then fair market value < face value

(8.3) How do businesses and governments determine the level of interest to pay investors?

In the US, interest rates are influenced most profoundly by the Federal Reserve, which is the central bank of the country

The Federal Reserve has two primary goals:

• To promote stable prices (low inflation)

• To maximize employment

Federal funds rate:

• A group within the Fed called the Federal Open Market Committee sets the baseline interest rate in the economy

• is the interest rate banks charge when lending money to other banks