Personal Finance BUS 291

The 6 steps of the personal financial planning process

• Determine current financial situation

• Develop financial goals

• List alternative courses of action

• Evaluate alternatives

• Create and implement the plan chosen

• Re-evaluate and revise the financial plan

What are the criteria for effective financial goals?

• Goals must be realistic

• Stated in detail

• Clear time frame

• Indicate plan of action

Define opportunity cost in a financial context.

the value of the next-best financial opportunity or benefit you give up when choosing one investment or spending option over another

What is the formula for calculating Net Worth on a balance sheet?

Assets - Liabilities

What is the purpose of a cash flow statement?

summarizes income and spending for a specific period of time to identify spending patterns

Difference between a cash flow statement and balance sheet

A balance sheet is a snapshot of Money in and Money out while a Cash flow is recorded over time to find patterns so more like a video

How is the value of savings needed for a financial goal calculated?

Through future value (FV) and present value (PV) calculations

List common types of taxes relevant to personal financial planning.

• Income tax

• Consumption tax

• Property tax

• Estate/gift tax

Difference between Tax-Exempt and Tax-Deferred Income and an example for each

• Tax exempt is income that is never subjected to federal tax ( Inheritance, gifts, interest on specific municipal bonds )

• Tax deferred is income taxed at a later date rather than when it is earned ( RRSP contributions, investment accounts)

How do you calculate Adjusted Gross Income (AGI)

Gross income - specific adjustments like contributions to retirement plan or alimony payments

Explain the Tax Benefit of a Capital Loss

A capital loss occurs when an investment is sold for less than its purchase price; it can be used to offset capital gains in other years and in come cases other types of income

Identify the primary methods for reducing Taxable Income

• Contribute to tax-advantage accounts (RRSP, Education savings)

• Maximizing deductions and credits ( Standard [ a set amount ] or Itemized deductions [ charity ] and credits like child tax or energy saving home improvements)

• Income strategies ( Income splitting between spouse, tax loss harvesting)

Distinguish between APR and EAR

APR ( annual percentage rate) is the basic yearly borrowing cost while EAR ( effective annual rate ) shows the true costs of borrowing by including compound interest

• Example: A 10% APR loan with monthly compounding has a 10% stated rate, but the interest is calculated monthly. 

• Example: A 10% APR compounded monthly becomes an EAR of EAR = (1 + (APR / m))^m - 1 (where 'm' is the number of compounding periods per year). 

Define a Guaranteed investment certificate GIC/ CD

A savings plan requiring a specific amount to be left on deposit for a set time (term) to earn higher interest rate than a regular savings account; early withdrawal results in a penalty

Explain the function of a Debit Card

A card that immediately deducts the amount of a purchase from the users chequing account

Define Overdraft Protection.

An automatic loan made to the chequing account to cover cheques or withdrawals that exceed the available balance

Difference between Commercial Banks vs. Credit Unions

• Commercial banks are for-profit corporations owned by stockholders

• Credit unions are non-profit cooperatives owned by their members

Define consumer credit

The use of credit for personal needs (except a home mortgage) by individuals and families

Difference between Closed-End vs. Open-End Credit

• Close-end credits are one time loans for a specific purpose and amount, paid back in equal installments ( e.g., mortgage, car loans )

• Open-end credits are continuous loans with a specific credit limit ; money can be borrowed repeatedly if the balance is paid (e.g., credit cards, line of credits)

Identify the two main ratios for measuring credit capacity

• Debt Payments to Income ratio : monthly debt payments (excluding mortgage ) divided by net monthly income; should not exceed 20%

• Debt to Equity Ratio: Total liabilities divided by net worth (excluding home value and mortgage); should be less than 1

List the 5 C’s of credit

• Character (Reliability)

• Capacity (ability to pay)

• Capital (net worth)

• Collateral (assets to secure loan)

• Conditions (economic factors)

Examples of Inexpensive, Medium-Priced, and Expensive loans

• Inexpensive : loan from family or secured by assets (GICS)

• Medium-priced: Loans from chartered banks, trust companies, credit unions

• Expensive: Loans from finance companies, retailers, or credit cards

Define Adjusted Balance Method vs. Previous Balance

Adjusted balance is interest calculated within the current billing cycle to lower interest charge while Previous balance is interest calculated on the balance at the beginning of a billing cycle ignoring any activity which makes higher interest payments

What is the "Rule of 78s" (Sum of the Digits)

A math formula used to determine how much interest is paid at any point in a loan ; favours lenders by charging more interest at the beginning of the loan term

Define Credit Insurance

A type of insurance that ensures repayment of a loan in event of death, disability, or loss of property; usually expensive and not needed if you have life insurance

Difference between defined Benefit and Defined Contribution Pension Plans.

defined benefit plan specifies the monthly benefit you will receive at retirement based on age and years of service while defined contribution pension plan is contributed by the employer and employee and based off investment performances

Define vesting

Your right to at least a portion of the benefits you have accrued under employer pension plan, even if you leave before retirement

Identify the three primary sources of retirement income in Canada

• Government contributions (CPP)

• Employer-sponsored pension plans

• Personal savings and investments (RRSP’s and TFSAs)

Explain the tax advantage of a Registered Retirement Savings Plan (RRSP)

Contributions are tax deductible (reducing current taxable income), and investment earnings grow tax-deferred until funds are withdrawn

Difference between Contrast Will and Power of Attorney

• The Will is a legal document specifying how your assets are distributed after death, while Power of Attorney is a legal document authorizing someone to act on your behalf if you’re alive but incapacitated

Define Probate

The legal procedure of proving a valid will or settling an estate when no will exists

RRSP vs TFSA comparison in terms of contributions, growth, and withdrawals

• Contributions for RRSP are tax-deductible and TFSA’s are not tax deductible

• Growth on RRSP are tax-deferred and TFSA are tax-free

• Withdrawals for RRSP are taxed as regular income and TFSA are not taxed

Define Corporate Bond

A corporation’s written pledge to repay a specific amount of money (face value) plus interest

What is face value

The dollar amount a bondholder receives at the bond’s end date

what is Maturity Date

The specific date when the corporation must repay the principal (face value)

List three reasons corporations issue bonds

• To raise capital for major purchases

• To fund ongoing business activities

• Bond interest is tax-deductible for the corporation

Define Debentures

Just like bonds, they are issued by companies or the government for long term projects but are unsecure and principal sometimes unredeemable. Debenture holders are lenders not owners.

Define mortgage bond

Bond secured by various assets such as real estate

Define Subordinated Debenture

Unsecured bond that gives bondholders secondary claim to assets and income

Explain the Callable feature for bonds

Allows the corporation to call in or buy back outstanding bonds before the maturity date

What is the Current Yield Formula and define Yield to Maturity (YTM)

• Current Yield formula: Annual Interest amount divided by current market value

• Yield to Maturity is a calculation that considers the relationship between the bond’s maturity value, time to maturity, current price and interest amount

How do you calculate dividend yield

Dividend Yield = Dividends/purchase prince

How do you calculate Capital gain yield

Capital gain yield = Ending price - Purchase price / Purchase price

How do you calculate shareholder return

Total Shareholder return = Dividend Yield + Capital gain Yield

List the 5 components of Investment Risk Factors ( Hint: In, In, Fail, Mar, Global)

• Inflation risks

• Interest rate risks

• Business failure

• Market risk

• Global investment risk

Difference between investment growth and income

Investment Growth is the increase in market value of the investment overtime (e.g, common stocks) while income is the regular distributions of cash (e.g, dividends from stocks or interest from bonds)

Difference between common and preferred stock

Common stock provides voting rights but has lower priority for dividends while a Preferred stock offers a fixed dividend and priority over common stockholders in event of bankruptcy

Blue chip vs Penny Stocks

Blue chip is issued by large stable corporations with history of profit while penny stocks are low priced highly speculative and issued by companies with high uncertainty

for Life insurance whats the difference between income replacement method vs expense method

Replacement method multiplies current gross income by 7 (70% for 7 years), while expense method estimates specific future financial obligations to determine the required lump sum

Explain the “elimination period” in disability insurance

The waiting period (usually 30-180 days) after the disability starts before benefit payments begin. Longer periods reduces premiums

what are the recommended percentage limits for GDS and TDS

GDS typically 30-32%

TDS typically 40%

Difference between Conventional mortgage and High-ratio mortgage

Conventional mortgage has a downpayment of 20% or more while High-ratio is less than 20% and requires mortgage loan insurance

Impact of Amortization Period on total cost

Amortization period is the total time to pay off the loan, the longer it is the less the monthly payments but increases total interest paid over the life of the mortgage

What is a load fund

is the payment of a sales charge or commission (the "load"), not a management fee. 

What is bond indenture

a legal document that details all the conditions relating to a bond issue

Difference between Efficient Market Hypothesis and Technical Analysis

EMH implies that the future price movements cannot be predicted by historical trends while the technical analysis implies historical price patterns can be extrapolated to predict future values

Pure Risk vs Speculative risk

Pure risk involves only a chance of loss and is accidental and insurable (eg. fire, accident) while Speculative risk involves a chance of either a loss or a gain (eg., gambling, starting a business) and is legally uninsurable

the 4 main risk management methods (hint: A, A, R, S)

• Risk avoidance

• Risk reduction

• Risk assumption

• Risk shifting

Difference between Negligence and Vicarious Liability

Negligence is failure to take reasonable care to prevent harm while VIcarious is being held legally responsible for actions of another person (child, employee)