Personal Finance Chapters 1-4
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Questions and Answers

What is a budget?

A plan based on your goals and financial obligations that limits spending in different categories

What does the current ratio measure?

  • Income tax rate
  • Adequate liquidity to meet emergencies based on monetary assets and current liabilities (correct)
  • Long-term debt coverage
  • Savings rate

    • What is the month's living expenses covered ratio?

  • Monetary assets divided by annual living expenditures divided by 12 (correct)
  • Cash flow ratio
  • Income available for savings divided by income available for living expenditures
  • Total debt divided by total assets

    • What is an emergency fund?

    <p>A reserve with money set aside to be used in emergencies</p> Signup and view all the answers

    What does the debt ratio indicate?

    <p>Ability to meet debt obligations based on total debt and total assets</p> Signup and view all the answers

    What is the long-term debt coverage ratio?

    <p>Total income available for living expenses divided by total long-term debt payments</p> Signup and view all the answers

    What does the savings ratio measure?

    <p>Income available for savings divided by income available for living expenditures</p> Signup and view all the answers

    What is the time value of money?

    <p>The concept that a dollar received today is worth more than a dollar received in the future</p> Signup and view all the answers

    What does the term principal refer to?

    <p>The face value of a deposit or debt instrument</p> Signup and view all the answers

    What is present value?

    <p>The current value of a future sum of money</p> Signup and view all the answers

    What is the annual interest rate?

    <p>The rate charged or paid for the use of money on an annual basis</p> Signup and view all the answers

    What does future value refer to?

    <p>The value of an investment at some future point in time</p> Signup and view all the answers

    What is reinvesting?

    <p>Taking money earned on an investment and putting it back into that investment</p> Signup and view all the answers

    What does the rule of 72 help determine?

    <p>The number of years it will take for a sum to double based on the annual growth rate</p> Signup and view all the answers

    What is an annuity?

    <p>A series of equal dollar payments coming at the end of each time period</p> Signup and view all the answers

    What is an amortized loan?

    <p>A loan paid off in equal installments</p> Signup and view all the answers

    What is a progressive tax?

    <p>A tax system in which tax rates increase for higher incomes</p> Signup and view all the answers

    What are tax brackets?

    <p>Income ranges in which the same marginal tax rates apply</p> Signup and view all the answers

    What is adjusted gross income?

    <p>Your taxable income from all sources minus specific adjustments</p> Signup and view all the answers

    What does the marginal tax rate indicate?

    <p>The percentage of the last dollar you earn that goes toward taxes</p> Signup and view all the answers

    What does the term capital asset mean?

    <p>An asset you own, including stocks, bonds, and real estate</p> Signup and view all the answers

    What is a capital gain?

    <p>The amount by which the selling price of a capital asset differs from its purchase price</p> Signup and view all the answers

    What is a capital gains tax?

    <p>The tax you pay on your realized capital gains</p> Signup and view all the answers

    What is bracket creep?

    <p>The movement into a higher tax bracket when wages increase due to inflation</p> Signup and view all the answers

    What is Social Security?

    <p>A federal program that provides disability and retirement benefits</p> Signup and view all the answers

    What is Medicare?

    <p>The federal government's insurance program to provide medical benefits to those over 65</p> Signup and view all the answers

    Which one of the following is the 'enemy' of compound interest and makes it very difficult to reach your financial goals?

    <p>Inflation</p> Signup and view all the answers

    Joseph can qualify for all of the following except:

    <p>Lifetime learning credit</p> Signup and view all the answers

    Which of the following statements about portfolio income from investments that are not held in a tax-deferred account is accurate?

    <p>All of the above</p> Signup and view all the answers

    What would be the interest rate on a loan of $39,927.10 that you paid off with annual payments of $10,000 for each of the next five years?

    <p>8%</p> Signup and view all the answers

    If Monica invests $15,750 at 8% annual interest, how much would she have after 8 years?

    <p>$29,152.15</p> Signup and view all the answers

    Approximately how long will it take Enrique's investment to grow into $2,000 if he invests $1,000 at 8% interest?

    <p>9 years</p> Signup and view all the answers

    Which factors affect your choice between claiming itemized deductions and the standard deduction?

    <p>All of the above</p> Signup and view all the answers

    Which adjustments, deductions, or credits might apply to Danielle?

    <p>All of the above</p> Signup and view all the answers

    What are deductions calculated using the federal tax form 'Schedule A' called?

    <p>Itemized deductions</p> Signup and view all the answers

    How much is now in your college account if your great-uncle placed $500 a year for 18 years at an annual rate of return of 6%?

    <p>$15,452.83</p> Signup and view all the answers

    FICA deductions from your paycheck are for which mandatory federal insurance programs?

    <p>Social Security and Medicare</p> Signup and view all the answers

    Which of the following is closest to the amount Adrian will have to save each year for a $30,000 down payment in 5 years at a 9% rate of return?

    <p>$5,013</p> Signup and view all the answers

    Generally, wages are reported on a ___ form while interest and dividends are reported on a ___ form.

    <p>W-2; 1099</p> Signup and view all the answers

    Using the Rule of 72, if it will take approximately 12 years for your money to double, at what annually compounded interest rate is it invested?

    <p>6%</p> Signup and view all the answers

    What is the basic step to personal financial planning when establishing your personal financial goals?

    <p>Step 2</p> Signup and view all the answers

    A personal income statement is prepared:

    <p>Both on a cash basis and based on actual cash flows</p> Signup and view all the answers

    Your financial situation is insolvent when:

    <p>Your assets are less than your liabilities</p> Signup and view all the answers

    Which of the following typically occurs during stage 1 of the financial life cycle?

    <p>All of the above</p> Signup and view all the answers

    Why do you need to review your progress and reevaluate your plan (Step 5)?

    <p>All of the above</p> Signup and view all the answers

    What is an economic condition in which rising prices reduce the purchasing power of money called?

    <p>Inflation</p> Signup and view all the answers

    When including an asset such as a car on your balance sheet, you should:

    <p>List its current value as indicated in a blue book or site like <a href="http://www.edmunds.com">www.edmunds.com</a></p> Signup and view all the answers

    Your net worth is found by:

    <p>Subtracting your liabilities from your assets</p> Signup and view all the answers

    ___ is the process of identifying a job that you feel is important and that will lead to the kind of lifestyle you desire.

    <p>Career planning</p> Signup and view all the answers

    What is Cathy's net worth if her assets include a car worth $10,000 and a checking account balance of $5,000, while her liabilities include a student loan of $2,000 and a car loan of $8,000?

    <p>$5,000</p> Signup and view all the answers

    Which step requires you to prepare a personal balance sheet?

    <p>Step 1</p> Signup and view all the answers

    What aspect of financial planning might you discuss with a friend who buys fancy coffee drinks and prefers impulse buying?

    <p>Waste not, want not - smart spending matters</p> Signup and view all the answers

    What is the first step if you have recently expanded your online marketing business and neglected your personal finances?

    <p>Separate your personal finances from the business finances</p> Signup and view all the answers

    While reviewing your current financial plan, you discover you won't achieve your long-term financial goals. What should you do?

    <ul> <li>Look at increasing your income</li> <li>Look at cutting back on your expenses</li> <li>Look at revising your goals</li> </ul> Signup and view all the answers

    What is Kareem's current ratio if he has $6,000 in monetary assets and $2,000 in current liabilities?

    <p>3 times or 6,000/2,000</p> Signup and view all the answers

    The first section of a balance sheet represents your:

    <p>Assets</p> Signup and view all the answers

    Which of the following is not a type of long-term debt?

    <p>Credit card debt</p> Signup and view all the answers

    Which of the following is a relevant question to ask a financial planner?

    <p>All of the above</p> Signup and view all the answers

    Is it possible to save $585,000 for retirement instead of $310,000 without requiring much more to be invested every month?

    <p>Depends upon the interest rate or return you earn on the investment as well as the number of years until retirement</p> Signup and view all the answers

    Hector's month's living expenses covered ratio is 0.25 months. He just broke his leg. Without a paycheck for 6 weeks, what will Hector most likely experience?

    <ul> <li>He may have to liquidate some of his tangibles or investment assets to keep current on his monthly bills</li> <li>He may have to borrow some money to keep current on his monthly bills</li> </ul> Signup and view all the answers

    What is the present value of an IOU for $1,000 due to be paid in 2 years if the discount rate is 8%?

    <p>$857.34</p> Signup and view all the answers

    Which indicates the correct order for completing your tax returns?

    <p>Determine gross income, subtract adjustments, subtract deductions, claim exemptions, calculate total tax</p> Signup and view all the answers

    What is Alisha's current ratio if she has $500 in monetary assets and $5,000 in current liabilities?

    <p>0.10 times</p> Signup and view all the answers

    How can we describe Jorge's and Jose's current financial situation if Jorge has a debt ratio of 37% and Jose has a ratio of 102%?

    <ul> <li>Jorge is currently solvent</li> <li>Jose is currently insolvent</li> <li>Jorge probably has more money available to enjoy every month</li> <li>Jose probably doesn't have much money available to enjoy every month</li> </ul> Signup and view all the answers

    Which of the following adheres to the financial principle 'just do it'?

    <p>The amount you can spend is what's left after you put aside your savings</p> Signup and view all the answers

    What are excise taxes?

    <ul> <li>Imposed on specific purchases, such as alcohol and cigarettes</li> <li>Often aimed at reducing the consumption of the items being taxed</li> <li>Referred to as 'sin taxes' in some cases</li> </ul> Signup and view all the answers

    What interest rate do you need to earn in order to have $20,000 in your account in 10 years if you currently have $11,167?

    <p>6%</p> Signup and view all the answers

    What does planning for your eventual death and the passage of your wealth to your heirs refer to?

    <p>Estate planning</p> Signup and view all the answers

    Personal financial planning will enable you to:

    <p>All of the above</p> Signup and view all the answers

    List the 5 basic steps to personal financial planning.

    <ol> <li>Evaluate your financial health</li> <li>Define your financial goals</li> <li>Develop a plan of action</li> <li>Implement your plan</li> <li>Review your progress, reevaluate, and revise your plan</li> </ol> Signup and view all the answers

    What is liquidity?

    <p>The relative ease and speed with which you can convert non-cash assets into cash</p> Signup and view all the answers

    List the 3 stages in the financial life cycle.

    <ol> <li>The early years - a time of wealth accumulation</li> <li>Approaching retirement - the golden years</li> <li>The retirement years</li> </ol> Signup and view all the answers

    List the four key factors involved in step 3 of personal financial planning basics.

    <ul> <li>Flexibility</li> <li>Liquidity</li> <li>Protection</li> <li>Minimization of taxes</li> </ul> Signup and view all the answers

    List the ten principles of personal finance.

    <ol> <li>The best protection is knowledge</li> <li>Nothing happens without a plan</li> <li>The time value of money</li> <li>Taxes affect personal finance decisions</li> <li>Stuff happens, or the importance of liquidity</li> <li>Waste not, want not - smart spending matters</li> <li>Protect yourself against major catastrophes</li> <li>Risk and return go hand-in-hand</li> <li>Mind games, your financial personality, and your money</li> <li>Just do it!</li> </ol> Signup and view all the answers

    What is interest paid on interest called?

    <p>Compound interest</p> Signup and view all the answers

    What is diversification in finance?

    <p>Acquisition of a variety of different investments, instead of just one, to reduce risk</p> Signup and view all the answers

    What is a personal balance sheet?

    <p>A statement of your financial position on a given date. It includes the assets you own, the debt or liabilities you have incurred, and your level of wealth, which is referred to as net worth</p> Signup and view all the answers

    What is assets?

    <p>What you own</p> Signup and view all the answers

    What are liabilities?

    <p>What you owe; your debt or borrowing</p> Signup and view all the answers

    What is net worth or equity?

    <p>A measure of the level of your wealth. It is determined by subtracting the level of your debt or borrowing from the value of your assets</p> Signup and view all the answers

    What is fair market value?

    <p>What an asset could be sold for, rather than what it costs or what it will be worth sometime in the future</p> Signup and view all the answers

    What is a tangible asset?

    <p>A physical asset, such as a house or a car, as opposed to an investment</p> Signup and view all the answers

    What is a blue book?

    <p>A listing of used car prices (by model year manufactured), giving the average price a particular car sells for and its expected trade-in value</p> Signup and view all the answers

    What does it mean to be insolvent?

    <p>Owing more money than one's assets are worth</p> Signup and view all the answers

    What is an income statement?

    <p>A statement that tells you where your money has come from and where it has gone over some period of time</p> Signup and view all the answers

    What is a variable expenditure?

    <p>An expenditure over which you have control. That is, you are not obligated to make that expenditure, and it may vary from month to month</p> Signup and view all the answers

    What is a fixed expenditure?

    <p>An expenditure over which you have no control. You are obligated to make this expenditure, and it is generally at a constant level each month</p> Signup and view all the answers

    What is a plan for controlling cash inflows and cash outflows?

    <p>Budgeting</p> Signup and view all the answers

    Study Notes

    Personal Finance Key Concepts

    • Inflation: Considered the enemy of compound interest, it complicates achieving financial goals by reducing purchasing power.

    • Tax Filing: Individual circumstances like income, dependents, and types of deductions impact eligibility for tax credits and deductions.

    • Portfolio Income: Includes income from non-tax-deferred investments such as dividends and interest that must be reported on tax returns and may be taxed differently than wages.

    • Interest Rate Calculation: A loan payment structure can determine interest rates; e.g., a loan of $39,927.10 repaid in five annual payments of $10,000 equals an 8% interest rate.

    • Investment Growth: Investing at an annual interest rate accumulates over time; e.g., $15,750 at 8% grows to $29,152.15 in 8 years.

    • Compounding Effect: Long-term saving strategies emphasize self-discipline, such as leaving an $1,000 investment untouched to double in approximately 9 years.

    • Deductions and Standard Deductions: Factors influencing decision-making between itemized deductions and standard deductions include home ownership, deductible expenses, and record-keeping requirements.

    • Parenting Financial Adjustments: Single parents may qualify for various deductions, such as student loan interest adjustment and child-related credits.

    • Itemized Deductions: Deductions calculated from Schedule A that lower taxable income can significantly affect tax obligations.

    • Savings for Down Payments: Calculating future savings to meet down payment requirements, e.g., $30,000 needed in 5 years at 9% return requires annual savings of about $5,013.

    Understanding Financial Statements

    • Wage Reporting: Wages are reported on W-2 forms, while interest and dividends are reported on 1099 forms.

    • Personal Balance Sheet: This financial position statement includes assets, liabilities, and calculates net worth (assets minus liabilities).

    • Income Statement: Reflects money flow, detailing income sources and expenditures over time to manage budgeting effectively.

    • Fixed vs. Variable Expenditures: Understand control over expenses; fixed expenditures are obligatory, while variable expenditures can fluctuate.

    Financial Ratios and Indicators

    • Current Ratio: Measures liquidity, defined as monetary assets divided by current liabilities.

    • Debt Ratio: Indicates financial health, calculated as total liabilities divided by total assets.

    • Long-Term Debt Coverage Ratio: Assesses ability to meet long-term debt obligations by comparing income available for living against long-term payments.

    • Month's Living Expenses Covered Ratio: A liquidity indicator that measures monetary assets against annual expenditures divided by 12.

    Principles of Personal Finance

    • Rule of 72: A time-saving method to estimate how long it will take for an investment to double; divide the annual growth rate into 72.

    • Time Value of Money: Emphasizes that a dollar today is worth more than a future dollar, affecting savings and investment comparisons.

    • Diversification: Mitigates investment risk by spreading investments across various assets.

    • Liquidity: Refers to the ease of converting assets to cash, crucial for meeting financial obligations.

    • Personal Financial Planning Steps: Include evaluating financial health, defining goals, developing a plan, implementing it, and regularly reviewing progress.

    Final Notes

    • Tax Planning: Understanding expenses, exemptions, and the progressive tax system is crucial for minimizing tax liabilities.

    • Emergency Fund: Essential for financial stability, it ensures availability of cash reserves during unforeseen circumstances.

    • Estate Planning: Involves preparing for wealth transfer and ensuring that assets are managed according to one’s wishes after death.

    • Investment Terms: Key concepts like principal, future value, present value, and annuity are foundational in understanding financial returns and investments.### Deductions and Income Terms

    • Allowable deductions are calculated and subtracted from adjusted gross income to determine taxable income.

    • Itemized deductions refer to specific expenses that taxpayers can list to reduce taxable income, rather than opting for the standard deduction.

    • Standard deduction is a fixed dollar amount determined by the IRS, available regardless of actual expenses incurred by the taxpayer.

    Income Definitions

    • Taxable income encompasses all income that is subject to taxation.
    • Adjusted gross income (AGI) includes all sources of income minus certain adjustments such as IRA contributions, student loan interest, and alimony paid prior to standard or itemized deductions.

    Tax Rates and Categories

    • Marginal tax rate or marginal tax bracket denotes the tax rate applied to the last dollar earned by the taxpayer.
    • Bracket creep occurs when taxpayers move into higher tax brackets due to inflation-driven wage increases, leading to higher effective tax rates.

    Capital Gains and Assets

    • Tax-deferred income refers to earnings on which taxes are postponed until a later date, allowing for potential growth over time.
    • Capital assets include personal property such as stocks, bonds, and real estate, excluding certain business assets.
    • Capital gain is defined as the profit realized from the sale of a capital asset when the selling price exceeds its purchase price.
    • Capital gains tax is the tax imposed on the realized profit from the sale of capital gains.

    Social Programs

    • Social Security is a federal program providing benefits for disability and retirement based on an individual's work history and contributions.
    • Medicare is the federal insurance program offering medical benefits to individuals aged 65 and over.

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    Test your knowledge on the essential concepts from Chapters 1-4 of Personal Finance. This quiz covers critical topics such as the impact of inflation on compound interest and understanding tax returns. Enhance your financial literacy with these flashcard-style questions.

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