WSE Financial Test Review Source of income Earned

W!SE Financial Test Review

Source of income �Earned Income: Income derived from active participation in a trade or business, including wages, salary, tips, commissions and bonuses. �Unearned Income: Any income that comes from investments and other sources unrelated to employment services. Examples: interest from a savings account, bond interest, alimony, and dividends from stock

Exemptions �If you are not claimed as a dependent on another taxpayer's return, then you can claim one personal tax exemption. The exemption reduces your taxable income just like a deduction does, but has fewer restrictions to claiming it. If you are married and file a joint tax return, both you and your spouse each get an exemption. �The IRS allows you to take additional exemptions for each dependent you claim. Frequently, the source of these exemptions are the children who live with you for more than half the year, are under 19 years old (or under 24 if a full-time student) and who don't provide more than half of their own financial support during the tax year.

Liquidity �The ability to convert an asset to cash quickly and with minimal impact to the price. �Examples: Cash, Most stocks, money market instruments and government bonds. �Money market accounts: It is the organized exchange on which participants can lend and borrow large sums of money for a period of one year or less. �Bonds- It is the organized exchange on which participants can lend and borrow large sums of money for a period of one year or less.

Gift cards � A gift card is a restricted monetary equivalent is issued by retailers or banks to be used as an alternative to a nonmonetary gift. � Prepaid cards, gift cards, and gift certificates cannot expire within five years of activation or unless the terms of the expiration are clearly disclosed. The law bans dormancy fees, inactivity fees or service fees on gift cards unless there has been no activity in a 12 -month period and the issuer clearly discloses all fees before the gift card is purchased. � Exclusions: Prepaid phone cards , reloadable cards, loyalty or rewards cards, cards issued for admission to special events or venues and certificates issued in paper form only are exempt.

Discretionary income and budget surplus �The amount of an individual's income that is left for spending, investing or saving after taxes and personal necessities (such as food, shelter, and clothing) have been paid. Discretionary income includes money spent on luxury items, vacations and non-essential goods and services.

Money Orders �A certificate that allows the stated payee to receive cash on-demand, usually issued by governments and banking institutions. A money order functions much like a check, in that the person who purchased the money order may stop payment

Why does the US currency have value �Its value is only based on what we can get in exchange for it. Or put it another way, money has value as long as other people believe the money you give them can be exchanged for the goods and services they desire in the future.

Opportunity cost �The value of the best alternative that must be given up when scarce resources are used for one purpose instead of another

Inflation �Inflation is a general increase in prices and a corresponding decrease in money's purchasing power. �The economic indicator for stable prices is the Consumer Price Index (CPI). The CPI measures inflation in consumer goods. Inflation is an increase in the overall price level—sometimes referred to as an increase in the cost of living. Inflation is not when gas prices rise or coffee prices rise—it is when prices in general are rising.

Inflation �The biggest losers due to inflation are those willing to lend money. An extreme example would be during the hyper-inflation of 1923 in Germany. If you had loaned a friend enough money to buy a car in early 1923 and he had repaid it at the end of 1923 you might have been able to buy a box of matches with it. So it is easy to see that the borrower got a car and he was able to repay it with pocket change. The lender of course was the big loser.

Inflation �People hurt the most: Those on fixed incomes (retired people) �People hurt the least: Borrowers and producers

Inflation �When individuals, businesses, and governments borrow, it is usually at a fixed rate of Interest that had some expected level of inflation built into it. If higher than expected inflation occurs, then the real value of the borrower's debt is reduced. Assume that banks lend billions of dollars at a fixed nominal interest rate of 5%. If inflation were to unexpectedly increase from 2% to 4%, then borrowers' real interest rate paid would be reduced from 3% to 1%. In simpler terms, the money that was lent was more precious than the money being repaid.

Inflation �Another group that benefits from an increase in consumer prices in the short run is producers. When unexpected inflation occurs, consumer prices rise while wages paid to employees remain relatively stable. This allows producers to experience higher profits for a time until wages adjust to reflect the higher prices consumers are paying.

Treasury Department �The United States Department of the Treasury is the government (Cabinet) department responsible for issuing all Treasury bonds, notes and bills. �The U. S. Treasury is responsible for the revenue of the U. S. government, but here are some other key functions:

Treasury Department �Printing of bills, postage, Federal Reserve notes, and minting of coins �Collection of taxes and enforcement of tax laws (through the IRS) �Management of all government accounts and debt issues �Overseeing U. S. banks �Identifying and targeting the financial support networks of national security threats

Banks

Pay Yourself First �Put money into savings each month as if it were a bill. At least 10% of your income should go into savings. It’s recommended you have 6 -8 months of expenses saved.

Certificate of Deposit �Sold by financial institutions, certificates of deposit (CDs) are low-risk –- and relatively low-return — investments suitable for cash you don’t need for months or years. If you leave the money alone during the investment period (known as the “term” or “duration”), the bank will pay you an interest rate slightly higher than what you would have earned in a money market or checking account. All gains from CDs are taxable as income.

Certificate of Deposit �CDs are among the safest investment a person can make. The interest rate is determined ahead of time, and you’re guaranteed to get back what you put in, plus interest once the CD matures. �Traditional CD: You receive a fixed interest rate over a specific period of time. When that term ends, you can withdraw your money or roll it into another CD.

Certificate of Deposit �Liquid CD — This kind of account allows you to withdraw part of your deposit without paying a penalty. The interest rate on this CD usually is a little lower than others, but the rate is still higher than the rate in a money market account. �Zero-coupon CD — This kind of CD does not pay out annual interest, and instead re-invests the payments so you earn interest on a higher total deposit. The interest rate offered is slightly higher than other CDs, but you’ll owe taxes on the re-invested interest.

Institutions that give loans �Pawnshops: You are given a short-term loan in exchange for leaving a personal item, such as jewelry or an electronic device, as collateral. If you pay back the loan, including interest, on time, you get the item back. You may be able to renew the loan by paying the interest. However, if you fail to repay or renew the loan, your item can be sold. The APRs for pawn shop loans are typically around 120 -300 percent, much higher than the rate charged on credit cards. Many pawn shops also charge additional fees for insurance and storage.

Institutions that give loans �Payday lenders: A payday lender allows you to borrow against your future income. You give them a postdated check, which is deposited if you do not pay back the loan. The APR (interest expressed as an annual percent rate) is usually over 200 percent and can go much higher if you refinance the loan instead of paying it off as soon as it comes due.

Institutions that give loans �Banks vs. credit unions: Credit unions generally charge lower interest rates. �Tax preparers: short-term consumer loans, usually 24 to 48 hours, secured by a taxpayer’s expected tax refund, and designed to offer customers quicker access to funds.

What is a Credit Union? �Member-owned financial co-operative. These institutions are created and operated by its members and profits are shared among the owners. �Advantages: Lower interest rates for loans, higher interest rates for savings accounts and investments because they are a non-profit and pass savings to customer/owner.

Overdraft protection – how it works �A line of credit that banks offer to their customers to cover their overdrafts. Overdraft protection kicks in when a customer writes a check for more than the amount in their account. Banks usually charge interest on the amount used to cover the overdraft.

Compound interest �“Interest on interest, ” It will make a deposit or loan grow at a faster rate than simple interest, which is interest calculated only on the principal amount. The rate at which compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods, the greater the compound interest. �Time value of money The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity.

Liquid financial products �Liquid assets: Those that can be converted to cash easily, with little effect on value. Examples: most stocks, money market instruments and government bonds. �Less liquid (Illiquid): The state of a security or other asset that cannot easily be sold or exchanged for cash without a substantial loss in value. Illiquid assets also cannot be sold quickly because of a lack of ready and willing investors or speculators to purchase the asset. Examples: Housing, stocks that have no buyers.

Rule of 72 �The 'Rule of 72' is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to duplicate itself.

Reconciling a Checking account �A record, usually sent to the account holder once per month, summarizing all transactions in an account during the time from the previous statement to the current statement. The opening balance from the prior month combined with the net of all transactions during the period should result in the closing balance for the current statement. �Consumers should carefully review their bank statements and retain them for their own records. In reconciling their own record of transactions with the bank's records, account holders should be on the lookout for incorrect or transposed numbers as well as unauthorized transactions. Discrepancies should be reported as soon as possible, in writing if possible.

Repayment of student loans �You must repay a student loan even if your financial circumstances become difficult. Your student loans cannot be canceled because you didn’t get the education or job you expected, or because you didn’t complete your education (unless you couldn’t complete your education because your school closed).

Tax anticipation loans �A Refund Anticipation Loan (RAL) is a loan that is offered by many tax preparation companies to people against their income tax return. These loans are based on the full amount of the tax refund. Loans can be had for the entire amount or a partial amount of the anticipated refund. When the check arrives at the tax preparer’s office, the loan is paid in full, with interest, and any remaining balance is issued to the recipient. Many people use this program for its quick access to money without considering the high interest rates attached.

CREDIT

Credit card cash advances �A service provided by many credit card issuers allowing cardholders to withdraw a certain amount of cash, either through an ATM or directly from a bank or other financial agency. Cash advances typically carry a high interest rate - even higher than credit card itself - and the interest begins to accrue immediately. On the plus side, cash advances are quick and easy to obtain in a pinch.

Credit �Truth in Lending Act A federal law enacted in 1968 with the intention of protecting consumers in their dealings with lenders and creditors. The Truth in Lending Act was implemented by the Federal Reserve through a series of regulations. �Consequences of paying the minimum payment due on a credit card bill or paying a bill late Your credit score will fall Your monthly bills start to balloon Your credit card costs skyrocket

Credit �How does the degree of risk influence the interest rate charged for credit Higher risk = higher interest rate Lower risk = lower interest rate �Debt to credit ratio Amount of available credit you are using Divide the aggregate outstanding balance of all your credit cards by the total credit limit across all the cards One should try to keep that percentage to below 30%

Credit Reports �Report detailing your use of credit Identifying information (name, address, etc. ) Account information (date opened, balance, payment history) Credit inquiries (companies who’ve checked your credit) � Important because it shows if you’ve been seeking new credit �Public record and collection information Such as: bankruptcies, liens, law suits, judgments and collections

Consequences of a lost or stolen credit card �Identity theft, use of your credit �In the event that your credit card is stolen in the United States, federal law limits the liability of card holders to $50 regardless of the amount charged on the card by the unauthorized user. In today's world of electronic fraud, if just the credit card account number itself is stolen, federal law guarantees that the card holder has a zero liability to the issuer.

Consequences of a lost or stolen credit card �As a card holder, you should notify the issuer immediately if you notice that your credit card is missing or stolen. This early notification will give the issuer time to help you with the following: 1. Verify if and where fraud has occurred. 2. Remove unauthorized charges from your credit. 3. Close down your account to prevent future fraudulent charges. 4. Issue you a new card and account number.

Consequences of a lost or stolen credit card �Several credit card companies have adopted a "zero liability" policy which means the consumer is not held responsible for any fraudulent charges. You should also check with the three major credit reporting agencies and obtain a copy of your credit report to be sure that nothing else has been accessed fraudulently.

Consequences of a lost or stolen credit card �Be wary of credit card protection offers. This type of insurance is unnecessary because federal law limits your credit card fraud liability. But scam artists try to sell $200 -300 credit card insurance by falsely claiming that cardholders face significant financial risk if their cards are misused. According to recent Federal Trade Commission estimates, 3. 3 million consumers have purchased unnecessary insurance to prevent unauthorized use of their credit cards.

Credit �The length of debt repayment and impacts on cost Longer you take to pay, the more you pay in total (accumulating interest) �What to do if a person thinks he/she is the victim of identity theft Report to creditors and credit reporting agencies Watch credit report carefully for several months �Characteristics of predatory loans Giving unfair and abusive loan terms to borrowers Showing lower interest than actually paying, making it seem they can afford more than they can, using collateral against default, high fees, etc.

Credit �Collateral (secured vs. unsecured) Secured = has collateral tied to it in case of default (home mortgage, car financing) Unsecured = no collateral (credit cards) �Pawnshops Offer collateralized loans Bring in item of value, get loan of percentage of value Pay back with interest If unpaid, item is forfeited to the pawnshop and considered paid in full Does NOT affect credit score, doesn’t require a credit check or bank account

Insurance, Investing, & Financial Planning

Insurance �How insurance works – concept of sharing risk Insurance is a form of risk management in which the insured transfers the cost of potential loss to another entity in exchange for monetary compensation known as the premium �Insurance deductible – what happens to the premium when the deductible is raised or lowered Deductible=The amount you have to pay out-of-pocket for expenses before the insurance company will cover the remaining costs. A lower deductible creates higher premiums (cost for insurance coverage), higher deductible creates lower premiums.

Collision coverage �Collision Insurance will reimburse the insured for any damage sustained to their personal automobile that is due to the fault of the insured driver. �People typically drop this coverage when their car’s value is low enough that the cost of the insurance deductible and premiums aren’t worth paying

Term life insurance �A policy with a set duration limit on the coverage period. Once the policy is expired, it is up to the policy owner to decide whether to renew the term life insurance policy or to let the coverage end. �The policy pays out upon death only – no savings or investment component.

Whole life insurance �A life insurance contract with level premiums that has both insurance and an investment component. The insurance component pays a stated amount upon death of the insured. The investment component accumulates a cash value that the policyholder can withdraw or borrow against.

Health insurance – HMO insurance and co-pays �An HMO is a type of health insurance plan that gives you access to certain doctors and hospitals, often called network or contracting doctors and hospitals (sometimes called "providers"). �Co-pays: paid by the insured person each time a medical service is accessed.

Disability insurance �Disability insurance offers income protection to individuals who become disabled for a long period of time, and as a result can no longer work during that time period. Employees, who have paid the Federal Insurance Contributions Act (FICA) tax for a certain amount of time, are eligible to receive the Social Security disability income insurance.

How to reduce the cost of auto insurance �Increase deductible, purchase a low profile car, drop unneeded coverage, drive less, safety discounts, student discounts, combine policies

Securities and equities � When you sell a capital asset, the difference between the amounts you sell it for and what you paid for it – is a capital gain or a capital loss. � Historical performance of stocks: Up and down but average 910% � Primary market: The primary market is where securities are created. It's in this market that firms sell new stocks and bonds to the public for the first time (IPO – Initial Public Offering) � Secondary market: The secondary market is what people are talking about when they refer to the "stock market". This includes the New York Stock Exchange (NYSE), NASDAQ and all major exchanges around the world. The defining characteristic of the secondary market is that investor’s trade among themselves.

What is a bull market? �The use of "bull" and "bear" to describe markets comes from the way the animals attack their opponents. A bull thrusts its horns up into the air while a bear swipes its paws down. These actions are metaphors for the movement of a market. If the trend is up, it's a bull market. If the trend is down, it's a bear market.

Bonds �A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U. S. and foreign governments to finance a variety of projects and activities. �The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually). The main categories of bonds are corporate bonds, municipal bonds, and U. S. Treasury bonds, notes and bills, which are collectively referred to as simply "Treasuries. "

Mutual funds �An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors.

Investment Portfolio �A grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchangetraded and closed-fund counterparts. Portfolios are held directly by investors and/or managed by financial professionals. �Investors should construct an investment portfolio in accordance with risk tolerance and investing objectives. Think of an investment portfolio as a pie that is divided into pieces of varying sizes representing a variety of asset classes and/or types of investments to accomplish an appropriate risk-return portfolio allocation.

Investing �Diversification “Don’t put all your eggs in one basket” - create a portfolio that includes multiple investments in order to reduce risk. �Dividends A distribution of a portion of a company's earnings (profits) to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount each share receives (dividends per share).

Treasury bills �A short-term debt obligation backed by the U. S. government with a maturity of less than one year. Tbills are sold in denominations of $1, 000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks).

Determine Net Worth �Net worth = value of assets – amount of liabilities �Assets: real estate, stock investments, bank accounts, cash �Liabilities: debts, loans (mortgage, car, student, etc. ) �Assets = Liabilities + Owner’s Equity

Retirement �A pension is a retirement account that an employer maintains to give you a fixed payout when you retire. It's a kind of defined benefit plan. �Your payout typically depends on how long you worked for your employer and on your salary. When you retire, you can choose between a lump-sum payout or a monthly "annuity" payment

Retirement �Traditional IRA: An individual retirement account (IRA) that allows individuals to direct pretax income, up to specific annual limits, toward investments that can grow tax-deferred (no capital gains or dividend income is taxed). Taxes are paid at the time of distribution/withdrawal. �Roth IRA: With a Roth IRA, you make contributions with money on which you've already paid taxes. Your money can then potentially grow tax-free, with taxfree withdrawals in retirement, provided that certain conditions are met.

Inflation: A general increase in prices �Purchasing power of money. Government tries to keep it to 2 -3%. Most hurt: lenders and those on fixed incomes (retired) Least hurt: minimum wage earners, middle class home owners �Deflation: Reduction in the general level of prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

Taxes �Income taxes: a tax that takes a larger percentage from the income of high-income earners than it does from low-income individuals. Taxpayers are broken down into categories based on taxable income; the more one earns, the more taxes they will have to pay once they cross the benchmark cut-off points between the different tax bracket levels.

Regulatory Agencies �SEC (Securities and Exchange Commission): A government commission created by Congress to regulate the securities markets and protects investors. In addition to regulation and protection, it also monitors the corporate takeovers in the U. S. Role is to protect the investing public against fraudulent and manipulative practices in the securities markets. �The Fed: The central bank of the United States and the most powerful financial institution in the world. Roles: Conducting national monetary policy by influencing monetary and credit conditions in the U. S. economy to ensure maximum employment, stable prices and moderate long-term interest rates.

Regulatory Agencies �Supervising and regulating banking institutions to ensure safety of the U. S. banking and financial system and to protect consumers’ credit rights. �Maintaining financial system stability and containing systemic risk. �Providing financial services – including a pivotal role in operating the national payments system – to depository institutions, the U. S. government and foreign official institutions.

Regulatory Agencies �FDIC (Federal Deposit Insurance Corporation): The U. S. Corporation insuring deposits in the U. S. against bank failure. The FDIC was created in 1933 to maintain public confidence and encourage stability in the financial system through the promotion of sound banking practices. The FDIC will insure deposits of up to US$250, 000 per institution as long as the bank is a member firm. �CFPB (Consumer Fraud Protection Bureau): A regulatory agency charged with overseeing financial products and services that are offered to consumers. Role is to protect and educate consumers about the various types of financial products and services that are available.