FHCE Exam 4 fully solved & updated

Financial Illiteracy - answer--more than one in six U.S. teens are unable to make simple, everyday choices about spending, and only one in ten can solve complex financial tasks. -17.8% of US students do not even reach the baseline level of financial proficiency What Will Plans Do - answer--Achieve your financial goals -Achieve financial independence. -Invest intelligently -Minimize your payments to Uncle Sam -Cover your assets Life Cycle of Financial Planning - answer--Stage 1: The Early Years -- A Time of Wealth Accumulation -Stage 2: Approaching Retirement -- The Golden Years -Stage 3: The Retirement Years Stage 1: The Early Years -- A Time of Wealth Accumulation - answer--Develop your savings plan. -Set your initial goals of all lengths. -Establish your long-range investment strategy. -Through age 54 Stage 2: Approaching Retirement -- The Golden Years - answer--Realize intermediate-term goals -Re-evaluate the plan to match current goals. -Plan for retirement. -Age 55-64 Stage 3: The Retirement Years - answer--Reduce investment risk -Concentrate on preservation rather than growth of assets -Plan for the transfer of your estate -Ages 65+ The Personal Financial Planning Process - answer--Step 1: Evaluate Your Financial Health -Step 2: Define Your Financial Goals -Step 3: Develop a Plan of Action -Step 4: Implement your plan -Step 5: Review Your progress, Reevaluate, and Revise your plan Step 1: Evaluate Your Financial Health - answer--Evaluate your current situation: income, spending, wealth -Assess your whole financial picture Step 2: Define Your Financial Goals - answer--Specifically define and write down your financial goals to reflect your financial and life situation. -Attach a cost to each goal. -Set a date for when the money is needed to accomplish the goal Goals: The Cornerstone of aFinancial Plan - answer--Goals keep the future in mind by reminding you of the rewards. -Goals entice you to keep the plan in effect. -Goals provide tangibility for the question, "Why?" What Are the Time Horizons forFinancial Goals? - answer--Short-term goals can be accomplished within a 1-year period -Intermediate-term goals take 1-10 years to accomplish. -Long-term goals take more than 10 years to achieve. Step 3: Develop a Plan of Action - answer--Flexibility -- The ability for your plan to change as your situations or goals change. -Liquidity -- Your ability to convert non-cash assets into cash with relative ease and speed -Protection -- Your ability to meet the unexpected large expenses without destroying your plan. -Minimization of Taxes -- Your ability to pay as little as possible to Uncle Sam Step 4: Implement Your Plan - answer--Your plan is your road map -Use common sense and moderation; don't force yourself to track every penny; -Remain positive about your plan; -Stay on track after the detours Step 5: Revise Your Plan - answer-Review your progress. -Match your plan to your goals. -Be prepared to start over if your plan no longer meets your needs Step 1: Evaluate your Financial Health - answer-You can't get to where you want to be financially until you know exactly where you are. -Balance sheets -Income statements -Budget Using A Balance Sheet to Measure Your Wealth - answer--Personal balance sheet: A statement of your financial position on a given date. "the financial selfie or snap shot" of THE PRESENT -Lists 1) your assets and 2) your liabilities 1) Your Assets: What You Own - answer--Monetary -Investment -Retirement plans -Real estate -Automobiles and other vehicles -Personal property Monetary Assets: - answer--Cash or other assets that can be easily liquidated -Examples -- cash, checking accounts, savings accounts Investment Assets: - answer--Assets that are invested for the future -Examples -- stocks, bonds, mutual funds, cash value life insurance Retirement Plans: - answer--Investments by you or your employer to save for retirement -Examples -- pensions, IRAs, 401(k), 403(b), Keogh, or SEP-IRA plans A quick definition - answer--Tangible asset: a physical asset; something you can use, feel, and touch. -Examples: Real Estate - answer--Tangible asset such as land or a dwelling; -Represents most of your savings, and normally appreciates in value; -Examples -- primary residence, vacation home, rental property Automobiles and Other Vehicles - answer--Tangible assets that must be inspected and licensed -Reported as fair market value, but normally depreciate in value -Examples -- cars, trucks, motorcycles, and recreational vehicles Personal Property - answer--Tangible assets that represent your lifestyle -Reported as fair market value, but normally depreciate in value -Examples -- boats, furniture, electronics, clothing, jewelry 2) Your Liabilities: What You Owe - answer--Current liabilities are liabilities that must be paid-off within the next year. -examples - personal loan, orthodontics bill -Long-term liabilities are liabilities that extend beyond one year. -examples -- home mortgage and auto loans Your Net Worth: A Measure of Your Wealth - answer--Assets (own) - Liabilities (owe) = -NETWORTH Insolvent - answer--The condition in which you owe more money than your assets are worth. Using a Personal Income Statement to Trace Your Money - answer--Personal income statement - tells where your money comes from and where it has gone -"the financial motion picture" of THE PAST -Cash basis: statement based entirely on actual cash flows Expenditures: Where Your Money Goes - answer--The two major expenditure categories: taxes and living expenses -Fixed expenses: Expenses you signed up for....and MUST make the full payment on the debt: -- e.g., mortgage, rent, cable TV -*not making the full payment will result in your home being foreclosed upon, you being evicted, and your TV/Internet being discontinued. *debt collections start on debts of this type -Variable expenses: Expenses you signed up for and the amount may vary from month to month -- e.g., food, entertainment, clothing -When needing to control one's finances one can easily make budget cuts here Using Ratios: A Financial Thermometer - answer--Analyzes the raw data from your balance sheet and income statement to identify your financial strengths and weaknesses. -Allows you to answer the following questions..... Question 1: Do You Have Adequate Liquidity? - answer--Liquidity: the relative ease and speed with which you can convert non-cash assets into assets Ratios - answer--Ratios to determine whether or not you have enough monetary assets -(1) to pay for an unexpected large expense or -(2) to tide you over during periods of reduced or eliminated earnings Liquidity Ratios - answer-1. Current Ratio 2. Month's living expenses covered ratio Current Ratio - answer--monetary assets/current liabilities (divided by) -Shows whether you have enough liquid assets to cover expenses currently due. -Ratio greater than 2 recommended Monetary Assets - answer--Cash or other assets that can be easily liquidated -Examples -- cash, checking accounts, savings accounts, certificates of deposit, money market accounts Your Liabilities: What You Owe - answer--Current liabilities are liabilities that must be paid-off within the next year. -examples - personal loan, orthodontist bill Calculate Current Ratio - answer--Frank has: -$4,000 in checking -$8,000 loan due 12/27/2023 -$15,000 in Money Market Acct -$2,000 cash -$15,000 attorney payment due 10/27/23 -$3,000 therapy installment 11/18/23 -$12,000 balloon payment on auto loan 11/15/25 -Monetary Assets: -4000 checking -15000 Money Market -2000 cash -Current Liabilities: -8000 loan -15000 attorney -3000 therapy Answer to Frank - answer--21,000 divided by 26,000 -Ratio=.8077 -Is this a good ratio? NO. With your current assets you can only pay off 80% of current debt Month's Living Expenses Covered Ratio - answer--monetary assets/annual living expenses/12 -rule of thumb: 3 to 6 months of expenses Calculate Month's Living Expenses Ratio - answer--$3,000 savings -$1,000 Money Market -$600 checking -$6,000 annual rent -$5,000 annual medical ins. -$4,000 annual liability ins. -$3,000 annual food -$9,600 annual debt Answer to Month's Calculation - answer--$4,600 in monetary assets divided by $2,300or (27,600/12) in living expenses -Results in enough liquid monetary assets to cover only 2 months of living expenses -Book says this is not adequate! Calculate Month's Living Expenses Ratio (example 2) - answer-$13,000 savings -$10,000 MoneyMarket -$600 checking -$6,000 annual rent -$3,000 annual medical ins. -$4,000 annual liability ins. -$5,000 annual food -$9,600 annual debt Answer to Month's Example 2 - answer--$23,600 in monetary assets divided by $2,300or (27,600/12) in living expenses -Results in enough liquid monetary assets to cover 10.26 months of living expenses -this is adequate! Question 2: Can You Meet Your Debt Obligations? - answer--Ratios to determine whether or not you can meet current or long-term debt obligations: -1) Debt ratio -2) Long-term debt coverage ratio 1. Debt Ratio - answer--total (debt) liabilities/ total assets -This ratio tells you whether you could payoff all your liabilities if you liquidated all your assets Debt Ratio Example - answer--$4,500 car loan -$26,000 student loan -$112,000 mortgage -$277,000 house value -$15,000 car value -$54,000 jewelry -Liabilities: -4500 car loan -26000 student loan -112000 house loan -Assets: -277000 house -15000 car -54000 jewelry Debt Ratio Example Answer - answer--$142,500/$346,000 -=.4118 or 41.18% of their assets are financed through debt, and yes they could pay the debt off if needed 2. Long-term Debt Coverage Ratio - answer--total income available for living expenses/total long-term debt PAYMENT -This ratio tells you how many times you could make your debt payments with your current annual income. -Ratio of 2.5 or greater recommended Long-term Debt Coverage Ratio Example - answer--income available for living: $56,510 -Debts: -Mortgage: $19,656 -Auto loan: $2,588 -College loan: $1,600 -TV loan: $230 -56,510/24,074 -=2.35 times -anything less than 2.5=red flag Question 3: Are You Saving As Much As You Think? - answer--Ratio to determine if you are saving as much as you think Savings Ratio - answer--income available for savings/income available for living expenses -This ratio tells you what proportion of your AFTER-TAX income is being saved Savings Ratio Example - answer--Income available for saving: $4,276 -Income available for living: $56,510 -Ratio=.076 or 7.6% Interpretation - answer--U.S. rate typically 3%- 8% -US Personal SavingRate is at ~4.1% -Retirement will be challenging for those who do not increase this percent! Balance Sheet: Net Worth - answer--NET WORTH -Measure of your financial worth -Equity in owned assets -What remains after selling all your owned assets and paying off all your liabilities -Net worth = Total assets - Total Liabilities -Insolvent -Condition in which you owe more money than your assets are worth -Net worth is zero or negative PREPARING THE INCOME AND EXPENSE STATEMENT - answer--Record your income from all sources for the chosen period -Establish meaningful expense categories INCOME / EXPENDITURE STATEMENT(PAST BEHAVIOR) - answer--Income (Cash in) -Earned income -Nonearned income INCOME/EXPENDITURE STATEMENT -Expenditures (Cash out) -Fixed versus flexible - whether the expenditure category is a necessity for the family or not -Certain versus uncertain -whether the amount of the expense is known for sure or not The Budget - answer--Income and expense statements and balance sheets are used to develop budgets -Past: -The income and expense statement provides a record of what was earned and spent in a previous period -Present: -The balance sheet shows a person's current financial situation -Future: The BUDGET Spending Money Wisely-Current Needs - answer--Based on necessities of life and your average propensity to consume -Average propensity to consume -The percentage of each dollar of income, on average, that a person spends on current needs rather than savings Spending Money Wisely-Future Needs - answer--Setting aside a portion of current income for future spending in savings or investments -Retirement -Home Definitions and Examples of Credit - answer--Credit - receiving cash, goods, or services with an obligation to pay later. -Closed credit - credit that you can must repay in fixed payments -Examples - car loans, mortgages -Open credit -- credit that you can use and repay at your pace so long as you pay the required minimum monthly payment. -Examples -- Credit cards or department store credit cards Factors That Determine "Creditworthiness" to Financial Institutions - answer-Annual income ~ different sources -Length of time at current residence -Length of time at current job -Number of bank accounts ~ in case they need to recover funds -Number of credit cards ~ less is better -Credit history ~ YOU MUST KEEP THIS PRISTINE! GETTING A CREDIT CARD: THE FIVE C'S OF CREDIT - answer-1. Character 2. Capacity 3. Capital 4. Collateral 5. Conditions CHARACTER: SENSE OF RESPONSIBILITY TOWARD DEBT REPAYMENT - answer--Proven debt repayment history -Job stability -Homeownership/rental length -Low debt load ~ do not take on too much debt CAPACITY: ABILITY TO REPAY DEBT - answer--Current level of income and source of income ~more is better -Current level of borrowing (how many lines of credit do you currently have ~ less is better) -Level of non-obligated income -Debt including mortgage should be less than 36% of your gross income (debt to income ratio) CAPITAL: SIZE OF YOUR FINANCIAL HOLDINGS - answer--Investments -Savings -Checking -Income -Assets COLLATERAL: THE TANGIBLE ASPECT OF BORROWING - answer--Assets or property secured to obtain credit -The creditor holds the title or deed to the assets until repaid -If you default the asset is sold to repay the debt -Typically secured assets include: automobiles, homes, boats CONDITIONS: EXTRANEOUS FACTORS - answer--Impact the current economic environment may have on your ability to repay debt -Unemployment rate -Discount rate ~ federal interest rate -Inflation rate COSTS ASSOCIATED WITH CREDIT CARDS - answer--The balance owed -Interest rate/finance charge -Cash advance costs -The annual fee -Additional or penalty fees BALANCED OWED = REVOLVING BALANCE - answer--Revolving credit: -If you carry a balance from month to month on your credit card then you have a revolving account -Compound interest is calculated on revolving balances INTEREST RATES DETERMINES FINANCE CHARGE - answer--Annual percentage rate (APR) -interest rate paid over the life of the loan -Teaser rates - introductory rates used to attract new customers, some as low as 0.0% -Most credit cards compound interest on a monthly basis (APR/12) BUYING MONEY: THE CASH ADVANCE - answer--Interest begins immediately and maybe at a higher rate than for purchases -Usually there is a "cash advance fee"of 2% to 4% of the amount advanced -Some cards require payment of the purchase balance before payment of the cash advance balance The Grace Period - answer--Normally 20 to 25 days, excluding cash advances -Doesn't apply if you carry a balance -Not all credit cards offer a grace period Fees - answer--Range from $0 to $100 (American Express charges $300 for their Platinum card.) -Cash advance fee -Late fee (averaged $35) -Over-the-limit fee (averaged $35) -The 2010 Credit Card Act limited most fees to $25 CREDIT EVALUATION: THE CREDIT BUREAU - answer--The credit bureau: collects and reports information from creditors, public court records, and the consumer. -Determining your credit worthiness -- credit scoring determines if you qualify for credit and the interest rate offered. INFORMATION ON YOUR CREDIT REPORT - answer--Personal demographics -Age, Social Security number, address -Employment history -Credit repayment history -Criminal convictions and judgments -Previous two years of inquiries by creditors NATIONAL CREDIT REPORTING BUREAUS - answer--Equifax Credit Information Services -Experian -Trans Unio Characteristics of Consumer Loans - answer--Single payment (balloon) vs. installment loans (amortized) -What does amortized mean?-Secured vs. unsecured -Variable rate (tied to other national rate)vs. fixed rate -Who determines the national rate? The Loan Contract: all the conditions of the loan - answer--The APR -The number of payments -Total amount financed -How interest is calculated -The APR [the annual percentage rate you are charged...is it monthly...quarterly....semiannually??] -The number of payments [usually years worth] -The APR [the annual percentage rate you are charged...is it monthly...quarterly....semiannually??] -If the offer of a car loan is 6.9%APR...typically the payments are monthly: 6.9%/12 = .005750 monthly interest rate -Total amount financed [principle +interest] -How interest is calculated [monthly or how?] The Loan Contract: The Clauses - answer-1. Insurance agreement clause 2. Acceleration clause 3. Deficiency payments clause 4. Recourse clause 1) Insurance Agreement Clause - answer--Requires you to purchase life insurance that will payoff your loan after your death -Normally benefits only the lender -Increases your total loan cost -TYPICALLY ONLY FOR HOME LOANS WHERE LESS THAN 20% HAS BEEN PUT AS A DOWN PAYMENT 2) Acceleration Clause - answer--Requires the entire loan to be paid-in-full if you miss just one payment -Are standard on most loans -Normally not invoked if you make a good faith effort to pay -Requires the entire loan to be paid-in-full if you miss just one payment..... 2) Acceleration Clause-late payments - answer--Know this about late payments:::::: -You may think it's no big deal that your car payment arrives 5 days past the due date............however, THIS SHOWS UP ONYOUR CREDIT REPORT AS 30 DAYS LATE....THERE IS NO 5-DAY LATE BUCKET......It is 30; 60; 90; 120; 180 it's not based on calendar days late!!!! 3) Deficiency Payments Clause - answer--Requires any amount in excess to be paid if the collateral's value does not satisfy the loan. -Also requires payment of any outstanding charges incurred by the lender associated with the disposal of the collateral 4) Recourse Clause - answer--Defines the lender's ability to collect any outstanding balance -Repossession of property—they can take your collateral back to pay off your debt!!!!!! -wage attachments and garnishments—they can take your paycheck—then your boss knows you can't manage your $$$ -liens on other property (secondary collateral)—they can take other stuff to pay off your debt Bankruptcy.....one way to stop some of the clauses - answer--Chapter 7: Liquidation---with this type of bankruptcy you KEEP YOUR INCOME—BUT THEY SELL YOUR STUFF TOPAY YOUR DEBTORS -Chapter 13: Repayment—with this type YOU KEEP YOUR STUFF BUT AREPUT ON A PAYMENT SO YOU LOSE YOUR INCOME FOR 3-5 YEARS -Chapter 11: Business—this is the type of bankruptcy that most businesses file: Hostess, Delta Airlines, Toys R Us, etc etc. -Chapter 12: Farmers—this is only for small independent family owned farmers Special Types of Consumer Loans - answer--Home equity loans -Student loans -Automobile loans -Pay day loans Home Equity Loans - answer--Are basically second mortgages -Use the equity in your home to secure your loan -Normally allow you to borrow up to 80% of your equity Home Equity Loans (cont'd) - answer--Advantages -interest payments are tax-deductible -lower rates of interest than other types of consumer loans -Disadvantages -puts your home at risk if you default -sacrifices future financial flexibility because you can only have one outstanding home equity loan Student Loans - answer--Loans with low, federally subsidized interest rates used for higher education. -Are tax-advantaged under the 1997 Taxpayer Relief Act. -Examples - Federal Direct/Stafford loans for students; PLUS Direct/PLUS Loans for parents Dismissal or reduction of student loans - answer-Student loans may be reduced or dismissed under these conditions: -Volunteerism in Peace Corps, VISTA -Teaching in a school that is low-income STUDENT LOANS AND BANKRUPTCY...... - answer--USUALLY NO.............. -There are typically 3 debts that cannot be eliminated through bankruptcy: -Student loan debt -Child support debt -Taxes debt Automobile Loans - answer--A consumer loan that is secured with an automobile. -Has a lower interest rate than an unsecured loan. -Normally has a maturity length of 2 to 6years Cost of Single-Payment Loans - answer--The simple interest calculation method -both principal and interest are due at maturity -interest = principal x interest rate x time -I = (P*R*T) -$700 = $5,000 (P)* 0.14 (R)* 1(T= 1) -Interest = $700 -Total Payment $5,700 Definition of Cost of Single-Payment Loans - answer--interest is the finance charges you will pay ($700) -principal is the amount you are seeking to borrow ($5000) -This is the rate of interest the lending institution is charging you: 14%. This is always put into the formula as a decimal so 10% = .10; 17% = .17; 33% = .33 -time is his is the length of the loan [this is always put into terms of one year] meaning.....if the loan is 15 months then the number used is 15/12 or 1.25; if its 3 days then its 3/365 or . Payday Loans - answer--High fees charged. -Short-term loan of 1-2weeks. -Those with jobs and checking accounts and students are typical users. -Check "held" by the payday lender Calculate the Interest Rate - answer--Josh took out a pay-day loan for $500. He is borrowing the money for 2 weeks.The clerk said they don't charge interest but he does have to pay a small $60 fee. Honestly, what is Josh's interest rate? -I = P*R*T -$60 = 500*R*.0385 -$60= 19.25*R -60/19.25 = R -3.1169 = R -RATE = 311.69% Ah banks......... - answer--Think your bank isn't predatory??? -Think again—what about overdraft protection??? -You overdraw your account by $65 but put the money back in within 3 DAYS and they cover your overdraft for a small fee of $35.........SOUND FAMILIAR??? Overdraft Calculation - answer--I = P * R * T -$35 = $65 * R * (3/365) -$35 = 65 * R * .0082192 -$35 = .534246 * R -35/.534242 = (.534246/.534242) * R -65.513 (take this times 100%) -6551% Payment, Interest Rate and Loan Term - answer--The total interest cost of your loan is directly related to the interest rate. -The total interest cost of your loan is directly related to the maturity length. -Your periodic payment is directly related to both the duration and interest rate Controlling your use of debt - answer--Debt limit ratio: what percentage of your take home pay or income is taken up by non-mortgage debt payments? -= total monthly non-mortgage debt pmts/ (divided by) Total monthly take home pay Investing Versus Speculating - answer--Investing -- putting your money into an asset that generates a return -Examples -- stocks, bonds, mutual funds, or real estate -Speculating -- putting your money into an asset that the future value, or return, relies on supply and demand -Examples -- collectors items, gold, baseball cards, or derivative securities Investment Choices - answer--lending investments -ownership investments Lending Investments - answer--Savings account: loan institutions money -Bonds: loans where your rate of return is predetermined -Par value: the amount you receive when bond matures -Coupon interest rate: the interest paid annually on a bond as a percentage of par value Ownership Investments - answer--Stocks: You become part owner in the corporation and receive a portion of the profits as dividends. -Real estate:You generate a return through rent or capital appreciation Returns From Investing - answer--Investors expect a return for delayed consumption: 1. Capital gains/losses: your investment goes up or down 2. Income -1. from bonds you receive interest -2. from stocks you receive dividends Nominal and Real Rates of Return - answer--Nominal (quoted) rate -- the rate of return without adjusting for inflation. -Real rate -- the inflation adjusted rate of return -Premiums -- additional returns demanded by investors for taking on additional risk -You frequently see "premiums" occur when companies are merging; in that, one company is taking over the stock of another company so they offer these additional benefits to the previous stockholders Types of Risk Premiums - answer--Inflation risk premium (IRP) --compensation for the anticipated inflation over the life of the investment. -Default risk premium (DRP) --compensation for the possibility that the issuer may not pay the interest or repay the principal -Maturity risk premium (MRP) -- compensation on longer-term bonds for value fluctuations in response to interest rate changes. -Liquidity risk premium (LRP) -- compensation for a bond that can not be quickly converted into cash at a fair market value SOURCES OF RISK IN THE RISK-RETURN TRADE-OFF - answer--Interest rate risk -Inflation risk -Business risk -Financial risk -Liquidity risk -Market risk -Political and regulatory risk -Call risk Interest Rate Risk - answer--Risk associated with fluctuations in security prices due to changes in the market interest rate. -A rise in the market interest rate reduces the value of your lower rate security. -Impossible to eliminate Inflation Risk - answer--Risk that rising prices will erode purchasing power -Closely linked to interest rate risk because of the effect of inflation on interest rates -Almost impossible to eliminate Business Risk - answer--Is the risk associated with poor company management or product acceptance in the marketplace Financial Risk - answer--The risk associated with the company's use of debt Liquidity Risk - answer--Risk associated with not being able to liquidate a security quickly and cost effectively. -Collectibles and real estate have high liquidity risk Market Risk - answer--Risk associated with the swings in the overall market -Can be caused by the economy, supply and demand, and interest rates -Impossible to eliminate Political and Regulatory Risk - answer--Risk that results from unanticipated changes in the tax or legal environment. -Can be very difficult to predict Political Risk - answer--Risk that results from unanticipated or anticipated changes in the political-legal environment. -Can be very difficult to predict or can be pretty easy to predict; for example....when Democrat President Obama took over after Republican President Bush—the gun industry raised the prices of all its guns/ammo because of the belief that Democrats want to take away people's guns....so they wanted to make money "before that happened"—which of course it never did Call Risk - answer--Risk that a callable security may be taken back before maturity. -If a bond is called, the investor normally receives the face value plus one year of interest payments. -Only applies to callable bonds SYSTEMATIC AND UNSYSTEMATIC RISK - answer--Systematic risk: the risk associated with all securities and can not be reduced through diversification. (est rate risk) -Unsystematic risk: risks associated with one particuterm-139lar investment and can be reduced through diversification. (i.e. financial risk) Risk and Diversification - answer--Diversification refers to the number of different types of securities owned. -Diversification reduces risk -Investors demand a return for taking on additional systematic risk Coca Cola - answer--Just one $40 share of the company's stock bought in 1919, with dividends reinvested, would be worth $9,800,000 today. -Reinvesting dividends -While $40 in 1919 may sound like a lot, it's the equivalent of about $531 today. -It's an amount that's not all that difficult for the average American to save up Apple Stock - answer--Apple first sold shares to the public on Dec. 12,1980, at $22 per share -If you had invested $10,000 in Apple in 1980, you would have about $6.7 million today Company Ownership - answer--One vote per share to elect the board of directors at annual meetings is the extent to which you have a say in the company. -Just because you have shares in Barnes and Noble does not mean you can go help yourself to free books! Stock Basics: Buying Stocks - answer--1. Using a Brokerage firm -Full Service Brokers -Discount Brokers 2. DRIPs & DIPs -Dividend Reinvestment Plans (DRIPs) and; -Direct Investment Plans (DIPs) are plans with which individual companies for a minimal cost, allow shareholders to purchase stock directly from the company TERMINOLOGY AND FEATURES (CONT'D) - answer--Stock splits --The company cuts the stock price and you get more shares, but retain the same total investment. -In a 2:1 split—100 shares selling for $100 will split into 200 shares at $50 each -Stock repurchases -- companies buying back their own stock Why Consider Stocks - answer--Over time, common stocks outperform all other investments. -Stocks reduce risk through diversification. -Stocks are fairly liquid. -Growth of investment is determined by more than just interest rates Basic Common Stock Terminology and Features - answer--Limited liability -- If the company goes broke, you can only lose the amount you invested. -Claim on income -- as a shareholder you have a right to any earnings of the company after all other obligations are me -Claims on assets -- Common share holders can claim their assets only after debtors and preferred stock holders have been paid. -Voting rights -- you have the right to vote; however, this right is normally executed through a proxy. -Proxy -- an agreement allowing a designated party to "vote your shares. -Stock splits --The company cuts the stock price and you get more shares, but retain the same total investment. -In a 2:1 split—100 shares selling for $100 will split into 200 shares at $50 each Google Stock Split - answer--In 2022, Google parent Alphabet implemented its 20-for-1 stock split. -The price of a single share of the company stock became more affordable after the split, dropping from roughly $2,200 onFriday to $113 on Monday morning. -This means more consumers can afford to invest in Google More Terms - answer--Stock repurchases -- companies buying back their own stock -Repurchases return cash to shareholders who want to exit the investment. -With a buyback, the company can increase earnings per share, all else equal. -The same earnings pie cut into fewer slices is worth a greater share of the earnings Stock Spin Out - answer--where a company "splits off" sections of itself as a separate business. -The common definition of spin out is when a division of a company or organization becomes an independent business. The "spin out" company takes assets, intellectual property, technology, and/or existing products from the parent organization. -Many times the management team of the new company are from the same parent organization. Often, a spin-out offers the opportunity for a division to be backed by the company but not be affected by the parent company's image or history Spin Out Example - answer--On January 27, 2003, Philip Morris Companies Inc. changed its name to AltriaGroup, Inc. -On March 30, 2007, a spin-out of Kraft Foods subsidiary (publicly traded since 2001) was concluded through the distribution of the remaining stake of shares (88.1%) to Altria shareholders. -FYI: ALTRIA comes from the Latin word for "high" ☺ GENERAL CLASSIFICATIONS OF COMMON STOCK - answer--Blue-chip stocks -Growth stocks -Income stocks -Speculative stocks -Cyclical stocks -Defensive stocks Blu-Chip Stocks - answer--Stock issued by large well-known companies -Normally have sound financial histories -Normally have solid dividend and growth records -Examples - General Electric, Texaco, and Proctor & Gamble -The term "blue chip stock" comes from the world of poker, where chips used in gambling have different colors to represent different dollar amounts. -A blue chip is typically the one with the highest value of all, surpassing white chips and red chips Growth Stocks - answer--Stock issued by companies whose sales and earnings growth have outpaced the market -Often are newly formed, smaller companies -Typically have a product in which consumers are very interested -Example -- Tesla Income Stocks - answer--Stock issued by mature firms that normally pays high dividends -Usually have low growth rates -Examples -- Utility companies Speculative Stocks - answer--Stock issued by higher risk companies and generally sold on the OTC market -Some are associated with astronomical gains and losses -Examples -- companies with new innovations or technology stocks -A speculative stock is a stock that a trader uses to speculate. -The fundamentals of the stock do not show an apparent strength or sustainable business model, leading it to be viewed as very risky and trade at a comparatively low price, although the trader is hopeful that this will one day change Cynical Stocks - answer--Stock issued by companies whose earnings tend to follow the economy -Examples -- Ford and General Motors Defensive Stocks - answer--Issued by companies whose earnings tend to move inversely to the broader economy and may actually increase during economic downturns -Examples - manufacturers or sellers of repair parts -The consumer who is NOT buying the new car in a down economy; however, does have to keep his/her/their car running; thus, will buy replacement parts ~therefore, THESE types of companies do well in down economies What are Bonds? - answer--Similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer. -The issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it "matures," or comes due Basic Bond Terminology and Features - answer--Par value (face value) -- the amount returned to the holder at maturity -Coupon interest rate -- indicates the percentage of the face value that will be paid annually to the holder in the form of interest -Indenture -- a document that outlines the terms of the loan agreement -Call provision -- allows the issuer to repurchase the bonds before the maturity date -Sinking fund -- money set aside annually to pay off the bonds at maturity Bond Investment Considerations - answer--Interest rate: -Fixed, floating, or payable at maturity -Read the contract ~know what type you are getting! -Redemption features -Call provisions (when % rates drop in the issuer's favor ~ the issuer will want you to return your high % paying bond!!) -Puts—you make the issuer buy back the bond (when % rates increase in YOUR favor!) -Tax status -Income from bonds issued by state, city, and local governments (municipal bonds, or munis) is generally free from federal taxes. -* You will, however, have to report this income when filing your taxes. =Municipal bond (Munis) income is also usually free from state tax in the state where the bond was issued Corporate Bonds - answer--Corporations borrow $$ by issuing bonds -Secured corporate debts are secured by collateral or real property liens -Unsecured corporate debts are not secured by collateral, and pay a higher return TREASURY AND AGENCY BONDS - answer--Treasury bonds (US treasury) -Bills, notes, and bonds -Treasury inflation-indexed bonds -Savings bonds (US treasury) -U.S. Series EE bonds -I bonds -Agency bonds -Pass-through certificates (mortgages) -Treasury Bonds are for a term of either 20 or 30 years. -Bonds pay a fixed rate of interest every six months until they mature. -You can hold a bond until it matures or sell it before it matures EE Bonds - answer--Guaranteed to double in value in 20 years -Earn a fixed rate of interest -Electronic only - keep them safe in your Treasury Direct account -Buy for any amount from $25 up to $10,000. -Maximum purchase each calendar year: $10,000. -Can cash in after 1 year. (But if you cash before 5 years, you lose 3 months of interest.) I Bonds - answer--Protect against inflation. Earn both a fixed rate of interest and a rate based on inflation. The overall rate is reset twice a year. -Primarily electronic - keep them safe in your Treasury Direct account (minimum amount $25) -You can choose to use all or part of your IRS tax refund to buy paper I bonds (minimum amount $50) -Maximum purchase each calendar year: $10,000 in electronic I bonds + $5,000 in paper I bonds -Can cash in after 1 year. (But if you cash before 5 years, you lose 3 months of interest. Agency Bonds - answer--Pass-through certificates (mortgages) -U.S. government agency bonds are debt obligations issued by government-sponsored enterprises (GSEs) or U.S. government agencies. -GSEs are independent organizations sponsored by the federal government and established with a public purpose. -Agency bonds usually are issued in$1,000 denominations Mutual Funds - answer--=buffet -Investment company that pools money from investors to buy stocks, bonds, and other investments. Investors own a share of the fund proportionate to the amount of the investment 4 Types of Investment Companies - answer-1. Open-end investment companies or mutual funds 2. Closed-end investment companies or mutual funds 3. Unit investment trusts 4. Real estate investment trusts (REITs) 1. OPEN-END INVESTMENT COMPANIES OR MUTUAL FUNDS - answer--Have an unlimited number of shares -Buy and sell shares directly to investors without asecondary market 2. CLOSED-END INVESTMENT COMPANIES OR MUTUAL FUNDS - answer--Have a limited number of shares -Sell only the initial offering. Subsequent trades are done in a secondary market, similar to the common stock market 3. UNIT INVESTMENT TRUSTS - answer--Fixed pool of securities, normally municipal bonds -Normally require $1,000 minimum investment 4. REAL ESTATE INVESTMENT TRUSTS - answer--Have 3 types (equity; mortgage; hybrid). -Lack the liquidity of most mutual funds, but more liquidity than direct real estate investments