FINA 200 - Lecture notes final exam PDF

Preview

Summary

yabFINA 200Chapter 1 - 3 questions1. Explain how you could benefit from personal financial planning● Make Your Own Financial Decisions○ Know there is an opportunity cost to your decisions● Judge the Advice of Financial Advisers ○ Be informed Evaluate potential financial advisers using questions crea...

Description

yabFINA 200 Chapter 1 - 3 questions 1. Explain how you could benefit from personal financial planning ● Make Your Own Financial Decisions ○ Know there is an opportunity cost to your decisions ● Judge the Advice of Financial Advisers ○ Be informed Evaluate potential financial advisers using questions created by the Financial Planning Standards Council (FPSC)

2. Identify the key components of a financial plan 1. Budgeting and tax planning ○ Budgeting: the process of forecasting future income, expenses and savings goals ■

Requires you to decide whether to spend or save

■ Helps you estimate how much of your income will be required to cover monthly expenses so that you can set a reasonable and practical goal ● Big spenders: focus on spending (with little or no money for savings)

●

Big savers: save and consider spending only after allocating a portion toward saving

○ Tax Planning: many financial decisions are affected by tax laws and by understanding how your alternative financial choices affect taxes, you can make financial decisions that have the most favourable effect on your after-tax cash flows. ■

Entertainment/purchases etc.: Most do not realize how taxes permeate our daily lives as we pay taxes on almost anything and everything we do.

■ Income: Canadians pay a lot of income tax and our tax system is complex, but given that personal income taxes are probably the biggest single expense you will incur over your lifetime, it is a good idea to understand how the system works and how to legally control the level of your tax bill. 2. Financing your purchases ○ Liquidity: access to ready cash, including savings and credit, to cover short-term cash needs or unexpected expenses, ease investor can convert an investment into cash without a loss of capital. ○ Money management: decisions regarding how much money to retain in liquid form and how to allocate the funds among short-term investment instruments ○ Emergency fund: a portion of savings that you have allocated to short-term needs such as unexpected expenses in order to maintain adequate liquidity ○ Credit management: decisions regarding how much credit to obtain to support your spending and which sources of credit to use 3. Protecting your assets and income (insurance) ○ Risk: Exposure to events (or perils) that can cause a financial loss ○ Risk management: decision about whether and how to protect against risk ○ Insurance planning: determining the types and amount of insurance needed to protect your assets ■ Insure risks that would result in either a significant loss of income for a long period of time or an unplanned use of your financial resources 4. Investing your money ○ Any funds you have beyond what you need to maintain liquidity should be invested with the primary objective of earning a return ■ ○

Stocks, bonds, mutual funds, real estate

All investments have some level of risk

■

Investment risk: uncertainty surrounding the potential return on an investment and its future potential value

■ Risk tolerance: your ability to accept a potential loss 5. Planning your retirement and estate ○ Retirement planning: determining how much money should be set aside each year for retirement and how those funds should be invested ○ Estate planning: determining how your wealth will be distributed before and/or after your death (effective estate planning protects your wealth against unnecessary taxes, and ensures that your wealth is distributed in a timely and orderly manner) How the 5 components relate to cash flow ○ Protecting your assets and income focuses on determining your insurance needs and costs ○

Investing uses cash to build wealth

○ Retirement planning focuses on building wealth in your retirement account ○

Estate planning is used to determine how you will distribute your assets before and/or after your death

3. Outline the steps involved in developing a financial plan 1. Establish your financial goals ○ Specify your goals (i.e. down payment on a house, pay down your debt ○ Measure your goals ○ Act on your goals (include specific action steps) ○ Realistic goals (stronger likelihood of reaching goals) ○ Timing of goals ■ Short term (within one year) – i.e. purchase a car in 6 months ■ Medium term (between 1–5 years) – i.e. pay off a school loan in the next three years ■ Long term (five years+) – i.e. save enough money for retirement 2.

Consider your current financial position ○ How your future financial position is tied to your current level of debt − ■

Individuals with lower levels of debt will make different decisions than someone who has mounting debt

○

How your future financial position is tied to your age and wealth −

■

A 20 year-old with less assets will have a different financial plan than a 65 year-old with many assets

3. Identify and evaluate alternative plans that could help you achieve your goals ○ Identify and evaluate alternative plans that could help you achieve your goals ■ Plans could be conservative or aggressive 4. Select and implement the best plan to achieve your goals ○ Individuals in the same financial position with the same goals may select different plans ■ Saving a specific amount every month vs. making some risky investments 5. Evaluate your financial plan ○ Keep plan in an accessible place and monitor your progress Review your plan annually (update based on life stages, milestones, etc.) 6. Revise your financial plan ○ Change plan as financial condition and financial goals change Revise based on specific events or changes in your means and priorities

Chapter 2 - 5 questions 1. Explain the difference between simple interest and compound interest ● Simple interest: interest on a loan computed as a percentage of the loan amount, or principal ○

Interest earned, or paid, is not reinvested ■

Measured using the principal (P),

■ the interest rate applied to the principal (r), ■ and the loan’s time to maturity (t) ● Compound interest: It is the process of earning interest on interest. ○ The money in your account earns interest, but the interest itself also earns interest – eventually snowballing into a larger and larger base on which to earn interest ○ Time Value of Money or compound interest problems can be solved with financial calculator ■ N: number of compounding periods ■ I/Y: nominal (annual) interest rate ■ PV: principal or present value ■ PMT: periodic annuity payment ■

FV: maturity value or future value

■ CPT: Compute

2. Calculate the future value of a single dollar amount that you save today ● Future value (FV) is the amount to which a current investment will grow over time when placed in an account that pays compound interest ● Basic TVM function keys are located in the 3rd row of the Texas Instruments BA II Plus keyboard ○

Important to clear the existing TVM values in the calculator’s TVM worksheet

○ Enter a value for four of the five TVM keys (N, I/Y, PV, PMT, FV); one value will be zero ○

Cash outflows, such as an investment amount, are entered as a negative number by pressing +/-

○ Cash inflows, such as investment income, are entered as a positive number ○ Specify the number of payments per year (P/Y) and the number of compounding periods per year (C/Y)

3. Calculate the present value of a single dollar amount that will be received in the future

● Present value (PV), which is also known as the discounted value, tells us how much a future sum of money is worth today, given a specified rate of return.

● ● Can use financial calculator by just solving for PV

4. Calculate the future value of an annuity ● Annuity: stream of equal payments received or paid at equal intervals in time at the end of a period ● Annuity due: a series of equal cash flow payments that occur at the beginning of each period ● Under the formula method, when payments are annuity due, you would multiply your answer by (1 + i)

● ● Helps to make a timeline to visualize flow of payments ○ When payments occur monthly, set P/Y to 12, ○ When compounding occurs monthly, you can set C/Y to 12, or multiply the amount of compounding periods by the amount of years

5. Calculate the present value of an annuity

● ● If payments are annuity due, you would multiply your answer by (1+i)

6. Calculate the number of compounding periods and the nominal annual interest rate

● ● Nominal interest rate: the stated or quoted, rate of interest Also known as annual percentage rate (APR) ○

Example: a nominal annual interest rate of 12 percent based on monthly compounding means a 1% interest rate per month

○ When comparing two or more interest rates, the nominal interest rate is not useful because it does not take into account the effect of compounding

7. Convert a nominal interest rate to an effective interest rate ● Effective interest rate: the actual rate of interest that you earn, or pay, over a period of time due to the result of compounding. Also known as the effective yield (EY or EFF) ○ Allows for the comparison of two or more interest rates because it reflects the effect of compounding ● Convert nominal interest rates to effective interest rates using the following formula:

● ● How to take advantage of compound interest ○ Invest early ○ Invest often - Those who invest what they can, when they can, will have higher returns. ○ Hold as long as possible - The longer you hold, the more time interest compound ○ Consider interest rates -The higher the annual interest rate, the better the return ○ The more frequently investments are compounded, the higher the interest accrued

Chapter 3 - 5 questions 1.Explain how to create your personal cash flow statement ● Personal cash flow statement: a financial statement that measures a person’s income and expenses ○ Record your income Salary, investment income (i.e. interest income, dividends, capital gains) ○ Record your expenses ○ Net cash flows: Disposable (after-tax) income minus expenses: total income- total expenses

2. Identify the factors that affect your cash flows ● Factors Affecting Income: ○ Stage in Your Career Path − ■ Closely related to your life stage (e.g., early career life stage vs. prime earning years) ○ Type of Job − Based on skill level and demand for those skills ○ Number of Income Earners in Your Household ● Factors Affecting Expenses: ○ Size of Family ○ Age ○ Personal Consumption Behaviour − Some people spend all of their income and more, while others, “big savers”, spend mainly on necessities and concentrate on saving for the future

3. Explain how to create a budget based on your forecasted cash flows ● Budget: a cash flow statement that is based on forecasted cash flows (income and expenses) for a future time period: Budgets are useful for anticipating either cash surpluses or cash deficiencies ● Anticipating Cash Shortages ○

Small shortages can usually be made up from your chequing account or an emergency fund Budgets provide warning of shortages so that you can prepare for them

● Assessing the Accuracy of the Budget ○ Compare projected cash flows to actual and take any necessary steps to improve your cash flow ○ Calculate forecasting errors ● Forecast Net Cash Flows over Several Months ○

Use the information for a typical month and adjust it for unusual expenses such as seasonal shopping (allow for unexpected expenses)

● Creating an Annual Budget

○ Large changes in cash flow could be the result of changes in income and/or expenses ●

Improving the Budget ○

Periodically review the budget to see if you are progressing toward your goals (always looking for ways to improve the budget over time)

● Alternative Budgeting Strategies ○ Envelope Method ■

Forces you to stick to a cash-only budget for the expense categories that are hardest to control, Create a separate envelope for each category

○ Pay Yourself First Method ■ Arrange for automatic transfer of money from chequing account to your savings account ■ Transfer would coincide with when you receive your paycheque

4. Describe how to create your personal balance sheet ● Personal balance sheet: overall snapshot of your wealth at a specific point in time summarizing you assets (what you own) less your liabilities (what you owe) to determine your net worth ○ Personal balance sheet is also called a: Net worth statement Personal net worth statement ● Assets ○ Liquid assets: can be easily converted into cash without a loss in value (e.g., cash, chequing) ○ Household assets: items normally owned by a household (e.g., car, furniture) ● Investments ○ Stocks: certificates representing partial ownership in a firm ○ Bonds: certificates issued by borrowers, usually firms and government agencies, to raise funds ○ Mutual funds ○

Real estate: holdings in rental property and land

● Liabilities ○ Current liabilities: personal debts that will be paid in the near future (e.g., credit card debt) ○

Long-term liabilities: debts that will be paid over a period longer than one year (student loan)

● Net worth = Value of total assets – Value of total liabilities ○

measure of wealth Closely related to your life state

5. Calculate financial ratios used to analyze personal financial statements ● Changes in the Personal Balance Sheet ○ Some changes will affect both your personal balance sheet and your net worth

○

Other changes will affect you personal balance sheet and leave your net worth unchanged

● Liquidity is measured by the current ratio and the liquidity ratio ○ (a high current ratio means a higher degree of liquidity) ○ Current ratio = Liquid Assets/Current Liabilities ○ Liquidity ratio = Liquid Assets/Monthly Living Expenses ● Debt-to-asset ratio measures the level of debt ○ (a high debt-to asset ratio means there is an excessive amount of debt) ○ Total liabilities/Total assets ○

Should be directly related to the financial planning life stages ■

Should have no debt when you reach the retirement life stage

● Savings Ratio measures savings over the period in comparison to disposable income over the period ○ Savings Ratio = Savings during the Period/Disposable Income during the Period

Chapter 4 - 3 questions ● The federal tax system is administered by the Canada Revenue Agency (CRA) ● The Quebec government collects its own provincial taxes to ensure the financing of public services and to administer various social programs; the level of government that is responsible for the collection of income tax and other taxes in Quebec is called Revenu Québec ● Taxes are paid at the federal, provincial, and municipal levels ●

Personal income taxes: taxes imposed on income you earn ○ Income taxes are withheld as income is earned throughout the year ○ The employer uses the TD1 (Personal Tax Credits Return form) to determine how much tax to withhold for deductions at source (for Quebec the form is TP -1015.3 (Source deduction)) ○ Self-employed individuals must estimate the amount of taxes payable

● If you have a tax balance owing for the year, you must file a tax return and pay on or before April 30th of the following year ○ Self-employed individuals have until June 15th to file income tax returns, although taxes owing (amount owed for the year) must be paid by April 30th An interest penalty may be payable if any of these deadlines are missed ○

Penalty (if taxes are owing (i.e. payable)): 5 percent of the amount owing, plus 1 percent for each additional full month that the return is late, to a maximum of 12 months

1. Explain the importance of taxes for personal financial planning ● Taxes are generally paid when capital assets are sold (paid via their tax return) ● Homeowners pay property taxes on value of their homes and land Based on assessed value of property ● Sale of a principal residence: if the property was solely the principal residence every year that it was owned, than the principal residence exemption can be claimed resulting in no taxes payable on the gain ● Why students should file tax returns ○ You may be eligible for a refundable Goods and Services Tax credit / Harmonized Sales Tax (GST/HST) CRA will automatically determine your eligibility (but you must file a tax return) ○ If you do not have any tax payable, your tuition tax credits can be: transferred to another taxpayer (a parent or grandparent), or carried forward to another tax year ○ If you have employment income, you will create RRSP contribution room for future contributions

2. Explain when you have to file a tax return ● You have to pay tax

● The CRA sent you a request to file a return ● You and your spouse or common-law partner elected to split pension income for the calendar year ● You received Working Income Tax Benefit (WITB) ● You disposed of property in a calendar year ● You have to repay any of your Old Age Security (OAS) or Employment Insurance (EI) benefits ● You have not repaid all of the amounts you withdraw from your Registered Retirement Savings Plan (RRSP) under the Hope Buyers’ Plan (HBP) or Lifelong Learning Plan (LLP) ● You have to contribute to the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) ● You are paying Employment Insurance (EI) premiums on self-employment and other eligible earnings

3.Outline the steps involved in completing a tax return 1. Calculate total income ○ Total income: all reportable income from any source, including pension, salary, benefits, etc. ■ Interest income, dividend income , and taxable capital gains received during the tax year ○ Interest income: interest earned from investments in savings accounts, ○ Dividend income: ■ Eligible dividends: cash or stock dividends from a Canadian public corporation ■ Non-eligible dividends: dividends from private Canadian companies ■ Dividends from foreign corporations ○ Capital gain: money earned when selling item at a higher price than bought 2. Subtract deductions ○ Deduction: an item that can be deducted from total income to determine taxable income ○ Common deductions: Registered Pension Plan (RPP) contributions, RRSP contributions, union/professional dues, child care expenses, support payments, carrying charges, moving expenses*, and employment expenses 3. Calculate taxable income ○ Taxable income is used to calculate net federal income tax ○ Taxable income = net income – some additional deductions 4. Calculate net federal tax payable ○ Canada has a progressive income tax system ■ The higher an individual’s income, the higher the percentage of income paid in taxes ○ Marginal tax rate: the percentage of tax you pay on your next dollar of taxable income

○ Average tax rate: the amount of tax you pay as a percentage of your total income

4. Describe the major deductions available to a taxpayer ● Registered Pension Plan (RPP) contributions, RRSP contributions, union/professional dues, child care expenses, support payments, carrying charges, moving expenses*, and employment expenses ● Non-refundable tax credit vs. tax deduction: ○ A non-refundable tax credit reduces the amount of tax owing while a tax deduction reduces the amount of income that is subject to income tax

5. Show how tax credits can be used to lower tax payable ● Non-refundable tax credits: Help reduce the amount of federal taxes you owe ○ Based on your personal and family situation ○ If non-refundable tax credits are higher than the amount of tax you owe, the amount will simply reduce the tax to zero (you will not receive a refund) and you cannot carry them forward ○ Amount is multiplied by the lowest marginal federal tax bracket (15 percent in 2017) ○ Examples of non-refundable tax...