Personal Finance, Seventh Edition
By Jeff Madura
Contents:
Preface………………………………………………………………………………. xxvii
Financial Literacy Pre-Test………………………………………………….. xli
Chapter 1 Overview of a Financial Plan………………………………………… 1
How Personal Finance Can Enhance Your Wealth…………………………………….. 2
How Personal Finance Can Enhance Your Job Marketability…………………. 6
Components of a Financial Plan…………………………………………………………………… 6
A Plan for Your Budgeting and Tax Planning………………………………………………………….. 7
A Plan to Manage Your Liquidity……………………………………………………………………………. 8
A Plan for Financing Your Large Purchases…………………………………………………………….. 8
A Plan for Protecting Your Assets and Income………………………………………………………… 8
A Plan for Investing Your Money……………………………………………………………………………. 9
A Plan for Your Retirement and Estate…………………………………………………………………… 9
Building Your Own Financial Plan………………………………………………………………………….. 9
How Financial Planning Affects Your Cash Flows……………………………………..10
Part 1: Tools for Financial Planning………………………………………………………………………..10
Part 2: Managing Your Liquidity…………………………………………………………………………….10
Part 3: Personal Financing…………………………………………………………………………………….11
Part 4: Protecting Your Wealth……………………………………………………………………………….11
Part 5: Personal Investing……………………………………………………………………………………. 12
Part 6: Retirement and Estate Planning………………………………………………………………… 12
Summary of Financial Plan Components……………………………………………………………… 13
Integration of the Financial Plan Components………………………………………………………. 14
How Psychology Affects Your Financial Plan………………………………………………………… 15
Developing Your Financial Plan…………………………………………………………………… 16
Step 1: Establish Your Financial Goals…………………………………………………………………. 16
Step 2: Consider Your Current Financial Position………………………………………………….. 17
Step 3: Identify and Evaluate Alternative Plans That Could Achieve Your Goals……… 18
Step 4: Select and Implement the Best Plan for Achieving Your Goals…………………… 21
Step 5: Evaluate Your Financial Plan…………………………………………………………………….. 22
Step 6: Revise Your Financial Plan……………………………………………………………………….. 22
Summary………………………………………………………………………………………………………… 24
Review Questions……………………………………………………………………………………………….. 24
Financial Planning Problems……………………………………………………………………………….. 25
Financial Planning Online Exercises…………………………………………………………………….. 26
Psychology of Personal Finance: Your Spending Behavior……………………………………. 26
Web Search Exercise…………………………………………………………………………………………… 26
Video Exercise: Benefits of Financial Planning……………………………………………………… 27
Building Your Own Financial Plan ……………………………………………………………………….. 29
The Sampsons—A Continuing Case ……………………………………………………………………. 31
Financial Literacy Pre-Test………………………………………………….. xli
Chapter 1 Overview of a Financial Plan………………………………………… 1
How Personal Finance Can Enhance Your Wealth…………………………………….. 2
How Personal Finance Can Enhance Your Job Marketability…………………. 6
Components of a Financial Plan…………………………………………………………………… 6
A Plan for Your Budgeting and Tax Planning………………………………………………………….. 7
A Plan to Manage Your Liquidity……………………………………………………………………………. 8
A Plan for Financing Your Large Purchases…………………………………………………………….. 8
A Plan for Protecting Your Assets and Income………………………………………………………… 8
A Plan for Investing Your Money……………………………………………………………………………. 9
A Plan for Your Retirement and Estate…………………………………………………………………… 9
Building Your Own Financial Plan………………………………………………………………………….. 9
How Financial Planning Affects Your Cash Flows……………………………………..10
Part 1: Tools for Financial Planning………………………………………………………………………..10
Part 2: Managing Your Liquidity…………………………………………………………………………….10
Part 3: Personal Financing…………………………………………………………………………………….11
Part 4: Protecting Your Wealth……………………………………………………………………………….11
Part 5: Personal Investing……………………………………………………………………………………. 12
Part 6: Retirement and Estate Planning………………………………………………………………… 12
Summary of Financial Plan Components……………………………………………………………… 13
Integration of the Financial Plan Components………………………………………………………. 14
How Psychology Affects Your Financial Plan………………………………………………………… 15
Developing Your Financial Plan…………………………………………………………………… 16
Step 1: Establish Your Financial Goals…………………………………………………………………. 16
Step 2: Consider Your Current Financial Position………………………………………………….. 17
Step 3: Identify and Evaluate Alternative Plans That Could Achieve Your Goals……… 18
Step 4: Select and Implement the Best Plan for Achieving Your Goals…………………… 21
Step 5: Evaluate Your Financial Plan…………………………………………………………………….. 22
Step 6: Revise Your Financial Plan……………………………………………………………………….. 22
Summary………………………………………………………………………………………………………… 24
Review Questions……………………………………………………………………………………………….. 24
Financial Planning Problems……………………………………………………………………………….. 25
Financial Planning Online Exercises…………………………………………………………………….. 26
Psychology of Personal Finance: Your Spending Behavior……………………………………. 26
Web Search Exercise…………………………………………………………………………………………… 26
Video Exercise: Benefits of Financial Planning……………………………………………………… 27
Building Your Own Financial Plan ……………………………………………………………………….. 29
The Sampsons—A Continuing Case ……………………………………………………………………. 31
PART 1 TOOLS FOR FINANCIAL PLANNING
Chapter 2 Planning with Personal Financial Statements……………………. 34
Personal Cash Flow Statement………………………………………………………………….. 35
Cash Inflows……………………………………………………………………………………………………….. 35
Cash Outflows…………………………………………………………………………………………………….. 35
Creating a Personal Cash Flow Statement……………………………………………………………. 36
Factors Affecting Cash Flows………………………………………………………………………. 37
Factors Affecting Cash Inflows…………………………………………………………………………….. 37
Factors Affecting Cash Outflows………………………………………………………………………….. 38
Forecasting Your Cash Flows………………………………………………………………………. 39
Anticipating Cash Shortages……………………………………………………………………………….. 41
Assessing the Accuracy of the Budget…………………………………………………………………. 41
Forecasting Net Cash Flows over Several Months………………………………………………… 41
Creating an Annual Budget…………………………………………………………………………………. 43
Improving the Budget…………………………………………………………………………………………. 44
Personal Balance Sheet……………………………………………………………………………….. 45
Assets………………………………………………………………………………………………………………… 45
Liabilities……………………………………………………………………………………………………………. 46
Net Worth…………………………………………………………………………………………………………… 47
Creating a Personal Balance Sheet………………………………………………………………………. 47
Changes in the Personal Balance Sheet……………………………………………………………….. 48
How Cash Flows Affect the Personal Balance Sheet……………………………………………… 50
Impact of the Economy on the Personal Balance Sheet………………………………………… 50
Analysis of the Personal Balance Sheet……………………………………………………………….. 51
How Budgeting Influences Your Financial Plan……………………………………….. 52
Discussion Questions………………………………………………………………………………………….. 54
Summary………………………………………………………………………………………………………… 54
Review Questions……………………………………………………………………………………………….. 54
Financial Planning Problems……………………………………………………………………………….. 55
Financial Planning Online Exercises…………………………………………………………………….. 57
Psychology of Personal Finance: Your Cash Outflows…………………………………………… 57
Web Search Exercise…………………………………………………………………………………………… 57
Video Exercise: Budgeting…………………………………………………………………………………… 58
Building Your Own Financial Plan ……………………………………………………………………….. 59
The Sampsons—A Continuing Case ……………………………………………………………………. 62
Chapter 3 Applying Time Value Concepts……………………………………………………… 65
Importance of the Time Value of Money…………………………………………………… 66
Future Value of a Dollar Amount………………………………………………………………… 67
Using the Future Value Table……………………………………………………………………………….. 67
Impact of a Longer Period…………………………………………………………………………………… 68
Impact of a Higher Interest Rate…………………………………………………………………………… 68
Using a Financial Calculator to Compute Future Value………………………………………….. 69
The Power of Compounding…………………………………………………………………………………70
The Future Value of Debt………………………………………………………………………………………70
Twisted Logic About Long-Term Debt…………………………………………………………………… 71
Present Value of a Dollar Amount………………………………………………………………. 71
Using the Present Value Table……………………………………………………………………………… 71
Using a Financial Calculator to Compute Present Value………………………………………… 72
Future Value of an Annuity………………………………………………………………………….. 72
Using the Future Value Annuity Table…………………………………………………………………….74
Using a Financial Calculator to Compute FVA………………………………………………………..74
Present Value of an Annuity………………………………………………………………………… 75
Using the Present Value Annuity Table…………………………………………………………………..76
Using a Financial Calculator to Compute PVA………………………………………………………..76
Using Time Value to Estimate Savings……………………………………………………….76
Estimating the Future Value from Savings……………………………………………………………. 77
Estimating the Annual Savings That Will Achieve a Future Amount……………………….. 77
How Time Value Concepts Can Motivate Saving…………………………………………………… 78
How Time Value Fits Within Your Financial Plan………………………………………. 79
Discussion Questions………………………………………………………………………………………….. 79
Summary………………………………………………………………………………………………………… 79
Review Questions……………………………………………………………………………………………….. 79
Financial Planning Problems……………………………………………………………………………….. 80
Financial Planning Online Exercises…………………………………………………………………….. 82
Psychology of Personal Finance: Future Value of Your Cash………………………………….. 82
Web Search Exercise…………………………………………………………………………………………… 82
Video Exercise: How Your Savings Grow……………………………………………………………… 83
Building Your Own Financial Plan ……………………………………………………………………….. 85
The Sampsons—A Continuing Case ……………………………………………………………………. 88
Chapter 4 Using Tax Concepts for Planning…………………………………………………. 91
Background on the Tax System…………………………………………………………………… 92
Social Security and Medicare Taxes…………………………………………………………………….. 92
Personal Income Taxes………………………………………………………………………………………… 93
Calculating Your Taxable Income………………………………………………………………… 94
Gross Income……………………………………………………………………………………………………… 94
Adjusted Gross Income……………………………………………………………………………………….. 95
Standard Deduction……………………………………………………………………………………………. 95
Calculating Your Taxes if You Take the Standard Deduction…………………… 96
Single Filer Calculation of Personal Income Taxes………………………………………………… 96
Joint Filer Calculation of Personal Income Taxes………………………………………………….. 98
Summary of Determining Your Personal Income Taxes
with the Standard Deduction……………………………………………………………………………….. 99
Calculating Your Taxes if You Itemize Deductions……………………………………. 99
Interest Expenses on Mortgage Loans……………………………………………………………….. 100
State and Local Taxes………………………………………………………………………………………… 100
Medical Expenses……………………………………………………………………………………………… 100
Charitable Gifts…………………………………………………………………………………………………..101
Comparison of Itemized Deductions to the Standard Deduction……………………………101
Conditions That Can Provide Tax Benefits………………………………………………..101
Child Tax Credits…………………………………………………………………………………………………101
College Expense Tax Credits and Education Savings Plans…………………………………..102
Earned Income Credit………………………………………………………………………………………….103
Investments That Offer Tax Benefits…………………………………………………………………….103
How Tax Planning Fits Within Your Financial Plan…………………………………..104
Discussion Questions………………………………………………………………………………………….105
Summary………………………………………………………………………………………………………..106
Review Questions……………………………………………………………………………………………….106
Financial Planning Problems……………………………………………………………………………….107
Financial Planning Online Exercises…………………………………………………………………….108
Psychology of Personal Finance: Your Taxes………………………………………………………..108
Web Search Exercise…………………………………………………………………………………………..109
Video Exercise: Tax Saving Tips…………………………………………………………………………..109
Building Your Own Financial Plan ………………………………………………………………………. 111
The Sampsons—A Continuing Case ……………………………………………………………………113
Brad Brooks—A Continuing Case ………………………………………………………………………. 114
Chapter 2 Planning with Personal Financial Statements……………………. 34
Personal Cash Flow Statement………………………………………………………………….. 35
Cash Inflows……………………………………………………………………………………………………….. 35
Cash Outflows…………………………………………………………………………………………………….. 35
Creating a Personal Cash Flow Statement……………………………………………………………. 36
Factors Affecting Cash Flows………………………………………………………………………. 37
Factors Affecting Cash Inflows…………………………………………………………………………….. 37
Factors Affecting Cash Outflows………………………………………………………………………….. 38
Forecasting Your Cash Flows………………………………………………………………………. 39
Anticipating Cash Shortages……………………………………………………………………………….. 41
Assessing the Accuracy of the Budget…………………………………………………………………. 41
Forecasting Net Cash Flows over Several Months………………………………………………… 41
Creating an Annual Budget…………………………………………………………………………………. 43
Improving the Budget…………………………………………………………………………………………. 44
Personal Balance Sheet……………………………………………………………………………….. 45
Assets………………………………………………………………………………………………………………… 45
Liabilities……………………………………………………………………………………………………………. 46
Net Worth…………………………………………………………………………………………………………… 47
Creating a Personal Balance Sheet………………………………………………………………………. 47
Changes in the Personal Balance Sheet……………………………………………………………….. 48
How Cash Flows Affect the Personal Balance Sheet……………………………………………… 50
Impact of the Economy on the Personal Balance Sheet………………………………………… 50
Analysis of the Personal Balance Sheet……………………………………………………………….. 51
How Budgeting Influences Your Financial Plan……………………………………….. 52
Discussion Questions………………………………………………………………………………………….. 54
Summary………………………………………………………………………………………………………… 54
Review Questions……………………………………………………………………………………………….. 54
Financial Planning Problems……………………………………………………………………………….. 55
Financial Planning Online Exercises…………………………………………………………………….. 57
Psychology of Personal Finance: Your Cash Outflows…………………………………………… 57
Web Search Exercise…………………………………………………………………………………………… 57
Video Exercise: Budgeting…………………………………………………………………………………… 58
Building Your Own Financial Plan ……………………………………………………………………….. 59
The Sampsons—A Continuing Case ……………………………………………………………………. 62
Chapter 3 Applying Time Value Concepts……………………………………………………… 65
Importance of the Time Value of Money…………………………………………………… 66
Future Value of a Dollar Amount………………………………………………………………… 67
Using the Future Value Table……………………………………………………………………………….. 67
Impact of a Longer Period…………………………………………………………………………………… 68
Impact of a Higher Interest Rate…………………………………………………………………………… 68
Using a Financial Calculator to Compute Future Value………………………………………….. 69
The Power of Compounding…………………………………………………………………………………70
The Future Value of Debt………………………………………………………………………………………70
Twisted Logic About Long-Term Debt…………………………………………………………………… 71
Present Value of a Dollar Amount………………………………………………………………. 71
Using the Present Value Table……………………………………………………………………………… 71
Using a Financial Calculator to Compute Present Value………………………………………… 72
Future Value of an Annuity………………………………………………………………………….. 72
Using the Future Value Annuity Table…………………………………………………………………….74
Using a Financial Calculator to Compute FVA………………………………………………………..74
Present Value of an Annuity………………………………………………………………………… 75
Using the Present Value Annuity Table…………………………………………………………………..76
Using a Financial Calculator to Compute PVA………………………………………………………..76
Using Time Value to Estimate Savings……………………………………………………….76
Estimating the Future Value from Savings……………………………………………………………. 77
Estimating the Annual Savings That Will Achieve a Future Amount……………………….. 77
How Time Value Concepts Can Motivate Saving…………………………………………………… 78
How Time Value Fits Within Your Financial Plan………………………………………. 79
Discussion Questions………………………………………………………………………………………….. 79
Summary………………………………………………………………………………………………………… 79
Review Questions……………………………………………………………………………………………….. 79
Financial Planning Problems……………………………………………………………………………….. 80
Financial Planning Online Exercises…………………………………………………………………….. 82
Psychology of Personal Finance: Future Value of Your Cash………………………………….. 82
Web Search Exercise…………………………………………………………………………………………… 82
Video Exercise: How Your Savings Grow……………………………………………………………… 83
Building Your Own Financial Plan ……………………………………………………………………….. 85
The Sampsons—A Continuing Case ……………………………………………………………………. 88
Chapter 4 Using Tax Concepts for Planning…………………………………………………. 91
Background on the Tax System…………………………………………………………………… 92
Social Security and Medicare Taxes…………………………………………………………………….. 92
Personal Income Taxes………………………………………………………………………………………… 93
Calculating Your Taxable Income………………………………………………………………… 94
Gross Income……………………………………………………………………………………………………… 94
Adjusted Gross Income……………………………………………………………………………………….. 95
Standard Deduction……………………………………………………………………………………………. 95
Calculating Your Taxes if You Take the Standard Deduction…………………… 96
Single Filer Calculation of Personal Income Taxes………………………………………………… 96
Joint Filer Calculation of Personal Income Taxes………………………………………………….. 98
Summary of Determining Your Personal Income Taxes
with the Standard Deduction……………………………………………………………………………….. 99
Calculating Your Taxes if You Itemize Deductions……………………………………. 99
Interest Expenses on Mortgage Loans……………………………………………………………….. 100
State and Local Taxes………………………………………………………………………………………… 100
Medical Expenses……………………………………………………………………………………………… 100
Charitable Gifts…………………………………………………………………………………………………..101
Comparison of Itemized Deductions to the Standard Deduction……………………………101
Conditions That Can Provide Tax Benefits………………………………………………..101
Child Tax Credits…………………………………………………………………………………………………101
College Expense Tax Credits and Education Savings Plans…………………………………..102
Earned Income Credit………………………………………………………………………………………….103
Investments That Offer Tax Benefits…………………………………………………………………….103
How Tax Planning Fits Within Your Financial Plan…………………………………..104
Discussion Questions………………………………………………………………………………………….105
Summary………………………………………………………………………………………………………..106
Review Questions……………………………………………………………………………………………….106
Financial Planning Problems……………………………………………………………………………….107
Financial Planning Online Exercises…………………………………………………………………….108
Psychology of Personal Finance: Your Taxes………………………………………………………..108
Web Search Exercise…………………………………………………………………………………………..109
Video Exercise: Tax Saving Tips…………………………………………………………………………..109
Building Your Own Financial Plan ………………………………………………………………………. 111
The Sampsons—A Continuing Case ……………………………………………………………………113
Brad Brooks—A Continuing Case ………………………………………………………………………. 114
PART 2 MANAGING YOUR LIQUIDITY
Chapter 5 Banking and Interest Rates…………………………………………………………… 120
Types of Financial Institutions………………………………………………………………….. 121
Depository Institutions………………………………………………………………………………………. 121
Nondepository Institutions………………………………………………………………………………… 122
Financial Conglomerates…………………………………………………………………………………… 123
Banking Services Offered…………………………………………………………………………… 123
Checking Services……………………………………………………………………………………………… 123
Check Float……………………………………………………………………………………………………….. 126
Savings Accounts……………………………………………………………………………………………… 128
Credit Card Financing………………………………………………………………………………………… 128
Safety Deposit Boxes………………………………………………………………………………………… 128
Automated Teller Machines (ATMs)……………………………………………………………………. 128
Cashier’s Checks……………………………………………………………………………………………….. 129
Money Orders…………………………………………………………………………………………………… 129
Traveler’s Checks………………………………………………………………………………………………. 129
Selecting a Financial Institution……………………………………………………………….. 129
Criteria Used to Select a Financial Institution……………………………………………………… 129
Interest Rates on Deposits and Loans…………………………………………………….. 131
Risk-Free Rate…………………………………………………………………………………………………… 131
Risk Premium……………………………………………………………………………………………………. 131
Comparing Interest Rates and Risk…………………………………………………………………….. 132
Term Structure of Interest Rates………………………………………………………………………… 133
Loan Rates………………………………………………………………………………………………………… 133
Why Interest Rates Change……………………………………………………………………….. 135
Shift in Monetary Policy…………………………………………………………………………………….. 135
Shift in the Government Demand for Funds……………………………………………………….. 135
Shift in the Business Demand for Funds…………………………………………………………….. 136
How Banking Services Fit Within Your Financial Plan………………………….. 136
Discussion Questions………………………………………………………………………………………… 137
Summary………………………………………………………………………………………………………. 138
Review Questions……………………………………………………………………………………………… 138
Financial Planning Problems……………………………………………………………………………… 139
Financial Planning Online Exercises…………………………………………………………………… 140
Psychology of Personal Finance: Paying Your Bills……………………………………………… 141
Web Search Exercise…………………………………………………………………………………………. 141
Video Exercise: Banking Tips……………………………………………………………………………… 141
Building Your Own Financial Plan ……………………………………………………………………… 143
The Sampsons—A Continuing Case ………………………………………………………………….. 144
Chapter 6 Managing Your Money……………………………………………………………………… 145
Background on Money Management………………………………………………………. 146
Liquidity…………………………………………………………………………………………………………… 146
Adequate Return……………………………………………………………………………………………….. 147
Money Market Investments………………………………………………………………………. 147
Checking Account……………………………………………………………………………………………… 147
NOW Account…………………………………………………………………………………………………… 149
Savings Deposit………………………………………………………………………………………………… 149
Certificate of Deposit…………………………………………………………………………………………. 149
Money Market Deposit Account (MMDA)……………………………………………………………. 150
Treasury Bills……………………………………………………………………………………………………. 151
Money Market Funds (MMFs)……………………………………………………………………………. 152
Asset Management Account………………………………………………………………………………. 152
Comparison of Money Market Investments………………………………………………………… 153
Risk of Money Market Investments…………………………………………………………. 154
Credit Risk………………………………………………………………………………………………………… 154
Interest Rate Risk………………………………………………………………………………………………. 154
Liquidity Risk……………………………………………………………………………………………………. 154
Risk Management……………………………………………………………………………………….. 155
Risk Assessment of Money Market Investments…………………………………………………. 155
Optimal Allocation of Money Market Investments………………………………………………. 156
How Money Management Fits Within Your Financial Plan………………….. 158
Discussion Questions………………………………………………………………………………………… 159
Summary………………………………………………………………………………………………………. 159
Review Questions……………………………………………………………………………………………… 159
Financial Planning Problems……………………………………………………………………………… 160
Financial Planning Online Exercises…………………………………………………………………… 161
Psychology of Personal Finance: Forced Savings……………………………………………….. 162
Web Search Exercise…………………………………………………………………………………………. 162
Video Exercise: Investing In Money Markets………………………………………………………. 162
Building Your Own Financial Plan ……………………………………………………………………… 163
The Sampsons—A Continuing Case ………………………………………………………………….. 164
Chapter 7 Assessing and Securing Your Credit………………………………………… 165
Background on Credit…………………………………………………………………………………. 166
Types of Credit………………………………………………………………………………………………….. 166
Advantages of Using Credit……………………………………………………………………………….. 166
Disadvantages of Using Credit…………………………………………………………………………… 167
Credit Rights…………………………………………………………………………………………………….. 168
Credit History……………………………………………………………………………………………………. 169
Credit Insurance………………………………………………………………………………………………… 169
Credit Bureaus……………………………………………………………………………………………… 169
Credit Reports Provided by Credit Bureaus…………………………………………………………..170
Correcting Credit Report Mistakes……………………………………………………………………….170
Credit Score……………………………………………………………………………………………………… 171
Different Credit Scores………………………………………………………………………………………. 173
Checking Credit Scores……………………………………………………………………………………….174
Interpreting Credit Scores………………………………………………………………………………….. 175
Improving Your Credit Score……………………………………………………………………………… 175
Identity Theft: A Threat to Your Credit………………………………………………………..176
The Cost of Identity Theft…………………………………………………………………………………… 177
Identity Theft Tactics………………………………………………………………………………………….. 177
Protecting Against Identity Theft……………………………………………………………… 179
Shielding Personal Information at Home……………………………………………………………. 179
Protecting Personal Information at Work……………………………………………………………. 181
Identity Theft Insurance…………………………………………………………………………………….. 181
Response to Identity Theft…………………………………………………………………………. 182
Contact the Police……………………………………………………………………………………………… 182
Contact the FTC………………………………………………………………………………………………… 182
Contact Credit Reporting Companies…………………………………………………………………. 182
Contact Creditors………………………………………………………………………………………………. 183
Contact Others………………………………………………………………………………………………….. 183
How Credit Assessment and Security Fit Within Your Financial Plan.. 184
Discussion Questions………………………………………………………………………………………… 185
Summary………………………………………………………………………………………………………. 185
Review Questions……………………………………………………………………………………………… 186
Financial Planning Problems……………………………………………………………………………… 187
Financial Planning Online Exercises…………………………………………………………………… 187
Psychology Of Personal Finance: Paying Off Credit Card Debt…………………………….. 187
Web Search Exercise…………………………………………………………………………………………. 188
Video Exercise: Improving Your Credit……………………………………………………………….. 188
Building Your Own Financial Plan ……………………………………………………………………… 189
The Sampsons—A Continuing Case ……………………………………………………………………190
Chapter 8 Managing Your Credit…………………………………………………………………………191
Background on Credit Cards……………………………………………………………………….192
Advantages of Credit Cards…………………………………………………………………………………192
Disadvantages of Credit Cards…………………………………………………………………………….192
Applying for a Credit Card…………………………………………………………………………………..193
Types of Credit Cards………………………………………………………………………………………….194
Credit Limit………………………………………………………………………………………………………..197
Overlimit Protection……………………………………………………………………………………………197
Annual Fee…………………………………………………………………………………………………………197
Grace Period………………………………………………………………………………………………………197
Interest Rate……………………………………………………………………………………………………….198
Cash Advances…………………………………………………………………………………………………..198
Repaying Credit……………………………………………………………………………………………..199
Average Daily Balance Method……………………………………………………………………………199
Previous Balance Method……………………………………………………………………………………199
Adjusted Balance Method……………………………………………………………………………………199
Estimating Credit Repayment…………………………………………………………………………….. 200
Reviewing Your Credit Card Statement…………………………………………………… 202
Regulation of Credit Cards………………………………………………………………………… 204
Credit CARD Act………………………………………………………………………………………………… 204
Consumer Financial Protection Bureau………………………………………………………………. 205
Tips on Using Credit Cards………………………………………………………………………… 205
Use a Credit Card Only if You Can Cover the Bill…………………………………………………. 205
Impose a Tight Credit Limit……………………………………………………………………………….. 206
Reduce Credit Limit When the Economy Weakens………………………………………………. 206
Pay Credit Card Bills Before Investing Money…………………………………………………….. 207
Pay Off Credit Card Debt Before Other Debt……………………………………………………….. 208
Avoid Credit Repair Services……………………………………………………………………………… 208
Resolving an Excessive Credit Balance………………………………………………………………. 208
How Credit Management Fits Within Your Financial Plan……………………. 209
Plan for Managing Credit…………………………………………………………………………………….210
Analysis……………………………………………………………………………………………………………..210
Decision……………………………………………………………………………………………………………..211
Discussion Questions………………………………………………………………………………………….211
Summary………………………………………………………………………………………………………..211
Review Questions……………………………………………………………………………………………… 212
Financial Planning Problems……………………………………………………………………………… 213
Financial Planning Online Exercises…………………………………………………………………… 214
Psychology of Personal Finance: Using Your Credit Cards…………………………………… 215
Web Search Exercise…………………………………………………………………………………………. 215
Video Exercise: Tips on Using Credit Cards………………………………………………………… 215
Building Your Own Financial Plan………………………………………………………………………. 217
The Sampsons—A Continuing Case ………………………………………………………………….. 218
Brad Brooks—A Continuing Case ……………………………………………………………………….219
Chapter 5 Banking and Interest Rates…………………………………………………………… 120
Types of Financial Institutions………………………………………………………………….. 121
Depository Institutions………………………………………………………………………………………. 121
Nondepository Institutions………………………………………………………………………………… 122
Financial Conglomerates…………………………………………………………………………………… 123
Banking Services Offered…………………………………………………………………………… 123
Checking Services……………………………………………………………………………………………… 123
Check Float……………………………………………………………………………………………………….. 126
Savings Accounts……………………………………………………………………………………………… 128
Credit Card Financing………………………………………………………………………………………… 128
Safety Deposit Boxes………………………………………………………………………………………… 128
Automated Teller Machines (ATMs)……………………………………………………………………. 128
Cashier’s Checks……………………………………………………………………………………………….. 129
Money Orders…………………………………………………………………………………………………… 129
Traveler’s Checks………………………………………………………………………………………………. 129
Selecting a Financial Institution……………………………………………………………….. 129
Criteria Used to Select a Financial Institution……………………………………………………… 129
Interest Rates on Deposits and Loans…………………………………………………….. 131
Risk-Free Rate…………………………………………………………………………………………………… 131
Risk Premium……………………………………………………………………………………………………. 131
Comparing Interest Rates and Risk…………………………………………………………………….. 132
Term Structure of Interest Rates………………………………………………………………………… 133
Loan Rates………………………………………………………………………………………………………… 133
Why Interest Rates Change……………………………………………………………………….. 135
Shift in Monetary Policy…………………………………………………………………………………….. 135
Shift in the Government Demand for Funds……………………………………………………….. 135
Shift in the Business Demand for Funds…………………………………………………………….. 136
How Banking Services Fit Within Your Financial Plan………………………….. 136
Discussion Questions………………………………………………………………………………………… 137
Summary………………………………………………………………………………………………………. 138
Review Questions……………………………………………………………………………………………… 138
Financial Planning Problems……………………………………………………………………………… 139
Financial Planning Online Exercises…………………………………………………………………… 140
Psychology of Personal Finance: Paying Your Bills……………………………………………… 141
Web Search Exercise…………………………………………………………………………………………. 141
Video Exercise: Banking Tips……………………………………………………………………………… 141
Building Your Own Financial Plan ……………………………………………………………………… 143
The Sampsons—A Continuing Case ………………………………………………………………….. 144
Chapter 6 Managing Your Money……………………………………………………………………… 145
Background on Money Management………………………………………………………. 146
Liquidity…………………………………………………………………………………………………………… 146
Adequate Return……………………………………………………………………………………………….. 147
Money Market Investments………………………………………………………………………. 147
Checking Account……………………………………………………………………………………………… 147
NOW Account…………………………………………………………………………………………………… 149
Savings Deposit………………………………………………………………………………………………… 149
Certificate of Deposit…………………………………………………………………………………………. 149
Money Market Deposit Account (MMDA)……………………………………………………………. 150
Treasury Bills……………………………………………………………………………………………………. 151
Money Market Funds (MMFs)……………………………………………………………………………. 152
Asset Management Account………………………………………………………………………………. 152
Comparison of Money Market Investments………………………………………………………… 153
Risk of Money Market Investments…………………………………………………………. 154
Credit Risk………………………………………………………………………………………………………… 154
Interest Rate Risk………………………………………………………………………………………………. 154
Liquidity Risk……………………………………………………………………………………………………. 154
Risk Management……………………………………………………………………………………….. 155
Risk Assessment of Money Market Investments…………………………………………………. 155
Optimal Allocation of Money Market Investments………………………………………………. 156
How Money Management Fits Within Your Financial Plan………………….. 158
Discussion Questions………………………………………………………………………………………… 159
Summary………………………………………………………………………………………………………. 159
Review Questions……………………………………………………………………………………………… 159
Financial Planning Problems……………………………………………………………………………… 160
Financial Planning Online Exercises…………………………………………………………………… 161
Psychology of Personal Finance: Forced Savings……………………………………………….. 162
Web Search Exercise…………………………………………………………………………………………. 162
Video Exercise: Investing In Money Markets………………………………………………………. 162
Building Your Own Financial Plan ……………………………………………………………………… 163
The Sampsons—A Continuing Case ………………………………………………………………….. 164
Chapter 7 Assessing and Securing Your Credit………………………………………… 165
Background on Credit…………………………………………………………………………………. 166
Types of Credit………………………………………………………………………………………………….. 166
Advantages of Using Credit……………………………………………………………………………….. 166
Disadvantages of Using Credit…………………………………………………………………………… 167
Credit Rights…………………………………………………………………………………………………….. 168
Credit History……………………………………………………………………………………………………. 169
Credit Insurance………………………………………………………………………………………………… 169
Credit Bureaus……………………………………………………………………………………………… 169
Credit Reports Provided by Credit Bureaus…………………………………………………………..170
Correcting Credit Report Mistakes……………………………………………………………………….170
Credit Score……………………………………………………………………………………………………… 171
Different Credit Scores………………………………………………………………………………………. 173
Checking Credit Scores……………………………………………………………………………………….174
Interpreting Credit Scores………………………………………………………………………………….. 175
Improving Your Credit Score……………………………………………………………………………… 175
Identity Theft: A Threat to Your Credit………………………………………………………..176
The Cost of Identity Theft…………………………………………………………………………………… 177
Identity Theft Tactics………………………………………………………………………………………….. 177
Protecting Against Identity Theft……………………………………………………………… 179
Shielding Personal Information at Home……………………………………………………………. 179
Protecting Personal Information at Work……………………………………………………………. 181
Identity Theft Insurance…………………………………………………………………………………….. 181
Response to Identity Theft…………………………………………………………………………. 182
Contact the Police……………………………………………………………………………………………… 182
Contact the FTC………………………………………………………………………………………………… 182
Contact Credit Reporting Companies…………………………………………………………………. 182
Contact Creditors………………………………………………………………………………………………. 183
Contact Others………………………………………………………………………………………………….. 183
How Credit Assessment and Security Fit Within Your Financial Plan.. 184
Discussion Questions………………………………………………………………………………………… 185
Summary………………………………………………………………………………………………………. 185
Review Questions……………………………………………………………………………………………… 186
Financial Planning Problems……………………………………………………………………………… 187
Financial Planning Online Exercises…………………………………………………………………… 187
Psychology Of Personal Finance: Paying Off Credit Card Debt…………………………….. 187
Web Search Exercise…………………………………………………………………………………………. 188
Video Exercise: Improving Your Credit……………………………………………………………….. 188
Building Your Own Financial Plan ……………………………………………………………………… 189
The Sampsons—A Continuing Case ……………………………………………………………………190
Chapter 8 Managing Your Credit…………………………………………………………………………191
Background on Credit Cards……………………………………………………………………….192
Advantages of Credit Cards…………………………………………………………………………………192
Disadvantages of Credit Cards…………………………………………………………………………….192
Applying for a Credit Card…………………………………………………………………………………..193
Types of Credit Cards………………………………………………………………………………………….194
Credit Limit………………………………………………………………………………………………………..197
Overlimit Protection……………………………………………………………………………………………197
Annual Fee…………………………………………………………………………………………………………197
Grace Period………………………………………………………………………………………………………197
Interest Rate……………………………………………………………………………………………………….198
Cash Advances…………………………………………………………………………………………………..198
Repaying Credit……………………………………………………………………………………………..199
Average Daily Balance Method……………………………………………………………………………199
Previous Balance Method……………………………………………………………………………………199
Adjusted Balance Method……………………………………………………………………………………199
Estimating Credit Repayment…………………………………………………………………………….. 200
Reviewing Your Credit Card Statement…………………………………………………… 202
Regulation of Credit Cards………………………………………………………………………… 204
Credit CARD Act………………………………………………………………………………………………… 204
Consumer Financial Protection Bureau………………………………………………………………. 205
Tips on Using Credit Cards………………………………………………………………………… 205
Use a Credit Card Only if You Can Cover the Bill…………………………………………………. 205
Impose a Tight Credit Limit……………………………………………………………………………….. 206
Reduce Credit Limit When the Economy Weakens………………………………………………. 206
Pay Credit Card Bills Before Investing Money…………………………………………………….. 207
Pay Off Credit Card Debt Before Other Debt……………………………………………………….. 208
Avoid Credit Repair Services……………………………………………………………………………… 208
Resolving an Excessive Credit Balance………………………………………………………………. 208
How Credit Management Fits Within Your Financial Plan……………………. 209
Plan for Managing Credit…………………………………………………………………………………….210
Analysis……………………………………………………………………………………………………………..210
Decision……………………………………………………………………………………………………………..211
Discussion Questions………………………………………………………………………………………….211
Summary………………………………………………………………………………………………………..211
Review Questions……………………………………………………………………………………………… 212
Financial Planning Problems……………………………………………………………………………… 213
Financial Planning Online Exercises…………………………………………………………………… 214
Psychology of Personal Finance: Using Your Credit Cards…………………………………… 215
Web Search Exercise…………………………………………………………………………………………. 215
Video Exercise: Tips on Using Credit Cards………………………………………………………… 215
Building Your Own Financial Plan………………………………………………………………………. 217
The Sampsons—A Continuing Case ………………………………………………………………….. 218
Brad Brooks—A Continuing Case ……………………………………………………………………….219
PART 3 PERSONAL FINANCING
Chapter 9 Personal Loans………………………………………………………………………………………. 222
Background on Personal Loans………………………………………………………………… 223
Sources of Personal Loans………………………………………………………………………………… 223
Determining Whether a Loan Is Sensible……………………………………………………………. 224
The Personal Loan Process………………………………………………………………………………… 225
Interest Rates on Personal Loans…………………………………………………………….. 227
Annual Percentage Rate…………………………………………………………………………………….. 228
Simple Interest………………………………………………………………………………………………….. 228
Add-On Interest………………………………………………………………………………………………… 230
Car Loans………………………………………………………………………………………………………. 230
How Much Money to Spend on a Car…………………………………………………………………. 231
Selecting the Car………………………………………………………………………………………………. 233
Negotiating the Price…………………………………………………………………………………………. 235
Financing Decisions………………………………………………………………………………………….. 237
Purchase Versus Lease Decision……………………………………………………………….. 238
Student Loans……………………………………………………………………………………………… 239
Types of Student Loans…………………………………………………………………………………….. 239
Repaying Student Loans……………………………………………………………………………………. 241
Home Equity Loans…………………………………………………………………………………….. 241
Credit Limit on a Home Equity Loan…………………………………………………………………… 242
Interest Rate……………………………………………………………………………………………………… 243
Payday Loans……………………………………………………………………………………………….. 243
Reasons to Avoid Payday Loans…………………………………………………………………………. 244
Alternatives to Payday Loans…………………………………………………………………………….. 244
How Personal Loans Fit Within Your Financial Plan………………………………. 245
Discussion Questions………………………………………………………………………………………… 246
Summary………………………………………………………………………………………………………. 246
Review Questions……………………………………………………………………………………………… 246
Financial Planning Problems……………………………………………………………………………… 247
Financial Planning Online Exercises…………………………………………………………………… 249
Psychology of Personal Finance: Your Car Loan………………………………………………….. 249
Web Search Exercise…………………………………………………………………………………………. 249
Video Exercise: Researching Payday Lenders……………………………………………………… 249
Building Your Own Financial Plan ……………………………………………………………………… 251
The Sampsons—A Continuing Case ………………………………………………………………….. 253
Chapter 10 Purchasing and Financing a Home…………………………………………… 255
How Much Can You Afford?……………………………………………………………………….. 256
Affordable Down Payment…………………………………………………………………………………. 257
Affordable Monthly Mortgage Payments……………………………………………………………. 257
Selecting a Home………………………………………………………………………………………… 258
Relying on a Real Estate Agent………………………………………………………………………….. 258
Using Online Realtor Services……………………………………………………………………………. 258
Criteria Used to Select a Home………………………………………………………………………….. 259
Valuation of a Home…………………………………………………………………………………… 260
Market Analysis………………………………………………………………………………………………… 260
Economic Impact on Home Values…………………………………………………………………….. 261
Impact of the Financial Crisis on Home Values……………………………………………………. 262
Effects of Business Activity and Zoning Laws……………………………………………………… 263
Obtaining a Second Opinion on Your Valuation………………………………………………….. 264
Negotiating a Price……………………………………………………………………………………………. 264
Transaction Costs of Purchasing a Home……………………………………………….. 264
Prequalification and Preapproval for a Mortgage………………………………………………… 265
Down Payment…………………………………………………………………………………………………. 265
Closing Costs……………………………………………………………………………………………………. 266
Financing with Fixed-Rate Mortgages…………………………………………………….. 268
Amortization Table…………………………………………………………………………………………….. 268
Impact of the Mortgage Amount on the Monthly Payment……………………………………270
Impact of the Interest Rate on the Monthly Payment…………………………………………… 271
Impact of the Mortgage Maturity on the Monthly Payment…………………………………. 271
Estimating the Monthly Mortgage Payment……………………………………………………….. 271
Financing with Adjustable-Rate Mortgages…………………………………………… 273
Initial Rate………………………………………………………………………………………………………….274
Interest Rate Index………………………………………………………………………………………………274
Frequency of Rate Adjustments…………………………………………………………………………..274
Caps on Adjustable-Rate Mortgages…………………………………………………………………… 275
Financing with a Fixed- Versus an Adjustable-Rate Mortgage……………………………… 275
Decision to Own a Home Versus Renting……………………………………………….. 275
Estimating the Total Cost of Renting and Owning……………………………………………….. 275
Special Types of Mortgages……………………………………………………………………….. 279
Graduated Payment Mortgage…………………………………………………………………………… 279
Balloon Payment Mortgage……………………………………………………………………………….. 279
Interest-Only Mortgage……………………………………………………………………………………… 279
Mortgage Refinancing………………………………………………………………………………… 279
Rate Modification……………………………………………………………………………………………… 280
Refinancing Analysis…………………………………………………………………………………………. 280
How a Mortgage Fits Within Your Financial Plan…………………………………… 280
Discussion Questions………………………………………………………………………………………… 281
Summary………………………………………………………………………………………………………. 282
Review Questions……………………………………………………………………………………………… 282
Financial Planning Problems……………………………………………………………………………… 283
Financial Planning Online Exercises…………………………………………………………………… 285
Psychology of Personal Finance: Buying Your Home…………………………………………… 285
Web Search Exercise…………………………………………………………………………………………. 286
Video Exercise: Purchasing a Home…………………………………………………………………… 286
Building Your Own Financial Plan ……………………………………………………………………… 287
The Sampsons—A Continuing Case ………………………………………………………………….. 289
Brad Brooks—A Continuing Case ……………………………………………………………………… 290
Chapter 9 Personal Loans………………………………………………………………………………………. 222
Background on Personal Loans………………………………………………………………… 223
Sources of Personal Loans………………………………………………………………………………… 223
Determining Whether a Loan Is Sensible……………………………………………………………. 224
The Personal Loan Process………………………………………………………………………………… 225
Interest Rates on Personal Loans…………………………………………………………….. 227
Annual Percentage Rate…………………………………………………………………………………….. 228
Simple Interest………………………………………………………………………………………………….. 228
Add-On Interest………………………………………………………………………………………………… 230
Car Loans………………………………………………………………………………………………………. 230
How Much Money to Spend on a Car…………………………………………………………………. 231
Selecting the Car………………………………………………………………………………………………. 233
Negotiating the Price…………………………………………………………………………………………. 235
Financing Decisions………………………………………………………………………………………….. 237
Purchase Versus Lease Decision……………………………………………………………….. 238
Student Loans……………………………………………………………………………………………… 239
Types of Student Loans…………………………………………………………………………………….. 239
Repaying Student Loans……………………………………………………………………………………. 241
Home Equity Loans…………………………………………………………………………………….. 241
Credit Limit on a Home Equity Loan…………………………………………………………………… 242
Interest Rate……………………………………………………………………………………………………… 243
Payday Loans……………………………………………………………………………………………….. 243
Reasons to Avoid Payday Loans…………………………………………………………………………. 244
Alternatives to Payday Loans…………………………………………………………………………….. 244
How Personal Loans Fit Within Your Financial Plan………………………………. 245
Discussion Questions………………………………………………………………………………………… 246
Summary………………………………………………………………………………………………………. 246
Review Questions……………………………………………………………………………………………… 246
Financial Planning Problems……………………………………………………………………………… 247
Financial Planning Online Exercises…………………………………………………………………… 249
Psychology of Personal Finance: Your Car Loan………………………………………………….. 249
Web Search Exercise…………………………………………………………………………………………. 249
Video Exercise: Researching Payday Lenders……………………………………………………… 249
Building Your Own Financial Plan ……………………………………………………………………… 251
The Sampsons—A Continuing Case ………………………………………………………………….. 253
Chapter 10 Purchasing and Financing a Home…………………………………………… 255
How Much Can You Afford?……………………………………………………………………….. 256
Affordable Down Payment…………………………………………………………………………………. 257
Affordable Monthly Mortgage Payments……………………………………………………………. 257
Selecting a Home………………………………………………………………………………………… 258
Relying on a Real Estate Agent………………………………………………………………………….. 258
Using Online Realtor Services……………………………………………………………………………. 258
Criteria Used to Select a Home………………………………………………………………………….. 259
Valuation of a Home…………………………………………………………………………………… 260
Market Analysis………………………………………………………………………………………………… 260
Economic Impact on Home Values…………………………………………………………………….. 261
Impact of the Financial Crisis on Home Values……………………………………………………. 262
Effects of Business Activity and Zoning Laws……………………………………………………… 263
Obtaining a Second Opinion on Your Valuation………………………………………………….. 264
Negotiating a Price……………………………………………………………………………………………. 264
Transaction Costs of Purchasing a Home……………………………………………….. 264
Prequalification and Preapproval for a Mortgage………………………………………………… 265
Down Payment…………………………………………………………………………………………………. 265
Closing Costs……………………………………………………………………………………………………. 266
Financing with Fixed-Rate Mortgages…………………………………………………….. 268
Amortization Table…………………………………………………………………………………………….. 268
Impact of the Mortgage Amount on the Monthly Payment……………………………………270
Impact of the Interest Rate on the Monthly Payment…………………………………………… 271
Impact of the Mortgage Maturity on the Monthly Payment…………………………………. 271
Estimating the Monthly Mortgage Payment……………………………………………………….. 271
Financing with Adjustable-Rate Mortgages…………………………………………… 273
Initial Rate………………………………………………………………………………………………………….274
Interest Rate Index………………………………………………………………………………………………274
Frequency of Rate Adjustments…………………………………………………………………………..274
Caps on Adjustable-Rate Mortgages…………………………………………………………………… 275
Financing with a Fixed- Versus an Adjustable-Rate Mortgage……………………………… 275
Decision to Own a Home Versus Renting……………………………………………….. 275
Estimating the Total Cost of Renting and Owning……………………………………………….. 275
Special Types of Mortgages……………………………………………………………………….. 279
Graduated Payment Mortgage…………………………………………………………………………… 279
Balloon Payment Mortgage……………………………………………………………………………….. 279
Interest-Only Mortgage……………………………………………………………………………………… 279
Mortgage Refinancing………………………………………………………………………………… 279
Rate Modification……………………………………………………………………………………………… 280
Refinancing Analysis…………………………………………………………………………………………. 280
How a Mortgage Fits Within Your Financial Plan…………………………………… 280
Discussion Questions………………………………………………………………………………………… 281
Summary………………………………………………………………………………………………………. 282
Review Questions……………………………………………………………………………………………… 282
Financial Planning Problems……………………………………………………………………………… 283
Financial Planning Online Exercises…………………………………………………………………… 285
Psychology of Personal Finance: Buying Your Home…………………………………………… 285
Web Search Exercise…………………………………………………………………………………………. 286
Video Exercise: Purchasing a Home…………………………………………………………………… 286
Building Your Own Financial Plan ……………………………………………………………………… 287
The Sampsons—A Continuing Case ………………………………………………………………….. 289
Brad Brooks—A Continuing Case ……………………………………………………………………… 290
PART 4 PROTECTING YOUR WEALTH
Chapter 11 Auto and Homeowner’s Insurance……………………………………………. 292
Insurance and the Management of Risk…………………………………………………. 293
Avoid Risk………………………………………………………………………………………………………… 293
Reduce Risk………………………………………………………………………………………………………. 294
Accept Risk……………………………………………………………………………………………………….. 294
Insure Against Risk……………………………………………………………………………………………. 294
Economic Impact on the Decision to Insure Against Risk…………………………………….. 295
Role of Insurance Companies……………………………………………………………………. 295
Insurance Company Operations…………………………………………………………………………. 295
Auto Insurance…………………………………………………………………………………………….. 297
Auto Insurance Policy Provisions……………………………………………………………………….. 298
Coverage A: Liability Coverage………………………………………………………………………….. 299
Coverage B: Medical Payments Coverage…………………………………………………………… 300
Coverage C: Uninsured or Underinsured Motorist Coverage………………………………..301
Coverage D: Collision and Comprehensive Coverage…………………………………………..301
Other Provisions……………………………………………………………………………………………….. 302
Summary of Auto Insurance Provisions……………………………………………………………… 302
Auto Insurance Premiums………………………………………………………………………….. 303
Characteristics of Your Car………………………………………………………………………………… 303
Your Personal Characteristics…………………………………………………………………………….. 304
Your Insurance Company…………………………………………………………………………………… 305
If You Are in an Auto Accident……………………………………………………………………. 306
Homeowner’s Insurance Provisions………………………………………………………… 307
Property Damage………………………………………………………………………………………………. 307
Other Structures on Property…………………………………………………………………………….. 308
Personal Property……………………………………………………………………………………………… 309
Liability…………………………………………………………………………………………………………….. 309
Other Types of Provisions………………………………………………………………………………….. 309
Homeowner’s Insurance Premiums…………………………………………………………..310
Factors That Affect Homeowner’s Insurance Premiums………………………………………..310
Reducing Your Homeowner’s Insurance Premium………………………………………………..311
Filing a Claim……………………………………………………………………………………………………..311
Renter’s Insurance……………………………………………………………………………………….. 312
Renter’s Insurance Policy Provisions………………………………………………………………….. 312
Umbrella Personal Liability Policy……………………………………………………………. 312
How Insurance Fits Within Your Financial Plan………………………………………. 312
Discussion Questions………………………………………………………………………………………… 313
Summary………………………………………………………………………………………………………. 313
Review Questions……………………………………………………………………………………………… 314
Financial Planning Online Exercises…………………………………………………………………… 315
Psychology of Personal Finance: Your Auto Insurance………………………………………… 316
Web Search Exercise…………………………………………………………………………………………. 316
Video Exercise: Selecting Auto Insurance…………………………………………………………… 316
Building Your Own Financial Plan ……………………………………………………………………… 317
The Sampsons—A Continuing Case ……………………………………………………………………319
Chapter 12 Health and Disability Insurance………………………………………………….. 321
Background on Health Insurance……………………………………………………………… 322
Cost of Health Insurance……………………………………………………………………………………. 322
Private Health Insurance…………………………………………………………………………….. 323
Types of Private Health Insurance Coverage……………………………………………………….. 323
Premiums for Private Health Care Insurance………………………………………………………. 325
Comparison of Private Health Insurance Plans……………………………………………………. 326
Contents of Health Care Plans………………………………………………………………….. 327
Identification of Insured Persons……………………………………………………………………….. 327
Location……………………………………………………………………………………………………………. 327
Cancellation and Renewability Options………………………………………………………………. 327
Other Coverage…………………………………………………………………………………………………. 328
Determinants of Unreimbursed Medical Expenses……………………………………………… 328
Expenses Not Covered by Private Insurance Plans……………………………………………… 329
Government Health Care Plans………………………………………………………………… 329
Medicare………………………………………………………………………………………………………….. 329
Medicaid…………………………………………………………………………………………………………… 330
Regulations in Health Care Insurance……………………………………………………… 330
Consolidated Omnibus Budget Reconciliation Act (COBRA)………………………………… 330
Health Insurance Portability and Accountability Act (HIPAA)……………………………….. 331
Affordable Care Act…………………………………………………………………………………………… 331
Long-Term Care Insurance…………………………………………………………………………. 333
Long-Term Care Insurance Provisions………………………………………………………………… 333
Factors That Affect Long-Term Care Insurance Premiums……………………………………. 334
Reducing Your Cost of Long-Term Care Insurance………………………………………………. 334
Determining the Amount of Coverage………………………………………………………………… 335
Disability Insurance…………………………………………………………………………………….. 335
Sources of Disability Income Insurance……………………………………………………………… 335
Disability Insurance Provisions………………………………………………………………………….. 336
Deciding on Disability Insurance………………………………………………………………………… 336
How Health and Disability Insurance Fit Within Your Financial Plan…. 337
Discussion Questions………………………………………………………………………………………… 337
Summary………………………………………………………………………………………………………. 338
Review Questions……………………………………………………………………………………………… 339
Financial Planning Problems……………………………………………………………………………… 340
Financial Planning Online Exercises…………………………………………………………………… 340
Psychology of Personal Finance: Your Health Insurance……………………………………… 340
Web Search Exercise…………………………………………………………………………………………. 341
Video Exercise: Selecting Health Insurance………………………………………………………… 341
Building Your Own Financial Plan ……………………………………………………………………… 343
The Sampsons—A Continuing Case ………………………………………………………………….. 344
Chapter 13 Life Insurance…………………………………………………………………………………………. 345
Background on Life Insurance…………………………………………………………………… 346
Role of Life Insurance………………………………………………………………………………………… 346
Psychology Behind the Life Insurance Decision………………………………………………….. 346
Role of Life Insurance Companies……………………………………………………………………… 347
Applying for Life Insurance……………………………………………………………………………….. 347
Types of Life Insurance……………………………………………………………………………….. 347
Term Insurance…………………………………………………………………………………………………. 347
Whole Life Insurance…………………………………………………………………………………………. 351
Universal Life Insurance……………………………………………………………………………………. 352
Determining the Amount of Life Insurance…………………………………………….. 353
Income Method…………………………………………………………………………………………………. 353
Budget Method…………………………………………………………………………………………………. 353
Contents of a Life Insurance Policy………………………………………………………….. 357
Beneficiary……………………………………………………………………………………………………….. 357
Grace Period…………………………………………………………………………………………………….. 357
Living Benefits………………………………………………………………………………………………….. 357
Nonforfeiture Clause…………………………………………………………………………………………. 357
Loans……………………………………………………………………………………………………………….. 357
Incontestability Date………………………………………………………………………………………….. 357
Renewability Option………………………………………………………………………………………….. 357
Conversion Option……………………………………………………………………………………………. 358
Settlement Options…………………………………………………………………………………………… 358
Selecting a Life Insurance Company……………………………………………………….. 358
The Specific Policy That You Want……………………………………………………………………… 358
Relatively Low Insurance Premiums…………………………………………………………………… 358
Strong Financial Condition………………………………………………………………………………… 359
Services……………………………………………………………………………………………………………. 359
Other Types of Insurance…………………………………………………………………………………… 359
How Life Insurance Fits Within Your Financial Plan………………………………. 360
Discussion Questions………………………………………………………………………………………… 360
Summary………………………………………………………………………………………………………. 361
Review Questions……………………………………………………………………………………………… 361
Financial Planning Problems……………………………………………………………………………… 362
Financial Planning Online Exercises…………………………………………………………………… 363
Psychology of Personal Finance: Your Life Insurance………………………………………….. 363
Web Search Exercise…………………………………………………………………………………………. 364
Video Exercise: Selecting Life Insurance…………………………………………………………….. 364
Building Your Own Financial Plan ……………………………………………………………………… 365
The Sampsons—A Continuing Case ………………………………………………………………….. 366
Brad Brooks—A Continuing Case ……………………………………………………………………… 367
Chapter 11 Auto and Homeowner’s Insurance……………………………………………. 292
Insurance and the Management of Risk…………………………………………………. 293
Avoid Risk………………………………………………………………………………………………………… 293
Reduce Risk………………………………………………………………………………………………………. 294
Accept Risk……………………………………………………………………………………………………….. 294
Insure Against Risk……………………………………………………………………………………………. 294
Economic Impact on the Decision to Insure Against Risk…………………………………….. 295
Role of Insurance Companies……………………………………………………………………. 295
Insurance Company Operations…………………………………………………………………………. 295
Auto Insurance…………………………………………………………………………………………….. 297
Auto Insurance Policy Provisions……………………………………………………………………….. 298
Coverage A: Liability Coverage………………………………………………………………………….. 299
Coverage B: Medical Payments Coverage…………………………………………………………… 300
Coverage C: Uninsured or Underinsured Motorist Coverage………………………………..301
Coverage D: Collision and Comprehensive Coverage…………………………………………..301
Other Provisions……………………………………………………………………………………………….. 302
Summary of Auto Insurance Provisions……………………………………………………………… 302
Auto Insurance Premiums………………………………………………………………………….. 303
Characteristics of Your Car………………………………………………………………………………… 303
Your Personal Characteristics…………………………………………………………………………….. 304
Your Insurance Company…………………………………………………………………………………… 305
If You Are in an Auto Accident……………………………………………………………………. 306
Homeowner’s Insurance Provisions………………………………………………………… 307
Property Damage………………………………………………………………………………………………. 307
Other Structures on Property…………………………………………………………………………….. 308
Personal Property……………………………………………………………………………………………… 309
Liability…………………………………………………………………………………………………………….. 309
Other Types of Provisions………………………………………………………………………………….. 309
Homeowner’s Insurance Premiums…………………………………………………………..310
Factors That Affect Homeowner’s Insurance Premiums………………………………………..310
Reducing Your Homeowner’s Insurance Premium………………………………………………..311
Filing a Claim……………………………………………………………………………………………………..311
Renter’s Insurance……………………………………………………………………………………….. 312
Renter’s Insurance Policy Provisions………………………………………………………………….. 312
Umbrella Personal Liability Policy……………………………………………………………. 312
How Insurance Fits Within Your Financial Plan………………………………………. 312
Discussion Questions………………………………………………………………………………………… 313
Summary………………………………………………………………………………………………………. 313
Review Questions……………………………………………………………………………………………… 314
Financial Planning Online Exercises…………………………………………………………………… 315
Psychology of Personal Finance: Your Auto Insurance………………………………………… 316
Web Search Exercise…………………………………………………………………………………………. 316
Video Exercise: Selecting Auto Insurance…………………………………………………………… 316
Building Your Own Financial Plan ……………………………………………………………………… 317
The Sampsons—A Continuing Case ……………………………………………………………………319
Chapter 12 Health and Disability Insurance………………………………………………….. 321
Background on Health Insurance……………………………………………………………… 322
Cost of Health Insurance……………………………………………………………………………………. 322
Private Health Insurance…………………………………………………………………………….. 323
Types of Private Health Insurance Coverage……………………………………………………….. 323
Premiums for Private Health Care Insurance………………………………………………………. 325
Comparison of Private Health Insurance Plans……………………………………………………. 326
Contents of Health Care Plans………………………………………………………………….. 327
Identification of Insured Persons……………………………………………………………………….. 327
Location……………………………………………………………………………………………………………. 327
Cancellation and Renewability Options………………………………………………………………. 327
Other Coverage…………………………………………………………………………………………………. 328
Determinants of Unreimbursed Medical Expenses……………………………………………… 328
Expenses Not Covered by Private Insurance Plans……………………………………………… 329
Government Health Care Plans………………………………………………………………… 329
Medicare………………………………………………………………………………………………………….. 329
Medicaid…………………………………………………………………………………………………………… 330
Regulations in Health Care Insurance……………………………………………………… 330
Consolidated Omnibus Budget Reconciliation Act (COBRA)………………………………… 330
Health Insurance Portability and Accountability Act (HIPAA)……………………………….. 331
Affordable Care Act…………………………………………………………………………………………… 331
Long-Term Care Insurance…………………………………………………………………………. 333
Long-Term Care Insurance Provisions………………………………………………………………… 333
Factors That Affect Long-Term Care Insurance Premiums……………………………………. 334
Reducing Your Cost of Long-Term Care Insurance………………………………………………. 334
Determining the Amount of Coverage………………………………………………………………… 335
Disability Insurance…………………………………………………………………………………….. 335
Sources of Disability Income Insurance……………………………………………………………… 335
Disability Insurance Provisions………………………………………………………………………….. 336
Deciding on Disability Insurance………………………………………………………………………… 336
How Health and Disability Insurance Fit Within Your Financial Plan…. 337
Discussion Questions………………………………………………………………………………………… 337
Summary………………………………………………………………………………………………………. 338
Review Questions……………………………………………………………………………………………… 339
Financial Planning Problems……………………………………………………………………………… 340
Financial Planning Online Exercises…………………………………………………………………… 340
Psychology of Personal Finance: Your Health Insurance……………………………………… 340
Web Search Exercise…………………………………………………………………………………………. 341
Video Exercise: Selecting Health Insurance………………………………………………………… 341
Building Your Own Financial Plan ……………………………………………………………………… 343
The Sampsons—A Continuing Case ………………………………………………………………….. 344
Chapter 13 Life Insurance…………………………………………………………………………………………. 345
Background on Life Insurance…………………………………………………………………… 346
Role of Life Insurance………………………………………………………………………………………… 346
Psychology Behind the Life Insurance Decision………………………………………………….. 346
Role of Life Insurance Companies……………………………………………………………………… 347
Applying for Life Insurance……………………………………………………………………………….. 347
Types of Life Insurance……………………………………………………………………………….. 347
Term Insurance…………………………………………………………………………………………………. 347
Whole Life Insurance…………………………………………………………………………………………. 351
Universal Life Insurance……………………………………………………………………………………. 352
Determining the Amount of Life Insurance…………………………………………….. 353
Income Method…………………………………………………………………………………………………. 353
Budget Method…………………………………………………………………………………………………. 353
Contents of a Life Insurance Policy………………………………………………………….. 357
Beneficiary……………………………………………………………………………………………………….. 357
Grace Period…………………………………………………………………………………………………….. 357
Living Benefits………………………………………………………………………………………………….. 357
Nonforfeiture Clause…………………………………………………………………………………………. 357
Loans……………………………………………………………………………………………………………….. 357
Incontestability Date………………………………………………………………………………………….. 357
Renewability Option………………………………………………………………………………………….. 357
Conversion Option……………………………………………………………………………………………. 358
Settlement Options…………………………………………………………………………………………… 358
Selecting a Life Insurance Company……………………………………………………….. 358
The Specific Policy That You Want……………………………………………………………………… 358
Relatively Low Insurance Premiums…………………………………………………………………… 358
Strong Financial Condition………………………………………………………………………………… 359
Services……………………………………………………………………………………………………………. 359
Other Types of Insurance…………………………………………………………………………………… 359
How Life Insurance Fits Within Your Financial Plan………………………………. 360
Discussion Questions………………………………………………………………………………………… 360
Summary………………………………………………………………………………………………………. 361
Review Questions……………………………………………………………………………………………… 361
Financial Planning Problems……………………………………………………………………………… 362
Financial Planning Online Exercises…………………………………………………………………… 363
Psychology of Personal Finance: Your Life Insurance………………………………………….. 363
Web Search Exercise…………………………………………………………………………………………. 364
Video Exercise: Selecting Life Insurance…………………………………………………………….. 364
Building Your Own Financial Plan ……………………………………………………………………… 365
The Sampsons—A Continuing Case ………………………………………………………………….. 366
Brad Brooks—A Continuing Case ……………………………………………………………………… 367
PART 5 PERSONAL INVESTING
Chapter 14 Investing Fundamentals……………………………………………………………………370
Paying Off Debt……………………………………………………………………………………………. 371
Types of Investments………………………………………………………………………………….. 372
Money Market Securities…………………………………………………………………………………… 372
Stocks………………………………………………………………………………………………………………. 372
Bonds………………………………………………………………………………………………………………..374
Mutual Funds……………………………………………………………………………………………………..374
Real Estate………………………………………………………………………………………………………… 375
Precious Metals………………………………………………………………………………………………… 375
Investment Return………………………………………………………………………………………..376
Return from Investing in Stock…………………………………………………………………………….376
Return from Investing in Bonds…………………………………………………………………………. 377
Return from Investing in Mutual Funds………………………………………………………………. 377
Return from Investing in Real Estate………………………………………………………………….. 377
Measuring the Return on Your Investment…………………………………………………………. 377
How Your Wealth Is Influenced by Your Return…………………………………………………… 379
Risk from Investing……………………………………………………………………………………… 380
Illustration of Risk……………………………………………………………………………………………… 381
Risk Due to Uncertainty Surrounding Economic Conditions………………………………… 381
Measuring an Investment’s Risk…………………………………………………………………………. 382
Trade-Off Between Return and Risk…………………………………………………………. 383
Return-Risk Trade-Off Among Stocks………………………………………………………………….. 383
Return-Risk Trade-Off Among Bonds………………………………………………………………….. 384
Return-Risk Trade-Off Among Mutual Funds………………………………………………………. 384
Return-Risk Trade-Off Among Real Estate Investments……………………………………….. 384
Comparing Different Types of Investments…………………………………………………………. 384
Learning from Investment Mistakes………………………………………………………… 385
Making Decisions Based on Unrealistic Goals…………………………………………………….. 385
Borrowing to Invest…………………………………………………………………………………………… 386
Taking Risks to Recover Losses………………………………………………………………………….. 386
How Personal Investing Fits Within Your Financial Plan………………………. 387
Discussion Questions………………………………………………………………………………………… 388
Summary………………………………………………………………………………………………………. 388
Review Questions……………………………………………………………………………………………… 388
Financial Planning Problems……………………………………………………………………………… 389
Financial Planning Online Exercises…………………………………………………………………… 391
Psychology of Personal Finance: Your Investments…………………………………………….. 391
Web Search Exercise…………………………………………………………………………………………. 391
Video Exercise: Investing…………………………………………………………………………………… 392
Building Your Own Financial Plan ……………………………………………………………………… 393
The Sampsons—A Continuing Case ………………………………………………………………….. 394
Chapter 15 Investing in Stocks……………………………………………………………………………… 395
Stock Exchanges………………………………………………………………………………………….. 396
New York Stock Exchange………………………………………………………………………………….. 396
Nasdaq Stock Market………………………………………………………………………………………… 397
Other Stock Exchanges……………………………………………………………………………………… 397
Over-the-Counter (OTC) Markets………………………………………………………………………… 397
Stock Quotations………………………………………………………………………………………… 398
Purchasing and Selling Stocks………………………………………………………………….. 399
Selecting a Broker…………………………………………………………………………………………….. 399
Placing an Order……………………………………………………………………………………………….. 400
Placing an Order Online………………………………………………………………………………………401
Buying Stock on Margin……………………………………………………………………………………. 402
Short Selling Stock……………………………………………………………………………………………. 402
Analyzing Stocks…………………………………………………………………………………………. 403
Analyzing a Firm’s Financial Condition………………………………………………………………. 403
Analyzing Economic Conditions………………………………………………………………………… 405
Industry Conditions…………………………………………………………………………………………… 407
Integrating Your Analyses………………………………………………………………………………….. 408
Limitations of Stock Analysis…………………………………………………………………………….. 408
How Stock Investment Methods Fit Within Your Financial Plan………… 409
Discussion Questions………………………………………………………………………………………….410
Summary………………………………………………………………………………………………………..410
Review Questions……………………………………………………………………………………………….411
Financial Planning Online Exercises…………………………………………………………………… 412
Psychology of Personal Finance: Buying Stocks on Margin…………………………………. 413
Web Search Exercise…………………………………………………………………………………………. 413
Video Exercise: Investing in Stocks…………………………………………………………………….. 413
Building Your Own Financial Plan ……………………………………………………………………… 415
The Sampsons—A Continuing Case ………………………………………………………………….. 416
Chapter 16 Investing in Bonds………………………………………………………………………………. 417
Background on Bonds………………………………………………………………………………… 418
Bond Characteristics…………………………………………………………………………………………. 418
A Bond’s Yield to Maturity…………………………………………………………………………………..419
Bond Trading in the Secondary Market………………………………………………………………..419
Types of Bonds………………………………………………………………………………………………419
Treasury Bonds…………………………………………………………………………………………………..419
Municipal Bonds…………………………………………………………………………………………………419
Federal Agency Bonds………………………………………………………………………………………. 420
Corporate Bonds……………………………………………………………………………………………….. 421
Return from Investing in Bonds………………………………………………………………… 421
Impact of Interest Rate Movements on Bond Returns…………………………………………. 422
Tax Implications of Investing in Bonds……………………………………………………………….. 422
Valuing a Bond…………………………………………………………………………………………….. 422
Risk from Investing in Bonds…………………………………………………………………….. 424
Default Risk………………………………………………………………………………………………………. 424
Call Risk……………………………………………………………………………………………………………. 425
Interest Rate Risk………………………………………………………………………………………………. 426
Bond Investment Strategies……………………………………………………………………… 426
Interest Rate Strategy………………………………………………………………………………………… 427
Passive Strategy……………………………………………………………………………………………….. 427
Maturity Matching Strategy……………………………………………………………………………….. 427
How Investing in Bonds Fits Within Your Financial Plan……………………… 427
Discussion Questions………………………………………………………………………………………… 428
Summary………………………………………………………………………………………………………. 428
Review Questions……………………………………………………………………………………………… 429
Financial Planning Problems……………………………………………………………………………… 430
Financial Planning Online Exercises…………………………………………………………………… 431
Psychology of Personal Finance: Buying Risky Bonds…………………………………………. 431
Web Search Exercise…………………………………………………………………………………………. 431
Video Exercise: Investing In Bonds…………………………………………………………………….. 432
Building Your Own Financial Plan ……………………………………………………………………… 433
The Sampsons—A Continuing Case ………………………………………………………………….. 434
Chapter 17 Investing in Mutual Funds……………………………………………………………… 435
Background on Mutual Funds…………………………………………………………………… 436
Motives for Investing in Mutual Funds……………………………………………………………….. 436
Net Asset Value…………………………………………………………………………………………………. 436
Open-End Versus Closed-End Funds………………………………………………………………….. 437
Load Versus No-Load Funds………………………………………………………………………………. 437
Expense Ratios…………………………………………………………………………………………………. 438
Types of Mutual Funds……………………………………………………………………………….. 439
Types of Stock Mutual Funds……………………………………………………………………………… 439
Types of Bond Mutual Funds……………………………………………………………………………… 442
Other Types of Mutual Funds…………………………………………………………………………….. 443
Exchange-Traded Funds……………………………………………………………………………… 443
Types of Exchange-Traded Funds………………………………………………………………………. 444
Advantages and Disadvantages of ETFs…………………………………………………………….. 444
Return and Risk of a Mutual Fund……………………………………………………………. 445
Return from Investing in a Mutual Fund……………………………………………………………… 445
Risk from Investing in a Stock Mutual Fund………………………………………………………… 447
Trade-Off Between Expected Return and Risk of Stock Funds………………………………. 447
Risk from Investing in a Bond Mutual Fund………………………………………………………… 447
Trade-Off Between Expected Return and Risk of Bond Funds………………………………. 448
Selecting Among Mutual Funds……………………………………………………………….. 448
Reviewing a Mutual Fund’s Prospectus………………………………………………………………. 449
Choosing the Type of Fund………………………………………………………………………………… 450
Making the Decision………………………………………………………………………………………….. 452
Quotations of Mutual Funds……………………………………………………………………… 452
Diversification Among Mutual Funds………………………………………………………. 453
Impact of the Financial Crisis on Diversification Benefits…………………………………….. 454
International Diversification of Mutual Funds…………………………………………………….. 454
Diversification Through Mutual Fund Supermarkets…………………………………………… 454
Other Types of Funds………………………………………………………………………………………… 455
How Mutual Funds Fit Within Your Financial Plan………………………………… 455
Discussion Questions………………………………………………………………………………………… 457
Summary………………………………………………………………………………………………………. 457
Review Questions……………………………………………………………………………………………… 458
Financial Planning Problems……………………………………………………………………………… 459
Financial Planning Online Exercises…………………………………………………………………… 460
Psychology of Personal Finance: Investing In Mutual Funds………………………………… 460
Web Search Exercise…………………………………………………………………………………………. 460
Video Exercise: Investing In Mutual Funds…………………………………………………………. 461
Building Your Own Financial Plan ……………………………………………………………………… 463
The Sampsons—A Continuing Case ………………………………………………………………….. 464
Chapter 18 Asset Allocation……………………………………………………………………………………. 465
How Diversification Reduces Risk……………………………………………………………. 466
Benefits of Portfolio Diversification……………………………………………………………………. 466
Determining Portfolio Benefits…………………………………………………………………………… 466
Factors That Influence Diversification Benefits……………………………………………………. 467
Strategies for Diversifying…………………………………………………………………………. 469
Diversification of Stocks Across Industries…………………………………………………………. 469
Diversification of Stocks Across Countries……………………………………………………………470
Economic Impact on Global Diversification Benefits…………………………………………….470
Asset Allocation Strategies…………………………………………………………………………470
Including Bonds in Your Portfolio………………………………………………………………………. 471
Including Real Estate Investments in Your Portfolio…………………………………………….. 471
Including Stock Options in Your Portfolio……………………………………………………………. 472
How Asset Allocation Affects Risk………………………………………………………………………..474
An Affordable Way to Conduct Asset Allocation……………………………………………………474
Your Asset Allocation Decision…………………………………………………………………. 475
Your Stage in Life……………………………………………………………………………………………… 475
Your Degree of Risk Tolerance……………………………………………………………………………..476
Your Expectations About Economic Conditions………………………………………………….. 477
How Asset Allocation Fits Within Your Financial Plan………………………….. 478
Discussion Questions………………………………………………………………………………………… 479
Summary………………………………………………………………………………………………………. 479
Review Questions……………………………………………………………………………………………… 480
Financial Planning Problems……………………………………………………………………………… 481
Financial Planning Online Exercises…………………………………………………………………… 482
Psychology of Personal Finance: Asset Allocation………………………………………………. 482
Web Search Exercise…………………………………………………………………………………………. 482
Video Exercise: Asset Allocation………………………………………………………………………… 482
Building Your Own Financial Plan ……………………………………………………………………… 483
The Sampsons—A Continuing Case ………………………………………………………………….. 484
Brad Brooks—A Continuing Case ……………………………………………………………………… 485
Chapter 14 Investing Fundamentals……………………………………………………………………370
Paying Off Debt……………………………………………………………………………………………. 371
Types of Investments………………………………………………………………………………….. 372
Money Market Securities…………………………………………………………………………………… 372
Stocks………………………………………………………………………………………………………………. 372
Bonds………………………………………………………………………………………………………………..374
Mutual Funds……………………………………………………………………………………………………..374
Real Estate………………………………………………………………………………………………………… 375
Precious Metals………………………………………………………………………………………………… 375
Investment Return………………………………………………………………………………………..376
Return from Investing in Stock…………………………………………………………………………….376
Return from Investing in Bonds…………………………………………………………………………. 377
Return from Investing in Mutual Funds………………………………………………………………. 377
Return from Investing in Real Estate………………………………………………………………….. 377
Measuring the Return on Your Investment…………………………………………………………. 377
How Your Wealth Is Influenced by Your Return…………………………………………………… 379
Risk from Investing……………………………………………………………………………………… 380
Illustration of Risk……………………………………………………………………………………………… 381
Risk Due to Uncertainty Surrounding Economic Conditions………………………………… 381
Measuring an Investment’s Risk…………………………………………………………………………. 382
Trade-Off Between Return and Risk…………………………………………………………. 383
Return-Risk Trade-Off Among Stocks………………………………………………………………….. 383
Return-Risk Trade-Off Among Bonds………………………………………………………………….. 384
Return-Risk Trade-Off Among Mutual Funds………………………………………………………. 384
Return-Risk Trade-Off Among Real Estate Investments……………………………………….. 384
Comparing Different Types of Investments…………………………………………………………. 384
Learning from Investment Mistakes………………………………………………………… 385
Making Decisions Based on Unrealistic Goals…………………………………………………….. 385
Borrowing to Invest…………………………………………………………………………………………… 386
Taking Risks to Recover Losses………………………………………………………………………….. 386
How Personal Investing Fits Within Your Financial Plan………………………. 387
Discussion Questions………………………………………………………………………………………… 388
Summary………………………………………………………………………………………………………. 388
Review Questions……………………………………………………………………………………………… 388
Financial Planning Problems……………………………………………………………………………… 389
Financial Planning Online Exercises…………………………………………………………………… 391
Psychology of Personal Finance: Your Investments…………………………………………….. 391
Web Search Exercise…………………………………………………………………………………………. 391
Video Exercise: Investing…………………………………………………………………………………… 392
Building Your Own Financial Plan ……………………………………………………………………… 393
The Sampsons—A Continuing Case ………………………………………………………………….. 394
Chapter 15 Investing in Stocks……………………………………………………………………………… 395
Stock Exchanges………………………………………………………………………………………….. 396
New York Stock Exchange………………………………………………………………………………….. 396
Nasdaq Stock Market………………………………………………………………………………………… 397
Other Stock Exchanges……………………………………………………………………………………… 397
Over-the-Counter (OTC) Markets………………………………………………………………………… 397
Stock Quotations………………………………………………………………………………………… 398
Purchasing and Selling Stocks………………………………………………………………….. 399
Selecting a Broker…………………………………………………………………………………………….. 399
Placing an Order……………………………………………………………………………………………….. 400
Placing an Order Online………………………………………………………………………………………401
Buying Stock on Margin……………………………………………………………………………………. 402
Short Selling Stock……………………………………………………………………………………………. 402
Analyzing Stocks…………………………………………………………………………………………. 403
Analyzing a Firm’s Financial Condition………………………………………………………………. 403
Analyzing Economic Conditions………………………………………………………………………… 405
Industry Conditions…………………………………………………………………………………………… 407
Integrating Your Analyses………………………………………………………………………………….. 408
Limitations of Stock Analysis…………………………………………………………………………….. 408
How Stock Investment Methods Fit Within Your Financial Plan………… 409
Discussion Questions………………………………………………………………………………………….410
Summary………………………………………………………………………………………………………..410
Review Questions……………………………………………………………………………………………….411
Financial Planning Online Exercises…………………………………………………………………… 412
Psychology of Personal Finance: Buying Stocks on Margin…………………………………. 413
Web Search Exercise…………………………………………………………………………………………. 413
Video Exercise: Investing in Stocks…………………………………………………………………….. 413
Building Your Own Financial Plan ……………………………………………………………………… 415
The Sampsons—A Continuing Case ………………………………………………………………….. 416
Chapter 16 Investing in Bonds………………………………………………………………………………. 417
Background on Bonds………………………………………………………………………………… 418
Bond Characteristics…………………………………………………………………………………………. 418
A Bond’s Yield to Maturity…………………………………………………………………………………..419
Bond Trading in the Secondary Market………………………………………………………………..419
Types of Bonds………………………………………………………………………………………………419
Treasury Bonds…………………………………………………………………………………………………..419
Municipal Bonds…………………………………………………………………………………………………419
Federal Agency Bonds………………………………………………………………………………………. 420
Corporate Bonds……………………………………………………………………………………………….. 421
Return from Investing in Bonds………………………………………………………………… 421
Impact of Interest Rate Movements on Bond Returns…………………………………………. 422
Tax Implications of Investing in Bonds……………………………………………………………….. 422
Valuing a Bond…………………………………………………………………………………………….. 422
Risk from Investing in Bonds…………………………………………………………………….. 424
Default Risk………………………………………………………………………………………………………. 424
Call Risk……………………………………………………………………………………………………………. 425
Interest Rate Risk………………………………………………………………………………………………. 426
Bond Investment Strategies……………………………………………………………………… 426
Interest Rate Strategy………………………………………………………………………………………… 427
Passive Strategy……………………………………………………………………………………………….. 427
Maturity Matching Strategy……………………………………………………………………………….. 427
How Investing in Bonds Fits Within Your Financial Plan……………………… 427
Discussion Questions………………………………………………………………………………………… 428
Summary………………………………………………………………………………………………………. 428
Review Questions……………………………………………………………………………………………… 429
Financial Planning Problems……………………………………………………………………………… 430
Financial Planning Online Exercises…………………………………………………………………… 431
Psychology of Personal Finance: Buying Risky Bonds…………………………………………. 431
Web Search Exercise…………………………………………………………………………………………. 431
Video Exercise: Investing In Bonds…………………………………………………………………….. 432
Building Your Own Financial Plan ……………………………………………………………………… 433
The Sampsons—A Continuing Case ………………………………………………………………….. 434
Chapter 17 Investing in Mutual Funds……………………………………………………………… 435
Background on Mutual Funds…………………………………………………………………… 436
Motives for Investing in Mutual Funds……………………………………………………………….. 436
Net Asset Value…………………………………………………………………………………………………. 436
Open-End Versus Closed-End Funds………………………………………………………………….. 437
Load Versus No-Load Funds………………………………………………………………………………. 437
Expense Ratios…………………………………………………………………………………………………. 438
Types of Mutual Funds……………………………………………………………………………….. 439
Types of Stock Mutual Funds……………………………………………………………………………… 439
Types of Bond Mutual Funds……………………………………………………………………………… 442
Other Types of Mutual Funds…………………………………………………………………………….. 443
Exchange-Traded Funds……………………………………………………………………………… 443
Types of Exchange-Traded Funds………………………………………………………………………. 444
Advantages and Disadvantages of ETFs…………………………………………………………….. 444
Return and Risk of a Mutual Fund……………………………………………………………. 445
Return from Investing in a Mutual Fund……………………………………………………………… 445
Risk from Investing in a Stock Mutual Fund………………………………………………………… 447
Trade-Off Between Expected Return and Risk of Stock Funds………………………………. 447
Risk from Investing in a Bond Mutual Fund………………………………………………………… 447
Trade-Off Between Expected Return and Risk of Bond Funds………………………………. 448
Selecting Among Mutual Funds……………………………………………………………….. 448
Reviewing a Mutual Fund’s Prospectus………………………………………………………………. 449
Choosing the Type of Fund………………………………………………………………………………… 450
Making the Decision………………………………………………………………………………………….. 452
Quotations of Mutual Funds……………………………………………………………………… 452
Diversification Among Mutual Funds………………………………………………………. 453
Impact of the Financial Crisis on Diversification Benefits…………………………………….. 454
International Diversification of Mutual Funds…………………………………………………….. 454
Diversification Through Mutual Fund Supermarkets…………………………………………… 454
Other Types of Funds………………………………………………………………………………………… 455
How Mutual Funds Fit Within Your Financial Plan………………………………… 455
Discussion Questions………………………………………………………………………………………… 457
Summary………………………………………………………………………………………………………. 457
Review Questions……………………………………………………………………………………………… 458
Financial Planning Problems……………………………………………………………………………… 459
Financial Planning Online Exercises…………………………………………………………………… 460
Psychology of Personal Finance: Investing In Mutual Funds………………………………… 460
Web Search Exercise…………………………………………………………………………………………. 460
Video Exercise: Investing In Mutual Funds…………………………………………………………. 461
Building Your Own Financial Plan ……………………………………………………………………… 463
The Sampsons—A Continuing Case ………………………………………………………………….. 464
Chapter 18 Asset Allocation……………………………………………………………………………………. 465
How Diversification Reduces Risk……………………………………………………………. 466
Benefits of Portfolio Diversification……………………………………………………………………. 466
Determining Portfolio Benefits…………………………………………………………………………… 466
Factors That Influence Diversification Benefits……………………………………………………. 467
Strategies for Diversifying…………………………………………………………………………. 469
Diversification of Stocks Across Industries…………………………………………………………. 469
Diversification of Stocks Across Countries……………………………………………………………470
Economic Impact on Global Diversification Benefits…………………………………………….470
Asset Allocation Strategies…………………………………………………………………………470
Including Bonds in Your Portfolio………………………………………………………………………. 471
Including Real Estate Investments in Your Portfolio…………………………………………….. 471
Including Stock Options in Your Portfolio……………………………………………………………. 472
How Asset Allocation Affects Risk………………………………………………………………………..474
An Affordable Way to Conduct Asset Allocation……………………………………………………474
Your Asset Allocation Decision…………………………………………………………………. 475
Your Stage in Life……………………………………………………………………………………………… 475
Your Degree of Risk Tolerance……………………………………………………………………………..476
Your Expectations About Economic Conditions………………………………………………….. 477
How Asset Allocation Fits Within Your Financial Plan………………………….. 478
Discussion Questions………………………………………………………………………………………… 479
Summary………………………………………………………………………………………………………. 479
Review Questions……………………………………………………………………………………………… 480
Financial Planning Problems……………………………………………………………………………… 481
Financial Planning Online Exercises…………………………………………………………………… 482
Psychology of Personal Finance: Asset Allocation………………………………………………. 482
Web Search Exercise…………………………………………………………………………………………. 482
Video Exercise: Asset Allocation………………………………………………………………………… 482
Building Your Own Financial Plan ……………………………………………………………………… 483
The Sampsons—A Continuing Case ………………………………………………………………….. 484
Brad Brooks—A Continuing Case ……………………………………………………………………… 485
PART 6 RETIREMENT AND ESTATE PLANNING
Chapter 19 Retirement Planning………………………………………………………………………….. 488
Social Security……………………………………………………………………………………………… 489
Qualifying for Social Security…………………………………………………………………………….. 489
Retirement Benefits…………………………………………………………………………………………… 489
Concern About Retirement Benefits in the Future……………………………………………….. 490
Defined-Benefit Versus Defined-Contribution Plans…………………………….. 490
Defined-Benefit Plans………………………………………………………………………………………… 490
Defined-Contribution Plans……………………………………………………………………………….. 491
Your Retirement Planning Decisions……………………………………………………….. 492
Which Retirement Plan Should You Pursue?……………………………………………………….. 492
How Much Should You Contribute?……………………………………………………………………. 492
How Should You Invest Your Contributions?………………………………………………………. 493
Retirement Plans Offered by Employers…………………………………………………. 494
401(k) Plan………………………………………………………………………………………………………… 494
Roth 401(k) Plan………………………………………………………………………………………………… 495
403(b) Plan……………………………………………………………………………………………………….. 495
Simplified Employee Pension (SEP) Plan……………………………………………………………. 495
SIMPLE Plan……………………………………………………………………………………………………… 496
Profit Sharing……………………………………………………………………………………………………. 496
Employee Stock Ownership Plan (ESOP)……………………………………………………………. 496
Managing Your Retirement Account After Leaving Your Employer………………………. 496
Retirement Plans for the Self-Employed………………………………………………… 496
Keogh Plan……………………………………………………………………………………………………….. 496
Simplified Employee Pension (SEP) Plan……………………………………………………………. 497
Individual Retirement Accounts……………………………………………………………….. 497
Traditional IRA………………………………………………………………………………………………….. 497
Roth IRA…………………………………………………………………………………………………………… 497
Comparison of the Roth IRA and Traditional IRA…………………………………………………. 498
Annuities……………………………………………………………………………………………………….. 498
Fixed Versus Variable Annuities…………………………………………………………………………. 499
Annuity Fees…………………………………………………………………………………………………….. 499
Estimating Your Future Retirement Savings………………………………………….. 499
Estimating the Future Value of a Set of Annual Investments………………………………… 500
How Retirement Planning Fits Within Your Financial Plan………………….. 503
Discussion Questions………………………………………………………………………………………… 504
Summary………………………………………………………………………………………………………. 504
Review Questions……………………………………………………………………………………………… 505
Financial Planning Problems……………………………………………………………………………… 506
Financial Planning Online Exercises…………………………………………………………………… 507
Psychology of Personal Finance: Your Retirement………………………………………………. 507
Web Search Exercise…………………………………………………………………………………………. 507
Video Exercise: Retirement Planning………………………………………………………………….. 508
Building Your Own Financial Plan ……………………………………………………………………… 509
The Sampsons—A Continuing Case ……………………………………………………………………510
Chapter 20 Estate Planning………………………………………………………………………………………511
Purpose of a Will………………………………………………………………………………………….. 512
Reasons for Having a Will………………………………………………………………………………….. 512
Creating a Valid Will………………………………………………………………………………………….. 512
Common Types of Wills…………………………………………………………………………………….. 513
Key Components of a Will…………………………………………………………………………………. 513
Changing Your Will……………………………………………………………………………………………. 513
Executing the Will During Probate……………………………………………………………………… 515
Estate Taxes…………………………………………………………………………………………………… 515
Determining Estate Taxes………………………………………………………………………………….. 515
Other Related Taxes…………………………………………………………………………………………… 515
Valuing Your Estate to Assess Potential Estate Taxes…………………………………………… 515
Trusts, Gifts, and Contributions………………………………………………………………… 516
Trusts……………………………………………………………………………………………………………….. 516
Gifts…………………………………………………………………………………………………………………. 516
Contributions to Charitable Organizations………………………………………………………….. 517
Other Aspects of Estate Planning…………………………………………………………….. 517
Living Will………………………………………………………………………………………………………… 517
Power of Attorney……………………………………………………………………………………………… 517
Maintaining Estate Plan Documents…………………………………………………………………… 517
How Estate Planning Fits Within Your Financial Plan…………………………… 518
Discussion Questions………………………………………………………………………………………….519
Summary………………………………………………………………………………………………………..519
Review Questions……………………………………………………………………………………………….519
Financial Planning Online Exercises…………………………………………………………………… 520
Psychology of Personal Finance: Your Will…………………………………………………………. 521
Web Search Exercise…………………………………………………………………………………………. 521
Video Exercise: Estate Planning…………………………………………………………………………. 521
Building Your Own Financial Plan ……………………………………………………………………… 523
The Sampsons—A Continuing Case ………………………………………………………………….. 524
Brad Brooks—A Continuing Case ……………………………………………………………………… 525
Chapter 19 Retirement Planning………………………………………………………………………….. 488
Social Security……………………………………………………………………………………………… 489
Qualifying for Social Security…………………………………………………………………………….. 489
Retirement Benefits…………………………………………………………………………………………… 489
Concern About Retirement Benefits in the Future……………………………………………….. 490
Defined-Benefit Versus Defined-Contribution Plans…………………………….. 490
Defined-Benefit Plans………………………………………………………………………………………… 490
Defined-Contribution Plans……………………………………………………………………………….. 491
Your Retirement Planning Decisions……………………………………………………….. 492
Which Retirement Plan Should You Pursue?……………………………………………………….. 492
How Much Should You Contribute?……………………………………………………………………. 492
How Should You Invest Your Contributions?………………………………………………………. 493
Retirement Plans Offered by Employers…………………………………………………. 494
401(k) Plan………………………………………………………………………………………………………… 494
Roth 401(k) Plan………………………………………………………………………………………………… 495
403(b) Plan……………………………………………………………………………………………………….. 495
Simplified Employee Pension (SEP) Plan……………………………………………………………. 495
SIMPLE Plan……………………………………………………………………………………………………… 496
Profit Sharing……………………………………………………………………………………………………. 496
Employee Stock Ownership Plan (ESOP)……………………………………………………………. 496
Managing Your Retirement Account After Leaving Your Employer………………………. 496
Retirement Plans for the Self-Employed………………………………………………… 496
Keogh Plan……………………………………………………………………………………………………….. 496
Simplified Employee Pension (SEP) Plan……………………………………………………………. 497
Individual Retirement Accounts……………………………………………………………….. 497
Traditional IRA………………………………………………………………………………………………….. 497
Roth IRA…………………………………………………………………………………………………………… 497
Comparison of the Roth IRA and Traditional IRA…………………………………………………. 498
Annuities……………………………………………………………………………………………………….. 498
Fixed Versus Variable Annuities…………………………………………………………………………. 499
Annuity Fees…………………………………………………………………………………………………….. 499
Estimating Your Future Retirement Savings………………………………………….. 499
Estimating the Future Value of a Set of Annual Investments………………………………… 500
How Retirement Planning Fits Within Your Financial Plan………………….. 503
Discussion Questions………………………………………………………………………………………… 504
Summary………………………………………………………………………………………………………. 504
Review Questions……………………………………………………………………………………………… 505
Financial Planning Problems……………………………………………………………………………… 506
Financial Planning Online Exercises…………………………………………………………………… 507
Psychology of Personal Finance: Your Retirement………………………………………………. 507
Web Search Exercise…………………………………………………………………………………………. 507
Video Exercise: Retirement Planning………………………………………………………………….. 508
Building Your Own Financial Plan ……………………………………………………………………… 509
The Sampsons—A Continuing Case ……………………………………………………………………510
Chapter 20 Estate Planning………………………………………………………………………………………511
Purpose of a Will………………………………………………………………………………………….. 512
Reasons for Having a Will………………………………………………………………………………….. 512
Creating a Valid Will………………………………………………………………………………………….. 512
Common Types of Wills…………………………………………………………………………………….. 513
Key Components of a Will…………………………………………………………………………………. 513
Changing Your Will……………………………………………………………………………………………. 513
Executing the Will During Probate……………………………………………………………………… 515
Estate Taxes…………………………………………………………………………………………………… 515
Determining Estate Taxes………………………………………………………………………………….. 515
Other Related Taxes…………………………………………………………………………………………… 515
Valuing Your Estate to Assess Potential Estate Taxes…………………………………………… 515
Trusts, Gifts, and Contributions………………………………………………………………… 516
Trusts……………………………………………………………………………………………………………….. 516
Gifts…………………………………………………………………………………………………………………. 516
Contributions to Charitable Organizations………………………………………………………….. 517
Other Aspects of Estate Planning…………………………………………………………….. 517
Living Will………………………………………………………………………………………………………… 517
Power of Attorney……………………………………………………………………………………………… 517
Maintaining Estate Plan Documents…………………………………………………………………… 517
How Estate Planning Fits Within Your Financial Plan…………………………… 518
Discussion Questions………………………………………………………………………………………….519
Summary………………………………………………………………………………………………………..519
Review Questions……………………………………………………………………………………………….519
Financial Planning Online Exercises…………………………………………………………………… 520
Psychology of Personal Finance: Your Will…………………………………………………………. 521
Web Search Exercise…………………………………………………………………………………………. 521
Video Exercise: Estate Planning…………………………………………………………………………. 521
Building Your Own Financial Plan ……………………………………………………………………… 523
The Sampsons—A Continuing Case ………………………………………………………………….. 524
Brad Brooks—A Continuing Case ……………………………………………………………………… 525
PART 7 SYNTHESIS OF FINANCIAL PLANNING
Chapter 21 Integrating the Components of a Financial Plan……………… 528
Review of Components Within a Financial Plan……………………………………. 529
Budgeting…………………………………………………………………………………………………………. 529
Managing Liquidity…………………………………………………………………………………………… 530
Personal Financing……………………………………………………………………………………………. 531
Protecting Your Assets and Income……………………………………………………………………. 531
Managing Investments……………………………………………………………………………………… 531
Retirement Planning………………………………………………………………………………………….. 532
Maintaining Your Financial Documents………………………………………………………………. 532
Integrating the Components…………………………………………………………………….. 532
Summary………………………………………………………………………………………………………. 537
Review Questions……………………………………………………………………………………………… 537
Financial Planning Problems……………………………………………………………………………… 538
Financial Planning Online Exercises…………………………………………………………………… 539
Psychology of Personal Finance: Your Financial Plan………………………………………….. 539
Web Search Exercise…………………………………………………………………………………………. 539
Video Exercise: Financial Plan……………………………………………………………………………. 540
Certified Financial Planner Exercise……………………………………………………………………. 540
Building Your Own Financial Plan ……………………………………………………………………… 541
The Sampsons—A Continuing Case ………………………………………………………………….. 543
Financial Literacy Post-Test………………………………………………………………………………………. 545
Appendix A Your Career………………………………………………………………………………………………. 547
Determining Your Career Path…………………………………………………………………… 547
Factors That May Affect Your Career Path…………………………………………………………… 547
Sources of Information That Can Help You Select Your Career Path…………………….. 547
Getting the Skills You Need……………………………………………………………………….. 548
Training……………………………………………………………………………………………………………. 548
Education…………………………………………………………………………………………………………. 548
Internships……………………………………………………………………………………………………….. 549
Decisions About Your Education and Career………………………………………….. 550
How the Economy Can Affect Your Decision……………………………………………………….. 548
Comparative Analysis of Pursuing More Education Versus a Job………………………… 550
Selecting Your School…………………………………………………………………………………. 553
Factors to Consider When Choosing a College……………………………………………………. 553
Commuting versus Going Away to College………………………………………………………… 553
Selecting Your Major…………………………………………………………………………………… 556
Review Course Content……………………………………………………………………………………… 556
Research Possible Career Paths…………………………………………………………………………. 557
Recommendations Based on Self-Testing…………………………………………………………… 557
Conduct Analysis to Compare Majors………………………………………………………………… 557
Continuing Your Education………………………………………………………………………………… 559
Criteria Used to Assess Applicants…………………………………………………………… 560
Your Application……………………………………………………………………………………………….. 560
Your Résumé…………………………………………………………………………………………………….. 560
Using Social Media…………………………………………………………………………………………… 560
Your Interview…………………………………………………………………………………………………… 561
Comparing Job Offers……………………………………………………………………………………….. 561
Changing Your Career…………………………………………………………………………………. 562
Self-Employment………………………………………………………………………………………………. 562
Conclusion…………………………………………………………………………………………………….. 562
Appendix B Projects…………………………………………………………………. 563
Assessing Your Credit…………………………………………………………………………………. 563
Career Planning Project……………………………………………………………………………… 563
Information on Career Planning…………………………………………………………………………. 564
Leasing an Apartment………………………………………………………………………………… 565
Stock Market Project…………………………………………………………………………………… 566
Obtaining Stock Price and Dividend Information………………………………………………… 566
Enter the Stock Information……………………………………………………………………………….. 566
Determine Your Gain over the School Term………………………………………………………… 566
Comparing Your Stock to the General Market…………………………………………………….. 567
Team Project…………………………………………………………………………………………………….. 567
Appendix C Financial Tables…………………………………………………………………………………….. 568
Index…………………………………………………………….. 577
Free Apps for Personal Finance……………………………………………………… 597