UNIT 5 PERSONAL FINANCE

Spending, Saving and Investment

Monetary and Fiscal Policy

Using Credit

Types of Insurance

SPENDING, SAVING AND INVESTMENTRational Decisions and Financial PlanningFinancial Institutions and SavingsHigh returns in exchange for higher risk

RATIONAL DECISIONS AND FINANCIAL PLANNINGCost -benefit analysis - weighing marginal

benefits one receives for each additional unit of money spent.

Delayed gratification - delaying a small benefit now for a greater benefit later.

Our economy bombards us with information as to how to satisfy our wants NOW.

People need to decide how much of their income to spend now, how much to set aside for savings to achieve short-term goals, and how much to use for investments to achieve long-term goals.

RATIONAL DECISIONS AND FINANCIAL PLANNINGSavings - money deposits placed securely

in a ban or financial institution, for later use.

Interest - Money banks pay for the use of your savings.

Investments - money paid into a business with the expectation, (NOT GUARENTEE) of future rewards.

RATIONAL DECISIONS AND FINANCIAL PLANNINGFinancial plan - a set of goals, a process of

achieving those goals, putting your plan into action and setting priorities and making choicesWhat I

WantWhat it Costs

What Can I Do

When Can I Get it

Short Term Goal (Less than 6 months)

Prom Dress $200 Earn and save $20/week from babysitting

10 weeks from now

Long Term Goal (A year or more)

Used Car $2,000 Save $10/week from allowance and get after school job; save $30/week

1 year from now

FINANCIAL INSTITUTIONS FOR SAVINGS Banks Savings and loan Credit unions

FINANCIAL INSTITUTIONS FOR SAVINGSBanks - a corporation that stores deposits

and makes loans to earn a profit.Banks pay simple interest on savings

depositsCertificate of Deposit (CD) - a deposit you

promise to leave in the bank for a specific time - in exchange for a higher interest rate.

The interest a bank pays is always less than it charges its customers, that is how a bank earns money.

FINANCIAL INSTITUTIONS FOR SAVINGS Savings and Loan – gets most of its

deposits from consumers, rather than business, and lends most of its money to home buyers.

With banks the have reserve requirements – certain amount of money needed to be kept on hand

All deposits are insured up to $100,000 by the Federal Deposit Insurance Company (FDIC)

FINANCIAL INSTITUTIONS FOR SAVINGSCredit union – a not for profit financial

institution that is owned and controlled by its members – usually people who work in the same company

Credit union deposits earn interest, and depositors are eligible to borrow money from the credit Union sometimes at lower rates than banks can charge.

HIGHER RISKS = HIGHER RETURNSHierarchy of RiskSavings Account Mutual Fund Individual Stock

Least Risky Most Risky

Three important kinds of investmentsBondsStocksMutual Funds

INVESTMENTSBonds – Loans to corporationsInterest paid on the credit worthiness of

the corporationHave a maturity date – when loan comes

dueCan pay interest all at once or over

periods of timeOnly slightly more risky than savings

accounts because they are backed by company assets

INVESTMENTSStocks – individual ownership shares in a

corporation.Pay the highest rewards because they are

the riskiest. All monies paid on stocks are called dividends – portions of the corporations profits.

Capital Gains – money earned from the sale of assets (stock) when they are sold for a profit.

INVESTMENTSMutual Funds – a pool of money from

many investors and uses a variety of stocks and bonds called a portfolio. Mutual funds pool together low risk low return stocks and bonds with high risk high return stocks and bonds so investors can spread their risk and maximize their earning potential.

WHY DO COMPANIES SELL STOCKS OR BONDS?

Expanding their businessFor new capital resources

Tools, Buildings, etc.For new labor

Hiring more people to work

Stocks – selling ownership of a company Bonds – IOU from a company

TWO TYPES OF STOCK Common Stock (CS)

First stock offered by a companyMany offeredNo benefits (like dividend)

Dividend – money paid to stock holders either monthly or quarterly

Preferred Stock (PS)Has benefits (like dividends)Fewer shares

STOCK SYMBOLS Rather than put an entire company’s

entire name, Exchanges use symbols Examples:

Microsoft – MSFTGeneral Electric – GEHewlett-Packard – HWPHome Depot – HDHarley Davidson – HOG

PARENT COMPANIES Many places that we use are owned by

parent companies Examples:

Cadillac – GMCheerios – General MillsCrest Tooth Paste – Proctor-GambleDuracell – GillettePlay Station – SonyCNBC – General Electric

GATHERING THE INFORMATION

The Stock Prices Its like a Price TagThe price is for one (1) share of the stock Initial Public Offering (IPO) – the first time that a

stock is ever sold. (primary market)When you buy a share of a stock, you are buying it

from another person who is selling the same stock. (secondary market)

THE DOW JONES INDUSTRIAL AVERAGEAKA “THE DOW”

Originally, Charles Dow averaged the top 12 stocks prices This has expanded to 30 companies today Various industries Here they are, how many do you recognize?

• Alcoa Inc. • Altria Group • American Express

Co. • American Int'l

Group • Boeing Co. • Caterpillar Inc. • Citigroup Inc. • Coca-Cola Co. • DuPont Co. • Exxon Mobil Corp. • General Electric Co.

• Honeywell• International Inc. • Hewlett-Packard

Co.• International

Business Machines • Intel Corp.• J.P.Morgan Chase• Johnson & Johnson• McDonald's Corp.• Merck & Co. • Microsoft Corp.

• Pfizer Inc. • Procter & Gamble Co. • SBC Communications

Inc.• United Technologies

Corp.• Verizon

Communications• Wal-Mart Stores Inc. • Walt Disney Co.• Minnesota Mining &

Manufacturing• General Motors Corp. • Home Depot Inc.

INFLATIONHow does inflation effect groups in

society?

HOW INFLATION EFFECTS GROUPS IN SOCIETY. Borrowers (spenders)

Willing to borrow more because $ repaid are not equal to $ borrowed

Inflation causes interest rates to go ______?Expect to pay higher interest rates during

high inflationary times.

HOW INFLATION EFFECTS GROUPS IN SOCIETY. Savers

Hurt in high inflationary times $ invested does not always keep up with

inflation rates Invested money has less purchasing power

than invested money

HOW INFLATION EFFECTS GROUPS IN SOCIETY. Fixed Income People

Hurt the most because they can never catch up to inflation

Maintain same income levels even though they face continuing rising prices

Usually already on the lower side of the economic scales – retired/disabled people, people receiving social security

HOW INFLATION EFFECTS GROUPS IN SOCIETY. COLA (Cost of Living Adjustment)

receiversHurt the least because salary and benefits

are tied to the inflation (Cost of Living) rateUsually a union benefitNot available as much today as in the pastResponsible for increased prices or

decrease in employment because employers pass on losses to consumers

USING CREDITCredit – the ability to obtain goods and

service now, based on an agreement to pay for them later.

Positives – convenience, allow people to enjoy goods and services before they pay for them

Negatives – increases total costs of things, can lead to spiraling debt that can destroy an individual or family’s financial health and future

BECOMING CREDITWORTHYCreditworthy – the ability and likelihood to

pay back on a loan.Collateral – something a bank can take away

if you fail to repay on a loan.Credit history – how well you have managed

your bills and credit in the past. Show how reliable a person is. Shows every bill you have paid and weather if it was paid on time or not as well as how much that person has received in loans. Based on this information you are given a credit score – the higher the score the more creditworthiness you have.

BECOMING CREDITWORTHYCredit history follows you your whole life.It determines:If I can get a loanWhat interest I have to pay on my loanWhat insurance premiums I have to payCan I get that job or not

BECOMING CREDITWORTHYHow do I improve my credit scores1. Pay all bills on time2. Establish a steady work history3. Open a checking account and do not

bounce any4. Buy an item on an Installment Plan –

pay a fixed amount over a specified number of months – and make all payments on time

MAKING WISE CREDIT DECISIONSUnderstand you fixed expenses (expenses

that do not change on a monthly basis) – rent utilities, transportation.

Understand your variable expenses (expenses that change on a monthly basis) how much you usually spend on food entertainment clothes, etc.

Deduct these expenses from your income and see if you have enough left over every month to make your credit payment.

INTEREST RATESInterest – the cost of using credit.Interest Rate – a percentage of the total

amount owed. To compare the cost of different credit options, you need to know the following:

1. Is the interest rate quoted as an annual rate (the amount of interest charged per year rather than per month)

2. Is the interest rate fixed or variable? A fixed rate never changes, a variable rate can go up at any time

3. Is the interest calculated as simple interest or compound interest.

INTEREST RATESSimple Interest – interest charged only on

the original amount of the loan. Example

Loan of $1,000 at 10% interest – One year$1,000 + (.10 x 1,000)=$1,000 +$100

=$1,100If you take two years$1,000 + (.10 x 1,000) + (.10 x

1,000 )=$1,000 +$200 =$1,200

INTEREST RATESCompound Interest – Interest charged not

only on the original amount you borrowed, but on the existing amount you owe.

Take the same loan of $1,000 at 10% interest

Year one$1,000 + (.10 x 1,000)=$1,000 +$100

=$1,100Year Two$1,100 + (.10 x 1,100)=$1,100 +$110

=$1,210

CREDIT CARD INTERESTCredit cards charge an annual fee – a fee

for using the cardCredit cards charge compound interest –

compounded on a monthly basisCredit cards charge a finance charge – a

fraction of the annual interest rate on your monthly balance.

TYPES OF INSURANCEInsurance – a way to provide financial protection

against different kinds of risks we take in life.Insurance Policy – a written agreement between

a person and an insurance company.Coverage Limits – the maximum amount the

company will pay you for your lossDeductible – amount of loss that you must pay

yourself before the company will step in and pay the rest.

Claim – a request for payment of your lossesPremium – the amount of money you pay per

month, quarter or year in order to guarantee you r coverage.

HOW INSURANCE WORKSFactors that control insurance premiums1. Type of insurance – health very

expensive, auto not so expensive2. Amount of coverage – higher the

coverage, the higher the premium3. Amount of deductable – higher the

deductable, lower the premium4. Personal information – age, marital

status, where you live, and credit history

TYPES OF INSURANCECar insurance – states require drivers to

carry car insurance.two typesLiability Insurance – pays for personal injuries and property damages caused by an accidentCollision Insurance – pays for any damage to your own car

TYPES OF INSURANCEHealth Insurance – Insurance pays your

medical bills when you are sick or injured. Cheapest way to receive health insurance is thorough your job, if you are lucky enough to find an employer who offers it.

TYPES OF INSURANCEProperty Insurance – Renters’ or owner’s

insurance helps you replace your belongings in case they are stolen or destroyed.

Homeowners insurance helps protect the value of your belongings as well as the value of your house.

TYPES OF INSURANCEDisability of Insurance – if you suffer an

illness or injury that keeps you from working for an extended period, this insurance will pay you 75% of your monthly income until you recover.

TYPES OF INSURANCELife Insurance – provides money to people you

leave behind when you die.Beneficiary – the person who you want to receive

the money2 TypesTerm Insurance – cheaper insurance that pays a

higher death benefit - you purchase the policy for a period of time. When the time is over you need to buy a new policy usually at a higher price

Whole life Insurance – expensive insurance that pays a lower benefit Provides coverage for your whole life and the premiums never increase. Allows you to borrow or withdraw accumulated cash for emergencies or major expenses.