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# Financial Literacy

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Financial freedom is the direct result of the smart decisions you make with your money. This presentation teaches you a few simple financial concepts. By learning these simple concepts you can take …

Financial freedom is the direct result of the smart decisions you make with your money. This presentation teaches you a few simple financial concepts. By learning these simple concepts you can take control of your financial life.

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• 1. 1
• 2. A few simple concepts… Interest Taxes Rates Loans & Insurance Debt Assets Credit …is all you need to learn ©Copyright 2010 Outflyers™.com, all rights reserved. 2
• 5. Interest Rates  Interest is a fee paid to borrow or “rent” money. When you borrow from someone, you pay this fee. When you lend money like depositing in a saving account, you earn this fee.  There are two types of interest: simple and compound. ©Copyright 2010 Outflyers™.com, all rights reserved. 5
• 6. Simple Interest  Simple interest is only calculated on the unpaid portion of the principal amount borrowed, NOT on unpaid interests accrued on it.  The formula to calculate simple interest is: where I is interest, r is interest rate and P is principal amount. ©Copyright 2010 Outflyers™.com, all rights reserved. 6
• 7. Compound Interest  Compound interest is calculated on the unpaid principal amount borrowed PLUS on any unpaid interest accrued on it.  The formula to calculate compound interest is: where I is interest, r is interest rate, P is principal and n is number of compounding periods. ©Copyright 2010 Outflyers™.com, all rights reserved. 7
• 8. Compounding Effect  Suppose you borrow \$5,000 at the beginning of the year to pay back at the end of the year from (a) a friend with 12% simple interest (b) on your credit card with a %12 interest rate (APR) compounded monthly. The interest is: (a) (b) ©Copyright 2010 Outflyers™.com, all rights reserved. 8
• 9. Fixed & Variable Rates  Fixed interest rates are set when you borrow and don’t change during the life of the loan.  Variable or adjustable rates are subject to change as their reference rate changes. Two reference rates are commonly used:  Prime: for example “Prime + 4.75%”  LIBOR: for example “1 Year LIBOR + 3.25%” ©Copyright 2010 Outflyers™.com, all rights reserved. 9
• 10. Inflation  Inflation is the rise in the general level of prices of goods and services over a period of time, usually a year.  Your cash loses its purchasing power by the inflation rate just like a negative compound interest rate.  If you have P dollars today, it is worth: after n years if annual inflation rate is i (a constant). ©Copyright 2010 Outflyers™.com, all rights reserved. 10
• 11. APR  Annual Percentage Rate or APR is not the real rate that you pay on your loans. It is monthly interest rate times 12.  To convert APR to Effective APR or the real interest rate that you will pay on a loan use this formula: Use Effective APR just like r or compound yearly interest rate. ©Copyright 2010 Outflyers™.com, all rights reserved. 11
• 13. Loans  Loans fall into two main categories:  Secured: you pledge a collateral to get a loan such as mortgages and auto loans.  Unsecured: you get the loan without any collateral e.g. unsecured credit card debt and student loans.  If you default on a secured loan, the creditor will assume the ownership of the collateral. ©Copyright 2010 Outflyers™.com, all rights reserved. 13
• 14. Loans  The most common types of the loans are:  Mortgage Loans  Auto loans  Student loans  Credit card loans  Home equity loans  Equipment leasing ©Copyright 2010 Outflyers™.com, all rights reserved. 14
• 15. Common Characteristics of Loans  Loan and grace periods: Loan period is the total duration of the loan. It might be as short as one month for credit card debt or as long as 30 years for home mortgages. Grace period is a period of time in which someone is late with a payment, but penalties are not incurred. For example, credit cards have a typical 21 to 25 days grace period, which starts when your statement is issued. ©Copyright 2010 Outflyers™.com, all rights reserved. 15
• 16. Common Characteristics of Loans  Interest rate: A loan might have a fixed or variable interest rate. A variable interest rate might change considerably during the loan period, especially for longer- term loans. If your interest rate changes, your monthly payment will also change and might increase considerably. Also, the lender may increase your interest rate significantly if you miss a payment. ©Copyright 2010 Outflyers™.com, all rights reserved. 16
• 17. Common Characteristics of Loans  Repayment schedule: A loan may have fixed repayment schedule which means you pay fixed installments over the repayment period, for example \$5,00 per month for two years. Or a loan may have graduated repayment schedule starting with lower installments that increase after a period, for example you may pay \$200 for the first six months and then your installments increase to \$700. ©Copyright 2010 Outflyers™.com, all rights reserved. 17
• 18. Common Characteristics of Loans  Security: Security is what you pledge to the lender as collateral. For mortgages, it is the house itself and for auto loans, it is the car. If you default on your loan, the lender will take over the ownership of your collateral.  Pay attention to these four characteristics and other fees and conditions when you apply for a loan. They should be 100% known to you before you commit to anything. ©Copyright 2010 Outflyers™.com, all rights reserved. 18
• 19. Mortgage Loans  Mortgages are the loans for home buyers to purchase a property which is used as the collateral for the loan.  Home buyers can usually borrow up to 80% of the home value based on their credit history and income.  Mortgages can have fixed or variable interest rates and their duration varies from 15 to 30 years.  borrowers need to submit several documents including their credit history and home value appraisal to secure a mortgage. ©Copyright 2010 Outflyers™.com, all rights reserved. 19
• 20. Auto Loans  Auto loans are usually offered by financing units of car companies and have a duration of 36, 48, or 60 months.  The car is the collateral of the loan and the buyer usually is expected to pay a down payment in addition to dealer fees and sales tax as soon as the loan is approved.  The car needs to be insured for the duration of the loan. ©Copyright 2010 Outflyers™.com, all rights reserved. 20
• 21. Student Loans  Student loans are offered to pay for educational expenses, and to qualify for them, the borrower needs to have been admitted to an accredited, degree-awarding program.  Federal student loans in the U.S. can have fixed interest rates, but private student loans have variable interest rates.  The borrower usually doesn’t need to start paying back the loan while he is in college. ©Copyright 2010 Outflyers™.com, all rights reserved. 21
• 22. Credit Card Loans  Credit card companies usually treat any unpaid balances on a credit card as a loan with credit card APR.  Credit card loans generally have very high variable interest rates which can be bumped up significantly if a payment is missed.  Pay attention to the credit card APR and fees when you apply for one and never carry a credit card debt. ©Copyright 2010 Outflyers™.com, all rights reserved. 22
• 23. Home Equity Loans  Home equity loan is a loan that you receive from a bank by putting your home as collateral.  They are like mortgages but the home is not actually being bought or sold. ©Copyright 2010 Outflyers™.com, all rights reserved. 23
• 24. Equipment Leasing  In equipment leasing, an actual equipment such as a truck or a computer equipment is loaned or rented for a series of payments.  Lease agreements might have fixed or renewable period and the borrower may have the option of purchasing the equipment at the end of the lease period at a predefined price.  Most common types of leases are home rents and car leases. ©Copyright 2010 Outflyers™.com, all rights reserved. 24
• 25. Loan Calculations  Regardless of the type of the loan, if the interest rate, period, and principal amount are known, the periodical (usually monthly) payments can be calculated using this formula: P is the periodical payment, L is the principal, r is the interest rate and n is the number of periods. ©Copyright 2010 Outflyers™.com, all rights reserved. 25
• 26. Loan Calculations  Suppose you have got \$10,000 with an APR of 6% (0.5% per month) to pay back in 10 years (120 months). Your monthly payment will be:  Over the life of the loan, you will totally pay: ©Copyright 2010 Outflyers™.com, all rights reserved. 26
• 29. Credit History  Financial institutions report how you use or misuse your credit to the credit bureaus.  Sometimes credit histories might contain errors. Because it has such a big impact on your life, you had better monitor your credit history regularly.  You can get a free copy of your credit records per year from here: http://www.annualcreditreport.com/ ©Copyright 2010 Outflyers™.com, all rights reserved. 29
• 30. Credit Score  Credit score is a number representing the creditworthiness of a person or the likelihood that he will pay his debts  Credit score in the United States ranges from 300 to 850 with a credit score more than 750 considered excellent. POOR WEAK FAIR GOOD EXCELLENT 300 620 660 720 750 850 ©Copyright 2010 Outflyers™.com, all rights reserved. 30
• 31. Credit Score  Credit score is calculated from five categories of data in your credit report. Payment History (35%) Amounts Owed (30%) Length of Credit History (15%) New Credit (10%) Types of Credit Used (10%) ©Copyright 2010 Outflyers™.com, all rights reserved. 31
• 32. Improving Credit Score  Pay your bills on time. If you have missed a payment, get and stay current.  If you are having problem making ends meet, consult with a financial counselor.  Keep balances low on your credit cards. Pay your credit card bills in full every month.  Don’t open too many credit cards in a short period of time.  Use your credit cards from time to time. ©Copyright 2010 Outflyers™.com, all rights reserved. 32
• 35. Assets  In addition to cash, real estate, and equipments, these four classes of assets are commonly owned by individuals for investing or retirement saving:  Public companies stocks  Governmental and corporate bonds  Options  Exchange traded funds (ETF) ©Copyright 2010 Outflyers™.com, all rights reserved. 35
• 36. Trading Assets  In order to trade these four classes of assets, you will need to open an investment account with a brokerage firm.  Most brokerage firms don’t charge a fee to open an investment account. You are charged only when you buy or sell assets.  In the U.S., you need to have a valid social security number to open an investment account . ©Copyright 2010 Outflyers™.com, all rights reserved. 36
• 39. Stocks  Stock of a publicly traded company represents its value in the market or its market cap.  Stock of a company is divided to a number of shares that can be bought in the stock market if it is a public company.  When you buy a number of shares of a company, you will become one of its shareholder. You will own a piece of that company and are entitled to a portion of all its future revenues. ©Copyright 2010 Outflyers™.com, all rights reserved. 39
• 40. Stocks  Some companies pay out a portion of their profits, called dividend, to their shareholders every year.  Share prices fluctuate on the stock market every day during trading hours. Share of a company goes up if investors expect its profit will increase in future and vice versa.  You can see live share prices at http://google.com/finance ©Copyright 2010 Outflyers™.com, all rights reserved. 40
• 42. Common Characteristics of Stock  Every public company has a unique symbol on the stock market called the ticker. For example, the ticker of General Electric is GE, and the ticker of Wall Mart is WMT.  Other information you will find on the stock charts are:  Day trading range: the range between the lowest and the highest price on the trading day.  52 week hi & low: the lowest and the highest price in the past 52 weeks ©Copyright 2010 Outflyers™.com, all rights reserved. 42
• 43. Common Characteristics of Stock  Opening and closing prices: opening and closing price of the trading day.  Trading volume and average volume: the number of traded shares of that specific stock during the trading day and the average trading volume per day.  Market cap: the total value of all shares of the company in the market. ©Copyright 2010 Outflyers™.com, all rights reserved. 43
• 44. Common Characteristics of Stock  P/E: price per earning, current share price divided by the company’s profit per share in the past year. It basically means how much you have to pay to buy one dollar of the company’s profit if you buy its shares at the current price.  Dividend & yield: the amount of the dividend that the company pays for every share you hold in a year and its percentage of current share price. ©Copyright 2010 Outflyers™.com, all rights reserved. 44
• 45. Common Characteristics of Stock  EPS: earning per share, how much profit the company has had in the past year for each of its shares.  Shares: the number of company’s shares.  Beta: How fast the share price of the company moves comparing to the market average.  Institutional ownership: what percentage of the company is owned by institutions like pension funds rather than individuals. ©Copyright 2010 Outflyers™.com, all rights reserved. 45
• 46. Stock Indexes  A stock index is an average of the prices of a certain number of stocks in the stock market which shows the overall direction of the market. This average is usually weighted by the market cap of each company included in it.  The most famous stock indexes in the U.S. are:  Dow Jones Industrial Average (DJIA): contains 30 of the largest and most influential companies in the U.S. DJIA is not weighted. ©Copyright 2010 Outflyers™.com, all rights reserved. 46
• 47. Stock Indexes  Standard & Poor’s 500 (SPX): contains 500 of the mostly- held companies in the U.S. and is usually seen as the benchmark of the U.S. stock market.  NASDAQ Composite Index (NSAD): contains all companies that are traded on NASDAQ stock exchange. It mostly contains technology stocks. ©Copyright 2010 Outflyers™.com, all rights reserved. 47
• 48. Bonds  Bonds are promissory notes issued by governments or companies to borrow money. When you buy a bond, you actually lend your money to its issuer to receive it back at some time in future (maturity date) plus some interest.  Bonds are considered safer investment than stocks and their prices are less volatile than stock prices. ©Copyright 2010 Outflyers™.com, all rights reserved. 48
• 49. Bonds  Bonds may be issued by:  National governments - in the U.S. by the U.S. Treasury  State and local governments, which are called muni  Corporations  U.S. government bonds are divided into three categories:  Treasury bills: maturity date up to one year  Treasury notes: maturity date between one and ten years  Treasury bonds: maturity date more than ten years ©Copyright 2010 Outflyers™.com, all rights reserved. 49
• 50. Common Characteristics of Bonds  Face or par value: is the amount of money a holder will receive back once a bond matures. This is not the price one pays to buy a bond. Bonds may be sold more than their face value (at a premium) or less than their face value (at a discount). Corporate bonds usually have a face value of \$1,000.  Coupon: is the amount the bondholder will receive as interest payments usually as a percent of its face value per year. A bond with no coupon payments is called zero-coupon. ©Copyright 2010 Outflyers™.com, all rights reserved. 50
• 51. Common Characteristics of Bonds  Maturity: is the future day on which the investor's principal (bond face value) will be repaid.  Issuer: the institution that has issued the bond. U.S. government bonds are considered very safe. Other bonds are less safe than Treasury bonds. Three rating agencies in the U.S. rate bonds. These rates range from AAA to D. Bonds with rating lower than BBB are called junk bonds which means investing in them have the risk of losing your money. ©Copyright 2010 Outflyers™.com, all rights reserved. 51
• 52. Common Characteristics of Bonds  Yield: is yearly total of coupons (interest) paid divided by the face value of the bond. It is actually the rate of return on the money you have lent.  When the prevailing interest rate in the economy (Prime Rate in the U.S.) goes up the prices of bonds fall and vice versa. Also price of a bond has inverse relationship with its current yield (yearly interest divided by current price). ©Copyright 2010 Outflyers™.com, all rights reserved. 52
• 53. Options  Option is a contract that gives you the right to buy or sell shares of an underlying stock at a predefined price (strike price) on or before a specific date (expiration date).  There are two categories of options:  Call options: give you the right to buy shares  Put options: give you the right to sell shares  You can buy or sell both call and put options even if you don’t own the underlying stock. ©Copyright 2010 Outflyers™.com, all rights reserved. 53
• 54. Option Symbols CVX 01/21/2012 80 P VZ 01/21/2011 22.5 C I II III IV I II III IV I. Underlying stock, most of the times its ticker with one or two additional letters II. Expiration date III. Strike price IV. Option type (put or call) ©Copyright 2010 Outflyers™.com, all rights reserved. 54
• 55. ETFs  ETFs are investment funds managed by professional investors that can be traded on the stock market just like stocks.  ETFs may invest in stocks, bonds, options, currencies, or commodities.  For those who are not professional investors and don’t actively manage their investments, ETFs might be a good alternative.  Many ETFs can also be bought directly from the fund company or through brokerages with no fees. ©Copyright 2010 Outflyers™.com, all rights reserved. 55
• 56. ETFs  Many ETFs have been designed to track a specific index such as iShares S&P 500 Index (IVV) or Vanguard Total Stock Market Index (MUTF:VTSMX).  Pay attention to the expenses that ETFs charge you before investing in them.  The 1, 3, and 5 year return numbers advertised by ETFs can be very misleading. Don’t rely on these numbers alone when deciding to invest in an ETF. ©Copyright 2010 Outflyers™.com, all rights reserved. 56
• 58. Insurance  Insurance takes care of the risks that you cannot cover by your own financial means if they affect you for a (usually) monthly payment which is called premium.  Most common types of insurances for individuals are:  Property or home insurance  Auto insurance  Health insurance  Life insurance ©Copyright 2010 Outflyers™.com, all rights reserved. 58
• 59. Property Insurance  Property or home insurance provides protection against most risks to property, such as fire, theft and some weather damage.  Typical home insurances exclude some perils such as earthquake, flood, and war, but you can separately purchase specific insurances for them. ©Copyright 2010 Outflyers™.com, all rights reserved. 59
• 60. Types of home Insurances  The typical home insurance policies in the U.S. are:  HO1 – Basic: It covers 11 listed perils including fire and lighting, windstorm, vandalism, theft, damage from car or aircraft, and personal liability. It excludes earthquake and flood.  HO2- Broad: It covers 17 listed perils including all 11 covered by HO1. ©Copyright 2010 Outflyers™.com, all rights reserved. 60
• 61. Types of home Insurances  HO3 – Special: It is the most comprehensive coverage for single-family homes. It covers everything that is not explicitly excluded.  HO4- Renter’s insurance: It is for the tenants of a home not the homeowners.  HO5- Premier: It includes all coverage in HO3 plus some more. If the cause of a loss is not specifically excluded in the policy, it is covered. ©Copyright 2010 Outflyers™.com, all rights reserved. 61
• 62. Types of home Insurances  HO6 – Condominium: this type of policy is for owners of condominium.  HO8 – Older houses: this type of policy is for the owner- occupied older homes. ©Copyright 2010 Outflyers™.com, all rights reserved. 62
• 63. Auto Insurance  Auto insurance is purchased for cars, trucks, and other vehicles to provide protection against losses incurred as the result of traffic accidents and against the liability that can be incurred in an accident.  Liability insurance is mandatory in most states and the driver needs to carry the poof of insurance in his car all the time. ©Copyright 2010 Outflyers™.com, all rights reserved. 63
• 64. Auto Insurance Terms  Liability coverage: provides coverage for bodily injury (BI) or property damage (PD) for which the insured driver is at fault.  Collision coverage: provides coverage for the insured vehicle damages in an accident, subject to a deductible. When you rent a car, this coverage is called Collision Damage Waiver (CDW) or Loss Damage Waiver (LDW). ©Copyright 2010 Outflyers™.com, all rights reserved. 64
• 65. Auto Insurance Terms  Comprehensive coverage: provides coverage for the insured vehicle that is damaged by incidents not considered collisions such as fire, theft, vandalism, and weather, subject to a deductible.  Full coverage: collision and comprehensive coverage together.  Loss of use coverage: pays for rental expenses when the insured vehicle is repaired due to a covered loss. ©Copyright 2010 Outflyers™.com, all rights reserved. 65
• 66. Auto Insurance Terms  Uninsured motorist coverage: provides coverage if an at- fault driver involved in an accident either does not have insurance or has less than enough insurance.  Loan/lease payoff coverage: pays for the difference of the amount the owner of the insured vehicle owes on his auto loan or lease and the coverage from his auto insurance if the car is damaged beyond economical repair. ©Copyright 2010 Outflyers™.com, all rights reserved. 66
• 67. Auto Insurance Terms  Roadside assistance coverage: provides coverage for tows that are related to mechanical breakdowns, flat tires, and gas outages.  Personal property coverage: provides coverage for personal items in a vehicle damaged due to an accident and are not attached to the vehicle and thus are not covered by the principal insurance. ©Copyright 2010 Outflyers™.com, all rights reserved. 67
• 68. Health Insurance  Health insurance plans vary widely in different countries. In the United States, health insurance is usually provided by employers or individuals buy it from private insurers. State- provided health insurance is only available to the retired and low-income families (Medicare and Medicaid).  In some other countries, the state provides basic health insurance and additional insurance can be bought from private insurers. ©Copyright 2010 Outflyers™.com, all rights reserved. 68
• 69. Health Insurance Terms  Premium: the monthly payment that the insured individual or his employer pays for the health insurance.  Deductible: the amount that the insured individual has to pay out of his pocket before the insurer pays its share. The insurance actually starts paying if healthcare costs exceed its deductible amount.  Co-payment: the amount that the insured individual has to pay for each doctor visit or service out of his pocket.  Exclusions: services that are not covered by the insurance policy. ©Copyright 2010 Outflyers™.com, all rights reserved. 69
• 70. Health Insurance Terms  Coinsurance: the percentage of the total healthcare costs that the insured individual is responsible for, instead or in addition to co- payment.  Coverage limit: The maximum healthcare costs that the insurer pays in any case.  Out-of-pocket maximum: The maximum amount the insured individual has to pay for his healthcare costs under insurance plan.  In-network provider: A healthcare provider, such as a doctor or hospital, that is preferred or allowed by the insurer. ©Copyright 2010 Outflyers™.com, all rights reserved. 70
• 71. Life Insurance  Life insurance is a contract between the policy owner and the insurer whereby the insurer agrees to pay a sum of money to the beneficiaries if the insured individual dies or becomes critically ill.  In life insurance the policy owner and the insured individual might be different persons.  Three important factors that affects life insurance premiums are age, gender, and use of tobacco. ©Copyright 2010 Outflyers™.com, all rights reserved. 71
• 72. Types of Life Insurance  Term insurance: provides life insurance coverage for a specified number of years for example 10, 20, or 30 years in exchange for a specified premium.  Permanent Life Insurance: is a type of life insurance that remains in effect until the policy matures and pays out. The policy cannot be canceled by the insurer except for fraud in the application. ©Copyright 2010 Outflyers™.com, all rights reserved. 72