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chapter 1 notes

  1. 1. Chapter 1 Personal Finance Basics and the Time Value of Money 09/01/09
  2. 2. Why Important <ul><li>Nobody can avoid dealing with personal finance </li></ul><ul><li>People do claim bankruptcy </li></ul>
  3. 3. Chapter 1 Learning Objectives <ul><li>Analyze the process for making personal financial decisions </li></ul><ul><li>Develop personal financial goals </li></ul><ul><li>Assess personal and economic factors that influence personal financial planning </li></ul><ul><li>Determine the personal and financial opportunity costs associated with personal financial decisions </li></ul><ul><li>Identify strategies for achieving personal financial goals for different life situations </li></ul>
  4. 4. The Financial Planning Process <ul><li>Objective 1 : Analyze the process for making personal financial decisions </li></ul><ul><li>Personal Financial Planning is the process of managing your money to achieve personal economic satisfaction </li></ul><ul><li>Advantages of Personal Financial Planning are: </li></ul><ul><li>Increased effectiveness in obtaining, using and protecting financial resources </li></ul><ul><li>Increase control of one’s financial affairs </li></ul><ul><li>Sense of freedom from financial worries </li></ul>
  5. 5. The Financial Planning Process (continued) <ul><li>Six-step procedure for Financial Planning </li></ul><ul><li>Determine your current financial situation. </li></ul><ul><li>Develop your financial goals. </li></ul><ul><li>Identify alternative courses of action. </li></ul><ul><li>Evaluate your alternatives. </li></ul><ul><li>Create and implement your financial action plan. </li></ul><ul><li>Review and revise your plan. </li></ul>
  6. 6. The Financial Planning Process (continued) <ul><li>Step 1 : DETERMINE YOUR CURRENT FINANCIAL SITUATION </li></ul><ul><li>Determine current financial situation regarding income, savings, living expenses, and debts </li></ul><ul><li>Prepare a list of current asset and debt balances and amount spent for various items </li></ul><ul><li>Match financial goals to current income and potential earning power </li></ul>
  7. 7. The Financial Planning Process (continued) <ul><li>Step 2 : DEVELOP YOUR FINANCIAL GOALS </li></ul><ul><li>Identify feelings about money and the reasons for those feelings </li></ul><ul><li>Determine the source of your feelings about money </li></ul><ul><li>Determine the effects of economy on your goals and priorities </li></ul><ul><li>Make sure that your goals are your own and are specific to your situation </li></ul>
  8. 8. The Financial Planning Process (continued) <ul><li>Step 3 : IDENTIFY ALTERNATIVE COURSES OF ACTION </li></ul><ul><li>Possible courses of action can be: </li></ul><ul><ul><li>Continue the same course of action </li></ul></ul><ul><ul><li>Expand the current situation </li></ul></ul><ul><ul><li>Change the current situation </li></ul></ul><ul><ul><li>Take a new course of action </li></ul></ul><ul><ul><li>Creativity in decision making is vital to effective choices </li></ul></ul>
  9. 9. The Financial Planning Process (continued) <ul><li>Step 4 : EVALUATE YOUR ALTERNATIVES </li></ul><ul><li>CONSEQUENCES OF CHOICES </li></ul><ul><ul><li>Opportunity cost - What you give up </li></ul></ul><ul><ul><li>when you make a choice </li></ul></ul><ul><ul><li>The cost or trade-off of a decision cannot always be measured in dollars. Sometimes the cost is your time </li></ul></ul><ul><li>EVALUATING RISK </li></ul><ul><ul><li>Uncertainty is a part of every decision. </li></ul></ul><ul><ul><li>Best way to analyze and minimize risk is to gather information from financial planning sources. (Exhibit 1-3) </li></ul></ul>
  10. 10. The Financial Planning Process (continued) <ul><li>Step 5 : CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN </li></ul><ul><ul><li>Develop an action plan that identifies ways to achieve financial goals </li></ul></ul><ul><ul><li>Possible action plans can be increasing savings, reducing spending, or making provisions for taxes </li></ul></ul><ul><ul><li>To implement action plans you may need assistance from others </li></ul></ul>
  11. 11. The Financial Planning Process (continued) <ul><li>Step 6 : REVIEW AND REVISE YOUR PLAN </li></ul><ul><li>Financial planning decisions need to be assessed regularly </li></ul><ul><li>Complete review should be done at least once a year </li></ul><ul><li>Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals </li></ul>
  12. 12. Developing Personal Financial Goals <ul><li>Objective 2: Develop personal financial goals </li></ul><ul><li>TYPES OF FINANCIAL GOALS can be: </li></ul><ul><ul><li>Influenced by the time frame in which you want to achieve your goals </li></ul></ul><ul><ul><li>Influenced by the financial need that drives your goals </li></ul></ul><ul><li>TIMING OF GOALS </li></ul><ul><ul><li>Short-term, intermediate and long-term goals </li></ul></ul><ul><li>Long term goals should be planned in coordination with short-term and intermediate goals </li></ul><ul><li>GOALS FOR DIFFERENT FINANCIAL NEEDS </li></ul><ul><ul><li>Consumer product goals </li></ul></ul><ul><ul><li>Durable-produce goals </li></ul></ul><ul><ul><li>Intangible-purchase goals </li></ul></ul>
  13. 13. Developing Personal Financial Goals (continued) <ul><li>GOAL-SETTING GUIDELINES </li></ul><ul><li>Goals should be realistic </li></ul><ul><li>Goals should be stated in specific terms </li></ul><ul><li>Goals should have a time frame </li></ul><ul><li>Goals should indicate the action to be taken </li></ul><ul><li>Discuss some of your goals </li></ul>
  14. 14. Developing Personal Financial Goals (continued)
  15. 15. Influences on Personal Financial Planning <ul><li>Objective 3: Assess personal and economic factors that influence personal financial planning </li></ul><ul><li>LIFE SITUATION AND PERSONAL VALUES </li></ul><ul><li>Adult life cycle stage </li></ul><ul><li>Marital status, household size, and employment </li></ul><ul><li>Major events </li></ul><ul><ul><li>Graduation, marriage, career change, children, retirement, etc </li></ul></ul><ul><li>Values </li></ul><ul><ul><li>What values are important to you? </li></ul></ul>
  16. 16. Influences on Personal Financial Planning (continued) <ul><li>ECONOMIC FACTORS </li></ul><ul><li>Forces of Supply and Demand and prices </li></ul><ul><li>Federal Reserve Bank and it’s role in the economy </li></ul>
  17. 17. Influences on Personal Financial Planning (continued) <ul><li>GLOBAL INFLUENCES </li></ul><ul><li>Global marketplace influences financial activities </li></ul><ul><li>Balance of exports and imports </li></ul><ul><li>Foreign investments and their role in the US Money Supply </li></ul>
  18. 18. Influences on Personal Financial Planning (continued) <ul><li>ECONOMIC CONDITIONS </li></ul><ul><li>Consumer The value of the dollar prices changes in inflation </li></ul><ul><li>Consumer The demand for goods and spending services by individuals and households </li></ul><ul><li>Interest rates The cost of money; cost of credit when you borrow; return on your money when you save or invest </li></ul>
  19. 19. Opportunity Costs and the Time Value of Money <ul><li>Object 4: Every financial decision involves giving up something to obtain something else </li></ul><ul><li>PERSONAL OPPORTUNITY COSTS </li></ul><ul><li>Time </li></ul><ul><li>Other personal opportunity costs can be related to health, leisure etc. </li></ul><ul><li>Personal resources like financial resources require careful management </li></ul>
  20. 20. Opportunity Costs and the Time Value of Money (continued) <ul><li>FINANCIAL OPPORTUNITY COSTS </li></ul><ul><li>Time Value of Money </li></ul><ul><li>Increases in an amount of money as a result of interest earned. </li></ul><ul><li>Saving today means more money tomorrow. Spending means lost interest. </li></ul><ul><li>Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile. </li></ul>
  21. 21. Opportunity Costs and the Time Value of Money (continued) <ul><li>INTEREST CALCULATIONS </li></ul><ul><li>Three amounts are required to calculate the time value of money </li></ul><ul><ul><li>Principal </li></ul></ul><ul><ul><li>Interest rates </li></ul></ul><ul><ul><li>Time </li></ul></ul>
  22. 22. Opportunity Costs and the Time Value of Money (continued) <ul><li>COMPUTING SIMPLE INTEREST </li></ul><ul><li>(Amount in savings) x (annual interest rate) x (time period) = (interest) </li></ul><ul><li>For Example: </li></ul><ul><li>$100 x 5% x 1 (1 year) 100 x .05 x 1 = $5.00 In one year you have $100 in principle plus $5.00 in interest for a total of $105 at the end of the year </li></ul>
  23. 23. Opportunity Costs and the Time Value of Money (continued) <ul><li>FUTURE VALUE OF A SINGLE AMOUNT </li></ul><ul><li>Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period </li></ul><ul><li>Future value is also call compounding - earning interest on previously earned interest </li></ul><ul><li>FUTURE VALUE OF A SERIES OF DEPOSITS </li></ul><ul><li>Future value can be computed for a single amount or for a series of deposits called annuities </li></ul>
  24. 24. Opportunity Costs and the Time Value of Money (continued)
  25. 25. Opportunity Costs and the Time Value of Money (continued) <ul><li>PRESENT VALUE OF A SINGLE AMOUNT </li></ul><ul><li>Present Value is the current value of a future amount based on a certain interest rate and a certain time period </li></ul><ul><li>Present value calculations are also called discounting </li></ul><ul><li>The present value of the amount you want in the future will always be less than the future value (See Exhibit 1-8C) </li></ul><ul><li>PRESENT VALUE OF A SERIES OF DEPOSITS </li></ul><ul><li>Present value can be computed for a single amount or for a series of deposits (See Exhibit 1-8D) </li></ul>
  26. 26. Achieving Financial Goals <ul><li>Objective 5: Identify strategies for achieving personal financial goals different life situations </li></ul><ul><li>COMPONENTS OF PERSONAL FINANCIAL PLANNING </li></ul><ul><li>Obtaining (chapter 2) </li></ul><ul><li>Planning (chapters 3, 4) </li></ul><ul><li>Saving (chapter 5) </li></ul><ul><li>Borrowing (chapters 6, 7) </li></ul><ul><li>Spending (chapters 8, 9) </li></ul><ul><li>Managing risk (chapters 10-12) </li></ul><ul><li>Investing (chapters 13-17) </li></ul><ul><li>Retirement and estate planning (chapters 18, 19) </li></ul>
  27. 27. Achieving Financial Goals (continued) <ul><li>DEVELOPING A FLEXIBLE FINANCIAL PLAN </li></ul><ul><li>A financial plan is a formalized report that... </li></ul><ul><ul><li>Summarizes your current financial situation </li></ul></ul><ul><ul><li>Analyzes your financial needs </li></ul></ul><ul><ul><li>Recommends future financial activities </li></ul></ul><ul><li>Your financial plan can be created by you, with assistance from a financial planner, or made using a money management software package </li></ul>
  28. 28. Achieving Financial Goals (continued) <ul><li>IMPLEMENTING YOUR FINANCIAL PLAN </li></ul><ul><li>Develop good financial habits </li></ul><ul><ul><li>Use a well conceived spending plan to help you stay within your income, while allowing you to save and invest for the future </li></ul></ul><ul><ul><li>Have appropriate insurance protection to prevent financial disasters </li></ul></ul><ul><ul><li>Become informed about tax and investment alternatives </li></ul></ul>

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