Personal Finance, Seventh Edition PDF by Jeff Madura

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Personal Finance, Seventh Edition
By Jeff Madura
Personal Finance, Seventh Edition

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
 
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
 
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 
 
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
 
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
 
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
 
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
 
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

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