Personal Finance Overview

People’s income, in part, reflect choices they have made about education, training, skill development, and careers. People with few skills are more likely to be poor.

There are two methods for classifying how income is distributed in a nation—the personal distribution of income and the functional distribution of income.

GovernmentGovernment often redistribute income directly when individuals or interest groups are not satisfied with income distribution resulting from markets.

Transfer payments can be cash or in-kind (noncash) benefits (such as food stamps, housing subsidies, or gifts between friends and family members).

Government also redistribute income indirectly as side-effects of other government actions that affect prices or output levels for various goods and services.

IncomeThere are four basic categories of income: wages, rent, interest, and profit (corporate or proprietors income).

The majority of income earned in the U.S. is from wages and salaries—income earned working for an organization not owned by the worker). The smallest amount of income is earned from rental income.

Personal Finance Economics SSEPF1 The student will apply rational decision making to personal spending and saving choices.  a. Explain that people respond to positive and negative incentives in predictable ways.  

b. Use a rational decision making model to select one option over another.  

c. Create a savings or financial investment plan for a future goal.

 

Rational Decision Making

A framework for understanding and often formally modeling social and economic behavior. Rationality, interpreted as "wanting more rather than less of a good", is widely used as an assumption of the behavior of individuals in microeconomic models and analysis and appears in almost all economics textbook treatments of human decision-making.

In short, this simply means that an individual acts as if balancing costs against benefits to arrive at action that maximizes personal advantage (choose the alternative that best meets your criteria).

a. Explain that people respond to positive and negative incentives in predictable ways.

• People will decide to perform an act if offered a positive incentive– Ex. Complete chores for an allowance

• People will decide not to perform a task if offered a negative incentive

- Ex. Most people do not commit crimes because of the fear of going to jail

Rational Decision Making Model

Alternatives

Choice 1 Choice 2Benefits ----- -----

Decision ----- -----

Opportunity Cost Choice 2 Choice 1Benefits Forgone Benefits of choice 2 Benefits of choice 1

Ex. (riding the bus rather than riding with an unreliable friend to school/work).

Remember, people are motivated by incentives (positive = reward; negative = punishment).

b. Use a rational decision making model to select one option over another.

Decision making model Alternative Alternative

Choice 1- Sleep late Choice 2 –wake up early to study

Benefits Enjoy more sleep

Have more energy during the day

Better grade on test

Teacher and parental approval

Personal satisfaction

Decision Sleep late wake up early to study

Opportunity Cost Extra study time Extra sleep time

Benefits Forgone Better grade on test

Teacher and parental approval

Personal satisfaction

Enjoy more sleep

Have more energy during the day

c. Create a savings or financial investment plan for a future goal.

What I want What It Costs What I Can Do When I Can Get It

Short-Term Goal (achievable in 6 months or less)

Prom dress $200 Earn and save $20/ week from baby sitting

10 weeks from now

Long- Term Goal (takes a year or more to save for)

Used car $2000 Save $10/week from allowance and get after-school job; save $30/week

1 year from now

QUESTIONS FOR REVIEW

1. Ted wants to be a doctor. He also wants to buy a brand new car. Since both medical school and the new car are very expensive, Ted cannot afford to do both. If Ted decides that the benefits of going to medical school will ultimately outweigh the gratification of buying a new car, then the MOST rational thing Ted can do is

A. Use the money for medical school.B. Invest the money in bonds.C. Buy the car.D. Avoid using the car as a trade-off.

Ans: A

2. Rikki just about to complete high school. Before graduation her parents tell her that, since she was a little girl, they have been saving money to give her when she graduates. Rikki learns, upon graduation, she will receive $50,000. Rikki must now decide what is next for her in the future. Which would be the MOST rational thing for Rikki to do?

A. Use the money to by the awesome new sports car she desperately wants, then work her way through college.

B. Use the money to by the awesome new sports car and get college loans to pay for her education.

C. Use the money to pay for college and continue to drive her old used car.

D. Use the money to pay a part of her college tuition and a

down payment on the car and find a job to in order to make payments on both her college tuition and car payment. Ans. C

SEPF2 The student will explain that banks and other financial institutions are businesses that channel funds from savers to investors.

a. Compare services offered by different financial

institutions.

b. Explain reasons for the spread between interest

charged and interest earned.

c. Give examples of the direct relationship between risk

and return.

d. Evaluate a variety of savings and investment options;

include stocks, bonds, and mutual funds.

“The Bank”

• Place to store money• Kept in checking and savings deposits• Also store other valuables: jewels,

stocks, documents (safety deposit boxes in vault)

• Offers LOANS: mortgage, credit cards, car, personal, business, …. etc.

• Interest creates a RETURN, yet still includes RISK!!!

Sources of Loans & Credit• Types of Financial Institutions Include

…..

1) Commercial Banks: accept deposits & lend $; transfer funds among banks, businesses and individuals: today control largest amount of $ and offer widest range of services.

2) Credit Unions: formed by employees; owned & operated by its members to provide low-interest loans only to its members.

3) Savings and Loan Association: similar to commercial bank (deposits & loans); originally called “building societies” for purpose of home building.

4) Savings Bank: similar to S & L’s in that most of their business comes from savings and home loans; originally created to serve the “small saver” overlooked by large banks.

5) Consumer Finance Companies: take over contracts for installment debts from stores and add fees for collection; PLUS …often used by people unable to obtain credit from other routes; higher interest rates!

QUESTIONS FOR REVIEW

1. Which of the following types of institutions will allow for both deposits and lending money. It also controls the largest amount of money and offers the widest range of services today?

A. Commercial Banks C. Credit UnionsB. Consumer Finance companies D. Savings Bank

2. What is the difference between a Credit Union and a Commercial Bank?

A. Credit Unions are owned and operated by its members to offer higher interest rates on loans than Commercial Banks.

B. Credit Unions are safer than Commercial Banks.C. Credit Unions are owned and operated by its members

to offer lower interest rates on loans than Commercial Banks.

D. Credit Unions are insured by the Federal Government to insure deposits and Commercial Banks are not.

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3. Frankie and Suzy are married and are planning to build a home. Both have only been working in their job for 4 years, where should they try to get a loan to build their home?

A. Credit Union C. Bank of AmericaB. Laurens Savings & Loan D. EZ Credit

4. John needs cash fast and does not have a job but owns a 2005 Ford Mustang. Where would John most likely get the cash he needs without having to verify most of his current income?

A. Local Commercial Bank C. Title MaxB. Heartland Mortgage Co. D. Credit Union

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“Reserve” Requirement

• Federal Reserve system requires banks to keep certain amounts of money on hand

• A percentage of total deposits

• Current Reserve Requirement =

10 % of value of all checking and

savings accounts

Channeling Funds from Savers to Investors

• Banks and other Financial Institutions are BUSINESSES that channel funds from the people who “save” money to people who “borrow” for investment purposes.

• Can you think of a situation where this would happen?? _____________________________

Savers Include …

• People seeking to save money through a variety of means. How??

• Buying government securities such as bonds (regularly offered) by investing in them the investor is offered interest

• Buying corporation stock in exchange for ownership in the company.

• Investing in mutual funds pooling monies to increase purchasing power.

Investors Include …People seeking to earn more (future) money through

an

investment of present money.

• Stocks: ownership in a company (offered dividends as a form of payment that might not be guaranteed).

• Bonds: government securities (lent money out to be paid interest on the loan).

• Mutual Funds: a collection of investments (money combined with others and managed by one group to increase purchasing power and profits).

• Business Start-Up: entrepreneurship

The Relationship Between “Risk” and “Return”

• Risk: chance taken that money loaned will be repaid by borrower

• Return: amount received through repayment of original loan PLUS INTEREST

• Many loans are insured by …COLLATERAL it is often property.

Examples of Risk and Reward

Investment Income Generated

Growth Potential

Risk Level

Savings Very steady Good Low risk (based on interest rates)

Stocks Variable (up and down with stock market)

Good (in a good economy)

High to moderate risks

Bonds Very steady Little or none (but guaranteed to be paid and maturity date)

Low risk and the safest

Mutual Fund Variable (up and down with stock market)

Combined with your invest-ment/Good

Low to variable risks

QUESTIONS FOR REVIEW

1. Which of the following will allow for good profit returns if the economy is functioning at high level?

A. Mutual funds C. StocksB. Savings D. Bonds

2. Which sentence describes the risks and returns of investing in stocks?

A. They offer the lowest risks and the lowest potential returns.

B. They offer the highest risks and the highest potential returns.

C. They offer the lowest risks, but the highest potential returns.

D. They offer the highest risks, but the lowest possible return.

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Difference Between“Interest Charged” and “Interest Earned”

• Why? = profit for bank as a business• Interest Rate: the percentage amount of

payment by borrowers to the lender.– Interest Charged: is determined on a loan amount or

credit account by the lender (lender makes profit).– Interest Earned: is determined on a savings,

checking, etc. once your money is deposited and the bank owes you (depositor makes profit).

• Two types: Compound Interest rate and Simple Interest rate; Compound is greater than Simple rate.

Questions for Review1. Juan goes to the Southern Union Bank to get a loan. Juan has an account at the bank on which he receives 2.2% annual interest. Which of the following can be said of the rate of interest he will pay on the loan that he takes out?

A. It will be lower than 2.2%.B. Nothing can be known about it, because he has

not yet applied.C. It will be higher than 2.2%.D. He will be denied the loan.

2. On which of the following loans would one be MOST LIKELY to pay the highest interest rate?

A. A home mortgage loanB. An automobile loanC. A credit cardD. A student loan for college

Ans: C

Ans: C

SSEPF3 The student will explain how changes in monetary and fiscal policy can have an impact on an individual’s spending and saving choices. a. Give examples of who benefits and who

loses from inflation. b. Define progressive, regressive, and proportional taxes. c. Explain how an increase in sales tax

affects different income groups.

Types of Income Taxes

1. Progressive tax—the tax rate increases as income increases, meaning the wealthy pay a higher percentage of their earnings than people less well off (ex. U.S. personal income tax); tends to reduce inequalities in income.

2. Regressive tax— people with lower income tend to pay a larger proportion, or percentage of their income that people with higher income; the tax rate decreases as income increases (ex. sales tax). Most sales taxes are imposed by state governments.

3. Proportional tax—known as a flat tax, does not change with respect to changes in income (does not redistribute income from one social class to another).

Sales Tax and Inflation Sales Tax• A regressive tax because

it affects the lower income people with regard to a great proportion of their income going to pay taxes.

• To protect this, necessities (such as food, clothing, and medicines) are put in place to be often sold tax free.

• The alternative is excise tax or “sin tax” on items such as alcohol and tobacco.

Inflation• Simply stated, the

rising in prices. When inflation is high the purchasing power of the dollar declines.

• The individuals with lower income suffer from this due necessities of basic living cost.

• Some union workers have contracts with their employers to receive cost-of-living adjustments to counter the increasing in prices.

Questions for Review

1. The BEST example of a regressive tax in the United States isA. Personal income taxes. C. Luxury taxes.B. Sales taxes. D. Property taxes.

2. Susan earns $70,000 annually and pays a tax of $8,500. John earns $30,000 during the same period and pays taxes of $2,500. The tax they both paid was a

A. Proportional tax. C. Progressive tax.B. Regressive tax. D. Marginal tax.

3. How does high inflation cost affect consumer spending and saving?

A. Consumers save more and spend less.B. Consumers spend more and save less.C. Consumers decrease both spending and

savings.D. It has no effect on spending or saving.

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SSEPF4 The student will evaluate the costs and benefits of using credit.  a. List factors that affect credit worthiness.  b. Compare interest rates on loans and credit cards from different institutions.  c. Explain the difference between simple and compound interest rates.

Credit Cards: Buy Now, Pay Later Credit: Who needs it????

• The ability to obtain goods and services now, based on an agreement to pay for them later.

• Includes bank loans to pay major expenses such as cars, houses, and higher education.

• It can lead to spiraling debt that can destroy an individual’s or family’s financial health now and in the future.

Are you CREDIT WORTHY???• An important part of a being successful adult in the

U.S. is learning how to build a good credit history, how to obtain credit at the lowest possible cost, or interest rate, and how to use credit wisely.

• Factors that affect your credit worthiness are:– Where you work, how much you earn, how much money

you have saved.– What is your current expenses?– How many people depend on your basic needs

(dependents)?– How much you owe in debts?– What property you own (collateral)?

Interest Rate (the cost of using credit)

Fixed or Variable Fixed• A fixed rate never

changes regardless of your living circumstances.

• Mostly on car or house loans.

• Commercial banks/ Credit Unions

Variable• A variable rate can go

up at any time regardless of your living expenses—follows your payment history, stock market, etc.

• Mostly on credit cards, title pawns, etc. usually has an annual fee.

Difference Between“Interest Charged” and “Interest Earned”

• Why? = profit for bank as a business

• Interest Rate: the percentage amount of payment by borrowers to the lender

• Simple Interest: determined annually with the original loan amount

• Compound Interest: future interest is determined with the existing amount owed

• Compound rate is greater than simple rate

Calculating Interest

Example 1. Simple Interest: The formula for simple interest is I = P x r x t, where I is interest, P is the principal, r is rate of interest, and t is time period.

Simple interest for one year on $100 at 3 percent is 100 x .03 x 1 = $3

Simple interest for second year on $100 at 3 percent is 100 x .03 x 1 = $3

Total interest for two years = $6.

The account, therefore, is worth $106 after two years of simple interest at 3 percent per annum.

Calculating Interest

Example 2. :Compound Interest The formula for compound interest is A A = = PP(1 + (1 + rr))nn, where A is the money accumulated after n is years including interest, P is the principal, r is the annual rate of interest, and n is the number of years.

The step-by-step explanation for $100 for two years at 3 percent compound interest is:

Interest for year oneyear one = 100 x .03 x 1 = 3.00; amount at end of year one = 100 + 3 = $103.00

Interest for year two = 103 x .03 x 1 = 3.09;

The total amount at end of year two = 103 + 3.09 = 106.09.

Questions for Review1. George deposits $100,000 in Kennesaw Mountain Bank. A year later, he borrows $100,000 from Kennesaw Mountain Bank to finance his son’s college education. Which of the following statements is true?

A. George did not have to prove he had collateral and credit worthy.

B. George is being paid compound interest by the bank.C. George is being charged a higher interest rate and

receiving high interest on his deposit.D. George is earning more interested that he’s charged.

Which of the following people would benefit the most from compound interest?

A. Someone applying for a home loan.B. Someone who needs a car loan.C. Someone investing their money in an mutual fund.D. A borrower with a high credit score.

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SSEPF5 The student will describe how insurance and other risk-management strategies protect against financial loss. a. List various types of insurance such

as automobile, health, life, disability,

and property. b. Explain the costs and benefits associated with different types of insurance.

InsuranceAn investment in your possessions

• The purpose of insurance is to provide financial protection against different kinds of risks one faces in life.

• It involves transferring risks to others.• An individual or household has something of

great value and wants to make sure that, if it is lost or damaged, it will be financially covered.

• The cost/benefit associated with insurance is it covers what you might lose. The money you pay to the insurance company (usually monthly) is assurance that if your possessions are lost (either in full or in part) are covered and can be replaced.

How does Insurance work?• When you buy insurance, you receive an insurance

policy—a written agreement between you and the insurance company.– The policy explains the kinds of losses the company will

cover and how much you pay for the protection (coverage limits—maximum covered and deductible amounts—the amount you must pay before the company will pay).

– NOTE: The higher your deductible the lower your premium.

• Premium-amount of money you pay per month to be insured.

• Claim-requested payment/filing on what you have loss from the company.

Types of Insurances1. Automobile—Most states require all drivers to have at least minimum coverage on their vehicle. In order to protect you and/or the other driver.

Liability coverage—to pay for personal injuries or property damage.

Collision coverage—to pay for any damage to your own car.

Uninsured motorist—to pay for your damages or injuries if the other driver if uninsured.

2. Health—designed to pay for medical costs, expenses, etc. It is very expensive. One can chose different coverage limits. Usually employers offer to their employees.

3. Disability—set up to help provide people with an income in case they become injured or unable to work at a job. It can provide up to 60% of a person’s income until they can return to work.

4. Life—designed to provide people with money in case a family member unexpectedly passes away.

A. Term Life—simply pays the money of the policy to a beneficiary (family member money goes to). It is cheaper and pays a higher death benefit but the policy is for a limited term. NO CASH VALUE

B. Whole Life—more expensive and less of a benefit because it builds cash value like an investment. It provides coverage for your whole life and the premium never increases. CASH VALUE YOU CAN BORROW

5. Property/Homeowners—coverage on house or other property in the event it is damaged or destroyed, often it will include liability (for personal injuries). NOTE: Business have comprehensive liability which covers a much wider range.

Questions for Review1. If you switched to an insurance policy with a higher deductible, you could probably expect,

A. A higher premium. C. A lower premium.B. A higher coverage limit D. No coverage limit.

2. Of the following people, which one would probably pay the highest rate for car insurance? A. A 50-year old single man C. An 18-year old boy B. A 30-year old married woman D. An 30-year old woman

3. Which kind of insurance pays a monthly income to people who are unable to work for an extended period?

A. Health insurance C. Life insuranceB. Disability insurance D. Homeowner’s insurance

4. The cost you pay for insurance coverage is called yourA. Policy C. DeductibleB. Premium D. Coverage limit

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SSEPF6 The student will describe how the earnings of workers are determined in the marketplace.  

a. Identify skills that are required to be successful in the workplace.  b. Explain the significance of investment in education, training, and skill development.    

Workers’ Earnings• Workers’ Earnings—how much employers pay

workers for their labor. Their earnings determine how much money laborers have to spend and save/invest for the future.

• The amount of money one makes in the labor market is due to the skills, training, education, etc. This is called the earning potential.

• People who are financially successful tend to earn more money for their labor because they possess special skills and/or training.

• Usually, the highest paid workers are college educated, have good communication skills, show respect for their peers and authority figures, conduct themselves professionally, and have actively sought to improve their skills with additional training.

1. Sophie is the major income earner for her family. For this reason, Sophie is concerned that her family would struggle financially if she got hurt and could not work, or even worse, died and was no longer around. Sophie asks you what steps she could take to ease some of her concerns. The BEST answer you could give her is to tell her to

A. Invest in liability insurance.B. Invest in promising stocks.C. Invest in life and disability insurance.D. Invest in health and life insurance.

2. Kelly works for a large law firm in San Diego. Her boss informs her that a promotion will be available in the next 4 months. Kelly wants the job, so she works as hard as she can to impress her boss and bring in profits for the company. Kelly is motivated by a

A. Negative incentive. C. Rational decision.B. Positive incentive. D. List of alternatives.

Ans: C

Ans: B

3. Which of the following people will LIKELY find the highest paying job in the workforce?

A. Someone with a high school diploma.B. Someone with a college degree and additional training.C. Someone with mediocre communications skills.D. Someone with a history of bouncing from job to job.

4. Arthur gets high 2006 tax returns back from his accountant to discover that he owes fewer taxes this year than last year. As a result, he gets a refund check for $3000. What impact will this have on Arthur?

A. He will be more likely to spend money on consumer goods and services.

B. He will be less likely to spend money on consumer goods and services.

C. He will not have to depend as heavily on subsidies as he did the previous year.

D. He will pay fewer tariffs.

Ans: B

Ans: A

5. Annabelle is tired of making less than $40,000 a year. Which of the following is the BEST way for Annabelle to raise her earning potential?

A. Support subsidies that will protect US jobs.B. Save more of her income.C. Invest in capital.D. Acquire more education and training.

6. In 2007, the United States experienced record numbers of home foreclosures. In other words, because many people had signed home loans that they ultimately could not afford to pay back, record number lost their homes to lenders. Lenders were able to take these homes because they home were

A. Illegally bought. C. Collateral.B. Uninsured. D. Part of a housing surplus

Ans: D

Ans: C

Personal Finance Activity1. PF/EQ1: Using the rational decision making model

explain in 1 paragraph how you completed your Standard of Living budget based on your monthly income. Rank choices on budget to pay, list costs and benefits, benefits forgone, etc.

2. PF/EQ2: Based on Visual 1 (Economic Cartoon 10 packet). Give a biographical sketch of your

educational level/life and describe your ambitions to progress economically. You can only progress one level.***Your biographical sketch should be like an interview for a better job*** **********DUE Wednesday, August 28th ************