B.10 Financing strategies and debt management

Question 1

Which of the following is an example of a debt security?

A. Common stock
B. Preferred stock
C. Corporate bond
D. Treasury bill

Answer 1

C. Corporate bond

A corporate bond is a debt security issued by a corporation to raise capital.

B.10 Financing strategies and debt management

Question 2

Which of the following is NOT a factor that affects interest rates?

A. Inflation
B. Federal Reserve policy
C. Government spending
D. Stock market performance

Answer 2

D. Stock market performance

While stock market performance can have an impact on the economy, it does not directly affect interest rates.

B.10 Financing strategies and debt management

Question 3

What is the purpose of a credit score?

A. To determine a borrower’s creditworthiness
B. To determine a borrower’s income level
C. To determine a borrower’s net worth
D. To determine a borrower’s tax liability

Answer 3

A. To determine a borrower’s creditworthiness.

A credit score is a numerical representation of a borrower’s creditworthiness, based on their credit history and other factors.

B.10 Financing strategies and debt management

Question 4

Which of the following is a disadvantage of using credit cards?

A. High interest rates
B. Increased purchasing power
C. Enhanced fraud protection
D. Improved credit score

Answer 4

A. High interest rates

Credit cards often come with high interest rates, which can make it difficult for borrowers to pay off their balances.

B.10 Financing strategies and debt management

Question 5

Mary currently has a credit card balance of $5,000 with an interest rate of 18% per annum. If she can afford to make a fixed monthly payment of $200, how many months will it take for her to pay off her balance completely?

A. 25 months
B. 29 months
C. 32 months
D. 37 months

Answer 5

C. 32 months

In this case, Mary’s annual interest rate is 18%, which translates to a monthly interest rate of 1.5% when divided by 12. Therefore, the principal grows by 1.5% before each monthly payment.

This is a classic case of an amortizing loan, which is a loan where the principal is paid over a series of payments.

If we plug the values into a financial calculator or an online loan payoff calculator (a principal of $5,000, a monthly interest rate of 1.5%, and a monthly payment of $200), it’s estimated that Mary would need approximately 32 months to pay off her balance entirely.

When in doubt, calculate the amortization table

B.10 Financing strategies and debt management

Question 6

What is the difference between a secured loan and an unsecured loan?

A. The interest rate charged
B. The length of the loan term
C. The collateral required
D. The borrower’s credit score

Answer 6

C. The collateral required

A secured loan requires collateral, such as a house or car, while an unsecured loan does not require collateral.

B.10 Financing strategies and debt management

Question 7

Which of the following is an example of a fixed expense?

A. Groceries
B. Entertainment
C. Rent
D. Clothing

Answer 7

C. Rent

A fixed expense is an expense that stays the same from month to month, such as rent or a car payment.

B.10 Financing strategies and debt management

Question 8

Which of the following is an advantage of using a debt consolidation loan?

A. Lower interest rates
B. Increased credit card usage
C. Reduced monthly payments
D. Longer loan terms

Answer 8

A. Lower interest rates

A debt consolidation loan can help borrowers lower their interest rates, which can make it easier to pay off their debt.

B.10 Financing strategies and debt management

Question 9

What is a debt management plan?

A. A plan to pay off debt that involves negotiating with creditors
B. A plan to pay off debt that involves taking out a new loan
C. A plan to pay off debt that involves increasing credit card usage
D. A plan to pay off debt that involves filing for bankruptcy

Answer 9

A. A plan to pay off debt that involves negotiating with creditors

A debt management plan is a plan to pay off debt that involves working with a credit counseling agency to negotiate with creditors on behalf of the borrower.

B.10 Financing strategies and debt management

Question 10

John has a credit card with a balance of $2,000 and an interest rate of 20%. He can only afford to make the minimum monthly payment of $50. How long will it take him to pay off his balance?

A. 2 years
B. 3 years
C. 4 years
D. 5 years

Answer 10

D. 5 years

Making only the minimum monthly payment on a credit card can lead to a long repayment period and a significant amount of interest paid over time. Using a debt repayment calculator, it would take John approximately 5 years to pay off his balance.

B.10 Financing strategies and debt management

Question 11

What is a debt-to-income ratio?

A. The amount of debt a borrower owes divided by their income
B. The amount of debt a borrower owes divided by their credit limit
C. The amount of money a borrower saves each month divided by their income
D. The amount of money a borrower spends on housing expenses divided by their income

Answer 11

A. The amount of debt a borrower owes divided by their income.

A debt-to-income ratio is a measure of a borrower’s ability to repay their debt, calculated by dividing their debt payments by their income.

B.10 Financing strategies and debt management

Question 12

Which of the following is an example of a variable expense?

A. Rent
B. Insurance
C. Groceries
D. Car payment

Answer 12

C. Groceries

A variable expense is an expense that can change from month to month, such as groceries or entertainment.

B.10 Financing strategies and debt management

Question 13

Which of the following is a disadvantage of using a home equity loan to consolidate debt?

A. High interest rates
B. Risk of foreclosure
C. Limited loan amounts
D. Short loan terms

Answer 13

B. Risk of foreclosure.

A home equity loan uses the borrower’s home as collateral, which means that if the borrower is unable to repay the loan, they could risk losing their home.

B.10 Financing strategies and debt management

Question 14

What is a debt settlement program?

A. A program that helps borrowers negotiate with creditors to pay off their debt
B. A program that provides borrowers with a new loan to consolidate their debt
C. A program that helps borrowers file for bankruptcy
D. A program that helps borrowers improve their credit score

Answer 14

A. A program that helps borrowers negotiate with creditors to pay off their debt

A debt settlement program is a program that helps borrowers negotiate with creditors to pay off their debt at a reduced amount.

B.10 Financing strategies and debt management

Question 15

Sarah has $20,000 in credit card debt with an average interest rate of 15%. She is considering a balance transfer to a new credit card with a 0% introductory rate for 12 months, but the balance transfer fee is 3%. Should she do it?

A. Yes, it will save her money in interest charges
B. No, the balance transfer fee is too high
C. It depends on how quickly she can pay off the balance
D. It depends on the terms of the new credit card

Answer 15

C. It depends on how quickly she can pay off the balance

A balance transfer can be a good way to save money on interest charges, but the balance transfer fee can be costly. It is important for Sarah to consider how quickly she can pay off the balance before the introductory rate expires, and whether the savings on interest charges outweigh the balance transfer fee.

B.10 Financing strategies and debt management

Question 16

«VERIFY»Sarah is considering a 15-year mortgage to purchase her dream home. She plans to borrow $80,000 at an interest rate of 6.5%. Assuming equal monthly payments over the term of the loan, what is the approximate amount of interest Sarah will pay over the mortgage term?

A. $78,000
B. $48,000
C. $42,000
D. $55,000

Answer 16

C. $42,000

To calculate the approximate amount of interest paid over the mortgage term for the scenario mentioned (borrowing $80,000 at 6.5% interest for 15 years with equal monthly payments), using the HP 10bII+ calculator

Step 1: Set Up Your Calculator
Make sure your calculator is set to operate in financial mode. If it’s not already set, you can do so by pressing the “MODE” button and selecting “END.”

Step 2: Calculate the Monthly Interest Rate (I/Y)
To calculate the monthly interest rate, you need to take the annual interest rate (6.5%) and divide it by 12 since there are 12 months in a year.

.065/12 = .5417

So, set your calculator’s interest rate per period (I/Y) to 0.5417.

Step 3: Set the Number of Payments (N)
Since the loan term is 15 years, you’ll make monthly payments for 15 years, which is 180 months. Set your calculator’s number of payments (N) to 180.

Step 4: Set the Loan Amount (PV)
In this scenario, you’re borrowing $80,000, so set your calculator’s present value (PV) to -80,000 (negative because it’s a cash outflow).

Step 5: Calculate the Monthly Payment (PMT)
Now, you can calculate the monthly payment (PMT) by pressing the PMT button or by solving for it. Press the “PMT” button, and you’ll get the approximate monthly payment amount.

Step 6: Calculate Total Payments and Interest Paid
To find the total payments made over the term and the amount of interest paid, you can use the following formulas:

Total Payments = PMT × N
Interest Paid = Total Payments - PV

Plug in the values:

Total Payments = PMT × 180
Interest Paid = Total Payments - (-80,000)

Step 7: Calculate
Calculate both the total payments and interest paid using your calculator.

Step 8: Display the Result
The calculator will provide the values for total payments and interest paid.

Using the HP 10bII+ calculator, you should find that the approximate amount of interest paid over the mortgage term is approximately $54,823.80

B.10 Financing strategies and debt management

Question 17

Sarah, a CFP® professional, advises her client, Paul, to set up a $40,000 cash reserve account. Paul expresses his reluctance and would rather invest the $40,000 in the stock market, anticipating better returns compared to the money market. How should Sarah proceed, given Paul’s feedback?

A. Ignore Paul’s preference and insist on the cash reserve account.
B. Immediately invest the $40,000 in the stock market without further discussion.
C. Discuss the importance and purpose of a cash reserve account and then revisit Paul’s investment goals.
D. Encourage Paul to invest half in the cash reserve and half in the stock market without understanding his financial situation.

Answer 17

C. Discuss the importance and purpose of a cash reserve account and then revisit Paul’s investment goals.

The role of a CFP® professional is to provide advice in the best interest of the client while also educating them on financial principles. Sarah should discuss with Paul the rationale behind a cash reserve (e.g., emergency fund, liquidity, etc.) and the risks associated with investing all funds in the stock market. After understanding Paul’s financial goals, risk tolerance, and needs, they can make a more informed decision together.

B.10 Financing strategies and debt management

Question 18

Jessica, a 46-year-old, is employed at ZetaTech earning $40,000 annually. Her assets are allocated as follows:

Cash: $1,200
Equity Mutual Funds: $7,200
Fixed Income Exchange-Traded Funds: $8,000
Limited Partnerships: $60,000
401(k) (employer stock): $25,000

Which of the following assessments is MOST accurate about Jessica’s financial situation?

A. Her portfolio showcases a well-diversified asset allocation.
B. She might face challenges covering emergency expenses due to low liquidity.
C. Her returns are notably above the average.
D. She has significantly safeguarded her assets from interest rate fluctuations.

Answer 18

B. She might face challenges covering emergency expenses due to low liquidity.

A quick review of Jessica’s assets shows that she only has $1,200 in cash, which is typically the most liquid asset. This amount might not be sufficient to cover unexpected emergency expenses, especially considering that a common recommendation is to have three to six months of living expenses in an emergency fund. The other assets, like mutual funds, ETFs, limited partnerships, and 401(k) stocks, might not be as easily accessible or might have penalties or tax implications when liquidated.

B.10 Financing strategies and debt management

Question 19

Sarah and John are considering refinancing their existing 30-year mortgage, which they took out 5 years ago at an interest rate of 4.5%. They currently owe $250,000 on their mortgage. They have the option to refinance at a lower interest rate of 3.5% for a new 30-year term. Their goal is to reduce their monthly payment amount. The closing costs for the refinancing will be $5,000.

Question:
Which of the following should Sarah and John consider to make an informed decision about refinancing their mortgage?

A. The impact of refinancing on their tax liabilities.
B. The time they plan to stay in their home compared to the break-even point of the refinancing costs.
C. The possibility of switching to an adjustable-rate mortgage (ARM).
D. All of the above.

Answer 19

D. All of the above.

Sarah and John should consider all listed factors:

Impact on tax liabilities: Refinancing could alter their mortgage interest deduction.
Break-even analysis: They need to compare the time they plan to stay in the home with how long it will take to recoup the closing costs through monthly savings.
Type of mortgage: Considering different types of mortgages, like an ARM, could offer additional benefits or risks depending on future rate changes.

B.10 Financing strategies and debt management

Question 20

Mark has three outstanding student loans:

Loan A: $10,000 at 6% interest
Loan B: $15,000 at 5% interest
Loan C: $20,000 at 4.5% interest
He is considering consolidating all three loans into one single loan at a fixed rate of 5.25%.

Question:
Which of the following is the most significant risk associated with Mark’s decision to consolidate his student loans?

A. Increase in the overall interest rate for some of the loan amounts.
B. Loss of specific loan forgiveness options that may apply to original loans.
C. Extended loan term that increases the total amount of interest paid over time.
D. Both A and B.

Answer 20

D. Both A and B.

Consolidating loans can lead to:

Increased overall interest rate: Loans that previously had lower interest rates (e.g., 4.5% and 5%) will now incur a higher rate of 5.25%, which increases the cost.
Loss of benefits: Specific benefits or forgiveness options tied to original loans may be lost upon consolidation.

B.10 Financing strategies and debt management

Question 21

A CFP® professional is consulting with a couple who are seeking advice on their home loan. In assessing their financial situation, the professional discovers that their daily living expenses are exceeding their income. Recently, mortgage interest rates have declined significantly, and the couple is considering refinancing their existing 30-year mortgage to a 15-year mortgage. This would increase their monthly payments but allow them to pay off the loan 15 years earlier than the original schedule. What should the CFP® recommend?

A. Advise them to maintain their current mortgage to maximize interest tax deductions.
B. Recommend they refinance to a 30-year fixed mortgage to reduce monthly payments and start an emergency fund.
C. Encourage them to proceed with the 15-year mortgage refinance to save on total interest costs.
D. Propose they consult a financial advisor to explore all possible refinancing options.

Answer 21

B. Recommend they refinance to a 30-year fixed mortgage to reduce monthly payments and start an emergency fund.

While a 15-year mortgage would indeed save on interest payments over the life of the loan, it would also result in significantly higher monthly payments. Given that the clients are already experiencing a shortfall in covering their essential expenses, increasing their monthly financial burden could potentially put them in a riskier financial situation.

B.10 Financing strategies and debt management