Chapter 12 Flashcards
0
Q
Elements of Debt Capacity: (2)
A
- Short-run liquidity and long-run solvency
- Expected net assets and net cash flow
1
Q
Debt capacity: (5)
A
- Debt capacity depends on both current and future financial situation:
- Assets
- Liabilities
- Income
- Cash Flow
2
Q
Risk: Variation in Net Cash Flow:
A
- Job loss (business failure, income cut, pregnancy, etc.)
- Death
- Disability
3
Q
Risk: Variation in Net Asset Values: (5)
A
- Damage or theft
- Physical depreciation
- Obsolescence, including professional skills
- Changes in economic conditions
- Changes in interest rates
4
Q
Approaches for determining debt levels: (3)
A
- Workable theory to determine debt capacity, or optimal level of debt?
- Family’s use of debt will be affected by desired spending level and attitude to risk
- Family budgets can be used as tool to assess debt capacity
5
Q
Problems using Debt Service Ratios: (4)
A
- No risk adjustment
- Based on gross income, not after-tax family income
- apply to average income, applying less to higher or lower incomes
- better information about liquidity and solvency can be obtained through family budgets
6
Q
Sources of credit: Grouped by their risk exposure (3)
A
- Banks, trust companies and credit unions
- Finance and loan companies tied to specific sellers (bay, GM)
- Small finance companies, pawn shops
7
Q
Qualifications for Credit: Scoring (4)
A
- Personal: age, marital status, character
- Assets: Home, automobile, investments, etc.
- Debt: Mortgage, loan, credit card balances
- Credit history: credit record, bankruptcy, etc.
8
Q
Credit cards: (4)
A
- Annual fee
- Free loan period
- Interest rate on unpaid balance
- Additional features (air mileage, insurance)
9
Q
Types of Credit: (5)
A
- Open account (retail, utility)
- Overdraft protection
- Unsecured personal credit line
- Secured personal line of credit
- Home equity line of credit
10
Q
Debt Management: (2)
A
- Pay cash for consumption and borrow for investment
- If you have investment assets and consumer debt, convert consumer debt into investment debt
11
Q
Borrowing to Create Tax Shelters:(3)
A
- Interest on money borrowed for investment is tax deductible
- Capital gains are taxed at lower rate than other income
- Save high current taxes and pay lower future taxes on capital gains.
12
Q
Why borrow money to invest: (3)
A
- Increase rate of return on investment
- Increase after-tax investment return
- Create tax shelter by deferring tax
