General Principals Flashcards
What is a balance sheet?
A point in time
Assets = Liabilities + Net Worth
Assets listed in order of liquidity. CKG on top
Purpose: Financial Position
Starting Point: Cash Balance
Ending Point: Retained Earnings
Personal Balance Sheet
Reported at FMV
Assets on Left.. Liabilities on right
Assets listed in order of liquidity
Liabilities listed in order of term.
Corporate Balance Sheet
Reported at the lower of cost and FMV
Cash Flow Statement
Period in time (1 month, year)
Purpose: Shows cash management
Measures: Increases & decreases in cash flow
Starting point: Net Income
Ending Point: Cash Balance
Current Ratio
Current Assets / Current Liabilities
Quick Ratio
Current assts - inventories / Current Liabilities
Working Capital Ratio
Current Assets - Current Liabilities
Debt to Equity Ratio
Total long-term debt / Equity
Times Interest Earned Ratio
EBIT / Interest Expense
Earnings Before Intereset & taxes
Debt Ratio
Total Debt / Total Assets
Front End Ratio
PITI / Gross Income
Principal, Interest, Taxes, Insurance
Back End Ratio
PITI + other debt / Gross Income
Inventory Turnover
Cost of Goods sold / Avg Inventory
Days to sell inventory
365 / Inventory turnover
Acct’s Receivable Turnover
Sales (credit) / Avg. Acct. Receivable
Receivable Collection Period
365 / Accts Rec. Turnover
Gross Profit Margin
Gross Profit / Sales
Operating Profit Margin
Operating Income / Revenue
Return on Assets (ROA)
EAT / Total Assets
Return on Equity (ROE)
EAT / Equity
Emergency Fund Ratio
Montetary Assets / Monthly Living Expenses
Emergency Fund
Single Earner: 6 Mo.
Two Earners: 3-6mo.
Must be liquid (easily converted to cash)
Must be marketable (bought or sold with ease)
cash, MMMF, T-Bills, CD’s, Cash Value LI, HELOC
Cross Purchase Plans
Method to transfer business interest among partners or owners using life insurance.
* tax free death benefit
* only good for low # of owners
If 4 partners, each would purchase 3 policies for a total of 12.
Nx(N-1)
Entity Purchase Agreements (or, Stock Redemption Plan)
Method of transfering business interest to business using life insurance policies.
* Good for multiple partners.
* Business buys a policy for each partner.
* Benefit passes tax free to business
* Business pays policy.
* Better for more owners
Wait & See Agreement
Method of transfering business interest that offers flexibility to both partners & business.
Step #1: Business has 1st option to buy deceased partners stock. or half
Step #2: Surviving partners have option to buy if business declined or if the business only bought half.
Step #3: Business is required to buy rest of shares
Over Confidence
Causes people to overestimate their knowledge and under estimate risk.
Factors leading to overconfidence: Choice, Task Familiarity, Info, Past success.
Prospect Theory
People suffer more greatly to losses than benefit from gain.
Disposition Effect
People seek pride and avoid regret.
- Sell winners too quickly
- Hold losers too long
When investors consider the past, they tend to suffer from…
House Money Effect: Take more risk. Maybe they won early and are playing with house money now.
Snakebite Effect: Take Less risk
Break-Evenitis - Take more risk to catch up.
Mental Accounting
Leads to naive diversification
Home Bias
Single stock concentration… maybe due to where they worked
Herd Mentality
Find comfort in groups/numbers. Tend to do what they do.
Optimism
Can be convinced of trends or patters that aren’t really there. Leads to market bubbles.
What are the feds goals?
Have a stable economy with…
2% inflation
4% unemployment
What are the feds tools?
There are three…
Discount Rate (rate banks borrow from government)
Reserve Requirement
Open Market Activities (buy/sell securities in open market)
“Tight” Policy or Contractionary Policy
Goal is to slow pace of growth & lower inflation.
Fed will:
Raise discount rate (increase cost of borrowing)
Raise Reserve Requirement
Sell Securities (take $$ out of economy)
“Easy” Policy or Expansionary Policy
Goal is to encourage the economy to grow.
Lower Discount Rate (lowers cost to borrow $$)
Lower Reserve Requirement (makes banks hold less in reserve)
Buys Securities (puts $$ back into economy)
Heuristic
Any approach to problem solving that employs a more practical method that’s not guaranteed to be optimal.
-Rules of thumb, trial & error, educated guesses.
Anchoring
When an investor sets a value at initial point of purchase.
- usually the buy price
- they tend to think its the true value of the investment despite what the market says.
Fiscal Policy Tools
Government Spending & Taxation
- When things are bad, congress will spend more to stimulate the economy and lower taxes.
- political in nature
Fiscal Policy is implemented by…
Congress
Monetary Policy is controlled by…
The Federal Reserve (the fed)
Sharpe Ratio
- measures risk adjusted return of a portfolio in terms of standard deviation.
- ONLY appropriate when R2 is less than .7
- Use to compare against other instruments sharpe ratio.
rp-rf/standard deviation
Treynor Ratio
Measures risk adjusted performance of a portfolio manager.
Appropriate to use when R2 is greater than or equal to .7
useful when comparing to other investments.
Capital Asset Pricing Model (CAPM)
Used to quantify expected return given a market return & a beta to the market.
- Used to quantify investors required rate of return.
- Used to plot security market line (efficient frontier)
CAPM Formula
Formula is on CFP Sheet.
ri=rf+(rm-rf)Bi
(rm-rf)Bi = Stock Premium
(rm-rf) = Market Risk Premium
Once CAPM prudces expected return, it can be subtracted from actual return to produce ALPHA
Jenson’s Performance Index (ALPHA)
Measure that is used to evaluate the benefit of a portfolio manager.
- Absolute value
- Only valid if R2 is .70 or higher.
- Plot above or on the Security Mkt Line is good. Anything below is inefficient.
ALPHA Formula
CAPM minus Expected Returns
Actual Return - Expected Return = Alpha
rp-[rf+(rm-rf)Bp]
FDIC Insurance
A $250,000 insurance on bank deposits.
* Per person.
* Per Ownership Category
* Per institution
Chapter 7 Bankruptcy
A liquidation type of bankruptcy that eleminates consumers debt.
Primary Purpose: Liquidation
Who?: Individuals & Businesses
Does not stop foreclosure, but can delay it
How long does a bankruptcy stay on credit report?
10 years
How long does a Chapter 7 Bankruptcy take to process?
4-6 Months
What obligations must still be repaid after Chapter 7?
- Child Support
- Alimony
- Income taxes less than 3 years past due
- student loans
- secured debt
Chapter 13 Bankruptcy
The wage-earner plan.
Allows debtors to keep their personal assets, but they are obligated to repay their debt over a period.
Primary purpose: Repayment
Who: Individuals
Stops foreclosure
How can you be eligible for Chapter 13?
- Can have no more than $419,275 in unsecured debt.
- Can have no more than $1,257,850 in secured debts.
How long does Chapter 13 bankruptcy take?
3-5 years
How long will Chapter 13 stay on your credit report?
7 Years
Chapter 11 Bankruptcy
Intended for business but also accommodates those who exceed Chapter 13 debt limitations or lack regular income.
Primary Purpose: Reorganization
Who?: Businesses
Stops foreclosure
How long does Chapter 11 take?
6 Months - 2 years
How long is Chapter 11 on your credit report?
10 Years
Consumer Credit Protection Act
Right to know costs and terms of credit
Equal Credit Opportunity Act
Right to fair opportunity to obtain credit
Fair Credit Reporting Act
Right to know whats in your credit file
Fair Credit Billing Act
Right to have billing mistakes resolved
Fair Debt Collecting Practices Act
Right to be protected from collection agencies
What are the five categories that make up a FICO score?
- Payment History (35%)
- Amounts Owed (30%)
- Length of credit history (15%)
- New Credit (10%)
- Credit mix (10%)
Poor credit rating…
Below 580 is poor
Fair credit rating
580-669 is fair
Good credit rating
670-739 is good
Very Good credit rating
740-799 is very good
Exceptional Credit Rating
800+
What is considered a Conventional Mortgage?
Any mortgage under $726,200 are considered a conventional mortgage.
- Downpayment: 3-20%
- Terms: 15-30 years
- Insurance: Applies if downpayment is under 20%
- Can be fixed or variable rates
What is considered a Jumbo Mortgage?
Any mortgage over $726,200 will be considered a jumbo mortgage and will carry a higher interest rate.
What is a balloon mortgage?
A mortgage in which a large portion of the borrowed principal is repaid in a single payment at the end of the laon period.
Shaped like a balloon. Less at first and grows.
FHA Mortgage?
Downpayment: 3.5% - 20%
Terms: 15-30 Years
Insurance: Always, for 11 years or life of loan
USDA Morgage
Downpayment: 0%
Terms: 15-30 Years
Insurance: None
Rate: Fixed only
Funding Fees: 1% fee upfront, annual fee of .35%
VA Mortgage
Down payment: 0%
Terms: 15-30 years
Insurance: None
Funding Fees: 2.3% - 3.6% waived for disabled veterans
Housing Cost Ratio
(Front-end ratio)
(Mortgage Debt Services Ratio)
PITI / Gross Household Income
28% an under = PASS
Total Debt Ratio
(Back-End Ratio)
(Debt Repayment Ratio)
(PITI + Monthly Consumer Debt) / Monthly household Gross Income
Pass = under 36%
Consumer Debt Ratio
Monthly COnsumer Debt (non-housing) / Monthly net household income
Pass = Under 20%
529 ABLE Plans
Acct. may be established if blindness or disability occurred before age 26.
Balances of 100k or less are disregarded from FAFSA.
Contributions are considered gifts, 17k annual exclusion amount.
Student Owned Acct.
FAFSA Expected Family Contribution (EFC)
Students assets are included at 20%
4 Types of Student Aid
Grants - based on financial need
Scholarship - money is awarded based on accomplishments
Loans - Must be paid back
Work-Study - A job that lets you earn money while in school.
Grants
Pell Grants : Awarded to undergraduate students who have exceptional financial need.
Federal Supplemental Educational Opportunity Grant (FSEOG): For Undergrads with exception financial needs. Students with lowest EFC’s priority to students who receive Pell Grants.
Loans
Direct Subsidized Loans - Need Based - Dept of Ed pays interest while you’re at school.
Direct Unsubsidized Loans - Non Need Based. students pay interest on loans during all periods
FAFSA (Free Application for Federal Student Aid)
- 2 Year Lookback for reported income.
- Used to determine Financial Aid.
Expected Family Contribution (EFC)
Income (Parent & Student) + Assets (Parent & Student)
EFC Formula =
Income (22% Parent to 47%, 50% Student) + Assets (5.64% Parents, 20% Students)
Income…
Parents = AGI minus an allowance for taxes + Living Expenses.
Students= Amount over protected amt $7,600
Assets…
IRA’s and Home Equity are omitted
Financial Needs Formula =
Cost of Attendance (COA) - EFC = Financial Need
American Opportunity Tax Credit (AOTC)
- Up to $2,500 per eligible student
- 40% Refundable (only $1,000 max can go to refund, rest decreases taxes)
- 180k MAGI limit for MFJ
- 90k MAGI limit for all other filers
- 4 Tax Years per eligible students
- Can use BOTH credits but cannot overlap expenses
- Must be at least half time.
First 4 Years of post-secondary education
Tuition, required enrollment fees, materials needed for study.
4k of Qualifying Expenses:
1st $2,000 = 100% inclusion
2nd $2,000 = 25% inclusion
Lifetime Learning Credit (LLC)
- Up to $2,000 credit per return
- Not Refundable (only decreases taxes)
- 180k MAGI Limit for MFJ
- 90k MAGI limit for all other filers
- Unlimited # of tax years.
- Can use BOTH credits but cannot overlap expenses
Post secondary education studies
Tuition and fees required for attendance only.
20% of $10,000 of qualifying expenses.
