General Principles/Conduct/Psychology Flashcards
Behavioral Finance: Familiarity
E.g., familiarity with an employer and investing in ER stock because of familiarity only
Behavioral Finance: Loss Aversion
Unwillingness to sell a losing investment in the hopes it will turn around because losses are more painful than gains. (compare Prospect Theory)
Behavioral Finance: Affect Heuristic
Judging something, good or bad, pertains to likes or dislikes of a company based on non-financial issues.
Behavioral Finance: Anchoring
Attaching/Anchoring one’s thoughts to a reference point even if there is no logical relevance or no pertinence to the issue in question; aka conservatism or belief perseverance.
The investor sets a value at the initial point of information (typically their buy price)
Behavioral Finance: Availability Heuristic
Reliance on information that is readily available in one’s memory, thus overweighting recent events or patterns and ignoring longer term trends.
Behavioral Finance: Bounded rationality
Making decisions based on rationality limited by available information, tractability of decision problem, cognitive limitations, time available to make a decision. Seeking a satisfactory solution rather than an optimal one, thus additional information does not lead to an improvement in decision because investor is unable to consider significant amounts of information.
Behavioral Finance: Cognitive Dissonance
Tendency to misinterpret information that is contrary to an existing opinion or only pay attention to information that supports an existing opinion, e.g., exaggerating gains and minimizing/forgetting about losses.
Behavioral Finance: Confirmation Bias
Tendency to filter information and focus on information that supports one’s opinions.
Behavioral Finance: Disposition effect
People seek pride and avoid regret, thus
- sell winners too quickly (confirms correct choice)
- hold losers too long (avoids confirming incorrect choice)
Behavioral Finance: Familiarity Bias
Tendency to overestimate/underestimate the risk of investments with which one is familiar/unfamiliar.
Leads to home bias and single stock concentration.
Behavioral Finance: Gambler’s Fallacy
Based on incorrect understanding of probabilities, investors may sell stock when it has been successful in consecutive trading sessions because they may not believe it is continuing its upward trend.
Behavioral Finance: Herding
Following the herd. Finding comfort in groups/numbers.
Behavioral Finance: Hindsight Bias
Looking back after the fact is known and assuming one can predict the future as readily as the past.
When considering the past, investors tend to suffer from:
- House money effect (take more risk)
- Snakebite effect (take less risk)
- Break-evenitis (take more risk)
Behavioral Finance: Illusion of Control Bias
Tendency to overestimate ability to control events, e.g., sense of control over outcomes one can demonstrably not influence.
Behavioral Finance: Naïve diversification
Common with 401k plans or other employer sponsored retirement plans: idea that one is adequately diversified by investing an equal amount in all of the funds.
Mental accounting can lead to naïve diversification.
Behavioral Finance: Optimism
Can lead to exuberance, which can lead to market bubbles.
Behavioral Finance: Overconfidence Bias
Tendency to listen to oneself, rely on one’s own skills and capabilities to do one’s own homework or make one’s own decisions. This often leads investors to overstate their risk tolerance, overestimate their knowledge, underestimate risks, exaggerate ability to control events and predict outcomes.
Factors leading to overconfidence:
Choice
Task familiarity
Information (confirmation bias)
Active involvement
Past success
Behavioral Finance: Overreaction
Common emotion towards receipt of news or information
Behavioral Finance: Prospect Theory
Tendency to value gains and losses differently. Investors are loss averse, suffer more from a loss of $100 than they benefit from a $100 gain. Examples: Avoiding higher risk investments even if they offer strong risk adjusted returns or over insuring against risks through low deductibles.
Behavioral Finance: Recency
Focusing on short-term past performance, giving too much weight to recent events, leading to faulty predictions that this is how it is always going to be.
Behavioral Finance: Representativeness
Idea that a good company is a good investment without an analysis of the investment
Behavioral Finance: Similarity Heuristic
Used when a decision is made when an apparently similar situation occurs even though the situations may have very different outcomes
CFP Code of Ethics
- Act with honesty, integrity, competence, and diligence
- Act in the client’s best interests
- Exercise due care
- Avoid or disclose and manage conflicts of interest
- Maintain the confidentiality and protect the privacy of client information
- Act in a manner that reflects positively on the financial planning profession and the CFP certification
Economic Forces: Complements
Products that are usually consumed jointly. A decrease in the price of one will cause an increase in the demand of another, e.g., when peanut butter goes on sale, the demand for jelly will increase.
DEC forms of discipline : Private Censure
An unpublished written reproach mailed by the the DEC to a censured respondent
DEC forms of discipline : Public letter of admonition
A written reproach of the respondent’s behavior published in a press release
DEC forms of discipline : Revocation
The termination of a respondent’s right to use the CFP marks. Respondents are permanently barred from applying for or obtaining CFP certification. No appeal is possible.
DEC forms of discipline : Suspension
Respondent is prohibited from using the CFP certification marks, stating or suggesting that they are a CFP professional or holding out to the public as being certified by the CFP Board.
Min. 90 days; Max 5 years
Duties owed to clients at all times
- Integrity
- Competence
- Diligence
- Sound and Objective Professional Judgement
- Professionalism
- Comply with the law
- Confidentiality and Privacy
- Duties when communicating with a client
- Duties when selecting, using and recommending technology
- Refrain from borrowing or lending money and commingling financial assets
Duties owed to clients when providing financial advice that requires planning
- The duties that apply when providing financial advice (without planning)
- The practice standards for the financial planning process
- Information to a client in writing
Duties owed to clients when providing financial advice without planning
- The Duties that apply at all times
- Fiduciary Duty
- Disclose and manage conflicts of interest
- Provide information to a client
- Duties when recommending, engaging, and working with additional persons
Duties owed to clients: Competence
With relevant knowledge and skill to apply that knowledge.
A CFP professional must bring in or advise a client go to an expert with competence in area the advisor lacks
Duties owed to clients: Comply with the law
A CFP professional must comply with the laws, rules and regulations governing professional services. Intentional violation of the Codes & Standards is not permitted
Duties owed to clients: Confidentiality & Privacy
A CFP professional must keep confidential and may not disclose any non-public personal information abut any prospective, current, or former client, except to the CFP
Duties owed to clients: Diligence
Must provide professional services, including responding to reasonable client inquires in a timely and thorough manner
Duties owed to clients: Disclose and Manage conflicts of interest
Applies to material conflicts of interest
Written consent to conflict is not required (oral is acceptable)
Duties owed to clients: Fiduciary Duty
Duty of Loyalty
Duty of Care
Duty of Following Client Instructions
Duties owed to Clients: Integrity
Centered on honesty and candor
Duties owed to clients: Profesionalism
A CFP professional must treat Clients, prospective clients, fellow provisionals, and others with dignity, courtesy, and respect.
Duties owed to clients: Provide information to a a client
Material changes and disciplinary updates/bankruptcy must be disclosed to clients within 90 days
Duties owed to clients: Refrain from borrowing or lending money and commingling financial assets
Exceptions:
- member of the CFP’s immediate family
- Lender is in the business of lending
Never permitted
Client’s financial assets may not be commingled with the CFP professionals’ assets or the firm’s assets.
Duties owed to clients: Selecting, Using ,and recommending technology
A CFP professional must use “reasonable care and judgement” when using technology in a planning engagement. The technology must produce “reliable objects, and appropriate outcomes:
Duties owed to clients: Sound and objective professional judgement
CFP professionals must exercise professional judgement on behalf of the client and may not solicit or accept any gift that could be expected to compromise objectivity
Duties owed to clients: When communicating with a client
Accurate information in a manner and format that client reasonably may be expected to understand
Duties owed to clients: When recommending, engaging and working with additional persons
Basis for recommendation must be reasonable and any conflict of interest must be properly disclosed and managed.
Duties owed to clients: When representing compensation method
Fee only - No commission, trails, etc. Flat fee, or AUM only
Fee based - primarily compensated through fees, but has some commission based products, or products that have a trail.
Sales related compensation - primarily commission based
Fiduciary Duty: Duty of Care
Act with the care, skill, prudence, and diligence that a prudent professional would exercise in light of the client’s goals, risk tolerance, objectives, and circumstances.
Fiduciary Duty: Duty of Loyalty
- Place the interest of the Client above the interests of the CFP professional’s firm
- Avoid conflicts of interest or fully disclose material conflicts of interest to the client, obtain the client’s informed consent and properly manage the conflict
- Act without regard to the financial or other interests of the CFP professional the CFP professional’s firm or any individual or entity other than the client which means a CFP professional acting under a conflict of interest continues to have a duty to act in the best interests of the Client and place the client’s interest above the CFP professsional.
Fiduciary Duty: Duty to Follow Client Instructions
Comply with the terms of the client engagement and follow all directions of the clients that are reasonable and lawful.
Financial Advice
A. Communication that, based on its content, context, and presentation, would reasonably be viewed as a recommendation that the client take or refrain from taking a particular course of action with respect to:
- The development or implantation of a financial plan
- The value of or the advisability of investing in, purchasing, holding, gifting, or selling financial assets
- Investment policies or strategies, portfolio composition, the management of financial assets, or other financial matters
- The selections and retention of other persons to provide financial or professional services to the client
B. Exercise of discretionary authority over the financial assets of a client.
Exam Tip: the more individually tailored the communication, the more likely you are giving Financial Advice and are thus bound by Fiduciary Duty!
Financial Planning
Collaborative process that helps maximize a client’s potential for meeting life goals through financial advice that integrates relevant elements of the client’s personal and financial circumstances.
Heuristic
Any approach to problem-solving that employs a more practical method that is not guaranteed to be optimal or rational, but is sufficient for reaching short-term goals or an approximation, such as rules of thumb, educated guesses, trial & error.
Heuristics reduce the cognitive load of decision making, which allows biases to cloud objectivity.
In which step of the financial planning process do you analyze the client’s current course of action?
Step 3: Analyzing the client’s current course of action and potential alternative course(s) of action.
Behavioral Asset Pricing Model
Determines the expected returns of a stock using Beta, book to market ratios, market capitalization ratios, stock momentum, the investor’s likes and dislikes about the stock or company, social responsibility factors, status factors, and more.
Marginal utility
Additional benefit (utility) received from consumption of an additional unit of a good. As the rate of consumption increases, the marginal utility derived from consuming additional units will decline. “Diminishing marginal utility”
Mental accounting
the different values a person places on the same amount of money, based on subjective criteria, often with detrimental results (e.g., tax refund is often treated as “found” money rather than a “refund” that belonged to the taxpayer all along)
Price elasticity
Measures the quantity demanded of a good in response to changes in that good’s price
A good is elastic when its quantity demanded responds greatly to price changes (consumer discretionary)
A good is inelastic when its quantity demanded responds little to price changes (gasoline)
Real GDP excludes
Imports
Inflation
Transactions where money changes hands but no new goods or services are produced
Income of US citizens working abroad
Profits earned by US companies in foreign countries
Real GDP includes
Market value of all final goods and services produced within an economy
Income of foreigners working in the US
Profits that foreign companies earn in the US
GDP = C + I + G + (X-M)
Or GDP = C + I + G + NE
Where C = consumer spending
I = investments
G = government spending
X-M = excess of exports over imports (also referred to as NE for Net Exports)
Standards of Conduct - Duties owed to Firms and Subordinates
- Use reasonable care when supervising
- Comply with lawful objectives of CFP Professional’s firm
- Provide notice of public discipline
Standards of conduct: Duties owed to the CFP board
- Refrain from adverse conduct
- Reporting
- Provide Narrative statement
- Cooperation
- Compliance with Terms and Conditions of
- Certification and Trademark License
Substitutes
Increase in the price of one will cause an increase in the demand for the other, e.g., sharp increase in price of oil, gas, or propane would likely cause increase in price of firewood.
The Financial Planning Process Step 1
Understanding the client’s personal and financial circumstances
- obtain quantitative and qualitative information
- analyze information
- address incomplete information
The financial planning process step 2
Identifying and selecting goals
- Identify potential goals
- help the clients select and prioritize goals
The financial planning process step 3
Analyzing the client’s current course of action and potential alternative course(s) of action
The financial planning process step 4
Developing the financial planning recommendations
For each recommendation the financial professional must consider
- Assumptions and estimates used to develop the recommendations
- Basis for making the recommendation
- timing and priority of the recommendation
- whether the recommendation is independent or must be implemented with another recommendation
The financial planning process Step 5
Presenting the financial planning recommendation(s)
For each recommendation the CFP professional must:
- present to the clients the selected recommendations and information that was required to consider when developing the recommendations
The financial planning process step 6
Implementing the financial planning recommendations
- address implementation responsibilities
- identify, analyze, and select actions, products, and services
- recommend one or more actions, products, and services for implementation
- select and implement actions, products, or services
The financial planning process step 7
Monitoring progress and updating
- establish monitoring and updating responsibilities
- monitor the client’s progress
- obtain current qualitative and quantitative information
- update goals, recommendations, or implantation decisions
What are the three categories of adverse conduct that relate to CFP certification fitness standards?
- Conduct Deemed Unacceptable
- Conduct Deemed A Presumptive Bar
- Other Adverse Conduct
What category of adverse conduct would a felony conviction for tax fraud or other tax-related crimes be subject to?
Conduct deemed unacceptable
Unacceptable
What category of adverse conduct would a felony conviction for non-violent crimes (including perjury) within the last five years be subject to?
Presumptive Bar
What category of adverse conduct would a Felony conviction for any degree of murder or rape be subject to?
Conduct deemed unacceptable
unacceptable
What category of adverse conduct would a felony conviction for violent crimes other than murder or rape that occurred more than 5 years ago be subject to?
Presumptive Bar
What category of adverse conduct would a Felony conviction for any other violent crime within the last five years be subject to?
Conduct deemed unacceptable
unacceptable
What category of adverse conduct would a Revocation of a financial professional license (unless the revocation is administrative in nature) be subject to?
Conduct deemed unacceptable
unacceptable
What category of adverse conduct would suspension of a financial license (unless due to administrative issues)
be subject to?
Presumptive Bar
What category of adverse conduct would a Felony conviction for theft, embezzlement, or other financially based crimes be subject to?
Conduct Deemed Unacceptable
Unacceptable
What category of adverse conduct would two or more personal or business bankruptcies be subject to?
Deemed to be a presumptive bar
presumptive bar
What consequence will be issued for conduct deemed unacceptable?
The individual is permanently barred from becoming certified with no possibility for appeal.
What constitutes other adverse conduct?
Customer complaints
Arbitrations and other civil proceedings
Felony convictions for non-violent crimes that occurred more than 5 years ago
Misdemeanor convictions
Employer investigations and terminations
What decision will be issued for conduct presumed to be unacceptable?
An individual is barred from becoming certified unless they petition the Disciplinary and Ethics Commission (DEC) and the DEC grants the petition or permits the individual to reapply for certification later.
What does GDP measure?
Measures economy on a quarterly basis
Measures total market value of a country’s income and output of goods and services produced by all the people and companies in the US
What happens if a complaint for the CFP Board Counsel is not responded to in the required time frame
Failure to answer a complaint will result in CFP Board Counsel delivering an Administrative Order of Suspension or an Administrative Order of Revocation.
If conduct is unacceptable the revocation order is used, if conduct is deemed to be presumed unacceptable the order of Suspension is used.
Mandatory timeframe for suspension is 1 year and 1 day.
What is the CFP Board Disciplinary Hearing Process
CFP Board Counsel delivers complaint
Either Settlement without investigation or respondent answer due within 30 days
- Respondent pays hearing/settlement review fee or requests waiver. Due within 30 days of assessment
Hearing documents, witness list, written statements, and stipulations
- docs due 45 days after delivery of complaint
- witness list due 30 days after delivery of complaint
Notice of hearing from CFP Board Counsel
- due not less than 30 days before hearing
Hearing before hearing panel
Hearing panel recommendations
Disciplinary and Ethics Commission (DEC) reviews hearing panel recommendation
DEC Final order
Appeal to the Board of Directors’ Appeals Committee
- must be filed within 30 days of issuance of DEC final order
What is the DEC
The _D_isciplinary and _E_thics _C_ommission
What step of the financial planning process do you address incomplete information provided to you by your client(s)?
Step 1: Understanding the Client’s personal and financial circumstances
What step of the financial planning process do you analyze the information you collected from your client(s)?
Step 1: Understanding the Client’s Personal and Financial Circumstances
What step of the financial planning process do you help the client(s) select and prioritize their goals?
Step 2: Identifying and Selecting Goals
What step of the financial planning process do you identify potential goals
Step 2: Identifying and Selecting Goals
What step of the financial planning process do you obtain quantitative and qualitative information?
Step 1: Understanding the Client’s personal and financial circumstances
When investors consider the past, they tend to suffer from:
House money effect - take more risk
Snakebite effect - take less risk
Break-evenitis - take more risk
What category of adverse conduct would a Revocation or suspension of a non-financial professional license (unless due to administrative issues) be subject to?
Presumptive Bar
examples: Real Estate license
What body has the authority to investigate and file a complaint against a respondent for alleged violations of the Code of Ethics and/or the Standards of Conduct?
The CFP Board Counsel
Who has the authority to issue a final order for violations of the Code of Ethics and/or Standards of Practice?
The Disciplinary & Ethics Committee (DEC)
How soon must a CFP professional respond to a complaint delivered by the CFP Board Counsel?
30 Days or an Administrative Order or Suspension that suspends the respondent’s certification and license for one year and one day. Or a Administrative order of revocation that revokes the respondent’s certification and License.
GDP Formula
Y=C + I + G+ (X-M) Where: Y = GDP C= Consumer Spending I = Investment made by industry G = Governmental Spending X-M = excess of exports over imports. Also listed as NE or Net Exports
Component of GDP: Personal Consumption Expenditures
Durable Goods: Cars, furniture large appliances Non-Durable Goods: Clothing, food, fuel
GDP Components: Business Investments
Fixed Investment Change in private inventory
Business consists of which 2 general phases
Expansion: increasing GDP
Contraction: decreasing GDP and increasing unemployment
Define GDP
Market value of all goods and services produced by labor and property in the U.S.
Define recession
2 consecutive quarters of negative GDP growth. Not every contraction is a recession, but every recession is a contraction.
Put the phases of the business cycle in the right order
Peak
Expansion
Trough
Contraction
How is trend growth defined?
long term non-inflationary increase in GDP (caused by increase in a country’s productive capacity)
average sustainable rate of economic growth over time
Define characteristics of early signs of an expansion
activity rebounds (GDP, employment)
credit begins to grow
rapid growth of profits
low inventories, sales improving
stimulative policy
What are the characteristics during the mid-phase of an expansion?
Growth peaking
Strong credit growth
Profit growth peaks
Neutral policy
Inventories and sales grow; equilibrium reached
What are the characteristics of a late cycle expansion?
Growth is moderating
Credit tightens
Earnings are under pressure
Policy is contractionary
Inventories grow, sales growth declines
What are characteristics of a contraction?
Falling activity
Credit dries up
Profits decline
Policy eases
Inventories and sales fall
Unemployment rates rise
Leading indicators
Yield curve
S&P 500
new private housing starts
money supply (M2) growth rate
consumer confidence
Manufacturers’ new orders
average weekly hours of production workers (manufacturing)
initial claims for unemployment
percentage of companies reporting slower deliveries
new orders of non-defense capital goods
Lagging indicators
average duration of unemployment
CPI
commercial and industrial loans outstanding
ratio of consumer installment credit outstanding to personal income
ratio of trade inventories to sales
change in index of labor cost per unit of output
average prime rate
Coincident indicators
employees on non-agricultural payroll
personal income minus transfer payments
industrial production / average weekly hours worked in manufacturing
turnover
manufacturing and trade sales
Define fiscal policy
Interventions by the federal government / Congress to influence the economy, such as:
taxation (increase: reduces disposable income; decrease: increases disposable income)
Government spending (increase to promote growth/recovery; decrease = tightening policy)
debt management
Deficit spending
Government expenditures > revenues generated
Government will sell Treasuries
Treasuries will compete with other issuers of debt securities and drive values lower
Define monetary policy
Federal Reserve Bank (Fed) controls monetary policy to control money supply, influence lending rates, slow down or stimulate economy.
Fed mandates
sustainable long term growth
stable prices
full employment
Fed monetary policy tools
Discount rate: rate at which banks borrow from government
Reserve requirement: percentage of deposits that must be held on reserve
Open market activities: Fed buys and sells securities in the open market
Contractionary Monetary Policy Action
increase discount rate (increases cost of borrowing)
increase reserve requirements
sell securities to the market
Standards of Conduct: Prohibition on Circumvention
No third parties can be used to go around and violate the guidelines provided in the Code of Ethics & Standard of Conduct.
Standards of Conduct
A. Duties Owed to Clients (Focus Area!)
B. Financial Planning and Application of the Practice Standards for the Financial Planning Process
C. Practice Standards for the Financial Planning Process (Focus Area!)
D. Duties Owed to Firms and Subordinates
E. Duties Owed to CFP Board
F. Prohibition on Circumvention
Conduct deemed unacceptable
- felony conviction for theft, embezzlement, or other financially based crimes
- felony conviction for tax fraud or other tax related crimes
- revocation of a financial professional license unless administrative in nature
- felony conviction for any degree of murder or rape
- felony conviction for any other violent crime within last 5 years
Conduct presumed unacceptable
- 2 or more personal or business bankruptcies
- revocation of a non-financial, professional license unless administrative in nature
- suspension of a financial, professional license unless administrative in nature
- felony conviction for non-violent crimes within last 5 years (including perjury)
- felony conviction for violent crimes other than murder or rape more than 5 years ago
What authority does the CFP Board Counsel have?
To investigate and file a complaint against a respondent for alleged violations against the Code of Ethics and Standards of Conduct
What authority does the DEC have?
issue a final order that finds facts, determines whether a violation has occurred, and imposes discipline in the form of sanction where appropriate
DEC reviews Hearing Panel’s recommendation and approve or remand to Hearing Panel for further consideration
within 45 calendar days of the hearing DEC must mail by certified mail to respondent a final order containing DEC’s findings of fact and sanction imposed if any
What authority does the Hearing Panel have?
Conduct a hearing
(must consist of at least 3 persons, mostly CFP professionals and a majority must be DEC members - DEC member must serve as chair)
What does the CFP Board Designated Counsel do?
outside attorney who represents the case to the Hearing Panel as an advocate for the CFP Board
What does the CFP Board Advisory Counsel do?
attorney who acts in advisory capacity in providing advice on the Standards of Professional Conduct and hearing procedures to the Hearing Panel and the DEC during ratification meeting
When will the DEC issue an Interim Suspension?
When CFP Board receives evidence that professional has engaged in conduct that poses an immediate threat to the public and the gravity of conduct significantly impinges upon stature and reputation of the marks.
Professional must show cause in form of a written response why he/she should continue to have the right to use the marks while case is pending.
Automatic issuance of interim suspension
failure to respond to show cause within 20 calendar days
felony conviction for any crime
misdemeanor conviction for fraud, misrepresentation or crimes of moral turpitude
revocation of financial professional license unless administrative
Filing certificate with DEC demonstrating that criminal convictions or professional discipline has been reversed will lead to automatic reinstatement but has no effect on any proceedings pending against the professional
What happens if CFP professional does not send written response within 30 calendar days to notice of investigation?
CFP Board Counsel gives 2nd request for information via certified mail, and professional has 20 calendar days to respond
Failure to provide requested information gives rise to adverse inference
Does the CFP Board Counsel have the right to reopen an investigation after dismissal of the case?
Yes
How many days to respond to being served a Complaint by the CFP Board Counsel?
20 calendar days from the date of service of the complaint to respondent
Failure to respond or failure to pay the hearing cost assessed by CFP Board lead to admission of the allegations set forth in the complaint, and CFP Board issues Administrative Order of Revocation
How many days to provide documents, witnesses, and counsel for consideration to the DEC for an investigation?
No evidence may be accepted less than 45 calendar days prior the scheduled hearing
Documentation must not exceed 100 pages
witnesses shall be identified no later than 45 calendar days prior to the hearing
Respondent’s counsel must be identified to CFP Board no later than 45 calendar days prior to hearing
How many calendar days to submit an appeal to CFP Board’s Appeals Committee?
30 calendar days after notice of order
Duty to report criminal conviction or profession discipline applies in which cases?
- conviction of a crime other than minor traffic offenses
- being subject of professional discipline
- upon notification of a change to a matter previously disclosed under 1 & 2 to CFP Board
What action is required after revocation suspension?
Respondent must provide evidence within 30 days of receiving an order of suspension that he/she ceased all use of the marks by providing copies of documents requested by DEC.
Reinstatement after suspension
Suspension for one year or less: automatic reinstatement
Suspension for longer than one year: respondent must file request for reinstatement within 30 calendar days of expiration of suspension (petition DEC for a reinstatement hearing within 6 months of end of the suspension) - failure to do so leads to permanent bar from using CFP certification
Ways to prove rehabilitation to DEC after suspension
maintained competence and learning in the are of financial planning
respondent’s conduct has been exemplary and beyond reproach since issuance of DEC’s order
respondent made restitution or settled all claims from persons injured or harmed by misconduct
documentary evidence of all business activities conducted during suspension period
Balance Sheet / Statement of Financial Position
financial position at a point in time
items on personal balance sheets are reported at FMV
items on corporate balance sheets are reported at the lower of cost or FMV
every asset on balance sheet = source for risk management
assets on left side, top to border in order of liquidity
liabilities and net worth on right side: ST, LT, net worth
total liabilities = ST + LT liabilities
balance sheet equation: Assets = Liabilities + Net Worth
measures assets, liabilities, shareholder’s equity
starts with cash balance and ends with retained earnings
Statement of Cash Flow
cash inflow and outflows during reporting period - cash movements (increases and decreases) over a period of time
assists in reconciling ending cash from prior year with ending cash during reported period
breaks cash into sources and uses
details where cash comes from (earnings, investments, loans, gifts)
starts with net income and ends with cash balance
4 basic types of financial ratios
Liquidity ratios: determine ability to meet ST obligations
Activity ratios: determine relative efficiency of financial management
Profitability ratios: measure relative profitability
Debt ratios: determine ability to meet LT obligations
Liquidity ratios
Current Ratio (Liquid Ratio): Current Assets / Current Liabilities
Quick Ratio: (Current Assets - Inventories) / Current Liabilities
Working Capital: Current Assets - Current Liabilities
Activity Ratios
Inventory Turnover: Cost of Goods Sold / Average Inventory
Days to Sell Inventory: 365 / Inventory Turnover
Accts Receivable Turnover: Sales (credit) / Avg. Accts. Rec.
Receivable Collection Period: 365 / Accts. Rec. Turnover
Profitability Ratios
Gross Profit Margin: Gross Profit / Sales (or Net Earnings / Total Sales)
Operating Profit Margin: Operating Income / Revenue
Return on Assets: EAT (Earnings after tax) / Total Assets
Return on Equity: EAT / Equity
Price to Earnings Ratio: Market Cap / Net Earnings
Debt Ratios
Debt to Equity: Total LT debt / Equity
Times Interest Earned: EBIT / Interest Expense
Debt Ratio: Total Debt / Total Assets
Emergency Fund Ratio
Monetary Assets / Monthly Living Expenses
(Target = 3-6+ months - depending on HH earners; single: 6 mo; 2 earners: 3-6 mo)
Emergency Fund Acceptable Investments
Cash
Checking and savings account
Money market mutual funds
T-Bills
CDs
Cash value life insurance
Lines of credit
Home equity loans
Assets must be liquid and marketable!
Exam tip: client with children but no will establishing guardianship - will has priority; disability insurance for single earner supersedes emergency fund!
FDIC Insurance
Single accounts
Joint accounts (2 or more persons)
Revocable Trust accounts
Irrevocable Trust accounts
Certain Retirement accounts
Corporation, Partnership, and Unincorporated Association accounts
Employee Benefit Plan accounts
Government accounts
$250k per person, per ownership category, per bank (not per branch)
RTFQ: is question testing total coverage or individual coverage?
Which rate do banks charge their most creditworthy customers?
Prime rate
Debt resolution rule
Repay all outstanding debt every 4 years
Chapter 13 bankruptcy
requires debtor and attorney to draw up repayment plan based on debtor’s income/wages/benefit/payments/rental income
Chapter 7 bankruptcy
liquidation procedure: eliminates consumer debt by having a trustee sell some of the debtor’s personal property to repay their creditors (unsecured debt is eliminated, nonexempt assets are sold to pay off secured debt)
Eligibility: income must be under a certain amount
most debts are discharged after 115 days from the day of filing for Chapter 7
debts that cannot be erased: income taxes less than 3 years past due, alimony and child support, student loans, secured debts; furniture and personal belongings, cars and house are usually kept
cannot stop foreclosure but delay it
usually takes 4-6 months
stays on credit reports for 10 years
Chapter 11 bankruptcy
generally best for businesses but also accommodates those who exceed Chapter 13 debt limitations or lack regular income
reorganize debts to pay them more in line with income: unsecured debt is reorganized and paid back over time, secured debt is restructured and paid back over time
Mortgage debt is frequently rewritten under Chapter 11 to give smaller payments, and there is often a “breathing spell” provided in Chapter 11 so that payments don’t have to be made for many months.
Can stop foreclosure
usually takes 6 mo - 2 yrs
Stays on credit reports for 10 years
Chapter 12 Bankruptcy
permits restructuring of farm, reorganization of debt
like Chapter 13, but for farmers only, and with a higher amount of debt allowed.
very strict eligibility requirements: available only to family farmers with regular annual income
primary advantage: ability to reorganize debt without the complex procedures involved in a Chapter 11.
Chapter 13 Bankruptcy
wage earner plan: allows debtors to keep personal assets, but obligated to repay unsecured and secured debt in full over a period
Eligibility: no more than $419,275 in unsecured debt (credit cards, personal loans); no more than $1,257,850 in secured debt (incl. mortgages and car loans)
good chapter to use if behind on house payments: instantly stops foreclosure
good for paying state and federal taxes without having to pay interest
debtor will pay more every month to make payments on overdue debt along with current monthly payments
one payment each month to the court appointed trustee, who pays all creditors according to the plan. Chapter 13 can also protect people who co-signed with you
usually takes 3-5 yrs
stays on credit reports for 7 years
Consumer Credit Protection Laws
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 what is in your credit file
Fair Credit Billing Act: right to have billing mistakes resolved
Fair Debt Collection Practices Act: right to be protected from collection agencies
Consumer Financial Protection Bureau: implements and enforces Federal consumer financial law and ensures that markets for consumer financial products are fair, transparent, and competitive
Credit Score
FICO scores estimate level of future credit risk, how likely a person is to repay a loan on time
comprised of:
- payment history - 35%
- amounts owed - 30%
- length of credit history - 15%
- new credit - 10%
- credit mix - 10%
<580 Poor (well below average, risky borrower)
580-669 Fair (below average, many lenders will approve loans)
670-739 Good (near/slightly above average, most lenders consider this a good score)
740-799 Very good (above average, very dependable borrower)
800+ Exceptional (well above average, exceptional borrower)
Missed payment: 7 years until removed from credit report!
Mortgage Financing - rates
Fixed rate: when rates are low and/or home owner is going to stay in the home for a long period of time
Variable rate: when rates are high (expected to go down) or homeowner is not planning on keeping the home long-term
Mortgage origination points
borrowers can pay origination points to lower rate or improve terms otherwise
points = percentage of mortgage borrowed, can be added to mortgage
Mortgage conventional vs. jumbo
Conventional mortgage: below $647,200
Jumbo mortgage: above $647,200 - higher interest rate
When do you have to pay Private Mortgage Insurance?
Down payment < 20%
PMI can be eliminated after homeowner reaches 20% equity and makes 2 years of on-time payments
Balloon mortgage
Large portion of principal is repaid in a single payment at the end of the loan period
Government mortgage programs are available through:
Federal Housing Administration
Veterans Administration
United States Department of Agriculture
Mortgage Financing Compared
Down Payment Terms Insurance Fixed or Adjustable Funding fees
Conv. 3-20% 15-30yrs DP<20% Either None
VA 0 15-30yrs None Either 2.3-3.6% waived
disab. vet.
FHA 3.5-20% 15-30yrs 11yrs of loan Either None
USDA 0 15-30yrs None Fixed only 1% upfront, 0.35%/yr
Education Funding Options - 529 Plan vs. Coverdell ESA
Contributions to both a 529 and a Coverdell ESA can be made in the same year for the same beneficiary
529 Plan:
- no income restrictions for contributions
- distributions tax free if used for qualified education expenses
- non-deductible contributions (some states give state income tax deduction, some states give tax credit)
- contributions = completed gifts (annual exclusion $16,000 or up to $80,000 with 5-year election)
- maximum investment is established by program, many > $400,000 per beneficiary
- can change beneficiary to other family member
- no time/age restrictions
- for federal aid purposes counted as parental asset if owner is parent or dependent student
- use for nonqualifying expenses: earnings withdrawn subject to federal tax and 10% penalty
- Qualified expenses: tuition, fees, books, computers & related equipment, supplies, special needs, room & board for maximum half-time students, up to $10,000 private school tuition, up to $10,000 student loan payment
Education Funding Options - Coverdell ESA
- non-deductible contributions, withdrawn earnings excluded from income for qualified higher education expenses and qualified K-12 expenses
- contribution = completed gift, annual exclusion $16,000
- value removed from donor’s gross estate
- maximum contribution: $2000 per beneficiary per year from all sources
- beneficiary can be changed to other family member
- contributions are allowed until beneficiary reaches age 18, must use account by age 30
- contribution phase-out between $190-220K (MFJ) or $95-110K (single)
- counted as parental asset for federal aid purposes
- if used for non-qualifying expenses, earnings subject to federal tax and 10% penalty
- Qualified expenses: tuition, fees, books, computers & related equipment, supplies, special needs, room & board for maximum half-time students, up to $10,000 private school tuition, up to $10,000 student loan payment
Education Funding Options - UGMA/UTMA
- earnings and gains taxed to minor; first $1150 of unearned income is tax exempt; unearned income over $2,300 for certain children under 24 is taxed at parents highest marginal rate
- transfers = completed gift (annual exclusion applies)
- value removed from donor’s estate unless donor remains custodian
- no maximum limit
- funds can be used for any purpose
- no change of beneficiary possible: irrevocable gift to child
- custodianship terminates when minor reaches age of majority (18 or 21)
- no income restrictions
- for federal aid purposes counted as student’s asset
- investments as permitted under state lawas
- funds must be used for benefit of minor
Education Funding Options - Series EE and Series I Bonds
- tax deferred for federal, tax free for state; certain post-1989 Series EE and I bonds may be redeemed federal tax free for qualified higher education expenses
- NO gift - qualifying bond must be owned by the parent!
- value included in owner’s gross estate
- maximum investment: Series EE: $10,000/yr, per owner Series I: $10,000 (digital); $5000 (paper) per year, per owner
- qualified expenses: tuition and fees
- bond purchaser must be at least 24 years old at time of bond issuance
- income phaseout: $128,650-$158,650 (MFJ), $85,800-$100,800 (single)
- for federal aid purposes asset of bond owner
- investments: interest-earning bond backed by full faith and credit of US Government
- no penalty for use for nonqualifying expenses, interest on redeemed bonds included in federal income
Calculation of tax free interest:
Example: receipt of $3000 interest, $6000 principal, tuition and fees are $7650
3000 x (7650/9000) = $2550 = tax free interest; $3000 - $2550 = $450 taxable interest
Education Funding Options - Alternate Sources
- Roth IRA (tax free withdrawals at 59 ½ and after 5 years! - not counted as asset for federal aid, taxable portion of withdrawal prior to 59 ½ subject to 10% penalty - waived if used for qualified education expenses; value included in owner’s gross estate
- Traditional IRA- not counted as asset for federal aid, taxable portion of withdrawal prior to 59 ½ subject to 10% penalty - waived if used for qualified education expenses; value included in owner’s gross estate
- Mutual funds: earnings and gains taxed in year realized; direct payments of tuition not considered gifts; no restrictions for non-qualified education expenses
Financial Aid Alternatives
- Home Equity Loan
- Life Insurance Cash Values (low coast loan)
- Qualified Plans (may allow to borrow for educational expenses)
- Defer Admission (some colleges allow students to defer admission while students work and live at home)
- Community College (2-year program, then transfer to 4-year college)
529 ABLE Plans
for eligible individual with disability or who is blind, and who is designated beneficiary and owner of the account (provides for qualified disability expenses)
- ABLE account may be established if blindness or disability occurred before age 26; condition must be expected to last at least 12 consecutive months; must be receiving benefits under SSI and/or SSDI or be able to obtain disability certification from a doctor
- only ONE ABLE account per beneficiary
- earnings in an ABLE account are not taxed unless a distribution exceeds a designated beneficiary’s qualified disability expenses
- Qualified expenses: any expenses incurred relating to blindness or disability, including expenses for maintaining or improving health, independence, or quality of life (no restrictions)
- total annual contributions (including rolled from a 529 account) are limited to annual gift tax exclusion
- Contributions are not tax deductible and must be in cash or cash equivalents
- distributions may be used for any qualified expense
- rollovers allowed from a section 529 tuition account or a section 529 ABLE account
- upon death of beneficiary, ABLE account balance is included in his/her gross estate; amounts paid for outstanding qualified expenses and to state for claims under Medicaid program may be deductible for federal estate tax purposes
- maximum investment = subject to individual state and their limit for education-based 529 savings accounts (many > $400,000). Only the first $100,000 is exempt from the SSI $2000 limit.
- beneficiary cannot be changed
- for financial aid purposes, account balances ≤ $100,000 are disregarded; would also not be reported on sibling’s FAFSA
- use for non-qualifying expenses will result in taxation and penalties and could affect the beneficiary’s eligibility for public benefits
Types of Student Aid
Grants:
- Pell Grants: undergraduates, exceptional financial need, not earned bachelor’s, graduate, or professional degree
- Federal Supplemental Educational Opportunity Grant (FSEOG): undergraduates, exceptional financial need (lowest EFC), prioritizes students who receive Pell Grants, does not need to be paid back
Scholarships: tax-free if full- or part-time student for a degree at an accredited post-secondary institution
Loans:
Federal Direct / Stafford Loans
(a) Direct Subsidized Loans (need-based, undergrad only): help students with financial needs; US Department of Ed pays interest on a Direct Subsidized Loan
- while in school at least half-time
- for first 6 months after you leave school (“grace period”)
- during “deferment”
(b) Direct Unsubsidized Loans (need-based, undergrad, grad, & professional student)
- no requirement to demonstrate financial need
- students pay interest on a Direct Unsubsidized Loan during all periods
Direct PLUS / PLUS Loans:
- non-need based, undergrad, grad, & professional student (“Parent PLUS loan when made to parent; grad PLUS loan when made to graduate or professional student)
- US Department of Ed is lender
- CANNOT have adverse credit history
- maximum PLUS loan: cost of attendance - financial aid received
Work-Study:
- funded by federal, state, and/or institutional allocations; employers must match federal and state monies
- School’s office of financial aid administers work-study programs
Financial Aid and EFC
Financial Need Formula:
- cost of attendance - EFC = Financial Need
EFC = calculated based on financial resources that students and parents own:
income (parents & students) + assets (parents & students)
Income:
- parents: AGI - allowance for taxes + living expenses (22% to 47%)
- students: amount over protected amount ($7040) (50%)
Assets:
- Cash, savings, checking, MMKT funds, CDs
- Investments (mutual funds, stocks, stock options, bonds, commodities)
- Rental real estate equity, businesses, investment farms, trust funds
- College savings plans, CESAs, 529s
Retirement assets and home equity do NOT count towards EFC
Accounts held/owned by:
- parents or in dependent child’s name = parent assets (5.64%) - distributions no impact to aid
- independent students / spouses = student assets (20%)
- others (aunts, grandparents) = excluded - distributions impact aid up to 50%
Education Tax Credits (not available for MFS!)
AOTC
- up to $2,500 per eligible student (100% of first $2000 + 25% of next $2000)
- 40% of credit is refundable (i.e., up to $1,000)
- limit MAGI (MFJ): $180,000; (single, HH, qual. wid.) $90,000
- cannot claim if someone else can claim you as dependent on their return
- cannot be non-resident alien
- first 4 years of post-secondary education
- 4 tax years per eligible student
- must be pursuing degree or recognized education credential
- at least half-time for at least one academic period
- NO felony drug convictions
- qualified expenses: tuition, enrollment fees, materials needed - does NOT cover ROOM & BOARD!!!!
LLC
- Up to $2,000 credit per return (20% of up to $10,000 in expenses)
- not refundable
- Limit on MAGI (MFJ): $180,000; (single, HH, qual. wid.) $90,000
- cannot claim benefit if someone else can claim you as dependent on their return
- cannot be non-resident alien
- all years of post-secondary education and for courses to acquire/improve job skills
- benefit available unlimited number of tax years
- no need to pursue degree or other recognized education credential
- available for one or more courses
- felony drug conviction restriction does not apply
- qualified expenses: tuition and enrollment fees only
- Start with student’s level education/year of enrollment to determine which credit can be used
- Look at types of expenses covered to ensure they are qualifying costs
- Observe filing status and MAGI
Behavioral Finance: Affluenza
affects young people from affluent households
Outcomes include guilt, low motivation, a sense of entitlement, and isolation.
Behavioral Finance: Endowment Effect
Individuals value something that they already own more than something they don’t yet own. Sometimes referred to as divestiture aversion.
Perceived greater value occurs only because the individual possesses the object in question.
Investors tend to hold certain assets because of familiarity and comfort, even if the assets are inappropriate or become unprofitable.
Endowment effect = example of emotional bias
Behavioral Finance: Enabling Behavior
one person shields another person or persons from experiencing the impact of behavioral outcomes
Joaquin is the owner of a 529 account for his daughter, Jolene, a junior at Calisto Tech. Over the years, Joaquin made $50,000 of contributions to the account. Today, the balance is $92,500. Shortly after the academic year started, Joaquin used $25,000 from the 529 account to purchase a new car which he and Jolene use as needed. Joaquin is in the 32% marginal tax bracket.
Calculate the tax and penalty due on the $25,000 withdrawal.
Transportation is not a qualified educational expense, therefore the portion of account gains on the $25,000 distribution is considered ordinary income. In addition, a 10% penalty is applied to the gain portion. Joaquin is in the 32% marginal tax bracket.
The taxation & penalty is calculated as follows:
Gains: $92,500 - $50,000 = $42,500
Percentage of Gains in Balance: $42,500 ÷ $92,500 = 0.4595
Portion of Gains in Distribution: $25,000 × 0.4595 = $11,487.50
Tax Due on Gains: $11,487.50 × 0.32 = $3,676
10% Penalty on Gains: $11,487.50 × 0.10 = $1,148.75
Tax Due + Penalty: $3,676 + $1,148.75 = $4,824.75
When calculating the includible student and parent assets and income for the Expected Family Contribution (EFC), both parents and students are offered
- Income Protection Allowances
- Asset Protection Allowances
I only
II only
Both I and II
Neither I nor II
Both parents and students are offered an Income Protection Allowance as they determine the EFC on the FAFSA form.
The Asset Protection Allowance is only available to parents. It allows parents to exclude certain portions of their assets from consideration when calculating the Expected Family Contribution (EFC).
Jonah and Janelle are in the process of compiling information for the completion of their daughter Vivian’s FAFSA form. Vivian will be attending Upstate University in the coming academic year. Tuition and fees are $55,000. The following income and assets have been documented:
$100,000Equity in primary residence$15,000Brokerage account (Jonah & Janelle)$80,000AGI [after allowances, over protection amount] (Jonah & Janelle)$50,000529 in Vivian’s name (Jonah & Janelle)$250,000IRA (Jonah)$10,000Earned income (Vivian)$7,500Joint checking account (Jonah & Janelle)$5,000UTMA (Vivian)
Assume the rate of income inclusion for the parents is 24% & the maximum asset inclusion rate applies for the parents. Assume $0 in asset protection for the parents. Calculate the financial need using the EFC formula.
Equity in a primary residence and retirement assets are non-includible in the EFC + Financial Need calculations. Thus, the home equity and IRA are omitted.
- $80,000 AGI → Parent Income (24% rate) = $80,000 x 0.24 = $19,200
- $7,500 [Joint Checking] → Parent Asset (5.64%) = $7,500 x 0.0564 = $423
- $15,000 [Brokerage Acct.] → Parent Asset (5.64%) = $15,000 x 0.0564 = $846
- $50,000 [529] → Parent Asset (5.64%) = $50,000 x 0.0564 = $2,820
- $10,000 [Income] → Student Income (50% above protected amt.) = $10,000 - $7,040 = $2,960 x 0.50 = $1,480
- $5,000 [UTMA] → Student Asset (20%) = $1,000
EFC = $19,200 + $423 + $846 + $2,820 + $1,480 + $1,000 = $25,769
Cost of Attendance (COA) = $55,000
COA – EFC = Financial Need → $55,000 - $25,769 = $29,231
On September 15th, 2021, Tucker purchased a speedboat for $95,000. On October 1st, 2022, he gifted the speed boat to his cousin Pierre. At the time of the gift, the speedboat was valued at $150,000. After utilizing the annual exclusion amount, Tucker paid $4,250 in gift taxes.
Select Claude’s basis in the speedboat.
To calculate the adjusted basis to the donee, first calculate the gift tax adjustment:
Step 1: Calculate the ‘Appreciation Factor’ [(FMV – Basis) ÷ (FMV – Annual Exclusion)]
[{$150,000 - $95,000) ÷ ($150,000 - $16,000)] = [$55,000 ÷ $134,000] = 0.4104
Step 2: Multiply the ‘Appreciation Factor’ by the Gift Tax Paid
0.4104 x $4,250 = $1,744
Next, add the gift tax adjustment to the original basis to find the adjusted basis.
$1,744 + $95,000 = $96,744
Which bias leads investors to sell winners too quickly and hold on to losers for too long?
The disposition effect causes investors to sell winners (confirms correct choice) and to avoid selling losers (confirms incorrect choice).
