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Lesson 3

Lesson 3. Announcements Did anyone make a few phone calls to find out about the price of a new house (additional buying details). Financial Planning and Its Benefits. Personal financial planning - Process of managing money to achieve personal economic satisfaction.

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Lesson 3

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  1. Lesson 3 Announcements Did anyone make a few phone calls to find out about the price of a new house (additional buying details).

  2. Financial Planning and Its Benefits • Personal financial planning - Process of managing money to achieve personal economic satisfaction. • Advantages of personal financial planning: 1) Increased effectiveness in obtaining, using, and protecting your financial resources. 2) Increased control / awareness of your financial affairs. 3) Improved personal relationships (know what to expect, fewer surprises, less stress) 4) A sense of freedom from financial worries obtained by looking to the future.

  3. The Financial Planning Process • Determine your current financial situation. A personal balance sheet will work. • Develop your financial goals. • Identify alternative courses of action. • Evaluate your alternatives. • Create and implement your financial action plan. • Review and revise your plan frequently The markets change quickly. Do not be caught on vacation when the market takes a dive!

  4. Create your ownBUDGET FORM See file: • FIN 401 Lesson 3 Personal Budget SAMPLE In class exercise to fill it in • Demonstrate using online template, how it can be used for own benefit outside of class. Explain formulas

  5. Consequences of Choices: Opportunity Cost Opportunity cost • What you give up when you make a choice • Less expensive house = ownership sooner / no mortgage and no interest charges • More expensive house = longer mortgage / continue paying interest • Opportunity Cost of Bigger House = more money paid in interest and not invested for use later in life.

  6. The cost, or trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your time. What opportunity costs do you have from being a college student? • Lost income while in university (4 – 7 years) equals 20,000 RMB * 7 = 140,000 RMB • Lost social recreational and leisure time because a true student does not have the money AND is working all the time. • Other ?

  7. Every Financial Decision Involves Evaluating Types of Risk • Inflation risk. • Rising prices cause lost buying power. • Interest-rate risk. • Effect costs of borrowing and rate of return.

  8. Income risk. • If I do not invest and I lose my job, how will I feed myself and my family? • Personal risk. • If I have partial or no health benefits, how will pay for costly medical procedures for myself or my children (Emma’s story)

  9. Liquidity risk (Higher return may mean less liquidity) What is liquidity? Examples: 1) 60 days to get money 2) Penalty for taking it early 3) Share price may be down 4) Real Estate: 6 months to sell a house is not unheard of.

  10. Financial Planning Information Sources • Printed materials. • Financial institutions. • School courses and educational seminars. • The internet, online sources, computer software. • Financial specialists. • Financial planners, bankers, accountants, insurance agents, lawyers and tax preparers.

  11. The time frame in which you want to achieve your goals can be measured in the short-term, intermediate and long-term. In your current position as 3rd year university students, give me examples of each. Short term Clothing, cell phone, travel and vacation, dining out, OTHER. Intermediate Computer, business clothing for job interview and work, television, OTHER. Long-term Car, house, retirement, OTHER

  12. Mutual Funds are a group of investments commonly offered by North American Banks Mutual Funds quote past historic rates of return because they can not tell us what is going to happen in the future. They take a historical mean (average).

  13. Mutual Funds (continued) We buy mutual funds based on their good performance in the past. In theory, if they performed well in the past, they were probably managed well and will be more likely to perform well in the future. There is no formula to accurately predict which will be the most profitable or safe investments.

  14. Discount Rate Discount Rate is the rate of return that is applied to an investment whose future value is known. For example, if you require a 10% rate of return, you will need to invest $909.09 today, to be paid $1,000 in one year. Therefore, $909.09 is the value of $1,000 discounted at 10% for one year.

  15. Discount Bond A discount bond is an investment that pays no interest (profit) until the final payment. The formula on the next slide demonstrates the calculation for discount bonds, which are for one period of time only.

  16. $909.09 today at 10% interest for 1 yearSee page 16 and 17 of your textbook

  17. $909.09 is the value of $1,000 discounted at 10% for one year.

  18. Future Value The Future Value is computed when you know what you have to invest and at what rate and the length of the time period. The future value shows you the final compounded value.

  19. Time Value of Money considers Compounding Investing: Compounding gives a return on your original investment plus a return on previous returns. (interest earned on interest) What annual rate compounds $100 to $120 in two years? Is it 10% ? No. Answer = 9.5445% If the rate was 10%, the value would be $121 in two years. Think of these investments as 2 investments, each being 1 year in duration.

  20. Year 1 $100 x 9.5445% = $9.545 = 109.5445 Year 2 $109.5445 x 9.5445% = $10.456 Value of money after 2 years = $120 We call the $120 the future value of $100 invested for 2 years at 9.5445%

  21. Year 1 $100 x 10% =$10 $100 + 10 Year 2 $110 x 10% = $11 + 11 $121 The value of $100 invested for 2 years at 10% is $121 Why is it important to know about compounding interest? • When borrowing, the cost adds up • When lending your money (INVESTING), it is important to know if you are getting the best rate available at the time.

  22. HomeworkAnswer these questions in your notebook. Include the date and a short explanation • Find out the approximate annual income of a front line worker in Walmart. • You have $100 to invest. Which will bring you more profit, investing it at 10% daily or annually? In your notebook, write the answer with an explanation that demonstrates you understanding. At the beginning of next class, offer your explanation to the class and earn participation marks.

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