financial literacy

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Interest Rates

Loans & Debt

CreditAssets

Insurance

Taxes

A few simple concepts…

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©Copyright 2010 Outflyers™.com, all rights reserved.

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Interest Rates


Interest Rates

Loans & Debt

CreditAssets

Insurance

Taxes

Interest is a fee paid to borrow or “rent” money. When

you borrow from someone, you pay this fee. When you

lend money like depositing in a saving account, you earn

this fee.

There are two types of interest: simple and compound.

5

Interest Rates


Simple interest is only calculated on the unpaid portion of

the principal amount borrowed, NOT on unpaid interests

accrued on it.

The formula to calculate simple interest is:

where I is interest, r is interest rate and P is principal

amount.

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Simple Interest


Compound interest is calculated on the unpaid principal

amount borrowed PLUS on any unpaid interest accrued

on it.

The formula to calculate compound interest is:

where I is interest, r is interest rate, P is principal and n is

number of compounding periods.

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Compound Interest


Suppose you borrow $5,000 at the beginning of the year

to pay back at the end of the year from (a) a friend with

12% simple interest (b) on your credit card with a %12

interest rate (APR) compounded monthly. The interest is:

(a)

(b)

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Compounding Effect


Fixed interest rates are set when you borrow and don’t

change during the life of the loan.

Variable or adjustable rates are subject to change as their

reference rate changes. Two reference rates are

commonly used:

Prime: for example “Prime + 4.75%”

LIBOR: for example “1 Year LIBOR + 3.25%”

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Fixed & Variable Rates


Inflation is the rise in the general level of prices of goods

and services over a period of time, usually a year.

Your cash loses its purchasing power by the inflation rate

just like a negative compound interest rate.

If you have P dollars today, it is worth:

after n years if annual inflation rate is i (a constant).10

Inflation


Annual Percentage Rate or APR is not the real rate that

you pay on your loans. It is monthly interest rate times 12.

To convert APR to Effective APR or the real interest rate

that you will pay on a loan use this formula:

Use Effective APR just like r or compound yearly interest

rate.

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APR


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Loans & Debt


Interest Rates

Loans & Debt

CreditAssets

Insurance

Taxes

Loans fall into two main categories:

Secured: you pledge a collateral to get a loan such as

mortgages and auto loans.

Unsecured: you get the loan without any collateral e.g.

unsecured credit card debt and student loans.

If you default on a secured loan, the creditor will assume

the ownership of the collateral.

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Loans


The most common types of the loans are:

Mortgage Loans

Auto loans

Student loans

Credit card loans

Home equity loans

Equipment leasing

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Loans


Loan and grace periods: Loan period is the total duration

of the loan. It might be as short as one month for credit

card debt or as long as 30 years for home mortgages.

Grace period is a period of time in which someone is late

with a payment, but penalties are not incurred. For

example, credit cards have a typical 21 to 25 days grace

period, which starts when your statement is issued.

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Common Characteristics of Loans


Interest rate: A loan might have a fixed or variable

interest rate. A variable interest rate might change

considerably during the loan period, especially for longer-

term loans. If your interest rate changes, your monthly

payment will also change and might increase

considerably. Also, the lender may increase your interest

rate significantly if you miss a payment.

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Repayment schedule: A loan may have fixed repayment

schedule which means you pay fixed installments over the

repayment period, for example $5,00 per month for two

years. Or a loan may have graduated repayment schedule

starting with lower installments that increase after a

period, for example you may pay $200 for the first six

months and then your installments increase to $700.

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Security: Security is what you pledge to the lender as

collateral. For mortgages, it is the house itself and for

auto loans, it is the car. If you default on your loan, the

lender will take over the ownership of your collateral.

Pay attention to these four characteristics and other fees

and conditions when you apply for a loan. They should be

100% known to you before you commit to anything.

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Mortgages are the loans for home buyers to purchase a

property which is used as the collateral for the loan.

Home buyers can usually borrow up to 80% of the home value

based on their credit history and income.

Mortgages can have fixed or variable interest rates and their

duration varies from 15 to 30 years.

borrowers need to submit several documents including their

credit history and home value appraisal to secure a mortgage.19

Mortgage Loans


Auto loans are usually offered by financing units of car

companies and have a duration of 36, 48, or 60 months.

The car is the collateral of the loan and the buyer usually

is expected to pay a down payment in addition to dealer

fees and sales tax as soon as the loan is approved.

The car needs to be insured for the duration of the loan.

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Auto Loans


Student loans are offered to pay for educational expenses, and

to qualify for them, the borrower needs to have been

admitted to an accredited, degree-awarding program.

Federal student loans in the U.S. can have fixed interest rates,

but private student loans have variable interest rates.

The borrower usually doesn’t need to start paying back the

loan while he is in college.

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Student Loans


Credit card companies usually treat any unpaid balances

on a credit card as a loan with credit card APR.

Credit card loans generally have very high variable

interest rates which can be bumped up significantly if a

payment is missed.

Pay attention to the credit card APR and fees when you

apply for one and never carry a credit card debt.

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Credit Card Loans


Home equity loan is a loan that you receive from a bank

by putting your home as collateral.

They are like mortgages but the home is not actually

being bought or sold.

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Home Equity Loans


In equipment leasing, an actual equipment such as a truck or a

computer equipment is loaned or rented for a series of

payments.

Lease agreements might have fixed or renewable period and

the borrower may have the option of purchasing the

equipment at the end of the lease period at a predefined price.

Most common types of leases are home rents and car leases.

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Equipment Leasing


Regardless of the type of the loan, if the interest rate,

period, and principal amount are known, the periodical

(usually monthly) payments can be calculated using this

formula:

P is the periodical payment, L is the principal, r is the

interest rate and n is the number of periods.

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Loan Calculations


Suppose you have got $10,000 with an APR of 6% (0.5%

per month) to pay back in 10 years (120 months). Your

monthly payment will be:

Over the life of the loan, you will totally pay:

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Loan Calculations


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Credit


Interest Rates

Loans & Debt

CreditAssets

Insurance

Taxes

Your creditworthiness determines how much credit and under

which terms you receive as different kinds of loans from lenders.

In the U.S., three credit bureaus collect financial records of

individuals: Experian, Equifax, and TransUnion.

When you ask for credit from a lender, it obtains a copy of your

credit history from one of these bureaus. Based on your credit

history, it decides to approve or reject your loan request.

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Consumer Credit


Financial institutions report how you use or misuse your

credit to the credit bureaus.

Sometimes credit histories might contain errors. Because

it has such a big impact on your life, you had better

monitor your credit history regularly.

You can get a free copy of your credit records per year

from here: http://www.annualcreditreport.com/

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Credit History


Credit score is a number representing the creditworthiness of

a person or the likelihood that he will pay his debts

Credit score in the United States ranges from 300 to 850 with

a credit score more than 750 considered excellent.

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Credit Score


300 620 660 720 750 850

POOR WEAK FAIR GOOD EXCELLENT

Credit score is calculated from five categories of data in

your credit report.

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Credit Score


Payment History (35%)

Amounts Owed (30%)

Length of Credit History (15%)

New Credit (10%)

Types of Credit Used (10%)

Pay your bills on time. If you have missed a payment, get and

stay current.

If you are having problem making ends meet, consult with a

financial counselor.

Keep balances low on your credit cards. Pay your credit card

bills in full every month.

Don’t open too many credit cards in a short period of time.

Use your credit cards from time to time.

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Improving Credit Score


Based on the Fair Credit Reporting Act (FCRA) in the U.S.:

You have the right to receive a free and complete copy of your

credit report once per year.

If you are denied credit, you have the right to know why, and a copy

of your credit report that based on it the decision was taken.

You have the right to know who has accessed your credit record

during the past year (for most purposes).

You have the right to dispute the accuracy of your credit report and

the credit bureau is legally obligated to investigate your dispute.33

Credit Rights


34

Assets


Interest Rates

Loans & Debt

Credit

Assets

Insurance

Taxes

In addition to cash, real estate, and equipments, these

four classes of assets are commonly owned by individuals

for investing or retirement saving:

Public companies stocks

Governmental and corporate bonds

Options

Exchange traded funds (ETF)

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Assets


In order to trade these four classes of assets, you will need

to open an investment account with a brokerage firm.

Most brokerage firms don’t charge a fee to open an

investment account. You are charged only when you buy or

sell assets.

In the U.S., you need to have a valid social security number

to open an investment account .

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Trading Assets


These classes of assets are usually traded on stock exchanges.

Two of the largest stock exchanges in the U.S. are New York

Stock Exchange (NYSE) and NASDAQ.

When you want to trade a particular asset, you will place an

order through your investment account. Your order flows

through the computerized trading system in one of the stock

exchanges and is executed.

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Trading Assets


By opening a free investment account you will get

access to many investment reports and educational

materials even if you don’t plan to actively trade.

But if you do not know enough about investing, do

NOT trade without consulting with a professional

first. Otherwise, you are almost sure to lose money.

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Trading Assets


Stock of a publicly traded company represents its value in the

market or its market cap.

Stock of a company is divided to a number of shares that can be

bought in the stock market if it is a public company.

When you buy a number of shares of a company, you will

become one of its shareholder. You will own a piece of that

company and are entitled to a portion of all its future revenues.

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Stocks


Some companies pay out a portion of their profits, called

dividend, to their shareholders every year.

Share prices fluctuate on the stock market every day

during trading hours. Share of a company goes up if

investors expect its profit will increase in future and vice

versa.

You can see live share prices at http://google.com/finance

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Stocks


You can track the price of a stock on the stock charts

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Stock Charts


Every public company has a unique symbol on the stock

market called the ticker. For example, the ticker of General

Electric is GE, and the ticker of Wall Mart is WMT.

Other information you will find on the stock charts are:

Day trading range: the range between the lowest and the

highest price on the trading day.

52 week hi & low: the lowest and the highest price in the past 52

weeks

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Common Characteristics of Stock


Opening and closing prices: opening and closing price of

the trading day.

Trading volume and average volume: the number of traded

shares of that specific stock during the trading day and the

average trading volume per day.

Market cap: the total value of all shares of the company in

the market.

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P/E: price per earning, current share price divided by the

company’s profit per share in the past year. It basically

means how much you have to pay to buy one dollar of the

company’s profit if you buy its shares at the current price.

Dividend & yield: the amount of the dividend that the

company pays for every share you hold in a year and its

percentage of current share price.

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EPS: earning per share, how much profit the company has had in

the past year for each of its shares.

Shares: the number of company’s shares.

Beta: How fast the share price of the company moves comparing

to the market average.

Institutional ownership: what percentage of the company is

owned by institutions like pension funds rather than individuals.

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A stock index is an average of the prices of a certain number of

stocks in the stock market which shows the overall direction of

the market. This average is usually weighted by the market cap

of each company included in it.

The most famous stock indexes in the U.S. are:

Dow Jones Industrial Average (DJIA): contains 30 of the largest

and most influential companies in the U.S. DJIA is not weighted.

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Stock Indexes


Standard & Poor’s 500 (SPX): contains 500 of the mostly-

held companies in the U.S. and is usually seen as the

benchmark of the U.S. stock market.

NASDAQ Composite Index (NSAD): contains all companies

that are traded on NASDAQ stock exchange. It mostly

contains technology stocks.

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Stock Indexes


Bonds are promissory notes issued by governments or

companies to borrow money. When you buy a bond, you

actually lend your money to its issuer to receive it back at

some time in future (maturity date) plus some interest.

Bonds are considered safer investment than stocks and

their prices are less volatile than stock prices.

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Bonds


Bonds may be issued by:

National governments - in the U.S. by the U.S. Treasury

State and local governments, which are called muni

Corporations

U.S. government bonds are divided into three categories:

Treasury bills: maturity date up to one year

Treasury notes: maturity date between one and ten years

Treasury bonds: maturity date more than ten years

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Bonds


Face or par value: is the amount of money a holder will receive

back once a bond matures. This is not the price one pays to buy

a bond. Bonds may be sold more than their face value (at a

premium) or less than their face value (at a discount).

Corporate bonds usually have a face value of $1,000.

Coupon: is the amount the bondholder will receive as interest

payments usually as a percent of its face value per year. A bond

with no coupon payments is called zero-coupon.

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Common Characteristics of Bonds


Maturity: is the future day on which the investor's principal

(bond face value) will be repaid.

Issuer: the institution that has issued the bond. U.S.

government bonds are considered very safe. Other bonds are

less safe than Treasury bonds. Three rating agencies in the U.S.

rate bonds. These rates range from AAA to D. Bonds with

rating lower than BBB are called junk bonds which means

investing in them have the risk of losing your money.

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Yield: is yearly total of coupons (interest) paid divided by

the face value of the bond. It is actually the rate of return

on the money you have lent.

When the prevailing interest rate in the economy (Prime

Rate in the U.S.) goes up the prices of bonds fall and vice

versa. Also price of a bond has inverse relationship with

its current yield (yearly interest divided by current price).

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Option is a contract that gives you the right to buy or sell

shares of an underlying stock at a predefined price (strike

price) on or before a specific date (expiration date).

There are two categories of options:

Call options: give you the right to buy shares

Put options: give you the right to sell shares

You can buy or sell both call and put options even if you don’t

own the underlying stock.

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Options


CVX 01/21/2012 80 P VZ 01/21/2011 22.5 C

I. Underlying stock, most of the times its ticker with one

or two additional letters

II. Expiration date

III. Strike price

IV. Option type (put or call)

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Option Symbols


I II III IV I II III IV

ETFs are investment funds managed by professional investors

that can be traded on the stock market just like stocks.

ETFs may invest in stocks, bonds, options, currencies, or

commodities.

For those who are not professional investors and don’t actively

manage their investments, ETFs might be a good alternative.

Many ETFs can also be bought directly from the fund company

or through brokerages with no fees.

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ETFs


Many ETFs have been designed to track a specific index such

as iShares S&P 500 Index (IVV) or Vanguard Total Stock Market

Index (MUTF:VTSMX).

Pay attention to the expenses that ETFs charge you before

investing in them.

The 1, 3, and 5 year return numbers advertised by ETFs can be

very misleading. Don’t rely on these numbers alone when

deciding to invest in an ETF.

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ETFs


57

Insurance


Interest Rates

Loans & Debt

CreditAssets

Insurance

Taxes

Insurance takes care of the risks that you cannot cover by your

own financial means if they affect you for a (usually) monthly

payment which is called premium.

Most common types of insurances for individuals are:

Property or home insurance

Auto insurance

Health insurance

Life insurance

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Insurance


Property or home insurance provides protection against

most risks to property, such as fire, theft and some

weather damage.

Typical home insurances exclude some perils such as

earthquake, flood, and war, but you can separately

purchase specific insurances for them.

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Property Insurance


The typical home insurance policies in the U.S. are:

HO1 – Basic: It covers 11 listed perils including fire and

lighting, windstorm, vandalism, theft, damage from car or

aircraft, and personal liability. It excludes earthquake and

flood.

HO2- Broad: It covers 17 listed perils including all 11

covered by HO1.

60

Types of home Insurances


HO3 – Special: It is the most comprehensive coverage for

single-family homes. It covers everything that is not

explicitly excluded.

HO4- Renter’s insurance: It is for the tenants of a home not

the homeowners.

HO5- Premier: It includes all coverage in HO3 plus some

more. If the cause of a loss is not specifically excluded in

the policy, it is covered.

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HO6 – Condominium: this type of policy is for owners of

condominium.

HO8 – Older houses: this type of policy is for the owner-

occupied older homes.

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Auto insurance is purchased for cars, trucks, and other

vehicles to provide protection against losses incurred as

the result of traffic accidents and against the liability that

can be incurred in an accident.

Liability insurance is mandatory in most states and the

driver needs to carry the poof of insurance in his car all

the time.

63

Auto Insurance


Liability coverage: provides coverage for bodily injury

(BI) or property damage (PD) for which the insured driver

is at fault.

Collision coverage: provides coverage for the insured

vehicle damages in an accident, subject to a deductible.

When you rent a car, this coverage is called Collision

Damage Waiver (CDW) or Loss Damage Waiver (LDW).

64

Auto Insurance Terms


Comprehensive coverage: provides coverage for the insured

vehicle that is damaged by incidents not considered collisions

such as fire, theft, vandalism, and weather, subject to a

deductible.

Full coverage: collision and comprehensive coverage together.

Loss of use coverage: pays for rental expenses when the

insured vehicle is repaired due to a covered loss.

65



Uninsured motorist coverage: provides coverage if an at-

fault driver involved in an accident either does not have

insurance or has less than enough insurance.

Loan/lease payoff coverage: pays for the difference of

the amount the owner of the insured vehicle owes on his

auto loan or lease and the coverage from his auto

insurance if the car is damaged beyond economical repair.

66



Roadside assistance coverage: provides coverage for

tows that are related to mechanical breakdowns, flat

tires, and gas outages.

Personal property coverage: provides coverage for

personal items in a vehicle damaged due to an

accident and are not attached to the vehicle and thus are

not covered by the principal insurance.

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Health insurance plans vary widely in different countries. In

the United States, health insurance is usually provided by

employers or individuals buy it from private insurers. State-

provided health insurance is only available to the retired and

low-income families (Medicare and Medicaid).

In some other countries, the state provides basic health

insurance and additional insurance can be bought from private

insurers.

68

Health Insurance


Premium: the monthly payment that the insured individual or his

employer pays for the health insurance.

Deductible: the amount that the insured individual has to pay out of

his pocket before the insurer pays its share. The insurance actually

starts paying if healthcare costs exceed its deductible amount.

Co-payment: the amount that the insured individual has to pay for

each doctor visit or service out of his pocket.

Exclusions: services that are not covered by the insurance policy.

69

Health Insurance Terms


Coinsurance: the percentage of the total healthcare costs that the

insured individual is responsible for, instead or in addition to co-

payment.

Coverage limit: The maximum healthcare costs that the insurer pays

in any case.

Out-of-pocket maximum: The maximum amount the insured

individual has to pay for his healthcare costs under insurance plan.

In-network provider: A healthcare provider, such as a doctor or

hospital, that is preferred or allowed by the insurer.

70

Health Insurance Terms


Life insurance is a contract between the policy owner and the

insurer whereby the insurer agrees to pay a sum of money to

the beneficiaries if the insured individual dies or becomes

critically ill.

In life insurance the policy owner and the insured individual

might be different persons.

Three important factors that affects life insurance premiums

are age, gender, and use of tobacco.

71

Life Insurance


Term insurance: provides life insurance coverage for a

specified number of years for example 10, 20, or 30 years

in exchange for a specified premium.

Permanent Life Insurance: is a type of life insurance that

remains in effect until the policy matures and pays out.

The policy cannot be canceled by the insurer except for

fraud in the application.

72

Types of Life Insurance


73

Taxes


Interest Rates

Loans & Debt

CreditAssets

Insurance

Taxes

Tax is a financial charge or levy on a taxpayer by a

national or local government with the authority to punish

failure to pay according to law.

Taxes are often calculated as a percentage. Tax tables

contain marginal rates. Marginal rate is the rate you pay

for that portion of your income that falls into its bracket.

Effective tax rate is average tax rate for your total income.

74

Taxes


For example if you were to file your U.S. federal income tax in

2009 as the head of household (versus single or married filing

jointly), you would have to use the following tax table:

75

Tax Rates


Taxable Income Rate

$0 - $11,950 10%

$11,951 - $45,500 15%

$45,501 - $117,450 25%

$117,451 - $190,200 28%

$190,201 - $372,950 33%

$372,951 & Over 35%

Based on this table, a head of household with $87,500

taxable income in 2009 has to pay (excluding tax credits):

His effective tax rate will be:

76

Tax Rates


A tax deductible expense such as interest on your home

mortgage is an expense that you can deduct from your total

income before you calculate its income taxes. It lowers your

income tax by bringing down your taxable income. It does NOT

lower your tax dollar by dollar.

You can deduct a tax credit such as first-time home buyer tax

credit directly from your payable tax. Therefore it brings down

your payable tax dollar by dollar.

77

Tax Deductions


Capital gain tax: charged on the profit made by selling a capital

asset such as a stock or bond.

Income tax: charged on the financial income of individuals and

corporations.

Estate tax: charged on the transfer of the taxable estate of a

deceased person.

Property tax: charged on the owners of real estate.

Sales tax: charged when a product is sold to the final consumer.

78

Types of Taxes


For more detailed information about topics on this

presentation please visit:

Visit: http://www.outflyers.com/investing/financial-literacy

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