Module 3 Financial Statements, Cash Flow Management, Financing Strategies, and Financial Institutions Flashcards
Which of the following statements concerning a client’s level of savings is CORRECT?
A budget should consider the client’s financial goals and serve as a control document for future cash flows, including cash available for savings.
If future spending exceeds budget projections, the cash actually saved will be more than anticipated.
A)
II only
B)
I only
C)
Both I and II
D)
Neither I nor II
The answer is I only. Statement I is correct. A budget should consider the client’s financial goals and serve as a control document for future cash flows, including cash available for savings. Statement II is incorrect. If future spending exceeds budget projections, the cash actually saved will be less than anticipated.
LO 3.2.3
The simple formula to determine the net cash flow (surplus or deficit) of a client is
A)
fixed outflows – variable outflows.
B)
assets – liabilities.
C)
inflows – outflows.
D)
inflows + outflows.
The answer is inflows ‒ outflows. The net cash flow (surplus or deficit) of a client can be determined by subtracting outflows from inflows.
LO 3.1.2
Which of these types of information are important to gather from a client prior to developing financial planning recommendations?
Their desired age of retirement
Current asset mix within 401(k) or 403(b) plan
Potential inheritance from parents
Number of children client and spouse intend to have
A)
I and IV
B)
I, III, and IV
C)
I, II, III, and IV
D)
II and III
The answer is I, II, III, and IV. The age of retirement is required for determining investment and life insurance needs. The current asset mix is necessary to know when developing an investment strategy based on other information provided by the client. A potential inheritance should not generally be counted on for financial planning, but it can be a warning that estate tax problems may crop up in the future. The number of children a couple may have gives an indication as to what may be needed for education expenses and how children will affect family income, and creates the need for other forms of planning such as trusts and guardianship issues.
LO 3.2.1
Hannah has the following assets, some of which are deposited at National Bank.
Assets Ownership Balance
Savings account (National Bank) Hannah $250,000
Traditional IRA (National Bank is custodian) Hannah $275,000
Checking account (National Bank) Joint with sister $10,000
Certificate of deposit (National Bank) Hannah $50,000
Savings account (National Bank) Joint with son $50,000
Money Market mutual fund (National Bank Advisors) Hannah $80,000
What amount of Hannah’s assets is currently insured by the Federal Deposit Insurance Corporation (FDIC)?
A)
$585,000
B)
$640,000
C)
$530,000
D)
$560,000
The answer is $530,000. The amount currently insured by the FDIC for Hannah is $530,000. FDIC insurance coverage is $250,000 for the account owned solely by Hannah and the CD (the values total $300,000; however, the maximum FDIC coverage for assets with the same ownership is $250,000). Hannah’s FDIC insurance covers 50% of the joint checking account ($5,000), 50% of the joint savings account ($25,000), and the IRA up to the $250,000 limit for IRAs. The money market mutual fund is not a money market deposit account and, therefore, is not covered. ($250,000 + $5,000 + $25,000 + $250,000 = $530,000)
LO 3.4.1
Which of the following guidelines are used to determine whether a client has excessive debt?
Payments on housing should be no greater than 28% of gross income.
Total monthly payment on all debts should be no greater than 36% of gross monthly income.
Total monthly payment on all debts should be no greater than 28% of gross monthly income.
Consumer debt payments should be no greater than 30% of net income.
A)
I, II, and III
B)
I, II, III, and IV
C)
I and II
D)
III only
The answer is I and II. Consumer debt payments should be no greater than 20% of net income.
LO 3.1.3
A client provides a current personal balance sheet to the financial planner during the initial data gathering phase of the financial planning process. This financial statement will enable the financial planner to gain an understanding of all of the following except
A)
the client’s liquidity position.
B)
the size of the client’s net cash flow.
C)
the diversification of the client’s assets.
D)
the client’s use of debt.
The answer is the size of the client’s net cash flow. A balance sheet (also called a statement of financial position or net worth statement) reports assets and liabilities. Cash flow information is reported on a cash flow statement.
LO 3.1.1
Robert Smith asks for your help in preparing his cash flow statement. He tells you that his salary before taxes is $250,000 and that he has no mortgage on his home. Which of the following statements is true about Robert’s cash flow statement?
A)
The value of the home would be an income source since there is no mortgage.
B)
The value of the home would be an asset.
C)
The taxes on his salary would be a liability.
D)
The taxes on his salary would be an expense.
The answer is the taxes on his salary would be an expense. Cash flow statements show income and debt payments (i.e., inflows and outflows). Assets and liabilities are shown on a statement of financial position or net worth statement. The home’s value by itself would be recorded as an asset on a statement of financial position, rather than as an income source on a cash flow statement. Again, income rather than income sources are shown on cash flow statements.
LO 3.1.2
Trenton, age 59, is unmarried and retired. He has the following assets on deposit at Riverview Bank, an
FDIC-insured financial institution:
Account Ownership Balance
Checking account Trenton $70,000
Savings account Joint with daughter, Bailey $80,000
Certificate of deposit (CD) Trenton $225,000
Rollover traditional IRA Trenton $150,000
What amount is insured by the FDIC?
A)
$525,000
B)
$325,000
C)
$480,000
D)
$250,000
The answer is $480,000. The FDIC insures separate legal categories of accounts of a legal institution. As a result, the individual accounts owned by Trenton (CD and checking account) are aggregated and are insured up to a total of $250,000. The joint account is insured for $80,000. The individual retirement account (IRA) will be insured up to $250,000. Total amount insured is $480,000 ($250,000 max on CD and checking account + $80,000 joint savings account because titled differently + $150,000 rollover traditional IRA).
LO 3.4.1
As a rule, the housing cost ratio should NOT exceed what percentage of gross monthly income?
A)
22%
B)
28%
C)
36%
D)
20%
The answer is 28%. As a rule, the housing cost ratio should not exceed 28% of gross monthly income.
LO 3.1.3
A generally accepted rule in personal financial planning is that the consumer debt ratio should NOT exceed
A)
36%.
B)
28%.
C)
33%.
D)
20%.
The answer is 20%. This ratio, which is monthly consumer debt divided by monthly net income, refers to debt other than mortgage indebtedness and should not exceed 20%.
LO 3.1.3
William is in the market for a new automobile. He is weighing the choice between leasing and buying. Which of the following are reasons he should consider leasing rather than buying?
Drives fewer than 15,000 miles per year
Uses the car mostly for business purposes
Keeps a car for five years or longer
A)
II only
B)
II and III
C)
I, II, and III
D)
I and II
The answer is I and II. William should consider leasing an automobile if he drives fewer than 15,000 miles per year, uses the car for business, likes to have a new car every two to four years, does not like to borrow money for automobile purchases, and wants a lower monthly car payment.
LO 3.3.4
Margaret is in the market for a new automobile. An automobile dealer has suggested that she lease a vehicle. The proposed lease terms include making 36 monthly payments of $325 and returning the vehicle to the dealer at the end of the lease period. Margaret may owe the lease company additional money if the car’s actual value is less than the projected value. What type of lease agreement is the dealer proposing to Margaret?
A)
Finance/open-end lease
B)
Operating lease
C)
Closed-end lease
D)
Fixed-cost lease
The answer is finance/open-end lease. Finance and open-end leases are the same. Closed-end and fixed-cost leases are also the same, except for unusual use or damage, there are no additional costs. Operating leases don’t exist.
LO 3.3.4
What is the key to successfully using the snowball technique to eliminate debt?
A)
Develop a plan that the client can commit to executing.
B)
Start with the debt that has the highest account balance.
C)
Begin with the debt that has the highest interest rate.
D)
Begin with the debt that has the highest payment.
The answer is develop a plan that the client can commit to executing. Whether a client starts with the lowest account balance or highest interest rate, the key to the effectiveness of using the snowball technique is developing a plan that the client can commit to and execute. The goal is eliminating debt, and the client needs to agree to the process to make that happen. Beginning a debt reduction plan with the debt that has the highest payment is not a typical debt reduction technique.
LO 3.3.2
The ratio of a client’s monthly consumer debt payments to monthly net income should NOT exceed
A)
20%.
B)
25%.
C)
15%.
D)
30%.
The answer is 20%. Consumer debt refers to debt other than mortgage indebtedness and most often includes debt incurred to service automobile and credit card purchases. A generally accepted rule in personal financial planning is that this ratio should not exceed 20%.
LO 3.1.3
Which of the following assets is appropriate to include in an emergency fund for a family with $500 per month in discretionary income?
A)
A certificate of deposit with a 2-year maturity
B)
An S&P 500 Index mutual fund
C)
Cash advance limit on consumer lines of credit
D)
A money market deposit account
The answer is a money market deposit account. The only liquid and time-appropriate asset listed is a money market deposit account. An S&P 500 Index mutual fund should not be used for emergency fund purposes because its value may decline and any sale of shares may result in a taxable event.
LO 3.2.2
Which of the following are good savings strategies?
Use an overdraft feature on debit cards
Choose an economical cell phone plan
Increase deductibles on automobile insurance policies
Limit credit card purchases to those that can be paid off in full in six month
A)
II and III
B)
III and IV
C)
I, II, III
D)
II and IV
The answer is II and III. Using an overdraft feature on debit cards may entice individuals to spend money they do not have available in their accounts. Increasing insurance deductibles decreases premiums, which is a good savings strategy. Another good plan is to choose an economical cell phone plan (and limiting texting and calls). If credit cards are used, they should be paid off in full at the end of each month.
LO 3.2.3
Which of the following items are normally included as variable expenses in a budget?
Auto loan repayment
Home mortgage
College education savings fund deposits
Charitable contributions
A)
III and IV
B)
I and II
C)
I, II, and IV
D)
I, III, and IV
The answer is III and IV. Debt repayment and housing costs are generally shown as fixed expenses. While they may vary somewhat each month, they are regular and recurring. Education savings funds and contributions to charitable organizations are normally viewed as discretionary or variable.
LO 3.3.1
On a statement of cash flows, the following items would be classified under which category?
Food expenses
Clothing expenses
Utilities expenses
Travel and entertainment expenses
A)
Discretionary expenses
B)
Fixed outflows
C)
Nondiscretionary expenses
D)
Variable outflows
All of these items are variable outflows. Variable outflows are considered as such because there is some variation in occurrence and amount.
LO 3.1.2
Justin has the following accounts on deposit in the same bank.
Account Ownership Balance
Savings account Justin $300,000
Checking account Justin $25,000
Savings account Justin with spouse $400,000
Savings account Justin with son $100,000
How much Federal Deposit Insurance Corporation (FDIC) insurance coverage does Justin currently have for his accounts?
A)
$500,000
B)
$625,000
C)
$825,000
D)
$600,000
The answer is $500,000. Each category of ownership (e.g., individual, joint, or retirement account) in the same institution is subject to a separate limit of $250,000. Justin has $250,000 of coverage on his individual accounts and $250,000 of coverage ($200,000 with his spouse and $50,000 with his son) on his joint accounts, for a total of $500,000 of coverage.
LO 3.4.1
Frank and Sarah are not sure whether to purchase a new home or lease. Which one of the following would best support a decision to lease (rent) a personal residence in the near future?
A)
Frank and Sarah are native to the area and expect to stay in the area for at least for the next 10 years.
B)
Frank and Sarah were just married and plan to start a family within four years.
C)
Frank and Sarah want to spend time and money making their residence look better on the interior and exterior of the home.
D)
Frank and Sarah believe real estate in the area will appreciate faster than the inflation rate.
The answer is Frank and Sarah were just married and plan to start a family within four years. The expectation of staying in one location for 10 years is reasonable justification for buying a home. With an impending marriage and family plans in the future, the individual’s housing needs may change substantially. Anyone who wants to spend the time and money to improve the appearance of his or her home should own the home; otherwise the improvement efforts will simply benefit the landlord. It would be best to own a home if you think prices will appreciate faster than the inflation rate to participate in the price appreciation and avoid rent increases.
LO 3.3.4
Which one of the following is a CORRECT statement regarding an issue applicable to the buy-versus-lease decision?
I. Individuals should lease autos if they intend to keep them for many years.
II. An automobile should be leased if it is the owner’s intention to use it in business.
A)
II only
B)
I only
C)
Both I and II
D)
Neither I nor II
The answer is II only. Individuals should buy, not lease, autos if they intend to keep them for many years.
LO 3.3.4
Which of the following items are normally included in a cash flow statement?
Dividend income
Money market account balance
Mortgage note balance
Vested pension benefits
A)
II and III
B)
II, III, and IV
C)
I and IV
D)
I only
The answer is I only. The remaining items are asset values, correctly shown on a statement of financial position or balance sheet. Income items (e.g., dividend income) are on the cash flow statement.
Which one of the following client goals is stated appropriately?
A)
$14,000 in current dollars, per year, for each child’s education
B)
An adequate emergency fund
C)
A comfortable retirement
D)
Enough life insurance to keep the family in its “own world”
The answer is $14,000 in current dollars, per year, for each child’s education. A specified dollar amount to be accumulated for education is a goal that can be attained. The other goals/targets are ambiguous and require more specificity to be of any use.
LO 3.2.1
What asset listed below should typically not be used to establish an emergency fund?
A)
Short-term CDs
B)
Cash in a basement safe
C)
U.S. government bonds
D)
Money market account
The answer is U.S. government bonds. Bonds are not as liquid as other assets and they can go down in value if interest rates rise, so they are not typically a good source of emergency funds. Cash is a good source for emergency funds. Putting the cash in a basement safe (or any other non-interest-earning account) is probably not the best choice. However, the point is to identify that cash, or cash equivalents, are usually the best choice for emergency funds.
LO 3.2.2
Which of the following are considered financial weaknesses?
Low risk tolerance level
Insufficient insurance coverage
Inarticulate financial goals
Weak cash flow management skills
A)
I, II, III, and IV
B)
II, III, and IV
C)
III and IV
D)
I only
The answer is II, III, and IV. A client’s low risk tolerance level is not considered a financial weakness. However, planners need to consider a client’s risk tolerance level when making investment recommendations.
LO 3.1.4
A financial institution that allocates earnings from loan interest and investments to its members in the form of dividends is
A)
a trust company.
B)
a bank.
C)
a credit union.
D)
an investment bank.
The answer is a credit union. This statement describes a credit union. Credit union members may also elect a board of directors.
LO 3.4.2
The estimated value of a real estate asset in a financial statement prepared by a CFP® certificant should be based upon
A)
the basis of the asset, after taking into account all straight line and accelerated depreciation.
B)
the current replacement value of the asset.
C)
the value that a well-informed buyer is willing to accept from a well-informed seller where neither is compelled to buy or sell.
D)
the client’s estimate of current value.
The answer is the value that a well-informed buyer is willing to accept from a well-informed seller where neither is compelled to buy or sell. On a financial statement, in the absence of special circumstances, assets are normally valued at fair market value. Fair market value can be defined as what a well-informed buyer is willing to accept from a well-informed seller where neither is compelled to buy or sell.
LO 3.1.1
What purpose do footnotes serve on personal financial statements?
Used to describe details of assets and liabilities listed on the client’s financial statement
List values or circumstances not disclosed in the body of the client’s financial statements
Total the cash balance on the client’s financial statements
Total the investment balance on the client’s financial statements
A)
II, III, and IV
B)
I and III
C)
II and III
D)
I and II
The answer is I and II. Footnotes should be used to describe details of both assets and liabilities on a client’s financial statements. They may also be used to describe values and circumstances not disclosed in the body of the financial statements. Cash and Investments are two categories found in financial statements.
LO 3.1.1
Jennifer has the following debts and would like to start a process to pay them off, starting with the debt with the lowest balance. She currently has $70 in excess monthly cash flow to start this process.
Using the snowball technique, what would she be able to pay on Credit Card 4 once the smaller loans have been paid off?
Debt Balance Min Payment
CC1 225 25
CC2 575 35
CC3 1000 50
CC4 3200 120
Auto Loan 12000 300
A)
$230
B)
$300
C)
$120
D)
$180
The answer is $300. Jennifer would have the $70 she can start with, plus $110 once Credit Cards 1, 2, and 3 are paid off, plus the $120 she has been paying all along on Credit Card 4 for a total of $300.
LO 3.3.2
Basically, over time you’d crunch down the smallest debt first (snowball gets bigger over time) and you’d pay off CC1. Debt one was using the original $70 per month excess cash flow PLUS the $25 per month you were already paying. Now that you’ve paid off that one, you can put the 70 + 25 towards CC2. Pay that off and you can put 70+25+35 towards CC3. Then you’ll have 70+25+35+50 towards CC4, in addition to the 120 you’re already putting toward it in minimum payments. 70+25+35+50+120 = 300
The Martins have decided to set up an appointment with Michael, a CFP® professional and an experienced financial planner, to get their finances in order. Up to this point, the Martins had been making their financial decisions as the need arose without a comprehensive strategy. In addition, they believe that their life insurance coverage is inadequate and they need to update their will due to the birth of their second child, Zachary. Lately, they have been spending indiscriminately with very little set aside for savings and investment. What should be the first step that Michael should take in working with the Martins?
A)
The Martins should review their wills with the attorney recommended by their financial planner.
B)
The Martins should start an investment plan with their broker.
C)
Michael should assist the Martins in preparing a budget.
D)
The Martins should consult with their life insurance agent about purchasing additional policies.
The answer is Michael should assist the Martins in preparing a budget. Developing a budget is one of the most important ways to help clients in the savings process. The budget can reveal problem spending areas and help clients adjust their cash flow.
LO 3.2.1
Gerome, a CFP® practitioner, provides a SWOT analysis to all of his financial planning clients. The major advantage of providing this analysis to his clients is that they obtain a broad overview of their personal
A)
risk tolerance.
B)
financial strengths and weaknesses.
C)
vulnerability to longevity risk.
D)
credit rating and score.
The answer is financial strengths and weaknesses. A SWOT analysis would examine a client’s financial strengths and weaknesses, along with any significant opportunities or threats.
LO 3.1.4
Andrew and Angela are buying a house valued at $374,900. They have been saving for some time and are planning to put 20% down toward the house. They are looking at two mortgages: one for 30 years with an interest rate of 4.74%, and one for 20 years with a rate of 3.27%. They are interested in lower payments, but also shorter terms. What is the difference in the interest that will be paid between these two mortgages in the first year?
A)
$14,116
B)
$4,470
C)
$6,168
D)
$9,646
The answer is $4,470. Set the calculator for 12 payments per year [12, DOWNSHIFT, p/yr (the PMT key)]. Be sure the calculator is in End Mode. A 20% down payment of $74,980 means that Angela and Andrew financed the balance of $299,920 and this is used as the PV in both calculations. Because we must first calculate the regular monthly payment of the 30 year offer it reads as follows, N = 360 (or 30 years x 12 months per year). The interest or I/YR = 4.74 and all that needs to be done is to calculate the payment or PMT = $1,562.72. With the payment for the 30-year mortgage at $1,562.72 per month, next press 1, followed by 12 [DOWNSHIFT] [AMORT]. Then press the [=] key and the calculator will show principal paid in the first year of $4,636.26; interest paid is $14,116.35; and the remaining balance is $295,283.74.
Calculate the payments for the 20-year mortgage. The 20-year mortgage payment is calculated using $299,920 as PV; 240 = N; and 3.27 = I/YR; then press PMT and $1,704.72 is the monthly payment. Once this is calculated, the amortization schedule should be calculated. Press 1, followed by 12 [DOWNSHIFT] [AMORT], and then press the [=] key and the calculator will show on the 20-year mortgage the principal paid in the first year is $10,803.72; interest paid is $9,646.42; and the remaining principal balance is $289,116.74. A quick subtraction tells us that the total difference in interest paid between the two in the first year
$14,116.35 - $9,646.42 = $4,470
.
LO 3.3.5
Given the following data for Daphne Jones:
Checking account $1,000 Jewelry $5,000
Mutual funds $60,000 Vested 401(k) $55,000
Mortgage balance $95,000 Auto loan balance $20,000
Money market account $10,000 Personal assets $50,000
Sailboat $7,000 Credit card balance $5,000
Stock portfolio $10,000 90-day CD $2,000
Automobile $35,000 Personal residence $150,000
What is the total value of her investment assets?
A)
$125,000
B)
$157,000
C)
$152,000
D)
$150,000
The answer is $125,000. Daphne’s investment assets include the following:
Mutual funds $60,000
Stock portfolio $10,000
Vested 401(k) $55,000
$125,000
LO 3.1.1
Which assets typically are not used to establish an emergency fund?
A)
Corporate bonds
B)
Certificates of deposit with a three-month maturity
C)
Money market accounts
D)
Passbook savings accounts
The answer is corporate bonds. Corporate bonds are not as liquid as pure money market instruments, and their values are not fixed (unless held to maturity); therefore, they would not normally be used for an emergency fund. Savings accounts, money market deposit accounts, and short maturity CDs are all used as emergency funds.
LO 3.2.2
Bette and Bob are purchasing a new home and are evaluating financing alternatives. They have heard that using a graduated equity mortgage may be disadvantageous. You can tell them that
A)
negative amortization may occur.
B)
payment amounts are predictable
C)
the home must be sold to repay the mortgage.
D)
the principal amount must be paid in a lump sum.
The answer is negative amortization may occur. The payment amounts may change and are unpredictable. Principal is repaid in each payment over the mortgage term, not in a lump sum. Selling the home is unnecessary to repay the mortgage.
LO 3.3.5
Which of the following statements regarding a personal statement of financial position are CORRECT?
Assets − liabilities = net worth.
Current liabilities are due within two years.
Long-term liabilities are due in more than two years.
Personal use assets include cars and furniture.
A)
I and IV
B)
II, III, and IV
C)
II and III
D)
I, II, III, and IV
The answer is I and IV. Current liabilities are due in less than one year, while long-term liabilities are due in one year or more.
LO 3.1.1
Noah grew up in the period following the Depression and is very conservative with his finances. He has individual accounts at three separate federally chartered banks with balances of $265,000, $300,000, and $200,000. What is the total amount insured by the Federal Deposit Insurance Corporation (FDIC)?
A)
$250,000
B)
$765,000
C)
$500,000
D)
$700,000
The answer is $700,000. Each individual account in a federally chartered bank is insured against loss up to $250,000. Therefore, his two accounts with balances in excess of $250,000 will only be insured up to $250,000 each for a total of $500,000. The third account will be insured for the entire $200,000. The total insured amount is $700,000 ($250,000 + $250,000 + $200,000).
LO 3.4.1
Which of the following statements regarding savings and loan associations (S&Ls) is CORRECT?
S&Ls are also known as thrift institutions.
One purpose of S&Ls is to provide home loans.
Checking and savings accounts are offered by S&Ls.
Federally chartered S&Ls are regulated by the FDIC.
A)
I only
B)
I, II, III, and IV
C)
II and III
D)
I and II
The answer is I and II. S&Ls are not permitted to provide demand deposits, such as checking accounts. However, they can offer interest-bearing NOW accounts, which are similar to demand deposit accounts. The main purposes of an S&L are to accept savings and provide home loans. As a result of the Dodd-Frank Act, federal and many state-chartered S&Ls once regulated by the Office of Thrift Supervision are now regulated by the Office of the Comptroller of the Currency.
LO 3.4.2
Which of the following can be monitored and evaluated through the use of a budget?
Income
Net worth
Expenses
Spending patterns
A)
I, II, and III
B)
II and IV
C)
I, III, and IV
D)
I and III
The answer is I, III, and IV. A budget can help clients assess their income, expenses, and spending patterns. The statement of financial position is used to determine a client’s net worth.
LO 3.2.1
One way to free up cash flow is for the client to
A)
acquire a home equity line of credit.
B)
obtain an cash-back credit card.
C)
use a home equity loan for home improvements rather than savings.
D)
consolidate or eliminate consumer debt.
The answer is consolidate or eliminate consumer debt. Acquiring more debt will not improve a client’s cash flow unless the new debt restructures old debt into a lower monthly payment. Using a home equity line of credit or a home equity loan merely adds an additional liability against an asset and incurs an additional outflow when payments are due. Additional credit cards reduce cash flow when used, as they create an additional monthly payment. Consolidating or eliminating consumer debt frees up cash flow.
LO 3.3.1
Troy and Kacie realize they are in need of an emergency fund. Troy is a marketing executive for a local advertising firm, and Kacie is an office manager for a national distribution company. They come to you, their financial planner, and ask how much money they should have in this fund. Which of the following is the best response?
A)
An amount equal to 3 months of expenses
B)
An amount equal to 6 months of expenses
C)
An amount equal to 12 months of expenses
D)
An amount equal to 1 month of expenses
The answer is an amount equal to 3 months of expenses. Three months’ worth of expenses should be set aside if the clients are married and both are employed outside the home. A client who is a single wage earner or one who is married with a spouse not employed outside the home should have an amount equal to 6 months of expenses in an emergency fund.
LO 3.2.2
All of the following are debt management ratios except
A)
consumer debt ratio.
B)
housing cost ratio.
C)
P/E ratio.
D)
total debt ratio.
The answer is P/E ratio. The consumer debt ratio is the ratio of monthly consumer debt payments to monthly net income. The housing cost ratio measures the relationship of housing costs to gross income. The total debt ratio, which includes monthly housing costs and consumer debt payments, should not exceed 36% of gross monthly income. The P/E ratio is used in stock analysis and is not used for debt management.
LO 3.1.3
All of the following are ways to improve one’s credit score except
A)
pay down credit card balances and keep them low.
B)
close paid-off accounts on which there is a solid payment record.
C)
leave good, older debt on your report.
D)
always make payments on time.
The answer is close paid-off accounts on which there is a solid payment record. A mistake people often make is trying to eliminate debt off their credit report once it’s paid off. Older debt that has a solid payment history is good for your credit rating. Of course, making payments on time and keeping balances low are good ways to improve a credit score also.
LO 3.3.3
Which of the following is considered a strength in a client’s financial plan?
Well-defined financial goals
Promising employment status
Inadequate emergency fund
Lack of estate planning documents
A)
II only
B)
I, III, and IV
C)
III and IV
D)
I and II
The answer is I and II. Statements I and II are financial strengths. Other examples of strengths are appropriate investments given a client’s risk tolerance, appropriate savings, and an adequate emergency fund. An inadequate emergency fund and lack of estate planning documents are considered weaknesses.
LO 3.1.4
You have gathered the following information from Gerry’s financial statements:
Gross income
$110,000
Net income
$80,000
Total assets
$195,000
Total debt
$30,000
Consumer debt
$18,000
Based on this information, which of the following statements is CORRECT?
Gerry’s total debt ratio exceeds the generally recommended maximum.
Gerry’s consumer debt ratio exceeds the generally recommended maximum.
A)
Neither I nor II
B)
Both I and II
C)
II only
D)
I only
The answer is II only. Financial planners generally recommend that total debts do not exceed 36% of gross income. Gerry’s total debt ratio is 27%, less than the 36% maximum ($30,000/$110,000 = 27.3%). The consumer debt ratio is the ratio of consumer debt payments to net income. Gerry’s consumer debt ratio is 22.5%, which exceeds the generally recommended maximum of 20% ($18,000/$80,000 = 22.5%).
LO 3.1.3
