Personal Finance, Second Canadian Edition Solution Manual

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’SSOLUTIONS&RESOURCEMANUALPrepared byHardeep S. GillNAITPERSONALFINANCESecond Canadian EditionJeff MaduraFlorida Atlantic UniversityHardeep S. GillNAIT

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ContentsOverview.................................................................................................................................................iiiIntroduction.................................................................................................................................................ivChapter 1Overview of a Financial Plan...................................................................................................1Chapter 2Applying TimeValue Concepts............................................................................................10Chapter 3Planning with Personal Financial Statements.......................................................................18Chapter 4Using Tax Concepts for Planning..........................................................................................26Chapter 5Banking Services and Managing Your Money.....................................................................39Chapter 6Assessing, Managing, and Securing Your Credit.................................................................47Chapter 7Personal Loans........................................................................................................................58Chapter 8Purchasing and Financing a Home........................................................................................66Chapter 9Auto and Homeowner’s Insurance........................................................................................78Chapter 10Health and Life Insurance......................................................................................................86Chapter 11Investing Fundamentals......................................................................................................100Chapter 12Investing in Stocks..............................................................................................................111Chapter 13Investing in Bonds...............................................................................................................123Chapter 14Investing in Mutual Funds..................................................................................................134Chapter 15Retirement Planning............................................................................................................145Chapter 16Estate Planning....................................................................................................................157Chapter 17Integrating the Components of a Financial Plan...............................................................167

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iiiOverviewThe’s Solutions and Resource Manual has been prepared to offer instructors course-planningassistance when teaching personal finance. It incorporates several teaching aids customized specifically forPersonal Finance, Canadian Edition, Second Edition, by Jeff Madura and Hardeep Gill.The manual includes a brief overview of each chapteralong with a list of chapter objectives. Answers toboth the end-of-chapter review questions and the financial planning problems are included. Wherepossible, details of the calculations for the problems are also included. In some instances, answers may beslightly different when using tables, calculators, and/or the student CD-ROM.The manual presents answers for the questions accompanying the two continuing case exercises TheSampsons (on MyFinanceLab) and Brad MacDonald.Each chapter includes numerousteaching tips. These tips arose from many years of teaching personalfinance principles in the classroom. The tips are meant to help instructors promote discussion in theclassroom. The tips also address some common misconceptions that students sometimes have aboutpersonal financial planning.Many thanks go to those at Pearson Canada for their help in preparing and technically checking thismanual.

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ivIntroductionThe’s Solutions and Resource Manual forPersonal Finance, Second Canadian Edition,by JeffMadura and Hardeep Gill is designed to meet the far-ranging needs of personal finance instructors. In mostschools, a personal finance course is not a required course and therefore will often attract students frommany different backgrounds and colleges who will be taking the course as an elective. This subsequentlycreates a challenging teaching environment. Some students may feel overwhelmed by the material, whileothers may find it too basic. Having access to a variety of resources, methods, andmaterials may alleviatesome of these challenges. This introduction describes the many resources this instructor’s solutions andresource manual contains. We hope it will ease the burden of busy instructors and help them to enhancetheir students’ abilityto retain the material.An Overview of Chapter-by-Chapter ResourcesThis manual provides instructors with much more than the solutions to the end-of-the-chapter exercises.Each chapter begins with an introduction to the chapter. This introduction is intended to aid the instructorby offering a brief summary of the topics that will be covered in that chapter. In this way, each instructorshould be better able to determine if only a portion of the topics will be sufficient or if the coverage will becomprehensive.In-depth Teaching Suggestions for each chapter include both important topics to be discussed in anindividual chapter and additional assignments that may be helpful to aid the students in learning thematerial. Some of the teaching suggestions were created to provide a variety of teaching methods.Educational research shows that using a variety of teaching methods produces the best results. Thus, theinstructor may choose to implement some of the following methods to vary instruction.Teams:Manyof the suggestions are geared toward the implementation of teams (three to five memberson a team). Of course, team make-up depends on several things, including class size, number of hours inthe course, and whether the course is online or on-site. Students do learn from each other and in a coursesuch as personal finance, many students will have a variety of educational backgrounds and real-worldexperiences. The use of teams allows students to share this knowledge with their peers and has proven tobe very effective.Community Resources:The use of community resources is another way to provide a variety of learningexperiences. The following is not a comprehensive list, but simply a few suggestions that may be availablein various locales. These professionals will generally be most willing to give a presentation to the class atno charge. The exposure to professionals with careers dealing with personal financial issues in the “realworld” has proven to provide an invaluable learning experience for students.Consumer Counseling Service:Credit use and abuse, prevention and management, budgeting.Banks and Credit Unions:Financial services, home buying and credit, chequing, investing.CMHC:housing finance options, mortgage loan insurance, information on the housing market in CanadaInsurance Companies: Features of Auto and Property, Health, Disability, Critical Illness, Long-TermCare, and Life Insurance.Taxes:Canada Revenue Agency on tax laws, filing, and returns.Lawyers:Information on wills, estates, and legal issues.

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vFinancial Planners/Advisors:Information on building a financial services business and how to buildmeaningful client relationships.Stockbrokers:Various types of information on a variety of investment issues and types.Internet:There are many Internet assignments in the book and even more suggestions in the’sSolutions and Resource Manual. The Internet is a source of information that will be available to thestudents even after the class is finished. The information isgenerally more up to date than any other sourceand everyone today has at least limited access to a computer.Teaching Personal Finance OnlineThe unique needs of online courses merit separate mention regarding teaching resources and suggestions.Teaching suggestions geared to the needs of online courses are included in the materials corresponding toeach chapter. What follows are general suggestions to aid the many instructors who are restructuring theirindividual courses so they can be taught an online course.1.An online course should reflect the same rigour and content as the classroom course demands. Thisensures that students are exposed to the same content and learning experiences, which will help ensurethat the course both meets the prerequisite criteria for upper-level courses and/or transfer. Using acommon syllabus and textbook will diminish perceptions that the courses are different.2.Teams can also be used in an online course. Since many students take courses onlinebecause ofscheduling conflicts with work, etc., it would be beneficial before assigning teams to survey thestudents as to the times they are available to work online. This would then do some self-selecting forthe teams.The cases in the text are useful for team solving. Worksheets with discussion questions are also a goodway to use teams. If the students are self-paced, it is more difficult to implement teams. Thus, it isimportant to know the target audience before implementation.3.Communication is critical in any course and even more so in an online course. The address book is avaluable asset for an online course. The instructor can send messages to everyone at the same time, orindividually. Information can be disseminated quickly and efficiently. For example, answers toquizzes and exams can be distributed electronically immediately after the deadline assigned for each.4.Chat Rooms: This is another way to communicate with students. This can serve as office hours.Students know when the instructor will be online and can participate or not.5.Just as instructors teach differently in the classroom, so also will this happen in an online course.Knowing the audience is critical to the success of any class. Today, even in a conventional classroom,there is often a mix of traditional and nontraditional students. The nontraditional will often have moreexperience in financial matters. It is important, though, to remember that financial expertise is not amatter of intelligence. It is a skill that is learned and that is whystudents enroll in a personal financecourse. Even though the nontraditional student may have had financial life experiences, it does notmean that he or she had the necessary skills to make the best decisions at the time.6.Assessment instruments may vary in an online course. It is virtually impossible to give an exam overthe Internet and ensure that it has been completed as directed with no outside help. The use of a testingcenter is one way to alleviate this problem. The student would, of course, have to go on campus during

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vithe semester to complete the exams. This is a problem if the student lives a long distance from thecampus and has enrolled in the Internet course specifically because of this predicament. The use of aproctor at another institution would be another way to ensure that examinations are secure.7.Being a self-starter is a critical characteristic for a student to be successful in an online course. It ishelpful to include at least a brief discussion of this in the syllabus. Duringthe semester it would beadvisable to repeat this message, perhaps by e-mail. The student’s success will rely on howresponsible and self-motivated he/she is.Hardeep Singh Gill

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Chapter 1Overview of a Financial PlanChapter OverviewEvery individual and family needs to develop a financial plan. Financial planning will help them clarifytheir goals and ensure that spending, financing, and investing decisions are aligned with those goals.Chapter 1 discusses the benefits of financial planning: making your own financial planning decisions,judging the advice of financial advisers, even, becoming a financial adviser. In addition, this chapterbriefly discusses the six component plans that make up the over-all financial plan. These components arebudgeting and tax planning, managing liquidity, financing large purchases, protecting assets and income,investing, and retirement and estate plans.Each of these component plans requires sixsteps. First, an individual must establish financial goals.Once these are established, the individual must consider his or her current financial position. Next,alternative plans that could help achieve the goals should be identified and evaluated. One plan shouldthen be chosen and implemented. In the final two steps, the individual would evaluate his or her financialplan and revise it as needed.Chapter ObjectivesThe objectives of this chapter are to:1.Explain how you could benefit from personal financial planning2.Identify the key components of a financial plan3.Outline the steps involved in developing a financial planTeaching Tips1.Discuss this quote with students: “Most people don’t plan to fail, they fail to plan.” Ask studentsfor examples of situations (financial or otherwise) where they have seen this happen. Guide thediscussion toward financial matters.

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1-2Chapter 1Overview of a Financial Plan2.Relate financial planningto planning a trip.Steps in Financial PlanningSteps in Planning a TripSet goalsDecide where you are goingDetermine your current financial positionLocate your home on the mapIdentify and evaluate alternative plansIdentify and evaluate alternateroutesChoose and implement a planPick a route and start journeyEvaluate planIs the trip going smoothly?Revise plan as neededRoad construction causes major delays,so you pick an alternate routeA financial plan is just a financial road map.3.Many younger students have difficulty recognizing the benefits of devising a financial plan now.Money talks, however, and an effective demonstration of the time value of money involves the “Ruleof 72.” Briefly stated, the Rule of 72 is an indicator of howlong it will take a single sum of money todouble in value at a given interest rate. The time is computed by dividing 72 by the interest rate. Forinstance, at 12% a sum of money would double every six years. Provide this example for students:What if your parents had been able to invest $1,000 at 12% the day you were born?AgeValue of InvestmentAgeValue of Investment0$1,00036$64,00062,00042128,000124,00048256,000188,00054512,0002416,000601,024,0003032,000662,048,000This concept can also further be used to determine the rate of return necessary to achieve a financialgoal by simply dividing 72 by the number of periods available to reach the goal. This answer willprovide the percentage return needed to reach a goal. Forinstance, a $10,000 down payment ona house is desired in 6 years. Currently, $5,000 is the amount saved. The needed return would be12%. Other considerations, such as amount of risk to be taken, would then also need to be assessed,but this is a quick tool to make preliminary estimates.4.Have students write up a set of goals. Suggest a minimum of 2 goals for each time frame—short,medium-, and long-term goals. One of the short-term goals should be achievable by the completion ofthe course. Remind students that goals need to be monitored and assessed to determine progresstoward overall life goals.5.Teams—at the beginning of the semester/class, assign groups of 3–5 students to a team. In manychapters, these teams can be used for discussion purposes, reviewing quantitative materials,and quizzes.6.Discuss with students that goals are not stagnant. They change as an individual’s life changes. Theaddition of a spouse or child, change of career or job, etc., would often create a need to review andperhaps modify financial goals.

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Chapter 1Overview of a Financial Plan1-37.Online courses—individual or team submissions on questionnaires, review sheets, and Internetexercises can be helpful.8.Assign the internet exercise:http://cgi.money.cnn.com/tools/prioritize/prioritize_101.jsp. This takesstudents through a prioritizing goals exercise. Require students to hand in the final summary or send itonline to the instructor. This is a good exercise because it forces individuals to make choices. Toreach goals, it is impossible to “have it all.” Thereare several reiterations before the goal statement issummarized in rank order.Answers to End-of-Chapter Review Questions1.Personal financial planning is the process of planning your spending, financing, and investingactivities, while taking into account uncontrollable events such as death or disability, in order tooptimize your financial situation. A personal financial plan specifies your financial goals, describesthe spending, financing, and investing activities that are intended to achieve those goals, and the riskmanagement strategies that are required to protect against uncontrollable events such as death ordisability.2.An opportunity cost is what you forgo as the result of a decision. Some of the opportunity costs ofspending $10 on lottery tickets every week might be: lunch out once a week, reducing debt by anadditional $40per month, or having $520 in savings at the end of the year.3.An understanding of personal finance enables you to make more informed decisions about yourfinancial situation. You would be able to better judge the advice of financial advisers. You might evenpursue a career as a financial adviser.4.1. Budgeting and tax planning2. Managing your liquidity3. Financing your large purchases4. Protecting your assets and income (insurance)5. Investing your money6. Planning your retirement and estate5.Budget planning represents the process of forecasting future expenses and savings. It involvesevaluating your current financial position by assessing your income, your expenses, your assets, andyour liabilities.6.Your net worth is your assets (what you own) minus your liabilities (what you owe). You can measureyour wealth by your net worth and budgeting strategies can help you increase your net worth andthereby your wealth. For example, you can build your net worth by setting aside part of your incometo invest in additional assets or reduce your liabilities.7.Income is influenced by your life stage. If expenses are not accurately estimated, it may be difficult toreach savings goals. Many financial decisions are affected by tax laws, such as certain types ofincomebeing taxed at a higher rate than others. Knowledge of tax laws allows you to make more favourablechoices.8.Liquidity means having access to ready cash, including savings and credit, to cover unexpectedexpenses. In managing your liquidity you consider money management and credit management.Money management deals with deciding how much money to retain in a liquid form and how to

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1-4Chapter 1Overview of a Financial Planallocate the funds among short-term investment instruments. Credit management deals with thedecisions about how much credit you need to support your spending and which sources of credit touse.9.Factors considered in managing financing include: the size of the loan you can afford to borrow, thelength of time for the loan, and selecting a loan that charges a competitive low interest rate.10.The primary objective of investing is to use funds not needed for liquidity purposes to earn a highreturn. Most investments also carry an amount of risk. Potential investments include stocks, bonds,mutual funds, and real estate.11.A plan to protect your assets requires insurance planning, retirement planning, and estate planning.Insurance planning involves determining the types and amount of insurance that you need such asautomobile, homeowner’s, and life. Insurance reimburses you for damages to your assets, limits yourexposure to potential liabilities, or protects your income. Retirement planning involves determininghow much money you should set aside each year for retirement and how you should invest thosefunds. Retirement planning mustbegin well before you retire so that you can accumulate sufficientmoney to invest and use after you retire. Estate planning is the act of planning how your estate will bedistributed before and/or after you die. Effective estate planning can protect yourwealth againstunnecessary taxes and ensure that your wealth is distributed to your family in the manner that youdesire.12.Budgeting focuses on the relationship between your income and your expenses. Liquidity managementfocuses on depositing a portion ofyour excess cash in an emergency fund or obtaining credit if you areshort on cash. Financing focuses on obtaining cash to support large purchases. Protecting your assetsand income focuses on determining your insurance needs and spending money on insurancepremiums. Investing focuses on using some of your excess cash to build wealth. Planning yourretirement and estate dictates the wealth that you will accumulate by the time you retire and itsdistribution before or after your death.13.1. Establish your financial goals2. Consider your current financial position3. Identify and evaluate alternative plans that could achieve your goal4. Select and implement the best plan for achieving your goals5. Evaluate your financial plan6. Revise your financial plan14.Your goals will influence the amount of money and the timing you need to achieve the goals. If goalsare not realistic, they will be very difficult to accomplish and you will become discouraged and lose aninterest in planning. Short-term goals are thoseto be accomplished in less than a year such as saving$500 for Christmas gifts. A medium-term goal takes from one to five years to accomplish, such aspaying off a 3-year note. A long-term goal takes more than five years to accomplish; an example issaving for retirement in a set number of years.15.Some factors that might affect your current financial position are: your level of debt, your maritalstatus and family responsibility, your age, and your level of wealth accumulated.16.Your goals are where you want to be and your current financial position is where you are. Youralternative financial plans will “map” how to get from one position to the other. Several alternative

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Chapter 1Overview of a Financial Plan1-5financial plans are possible given one’s current financial position and goals. For example, twoalternative plans may involve different amounts of savings.17.Once you have developed and implemented a plan, you must monitor it. Monitoring the plan willensure that you are following the plan and that the plan is working as intended.18.You may find you need to revise the plan to make it more realistic. In addition, your life circumstancesand financial condition may change. As your financial conditions change, your goals may change,especially as the results of specific events such as graduating from a post-secondary institution, gettingmarried, or the birth of a child.19.• Bank deposit rates: buy now vs. save decision.• Prices of homes and cars in your area: planning for purchase.• Financing rates on car loans, personal loans, and home loans: deciding how much of a loan you canafford.• Stock price quotations and quotations on other investments: deciding when to invest and where toinvest.• Insurance quotations based on your needs: getting the best value for your insurance dollar.• Tax rates: for tax planning.• Retirement rules: retirement planning.• Financial calculators: determining how your savings will grow or what your mortgage payment willbe.20.There are several different levels of unethical behaviour by financial advisers. Some advisers areinvolved in Ponzi schemes and are focused on stealing your money. A more modest level of unethicalbehaviour is providing advice that is intended to benefit them, not you. An understanding of personalfinancial planning will enable you to make some decisions without an adviser. If you require anadviser, you will be better prepared to determine which advice is truly intended to benefit you.Answers to Financial Planning Problems1.a.Julia’s Income:$1,600Julia’s Expenses:Rent$350Utilities100Car Payment250Braces200Groceries ($50×4)200Miscellaneous150Total Expenses1,250Available for savings: ($1,600−$1,250)$350

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1-6Chapter 1Overview of a Financial Planb.Increase in car payment=$ 75Increase in insurance=60Opportunity cost=$135 per month that could not be usedfor savings, other purchases, etc.2.Net worth is the difference between assets and liabilities:$3,000−$500−$135=$2,3653.Arianne added $1,200 to her assets and $500 to her liabilities, so her new net worth is:$5,000+$1,200−$500=$5,7004.Buying the stereo would not change her net worth as she would be exchanging one asset for another.Investing $500 at 10 percent for one year will be worth $550 in one year.5.Although the situation seems dismal, Jason has a couple of options. First, he could look for a car thatrequires payments of less than $200 per month in either financing costs or lease payments. Thiswould require him to consult various dealers. Second, he could buy a cheaper car using the classifiedsin the newspaper. In either case, Jason’s net worth will be reduced by a large percentage, since a newcar will require a down payment even if he finances it. If Jason buys a cheap car using the classifiedsor another source,his cash flow will not be affected if he finds a car cheaper than $3,000.

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Chapter 1Overview of a Financial Plan1-7Suggested answers to EthicalDilemma questions(a)Although Larry did not act unethically, he should have provided Sandy and Phil with clearerinformation on the two life insurance products. Although whole life insurance and segregated fundsprovide some opportunity for savings, they are probably not the ideal choice for investors who arefocused on growing their investments. Whole life insurance is discussed in chapter 10. Segregatedfunds are discussed in chapter 12. In many instances, whole life insurance and segregated funds payout a very large commission to the brokers that sell these products to their clients. If Larry had soldthese products with the intention of maximizinghis income, he would have been acting unethicallywith Sandy and Phil.(b)Sandy and Phil failed to judge the advice provided by their financial adviser. A relative may not be thebest source for financial information and advice because it may be awkwardto ask the hard questionsthat you need to when making long-term decisions. As Sandy and Phil have learned, not asking theright questions can have negative consequences for your retirement.(c)In the future, Sandy and Phil need to ask the right questionsin order to become more informed aboutthe products they are purchasing. It may be better to deal with a financial adviser who is not related toeither of them. In addition, a course in personal finance may help them understand which questions toask whenpurchasing investment products for retirement planning.Note to: The instructor may wish to have the students research the name of this practice, whichis churning. They may also wish to have the students research the legal aspects of churning.Answers to Questions in The Sampson Family: A Continuing CaseCurrent Financial PositionMajor AssetsHome valued at $250,000; two carsSavingsVery littleMoney Owed$150,000 mortgage; $2,000 credit card balanceSalaryThe Sampson’s income was $54,000, but will now beabout $66,000 since Sharon just started a part-time job.

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1-8Chapter 1Overview of a Financial PlanFinancial GoalsGoal 1. Purchase NewCar for Sharon this YearGoal 2. Pay forChildren’s Post-secondary Education in12–17 Years from NowGoal 3. Set Aside Moneyfor RetirementHow to Achievethe GoalAssess alternative plansavailable and choose themost appropriate plangiven the financialsituation.Assess alternative plansavailable and choose themost appropriate plangiven the financialsituation and the savingsnecessary for Sharon’snew car.Set aside a manageableand realistic amounteach month towardretirement. This amountis currently contingenton meeting their other,shorter-term plans ofbuying a new car andsaving for theirchildren’s post-secondary education.How to Implementthe PlanSharon decided saving$500 a month is the bestplan; deposit the moneyin a liquid investment,such as a savings account.The Sampsons decidedsaving $300 a month isthe best plan. Long-terminvestments, such as atax-deferred educationaccount (RESP), shouldbe considered asinvestments.Seek the advice ofa financial adviser toassess differentinvestment options,such as stocks or bonds.The Sampsons shouldbe aware that advisersmay exaggerate thepotential of investmentsandmay recommendinvestments that givethe adviser highcommissions.How to Evaluatethe PlanSharon should monitor theprogress to ensure thatsaving $500 each monthis not too ambitious and isrealistic.The Sampsons shouldmonitor the progress toensurethey are saving$300 each month,especially given theadditional savings forSharon’s new car.The Sampsons shouldmonitor their progressto ensure they aresaving at least somemoney for retirement.Since this is a verylong-term goal,an annual assessment oftheir retirement savingsis appropriate.

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Chapter 1Overview of a Financial Plan1-9Answers to Myth or FactMargin QuestionsPageMyth or Fact3Financial planners and advisers are registered with a provincial financial planning regulatoryagency.Myth. Although the Institute of Advanced Financial Planners offers a Registered FinancialPlannerdesignation, and the activities of planners/advisers/dealers are regulated if they are registered with theMutual Fund Dealers Association of Canada (MFDA) or the Investment Industry RegulatoryOrganization of Canada (IIROC); there is no provincial financial planning regulatory agency thatregisters financial planners and advisers.5Budgeting is more important for individuals who have trouble covering their monthlyexpenses.Myth. Budgeting is a tool that you use to help you reach your financialgoals. As such, budgeting is foreveryone.10When setting goals, it is important to share them with family members so you are motivatedto achieve them.Fact. In general, sharing your goals, such as saving up for a Christmas vacation, will help motivate youto achieve them. Similar to a New Year’s Resolution, a goal that is shared with the ones who are mostaffected by your personal success are more likely to be achieved.

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