Personal Finance Define Which Stage Term Paper

Excerpt from Term Paper :

16. Help Rebecca and Jay apply four steps of the smart buying process to decide whether to replace Vehicle #2. What sources of consumer information might be useful to them? According to Auto Channel the four steps are: Determine your practical needs for a new vehicle, determine your budget and stick to it, determine your emotional needs, which car or truck really makes you happy when you drive it, and test drive, test drive, test drive, test drive (Gordon, B.N.D.P.1.). Resources which may be useful include: Consumer Reports, Edmunds, Kelly Blue Book, and Kiplinger's

17. Calculate the Bennett's gross monthly income and monthly debt repayments. What is the maximum mortgage amount for which Rebecca and Jay could qualify? Gross monthly income is $107,000 / 12= $8,916.67

Monthly debt payments are $1,145. There are two ratios to be calculated here the front end ratio and back end ratio. The front end ratio indicates "your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28% of your gross monthly income" ( N.D.P.1.). In this case the front end ratio yields a value of $2,496.67. The back end ratio "shows how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed 36% of your gross income" ( N.D.P.1.). In this case the back end ratio yields a value of $3,210. Based on these values and using a mortgage calculator, Jay and Rebecca can purchase a home up to $274,926 with 20% down (Key Bank. N.D.P.1.)

18. How has Rebecca's student loan affected her creditworthiness in applying for a mortgage? What is the relationship between GDS and consumer credit when calculating the 36-percent qualification rule? As above the Back end ratio or gross debt serve ratio is 36% of gross income which yields a value of $3,210 for Jay and Rebecca. This means their house expenses and debt load cannot exceed $3,210. The student loan payment is used in the calculation because she is paying on it. If she was in school and graduating more than 12 months out the payment would not be figured in.

19. Rebecca would like to consider a 15-year mortgage so that the house would be paid for before Emily enters university. Explain how the factors of monthly payment, total interest paid, and time value of money impact this decision. A fifteen year mortgage increases the monthly payment amount on the mortgage however; the total interest paid is cut dramatically. From a time value of money perspective the shorter mortgage is not advantageous because a dollar today is worth more than a dollar tomorrow. As such a fixed monthly payment will over 30 years be considerably less in terms of the future income available to make the payment.

20. Please provide your recommendation to Rebecca and Jay with respect to their life insurance. Is Jay's their current insurance satisfactory? If not, what changes would you recommend? Jay has a whole life insurance policy because he has cash value of $1,700. Based on quote information available, a monthly payment of $54.17 which Jay currently makes places the policy at approximately $100,000. Based on their current circumstances which include a child and the possibility of purchasing a home, the recommendation would be for a policy of at least $250,000. It also makes more sense to purchase a term policy which will allow for lower payments and higher coverage.

PART III: Investments

21. Based on the Bennett's stage in the lifecycle, what type of investment asset allocation would be appropriate, assuming they want to establish a retirement savings fund? What types of stocks should they consider for the equity portion of their asset allocation? What type of bonds would be appropriate for the fixed income portion of their portfolio? (List the bond maturity, rating and type of issuer). Please provide your asset allocation recommendation (use of charts and tables is recommended). As a couple that is relatively young and has time to save for retirement they can afford to have more of their investments in equities. The most simple investment option is the use of mutual funds or index funds. A mutual fund "is nothing more than a collection of stocks and/or bonds. You can think of a mutual fund as a company that brings together a group of people and invests their money in stocks, bonds, and other securities. Each investor owns shares, which represent a portion of the holdings of the fund" (Investopedia- Mutual fund. N.D.P.1.). An index fund is "a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover" (Investopedia- Index Funds. N.D.P.1.). Choosing specific stocks can be time consuming and may not adequately diversify a portfolio. Jay and Rebecca should consider being more aggressive though in their portfolio which could follow this program. "The old rule of thumb used to be that you should subtract your age from 100 - and that's the percentage of your portfolio that you should keep in stocks. For example, if you're 30, you should keep 70% of your portfolio in stocks. If you're 70, you should keep 30% of your portfolio in stocks" ( N.D.P.1.). The Bennett's should have 70% investment in equities. Their fixed income portfolio could also be a bond fund such as PIMCO Total Return which invests in a mix of corporate, treasury, municipal and foreign bonds. These bonds are typically rated AAA and AA.

(Carther, S.N.D.P.1)

22. What investment risks should be of primary concern to the Bennett's when choosing a savings or investment account for their emergency fund? What account would be most appropriate? Why? Loss of principal is the primary concern for the emergency fund. The account should be parked in a safe investment such as CD or high yield money market account to ensure security of principal.

23. Rebecca's parents recently gave the Bennett's $25,000 to start education fund for Emily. An investment advisor has recommended that they include a 10-year corporate bond in the education saving fund. The bond currently yields 6.75% per year and sells for $1,000. If interest rates increase by 2 percentage points and the bond is sold, how much will the bond sell for at that time? Calculate the bond price if rates fall 1%. What investing rule has this proved? If the rate increases to 8.75% the bond would be sold for $867. If rates fell by 1% the bond would sell for $1,076. This investment rule indicates that interest rates and bond values move in the opposite direction. An investor must be concerned not only with return but also valuation of the bond.

24. The same advisor who recommended a bond for Emily's education fund also recommended to include a preferred stock paying a $5 annual dividend, currently selling for $53/share. If the Bennett's required rate of return is 10%, how much should the preferred stock sell for? The stock based on a $100 par value should sell at $50 (Business Finance Online. N.D.P.1.).


Pp = the preferred stock price,

Dp = the preferred dividend, and r = the required return on the stock

25. The Bennett's, in the 33% marginal tax bracket, are concerned about the taxes paid on investment earnings. Show the calculations to answer the following questions:

a. A money market mutual fund is currently yielding 1.5%. Should Jay and Rebecca move their savings into this fund or keep their money in a savings account at the bank paying 1%. "Equivalent taxable yield is calculated by dividing the available tax-exempt yield by one minus the investor's marginal tax rate" (Investor Glossary. N.D.P.1.). In this case .015/.67= 2% required return to make up for taxes so the Bennett's should not move their money.

b. A Government of Canada bond is currently yielding 4.2%. What is the minimum yield that the Bennett's must receive in order to obtain an equivalent return on a pure equity mutual fund with about 75% of its returns in capital gains and 25% in dividends from Canadian companies?

"Equivalent taxable yield is calculated by dividing the available tax-exempt yield by one minus the investor's marginal tax rate" (Investor Glossary. N.D.P.1.). In this case the required return would be .042 / .67= 6.0%

PART IV: Life cycle planning

26. Jay and Rebecca plan to retire in 35 years. They estimate their living expenses at approximately $60,000/year after taxes when they retire.

a. How much before-tax income will they need to retire on, assuming an average tax rate of 19% during their retirement? The couple will need approximately $74,000 in pre-tax annual income.

b. Assume that through a combination of savings, government benefits and…

Sources Used in Document:


Bank of Canada. (March 14, 2011). T-Bills Rates and Statistics. Bank of Canada. P.1.

Retrieved March 14, 2011 from (N.D.). How Much House can you Buy? P.1. Retrieved

March 14, 2011 from -- 1.aspx

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