This Document Contains Chapters 9 to 10 9 LIFE, HEALTH, AND DISABILITY INSURANCE CHAPTER OVERVIEW In this chapter, we explain the meaning of life insurance, outline its history, and describe its purpose. We show how the principle of home insurance discussed in Chapter 8 can be applied to the lives of persons. Next, we describe the two basic types of life insurance policies—term life and permanent life and other types of life insurance policies are discussed in detail. Subsequently, we focus on major and important provisions contained in a life insurance contract. We emphasize the need for comparing insurance policy costs and examining a policy before and after the purchase. Various settlement options are also presented in this section. We also cover how annuities provide security to individuals. In addition to life insurance, health and disability insurance are also discussed. We explain the meaning of health insurance and look at the various types. We define disability insurance and show sources of disability income. Finally, supplementary health insurance such as dental, vision care, and long-term care insurance are covered. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: Obj. 1 Define life insurance and describe its purpose and principle. Life insurance is a contract between an insurance company and a policyholder under which the company agrees to pay a specified sum to a beneficiary upon the death of the insured. Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. Fundamental to the life insurance principle is the predictable mortality experience of a large group of individuals. Obj. 2 Determine your life insurance needs. In determining your life insurance needs, you must first determine your insurance objectives and then use the easy method, the DINK method, the “nonworking” spouse method, or the family need method. The family need method is recommended. You should consider a number of factors before you buy insurance, including your present and future sources of income, other savings and income protection, group life insurance, group annuities (or other pension benefits), and government benefits. Obj. 3 Distinguish between the two types of life insurance policies and analyze various types of life insurance. The two types of life insurance policies are term life or permanent life. In general, term insurance provides protection against a specified financial risk for a finite period of time, often 10 or 20 years. Permanent life insurance is purchased to cover life-long needs such as funeral expenses and supplementing a survivor’s income. Many variations of these two types of life insurance policies are available. Term Life insurance is available with a renewability option, conversion option or with a decreasing option. Permanent life insurance is available in the following forms: whole life, universal life, variable insurance and adjustable life. There are many additional options, therefore, LEARNING OBJECTIVES CHAPTER SUMMARY you should check with your insurance company to determine which type offers the best policy for your particular needs at the lowest price. As with other forms of insurance, price should not be your only consideration in choosing a life insurance policy. You should also consider the financial stability, reliability, and service the insurance company provides. Obj. 4 Select important provisions in life insurance contracts. The naming of the beneficiary, the grace period, policy reinstatement, the incontestability and suicide clauses, automatic premium loans, the misstatement of age provision, and the policy loan provision are important provisions in most life insurance policies. Common riders in life insurance policies are the waiver of premium disability benefit, the accidental death benefit, the guaranteed insurability option, cost of living protection and accelerated benefits. Obj. 5 Create a plan to buy your Before buying life insurance, consider your present and future life insurance. sources of income, group life insurance, group annuities (or other pension benefits), and government benefits. Then compare the costs of life insurance policies. Examine your policy before and after the purchase, and choose appropriate settlement options. The most common settlement options are lump-sum payment, limited installment payment, life income option, and proceeds left with the company. Online services provide a wealth of information about all topics related to life insurance. Obj. 6 Define health insurance and explain its importance in financial planning. Health insurance is protection that provides payment of benefits for covered sickness or injury. Disability income insurance protects your most valuable asset—your ability to earn income. Critical illness protects against the most common critical illness. Health insurance, critical illness, and disability income insurance are three protections against economic losses due to illness, accident, or disability. These should be a part of your overall insurance program to safeguard your family’s economic security. Disability can cause even greater financial problems than death. In fact, disability is often called “the living death.” Disabled persons lose their earnings power while continuing to incur normal expenses. In addition, they often face huge expenses for the medical treatment and special care their disabilities require. LEARNING OBJECTIVES CHAPTER SUMMARY Obj .7 Recognize the need for disability income insurance. Disability income insurance provides regular cash income lost by employees as the result of an accident or illness. Sources of disability income insurance include the employer, government benefits, unions, and private insurance. Obj. 8 Understand the value of supplemental health insurance. Supplemental health insurance is coverage that you can purchase in addition to the coverage available to you from the government, your employer, and other policies. Types of supplemental health insurance include dental expense insurance, vision care insurance, and long-term-care insurance. INTRODUCTORY ACTIVITIES • Ask students to comment on the opening case for the chapter (p. 256). • Point out the learning objectives (p. 256) in an effort to highlight the key points in the chapter. • Ask students to share common attitudes toward life insurance. • Discuss methods that a person can use to get basic information on life, health, and disability insurance. • Invite a human resources director from a local company to describe the various insurance coverages offered to company employees. CHAPTER 9 OUTLINE I. Life Insurance: An Introduction A. What Is Life Insurance? B. The Purpose of Life Insurance C. The Principles of Life Insurance II. Determining Your Life Insurance Needs A. Do You Need Life Insurance? B. Determining Your Life Insurance Objectives C. Estimating Your Life Insurance Requirements III. Types of Life Insurance A. Term Life insurance B. Permanent Life Insurance C. Other Types of Life Insurance Policies IV. Important Provisions in a Life Insurance Contract A. Naming Your Beneficiary B. The Grace Period C. Policy Reinstatement D. Nonforfeiture Clause E. Incontestability Clause F. Suicide Clause G. Automatic Premium Loans H. Misstatement of Age Provision I. Policy Loan Provision J. Riders to Life Insurance Policies V. Buying Life Insurance A. From Whom to Buy? B. Comparing Policy Costs C. Obtaining a Policy D. Examining a Policy E. Choosing Settlement Options F. Switching Policies VI. Health Insurance and Financial Planning A. What Is Health Insurance? B. The Need for Supplemental Health Insurance C. Group Health Insurance D. Individual Health Insurance E. Supplementing Your Group Insurance VII. Disability Income Insurance A. Definition of Disability B. Disability Insurance Trade-Offs C. Sources of Disability Income D. Determining Your Disability Income Insurance Requirement E. Critical Illness Insurance IX. Supplemental Health Insurance A. Dental Expense Insurance B. Vision Care Insurance C. Health Service Insurance D. Travel Insurance E. Accidental Death or Dismemberment Insurance F. Long-Term Care G. Major Provisions in a Health Insurance Policy H. Health Insurance Trade-Offs I. Health Care Expenditures in Canada J. Health Information Online CHAPTER 9 LECTURE OUTLINE LIFE INSURANCE: AN INTRODUCTION (p. 257) • Consumer awareness of life insurance has changed very little over the years. Life insurance is still more often sold than bought. What Is Life Insurance? (p. 258) • A person joins a risk-sharing group by purchasing a contract. The insurance company promises to pay a sum of money at the time of the policyholder’s death in return for the insured’s agreement to pay it a sum of money (premium) periodically. The Purpose of Life Insurance (p. 258) • Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. The Principle of Life Insurance (p. 258) • From records covering many years and including millions of lives, mortality tables have been prepared that shows the number of deaths for various age groups during any year. DETERMINING YOUR LIFE INSURANCE NEEDS (p. 260) • Instructional Suggestions • Discussion Question: Why do people buy life insurance? • Exercise: Have students create situations which point out the different reasons for buying life insurance. • Assignment: Have students survey several other people to determine their reasons for buying life insurance. • Text Highlight: Point out typical uses that are made of life insurance proceeds. (p. 258) • Discussion Question: What is the relationship between age and the amount a person pays for life insurance? • Assignment: Obtain life insurance rates tables from insurance companies. Compare the rates charged by different companies and for different age categories. • Concept Check 9-1 (p. 260) • Exercise: What personal, social, and financial factors should influence the amount of life insurance a person might desire and the amount the person would have to pay for the insurance? Create a list of these factors. • Text Highlight: Mortality table for Canadian Males. Refer to Exhibit 9-1. • Assignment: Have students talk to life insurance agents to obtain information on the methods they suggest for determining the amount of life insurance a person should have. • Discussion Question: Is four to five times annual income a valid guideline for determining the amount of insurance? • Text Reference: Discuss the values of different methods of determining life insurance You should consider these factors before you buy insurance. Do You Need Life Insurance? (p. 260) • If your death would cause financial stress for your spouse, children, parents, or anyone you want to protect, then you should consider purchasing life insurance. Determining Your Life Insurance Objectives (p. 260) • Before you consider the types of life insurance policies, answer the following questions: ∗ How much money do you want to leave to your dependents? ∗ When would you like to be able to retire? ∗ How much will you be able to pay for your insurance program? Estimating Your Life Insurance Requirements (p. 261) • These are four general methods for determining CHAPTER 9 LECTURE OUTLINE the amount of insurance you might need. ∗ The easy method: A typical family will need approximately 70 percent of wage earner’s salary for seven years before it adjusts to the financial consequences of wage earner’s death. ∗ The DINK method: If you have no dependents and your spouse earns as much or more than you do, you have very simple insurance needs. All you need to do is ensure that your spouse will not be unduly burdened by debts should you die. ∗ Nonworking spouse method: To estimate how much life insurance a homemaker should carry, multiply the number of years before the youngest child reaches age 18 by $10,000. ∗ The family need method: The first three methods assume that you and your family are “typical” and ignore such factors as government benefits and your liquid assets. TYPES OF LIFE INSURANCE (p. 262) • Term life insurance is protection for a specified period of time. ∗ Renewability option: term insurance can be continued if you have a renewable option. ∗ Conversion option: If you have convertible term insurance, you can exchange it for a whole life policy. ∗ Decreasing term insurance: term insurance is available in a form that pays less to the beneficiary as time passes. Permanent Life Insurance (p. 263) A common type of permanent life insurance is the whole life policy (also called a straight life policy or an ordinary life policy) in which you pay a specified premium each year for as long as you live. The cash value is an important feature. It is the amount that increases over the years and that you receive if you give up the insurance. • amounts; also point out the changing needs for life insurance in various life stages. • Test Highlight: Exhibit 9-2 (p. 261) gives you a worksheet to calculate your life insurance needs. • Concept Check 9-2 (p. 262) • Assignment: Have students research the differences in premium costs between term and permanent life insurance. • Current Example: New rules make it even more confusing and expensive to shop for term insurance. • Current Example: Term life: the safety net comes at a higher price. • Discussion Question: Why will many insurance agents dissuade you from buying lowcost term insurance? • Assignment: Have students obtain premium costs for various types of whole life insurance plans available from insurance agents in your community. New insurance products are introduced to the market regularly, and there are many different types available. However, they all fall into two basic types: term life or permanent life. Term Life Insurance (p. 263) • Instructional Suggestions Other variations of permanent life insurance policies include: CHAPTER 9 LECTURE OUTLINE ∗ ∗ ∗ ∗ ∗ ∗ Limited payment policy: you pay premiums for a stipulated period, but you remain insured for life. Participating policies have potential for earning dividends for the policy owner. Non participating policies, premiums are calculated according to the insurance company’s predicted future benefit payments. Universal life: a policy that combines term insurance and investment elements. Universal life is actually a more flexible version of whole life insurance. Variable life insurance: a policy that is sensitive to interest rates. Premiums are guaranteed, however, cash values are based on the performance of the investment fund or index. Endowment life insurance provides coverage from the beginning of the contract to maturity and guarantees payment of a specified sum to the insured, even if he or she is still living at the end of the endowment period. Instructional Suggestions • Text Highlight: Exhibit 9-4 (p. 265) is a comparison of mortgage insurance to term life insurance. Exhibit 9-5 (p. 266) describes the different types of insurance. • Discussion Question: What are the benefits of universal life insurance? What are the possible drawbacks of this type of policy? • Discussion Question: Why is credit life insurance frequently criticized as not being a wise use of financial resources, with more traditional types of life insurance recommended instead? Other Types of Life Insurance Policies (p. 267) • • Group life insurance insures a large number of persons under the terms of a single policy without requiring medical examinations. Credit life insurance is used to repay a personal debt should the borrower die before doing so. • Concept Check 9-3 (p. 267) IMPORTANT PROVISIONS IN A LIFE INSURANCE CONTRACT (p. 268) • Here are some of the most common provisions: Naming Your Beneficiary (p. 268) • A beneficiary is a person who is designated to receive life insurance proceeds from the insured. The Grace Period (p. 268) • The grace period allows 28 to 31 days to elapse, during which time the premium may be paid without penalty. Policy Reinstatement (p. 268) • A lapsed policy can be put back in force— reinstated—if it has not been turned in for cash. CHAPTER 9 LECTURE OUTLINE Instructional Suggestions Nonforfeiture Clause (p. 268) l The nonforfeiture clause prevents the forfeiture of accrued benefits if you choose to drop the policy. Incontestability Clause (p. 269) l The incontestability clause stipulates that after the policy has been in force for a specified period, the insurance company cannot dispute its validity during the lifetime of the insured for any reason, including fraud. Suicide Clause (p. 269) • A suicide clause is a provision stating that if the insured dies by suicide, the death benefit will equal the amount of the premium paid. Automatic Premium Loans (p. 269) • If the insured does not pay the premium within the grace period, the insurance company automatically pays it out of the policy’s cash value if that cash value is sufficient. Misstatement of Age Provision (p. 269) • If the company finds out that the insured’s age was incorrectly stated, it will pay the benefits that the insured’s premiums would have bought if his or her age had been correctly stated. Policy Loan Provision (p. 269) • A loan from the insurance company is available on a whole life or endowment policy after the policy has been in force for specified years. Riders to Life Insurance Policies (p. 270) • A rider is a document attached to a policy that modifies its coverage. ∗ waiver of premium disability benefit ∗ accidental death benefit ∗ guaranteed insurability option ∗ critical illness ∗ joint, last to die • Concept Check 9-4 (p. 270) BUYING LIFE INSURANCE (p. 271) • In buying your life insurance, consider your present and future sources of income, other savings and income protection, group life insurance, group benefits, and the financial strength of the company. • Discussion Question: Why CHAPTER 9 LECTURE OUTLINE Instructional Suggestions would comparing only the cost of life insurance coverage not be a completely valid approach to determining the best policy? From Whom to Buy? (p. 271) l Look for insurance coverage from financially strong companies with professionally qualified representatives. You should choose carefully when deciding on an insurance company or agent. Comparing Policy Costs (p. 271) • The price of life insurance policies varies considerably among life insurance companies. Ask your agent to give you interest-adjusted indexes. Obtaining a Policy (p. 272) • Text Reference: Use “Financial Planning Calculations” box on page 272 to explain the concept of the time value of money. • Discussion Question: What factors would influence the type of settlement option selected? • Concept Check 9-5 (p. 274) • Exercise: Ask students about special types of health insurance coverage they or their family members have. • Discussion Question: What is the relationship between health insurance coverage and other aspects of financial planning? • Assignment: Talk to others about the impact of their health insurance on other financial decisions. Also, obtain information on the types of health insurance coverage they have. • Assignment: Have students contact an insurance agent to obtain cost information for an The insurance company determines your insurability by means of information in your application, the medical examination, and the inspection report. Examining a Policy: Before and After the Purchase (p. 273) • • Read every word of the contract and, if necessary, ask your agent for point-by-point explanation of the language. Choosing Settlement Options (p. 273) • The most common settlement options are lumpsum payment, limited installment payment, life income option, and proceeds left with company. Switching Policies (p. 273) • If you already own whole life insurance, think twice if someone suggests that you replace it. HEALTH INSURANCE AND FINANCIAL PLANNING (p. 274) • In Canada most basic medical procedures are provided for under provincial government health-care plans. What Is Health Insurance? (p. 274) • • Health insurance is a form of protection whose primary purpose is to alleviate the financial burdens suffered by individuals because of illness or injury. Health insurance includes both medical expense insurance and disability income insurance. The Need for Supplemental Health Insurance (p. 274) • While the bulk of financial risks related to medical costs are minimized by the various provincial health CHAPTER 9 LECTURE OUTLINE Instructional Suggestions individual health insurance policy. care insurance programs, you should establish your capacity to pay any costs that are not covered. Group Health Insurance (p. 275) • • Group plans comprise more than 60 percent of all the health insurance issued by health and life insurance companies. The protection provided by group insurance varies from plan to plan. • Supplementary Resource: Talk to someone in a personnel office of a business to obtain information on the health insurance provided as an employee benefit. • Discussion Question: Should employers be required to provide employees some type of health insurance coverage, even if it is a group plan, with each employee paying his or her full premium? • Concept Check 9-6 (p. 276) • Text Highlight: Point out the basic purpose and provisions of disability income insurance. • Assignment: Survey several people to determine if they have disability income insurance. Also, compare costs of this type of coverage with several different insurance companies. Individual Health Insurance (p. 275) • Individual health insurance covers either one person or a family. Coverage and cost vary from company to company. Supplementing Your Group Insurance (p. 276) • • A sign that your group coverage needs supplementing would be its failure to provide benefits for the major portion of your medical care bills. In supplementing your group health insurance, consider the health insurance benefits that your employer-sponsored plan provides to your family members. DISABILITY INCOME INSURANCE (p. 276) • Disability income insurance benefits provide regular cash income lost by employees as the result of an accident or illness. Definition of Disability (p. 276) • There are different definitions of disability. Some policies define it as simply being unable to do your regular work, while others are stricter. Disability Insurance Trade-offs (p. 277) • There are important trade-offs to consider in buying disability income insurance. ∗ Waiting or elimination period ∗ Duration of benefits ∗ Amount of benefits ∗ Accident and sickness coverage ∗ Guaranteed renewability Sources of Disability Income (p. 277) CHAPTER 9 LECTURE OUTLINE • • Instructional Suggestions There are three major sources of disability income. ∗ Employer ∗ Private ∗ Public ∗ Employment Insurance ∗ Canada and Quebec Pension Plans ∗ Workers’ compensation ∗ Short-term or Long-term Welfare The availability and extent of these and other disability income sources vary widely in different parts of the country. Determining Your Disability Income Insurance Requirement (p. 279) • If the sum of your disability benefits approaches your after-tax income, you’ll be in good shape to pay your day-to-day bills while recuperating. Critical Illness Insurance (p. 279) • Critical Illness insurance provides money for care if you are diagnosed with a serious illness or condition. One in two men and one in three women will be struck by a critical illness at some point in their lives. SUPPLEMENTAL HEALTH INSURANCE (p. 281) • Several types of health insurance coverage are available under group and individual policies. Dental Expense Insurance (p. 281) • Dental expense insurance provides reimbursement for the expenses of dental services and supplies. Vision Care Insurance (p. 281) • A recent development in health care coverage has been vision care insurance. Health Services Insurance (p. 281) • Basic plan provides coverage for prescription drugs not covered by your provincial plan, semi-private or private hospital room, prosthetic appliances, wheelchairs, and other medical services not covered by your government plan. Travel Insurance (p. 281) • Provides coverage for hospital and medical expenses • Concept Check 9-7 (p. 280) CHAPTER 9 LECTURE OUTLINE Instructional Suggestions incurred outside Canada. It can also offer additional benefits such as baggage and personal effects insurance and flight and travel accident insurance. Accidental Death or Dismemberment Insurance (p. 282) • Adults under 65 years of age are covered for up to $25,000. Adults over 65 and children are covered for up to $10,000. Long-Term Care Insurance (p. 282) • Long-term care is day-in, day-out help that you could need if you ever have an illness or disability that lasts a long time and leaves you unable to care for yourself. Major Provisions in a Health Insurance Policy (p. 283) • All health insurance policies have certain provisions in common. They are: ∗ Eligibility ∗ Assigned benefits ∗ Internal limits ∗ Co-payment ( a provision under which the insured pays a flat dollar amount each time a covered medical service is received after the deductible has been met) ∗ Benefit limits ∗ Exclusions and limitations ∗ Coordination of benefits ∗ Guaranteed renewable ∗ Cancellation and Termination Health Insurance Trade-Offs (p. 284) • The benefits of health insurance policies differ, so consider the following: ∗ Reimbursement versus indemnity ∗ Internal limits versus aggregate limits ∗ Deductibles and coinsurance ∗ Out-of-pocket limit • Concept Check 9-8 (p. 285) CONCLUDING ACTIVITIES • Point out the chapter summary (p. 285) and key terms in the text margin. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use the Chapter Quiz in the Instructor’s Manual. • Use the end-of-part continuous case as an in-class discussion exercise or as an out-of-class assignment. CHAPTER 9 QUIZ ANSWERS True-False 1. T 2. T 3. F 4. T 5. F 6. F 7. T 8. T Multiple Choice 9. D 10. B 11. D 12. A 13. B 14. D 15. A 16. B Name ________________________________________ Date____________________________ CHAPTER 9 QUIZ TRUE-FALSE _____1. With a conversion option, you can exchange your term insurance to a whole life policy. _____2. Hospital expense insurance pays part or all of hospital bills for room, board, and other charges. A participating policy has somewhat lower premiums than a non-participating policy. _____3. _____4. _____5. _____6. _____7. _____8. A term insurance policy pays a benefit only if you die during the period that the policy covers.. The family need method for calculating life insurance is based on the 70 percent rule. Disability income insurance benefits provide for the full replacement of income lost by employees as the result of an accident or illness. An incontestability clause is a provision stating that the insurer cannot dispute the validity of policy after a specified period. Credit life insurance pays off your outstanding debts in the event of your death. MULTIPLE CHOICE _____9. Which of the following is not a characteristic of permanent your life insurance? a. level premiums b. cash value c. participating policy d. conversion option _____10. Which life insurance provision allows you not to forfeit all accrued benefits? a. Double indemnity b. Nonforfeiture clause c. Incontestability clause d. Suicide clause _____11. Which life insurance provision permits the owner of the policy to borrow any amount up to the cash value of the policy? a. Double indemnity b. Nonforfeiture clause c. Incontestability clause d. Policy loan provision _____12. What form of insurance is expected to face a growth over the next 5 to 10 years? a. Long-term care b. Vision care c. Medicare d. Dental expense _____13. A settlement option that provides for payment of life-insurance proceeds in equal periodic installments for a specified number of years after your death is called a. lump-sum payment. b. limited installment payment. c. life income option. d. interest-principal payment option. _____14. Dental expense insurance does not partially cover which of the following: a. Fillings b. Extractions c. Root canal d. Tooth bleaching _____15. Your health insurance policy does not cover plastic surgery for cosmetic reasons. Which provision of your health insurance policy would you find this in? a. Exclusions and limitations b. Guaranteed renewable c. Cancellation and termination d. Internal limits _____16. __________ provides regular cash earnings lost by individuals as the result of an accident or illness. a. Long term care b. Disability income insurance c. Medicare d. Health insurance SUPPLEMENTARY LECTURE Click Here for Coverage (Andrew Osterland) Scores of banks and securities brokers are chasing customers in cyberspace. Now, insurance companies are finally joining the race. You can go online to shop for—and sometimes, buy—term life policies and auto coverage. Besides marketing policies through banks and brokers, insurers are expanding their Web presence through a variety of quotation services. Insurers pay a commission for sales generated at these sites. Insurance malls give comparative prices but only feature insurers that pay to be listed. That limits the number of carriers they quote. If you’re shopping for insurance online, here’s what you can expect to find: LIFE INSURANCE: Term insurance, which pays your beneficiaries a set sum if you die, continues to be the dominant offering on the Net. It pays to check several sites to find the best deal. If you search for a policy through Insure-market, say, you must first answer 22 questions that include your age, weight, and family history of illness. The prices you’ll find online aren’t any cheaper than if you went to a carrier directly. But the shopping is more convenient. Once you find an acceptable price, it takes about five minutes to apply for coverage. Of course, some things you can’t do over the Net: You’ll need to book a medical exam, either online or over the phone. Once the test results are in, you should hear within two weeks on whether you were approved. SUPPLEMENTARY LECTURE Insurers Shouldn’t Be So Web-Shy (Susan Jackson) Insurers are in the business of addressing fears about the unknown. So why are they so scared of the Internet? The industry’s main problem can be summed up in one word: agents. They sell 90% of personal property and 98% of individual life premiums. “The biggest hurdle insurers see to [using the Internet] is the fear of cutting out agents,” says Michael E. Gazala, a senior analyst with Forrester Research Inc. Whichever company starts actively using the Net first risks agents defecting to other insurers. Even companies that don’t have agents would just as soon wait for someone else to test the waters. “It’s not clear there’s a real advantage to being first,” says the vice-president of a company that sells insurance directly to consumers. Some insurers are venturing onto the Net and providing quotation services, especially for term life and auto insurance. But it’s hard to actually buy policies online. What insurers should really be worried about is competition. More than 75% of banks now sell annuities, traditionally the province of insurers. The industry should develop clear strategies to take advantage of the cost savings and increased customer service the Internet can provide, particularly on less complex policies. Agents don’t necessarily have to be cut out of the loop by the Net, but they will have to start rethinking how they do business. Growing numbers of consumers are going to be clamoring to do more of their insurance business online. If insurers aren’t prepared, there are plenty of competitors who will be eager to pick up the slack. SUPPLEMENTARY ACTIVITY As individuals move from one stage of the life cycle to another, their changing financial resources, responsibilities, living situations, and life style will have an impact on their financial security. In the chart below, identify the key concerns or questions each person should identify in order to select a life insurance program that will contribute to their financial security now and in the future. Present Key Concerns/ Question in Five Years Mark: high school senior, working parttime, plans to go to college • married and expecting first child; graduated from college; wife is a full-time homemaker with no plans for a job Sandra: a married woman in her early 20s; free lance artist; husband employed; plans to have a family • two-year-old son; recently divorced; free lances full-time Ed: a married man in his 40s; a teenage daughter; wife works full-time; substantial mortgage and two car loans • daughter has been seriously ill and may be permanently disabled; Ed has recently changed jobs; purchased a vacation home Anne: a widow and in her early 60s; grown children; works, elderly, dependent mother lives with her • retired; elderly mother has died; recently remarried Key Concerns/ Questions SUPPLEMENTARY INFORMATION Quality Health Care Depends On 1. Access to adequate health care and appropriate business and individual resources. 2. Preservation of the health care system with modifications to contain costs and improve delivery of care. 3. Availability of comprehensive health insurance and prepayment plans. 4. Use of the private sector with governmental programs meeting needs which cannot otherwise be met. 5. Emphasis on the individual’s responsibility for wellness, supported by a variety of educational programs. 6. Planning of health services and facilities to avoid duplication. 7. Encouragement of innovative programs for care. ANSWERS TO CONCEPT QUESTIONS, OPENING CASE QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, AND LIFE SITUATION CASE. CONCEPT QUESTIONS Concept Check 9-1 (p. 260) 1. How can the Internet help you create a life insurance plan? Students’ answers will vary depending on the Web site they visit. 2. What is the meaning of life insurance? A person joins a risk-sharing group (an insurance company) by purchasing a contract (a policy). Under the policy, the insurance company promises to pay a sum of money at the time of the policy holder’s death to the person or persons selected by him or her (the beneficiaries). In the case of an endowment policy, the money is paid to the policyholder (the insured) if he or she is alive on the future date (the maturity date) named in the policy. The insurance company makes this promise in return for the insured’s agreement to pay it a sum of money (the premium) periodically. (p. 257) 2. What is the purpose of life insurance? Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. That “someone” could be the nonworking spouse and children of a singleincome family. It could be the wife or husband of a two-income family. It could be an aging parent. It could be a business partner or a corporation. (p. 258) 3. What is the principle of life insurance? The principle of home insurance discussed in Chapter 10 can be applied to the lives of persons. From records covering many years and including millions of lives, mortality tables have been prepared that show the number of deaths for various age groups during any years. (p. 258) 4. What do mortality tables indicate? Mortality tables provide the number of deaths expected during any given year of life. (p. 259) Concept Check 9-2 (p. 262) 1. 1. How do you determine the need for life insurance? If your death would cause financial stress for your spouse, children, parents, or anyone you want to protect, then you should consider purchasing life insurance. Your stage in the life cycle and the type of household you live in will influence this decision. Single persons living alone or with their parents usually have little or no need for life insurance. (p. 260) 2. What determines your life insurance objectives? Before you consider types of life insurance policies, you must decide what you want your life insurance to do for you and your dependents. First, how much money do you want to leave to your dependents if you should die today? Will you require more or less insurance protection to meet their needs as time goes on? Second, when would you like to be able to retire? What amount of income do you feel you and your spouse would need then? Third, how much will you be able to pay for your insurance program? When you are older, are you most likely to earn more than, the same as, or less than you do now? Are the demands on your family budget for other expenses of living likely to be greater or less as time goes on? When you have considered these questions and developed some approximate answers, you are ready to select the types and amounts of life insurance policies that will help you accomplish your objectives. (p. 257) 3. What are the two methods of estimating your life insurance requirements? The income replacement method is based on the rule of thumb that a “typical family” will need approximately 70 percent of the salary for seven years before it adjusts to the financial consequences of the wage earner’s death. The faamily need method is probably the best method of determining life insurance requirement. It does not assume you family is “typical” and takes into account important factors as government benefits and your liquid assets, expenses at death, living expenses, etc. (p. 261) Concept Check 9-3 (p. 267) 1. What are the major types and subtypes of life insurance? Assess the following types of insurance policies, and discuss their advantages and disadvantages. A. Term insurance: protection for a stated period; can have renewability or conversion option. B. Permanent life insurance: insurance for the whole of life; can be participating or nonparticipating for earning dividends; most have level premiums. o Whole life insurance: traditional permanent life insurance that fully guarantees the level of premiums, death benefits and growing cash reserves within the policy. o Universal life: combines term insurance and investment elements. o Variable life: guaranteed premiums and minimum death benefit with varying cash value. C. Endowment policy: provides payment after a specified number of years. D. Group life: a plan that insures a large number of people under the terms of a single policy. E. Credit life: used to repay personal debt should the borrower die before doing so. (p. 267) Concept Check 9-4 (p. 267) 1. What are the most common provisions in life insurance contracts? Here are some of the most common provisions: the grace period, naming your beneficiary, policy reinstatement, nonforfeiture clause, incontestability clause, suicide clause, automatic premium loans, misstatement of age provision, policy loan provision, riders, waiver of premium disability benefit, accidental death benefit, and guaranteed insurability option. (p. 268) 3. What is a beneficiary? An important provision in every life insurance policy is the right to name your beneficiary. A beneficiary is a person who is designated to receive something, such as life insurance proceeds, from someone. In your policy, you can name one or more persons as contingent beneficiaries who will receive your policy proceeds if the primary beneficiary dies before you do. (p. 268) 3. What is a rider? An insurance company can change the provisions of a policy by attaching a rider to the policy. A rider is any document attached to the policy that modifies its coverage by adding or excluding specified conditions or altering its benefits. A whole life insurance policy may include a waiver of premium disability benefit or an accidental death benefit, or both. (pp. 270) 4. What is the concept of double indemnity? Accidental Death Benefit. Under this provision, the insurance company pays twice the face amount of the policy if the insured’s death results from an accident. The accidental death benefit is often called double indemnity. Accidental death must occur within a certain time after the injury, usually 90 days, and before the insured reaches a certain age, usually 60 or 65. (p. 270) Concept Check 9-5 (p. 274) 1. How do insurance companies price their products? In brief, the price a company charges for a life insurance policy is affected by five factors: the company’s cost of doing business, the return on its investments, the mortality rate that it expects among its policyholders, the features contained in its policy, and competition among companies with comparable policies. The price of life insurance policies varies, therefore, considerably among life insurance companies. Moreover, a particular company will not be equally competitive for all policies. (p. 272) 2. How do insurance companies determine your insurability? The company determines your insurability by means of the information in your application, the medical examination, and the inspection report. Of all applicants, 98 percent are found to be insurable. (p. 272) 3. What should you do in examining a policy before and after the purchase? Before the Purchase. When you buy a life insurance policy, read every word of the contract and, if necessary, ask your agent for a point-by-point explanation of the language. Many insurance companies have rewritten their contracts to make them more understandable. Remember that these are legal documents and that you should be familiar with what they promise, even though technical terms are used. After the Purchase. After you buy new life insurance, you have a 10-day “free look” period, during which you can change your mind. If you do so, the company will return your premium without penalty. (pp. 273) 4. What are the four most common settlement options? Lump-Sum Payment. In the lump-sum payment option, the company pays the face amount of the policy in one installment to the beneficiary or to the estate of the insured. This form of settlement is the most widely used option. Limited Installment Payment. This option provides for payment of the life insurance proceeds in equal periodic installments for a specified number of years after your death. Life Income Option. Under the life income option, payments are made to the beneficiary for as long as the beneficiary may live. The amount of each payment is based primarily on the sex and attained age of the beneficiary at the time of the insured’s death. Proceeds Left with the Company. Under this option, the life insurance proceeds are left with the insurance company at a specified rate of interest. The company acts as trustee and pays the interest to the beneficiary. The guaranteed minimum interest rate paid on the proceeds varies among companies. (p. 273) 5. Should you switch life insurance policies? Think twice if someone suggests that you replace the whole life insurance you already own. Before you give up this protection, make sure you are still insurable (check medical and any other qualification requirements). Also remember that you are now older than you were when you purchased your policy and that a new policy will cost more because of your age. Moreover, the older policy may have provisions that are not duplicated in some of the newer policies. (p. 273) Concept Check 9-6 (p. 276) 1. What is health insurance and what is its purpose? Health insurance is a form of protection with a primary purpose to alleviate the financial burdens suffered by individuals because of illness or injury. The purpose of health insurance is to reduce the financial burden due to illness or injury. (p. 27) Concept Check 9-7 (p. 280) 1. What is disability income insurance? Disability income insurance benefits provide for the partial replacement of income lost by employees as the result of an accident or illness. Every worker needs disability income insurance to make his or her ends meet in case of a disability. Most disability income policies provide for a waiting period before payment begins, such as a week, a month, two months, or three months. (p. 276) 2. What are the three sources of disability income? Three sources of disability income are employers, private and public (Employment Insurance, Canada and Quebec Pension Plans). (p. 277) 3. How can you determine the amount of disability income insurance you need? If the sum of your disability benefits approaches your after-tax income, you can safely assume that should disability strike, you’ll be in good shape to pay your day-to-day bills while recuperating. (p. 279) Concept Check 9-8 (p. 283) 1. What are several types of health insurance coverage available under group and individual policies? Following are several types of health insurance coverage available under group and individual policies: dental expense insurance, vision care insurance, health services insurance, travel insurance, accidental death and dismemberment, and long-term care insurance. (pp. 281) 2. What are the major provisions of a health insurance policy? Major provisions in a health insurance policy are eligibility, assigned benefits, internal limits, copayment, benefit limits, exclusions and limitations, coordination of benefits, guaranteed renewability, and cancellation and termination. (p. 283) 3. How do you decide which coverage to choose? You should consider the premium, the coverage and the deductible. 4. How can you analyze the costs and benefits of your health insurance policy? The benefits of health insurance policies differ, and the differences in benefits can have a significant impact on your premiums. Consider the following trade-offs: reimbursement versus indemnity, internal limits versus aggregate limits, deductibles and co-insurance, and out-of-pocket limit. (p. 284) OPENING CASE QUESTIONS (p. 257) 1. How can the Internet help you create a life insurance program? Students’ answers will vary depending on the Web site they visit. 2. What was Harry Mills’ biggest asset? Were all his debts paid off when he died? Harry Mills’ biggest asset was a $250,000 life insurance policy. When Harry Mills died, all his debts were paid off. 3. What is an overlooked source of income for terminally ill people? Terminally ill people often overlook the income of life insurance. FINANCIAL PLANNING PROBLEMS (p. 286) 1. A group of 100,000 males, age 30, wish to contribute each year an amount to a common fund sufficient to pay $1,000 to the dependants of each group member who dies during the year. Use the mortality table in Exhibit 9-1 to determine the following. a. How many members of the group can be expected to die during the year? 86 deaths are expected What amount must each of the 100,000 members contribute at the beginning of the year to provide $1,000 for the dependants of those who die before the end of the year? 86 deaths x $1,000 = 86,000 x .00088 = $75.68 You are the wage earner in a “typical family”, with $30,000 gross annual income. Use the easy method to determine how much life insurance you should carry. Simply multiply the annual gross income of $30,000 by a factor of seven and 0.70: $30,000 × 7 × 0.70 = $147,000. 3. Analyze the two methods of determining life insurance requirements. Which method is best, and why? The two methods of determining life insurance requirements are the income replacement method and the family need method. The income replacement method is based on the general rule that the typical family needs 70 percent of salary for a period of 7 years. This method is simple and easy but it may not provide you with adequate protection. The family need method does not assume your family is typical. It takes into account income, government benefits, liquid assets, death expenses, living expenses, and determines your insurance needs based on the inflation rate and your expected rate of return. (pp. 261) 4. You and your spouse are in good health and have reasonably secure careers. You make about $35,000 annually and have opted for life insurance coverage of 3 times your salary through your employer. Considering your spouse’s income, you are able to absorb on-going living costs of $45,000 a year. You own a home with an $80,000 mortgage. Other debts include a $10,000 car loan, $5,000 student loan and $3,000 charged to credit cards. In the event of your death, you wish to leave your family debt-free. One of your most important financial goals involves building an education fund of $50,000 to cover the cost of a three-year university program for your 2-year old child. To date, you have accumulated $15,000 toward this goal. Should you die, your beneficiaries would receive a $2,500 lump sum payment from the Canada Pension Plan and $10,000 from your corporate pension plan. Your other financial assets are as follows: Bank accounts Term deposits (3 months) Canada Savings Bonds Stock investment account $2,100 3,000 1,000 2,500 Use the Family Need Method to determine your life insurance needs. (Obj. 2) Solution Refer to Exhibit 9-2: 1. 5 x $35,000 2. Education fund ($50,000 - $15,000) Debt payment ($80,000 + $10,000 + $5,000 + $3,000) 35,000 98,000 3. Emergency fund (3/12 x $45,000) 11,350 4. Funeral expenses 5. Total needs 6. Available assets: Liquid assets ($2,100 + $3,000 + $1,000) Government death benefit RPP death benefit Corporate life insurance (3 x $35,000) 7. Additional Life Insurance Needs $175,000 6,000 $325,350 6,100 2,500 10,000 105,000 $123,600 $201,750 5. Obtain premium rates for $25,000 whole life, universal life, and term life policies from local insurance agents. Compare the cost and provisions of these policies. The purpose of this activity is to learn that term life insurance is the least expensive form of life insurance. 6. Use Exhibit 9-2 as a worksheet to calculate your own life insurance needs. The purpose of this exercise is to learn how to estimate life insurance needs using the family need method. Students will have to consider such factors as government benefits and liquid assets. (p. 258) 7. Georgia Braxton, a widow, has a take-home pay of $600 a week. Her disability insurance coverage replaces 70 percent of her earnings after a four week waiting period. What amount would she receive in disability benefits if an illness kept Georgia off work for 16 weeks? $600 x .70 = $420 $420 x 12 weeks = $5,040 FINANCIAL PLANNING ACTIVITIES (p. 287) 1. Interview relatives and friends to determine why they purchased life insurance. Prepare an essay summarizing your findings. The Purpose of Life Insurance Most people buy life insurance to protect someone who depends on them from financial losses caused by their death. That someone could be the nonworking spouse and children of a single-income family. It could be the wife or husband of a two-income family. It could be an aging parent. It could be a business partner or corporation. 2. Choose one stock and one mutual life insurance company. Obtain and compare premiums for: a. Term life insurance for $50,000 b. Whole life insurance for $50,000 c. Universal life insurance for $50,000 Prepare a summary table indicating which policy you would consider and why. Students will discover that insurance rates for $50,000 of life insurance will vary for term, whole life, and universal life insurance. A mutual company will have a somewhat higher premium than a stock company, but a mutual life insurance company will refund a part of the premium to the policyholder annually. Let students compare the premiums. 3. List the benefits included in your employee benefit package such as health insurance, disability income insurance, and life insurance. Discuss the importance of such a benefit package to the consumer. Student responses will vary, but take this opportunity to emphasize that employer-sponsored health insurance, disability income insurance, and life insurance are an important part of financial planning. 4. Obtain sample health insurance policies from insurance agents or brokers, and analyze the policies for definitions, coverages, exclusions, limitations on coverage, and amounts of coverage. In what ways are the policies similar? In what ways are they different? Students will find that most insurance companies will have the same major clauses, but different coverages for different amounts of insurance. The premiums for the same coverage may vary widely. LIFE SITUATION CASE How Much Is Enough? (p. 289) 1. What are the advantage of buying life insurance when you are younger, and what is a good reason for having it? When you are in your 20s or 30s, the premium for term insurance is extraordinarily cheap. Although whole insurance is more expensive, buying the policy guarantees the same premium for the rest of your life. 2. What would be the total coverage needed for an average couple with two children and a combined income of $45,000? The total amount of insurance an average couple with two children and a combined income of $45,000 need is six to eight times their salary. The minimum the average couple would need is $270,000. 3. What is one advantage of whole life insurance? Although whole life insurance costs more in the early years, it guarantees that you will pay the same premium 10, 15, or even 20 years down the road. 4. Is term insurance the right choice for the Kitsos? Why or why not? Term insurance is the right choice for the Kitsos because it is much cheaper than buying whole life insurance, and the term insurance would last until their children graduate from college. COMMENTS ON CONTINUOUS CASE FOR PART 3 (p. 290) Managing Risks for Effective Financial Planning 1. How should the Mortimers determine whether they have enough insurance coverage for their home? Several factors affect how much insurance coverage you need for your home and property. Since the value of their home has increased and with more children using the house, the replacement value of damaged and/pr stolen items should be taken into consideration in determining their expanded coverage. 2. What factors should the Mortimers consider in deciding whether to purchase collision insurance coverage for their used car? Collision insurance pays for the damage to the automobile regardless of fault. The decision to purchase collision coverage should be based on the value of the automobile and the cost of collision coverage. 3. When considering disability income insurance, what length of waiting period and duration of benefits should the Mortimers consider? Disability income insurance provides regular cash income lost by employees as a result of an accident, or illness. With regard to waiting period, there is usually a waiting period of between 30 and 90 days with most disability income policies. For the Mortimers, a 30-day or 60-day waiting period would be a good choice since he has 30 days of sick leave. Most experts recommend that you purchase disability coverage that pays benefits for life. If you become permanently disabled, it would be financially disastrous if your benefits ended at age 55 or 65. 4. Do you think Pamela and Isaac Mortimer have enough life insurance? If not, what changes would you recommend? Explain your answer. The two general methods for determining the amount of insurance that the Mortimers need are the income replacement method and the family need method. While discussing the answer to this question, you may want to review the material on pages 261. 10 FUNDAMENTALS OF INVESTING CHAPTER OVERVIEW This chapter is the first chapter in Part Four—Investing Your Financial Resources. We begin our discussion by stressing the importance of preparing for an investment program. Then, we provide an overview of how the factors of safety, risk, income, growth, and liquidity affect investment programs. Next, we examine the different investment alternatives available to individuals. We also study methods that investors can use to reduce investment risk. Included in this section on reducing risks is a discussion on the role of financial planners and material on the importance of the individual’s role in the investment process. Finally, we discuss sources of investment information which include the Internet and Online computer services, newspapers, news programs, business periodicals and government publications, corporate reports, statistical averages, investor services newsletters, and desktop information services. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: Obj. 1 Explain why you should prepare for and establish an investment program. Investment goals must be specific and measurable and should be classified as short term, intermediate, and long term. Before beginning an investment program, you must make sure your personal financial affairs are in order. This process begins with learning to live within your means and providing adequate insurance protection. The next step is the accumulation of an emergency fund equal to three to nine months’ living expenses. Then, and only then, is it time to save the money needed to establish an investment program. Obj. 2 Describe how safety, risk, income, growth, and liquidity affect your investment decisions. Although each investor may have specific individual reasons for investing, all investors must consider the factors of safety, risk, income, growth, and liquidity. Especially important is the relationship between safety and risk. Basically, this concept can be summarized as follows: The potential return for any investment should be directly related to the risk the investor assumes. The risk factor can be broken down into five components: inflation risk, interest rate risk, business failure risk, market risk, and global investment risk. Obj. 3 Identify the major types of investment alternatives. Investment alternatives include stocks, bonds, mutual funds, and real estate. More speculative investment alternatives include options, derivatives, commodities, precious metals, gemstones, and collectibles. Before choosing a specific investment, all potential investments should be evaluated on the basis of safety, risk, income, growth, and liquidity. You should also diversify your investments to lessen risk. With all of these factors in mind, the next step is to develop a specific, personal investment plan to help you accomplish your goals. LEARNING OBJECTIVES CHAPTER SUMMARY Obj. 4 Recognize the role of the professional financial planner and your role in a personal investment program. There are no hard and fast rules that define what a person must to in order to use the designation of Personal Financial Planner. In general, however, there are a number of reputable associations that regulate the use of regulated designations such as CFP (Certified Financial Planner), RFP (Registered Financial Planner), and FP (Financial Planner). These associations generally insist on formal training of some kind as well as a minimum of experience and commitment. Financial planners can help individuals achieve their investment goals, but choosing a qualified planner is your responsibility. It is your responsibility to evaluate and monitor the value of your investments and to keep accurate and current records. Obj. 5 Use the various sources of financial information that can reduce investment risks and increase investment return. Since there is more information on investments than most investors can read and comprehend, investors must be selective in the type of information that they use for evaluation purposes. Sources of information include: the Internet, newspapers and news programs, business periodicals, government publications, corporate reports, statistical averages, and investor services. INTRODUCTORY ACTIVITIES • Discuss the information presented in the opening case (p. 293). Ask students to comment on Brian and Jane Seward’s financial planning activities. • Point out the learning objectives (p. 291) in an effort to highlight key points in the chapter. • Ask students to share experiences about investments they or their family have had. • Point out the benefits of investing for long-term personal financial security. CHAPTER 10 OUTLINE I. Preparing for an Investment Program A. Establishing Investment Goals B. Performing a Financial Checkup C. Getting the Money Needed to Start an Investment Program D. The Value of Long-Term Investment Programs II. Factors Affecting the Choice of Investments A. Safety and Risk B. Risk Tolerance C. Components of the Risk Factor D. Investment Income E. Investment Growth F. Investment Liquidity III. An Overview of Investment Alternatives A. Stock or Equity Financing B. Corporate and Government Bonds C. Mutual Funds D. Segregated Funds E. Real Estate F. Other Investment Alternatives G. Summary of Factors That Affect Investment Choices H. A Personal Investment Plan IV. Factors That Reduce Investment Risk A. The Role of a Financial Planner B. Your Role in the Investment Process C. Tax Considerations V. Sources of Investment Information A. The Internet and Online Computer Services B. Newspapers and News Programs C. Business Periodicals and Government Publications D. Corporate Reports E. Statistical Averages F. Investor Services and Newsletters G. Desktop Information Services CHAPTER 10 LECTURE OUTLINE PREPARING FOR AN INVESTMENT PROGRAM (p. 294) • Instructional Suggestions • Text Reference: There are nine specific questions included in this section that may help students establish valid investment goals. • Current Example: Many financial planners stress the importance of home equity as part of an investment plan. Not only does home ownership provide for an increase in equity, it also has definite tax advantages. Under current tax laws, interest on homes is fully deductible. • Discussion Question: When you decide to start an investment program, where does the money come from? • Text Reference: Use Exhibit 10-1(p. 282) to illustrate the growth of $2,000 for 1, 5, 10, 20, 30, and 40 year periods at different interest rates. The decision to start an investment program is an important first step to accomplishing your long-term financial goals. Establishing Investment Goals (p. 294) • • • To be useful, investment goals must be specific and measurable. Investment goals must be tailored to your particular financial needs. Investment goals must always be oriented toward the future. Performing a Financial Checkup (p. 295) • Before beginning an investment program, you must make sure your personal financial affairs are in order. To be successful, you must: 1. Work to balance your budget. 2. Obtain adequate insurance protection. 3. Start an emergency fund equal to three to nine months’ living expenses. 4. Have access to other sources of cash for emergency needs. Getting the Money Needed to Start an Investment Program (p. 296) • • Once you have established your investment goals and completed your personal financial checkup, it’s time to start investing—assuming that you have enough money to finance your investments. As pointed out earlier in this chapter, no one can make you save money to finance your investment program. The following suggestions may help you obtain the money you need. 1. You must pay yourself first. 2. Take advantage of employer-sponsored retirement programs. 3. You should participate in an elective savings program. 4. You can also make a special savings effort one or two months each year. 5. You should take advantage of gifts, inheritances, and windfalls. CHAPTER 10 LECTURE OUTLINE Instructional Suggestions The Value of Long-Term Investment Programs (p. 297) • • Many individuals never start an investment program because they only have a small sum of money. But even small sums of money grow over a long period of time. Exhibit 10-1 shows how much your investment would be worth at the end of selected time periods with different rates of return if you invested $2,000 each year. FACTORS AFFECTING THE CHOICE OF INVESTMENTS (p. 299) • • Concept Check 10-1 (p. 298) • Discussion Question: Have your students discuss the following statement: The potential return on any investment should be directly related to the risk that the investor assumes. (p. 284) • Text Highlight: You may want students to read the Advice from a Pro feature from Merrill Lynch on p.302. Although each investor may have specific individual reasons for investing, there are a number of factors that all investors must consider. Safety and Risk (p. 299) • • • • The safety and risk factors are two sides of the same coin. Safety in an investment means minimal risk of loss. On the other hand, risk in an investment means a measure of uncertainty about the outcome. A Speculative investment is a high risk investment made in the hope of earning a relatively large profit in a short time Investments range from very safe to very risky. At one end of the investment spectrum are very safe investments that attract conservative investors. Investors pick such investments because they know there is very little chance that investments will become worthless. At the other end of the investment spectrum are very risky investments. Such investments offer the possibility of a larger dollar return, but if they are unsuccessful, the investor may lose most or all of the initial investment. Risk Tolerance (p. 300) • • Risk tolerance is the amount of psychological pain you are willing to suffer from your investments. You could lose part or your entire principal, the purchasing power of your investment can decrease and you may not receive the returns you expected. In addition, the money you invested in securities, mutual funds, and other similar investments are not CHAPTER 10 LECTURE OUTLINE Instructional Suggestions insured by the CDIC (Canadian Deposit Insurance Corporation). Components of the Risk Factor (p. 300) • The factor of risk associated with a specific investment does change from time to time. In fact, the overall risk factor can be broken down into the following five components. 1. Inflation risk 2. Interest rate risk 3. Business failure risk 4. Market risk 5. Global Investment Risk Investment Income (p. 300) • • • Investors sometimes purchase certain investments because they want a predictable return or distribution of income from their investment. If income is a primary objective, most investors choose government bonds, corporate bonds, preferred stock, utility stocks, or selected common stocks. Other investments that provide income potential are mutual funds and real estate rental property. The more speculative investments, such as commodities, options, precious metals, gemstones, and collectibles, offer little, if any potential for regular income. • Text Reference: You may want to discuss Exhibit 10-2 (p. 304) (corporations with consecutive quarterly dividends). • Discussion Question: How can a GIC provide both income and growth? • Concept Check 10-2 (p. 304) Investment Growth (p. 303) • • • To investors, growth means that their investment will increase in value. Government bonds, corporate bonds, stocks, mutual funds, and real estate may offer growth possibilities. Precious metals, gemstones, and collectibles are more speculative investments and offer less predictable growth possibilities. Investment Liquidity (p. 304) • Liquidity is the ease with which an asset can be converted to cash without a substantial loss in dollar value. AN OVERVIEW OF INVESTMENT ALTERNATIVES (p. 305) • When establishing an investment program, investors should begin by gathering as much information as possible about investment alternatives. Text Highlight: Refer students to Exhibit 10-3 (p. 309) for a summary of the different investment alternatives and how they relate to safety, risk, etc. CHAPTER 10 LECTURE OUTLINE • Once you have established your emergency fund and have some money in the bank, it’s time to consider other investment alternatives. Stock or Equity Financing (p. 305) • • • • Instructional Suggestions • Discussion Question: Why would an investor purchase stock? • Discussion Question: Why would an investor purchase a mutual fund? Equity capital is money that a business obtains from its owners. Investors should consider at least two factors before investing in stock. First, a corporation is not obligated to repay the money obtained from the sale of stock or to repurchase the stock at a later date. Second, a corporation is under no legal obligation to pay dividends. A dividend is a distribution of money, stocks, or other property that a corporation pays to shareholders. There are two types of stock—common and preferred. Corporate and Government Bonds (p. 306) • • • There are two types of bonds that an investor should consider. A corporate bond is a corporation’s written pledge that it will repay a specified amount of money with interest. A government bond is the written pledge of a government or a municipality that it will repay a specified sum of money with interest. The maturity dates for most bonds range between 1 and 30 years. Interest payments on bonds are made every six months. Mutual Funds (p. 306) • • • A mutual fund is an investment alternative available to individuals who pool their money to buy stocks, bonds, and other securities based on the selections of professional managers who work for an investment company. Professional management is an especially important factor. Another reason why investors choose mutual funds is because of diversification. The goals of one investor may differ from those of another investor. The managers of mutual funds realize this and tailor programs to meet individual needs and objectives. Segregated Funds (p. 307) • A segregated fund is an investment alternative in the form of an annuity that is similar to a mutual fund but that is less risky as it provides a certain degree of CHAPTER 10 LECTURE OUTLINE Instructional Suggestions insurance to the investor. Once the annuity matures, the investor is entitled to 100 percent of the initial investment minus any withdrawals. Real Estate (p. 307) • • • . • Text Highlight: Have students discuss Exhibit 10-4 (p. 310): The Investment Pyramid. • Current Example: Eager to drum up new business, the people on Bay Street are encouraging investors to use asset allocation. Asset allocation is a fancy way of saying split up your money among stocks, bonds, cash equivalents, and other investments. In fact, asset allocation can be done in many ways—all building on the idea of diversification to spread risk. • Concept Check 10-3 (p. 313) As a rule, real estate increases in value and eventually sells for a profit, but there are no guarantees. Any investment has its disadvantages, and real estate is no exception. Like any other investment, real estate must be evaluated. Other Investment Alternatives (p. 309) • • A speculative investment is a high-risk investment that is made in the hope of earning a relative large profit in a short time. Speculative investments include: call options, put options, derivatives, commodities, precious metals, gemstones, coins, stamps, and antiques and collectibles. More detailed information is provided in later chapters. Summary of the Factors that Affect the Choice of Investments (p. 309) • • Earlier in this chapter, we examined how the factors of safety, risk, income, growth, and liquidity affect investments. Now it is possible to compare the different investment alternatives to those factors. Diversification is the process of spreading your assets among several types of investments to minimize risk. A Personal Investment Plan (p. 310) • • • • To be successful, you must develop a plan and then implement it. The individual begins investment planning by establishing realistic goals. The next step is to perform a personal financial checkup. The steps required for an effective personal plan of action are presented in Exhibit 10-5 (p. 311). A completed financial plan for Salomé Mari illustrated in Exhibit 10-6 (p. 312). FACTORS THAT REDUCE INVESTMENT RISK (p. 312) The Role of a Financial Planner (p. 312) • There is no such thing as a nationally designated financial planner in Canada. A number of CHAPTER 10 LECTURE OUTLINE • • • Instructional Suggestions organizations however allow special designations after certain criteria have been met. Financial planners may be divided into two categories; the first category consists of salaried planners who provide advice either free or for a nominal fee. The second category consists of commission planners who receive compensation from the sellers of the services and products that they sell. More information about financial planners is presented in the Appendix after Chapter 1. Your Role in the Investment Process (p. 314) • • Evaluation of an investment should begin before purchasing an investment and after it is purchased. Good investors continually assess the value of their investments. Some basic elements of evaluation include: 1. Evaluate potential investments. 2. Monitor the value of your investment. 3. Keep accurate and current records. • Text Highlight: You may want to cover “Charting the Value of Your Investment” boxed feature on p. 316. • Text Highlight : Exhibits 10-7 and 10-8 (p.317) for calculations of tax rates on dividend income. • Concept Check 10-4 (p. 318) Tax Considerations (p. 315) • • • • • Generally, investment income is tax exempt, tax deferred, or taxable. With the exception of capital dividends, the dividends, interest, and profits you receive from your investments are subject to federal income tax. Dividends are taxed in a peculiar way that is designed to reflect that the corporation paying you a dividend has already paid taxes on its profits. The total of the amount you receive in eligible dividend is “grossed up” by 45 percent. You are then taxed at your marginal rate minus a dividend tax credit at the rate of 18.97 percent. Non-eligible dividends continue to be grossed up by 25 percent and are then taxed at your marginal rate minus a dividend tax credit at the rate of 13.33 percent. Interest income and rental income is taxed as ordinary income. You are taxed on 50 percent of all capital gains you receive. Capital losses can only be used to offset capital gains. CHAPTER 10 LECTURE OUTLINE Instructional Suggestions SOURCES OF INVESTMENT INFORMATION (p. 319) • With most investments, there is more information than an investor can read and comprehend. Therefore, an investor must be selective in the type of information that he or she uses for evaluation purposes. The following sources may be of value: 1. The Internet and online computer services 2. Newspapers and news programs 3. Business periodicals and government publications 4. Corporate reports 5. Statistical averages 6. Investor services and newsletters 7. Desktop information services • Chapter Highlight, exhibit 10-9 (p. 320) for useful internet sites for personal planning. • Concept Check 10-5 (p. 322) CONCLUDING ACTIVITIES • Point out the chapter summary (pp. 323) and key terms in the text margin. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use the Chapter Quiz in the Instructor’s Manual. CHAPTER 10 QUIZ ANSWERS True-False 1. T 2. T 3. T 4. F 5. T 6. F 7. F 8.T Multiple Choice 9. B 10. A 11. C 12. B 13. D 14. B 15. D 16.B Name ________________________________________ Date____________________________ CHAPTER 10 QUIZ TRUE-FALSE _____1. _____3. Short-term objectives are defined as objectives that can be accomplished in under two years. An emergency fund is a certain amount of money that can be obtained quickly in case of immediate needs. Typically, young investors are more willing to take on riskier investments. _____4. There is no relationship between safety and risk when choosing an investment. _____5. _____6. A speculative investment is usually defined as one that is made in the hope of earning a relatively large profit in a short time. Dividends, interest and rent are tax-free investments. _____7. Real estate can be viewed as a “get rich quick” scheme _____8. A line of credit is a short-term loan that is approved before the money is actually needed. _____2. MULTIPLE CHOICE _____9. Corporate bonds a. Are tax exempt from federal taxation. b. Must be repaid at maturity. c. Pay dividends on a quarterly basis. d. Are debt obligations, and, therefore, risk free. _____10. Which of the following investments would have the greatest potential for safety? a. Government bonds b. Stocks c. Commodities d. Options _____11. Which of the following investments would have the greatest potential for risk? a. Preferred stock b. Corporate bonds c. Options d. Bank accounts _____12. Which of the following statements is true? a. Rental income is taxed as a long-term capital gain. b. 50 percent of capital gains are taxable. c. It is not necessary to monitor the value of your investments if you have a financial planner. d. It is possible to be a registered financial planner (RFP) with as little as three months of training. _____13. Which of the following investment objectives is most likely to be a priority with older retired investors? a. growth b. liquidity c. income d. safety _____14. A _________ is an investment alternative in the form of an annuity, that provides a certain degree of insurance to the investor. a. Mutual fund b. Segregated fund c. Derivatives d. Commodities _____15. A way to minimize the risk of your portfolio is through a. Spreading b. Day trading c. Increasing unsystematic risk d. Diversification _____16. Which of the following statements is false? a. Asset allocation is the process of spreading your assets among several different types of investments. b. Asset allocation eliminates the risk associated with an investment program. c. The time your investments can work for you is a major factor to consider when choosing investment alternatives. d. Your age is a factor that should be considered when establishing an investment program. SUPPLEMENTARY LECTURE You may want to review the time value of money concept as part of your discussion of Chapter 10. Sometimes students forget that any investment program is based, to some extent, on this important concept. The material below will help reinforce the time value of money concept. The Problem The old saying goes: “I’ve been rich and I’ve been poor, but believe me, rich is better.” While being rich doesn’t guarantee happiness, the accumulation of money does provide financial security and is a goal worthy of pursuit. Regardless of how much money you want or what you want to use the money for, the time value of money concept can help you obtain your financial goals. The Solution The time value of money is a concept that recognizes that money can be invested and earn interest over a period of time. For example, assume you invest $10,000 in a GIC that pays 5 percent interest. If you let your interest accumulate, your initial $10,000 investment is worth $10,500 at the end of one year. At the end of five years, your investment is worth $12,760. At the end of ten years, your investment has increased to $16,290. In this example, you have received $6,290 in interest over a ten-year period as a result of letting your interest compound and grow. How You Can Become a Millionaire Today, there is an ever increasing number of millionaires, and you, too, can become one. Here’s a plan guaranteed to work. Let’s assume you are 25 years old and invest $4,000 each year in an investment that provides a 8 percent return each year for the next forty years. When you reach age 65, your investment will be worth $1,036,240. Over a forty-year period of time, you have invested a total of $160,000. The remainder ($876,240) is the result of letting your investment accumulate and compound for forty years. ANSWERS TO CONCEPT QUESTIONS, OPENING CASE QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, AND LIFE SITUATION CASE CONCEPT QUESTIONS Concept Check 10-1 (p. 298) 1. How can the Internet help you create a financial plan or establish an investment program? The Internet can help investors by providing information about specific investments and general information about financial planning. A Web site like Moneysense can also help investors develop a financial plan. 2. Why should an investor develop specific investment goals? The goal setting process is important because it forces investors to consider what they want to accomplish in the future. You may want to remind students that these goals are not set in concrete, but can be changed if necessary. (p. 294) 3. What factors should you consider when performing a financial checkup? A financial checkup allows investors to determine if they are ready to invest. The four factors to consider are: (1) work and learn to save to balance your budget; (2) obtain adequate insurance protection; (3) start an emergency fund; and (4) have access to other sources of cash for emergency needs. (p. 295) 4. How can an investor accumulate the money needed to fund an investment program? There were five suggestions presented in Chapter 10. To begin with, you must pay yourself first. Second, take advantage of employer-sponsored retirement programs. Third, you should participate in an elective savings program. Fourth, you can also make a special savings effort one or two months each year. Fifth, you should take advantage of gifts. (pp. 296) 5. Explain the time value of money concept and how it could affect your investment programs. The time value of money allows people to invest money over a period of time. At the end of the investment period, people receive not only what they have invested, but also the earnings (dividends and interest) the investment has earned. For most people, accumulation is built on the principle of investing small sums of money over a long period of time. Thus, the time value of money can really help people accumulate wealth. (pp. 296) Concept Check 10-2 (p. 304) 1. Why are safety and risk two sides of the same coin? You cannot evaluate any investment without assessing how the factor of safety relates to the factor of risk. Safety in an investment means minimal risk of loss. On the other hand, risk in an investment means a measure of uncertainty about the outcome. (p. 299) 2. What are the five components of the risk factor? The five components of the risk factor are: (1) inflation risk; (2) interest rate risk; (3) business failure risk; (4) market risk; and (5) global investment risk. (p. 300 3. How do income, growth, and liquidity affect the choice of an investment? Each of these factors can affect the choice of investments. Investors purchase certain investments because they want a predictable return or distribution of income from the investment. Growth means that their investment will increase in value. Liquidity is the ease with which an asset can be converted to cash without a substantial loss in dollar value. Usually, investors must give up some of one factor to get more of another factor. (p. 303) Concept Check 10-3 (p. 313) 1. Of all the investment alternatives presented in this chapter, which one do you think would help you obtain your investment goals? Why? While student answers may vary, most people should indicate that common stocks or mutual funds are a good choice because they offer growth potential. (pp. 305-307) 2. Why do investors purchase stocks? Most investors purchase stocks for either income or growth. (p. 305) 3. What are two chief advantages of investing in mutual funds? The two chief advantages of investing in mutual funds are (1) professional management and (2) diversification. (p. 306) 4. What factors should you consider before purchasing real estate for investment purposes? As a rule, real estate increases in value and eventually sells at a profit, but there are no guarantees. Success in real estate investments depends on how well you evaluate alternatives. (p. 307) 5. How can the investment pyramid presented in Exhibit 10-4 help you build an investment program to reach your financial goals? Many financial planners suggest that to avoid this mistake of putting all your eggs in one basket, you should think of your investment program as a pyramid consisting of four levels, as illustrated in Exhibit 10-4 on page 309. The investment pyramid stresses the importance of diversification. Diversification is the process of spreading your assets among several types of investments to reduce risk. (p. 310) 6. What are the steps required for a personal investment plan? When discussing this question, you may want to review the steps for effective financial planning in Exhibit 10-5 on page 311 and the financial plan presented in Exhibit 10-6 on page 312. Concept Check 10-4 (p. 318) 1. What type of training does a registered financial planner have? Advocis requires that all Registered Financial Planners achieve an academic or professional standing recognized by the Association. The Member must be sponsored by other planners in the industry, be currently engaged in the profession and have demonstrated competence in financial planning. A minimum of two years experience in the practice is required. (p.313) 2. What is your role in the investment process? Your role is to evaluate potential investments, monitor the value of your investments, and keep current records. (p. 314) 3. How do dividends, interest, and rental income differ from capital gains and losses? Dividends, interest, and rental income are periodic payments made to investors. With each of the above types of income, the investor still maintains ownership after the income is received. A capital gain (or capital loss) is the result of an investor selling an investment. (p. 315) Concept Check 10-5 (p. 322) 1. What do you think is the most readily available source of information for the average investor? Explain your answer. While answers may vary, most investors would consider the Internet or newspaper as the most available. (p. 319) 2. What type of information can you obtain using the Internet? There is a wealth of information that can be obtained by using the Internet. Specifically, you can obtain information on interest rates, current price information for stocks, bonds, and mutual funds, and broker’s recommendations. It is possible to do financial planning on the Internet. (p. 319) 3. Briefly describe the additional sources of information that can be used to evaluate a potential investment. Other sources of information described in this section include: business periodicals and government publications, corporate reports, statistical averages, investor services and newsletters, and desktop information services. Each of these sources can be useful depending on the particular investment under consideration. (p. 320) OPENING CASE QUESTIONS (p. 293) 1. How important is an investment program for financial planning? An investment program provides a framework that is especially important for beginning investors. In some ways, an investment program is like a road map—it tells people where they are and where they are going. Maybe, the most important part of the answer to this question is the fact that establishing an investment program encourages people to begin investing. 2. Jane and Brian Seward began their search for investment information by examining the Moneysense Web site. If you were seeking help to establish an investment program, where would you obtain the needed information? While answers will vary, the Moneysense Web site is an excellent place to gather the information to establish an investment program. You may want to encourage your students to visit the Web site if they have not done so. Of course, there are many excellent sources of information on financial planning and establishing a financial plan. Your students may also mention books, financial planners, and other sources of information. FINANCIAL PLANNING PROBLEMS (p. 324) 1. Beth-Ann and Martin Stewart have a total take-home pay of $3,200 a month. Their monthly expenses total $2,800. Calculate the amount the couple needs to establish an emergency fund. How did you calculate this amount? The minimum amount for an emergency fund for the Stewarts is $8,400, as illustrated below. (p. 292) $2,800 ´ 3 months (minimum) = $8,400 Emergency Fund 2. Assume that three years ago, you purchased a corporate bond that pays 9.5 percent. The purchase price was $1,000. Also, assume that three years after your bond investment, comparable bonds are paying 8 percent. a. What is the annual dollar amount of interest that you will receive from your bond investment? $1,000 ´ 9.5 percent = $95 annual dollar amount of interest b. Assuming that comparable bonds are paying 8 percent, what is the approximate dollar price for which you could sell your bond? $95 annual interest ÷ 8 percent = $1,187.50 approximate market value c. In your own words, explain why your bond increased or decreased in value. This bond increased in value because it has a fixed interest rate of 9.5 percent during a time period when interest rates in the economy were declining. 3. a. List three personal factors that might lead some investors to emphasize income rather than growth in their investment planning. b. List three personal factors that might lead some investors to emphasize growth rather than income in their investment planning. The age of the investor should be considered when answering this question. An older investor approaching retirement may be more interested in income. Younger investors may want to concentrate on growth because they will not reach retirement age until twenty to thirty years from now. Also, some individuals need income because of their particular life situations. For example, a widow with three children may need income for today as opposed to growth for the future. Finally, different individuals have different feelings about the income and growth factors of a possible investment. 4. Choose three of the investment alternatives presented in this chapter and then rank them from high to low on the factors of safety, risk, and liquidity. Assume that 3 is the highest score and 1 is the lowest score for each factor. Based on your rankings, which one of the three alternatives would you choose in your own investment program? Why? To help evaluate student responses to this question, you may want to refer to Exhibit 10-3 and Exhibit 10-4. These illustrations summarize all the different investment alternatives presented in this chapter. 5. Assume that you are single and have graduated from college. Your monthly take-home pay is $2,100, and your monthly expenses total $1,800, leaving you with a monthly surplus of $300. Develop a personal plan of action for investing like the one illustrated in Exhibit 10-6. The answer to this question will vary from one student to another. You may want to discuss the factors of safety, risk, income, growth, and liquidity as they relate to this exercise. 6. Based on the information presented below, construct a graph that illustrates price movement for a share of the First Canadian T-Bill Mutual Fund. Note: you may want to review the material presented in the Financial Planning Calculations boxed feature in this chapter. (p. 315) (Sample graph appears on below.) January February March April May June $18.70 18.00 20.30 21.35 19.50 17.80 July August September October November December $16.10 15.50 16.40 16.90 18.40 17.20 2 4 2 3 2 2 2 1 2 Jan Feb Mar Apr May Jun Jul Aug Sep Oct 7. Suppose that you have just inherited 500 shares of General Motors of Canada stock. List five sources of information that you could use to evaluate your inheritance. Beside each of these sources, briefly state how the information it contains could help you evaluate your inheritance. When answering this question, students may choose five of the following sources of information. a. The Internet and online computer services—data ranges from current price information for a share of stock to detailed financial information about the company. b. Newspaper and news programs—current price information and information about dividends, sales, etc. c. Business periodicals—information about the company and the product and or service it provides. d. Corporate report—information about the financial status of the company. e. Statistical averages—information about the market in general. f. Investor services and newsletters—specific detailed financial information about the company from an objective source. FINANCIAL PLANNING ACTIVITIES p. 324 1. Choose a current issue of MoneySense, Canadian Money Saver, or IE: Money and summarize an article that provides suggestions on how you could use your money more effectively. Student answers will vary, but you may want to use this question to reinforce the importance of effective money management. 2. Assume that you are 28 years old and that your take home pay totals $2,200 a month, you have monthly living expenses that total $1,200, your monthly car payment is $300, and your credit card debts total $4,900. Using the information presented in this chapter, develop a three-part plan to (1) reduce your monthly expenses, (2) establish an emergency fund, and (3) save $4,000 to establish an investment program. To reduce debt, this 28-year-old needs to reduce spending—especially the use of credit cards. The emergency fund for this individual should be at least $3,600 ($1,200 x 3 = $3,600). Once monthly expenses are reduced and an emergency fund is established, it is time to save the $4,000 to establish an investment program. (Caution: warn students that this person did not accumulate $4,900 in credit card debt overnight, and it will take some time to eliminate this debt.) 3. As pointed out in the beginning of this chapter, it doesn’t make a lot sense to establish an investment program until credit card and installment purchases are reduced or eliminated. While most people are responsible and make payments when they’re supposed to, some people do get in trouble. To help avoid this problem, each of the following organizations has a home page on the Internet. Credit Counselling Service of Sault Ste. Marie & District provides information on managing debt and credit, as well as a newsletter and other resources (www.soonet.ca). The National Foundation for Credit Counselling (NFCC) offers information about debt management, credit facts, and a budget calculator (www.nfcc.org). Equifax Canada is one of the two main credit bureaus in Canada (www.equifax.ca). Choose one of the above organizations and visit its home page. Then, prepare a report that summarizes the information provided by the organization. Finally, indicate if this information could help you manage your consumer debt. Although student answers will vary depending on which Internet site they visit, you may want to use this opportunity to discuss the issue of how consumers can get in trouble by using credit cards and installment debt. 4. From the investment alternatives described in this chapter, choose two specific investments that you feel would help an individual who is 35 years old, divorced, and earns $20,000 a year begin an investment program. Assume that this individual has $30,000 that can be invested at this time. As part of your recommendation, compare each of your investment suggestions on the factors of safety, risk, income, growth, and liquidity. Although the specific investment alternatives chosen by students may be different, the ideal investment would have some capacity for growth. This investor—an individual who is 35 and divorced—should develop a long-term investment program. The $30,000 should be seed money to obtain long-term goals in the future. 5. Choose one of the investment alternatives presented in this chapter (stocks, bonds, mutual funds, real estate, or speculative investments) and prepare a two-page report describing why this investment would be appropriate for a widow who is 68 years old that has just lost her husband. Assume the woman is debt-free and has just inherited $175,000. Student reports should contain some of the material on safety, risk, income, growth, and liquidity presented in the text. These factors are summarized in Exhibit 10-3. The fact that this woman is 68 years old and a widow should be taken into account. Investments should be chosen to provide income and some growth potential. Above all, they should be conservative investments. 6. Prepare a two-minute presentation that describes why the principle of diversification is important when establishing an investment program. Diversification is the process of spreading your assets among several types of investments to lessen risk. This topic is covered on page 311 in the text. While discussing this question, you may also want to review the material presented in Exhibit 10-4. 7. Many people call themselves financial planners. Describe the process you would use to choose one financial planner to help you develop an investment plan. While the process each student uses may differ, some common factors should be included. A number of questions should be answered as part of this process. Some of the questions should deal with the type of training and certification that the financial planner has. Also, there should be questions that deal with the experience that the financial planner has. The amount of fees and whether the fees are based on an hourly charge or on a commission basis should be determined. Finally, there should be some mention of the names and telephone numbers of previous customers. Previous customers can be contacted to see if they are satisfied with the services provided by the financial planner. 8. Choose four of the following sources of investment income. Then describe how each type is taxed by the federal government. a. b. c. d. e. Dividend income Interest income Rental income Capital gains Capital losses Dividends are taxed in a peculiar way that is designed to reflect that the corporation paying you a dividend has already paid taxes on its profits. The total of the amount of eligible dividends you receive is “grossed up” by 45 percent. You are then taxed at your marginal rate minus a dividend tax credit at the rate of 18.97 percent. Interest income and rental income is taxed as ordinary income. You are taxed on 50 percent of all capital gains you receive. Capital losses can only be used to offset capital gains. 9. Assume you have established an emergency fund and that you have saved an additional $12,000 that could fund an investment in common stock issued by Bell Canada. Using the sources of information discussed in this chapter, go to the library and obtain information about this company. Summarize your findings in a three-page report that describes Bell Canada’s current operations and the firm’s past and present financial performance. Finally, indicate if you would still purchase Bell Canada common stock based on the information contained in your report. While student reports will vary, they should contain the type of information contained in reports published by SEDAR or Value Line. Some students may have access to a current annual report or business periodicals. And, some information may be obtained by looking in the financial pages of the newspaper. It would also be possible to obtain financial information about Bell Canada by accessing the Internet. 10. One of the most useful financial planning websites is Canoe.ca. Visit the Canada.ca Money website (http://money.canoe.ca). Then, describe in a two-page report the type of information that is available and how it could help you become a better investor. Probably, the most useful feature of Canoe.ca Money is the ability to obtain current price information about investments. In addition, this site contains among others, the following major divisions: News, Federal Budget, Personal Finance, Small Business, Tax Centre, RRSP Centre, Rates and Company Profiles. LIFE SITUATION CASE First Budget, And then Invest for Success! (p. 326) 1. How would you rate the financial status of the Faulks before the air conditioner broke down? The Faulks could be in better financial shape. The fact that they had to use part of the money they were saving for a vacation to fix a broken compressor is evidence that their financial affairs could be better. In reality, this means that they have no emergency fund, no investment program, and no money to fund their daughter’s college education. Fortunately, they are in their thirties, and they realize that they have a problem. Realization of a financial problem may be the first step. 2. The Faulks have a $235 surplus at the end of each month. Based on their current financial condition, what do you think they should do with this money? The first step would be to establish an emergency fund. The amount in the fund should be at least $11,145 ($3,715 monthly expenses x 3 = $11,145). Once they’ve established their emergency fund, they can begin to save the money needed to pay off some of their debts and eventually fund an investment program. 3. The Faulks take-home pay is almost $4,000 a month. And yet, after all expenses are paid, there is only a $235 surplus each month. Based on the information presented in this case, what expenses, if any, seem out of line and could be reduced in order to increase the surplus at the end of each month? A first step in increasing the amount of surplus might be to concentrate on paying off the automobile loan. While variable expenses seem reasonable, they may be able to reduce the $600 allotted for recreation and entertainment. Also, they should work to reduce the amount of credit card debt and the resulting monthly credit card payments. 4. Given that both Jonathan and Meredith Faulk are in their mid-thirties and want to retire when they reach age 65, what type of investment goals would be most appropriate for this couple? Their window of opportunity is approximately 30 years. Therefore, they should begin an investment program that stresses long-term growth. Ideally, common stocks and mutual funds that invest in stocks that have the potential for long-term growth seem appropriate for this couple in their midthirties. 5. How does the time value of money concept affect the type of long-term goals and the investments that couples like the Faulks might use to build their financial nest egg? The time value of money is the foundation for a long-term investment program. If they will start saving a little money each month and then investing that money in quality stocks and mutual funds, their nest egg will grow over the next 30 years. Naturally, they must be disciplined and continue to invest money on a regular basis. And they must realize that their earnings on their investments must be reinvested to accumulate the amount of money they need for their retirement and their daughter’s college education. 6. Based on the different investments described in this chapter, what specific types of investments (stocks, mutual funds, real estate, etc.) would you recommend for the Faulks? Why? Once the emergency fund is established and the money is saved to fund an investment program, the Faulks should concentrate on long-term investments that include common stocks and mutual funds. If they are unsure of the risk associated with these investments, they could choose more conservative investments that include certificates of deposits or certain corporate or government bonds. Unfortunately, these more secure investments will not provide the type of return the Faulks need to obtain their long-term financial goals. Solution Manual for Personal Finance Jack Kapoor, Les Dlabay, Robert J. Hughes, Arshad Ahmad 9780071320597, 9781259453144
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