PERSONAL FINANCE (GBB/GCB 3133) – SEMESTER JANUARY 2015ASSIGNMENT 2SUBMISSION DEADLINE: MONDAY, 13 MAY 2015 AT 5.00 PM

1. There are six (6) methods used to calculate interest. Identify and describe these

methods, giving appropriate examples.

[24 marks]

The various methods used to calculate interest include the following:

1. Simple Interest- computed on principal only, no compounding.

2. Simple Interest on the declining balance - a method used when more than one payment is made on a simple interest loan.

3. Add-on Interest- interest is calculated on the full amount of the original principal.

4. Adjusted balance method- finance charges after payments made during the billing period have been subtracted.

5. Previous balance method- gives no credit for payments made during the billing period.

6. Average daily balance method- uses a weighted average of the account balance throughout the current billing period.

2. Each investor may have specific goals for investing but all investors must consider a

number of factors affecting the choice of investments. Identify any four (4) of these

factors and discuss how they affect your investment decisions.

[16 marks]

Factors to consider in choosing investment alternative:-

1. Safety - safety in investment means minimal risk of loss. Very safe investment

which is attractive to conservative investors give low return. Examples of safe

investment are government bonds, certificate of deposit, mutual funds and

corporate bonds. Real estate may also be considered as a safe investment.

2. Risk - risk in investment means a measure of uncertainty about the outcome.

High-risk investment is made with the expectation of earning higher return in a

short time. Such investment is known as speculative investment which gives higher

return but if they fail, the losses will be greater if not all.

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Examples of high- risk investment are speculative stock, commodities, options,

precious metals, precious stones and certain stocks and bonds.

3. Income - this investment factor focused on a predictable source of income where it

is known as to how much exactly will be paid on a specific date. The concern on

investment income is on issuer’s ability to continue making periodic

interest/dividend payments. Where income is the primary objective to invest

then the focus will be on corporate bonds, preferred stocks, utility stocks or

selected common stock issues.

4. Growth - growth means investment will increase in value. Companies having

better than average earning potential, increasing in revenues, rapid expansion and

innovative management are associated with growth. Investors sacrifice immediate

cash dividend in return for greater dollar value in the future. Growth companies

reinvest profit they earned rather than declare them as dividend with the view of

financing future growth and manage the cost of borrowing money. This resulted in

faster rate of growth as the reinvested profit will normally increase the dollar value

of the share of stock for the investors. Examples of growth investments are

technology, energy, and health care.

5. Liquidity – liquidity in investment is the ability to buy or sell an investment quickly

without substantially affecting the investment’s value. Investments range from

near-cash investment such as checking/saving accounts to frozen-like investment

where getting cash is difficult such as investment into antiques, precious metals

and collectibles. Some investments impose penalties for disposal before maturity

date while other investments depend very much on market conditions and

economic conditions for the investment to have a good return or even equal to the

original investment.

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3. A friend wants to understand what affects the cost of auto insurance. Explain the factors

used to determine the automobile insurance premium a person pays.

[5 marks]

The main factors that influence the amount paid for auto insurance are the year, make,

and model of automobile; your geographic location; your driver classification, including

age, sex, marital status, driving record and driving habits; the amount of coverage; and

discounts for driver training, security devices, or other factors.

4. Explain the difference between direct and indirect investments in real estate. Give

examples of each.

[5 marks]

Real estate investments are classified as direct or indirect. Direct real estate

investments, in which the investor holds legal title to the property, include a home, a

vacation home, commercial property, and raw land. Indirect real estate investments

include real estate syndicates, REITs, mortgages, and participation certificates. In

indirect investment a trustee holds legal title to the property.

5. Bonds is generally considered a relatively safe investment. How is it possible to lose

money on bonds. Explain.

[5 marks]

An investor can actually lose money by selling the bond before its maturity date at a time

when the prevailing interest rate is above the coupon rate of the bond. In addition a

bondholder suffers if the company that issued the bond goes out of business and there

are insufficient assets to pay the bondholders.

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6. Kenny Tan recently purchased a stereo system. After a few weeks it overheated,

causing a small fire and minor damage. What action would you recommend to Kenny to

resolve his consumer complaint?

[8 marks]

The steps that are commonly suggested to solve consumer problems are (1) return to

the place of purchase, (2) contact the company's main office, (3) obtain assistance from

a consumer agency, and (4) take legal action such as small claims court or using a

lawyer.

7. Easy Money Financing approved your personal loan of RM5,000 to purchase a note

book computer. The interest rate is 5% per year. The loan is to be paid in 12 equal

installments. Using the rule 78s, prepare the payment schedule for each installment that

represents the interest and the reduction of debts.

[10 marks]

Total loan sum : RM 5,000

Interest rate : 5% per year

No. of loan installment : 12

Total interest charged : RM 5,000 x 5% x 12 = RM 250

12

Total payable (principal + interest) = RM 5,000 + RM 250 = RM 5,250

Monthly installment : RM 5,250/12 = RM 437.50

Interest payment formula: Total Interest x Parts of the Total Interest

The Sum of the Digits

Sum of the Digits for 12 nos. installment = 12 + 11 + 10 + 9 + 8 + 7 + 6 + 5 + 4+ 3 +

2 + 1= 78

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Payment No.

Interest Principal Total Payment

1 2 3 4 5 6 7 8 9 10 11 12

38.4635.2632.0528.8525.6422.4419.2316.0312.82 9.62 6.40 3.20

399.04402.24405.45408.65411.86415.06418.27421.47424.68427.88431.10434.30

437.50437.50437.50437.50437.50437.50437.50437.50437.50437.50437.50437.50

250.00 5,000.00 5,250.00

8. Your parents are considering the purchase of shares in a mutual fund. Discuss three (3)

advantages and three (3) disadvantages of mutual fund investing that you believe are

important for potential investors to consider.

[12 marks]

ADVANTAGES OF MUTUAL FUND INVESTING

Diversification

Professional management

Ease of buying and selling shares

Multiple withdrawal options

Distribution or reinvestment of income and capital gain distribution

Switching privileges within the same fund family

Services that include toll-free telephone numbers, complete records of all

transactions, and savings and checking accounts.

DISADVANTAGES OF MUTUAL FUND INVESTING

Purchase/withdrawal costs

Ongoing management fees

Poor performance that may not match the stock index

Inability to control when capital gain distribution occur and complicated tax-

reporting issues

Potential market risk associated with all investments

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Some sales personnel may be aggressive and/or unethical

9. If Carissa Dalton has a $130,000 home insured for $100,000, based on the 80 percent

coinsurance provision, how much would the insurance company pay on a $5,000 claim?

[5 marks]

$104,000 = $130,000 x 0.80$4,807.96 = ($100,000/$104,000 ¿ $5,000)

10. Gene, an assembly line worker at an automobile manufacturing plant, has a take home

pay of $900 a week. He is injured in an accident that kept him off work for 18 weeks. His

disability insurance coverage replaces 65 percent of his earnings after a 6 weeks waiting

period. What amount would he receive in disability benefits?

[5 marks]

Insurance will replace 65 percent of $900 or $900 x 0.65 = $585 per week. However

insurance will only pay after a 6-week waiting period or 18 – 6 = 12 weeks. Insurance will

pay $585 x 12 weeks = $7,020.

11. Your credit card has an Annual Percentage Rate (APR) of 18 percent and there is a 2

percent fee for cash advances. The bank starts charging your interest on cash advances

immediately. You get a cash advance of $600 on the first day of the month. You get your

credit card bill at the end of the month. What is the total finance charge you will pay on

this cash advance for the month?

[5 marks]

Total finance charge = (2% x $600) + [(18% x $600)/12] = $ 12 + $ 9 = $ 21

- END OF ASSIGNMENT 2 -

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