| Chapter 1: Understanding Personal Finance
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Chapter 1: Understanding Personal Finance

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annuity   A stream of payments to be received in the future.






business cycle/economic growth   Business cycles can be depicted as a wavelike pattern of rising and falling economic activity; the phases of the business cycle include expansion, peak, contraction (which may turn into recession), and trough.






compounding   When interest on an investment itself earns interest.

consumer price index (CPI)   A broad measure of changes in the prices of all goods and services purchased for consumption by urban households.






economic growth   A condition of increasing production (business spending) and consumption (consumer spending) in the economy and hence increasing national income.

emergency fund   Saving enough money to cover living expenses (perhaps 70 percent of gross income) for three to six months in case of financial emergency.

employee benefit   Compensation for employment that does not take the form of wages, salaries, commissions, or other cash payments.

expansion phase   Phase of the business cycle when economic activity is increasing, unemployment is falling, prices may rise, businesses are investing in capital equipment, and consumption is on the upswing.






federal funds rate   The rate that banks charge one another for overnight loans; set by the Federal Reserve Board.

Federal Reserve Board (Fed)   An agency of the federal government commonly referred to as the Fed, it regularly reports its decisions and opinions about the direction of monetary policy via setting the federal funds rate.

financial literacy   Knowledge of facts, concepts, principles, and technological tools that are fundamental to being smart about money.

financial planner   An investment professional who evaluates the personal finances of an individual or family and recommends strategies to set and achieve long-term financial goals.

financial responsibility   Means that you are accountable for your future financial well-being and that you strive to make wise personal financial decisions.

flexible benefit plan   An employer-sponsored plan that gives the employee a choice of selecting either cash or one or more qualifying nontaxable benefits; also known as a cafeteria plan.

flexible spending account (FSA)   An employer-sponsored account that allows employee-paid expenses for medical or dependent care to be paid with an employee's pretax dollars rather than after-tax income.

457 plans   Defined-contribution plan for state and local governments and non-church controlled tax-exempt organizations. Only employees (not employers) make contributions into the plan.

future value   The valuation of an asset projected to the end of a particular time period in the future.






gross domestic product   The nation's broadest measure of economic health, it reports how much economic activity (all goods and services) has occurred within the U.S. borders during a given period.






health care plan   An employee benefit designed to pay all or part of the employee's medical expenses.

health savings accounts (HSAs)   Tax-deductible savings accounts into which individuals or employers can deposit tax-sheltered funds to pay future medical bills.

high-deductible health care plan   A plan that requires individuals pay a higher deductible to cover medical expenses before insurance plan payments begin; chosen to save money on premiums.






index of leading economic indicators (LEI)   A composite index reported monthly by the Conference Board that collects relevant economic data for business, governments, and individuals' use.

inflation   A steady and sustained rise in general price levels across economic sectors; measured by the changing cost over time of a "market basket" of goods and services that a typical household might purchase.

interest   The price of borrowing money.

investments   Assets purchased with the goal of providing additional income from the asset itself.






marginal cost   The additional (marginal) cost of one more incremental unit of some item.

marginal tax rate   The tax rate at which your last dollar earned is taxed.

marginal utility   The extra satisfaction derived from gaining one more incremental unit of a product or service.






nominal income   Also called money income, it is income that has not been adjusted for inflation and decreasing purchasing power.






opportunity cost   The opportunity cost of any decision is the value of the next best alternative that must be forgone.






peak   Point in the business cycle when economic activity is at its highest.

personal finance   The study of personal and family resources considered important in achieving financial success; it involves how people spend, save, protect, and invest their financial resources.

personal inflation rate   Inflation's effect on a particular person's purchasing power. For example, inflation pushes up the cost of borrowing, so monthly car payments and home mortgage rates increase when the personal inflation rate rises.

present value   The current value of an asset (or stream of assets) that will be received in the future; also known as discounted value.

pretax dollars   Money income that has not been taxed by the government.

principal   The original amount invested; or total amount owed on a credit account not including interest.

purchasing power   Measure of the goods and services that one's income will buy.






real income   Income measured in constant prices relative to some base time period. It reflects the actual buying power of the money you have as measured in constant dollars.

recession   A recurring period of decline in total output, income, employment and trade, usually lasting from six months to a year and marked by widespread contractions in many sectors of the economy.

rule of 72   A formula for figuring the number of years it takes to double the principal using compound interest; simply divide the interest rate that the money will earn into the number 72.






savings   Income not spent on current consumption.

spending   Amount of cash flow used in consuming goods and services now.

standard of living   Material well-being and peace of mind that individuals or groups earnestly desire and seek to attain, to maintain if attained, to preserve if threatened, and to regain if lost.






tax-exempt income   Income that is totally and permanently free of taxes.

tax-sheltered income   Income exempt from income taxes in the current year but that will be subject to taxation in a later tax year.

tax-sheltered retirement accounts   Retirement account for which all earnings from the invested funds are not subject to income taxes.

tax-sheltered retirement plan   Employer-sponsored, defined-contribution retirement plans including 401(k) plans and similar 403(b) and 457 plans.

time value of money (TVM)   A method by which one can compare cash flows across time, either as what a future cash flow is worth today (present value) or what an investment made today will be worth in the future (future value).

trade-off   Giving up one thing for another.

trough   The point in the business cycle when economic activity is at its lowest point.






utility   A highly personalized concept that expresses how much satisfaction each person will obtain from any particular decision.







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