Garman/Forgue

Personal Finance
Twelfth Edition

Chapter 1:
Understanding
Personal Finance

PPT slide program prepared by

Raymond Forgue.

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Figure 1-1: Building Blocks to
Achieving Financial Success

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 The Economy and Financial
Success
• Economy: System of managing the
productive and employment resources of a
country, state, or community.

• Economic Growth: A condition of increasing

production (business spending) and
consumption (consumer spending) in the
economy.
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Where Are We in the Business Cycle?
• The economy grows and contracts over
time:
– Expansion - when the economy is increasing
– Peak – the end of expansion and the beginning
of contraction
– Contraction – when the economy is falling
– Downturn
– Trough
– Recovery – the end of a contraction and
beginning of an expansion
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 Business Cycles Phases

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 What is the Future Direction of the
Economy?
• The unemployment rate is the share of the
labor force that is jobless, expressed as a
percentage. When the economy is in poor
shape and jobs are scarce, the unemployment
rate can be expected to rise. When the
economy is growing at a healthy rate and jobs
are relatively plentiful, it can be expected to
fall.

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 What is the Future Direction of the
Economy?
• Gross Domestic Product (GDP) is the total
monetary or market value of all the finished
goods and services produced within a
country's borders in a specific time period. As
a broad measure of overall domestic
production, it functions as a comprehensive
scorecard of the country’s economic health.

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 GDP
Rank Country/Territory
(US$million)

World[20] 84,740,322

1 United States 20,494,050

— European Union[n 1] 18,750,052
2 China[n 2] 13,407,398
3 Japan 4,971,929
4 Germany 4,000,386
5 United Kingdom 2,828,644
6 France 2,775,252
7 India 2,716,746
8 Italy 2,072,201
9 Brazil 1,868,184
10 Canada 1,711,387
11 Russia[n 3] 1,630,659
12 Korea, South 1,619,424
13 Spain 1,425,865
14 Australia 1,418,275
15 Mexico 1,223,359
16 Indonesia 1,022,454
17 Netherlands 912,899
18 Saudi Arabia 782,4838
19 Turkey 766,428

20 Switzerland 703,750

— Taiwan 589,391

21 Poland 586,015

22 Sweden 551,135

23 Belgium 533,153

24 Argentina 518,092

25 Thailand 487,239

26 Austria 457,637

27 Iran 452,275

28 Norway 434,937

29 United Arab Emirates 424,635

30 Nigeria 397,270

31 Ireland 372,695

32 Israel 369,843

33 South Africa 368,135

— Hong Kong 363,031

34 Singapore 361,109

35 Malaysia 354,348

36 Denmark 350,874

37 Colombia 333,114

38 Philippines 330,846
9
 What is the Future Direction of the
Economy?
• The Index of Leading Economic Indicators
is a composite index that suggests the future
direction of the economy.
• Consumer Confidence Index gauges how
consumers feel about the economy and their
personal finances. It gives a sense of consumers’
willingness to spend. Growing confidence suggest
increased consumer spending. Consumers worried
about the future postpone purchases, and the
reduced spending acts as a drag on the economy.
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 What Is the Future Direction of
Inflation?
• 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.

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• How does inflation affect income and consumption?
Consider the case of Pedro Cruz, a single man who took
a job in a mall three years ago at a salary of P50,000 per year.
Since that time, Pedro has received annual raises of P1,000,
P1,200, and P1,500, but he still cannot make ends meet
because of inflation. Although Pedro received raises, his current
income of P53,700 (P50,000 + P1,000 + P1,200 + P1,500) did
not keep pace with the annual inflation rate of 3% (P50,000 x
1.03 = P51,500; P51,500 x 1.03 = P53,045; P53,045 x 1.03 =
P54,636). If Pedro’s own cost of living rose at the same rate as
the general price level, in the third year he would be P936
(54,636 – P53,700) short of keeping up with inflation. He would
need P936 more in the third year to maintain the same
purchasing power that he enjoyed in the first year.

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Seatwork:
Juan salary is P360,000 a year. He received
annual raises of P12,000, P18,000, and P24,000.
Annual inflation rate was 10%. How much would Juan
need in the third year to maintain the same purchasing
power that he enjoyed in the first year?
1. What is Juan’s current annual income?
2. What should be Juan’s annual income considering
the annual inflation rate?
3. How much does he need more in the third year to
maintain the same purchasing power that he
enjoyed in the first year?
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 Inflation
• How inflation is measured:
– Consumer Price Index (or CPI) is a broad
measure of changes in the prices of all
goods and services purchased for
consumption by urban households.

• Inflation reduces real incomes. Real income

reflects the actual buying power of the money
you have as measured in constant pesos.

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• Nominal income , also called money income,
is income that has not bee adjusted for
inflation and decreasing purchasing power.
• Personal incomes rarely keep up in times of
high inflation. Your real income is the more
important number. It reflects the actual
buying power of the nominal income that you
have to spend as measured in current pesos.
Rising nominal income during times of
inflation creates the illusion that you are
making more money, when in actuality that
may not be true.
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• To compare your annual wage increase with
the rate of inflation for the same time period,
you first convert your pesos raise into a
percentage as follows:

Percentage = Nominal annual income after raise – nominal annual income last year X 100
change nominal annual income last year

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 For example, imagine that Manny Lazaga received a P16,000
raise to push his P370,000 annual salary to P386,000. Using the
equation in the previous slide, Manny calculated his percentage
change in personal income as follows:

(P386,000 – P370,000)
= 0.043 x 100 = 4.3%
P370,000
After a year during which inflation was 4.0%, Lazaga did better
than the inflation rate because his raise amounted to 4.3%.
Measured in real terms, his raise was 0.3% (4.3 – 4.0). In pesos,
Lazaga’s real income after the raise can be calculated by dividing
his new nominal income by 1.0 plus the previous year’s inflation
rate (expressed as a decimal)
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Real income after raise = Nominal annual income after raise / 1 + previous
year’s inflation rate

P386,000 = P371,154
1 + 0.040

Clearly, a large part of the P16,000 raise Javier

received was eaten up by inflation. To Javier, only
P1,154 (P371,154 – P370,000) represents real
economic progress, while P14,846 (P16,000 –
P1,154) was used to pay the inflated prices on goods
and services.

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Seatwork
Alfredo Moreno, the school director of St. Cecilia’s College,
received a P30,000 raise to push his P600,000 annual salary to
P630,000. After a year of his salary increase, inflation was 4%.
Questions:
1. What was Alfredo’s percentage change in personal
income?
2. Measured in real terms, how much was his raise in
percentage?
3. What was his real income after the raise?
4. How much of his raise represents real economic progress?
5. How much was used to pay the inflated prices on goods
and services?

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Answers:
1. Percentage = Nominal annual income after raise – nominal annual income last year X 100
change nominal annual income last year
= P630,000 – P600,000
P600,000
= 0.05 X 100 = 5.0%
2. % raise in income measured in real terms = % increase – inflation rate = 5% - 4% = 1%

3. Real income after raise = nominal annual income after raise / 1 + previous year’s
inflation rate
= P630,000 = 605,769
1.04

4. Real economic progress = Real annual income after raise – nominal annual
income before raise
= P605, 769 – P600,000 = P5,769
5. Amount used to pay the inflated prices of goods and services = P30,000 – P5,769
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= P24,231
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service or on a password-protected website for classroom use.
Today is Monday, August 5, 2019
Quote for the day:
“God has a purpose behind every
problem.”

“God uses problems to draw you

closer to Himself.”
- Rick Warren
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Seatwork
Georgine Olmilla, a financial analyst of San Miguel
Packaging, received a P36,000 raise to push his P360,000
annual salary to P396,000. After a year of his salary increase,
inflation was 6%.
Questions:
1. What was Georgine’s percentage change in personal
income?
2. Measured in real terms, how much was her raise in
percentage?
3. What was her real income after the raise?
4. How much of her raise represents real economic
progress?
5. How much was used to pay the inflated prices on goods
and services?
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Answers:
1. Percentage = Nominal annual income after raise – nominal annual income last year X 100
change nominal annual income last year
= P396,000 – P360,000 = 0.10 X 100 = 10.0%
P360,000

2. % raise in income measured in real terms = % increase – inflation rate = 10% - 6% = 4%

3. Real income after raise = nominal annual income after raise / 1 + previous year’s
inflation rate
= P396,000 = 373,585
1.06

4. Real economic progress = Real annual income after raise – nominal annual
income before raise
= P373,585 – P360,000 = P13,585
5. Amount used to pay the inflated prices of goods and services = P36,000 – P13,585
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= P22,415
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Today is Wednesday, August 7, 2019

“No one can make you

feel inferior without
your permission” – Ken
Blanchard
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 Think Like an Economist

• Opportunity Cost: Cost of decision

measured by the value of the next
best alternative that must be foregone.
• Trade-off: Giving up one thing for
another.

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• Utility is the ability of a good or service to
satisfy a human want.
• Marginal Utility is the extra satisfaction
derived from gaining one more incremental
unit of a product or service.
• Marginal cost is the additional (marginal)
cost of one more incremental unit of some
item.
People are inclined to seek additional
utility as long as the marginal utility
exceeds the marginal cost.
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 Time Value of Money

• Time value of money addresses two

questions about money.

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 Time Value of Money

• What will an investment (or a series of

investments) be worth after a period of
time?

• This question asks for a future value.

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Simple interest

The calculation of interest involves

(1) the peso amount, called the principal,
which is the original amount invested
(2) the rate of interest earned on the
principal, and
(3) the amount of time the principal is
invested

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One way of calculating interest is called
simple interest and is illustrated by the simple
interest formula
i = prt where
p = the principal set aside
r = the rate of interest
t = the time in ears that the funds are left
on deposit
If someone save or invested P1,000 at 8% for
four years, he would received P320 in interest
(P1,000 X 0.08 X 4) over the four years.
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Compounding is the Basis of All Time Value
of Money Considerations
But something is missing in the simple
interest calculation. The simple interest
assumes that the interest is withdrawn each
year and only the P1,000 stays on deposit for
the entire four years, and thus interest is not
added to the principal. Most people do not
invest this way. Instead, they leave the interest
earned in the account so that it will earn
additional interest.
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 This earning of interest on interest is
referred to as compound interest. This
addition of interest to the principal is called
compounding.
The way to make build wealth is to make
money on your money, not simply to put
money away. Compounding over time is what
really builds wealth.

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Here is how the amount invested (or principal)
would grow using compounding:
At the end of year 1, the P1,000 would have
grown to P1,080 [P1,000 + (P1,000 X 0.08)]
At the end of year 2, the P1,080 would have
grown to P1,166.40 [(P1,080 + (P1,080 X 0.08)]
At the end of year 3, the P1,166.40 would have
grown to P1,1259.71 [P1,166.40 + (P1,166.40 X
0.08)]
AT the end of year 4, the 1,1259.71 would have
grown to P1,360.49 [P1,259.71 + (1,259.71 X 0.08)]

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 Due to the effects of compounding, this
investor would have earned an additional
P_____.

Seatwork
How much additional interest would you earn if you
deposit P5,000 for five years if you will not withdraw
any interest earned during the five years duration?
Interest rate for your deposit is 5%.

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Calculating Future Values
Future value (FV) is the valuation of an asset
projected to the end of a particular time period in the
future. You can calculate the future value of a lump
sum or the future value of a series of deposits.
Future Value of a Lump Sum
FV = (Present Value of sum of money) (1.0 + i)n
where i represents the interest rate and n represents
the number of time periods.

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 Applying this formula to our earlier
example of investing P1,000 at 8% for four
years, we obtain
P1,360.49 = (P1,000)(1 + 0.08) 4
or
P1,360.49 = (P1,000)(1.08)(1.08)(1.08)(1.08)
or use the table for Future Value of P1 After a
Given Number of Periods
P1,000 x 1.3605 = P1,360.50

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 Time Value of Money

• How much has to be put away today

(or as a series of investments) to
provide some dollar amount in the
future?

• This question asks for a present

value.

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 Compounding

• Compound Interest: Occurs when

interest on an investment is left on
deposit so you can earn interest on
interest.
• Compound interest (compounding) is
the key to building wealth.

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Calculating Future Values

• Future Value (FV) of a Lump-Sum:

Valuation of an asset projected to the
end of a particular time period in the
future.

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Table 1-1: Future Value of $1 After
a Given Number of Periods

Periods 2% 4% 8% 10%
1 1.0200 1.0400 1.0800 1.1000
2 1.0404 1.0816 1.1664 1.2100
3 1.0612 1.1249 1.2597 1.3310
4 1.0824 1.1699 1.3605 1.4641
5 1.1041 1.2167 1.4693 1.6105
10 1.2190 1.4802 2.1589 2.5937
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Figure 1-5: The Importance of
Higher Yields and More Time

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 The Rule of 72

• Rule of 72: Reveals number of years it

takes for the principle to double.
• $1000 invested at 8% would double to
$2000 in 9 years (72/9)
• $2000 to $4000 in 9 more years
• $4000 to $8000 in 9 years
without ever having to invest another $1
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 Rule of 72 Illustrated

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Calculating Future Values

• Future Value (FV) of an Annuity:

Valuation of a series of deposits
projected to the end of a particular
time period in the future.

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Future Value of $2000 Annual
Investments

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 Calculating Present Values

• Present Value of a Lump Sum: What is

the equivalent value today of a dollar
amount to be received in the future?
• Present Value of an Annuity: What is
the equivalent value today of a series of
payments to be received in the future?

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