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WebChapter 1: FinancialDecisionMaking
W1.1 InvestmentReturns
1)Thethingyoumustgiveupinthefuturetoconsumesomethingtodayisknownasthe ofconsuming
now.
A)opportunitycost
B)variablecost
C)averagecost
D)sunkcost
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:InvestmentReturns
2)Thegrowthprocessthatcausesinvestmentstoappreciateinvalueovermanyyearsisreferredtoas .
A)sniping
B)hedging
C)revaluating
D)compounding
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:HowMoneyGrows
3)Aninvestor’sprincipalis .
A)thevalueofherinitialinvestment
B)thefinalbalanceshehasinheraccountafteraperiodoftime
C)theamountsheearnsonherinvestment
D)thetaxshepaysonherinterestincome
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:HowMoneyGrows
4)Johnhad$2,000inhisaccountatthebeginningof2009.Attheendoftheyear,theaccounthad$2,002.Therate ofreturnontheaccountis .
A)0.02% B)0.1% C)2%
D)10%
Answer:B
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
5)IfMaryhad$500inherbankaccountatthebeginningof2010,shewouldhaveafinalbalanceof aftera yeariftherateofreturnis5%.
A)$505
B)$525
C)$550
D)$555
Answer:B
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
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6)Philipinvested$800foraperiodofoneyearatarateofinterestof6%,thereturnonhisinvestmentis .
A)$48
B)$80
C)$60
D)$88
Answer:A
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
7)Ronhad$100inhisbankaccountin2008.Hewillhaveafinalbalanceof after3yearsiftherateofreturn is1%.
A)$101.01
B)$103.03
C)$130
D)$300
Answer:B
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
8)Thetimedelaybetweentheinitialinvestmentandthefinalwithdrawalisreferredtoasthe .
A)effectivenesslag
B)problemoftimeinconsistency
C)holdingperiod
D)implementationlag
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:HowMoneyGrows
9)Whichofthefollowingistruewheninterestcompounds?
A)Interestisearnedonlyoninterest.
B)Interestisearnedonlyontheprincipal.
C)Theentireinterestincomeisnotreturnedtotheinvestor.
D)Interestisearnedbothontheinterestandtheprincipal.
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:HowMoneyGrows
10)Mr.Brownhaddepositedasumofmoneyinabankataninterestof5%.Ifhegotback$4,725after1year,what washisprincipal?
A)$945
B)$1,000
C)$4,500
D)$4,700
Answer:C
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
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11)Markinvestedanamountof$1,500foraperiodof2yearsatarateofinterestof5%.Inordertohaveafinal balanceof$1,653.75,Markshould .
A)consumetheinterestearnedattheendofeachyear
B)reinvesttheinterestearnedattheendofthefirstyear
C)withdrawhisprincipalattheendofthefirstyear
D)invest$100attheendofthefirstyear
Answer:B
Difficulty:Medium
AACSB:Analytical Thinking
Topic:HowMoneyGrows
12)Whichofthefollowingreducesthebuyingpowerofthefinalbalanceinaninvestorʹsaccount?
A)Ariseintheaggregatepricelevel
B)Ariseindomesticinterestrates
C)Anappreciationofthedomesticcurrency
D)Adecreaseinmoneysupply
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:HowMoneyGrows
13)Whichofthefollowingislikelytobetrueiftheinflationrateispositiveinaneconomy?
A)Thepurchasingpowerofthereturnsfrominvestmentsarelikelytodecline. B)Thepurchasingpowerofthereturnsfrominvestmentsarelikelytoincrease. C)Thenominalinterestratesarelikelytodecline.
D)Therealmoneysupplyislikelytoincrease.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:HowMoneyGrows
14)Therealrateofreturnonaninvestmentisobtainedby .
A)subtractingthelong-runinflationratefromthenominalrateofreturn
B)addingthelong-runinflationratetothenominalrateofreturn
C)multiplyingthelong-runinflationratewiththenominalrateofreturn
D)dividingthenominalrateofreturnbythelong-runinflationrate
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:HowMoneyGrows
15)Ifthenominalrateofreturnis6.5%andthelong-runinflationrateis3%,therealrateofreturn onan investmentis .
A)2.16% B)3.5% C)9.5% D)19.5%
Answer:B
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
Full file at
16)Iftherealrateofreturnonaninvestmentis4%andthelong-runinflationrateis4%,thenominalrateofreturn is .
A) 0% B) 1% C) 8% D)16%
Answer:C
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
17)Ifthenominalrateofreturnonaninvestmentis7.5%andtherealrateofreturnis5.2%,thelong-runaverage inflationrateis .
A)1.44% B)2.3% C)12.7% D)21.5%
Answer:B
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
Mr. Xinvested$5,000foraperiodof2years.Theinvestmentplanofferedanominalrateofreturnof6%ontheinvestment.
18)Refertothescenarioabove.Mr.Xwillhaveafinalbalanceof attheendoftwoyears.
A)$5,300
B)$5,618
C)$10,600
D)$18,024
Answer:B
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
19)Refertothescenarioabove.Ifthelong-runinflationrateintheeconomyis3.4%,therealrateofreturnonhis investmentwillbe .
A)1.77% B)2.6% C)9.4% D)20.4%
Answer:B
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
20)Refertothescenarioabove.Ifthelong-runaverageinflationrateis3%,therealvalueofhisinvestmentin todayʹsdollarsis .
A)$5,304.50
B)$5,618.00
C)$10,430.50
D)$15,612.00
Answer:A
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
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21)Bonds,stocks,andotherfinancialclaimsthatcanbetradedamonginvestorsarecalled .
A)unitsofaccount
B)principal
C)equity
D)securities
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
22)Whichofthefollowingisthesafestsecurity?
A)Ashort-termloantothegovernment
B)Along-termloantothegovernment
C)Along-termloantoasmallcorporation
D)Ashort-termloantoaprivatetrader
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
23) arelong-termloansmadetoaborrowerbyalender.
A)Bonds
B)Patents
C)Trademarks
D)Coupons
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
24)Ifthemarketinterestraterises, .
A)thevalueofapreviouslyissuedbondfalls
B)thevalueofapreviouslyissuedbondincreases
C)themarketpriceforbondsincreases
D)thedemandforbondsdecreases
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
25)Ifthemarketinterestraterises, .
A)thepresentvalueoffuturepaymentsincreases
B)thesupplyofbondsdecreases
C)themarketpriceforbondsdecreases
D)thedemandforbondsdecreases
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
Full file at
26)Whichofthefollowingwillhappenifmarketinterestratesriseatpresent?
A)Thequantitydemandedofpreviouslyissuedbondswilldecrease.
B)Thesupplyofbondswillincrease.
C)Themarketpricesofbondswillincrease.
D)Thepresentvalueoffuturepaymentswillincrease.
Answer:A
Difficulty:Hard
AACSB:Analytical Thinking
Topic:Securities
27)Ifthemarketinterestratefalls, .
A)thevalueofapreviouslyissuedbondfalls
B)thevalueofapreviouslyissuedbondincreases
C)themarketpriceforbondsdecreases
D)thedemandforbondsincreases
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
28)Ifthemarketinterestratefalls, .
A)thepresentvalueoffuturepaymentsdecreases
B)thesupplyofbondsdecreases
C)themarketpriceforcurrentbondsincrease
D)thedemandforbondsincreases
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
29)Whichofthefollowingistrueofbonds?
A)Bondsareshorttermloans.
B)Bondsareriskierthanmoneymarketaccounts.
C)Bondspaylowerreturnsthantreasurybills. D)Bondshaveafixedvalue.
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
30)Identifythecorrectstatementaboutbonds.
A)Bondsareshorttermloans.
B)Bondshaveafixedvalue.
C)Bondsarelessriskythanmoneymarketaccounts.
D)Bondspayhigherreturnscomparedtotreasurybills.
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
Full file at
31) areownershiprightsinacorporation.
A)Bonds
B)Shares
C)Treasurybills
D)Mutualfunds
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
32)Whichofthefollowingistrueofsharesofstock?
A)Sharesofstockareriskierthanbonds. B)Sharevaluescanbenegative.
C)Sharepricescannotbezero.
D)Bondsareriskierthansharesofstocks.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
33)Shareholders:
A)havelimitedliability.
B)haveunlimitedcontroloveracompanyʹsassets.
C)arecontractuallyobligatedtopaypremiumstocorporations.
D)areentitledtoafixedpaymentattheendofapre-determinedperiod. Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
34)Identifythecorrectstatement.
A)Acompanyiscontractuallyrequiredtopayinteresttobondholdersbeforepayingtheshareholders. B)Acompanyiscontractuallyrequiredtopayafixedamounttoshareholdersafteracertainperiod.
C)Acompanyreliesentirelyonitsshareholderstopayoffitsdebtsincaseofafinancialcrisis.
D)Acompanystopspayingitsbondholdersbutcontinuespayingitsshareholdersincaseofacrisis.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
35)Whichofthefollowingstatementsistrue?
A)Sharesofstockpayahigherreturnthanbonds.
B)Treasurybillspayahigherreturnthanshares. C)Bondspayahigherreturnthanshares.
D)Treasurybillspayahigherreturnthanbonds.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
Full file at
36)Whichofthefollowingisadifferencebetweenashareandabond?
A)Ashareofstockisashorttermloanwhileabondisalongtermloan.
B)Ashareofstockpaysalowreturnwhileabondpaysahighreturn.
C)Thereturnonashareofstockvarieswhilethereturnonabondisfixed.
D)Ashareofstockusuallyhasamaturitydatewhileabonddoesnothaveamaturitydate.
Answer:C
Difficulty:Medium
AACSB:Analytical Thinking
Topic:Securities
37)Whatisastockmarketindex?
Answer:Astockmarketindexisaweightedaverageofmanystockprices.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
38)Whatisthedifferencebetweenatreasurybillandabondissuedbythegovernment?
Answer:AtreasurybillisashorttimeloantotheU.S.government.Theseloansarepracticallyrisk-free,sothey don’tofferveryhighratesofreturn.Inotherwords,investorsdonotneedtobepaidahighrateof interesttobeinducedtomakeashort-termloantothegovernment. Overthelast76years,Treasury billshavepaidanannualreturnofonly3.81%peryear.
Abondissuedbythegovernmentisalong-termloantothegovernmentbythepersonbuyingthebond. Bondshaveavaluethatthedebtoriscontractuallyobligatedtopaythebond-holderattheendofa
pre-determinedperiod.Thedebtorisalsocontractuallyobligatedtomakeperiodicinterestpaymentsto thebond-holder.Bondscanlosevalueifthegovernmentorcompanythatissuesthebondlosesthe abilitytofullymeetitsobligations,orifthemarketinterestraterises.Ariseinthemarketinterestrate lowersthepresentvalueofthefuturecouponpayments,loweringthecurrentmarketpriceofthebond. Long-termloansaremoreriskythanshort-termloansandbondinvestorsarerewardedforbearingthis riskwitharateofreturnthatexceedstherateofreturnonone-yearloans. Overthelast57years,
10-yearbondsissuedbytheU.S.governmenthavepaidanaverageannualreturnof6.3%peryear.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
39)Differentiatebetweenashareandabondonthebasisofthereturnsfromeach.
Answer:Bondsarelong-termloansmadetoaborrower(debtor)byalender(creditor)whilesharesofstocksare ownershiprightsinacorporation.Bondshaveavaluethatthedebtoriscontractuallyobligatedtopay thebond-holderattheendofapre-determinedperiod. Thedebtorisalsocontractuallyobligatedto makeperiodicinterestpayments(couponpayments)tothebond-holder. However,corporations issuing sharesofstocksarenotcontractuallyobligatedtomakesuchpayments.Acompanypays dividendstoitsshareholdersifitcanaffordtodosoaftermakinginterestpaymentstobond-holders. Therefore,sharesofstocksareriskierthanbondsandshareholdersarerewardedforbearingallofthis riskwitharateofreturnthatismuchgreaterthantherateofreturnonbonds.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Securities
Full file at
40)Georgeinvestedacertainamountofmoneyatarateofinterestof3%forayear. i)Ifhereceived$5,150attheendofoneyear,howmuchdidheinvest?
ii)Ifheinveststhesameamountofmoneyatanannualrateofinterestof5%for3years,howmuchwillheget backattheendof3years?
iii)Howmuchwillheearnbyinvestingthesameamountofmoneyfor3yearsatarateofinterestof5%per annum,ifhewithdrawstheinterestearnedattheendofeachyear?
Answer:i)Iftherateofinterestis3%andtheamountreceivedattheendofoneyearis $5,150,theamountthat
Georgehadinvestedis$5,150/(1+0.03)=$5,000.
ii)IfGeorgeinvests$5,000atanannualrateofinterestof5%for3years,hewillgetback$5,000 ×
(1+0.05)3=$5,788.13.
iii)IfGeorgewithdrawstheinterestearnedattheendofeachyear,hewillearnaconstantamountatthe endofeachyear whichisequalto$5,000×0.05=$250.Therefore,hewillearnatotalamountof$250×3
=$750attheendof3years.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
41)Kathyinvests$650inanaccountthatearnsaconstantrateof6.2%over30years. i)WhatistheamountthatKathyreceivesonmaturity?
ii)Whatisthebalanceintheaccountafter5years?
iii)Whatistherealvalueof$650compoundedover30years,iftherateofinflationis4percentandthenominal rateofreturnis6.2percent?
Answer:i)Thefinalbalanceintheaccountcanbeexpressedintheformofthefollowingequation:Z×(1+r)T, whereZistheprincipalamount,r istherateofreturn,andTisthetimeintervalbetweentheinitial investmentandthefinalwithdrawal.Bysubstitutingthevaluesintheequation,weget;650×(1+
0.062)30=650×(1.062)30=$3,950.47.Therefore,onmaturity,Kathywillreceiveanamountof$3950.47.
ii)Inordertocalculatethebalanceintheaccountafter5yearsofinvestment,wecanusethesame equation:Z×(1+r)T.Bysubstitutingthevaluesintheequationweget;650×(1.062)5=$878.Therefore, after5years,Kathywillhaveanamountof$878inheraccount.
iii)Inordertofindouttherealvalueof$650,thevalueadjustedtoinflation,compoundedover30years, wehavetoreplacethenominalrateofreturn,r,withtherealrateofreturn,r-π,intheoriginal compoundinterest.Inthiscase,therealrateofreturn=r—π=6.2%-4%=2.2%.Therefore,thereal valueof$650,compoundedover30years=Z×[1+(r-π)]30=650×(1.022)30=$1,248.60.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
42)Hesterdecidestoinvest$500inHolden-EvanCorporationforaperiodof5years.Assumethatshereceivesa returnof8%,inthefirstyearofinvestment,areturnof5%inthesecondandthirdyearofinvestment,anda returnof-4% inthefourthandfifthyearsofinvestment.Whatisthetotalamountofmoneyshewillhaveafter
5years?
Answer:TheinitialinvestmentthatHestermakesisthatof$500.Shereceivesareturnof+8%inthefirstyearof investment,+5%inthesecondandthirdyearofinvestment,andareturnof-4%inthelasttwoyearsof investment.Therefore,theamountofmoneythatHesterwillreceiveafter5years=500×(1+0.08)× (1+0.05)×(1+0.05)×(1-0.04)×(1-0.04)=$548.67.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:HowMoneyGrows
Full file at
43)Jeff,John,andMartininvestedtheirsavingsindifferenttypesofassets.Jeff’sinvestmentpayshimareturnof
10%peryearandgrantshimownershiprightsinanorganization.However,hereceivesnomoneyifthe
organizationgoesthroughafinancialcrisis.John’sinvestmentpayshimareturnof5%peryear.Hereceives theperiodicinterestpaymentsonhisinvestmenteveniftheorganizationisgoingthroughfinancialhardships. Martin’sinvestmentpayshimariskfreereturnof3%peryear.WhichtypeofassetsareJeff,John,andMartin likelytohaveinvestedin?
Answer:Jeffislikelytohaveinvestedinsharesofacorporation,sincesharesofstocksareownershiprightsina corporation.Shareholderssufferwhenacompanyearnslessincomeorwhenitfacesanearnings shortfall.Therefore,shareholdersarerewardedwithacomparativelyhigherreturn,inthiscase10%,for bearingalltherisk.
Johnislikelytohaveinvestedinbondsofferedbyacompany.Bondshaveavaluethatthedebtoris contractuallyobligatedtopaythebond-holderattheendofapre-determinedperiod.Bondholdersalso receiveperiodicinterestpaymentsfromthedebtor,irrespectiveofthefinancialhealthofthecompany. Bondsarelong-termloansandarecomparativelyriskierthanshort-termloans.Therefore,interestrates onbondsarehigherthantheratesofferedonone-yearloans.Inthiscase,Johnreceivesareturnof5% peryear.
Martinislikelytohaveinvestedinatreasurybill.Treasurybillsareshort-termloanstoagovernmentor acorporation.Theseloansarerisk-free,hencetheydon’tofferhighrateofreturns.Inthiscase,Martin receivesareturnof3%peryear,muchlowerthanthereturnsearnedbyJeff,10%,andJohn,5%.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:Securities
W1.2 Risky Returns
1)WhatismeantbythetermʺNthpercentileʺ?
Answer:TheNthpercentileisacutoffthatdividesthedatasothatN%ofthedataisbelowthecutoffand
(100-N)%ofthedataisabovethecutoff.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Risky Returns
2)Whatistheriskassociatedwithinvestinginindividualstocks?
Answer:Thestockmarketasawholeisriskybuttheriskassociatedwithindividualstocksismuchhigher.Ifan investorinvestsinthesharesofoneparticularcompanyandthatcompanygoesbankruptsuddenly, theinvestorwillloseallhismoneyatthesametime.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Risky Returns
3)MarkandJeffhadinvestedsomemoneyin G&MCorps.However,whenthecompanywasgoingthrougha financialcrisis,Markcontinuedto receivetheperiodicreturnfromhisinvestmentwhileJeffdidnotreceive anymoney.Whichtypesofassetsaretheylikelytohaveinvestedin?
Answer:MarkislikelytohaveinvestedinbondsandJeffislikelytohaveinvestedinsharessinceacompanyis contractuallyrequiredtopayinteresttoitsbond-holdersbeforethecompanypaysanythingouttoits shareholders.Afterbondholdersgettheirinterestpayments,thecompanycanmakepaymentsto shareholdersifthecompanycanaffordtodoso.Inthissense,shareholdersaretheoneswhoprimarily sufferwhenacompanyearnslessincome.Ifthecompanyfacesanearningsshortfall,paymentsto shareholderswillcompletelydryupbeforeanybondholdershavetotakeahit.Inaddition,whena companygoesbankrupt,thebondholdersarepaidofffirstwhentheassetsofthebankruptcompanyare soldoff. Whateverisleftafterthispaymenttobondholdersisthenpaidouttoshareholders.
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:Risky Returns
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W1.3 Diversification
1)AfinancialadvisoraskedTomtoinvestinthestocksofseveraldifferentcompaniesinsteadofinvestinginone.
Thisisanexampleof .
A)amortization B)diversification C)speculation
D)depreciation
Answer:B
Difficulty:Medium
AACSB:Analytical Thinking
Topic:Diversification
Youareplanningtoinvest$5,000inthesharesofacompany.Youhavelearnedthatthecompanyisnegotiatingwitha prospectiveclientforanewproject.Ifthecompanygetstheproject,thesharepriceswillincreaseandthevalueofyour investmentwillincreaseto$5,500.However,ifarivalcompanygetstheproject,sharepricesofthecompanywillfalland youwillget$4,800.Thecompanyhasa30%chanceofgettingthenewproject.
2)Refertothescenarioabove.Yourexpectedfinalbalanceshouldbe .
A)$700
B)$5,000
C)$5,010
D)$10,300
Answer:C
Difficulty:Hard
AACSB:ApplicationofKnowledge
Topic:Diversification
3)Refertothescenarioabove.Theexpectedaveragereturnonyourinvestmentis .
A)0.002% B)0.2%
C)9% D)10%
Answer:B
Difficulty:Hard
AACSB:ApplicationofKnowledge
Topic:Diversification
4)Yourexpectedfinalbalancefromaninvestmentof$500is$640,theaveragereturnonyourinvestmentis .
A)1.28%
B)1.40% C)16% D)28%
Answer:D
Difficulty:Hard
AACSB:ApplicationofKnowledge
Topic:Diversification
Full file at
5)Listthreewaysinwhichaninvestorcandiversifyhisassets.
Answer:Diversificationworksinmanyways. Investorscandiversifybyholdingsharesinmanycompanies insteadofholdingsharesinjustonecompany. Investorscanalsodiversifybyholdingdifferentkindsof assets. Forexample,aportfolioofstocksandbondsismorediversifiedthanaportfoliothatonlyhas stocks. Inaddition,investorscandiversifytheirinvestmentsbyholdingassetsinmanydifferent countries.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Diversification
6)Tworivalcompanieshavesubmittedtheirblueprintsforanewprojecttoapotentialclient.Itisexpectedthat thereisa50%chancethatthesharepriceofthewinningcompanywillincreasefrom$25to$60anda50% chancethatthesharepriceofthelosingcompanywillfallfrom$25to$0.Howshouldaninvestorwith$100 investhismoneytogetanassuredreturnof20%?
Answer:Sincethesharepricesofbothcompaniesareinitiallyequalto$25,theinvestorcanpurchase$100/$25 =4 shares.Ifhebuys4sharesofCompanyA,hisexpectedfinalbalanceis0.5×$240+0.5×$0=$120. Similarly,ifhebuys4sharesofCompanyB,hisexpectedfinalbalanceis0.5×$240+0.5×0=$120.In boththecases,ahighlevelofriskisinvolvedsincetheinvestormightendupwithnothingifthe companyhechoosesdoesnotgettheorderfromtheclient.However,thereisonewayinwhichthe investorcangetanassuredreturnof20%.Hecanbuy2sharesofeachcompany.Inthiscase,
irrespectiveofwhichcompanygetstheorderfromtheclienttheinvestorʹsexpectedfinalbalanceis
always0.5×$120+0.5×$120=$120.
Difficulty:Hard
AACSB:ApplicationofKnowledge
Topic:Diversification
7)AquaInc.istryingdevelopinganewproduct.Thereisa60%chanceoftheproductbeingintroducedinthe marketthisyear.Itisexpectedthatthecompanyʹssharepricewillincreasefrom$70to$100bytheendofthe year iftheproductissuccessfullyintroducedinthemarket.However,ifitisnotintroduced,itspricewillfall by50%.
i)Whatisyourexpectedfinalbalanceattheendoftheyearifyouowntwosharesofthecompany?
ii)Calculatetheaveragerateofreturnfromyourinvestment.
Answer:i)Thereisa60%chanceoftheproductbeingintroducedinthemarketanda40%chanceoftheproduct notbeingintroducedinthemarket.Therefore,thereisa60%percentchanceofthesharepriceincreasing to$100anda40%chanceofthesharepricefallingto$35.Sinceyouown2sharesofthecompany,your expectedfinalbalanceattheendoftheyearshouldbe0.6x$200+0.4×$70=$120+$28=$148.
ii)Theaveragerateofreturnontheinvestmentis$148/($70×2) -1=0.057or,5.7%.
Difficulty:Hard
AACSB:ApplicationofKnowledge
Topic:Diversification
W1.4 InvestmentAccounts
1)Whichofthefollowingisadisadvantageofbankaccounts?
A)Bankaccountsareveryrisky.
B)Bankaccountspayverylowratesofinterest.
C)Bankaccountsdonotfacilitateeasytransactions.
D)Bankaccountsareusefulonlyforlargedeposits.
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Bank Accounts
Full file at
2)Ifyouhave$200,500depositedinonebankand$178,000inanotherbank,whichofthefollowingislikelytobe true?
A)Onlythefirstdepositispartiallyinsured. B)Onlytheseconddepositisfullyinsured. C)Bothdepositsarefullyinsured.
D)Noneofthedepositsareinsured.
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Bank Accounts
3)Neilhas$340,000depositedinonebankand$152,500inanotherbank,whichofthefollowingis true?
A)Onlythefirstdepositisinsured.
B)Onlytheseconddepositisfullyinsured. C)Bothdepositsarefullyinsured.
D)Noneofthedepositsarefullyinsured.
Answer:B
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:Bank Accounts
4)Johnhas$400,000depositedinonebankand$300,500inanotherbank,whichofthefollowingis true?
A)Onlythefirstdepositisfullyinsured.
B)Onlytheseconddepositisfullyinsured.
C)Bothdepositsarefullyinsured.
D)Noneofthedepositsarefullyinsured.
Answer:D
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:Bank Accounts
5)Mr.Wiliamsandhissonjointlyownanaccount.Alldepositsupto inthisaccountwillbefullyinsured bytheFederalDepositInsuranceCorporation.
A)$250,000
B)$500,000
C)$750,000
D)$8,00,000
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Bank Accounts
6)Whichofthefollowingistrueofbrokerageaccounts?
A)Brokerageaccountsareopenedforbuyingriskyassets.
B)Itisunlikelytolosemoneyinvestedinbrokerageaccounts. C)Brokerageaccountsareofferedbycommercialbanks.
D)MoneyinvestedinbrokerageaccountsisinsuredbytheFDIC.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Brokerage Accounts
Full file at
7)Whichofthefollowingislikelytoofferabrokerageaccount?
A)FederalReserve
B)FederalDepositInsuranceCorporation
C)FidelityInvestments
D)CommonwealthBank
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Brokerage Accounts
8)Mutualfundschargeanannualfee,whichisusuallyreferredtoasthe .
A)expenseratio
B)reserveratio
C)couponpayment
D)dividend
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Mutual Funds
9)Atypicalannualexpenseratiois ofthevalueoftheassetsinthemutualfund.
A)1%
B)5% C)10% D)20%
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Mutual Funds
10)Theexpenseratioofamutualfundisusuallyreportedonthe .
A)mutualfundʹsprospectus
B)investorʹspassbook
C)annualstatementofthemutualfund
D)quarterlystatementsofthemutualfund
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Mutual Funds
11)Thefeethatamutualfundchargesisusuallyproportionaltothe .
A)numberofinvestorswhoinvestinthefund
B)currentpricesoftheassetsthattheinvestorhas
C)incomesoftheinvestorswhoinvestinthefund
D)amountofassetsthattheinvestorhasinthemutualfund
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Mutual Funds
Full file at
12)Whichofthefollowingisadifferencebetweenanindexfundandmutualfund?
A)Anindexfundisactivelymanagedwhileamutualfundispassivelymanaged.
B)Anindexfundispassivelymanagedwhileamutualfundisactivelymanaged. C)Anindexfundchargesahighfeewhileamutualfundchargesalowfee.
D)Anindexfundonlyinvestsinbondswhileamutualfundonlyinvestsinstocks.
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Mutual Funds
13)Whichofthefollowingistrue?
A)Anindexfundisactivelymanagedwhileamutualfundispassivelymanaged. B)Anindexfundchargesalowfeewhileamutualfundchargesahighfee.
C)Anindexfundchargesahighannualfeewhileamutualfundchargesalowannualfee. D)Anindexfundonlyinvestsinbondswhileamutualfundonlyinvestsinstocks.
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Mutual Funds
14)Afinancialcontractthatprovidesastreamofbenefitsthatlastaslongasthebeneficiariesarestillaliveiscalled a(n) .
A)bond
B)compoundreturn
C)share
D)annuity
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
15)WhichofthefollowingistrueofSocialSecuritybenefits?
A)SocialSecurityisamandatoryretirementsavingsprogram.
B)SocialSecuritybenefitsenjoyedbyallworkersareequal.
C)OnlytheemployeespaytaxfortheSocialSecuritybenefitsenjoyedbythem.
D)Onlytheemployerspaytaxfor theSocialSecuritybenefitsenjoyedbyemployees.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
16)WhichofthefollowingtaxesislinkedtotheSocialSecuritysystem?
A)Payrolltax
B)Salestax
C)Exciseduty
D)Incometax
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
Full file at
17)SocialSecuritybenefits:
A) enjoyedbyallworkersareequal.
B) enjoyedbyaworkerareannuities. C)arenotindexedtopricechanges.
D)arehighforhigh-incomeworkers. Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
18) paytaxesfortheSocialSecuritybenefitsenjoyedbyworkers.
A)Onlytheemployees
B)Onlytheemployers
C)Boththeemployersandtheemployees
D)Neithertheemployernortheemployees
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
19)SocialSecuritybenefitstoatwo-earnerhousehold:
A)fallafterthedeathofthefirstmemberofthehousehold
B)stopafterthedeathofthefirstmemberofthehousehold
C)arenotindexedtopricechanges
D)increasewhenthepricelevelfalls
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
20)IdentifythecorrectstatementaboutSocialSecuritybenefits.
A)SocialSecuritybenefitsareavailabletobeneficiariesaslongastheyarealive. B)SocialSecuritybenefitsareavailabletobeneficiariesaslongastheywork.
C)SocialSecuritybenefitsincreasewhenthepricelevelfalls.
D)SocialSecuritybenefitsincreasewhenamemberofahouseholddies.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
21)WhichofthefollowingstatementsaboutSocialSecuritybenefitsistrue?
A)SocialSecuritybenefitsareindexedtoinflation.
B)SocialSecuritybenefitsincreasewhenthepricelevelfalls. C)SocialSecuritybenefitsincreasewhenaworkerretires.
D)SocialSecuritybenefitsincreasewhenamemberofahouseholddies.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
Full file at
22)WhichofthefollowingchangesisthefederalgovernmentlikelytointroduceinSocialSecuritypayments?
A)Lowerthenormalretirementage
B)Delaythenormalretirementage
C)Reducethepayrolltax
D)Increasethebenefitstohigh-incomebeneficiaries
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
23)WhichofthefollowingchangescanthefederalgovernmentintroduceintheSocialSecuritysystemtoprevent runningoutofmoneyintheyearstocome?
A)Increasethepayrolltax
B)Lowersalestax
C)Lowertheinterestrate
D)Increasepaymentstolow-incomebeneficiaries
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
24)Definedbenefitpensionsare .
A)indexedtopricechanges
B)contractuallyspecifiedretirementbenefits
C)amandatoryretirementsavingsprogram
D)availabletoworkersinallsectorsoftheeconomy
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
25)Whichofthefollowingistrue?
A)Definedbenefitpensionsarenotindexedtopricechanges.
B)Definedbenefitpensionsarenotavailabletolow-incomeworkers.
C)Definedbenefitpensionsareamandatoryretirementsavingsprogram
D)Definedbenefitpensionsareavailabletoworkersinallsectorsoftheeconomy
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
26)Whichofthefollowingistrueofdefinedbenefitpensions?
A)Definedbenefitpensionsareindexedtopricechanges.
B)Definedbenefitpensionsareonlyavailabletolow-incomeworkers.
C)Definedbenefitpensionsareamandatoryretirementsavingsprogram
D)Definedbenefitpensionsareavailabletomostpublicsectorworkers.
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
Full file at
27)Whichofthefollowingistrueofdefinedbenefitpensions?
A)Definedbenefitpensionsarenotindexedtopricechanges.
B)Definedbenefitpensionsareonlyavailabletolow-incomeworkers.
C)Definedbenefitpensionsaredependentonthenumberofyearsofaworkerʹsservice.
D)Definedbenefitpensionsareavailabletoworkersinallsectorsoftheeconomy.
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
28)Whichofthefollowingistrueofdefinedbenefitpensions?
A)Definedbenefitpensionsareavailableonlytopart-timeworkers.
B)Definedbenefitpensionsareonlyavailabletolow-incomeworkers.
C)Definedbenefitpensionsareamandatoryretirementsavingsprogram.
D)Definedbenefitpensionsaredependentonthefinalsalaryaworkerreceives.
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
29)AnnieandEdwardaretwocolleaguesinJITCorporation.Anniewillenjoyhigherdefinedbenefitpensionsif: A)AnnieisolderthanEdward.
B)AnniehasalargerfamilyincomparisontoEdward.
C)AnnieearnsalowersalarythanEdwardatthetimeofretirement.
D)Anniehasworkedinthecompanyforalongertimeperiod.
Answer:D
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
30)MaryandJosepharetwocolleaguesin M&SAssociates.Josephwillenjoyhigherdefinedbenefitpensionsif: A)JosephisolderthanMary.
B)JosephhasalargerfamilythanMary.
C)JosephearnsahighersalarythanMaryatthetimeofretirement.
D)JosephhasworkedinthecompanyforashorterdurationcomparedtoMary.
Answer:C
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
31)Billretiredafterworkingfor20yearswithAquaInc.Hislastdrawnsalarywas$125,000peryear.Howmuchis helikelytogetannuallyasdefinedbenefitpension?
A)$25,000
B)$50,000
C)$75,000
D)$100,000
Answer:B
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
Full file at
32)Adam,John,Jack,andJeanretiredfromOceaniaPvt.Ltd.afterworkingfor5,7,10,and12yearsrespectively.
Iftheyallearnedthesamesalaryatthetimeofretirement,whowillenjoythehighestdefinedbenefitpension afterretirement?
A)Adam
B)John
C)Jack
D)Jean
Answer:D
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
33)Fourcolleaguesretiredafterworkinginthesamecompanyfor10years.However,thedefinedbenefitpensions thateachofthemreceivedwasdifferent.Thisimpliesthat .
A)theirfamilysizesweredifferent
B)theirconsumptionpatternsweredifferent
C)thefinalsalaryearnedbyeachofthemwasdifferent
D)thetotalamountoftaxespaidbyeachofthemwasdifferent
Answer:C
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
34)Whichofthefollowingisadifferencebetweendefinedbenefitspensionsanddefinedcontributionpensions?
A)Definedbenefitpensionsareavailabletomostpublicsectorworkerswhiledefinedcontributionpensions
arecommonamongprivatesectorworkers.
B)Definedbenefitpensionsarepaidbytheemployerwhiletheemployeecontrolsthedefinedcontribution
pensions.
C)Definedbenefitpensionsareindexedtoinflationwhiledefinedcontributionpensionsarenotindexedto
inflation.
D)Definedbenefitpensionisavoluntaryretirementsavingsprogramwhiledefinedcontributionpensionis
amandatoryretirementsavingsprogram.
Answer:B
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
35)WhichofthefollowingisadifferencebetweenSocialSecurityanddefinedcontributionpensions?
A)SocialSecurityisamandatorypensionplananddefinedcontributionpensionisavoluntarypension plan.
B)SocialSecurityisonlyavailabletoprivatesectoremployeesanddefinedcontributionpensionisonly availabletopublicsectoremployees.
C)SocialSecurityismanagedsolelybytheemployeranddefinedcontributionpensionismanagedsolelyby theemployees.
D)SocialSecurityismanagedsolelybytheemployeesanddefinedcontributionpensionismanagedsolely bytheemployers.
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
Full file at
36)Whichofthefollowingisanadvantageofthedefinedcontributionpensionplan?
A)Itisindexedtopricechanges.
B)Itisamandatoryretirementsavingsplan. C)Itisaportableretirementsavingsaccount.
D)Allthecontributionsintheseaccountsaremadeonlybytheemployer.
Answer:C
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
37)Whichofthefollowingretirementplansinvolveindividualaccountsthatareownedandcontrolledbythe employee?
A)Definedcontributionpensions
B)Definedbenefitpensions
C)SocialSecuritypayments
D)Variableannuitypensions
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
38)Whichofthefollowingpensionsplansarealsoknownas401(k)accounts?
A)Definedcontributionpensions
B)Definedbenefitpensions
C)SocialSecurity
D)Individualretirementsaccounts
Answer:A
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
39)Whichofthefollowingisasimilaritybetweendefinedcontributionpensionsandindividualretirement accounts?
A)Botharemandatoryretirementsavingsaccounts.
B)Boththeaccountsaremanagedbytheemployerdirectly.
C)Boththeaccountsareavailableonlytopublicsectoremployees.
D)Boththeaccountsallowtheirownerstomakeassetallocationdecisions.
Answer:D
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
40)Listthemainaccountsthatbanksoffer.Whyarebankaccounts consideredtobesafeintheUnitedStates?
Answer:Checkingaccounts,savingsaccounts,moneymarketdepositaccounts,andcertificates
ofdeposit—usuallyreferredtoasCDs—arethemainaccountsthatbanksoffer.Bankaccountsare
consideredtobesafebecausetheseaccountsarecoveredbytheFederalDepositInsuranceCorporation, agovernmentagencythatinsuresupto$250,000perindividualaccount.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Bank Accounts
Full file at
41)Differentiatebetweenanactivelymanagedmutualfundandapassivelymanagedmutualfund.
Answer:Somemutualfundstrytobuyandsellassetsinatimelywaysothatthemutualfundoutperformsa particularbenchmarkindex. Thesemutualfundsaresaidtobeactivelymanaged.Ontheotherhand, somemutualfundsarepassivelymanaged,whichmeansthatthemutualfundmanagersimplytriesto trackthereturnofanindex,liketheStandardPoor’s500stockindex. Suchpassivelymanagedmutual fundsarereferredtoasindexfunds.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Mutual Funds
42)Whyaredefinedbenefitpensionsconsideredtoberelativelysafefinancialclaims?
Answer:Definedbenefitpensionsareconsideredtoberelativelysafefinancialclaimsbecausetheemployerhasto fundanauditedaccount—referredtoasthepensionplan—thatwillbeabletofullypayoutthese futurepensionobligations. Iftheaccountrunsshortoftheneededmoney,thecompanyislegally required torelativelyquicklytopuptheplan. Evenifthecompanygoesbankrupt,almostalldefined benefitpensionclaimsarepaidout,sincethesepensionplansareinsuredbythePensionBenefit GuaranteeCorporation(PBGC),agovernmentagency. ThePBGCguaranteesalldefinedbenefit
pensionsuptoanannualpayoutof$54,000perbeneficiary.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
43)Rebeccaisplanningtoquithercurrentjob.Howcanshemanagethemoneyinthedefinedcontributionplanof hercurrentemployer?
Answer:Sincetheemployeeisthesoleownerofadefinedcontributionaccount,shecandecidewhattodowith hermoneywhensheseparatesfromthefirmbyquitting,gettingfired,orretiring. Shecaneitherleave themoneyinthedefinedcontributionplanofherex-employerorshecantakethemoneywithher. In thelattercase,shecaneitherrollthemoneyintothedefinedcontributionplanathernextemployer,or shecanrollthemoneyintoanIndividualRetirementAccount,whichiscommonlyreferredtoasanIRA.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
44)Whataretargetdatemutualfunds?
Answer:Targetdatemutualfundsarediversifiedmutualfundsthatstartoutwithaveryhighallocationto equitiesforyoungemployees—nearly100%equities--whichslowlytransitionstoamuchlower equityconcentrationforagingemployees—about40%ofequitiesatretirement.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
45)WhatareindividualretirementaccountsorIRAs?
Answer:IRA’sarethefinalpillaroftheU.S.retirementsavingssystem. IRAsareretirementsavingsaccountsthat anyonecansetup;theyarenotsponsoredbyaperson’semployer. Ifanindividualdoesnotcontribute
toheremployer’sdefinedcontributionsavingsplan,thenshecanuseanIRAtosaveforretirement. In theU.S.,abouthalfoftheprivatesectoremployeesworkforafirmthatdoesnotofferanyretirement savingsplan. Fortheseworkers,IRAsaretheprimaryvehicleforvoluntaryretirementsavings. IRA contributionsalsooccurwhenpeoplerolloverbalancesfromadefinedcontributionaccount.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Retirement SavingsPlans
Full file at
46)Whatisreturnchasing?
Answer:Ifpeopleinvestinassetsthathaverealizedahighrateofreturninthepast,economistscallthisreturn chasing.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Evidence-Based Economics:Doinvestorschasehistoricalreturns?
47)WhatwasthemainfindingofShlomoBenartziʹsresearchonreturnchasing?
Answer:Employeesthatworkinfirmswhosestockhasdonerelativelywelloverthepastdecade,allocate40%of their401(k)contributionstoemployerstock. Employeesthatworkinfirmswhosestockhasdone relativelybadlyduringthepastdecade,allocateonly10%oftheir401(k)contributionstoemployerstock.
Difficulty:Easy
AACSB:Analytical Thinking
Topic:Evidence-Based Economics:Doinvestorschasehistoricalreturns?
48)Therearetwohouseholds—householdAandhouseholdB.HouseholdAhastwoearningmemberswithan incomeof$65,000peryearandHouseholdBhastwoearningmemberswithanincomeof$98,000peryear. i)Dotheearningmembersinboththehouseholdsneedtopaypayrolltaxes?Whyorwhynot?
ii)WhichhouseholdwillhaveahigherSocialSecurityincomereplacementratioafterretirement?
iii)SupposeoneoftheretiredmembersofhouseholdAdies2yearsafterretirement.Howwillitaffectthe
SocialSecurityincomeofthehousehold?
Answer:i)TheearningmembersinboththehouseholdsneedtopaypayrolltaxesbecauseSocialSecurityisa mandatoryretirementsavingsprogram.
ii)HouseholdAwillhaveahigherSocialSecurityreplacementratiothanhouseholdB.
iii)TheSocialSecurityincomeofthehouseholdwillfallafterthedeathofoneretiredmember.After
retirement,ahouseholdreceivesSocialSecuritybenefitsuntilbothmembersofthehouseholdhavedied. Inotherwords,thesebenefitsareanannuity:afinancialcontractthatprovidesastreamofbenefitsthat lastaslongasthebeneficiariesarestillalive.Hence,annuitiesprotectyou(andyourpartner)againstthe riskofoutlivingyoursavings.Theonlycatchisthatthebenefitsfallafterthefirstmemberofthe householddies. Thegovernmentreasonsthatyouwon’tneedasmuchmoneyafteroneofthetwo partnersisdeceased.Whenthesurvivingmemberofthehouseholdalsodies,allpaymentscease.
Difficulty:Easy
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
Full file at
49)Considerthefollowinghypotheticalexampleofthreehouseholds.HouseholdAhasanannualincomeof
$23,000,householdBhasanannualincomeof$165,000,andhouseholdChasanannualincomeof$35,000.
Assumethatallthethreehouseholdshavetwoearningmembers.
a.WhatistheamountpaidbyhouseholdAandhouseholdCaspayrolltaxtothegovernment?
b. WhichofthefollowinghouseholdshasthehighestSocialSecurityreplacementratioandwhatis theamount receivedbythehouseholdunderSocialSecurityprogram?Whatistheamountreceivedbythehouseholdthat hasthelowestSocialSecurityreplacementratio?
Answer:a.Thegovernmentreceives6.2%asemployee’scontributionand6.2%asemployer’scontribution,whichis atotalof12.4%ofanemployee’scappedincomeasSocialSecuritypayrolltax.Inthiscase,householdA is liabletopay$2,480,andhouseholdCisliabletopay$4,340aspayrolltaxtothegovernmentaspayroll taxes.
b.HouseholdAhasthehighestSocialSecurityreplacementratioof84%.Thehouseholdwillreceive84% oftheirincome,underSocialSecurity,afterboththeearningmembersofthehouseholdretire.Inother words,thehouseholdwillreceiveanamountof$19,320peryear.Thehouseholdthathasthelowest SocialSecurityreplacementratioisHouseholdB.Itfallsunderthereplacementratioof34%,henceitwill receiveanamountof$56,100peryear.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
50)GeorgeworkedinA2ZLtd.for15yearsandhisfinalsalaryatthetimeofretirementwas$125,000.Whatwill behisannualretirementincomefromdefinedbenefitpensions?
Answer:Definedbenefitpensionsarecontractuallyspecifiedemploymentbenefits,inwhichtheemployer promisestopaytheemployeeafixedannuityafterretirement. Thisannuityisusuallynotindexedto inflation. Themagnitudeoftheannuityisadjustedtoreflectyearsofserviceattheemployerandthe leveloftheemployee’ssalary. Forexample,acommonbenefitformulaisfortheretiringworkerto receiveanannualretirementincomeequalto:2%×(YearsofService)×(FinalSalary)=$37,500.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
51)Whatistheamountthatanemployeriscontractuallyobligatedtopay,undertheDefinedBenefitPensions
Plan,toanemployeewhoretiresafter20yearsofserviceandasalaryof$65,000?
Answer:Underthedefinedbenefitpensionsplan,theemployeriscontractuallyobligatedtopayanamountequal to(2%)×(YearsofService)×(FinalSalary).Inthiscase,theemployeewillreceiveanamountof$26,000 aspensionbenefitperyear.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans
52)Supposeyoumakeaninvestmentof$2,000inasavingsaccountthatoffersyouareturnof5percentper annum.Howmuchmoneywouldyouhaveinyouraccount,after35years,ifyouraccountchargesanannual overlookingfeeof2.5percent?
Answer:Aninitialinvestmentof$2,000thatearnsanannualreturnof5percent,willcompoundto:$2,000 ×(1+
0.05-0.025)35=$4,746.41,in35yearswithayearlyoverlookingfeesof2.5percent.
Difficulty:Medium
AACSB:ApplicationofKnowledge
Topic:Retirement SavingsPlans