Common Sense Economics
Common Sense Economics
Part IV. Twelve Key Elements of Practical Personal Finance
1. Financial insecurity in America is primarily the result of
a. the low incomes of Americans.
b. the huge amount of time and complex knowledge required for basic financial planning.
c. a low rate of personal saving and poor financial planning.
d. a shortage of financial planners and portfolio managers.
2. Which of the following is true?
a. Most entrepreneurs work very few hours.
b. Entrepreneurs generally save less of their income than other Americans.
c. Additional years of schooling will substantially increase your earnings even if it fails to increase your productivity and ability to provide others with things that they value.
d. If you want to make a lot of money, you had better figure out how to provide others with substantial value and find ways to discover and act on valuable opportunities.
3. Which of the following is the best example of an item that a “real world” savings account is designed to cover?
a. the monthly payment for the lease of your apartment
b. the purchase of the gasoline you use driving back and forth to work
c. an unexpected expenditure to repair the transmission of your car
d. funds you are setting aside for your retirement years
4. Deferred tax saving plans such as a Roth Individual Retirement Account (IRA) or 401k plan will
a. reduce your current tax liability because funds paid into these plans are tax deductible.
b. make it more difficult for a young person to save and accumulate wealth.
c. increase your tax liability now, but you will pay lower taxes when you withdraw the funds.
d. help those with the lowest incomes, but will be of little value to those with higher incomes who want to save for retirement.
5. Which of the following is an advantage of an indexed equity mutual fund relative to a managed equity fund?
a. Indexed funds generally have better stock pickers.
b. Indexed funds engage in more detailed research.
c. Indexed funds have lower operating costs because they engage in less stock trading.
d. Indexed funds earn a significantly higher rate of return than a broad portfolio that represents the entire stock market.
6. The random walk theory indicates that
a. investors can make money by purchasing stocks that are widely expected to earn substantial profits in the future.
b. while changes in the prices of specific stocks are difficult to predict, experts are able to forecast the future direction of broad stock market indexes with a high degree of accuracy.
c. changes in stock prices are driven by surprise occurrences that are difficult to predict.
d. managed mutual funds will persistently out-perform indexed funds.
7. The variation in the rate of return one can expect from ownership of stocks will generally be smaller
a. if all of the funds are invested in a specific sector of the economy such as health care.
b. if a diverse set of stocks is held over a lengthy period of time such as 30 or 40 years.
c. if all of the funds are invested in a single stock.
d. if the funds are invested for a relatively short period of time.
8. Buying shares of corporate stock tends to be risky when
a. the stock of a single corporation is purchased.
b. the stock may have to be sold within a few months.
c. all stocks bought are in the same industry.
d. all of the above are true.
9. If an investor’s primary stock holding is currently Exxon Mobil, the purchase of which of the following stocks would provide the investor with the largest reduction in risk?
a. BP / Amoco.
b. Shell Oil Corporation.
c. Wal-Mart.
d. Texaco.
10. Which of the following has enhanced the ability of investors, without any special business skills, to benefit from the ownership of corporate America?
a. the increased availability of mutual funds, that make it possible for even small investors to purchase a diverse stock portfolio at a low cost
b. an increased tendency of small investors to buy and sell stock frequently
c. the virtual disappearance of business failures among corporations with publicly traded stock shares
d. all of the above
11. Which of the following is a risk associated with investing in bonds?
a. Increases in interest rates can reduce the market value of a bond.
b. Unanticipated inflation lessens the value of both principal and fixed-interest income.
c. If the firm issuing the bond goes bankrupt, bondholders may lose all or most of their investment.
d. All of the above are risks associated with bond investments.
12. It is often substantially cheaper to own and operate a used car rather than a new one because
a. the interest rate on a used car loan is generally lower.
b. the maintenance cost of a new car is generally higher.
c. the depreciation cost for a new car will almost always be substantially higher.
d. This is a trick question. All things considered, the cost per mile traveled is generally cheapest if you buy a new car every year.
13. In a free market economy, the income you earn is determined
a. by a central planning committee.
b. by the U.S. Bureau of Labor Statistics.
c. solely by your number of years of schooling.
d. by the market value of the productive resources you sell.
14. Finding the occupational or business activity in which you are relatively more productive helps individuals earn more money than otherwise would be the case. This reflects
a. the law of diversification.
b. the principle of compound interest.
c. the law of comparative advantage.
d. the law of large numbers.
15. You can earn income through the productive use of
a. labor only.
b. capital only.
c. labor and capital only.
d. labor, capital and entrepreneurial talent.
16. In order to prosper, entrepreneurs in a market economy must
a. undertake projects that create wealth and increase the value of resources.
b. find ways to slow technological change.
c. have at least one million dollars of personal wealth for the financing of new projects.
d. undertake projects that require resources that are more valuable than the products produced.
17. Which of the following is true of entrepreneurs?
a. Entrepreneurs are their own bosses but they generally work more hours per week than wage and salary employees.
b. Entrepreneurs have high savings rates because they channel most of their business’ income back into the firm for improvement and expansion.
c. Entrepreneurs are adept at discovering innovative new products, cost-reducing production methods, and profitable opportunities that are often overlooked by others.
d. All of the above
18. Which of the following is an example of entrepreneurship?
a. a student who produces and sells t-shirts at a football game
b. a 15-year old who operates a lemonade stand during hot summer days
c. an employee who figures out how to make her services more valuable to the business for which she works
d. all of the above
19. Which of the following is an example of a tax-deferred savings plan?
a. Regular and Roth Individual Retirement Accounts (IRAs).
b. Indexed mutual funds.
c. Certificates of deposit.
d. Interest-only mortgages.
20. To take full advantage of earning compound interest income you should start saving
a. now!
b. three years from now.
c. as soon as you get a higher paying job.
d. after you have purchased the nice car you have always wanted.
21. Under current legislation, Americans can place a fraction of their incomes into non-taxable, qualified college accounts. Under this policy the incentive to save for college education. (Fill in the blank.)
a. increases
b. decreases
c. does not impact
d. has an indeterminate impact on
22. The use of debt financing to purchase food, clothing, vacations, and other non-durable items
a. is prudent as long as you plan to save more in the future.
b. is imprudent unless you need to purchase these items to impress your friends.
c. is prudent as long as you have an unused balance on your credit card.
d. is imprudent because such purchases will mean that you will soon be making payments on items that have no value.
23. Credit cards
a. make it easy for people to run up sizeable debt.
b. make it easy for people to borrow funds at a low rate of interest.
c. are like money because funds can be used to purchase things up to the credit limit.
d. can help you get more from your money because they make it possible for you to spend more than you earn.
24. The interest rates on outstanding credit card balances are generally high because
a. there is little competition in this lending market.
b. the banks “price gouge” consumers in this market.
c. the default rate on credit card loans is high and there are no assets backing these loans.
d. the administrative costs associated with these loans are low.
25. Which of the following outstanding debts should Jillian pay off first?
a. A three year loan of $5000 at 0 percent a year from her mom.
b. A $2000 debt on a credit card charging 18 percent annually.
c. A home equity loan of $10000 which has an effective rate of 6 percent after her tax advantages are taken into account.
d. A student loan of $40,000 with a fixed rate of 4 percent.
26. Other things constant, an increase in interest rates will
a. increase your incentive to save.
b. reduce your incentive to save.
c. increase your incentive to borrow.
d. increase your incentive to buy a new car on credit.
27. The “miracle of compound interest” is best described by which of the following?
a. Interest is paid only on a principal deposit of money by a depository establishment.
b. Interest is paid only on any interest already earned on the principal deposit.
c. Interest is paid on the principal plus any interest already earned.
d. Interest is paid on any currency held in your pockets or outside of depository institutions.
28. Which of the following is true?
a. The law of compound interest highlights the importance of beginning to save at a young age.
b. Compound interest means that you are earning interest on your prior interest as well as on the principal balance of your savings.
c. Given a 7 percent rate of interest, smoking one pack of cigarettes per day from age 16 until a retirement age of 69 will cost the smoker nearly $600,000 in funds for retirement.
d. All of the above are true.
29. Suppose your employer offers to match funds you place into a savings plan as long as you purchase the company stock and hold it for at least three years. Which of the following is true?
a. You should allocate funds into this plan if the company management recommends it.
b. You should not put funds into this plan unless you expect to hold the company stock for at least ten years.
c. It can be attractive to put funds into a plan like this but you should sell your company stock when permitted in order to diversify your portfolio.
d. It does not make any sense to put funds into such a plan.
30. Which of the following is true?
a. Most stockholders own stock because they want to participate in the daily decision-making of the firms that they own.
b. The shareholders of a large well-established firm are guaranteed to earn a return of seven percent next year.
c. The potential losses of shareholders are limited to the amount of their investment.
d. Ownership of a corporate bond provides the bondholder with an ownership right to a fraction of the firm's future profits.
31. Historically, which of the following has had the highest average annual rate of return?
a. corporate bonds
b. money market mutual funds
c. corporate stocks
d. U.S. Treasury bonds
32. Since 1871, the average rate of return for stock holdings, adjusted for inflation, has been approximately
a. 2.7 percent.
b. 7 percent.
c. 15 percent.
d. 30 percent.
33. Historically, when a diverse set of stocks is held over a lengthy time period, stocks have yielded a ______ rate of return and the variation in the rate of return has been _______. (Fill in the blanks.)
a. low; low
b. low; high
c. high; low
d. high; high
34. A diversified portfolio is comprised of
a. corporate stocks of several companies in the same industry.
b. a diverse set of corporate bonds.
c. government bonds issued by federal, state and local governments.
d. a broad range of various types of assets.
35. Diversification puts “the law of large numbers” to work for you because it
a. increases the chance that a single bond will substantially improve the overall performance of your portfolio.
b. lowers the chance that a reduction in the market value of a single asset like a corporate stock will significantly reduce your overall portfolio return.
c. eliminates all asset risk.
d. reduces tax liabilities on earned dividends.
36. The theory that stock prices reflect all available information and that the future movement of stock prices is unpredictable is called the
a. random walk theory.
b. theory of compound interest.
c. law of comparative advantage.
d. law of large numbers.
37. The random walk theory implies that stock prices
a. go down, then up, and then down again.
b. follow systematic trends.
c. can be forecast accurately by experts who are knowledgeable about how the stock market works.
d. will change as the result of unexpected factors that are virtually impossible to forecast accurately.
38. Which of the following will tend to result in the least variation in the expected real rate of return from the ownership of stocks?
a. Ownership of a single stock for a short period of time.
b. Ownership of a single stock over a lengthy period of time.
c. Ownership of stocks from a specific sector (for example, the technology sector) over a lengthy period of time.
d. Ownership of a diverse set of stocks (the Standard & Poor’s 500, for example) over a lengthy period of time.
39. Investment in a broad portfolio of stocks is most attractive for
a. short-term investors.
b. long-term investors.
c. investors seeking a fixed rate of return.
d. investors who will need the funds for other purposes in about 10 years.
40. If Apple Computer Corporation constitutes a sizeable share of your current stock holdings, the purchase of which of the following stocks would provide you with the greatest reduction in risk?
a. Hewlett Packard
b. Gateway
c. Dell Computer Corporation
d. McDonalds
41. Diversification
a. eliminates the risk of investing in the stock market.
b. generally leads to lower rates of return than an average stock picker could earn from equity investments.
c. puts the law of large numbers to work for you.
d. Indicates that you should invest in the company for which you work and in whom you trust.
42. An indexed equity mutual fund
a. is directly tied to the consumer price index.
b. is a fund that hires a manager who will try to pick the stocks that will increase most in value in the future.
c. merely holds stocks in the same proportion as they exist in a broad stock market index like the Standard & Poor's 500.
d. will have high operating costs because these funds engage in a substantial amount of stock trading.
43. Which of the following make it possible for even a small investor to hold a diverse set of stocks and still keep the cost of purchasing additional stock holdings low?
a. a real world savings account
b. an equity (stock) mutual fund
c. a bond mutual fund
d. a checking account at a local bank
44. Which of the following will reduce the risk of equity (stock) investments?
a. The purchase of shares of a mutual fund that holds the stocks of many diverse corporations.
b. The purchasing and holding of equities over a lengthy period of time.
c. The purchase of shares in firms doing business in a wider variety of industries and markets.
d. All of the above.
45. Which of the following investments would provide the best protection against inflation?
a. Corporate bonds
b. U.S. Treasury bonds
c. An indexed equity mutual fund
d. Treasury Inflation Protected Securities (TIPS)
46. If the inflation rate increases unexpectedly, the market price of a long term bond (for example, one that will not mature for another 20 years) will generally
a. increase proportionally.
b. Increase, but by less than the proportional increase in the inflation rate.
c. decrease.
d. remain the same, the market value of bonds is unaffected by the inflation rate.
47. As the time nears when you expect to use funds in your retirement portfolio, you will reduce your risk if you
a. move more of your assets into stocks and out of bonds.
b. move more of your assets into bonds and out of stocks.
c. move funds out of a managed equity fund and into individual stocks.
d. move all of your funds into a diverse holding of technology stocks.
48. Which of the following words of advice will reduce your likelihood of being “ripped off” by a fraudulent investment scheme?
a. Never purchase an investment solicited by telephone or email.
b. Never let yourself be forced into a quick decision.
c. Deal only with persons at companies who have reputations to protect.
d. All of the above.
49. What can parents and adult volunteers do to help children learn how to make wise financial decisions?
a. Do nothing.
b. Actively engage them in learning, earning and investing.
c. Take complete control over their finances.
d. Give the children everything they want.
50. Financial success is primarily a result of
a. setting goals and working hard to achieve them.
b. saving strategically and spending wisely.
c. figuring out how to make our services useful to others.
d. all of the above.