Common Sense Economics

Common Sense Economics Part IV. Twelve Key Elements of Practical Personal Finance 1 1 1. Financial insecurity in America is primarily the result of 0 a. the low incomes of Americans. 1 b. the huge amount of time and complex knowledge required for basic financial planning. 2 c. a low rate of personal saving and poor financial planning. 3 d. a shortage of financial planners and portfolio managers.

1 2. Which of the following is true? 0 a. Most entrepreneurs work very few hours. 1 b. Entrepreneurs generally save less of their income than other Americans. 0 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. 1 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.

1 3. Which of the following is the best example of an item that a “real world” savings account is designed to cover? 0 a. the monthly payment for the lease of your apartment 1 b. the purchase of the gasoline you use driving back and forth to work 2 c. an unexpected expenditure to repair the transmission of your car 3 d. funds you are setting aside for your retirement years

1 4. Deferred tax saving plans such as a Roth Individual Retirement Account (IRA) or 401k plan will 0 a. reduce your current tax liability because funds paid into these plans are tax deductible. 1 b. make it more difficult for a young person to save and accumulate wealth. 2 c. increase your tax liability now, but you will pay lower taxes when you withdraw the funds. 3 d. help those with the lowest incomes, but will be of little value to those with higher incomes who want to save for retirement. 2 1 5. Which of the following is an advantage of an indexed equity mutual fund relative to a managed equity fund? 0 a. Indexed funds generally have better stock pickers. 1 b. Indexed funds engage in more detailed research. 2 c. Indexed funds have lower operating costs because they engage in less stock trading. 3 d. Indexed funds earn a significantly higher rate of return than a broad portfolio that represents the entire stock market.

1 6. The random walk theory indicates that 0 a. investors can make money by purchasing stocks that are widely expected to earn substantial profits in the future. 0 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. 1 c. changes in stock prices are driven by surprise occurrences that are difficult to predict. 2 d. managed mutual funds will persistently out-perform indexed funds.

1 7. The variation in the rate of return one can expect from ownership of stocks will generally be smaller 0 a. if all of the funds are invested in a specific sector of the economy such as health care. 1 b. if a diverse set of stocks is held over a lengthy period of time such as 30 or 40 years. 2 c. if all of the funds are invested in a single stock. 3 d. if the funds are invested for a relatively short period of time.

1 8. Buying shares of corporate stock tends to be risky when 0 a. the stock of a single corporation is purchased. 1 b. the stock may have to be sold within a few months. 2 c. all stocks bought are in the same industry. 3 d. all of the above are true.

1 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? 0 a. BP / Amoco. 1 b. Shell Oil Corporation. 2 c. Wal-Mart. 3 d. Texaco. 1 10. Which of the following has enhanced the ability of investors, without any special business skills, to benefit from the ownership of corporate America? 0 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 1 b. an increased tendency of small investors to buy and sell stock frequently 2 c. the virtual disappearance of business failures among corporations with publicly traded stock shares 3 d. all of the above

1 11. Which of the following is a risk associated with investing in bonds? 0 a. Increases in interest rates can reduce the market value of a bond. 1 b. Unanticipated inflation lessens the value of both principal and fixed-interest income. 2 c. If the firm issuing the bond goes bankrupt, bondholders may lose all or most of their investment. 3 d. All of the above are risks associated with bond investments.

1 12. It is often substantially cheaper to own and operate a used car rather than a new one because 0 a. the interest rate on a used car loan is generally lower. 1 b. the maintenance cost of a new car is generally higher. 2 c. the depreciation cost for a new car will almost always be substantially higher. 3 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.

1 13. In a free market economy, the income you earn is determined 0 a. by a central planning committee. 1 b. by the U.S. Bureau of Labor Statistics. 2 c. solely by your number of years of schooling. 3 d. by the market value of the productive resources you sell.

1 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 0 a. the law of diversification. 1 b. the principle of compound interest. 2 c. the law of comparative advantage. 3 d. the law of large numbers. 1 15. You can earn income through the productive use of 0 a. labor only. 1 b. capital only. 2 c. labor and capital only. 3 d. labor, capital and entrepreneurial talent.

1 16. In order to prosper, entrepreneurs in a market economy must 0 a. undertake projects that create wealth and increase the value of resources. 1 b. find ways to slow technological change. 2 c. have at least one million dollars of personal wealth for the financing of new projects. 3 d. undertake projects that require resources that are more valuable than the products produced.

1 17. Which of the following is true of entrepreneurs? 0 a. Entrepreneurs are their own bosses but they generally work more hours per week than wage and salary employees. 1 b. Entrepreneurs have high savings rates because they channel most of their business’ income back into the firm for improvement and expansion. 2 c. Entrepreneurs are adept at discovering innovative new products, cost- reducing production methods, and profitable opportunities that are often overlooked by others. 3 d. All of the above

1 18. Which of the following is an example of entrepreneurship? 0 a. a student who produces and sells t-shirts at a football game 1 b. a 15-year old who operates a lemonade stand during hot summer days 2 c. an employee who figures out how to make her services more valuable to the business for which she works 3 d. all of the above

1 19. Which of the following is an example of a tax-deferred savings plan? 0 a. Regular and Roth Individual Retirement Accounts (IRAs). 1 b. Indexed mutual funds. 2 c. Certificates of deposit. 3 d. Interest-only mortgages. 1 20. To take full advantage of earning compound interest income you should start saving 0 a. now! 1 b. three years from now. 2 c. as soon as you get a higher paying job. 3 d. after you have purchased the nice car you have always wanted.

1 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.) 0 a. increases 1 b. decreases 2 c. does not impact 3 d. has an indeterminate impact on

1 22. The use of debt financing to purchase food, clothing, vacations, and other non- durable items 0 a. is prudent as long as you plan to save more in the future. 1 b. is imprudent unless you need to purchase these items to impress your friends. 2 c. is prudent as long as you have an unused balance on your credit card. 3 d. is imprudent because such purchases will mean that you will soon be making payments on items that have no value.

1 23. Credit cards 0 a. make it easy for people to run up sizeable debt. 1 b. make it easy for people to borrow funds at a low rate of interest. 2 c. are like money because funds can be used to purchase things up to the credit limit. 3 d. can help you get more from your money because they make it possible for you to spend more than you earn.

1 24. The interest rates on outstanding credit card balances are generally high because 0 a. there is little competition in this lending market. 1 b. the banks “price gouge” consumers in this market. 2 c. the default rate on credit card loans is high and there are no assets backing these loans. 3 d. the administrative costs associated with these loans are low.

1 25. Which of the following outstanding debts should Jillian pay off first? 0 a. A three year loan of $5000 at 0 percent a year from her mom. 1 b. A $2000 debt on a credit card charging 18 percent annually. 2 c. A home equity loan of $10000 which has an effective rate of 6 percent after her tax advantages are taken into account. 3 d. A student loan of $40,000 with a fixed rate of 4 percent. 1 26. Other things constant, an increase in interest rates will 0 a. increase your incentive to save. 1 b. reduce your incentive to save. 2 c. increase your incentive to borrow. 3 d. increase your incentive to buy a new car on credit.

1 27. The “miracle of compound interest” is best described by which of the following? 0 a. Interest is paid only on a principal deposit of money by a depository establishment. 1 b. Interest is paid only on any interest already earned on the principal deposit. 2 c. Interest is paid on the principal plus any interest already earned. 3 d. Interest is paid on any currency held in your pockets or outside of depository institutions.

1 28. Which of the following is true? 0 a. The law of compound interest highlights the importance of beginning to save at a young age. 1 b. Compound interest means that you are earning interest on your prior interest as well as on the principal balance of your savings. 2 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. 3 d. All of the above are true.

1 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? 0 a. You should allocate funds into this plan if the company management recommends it. 1 b. You should not put funds into this plan unless you expect to hold the company stock for at least ten years. 2 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. 3 d. It does not make any sense to put funds into such a plan.

1 30. Which of the following is true? 0 a. Most stockholders own stock because they want to participate in the daily decision-making of the firms that they own. 1 b. The shareholders of a large well-established firm are guaranteed to earn a return of seven percent next year. 2 c. The potential losses of shareholders are limited to the amount of their investment. 3 d. Ownership of a corporate bond provides the bondholder with an ownership right to a fraction of the firm's future profits. 1 31. Historically, which of the following has had the highest average annual rate of return? 0 a. corporate bonds 1 b. money market mutual funds 2 c. corporate stocks 3 d. U.S. Treasury bonds

1 32. Since 1871, the average rate of return for stock holdings, adjusted for inflation, has been approximately 0 a. 2.7 percent. 1 b. 7 percent. 2 c. 15 percent. 3 d. 30 percent.

1 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.) 0 a. low; low 1 b. low; high 2 c. high; low 3 d. high; high

1 34. A diversified portfolio is comprised of 0 a. corporate stocks of several companies in the same industry. 1 b. a diverse set of corporate bonds. 2 c. government bonds issued by federal, state and local governments. 3 d. a broad range of various types of assets.

1 35. Diversification puts “the law of large numbers” to work for you because it 0 a. increases the chance that a single bond will substantially improve the overall performance of your portfolio. 1 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. 2 c. eliminates all asset risk. 3 d. reduces tax liabilities on earned dividends.

1 36. The theory that stock prices reflect all available information and that the future movement of stock prices is unpredictable is called the 0 a. random walk theory. 1 b. theory of compound interest. 2 c. law of comparative advantage. 3 d. law of large numbers. 37. The random walk theory implies that stock prices 0 a. go down, then up, and then down again. 1 b. follow systematic trends. 2 c. can be forecast accurately by experts who are knowledgeable about how the stock market works. 3 d. will change as the result of unexpected factors that are virtually impossible to forecast accurately.

1 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? 0 a. Ownership of a single stock for a short period of time. 1 b. Ownership of a single stock over a lengthy period of time. 2 c. Ownership of stocks from a specific sector (for example, the technology sector) over a lengthy period of time. 3 d. Ownership of a diverse set of stocks (the Standard & Poor’s 500, for example) over a lengthy period of time.

1 39. Investment in a broad portfolio of stocks is most attractive for 0 a. short-term investors. 1 b. long-term investors. 2 c. investors seeking a fixed rate of return. 3 d. investors who will need the funds for other purposes in about 10 years.

1 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? 0 a. Hewlett Packard 1 b. Gateway 2 c. Dell Computer Corporation 3 d. McDonalds

1 41. Diversification 0 a. eliminates the risk of investing in the stock market. 1 b. generally leads to lower rates of return than an average stock picker could earn from equity investments. 2 c. puts the law of large numbers to work for you. 3 d. Indicates that you should invest in the company for which you work and in whom you trust.

1 42. An indexed equity mutual fund 0 a. is directly tied to the consumer price index. 1 b. is a fund that hires a manager who will try to pick the stocks that will increase most in value in the future. 2 c. merely holds stocks in the same proportion as they exist in a broad stock market index like the Standard & Poor's 500. 3 d. will have high operating costs because these funds engage in a substantial amount of stock trading. 1 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? 0 a. a real world savings account 1 b. an equity (stock) mutual fund 2 c. a bond mutual fund 3 d. a checking account at a local bank

1 44. Which of the following will reduce the risk of equity (stock) investments? 0 a. The purchase of shares of a mutual fund that holds the stocks of many diverse corporations. 1 b. The purchasing and holding of equities over a lengthy period of time. 2 c. The purchase of shares in firms doing business in a wider variety of industries and markets. 3 d. All of the above.

1 45. Which of the following investments would provide the best protection against inflation? 0 a. Corporate bonds 1 b. U.S. Treasury bonds 2 c. An indexed equity mutual fund 3 d. Treasury Inflation Protected Securities (TIPS)

1 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 0 a. increase proportionally. 1 b. Increase, but by less than the proportional increase in the inflation rate. 2 c. decrease. 3 d. remain the same, the market value of bonds is unaffected by the inflation rate.

1 47. As the time nears when you expect to use funds in your retirement portfolio, you will reduce your risk if you 0 a. move more of your assets into stocks and out of bonds. 1 b. move more of your assets into bonds and out of stocks. 2 c. move funds out of a managed equity fund and into individual stocks. 3 d. move all of your funds into a diverse holding of technology stocks.

1 48. Which of the following words of advice will reduce your likelihood of being “ripped off” by a fraudulent investment scheme? 0 a. Never purchase an investment solicited by telephone or email. 1 b. Never let yourself be forced into a quick decision. 2 c. Deal only with persons at companies who have reputations to protect. 3 d. All of the above. 1 49. What can parents and adult volunteers do to help children learn how to make wise financial decisions? 0 a. Do nothing. 1 b. Actively engage them in learning, earning and investing. 2 c. Take complete control over their finances. 3 d. Give the children everything they want.

50. Financial success is primarily a result of 0 a. setting goals and working hard to achieve them. 1 b. saving strategically and spending wisely. 2 c. figuring out how to make our services useful to others. 3 d. all of the above.