Test Bank to Accompany Personal Finance: Turning Money into Wealth, 7e

Test Bank

For

Personal Finance: Turning Money into Wealth

7th Edition

Oscar Solis Virginia Tech

Arthur J. Keown Virginia Tech

Copyright © 2016 Pearson Education, Inc.

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ISBN-13: 978-0-13-386668-1 ISBN-10: 0-13-386668-8

Contents Chapter 1 The Financial Planning Process ......................................................................................... 1

Chapter 2 Measuring Your Financial Health and Making a Plan ................................................. 23

Chapter 3 Understanding and Appreciating the Time Value of Money ...................................... 50

Chapter 4 Tax Planning and Strategies ............................................................................................. 74

Chapter 5 Cash or Liquid Asset Management ............................................................................... 103

Chapter 6 Using Credit Cards: The Role of Open Credit ............................................................. 127

Chapter 7 Student and Consumer Loans: The Role of Planned Borrowing .............................. 161

Chapter 8 The Home and Automobile Decision ........................................................................... 188

Chapter 9 Life and Health Insurance .............................................................................................. 227

Chapter 10 Property and Liability Insurance ................................................................................... 273

Chapter 11 Investment Basics ............................................................................................................ 305

Chapter 12 Investing in Stocks ........................................................................................................... 368

Chapter 13 Investing in Bonds and Other Alternatives ................................................................. 404

Chapter 14 Mutual Funds: An Easy Way to Diversify ................................................................... 432

Chapter 15 Retirement Planning........................................................................................................ 460

Chapter 16 Estate Planning: Saving Your Heirs Money and Headaches ..................................... 491

Chapter 17 Financial Life Events—Fitting the Pieces Together..................................................... 514

Chapter 1The Financial Planning Process

1.1 Facing Financial Challenges

1) Once a sound financial plan is in place, there should be no need to ever change it.

Answer: FALSEDiff: 1Topic: The Financial Planning ProcessAACSB: Analytical Thinking

2) One purpose of financial planning is to help you legally reduce the amount of taxes you have to

pay on your earnings.

Answer: TRUEDiff: 1Topic: Financial PlanningAACSB: Analytical Thinking

3) When comparing two different investment opportunities the investor should always choose the

investment that minimizes the total amount of taxes paid.

Answer: FALSEDiff: 2Topic: Minimization of TaxesAACSB: Analytical Thinking

4) Annual public school tuition and fees are three times more expensive than private school tuition

and fees.

Answer: FALSEDiff: 2Topic: Financial ChallengesAACSB: Analytical Thinking

5) Being financially secure involves balancing what you earn with

A) your investments. B) what you spend.

C) your retirement plans. D) your current level of debt.

Answer: BDiff: 1Topic: Financial PlanningAACSB: Analytical Thinking

6) Financial planning might not help you earn more, but it can help you use the money you do

earn to achieve your

A) lifeʹs purpose. B) dreams.

C) financial goals. D) desired lifestyle.

Answer: CDiff: 1Topic: Financial GoalsAACSB: Analytical Thinking


2 Keown Personal Finance: Turning Money into Wealth, 7e

7) Which statement is true about managing personal finances?

A) The ability to manage finances is a skill with which you are born.

B) Personal finance courses are commonly offered in high school.

C) Financial difficulties can be a major cause of marital problems.

D) Personal financial management is not a skill worth learning.

Answer: CDiff: 2Topic: Finance CompanyAACSB: Analytical Thinking

8) In order for your financial plan to be realistic and attainable it needs to be based upon your

A) budget.

B) income level.

C) number of tax deductions, exemption, exclusions, and credits.

D) balance sheet.

E) none of the above.


9) Personal financial planning can help you to

A) deal with unplanned health issues.

B) minimize your tax payments to Uncle Sam.

C) minimize your chances of personal bankruptcy.

D) have enough money for a comfortable retirement.

E) all of the above.

Answer: EDiff: 2Topic: Financial PlanningAACSB: Analytical Thinking

10) What elements are found in an effective financial plan?

A) Flexibility to allow for changes in your situation

B) Sufficient liquidity to meet unexpected needs

C) Insurance protection from catastrophic events

D) Helps you legally reduce the amount of taxes you owe

E) All of the above



Chapter 1 The Financial Planning Process 3

11) This course/text will assist you in accomplishing six financial objectives. What are they?

Answer: 1. Manage the unplanned.

2. Accumulate wealth for special expenses.

3. Realistically save for retirement.

4. Cover your assets.

5. Invest intelligently.

6. Minimize your payments to Uncle Sam.Diff: 2Topic: Financial PlanningAACSB: Analytical Thinking

12) How will a financial plan help you save for retirement?

Answer: A strong financial plan will help you forecast the costs of retirement and develop a plan

that will allow you to live a comfortable life after you retire.Diff: 2Topic: Financial PlanningAACSB: Reflective Thinking

1.2 The Personal Financial Planning Process

1) Today, most Americans over the age of 65 have adequate savings and income available to them

during retirement.

Answer: FALSEDiff: 1Topic: Financial Planning Life CycleAACSB: Analytical Thinking

2) The amount of current income that you earn today isnʹt relevant to setting your long term goals

for the future.

Answer: FALSEDiff: 1Topic: Financial PlanningAACSB: Reflective Thinking

3) A financial plan is only concerned with your future earnings and expenses. An examination of

your current financial situation is not so important.

Answer: FALSEDiff: 1Topic: The Financial Planning ProcessAACSB: Analytical Thinking

4) While each personʹs financial plan is different, some common factors guide all sound financial

plans: flexibility, liquidity, protection, and minimization of taxes.

Answer: TRUEDiff: 2Topic: The Financial Planning ProcessAACSB: Analytical Thinking



5) Financial planning is an ongoing process. As your financial situation and position in life change,

the plan changes.

Answer: TRUEDiff: 1Topic: The Financial Planning ProcessAACSB: Analytical Thinking

6) Which of the following is one of the five basic steps in personal financial planning?

A) Evaluate your personal health. B) Define your career goals.

C) Develop a plan of action. D) Let an accountant review your plan.

Answer: CDiff: 2Topic: The Financial Planning ProcessAACSB: Analytical Thinking

7) Which basic step to personal financial planning should be considered when examining your

current financial situation?

A) Step 1 B) Step 2 C) Step 3 D) Step 4

Answer: ADiff: 1Topic: The Financial Planning ProcessAACSB: Analytical Thinking

8) Which basic step to personal financial planning should be considered when establishing your

personal financial goals?

A) Step 1 B) Step 2 C) Step 3 D) Step 4

Answer: BDiff: 1Topic: The Financial Planning ProcessAACSB: Analytical Thinking

9) The personal financial planning process consists of ________ steps.

A) three B) five C) seven D) ten


10) While each personʹs financial plan is different, some common factors guide all sound financial

plans. Which of the following is one of the common factors?

A) Sustainability B) Illiquidity

C) Protection D) Maximization of taxes

Answer: CDiff: 2Topic: The Financial Planning ProcessAACSB: Analytical Thinking



11) Evaluating your financial health consists of

A) preparing a personal balance sheet.

B) determining what you are worth.

C) preparing a personal income statement.

D) determining where your money comes from and where it goes.


Answer: EDiff: 1Topic: The Financial Planning ProcessAACSB: Analytical Thinking

12) You need to review your progress and reevaluate and revise your plan (Step 5) because

A) your financial needs change over the course of your life.

B) your employment situation changes over time.

C) your net worth changes over time.

D) your family situation might change over time.

E) all of the above are good reasons to periodically review your financial plan.

Answer: EDiff: 3Topic: The Financial Planning ProcessAACSB: Analytical Thinking

13) Suppose that you just completed your first year of college with $12,000 in loans and plan to

borrow the maximum each year from now until graduation. You have never accounted for the

way you spend your money, do not have a budget, and want to insure that you will be able to

repay your loans after college. What is the most important thing you can do right now?

A) Talk to your parents about an allowance.

B) Visit your career counselor at school.

C) Ask a friend who took the Personal Finance course for advice.

D) Immediately begin to develop a personal financial plan.

Answer: DDiff: 3Topic: Financial PlanningAACSB: Reflective Thinking

14) Suppose you have just retired, have accumulated many luxury goods over the years, still owe a

mortgage on your home, still have unpaid travel expenses on your credit cards, and have

helped your adult children financially. Your spouse has recently passed away, and you miss

his/her contribution to the household income. Which step in the personal financial planning

process have you neglected?

A) Develop your financial health.

B) Define your financial goals.

C) Develop a plan of action.

D) Implement your plan.

E) Review your progress, reevaluate, and revise your plan.

Answer: EDiff: 2Topic: Financial PlanningAACSB: Reflective Thinking



15) While reviewing your current financial plan, you discover that you most likely wonʹt achieve

your long term financial goals. What should you do now?

A) Look at increasing your income.

B) Look at cutting back on your expenses.

C) Look at revising your goals.

D) All of these would be realistic things to do.

Answer: DDiff: 3Topic: The Financial Planning ProcessAACSB: Analytical Thinking

16) Step 3 of the personal financial planning process is ʺDevelop a Plan of Action.ʺ According to

your text, which of the following is not one of the ʺcommon concernsʺ that should guide all

financial plans?

A) Flexibility

B) Long-term profitability

C) Liquidity

D) Protection

E) Minimization of taxes


17) The term that considers having money readily available when you need it is the concept of

A) flexibility.

B) liquidity.

C) equity.

D) solvency.



18) Describe the five steps in the personal financial planning process.

Answer: Step 1: Evaluate your financial health by examining your current financial situation.

Look at your whole financial picture. Keep records and determine your net worth.

Step 2: Define your financial goals by describing what, when, and how much you want to

do. Written goals will draw you to them.

Step 3: Develop a plan of action to reach your goals. Donʹt just think about goals decide

how you will carry them out! Let flexibility, liquidity, protection, and minimization of

taxes guide your plan.

Step 4: Implement your plan by carrying it out just do it! Stick to your plan.

Step 5: Review your progress, reevaluate, and revise your plan periodically and as

needed.Diff: 2Topic: The Financial Planning ProcessAACSB: Analytical Thinking



19) Why do individuals need to plan for their finances?

Answer: Without financial planning individuals will suffer and be at a loss both in the present

time and in the future. Too many people reach retirement broke and in poor health. Their

financial means are so limited they live out a meager existence and become a burden

upon family and society. Life is meant to be enjoyed and only by planning can we do

that. Because it is always easier to spend than save, financial planning is a must!Diff: 2Topic: Financial PlanningAACSB: Diverse and Multicultural Work Environments

20) Elaborate upon the four common concerns that should guide all financial plans.

Answer: Your financial plan should be flexible enough to respond to changes in your life and

unexpected events. Planning must allow some funds to be liquid to allow access to

money when you need it quickly. Plan for protecting your assets and yourself with

adequate insurance. Finally, your financial plan should take taxes into account to pay as

little as legally possible.Diff: 3Topic: The Financial Planning ProcessAACSB: Reflective Thinking

21) What elements are included in a solid financial plan?

Answer: A solid personal financial plan includes an informed and controlled budget, outlines your

investment strategy, and reflects your unique personal and financial goals.Diff: 2Topic: The Financial Planning ProcessAACSB: Reflective Thinking

22) Why do you need to have liquidity?

Answer: Liquidity allows you to access your money with ease, when you need it. Life happens; at

any moment, you could develop an illness, lose a job, or wreck your car. When

unforeseen circumstances occur, you need to have access to enough money to make it

through.Diff: 2Topic: LiquidityAACSB: Reflective Thinking

1.3 Establishing Your Financial Goals

1) Proper financial planning can help you use your current income to achieve your long term

financial goals


2) A short-term goal might take from one to 10 years to accomplish.

Answer: FALSEDiff: 1Topic: Financial GoalsAACSB: Analytical Thinking



3) In the typical consumerʹs financial life cycle, one difference between stage 2 and stage 3 is that in

stage 3 you will earn more than you spend, whereas in stage 2 you will spend more than you

earn.

Answer: FALSEDiff: 2Topic: Financial Planning Life CycleAACSB: Analytical Thinking

4) Estate-planning tools such as wills, living wills, health proxies, powers of attorney, and

record-keeping should all be in place to help protect you, your assets, and your heirs.

Answer: TRUEDiff: 2Topic: Estate PlanningAACSB: Analytical Thinking

5) The major reason to make a financial plan is to

A) account for your spending.

B) see where you are overspending or underspending.

C) achieve your financial goals.

D) allow for a surplus.

E) serve as a tax planning guide.

Answer: CDiff: 1Topic: Financial GoalsAACSB: Analytical Thinking

6) What is the significance of the financial life cycle?

A) To help you to compare your situation with other peopleʹs situation

B) To better understand how your financial needs will most likely change over time

C) To allow you to be more proactive in dealing with expected changes in the future and take

steps today to prepare for them

D) To help you realize that your original plan is sufficient and doesnʹt need to change

E) Both B and C are significant aspects of the financial life cycle.

Answer: EDiff: 3Topic: Financial Planning Life CycleAACSB: Analytical Thinking

7) Which of the following typically occur(s) during stage 1 of the financial life cycle?

A) Initial goal setting

B) Insurance planning

C) Saving for goals

D) Home purchase

E) All the above

Answer: EDiff: 2Topic: Financial Planning Life CycleAACSB: Analytical Thinking



8) Suppose that you are a 21-year-old college student. What stage of the financial life cycle are

you currently in?

A) Stage 1: wealth accumulation

B) Stage 2: the golden years

C) Stage 3: the retirement years

D) Stage 4: the formative years

E) Stage 5: the educational years

Answer: ADiff: 2Topic: Financial Planning Life CycleAACSB: Analytical Thinking

9) After retirement starts, which aspect of financial planning becomes imperative?

A) Maintaining a regular pattern of saving B) Long-term borrowing commitments

C) Estate planning D) Effects of inflation

Answer: CDiff: 2Topic: Financial Planning Life CycleAACSB: Analytical Thinking

10) What should you do with your goals on a frequent basis throughout your lifetime?

A) Prioritize them B) Modify them

C) Put them in writing D) All of the above

Answer: DDiff: 2Topic: Financial GoalsAACSB: Analytical Thinking

11) An economic condition in which rising prices reduce the purchasing power of money is termed

A) deflation.

B) inflation.

C) stagflation.

D) cash erosion.


Answer: BDiff: 1Topic: InflationAACSB: Diverse and Multicultural Work Environments

12) When you are involved in ________ planning, you are planning for your eventual death and the

distribution of your wealth to your heirs.

A) prenatal

B) beneficiary

C) estate

D) actuarial

E) none of the above

Answer: CDiff: 1Topic: Estate PlanningAACSB: Analytical Thinking



13) Based on the Life Cycle of Financial Planning, when would be a good time to review and

possibly adjust an effective financial plan?

A) A really effective financial plan doesnʹt need to be adjusted.

B) When you get married

C) When you have children

D) When the stock market goes up

E) Both B and C are correct answers.


14) On his goals worksheet, James has written down his short-term goals for the next year. He has

prioritized his goals and determined a feasible due date by which he wants to achieve his goals.

According to the textbook, the final step James needs to complete in the goals process is to

A) determine an appropriate cost for each of his listed goals.

B) post his goals worksheet on his refrigerator so that he can see it every day.

C) contact his financial advisor for approval of his goals.

D) email himself a copy of the goals worksheet in case he loses the paper copy.

Answer: ADiff: 2Topic: Financial GoalsAACSB: Reflective Thinking

15) Which stage in the Financial Life Cycle is the longest in terms of years?

A) Stage 1: wealth accumulation B) Stage 2: the golden years

C) Stage 3: the retirement years D) Stage 4: the formative years

Answer: ADiff: 1Topic: Financial Planning Life CycleAACSB: Analytical Thinking

16) According to the Keown book, you might begin to think about estate planning during this stage

of the financial life cycle.



Answer: BDiff: 3Topic: Estate PlanningAACSB: Analytical Thinking

17) Suppose that you are a 60-year-old business owner. What stage of the financial life cycle are

you currently in?



Answer: BDiff: 2Topic: Financial Planning Life CycleAACSB: Analytical Thinking



18) During which stage of the financial life cycle do many people make their biggest investment, the

purchase of a home?



Answer: ADiff: 2Topic: Financial PlanningAACSB: Analytical Thinking

19) What is one difference between stage 2 in the Financial Life Cycle and stage 3 in the Financial

Life Cycle?

Answer: During stage 2, you will earn more than you spend; whereas during stage 3 you will

spend more than you earn.Diff: 2Topic: Financial Planning Life CycleAACSB: Reflective Thinking

20) Explain the essence and importance of each of the stages in the financial life cycle.

Answer: The overall financial life cycle allows you to better understand the timing and areas of

financial concern that youʹll probably experience. It allows you to focus on those concerns

earlier and to plan ahead to avoid future financial problems.

Stage 1 is a time of wealth accumulation, initial goal setting, home purchase, family

formation, insurance planning, saving for goals, and some tax and estate planning. Itʹs a

time to develop a regular pattern of saving because itʹs tempting to spend rather than

save. Consumers are ages 18 through 54 in this stage.

Stage 2 covers ages 55 to 64 or the golden years approaching retirement. This is a

transition from the earning years when you will earn more than you spend. Much of the

financial activities will be spent in fine tuning. Consumers put an emphasis on tax and

estate planning, paying ourselves first, and insurance planning.

Stage 3 consists of the retirement years, for most people age 65 and older. Consumers

reap the benefits of sound planning or the losses from unsound planning. You will

attempt to ensure continued financial security and perhaps work part-time.Diff: 2Topic: Financial Planning Life CycleAACSB: Reflective Thinking

21) Differentiate between short-term, intermediate, and long-term goals. Give examples.

Answer: Short-term goals can be accomplished within one year, such as taking a vacation.

Intermediate goals take between one and ten years to reach, such as saving for a college

education or the down payment on a house. Long-term goals take more than ten years to

accomplish. Retirement planning is a common long-term goal.Diff: 3Topic: Financial GoalsAACSB: Reflective Thinking



22) Why should you prioritize your financial goals?

Answer: Prioritizing goals might make you realize that some of your goals are simply unrealistic,

leading you to reevaluate them. However, once your final goals are in place, they become

the cornerstone of your personal financial plan, serving as a guide to action and a

benchmark for assessing the effectiveness of the plan.Diff: 2Topic: Financial ChallengesAACSB: Reflective Thinking

23) Give an example of a decision that might not be considered a financial decision but will have a

major impact on your financial situation.

Answer: The decision to have a child will have a major impact on your financial situation.

Although finances arenʹt considered the primary factor determining when to have

children, the timing certainly has enormous financial implications, causing significant

changes in housing, child care, and education costs. Considering that childrearing can

cost $9,683 to $22,210 per child per year, saving to finance that childʹs college education

might pose as a real challenge.Diff: 3Topic: Financial ChallengesAACSB: Diverse and Multicultural Work Environments

1.4 Thinking About Your Career

1) A well-educated and trained employee is virtually guaranteed job security by todayʹs

employers. Therefore, he or she doesnʹt need to worry about keeping his or her skills current.

Answer: FALSEDiff: 1Topic: Career ChoicesAACSB: Reflective Thinking

2) The most important aspect of choosing a career is the amount of income that career will

generate over your lifetime.

Answer: FALSEDiff: 1Topic: Career ChoicesAACSB: Reflective Thinking

3) Salaries vary for individuals working in similar jobs for different companies, but one thing is

clear: the more specialized skills and training a job requires, the higher the job tends to pay.

Answer: TRUEDiff: 2Topic: Determinants of IncomeAACSB: Reflective Thinking

4) The first steps in career planning are conducting a self-assessment and developing an

understanding of what sort of lifestyle you wish to lead.

Answer: TRUEDiff: 1Topic: Career PlanningAACSB: Analytical Thinking



5) According to a resumedoctor.com recruiting survey, the most common mistake made by job

interviewees is talking too much.

Answer: TRUEDiff: 2Topic: Career ChoicesAACSB: Reflective Thinking

6) What is the main factor in determining your potential income level?

A) Education and skills that you have attained

B) Who you know in your company administration

C) Your age and years of employment

D) The size of the company you work for

Answer: ADiff: 1Topic: Determinants of IncomeAACSB: Analytical Thinking

7) Which of the following statements applies to obtaining an undergraduate college degree?

A) They are expensive and rarely pay off in increased earnings.

B) There is no relationship between personal wealth and earning a college degree.

C) It may be the single best investment you will ever make.

D) All of the above.

Answer: CDiff: 1Topic: Determinants of IncomeAACSB: Analytical Thinking

8) Probably the most important determinant of your future earnings will be

A) your highest level of education obtained.

B) the size of the company where you will work.

C) your seniority with your company.

D) joining a labor union.

Answer: ADiff: 1Topic: Determinants of IncomeAACSB: Diverse and Multicultural Work Environments

9) One of the most important factors to remember when hunting for your first job is to

A) seize every opportunity. B) wait patiently.

C) start early. D) procrastinate.

Answer: CDiff: 1Topic: Career PlanningAACSB: Analytical Thinking



10) ________ is the process of identifying a job that you feel is important and that will lead to the

kind of lifestyle you desire.

A) Financial planning B) Career planning

C) Goal planning D) Retirement planning

Answer: BDiff: 1Topic: Career PlanningAACSB: Analytical Thinking

11) According to a 2014 resumedoctor.com recruiting survey, the most common mistake made by

job interviewees is

A) shaking hands softly. B) talking too much.

C) dressing inappropriately. D) arriving late to an interview.

Answer: BDiff: 2Topic: Career PlanningAACSB: Analytical Thinking

12) What is the relationship between earnings, education, and standard of living?

Answer: There is a direct relationship between earnings and standard of living and education. The

more education an individual has, the more he or she will earn in general and thus enjoy

a higher standard of living. The opposite holds true also. The less education one has the

lower the earnings and standard of living.Diff: 2Topic: Determinants of IncomeAACSB: Reflective Thinking

13) Why is it important to conduct an effective self-assessment?

Answer: Conducting an effective self-assessment allows you to look honestly at many aspects of

your life. After completing the assessment, you will have a valuable understanding of

your interests, skills, values, personal traits, and desired lifestyle. Then you can research

career options and identify those in which your abilities are valued. Once youʹve

narrowed down a list of possibilities, weigh the positive and negative aspects of each

profession.Diff: 2Topic: Career PlanningAACSB: Application of Knowledge



14) List some way to increase your value as an employee.

Answer: Do your best work.

Project the right image–one aligned with the organizationʹs values.

Gain an understanding of the organizationʹs power structure so that you can work

within it.

Gain visibility. Make those with power aware of your contributions.

Request new assignments in order to gain experience and an understanding of the

various operations of the organization.

Be loyal to and supportive of your boss. Remember, he or she controls your immediate

future.

Continually acquire new skills–particularly skills that are not easy to duplicate.

Develop a strong network of people who can assist you when you look for a new job.

Pay attention to ethical considerations. The most damaging event that you can experience

is for your coworkers to lose confidence in your ethical standards. Ethical violations end

careers.Diff: 2Topic: Career PlanningAACSB: Reflective Thinking

1.5 Lessons from the Recent Economic Downturn

1) The economic downturn that began in 2008 resulted in negative consequences, including

A) a dramatic increase in unemployment rates.

B) disrupted financial markets.

C) difficulty for consumers to borrow money from lending institutions.

D) all consumers increased their wealth.

E) only A, B, and C are correct.

Answer: EDiff: 2Topic: Financial Life EventsAACSB: Analytical Thinking

2) The economic downturn that began in 2008 demonstrated that many Americans have sufficient

emergency funds.

Answer: FALSEDiff: 2Topic: Financial Life EventsAACSB: Analytical Thinking

3) It is important to take a close look at the 2008 economic downturn as a means to highlight how

vulnerable Americanʹs finances are.

Answer: TRUEDiff: 1Topic: Financial Life EventsAACSB: Reflective Thinking



4) According to a recent Rockefeller Foundation report, the financial issue Americans worry about

the most is the ability to pay

A) for medical expenses. B) for retirement expenses.

C) debt expenses. D) home mortgage expenses.

Answer: BDiff: 3Topic: Financial Life EventsAACSB: Analytical Thinking

5) What did the economic downturn that began in 2008 reveal about many Americansʹ financial

concerns? How can you alleviate those concerns in your own personal financial planning?

Answer: Many Americans are not adequately prepared for retirement and have insufficient

emergency funds, too much debt, and inadequate health insurance.

These concerns can be alleviated with proper financial planning, maintaining a sufficient

emergency fund, avoiding excessive debt, and carrying adequate health insurance.Diff: 3Topic: Financial Life EventsAACSB: Reflective Thinking

1.6 Ten Principles of Personal Finance

1) Most individuals will reach their financial goals without planning or budgeting.

Answer: FALSEDiff: 1Topic: Principle 2: Nothing happens without a planAACSB: Analytical Thinking

2) All else being equal, an increase in inflation will cause investors to require a higher rate of

return on an asset.

Answer: TRUEDiff: 1Topic: Principle 8: Risk and return go hand in handAACSB: Diverse and Multicultural Work Environments

3) Diversification allows you to reduce risk.

Answer: TRUEDiff: 1Topic: Principle 8: Risk and return go hand in handAACSB: Analytical Thinking



4) Which of the following is outlined in the text as reason(s) why many people do not have an

adequate financial plan?

A) For most people it is easier to spend than save.

B) Procrastination can affect everyone.

C) Many of us lack the proper knowledge.

D) There is never enough time for organizing and planning.

E) All of the above are common excuses for not planning.


5) The concept of diversification is illustrated by the old saying

A) ʺSell eggs high and buy them low.ʺ

B) ʺDonʹt put all your eggs in one basket.ʺ

C) ʺKeep all your eggs in one basket.ʺ

D) ʺSeveral baskets of eggs are better than one.ʺ

Answer: BDiff: 2Topic: DiversificationAACSB: Analytical Thinking

6) Chapter 1 discusses 10 principles that form the foundation of personal finance. The principle

stating that a person can expect to earn additional return for increasing his or her investment

risk is the ________ principle.

A) ʺrisk and return go hand in handʺ

B) ʺmind games, financial personality, and your moneyʺ

C) ʺnothing happens without a planʺ

D) ʺthe best protection is knowledgeʺ

Answer: ADiff: 2Topic: Principle 8: Risk and return go hand in handAACSB: Diverse and Multicultural Work Environments

7) The concept that emphasizes that people should not put all their eggs in one basket is

A) the time dimension of investing.

B) the curse of competitive investment markets.

C) diversification reduces risk.

D) the farmers analogy.

E) liquidity is first.

Answer: CDiff: 2Topic: Principle 8: Risk and return go hand in handAACSB: Diverse and Multicultural Work Environments



8) What piece of advice might you give to someone for whom the act of saving is an afterthought?

A) Pay yourself first. B) Money isnʹt everything.

C) Donʹt put all your eggs in one basket. D) None of the above.

Answer: ADiff: 2Topic: Principle 10: Just do itAACSB: Reflective Thinking


that considers the value of compound interest is the ________ principle.

A) all risk is not equal

B) pay yourself first

C) competitive inflation adjustment

D) time value of money


Answer: DDiff: 2Topic: Principle 3: The time-value-of-money

AACSB: Analytical Thinking


that considers the importance of insurance is the ________ principle.

A) agency problem beware the sales pitch

B) all risk is not equal

C) time value of money

D) protect yourself against major catastrophes


Answer: DDiff: 2Topic: Principle 7: Protect yourself against major catastrophesAACSB: Analytical Thinking

11) Many people who signed up for adjustable-rate mortgages during the sub-prime mortgage

debacle were no longer able to afford their payments. Many of these people were misled by

their lenders. Which financial principle from Chapter 1 most applies?

A) The best protection is knowledge.

B) Mind games, financial personality, and your money

C) Stuff happens, or the importance of liquidity.

D) The time value of money

Answer: ADiff: 3Topic: Principle 1: The best protection is knowledgeAACSB: Analytical Thinking



12) In Chapter 1, Principle 3 espouses the time value of money. Why is this principle so important

to financial planning?

A) The principle allows us to determine how much money we will need to achieve our future

goals.

B) The principle shows us how inflation impacts our money over time.

C) The principle helps us determine our savings needs today, in order to meet our future

retirement goals.

D) The principle shows us how important time and interest rates are to the accumulation of

wealth.

E) All of the above.

Answer: EDiff: 3Topic: Principle 3: The time-value-of-money


13) Without recognizing ________ it is impossible to understand compound interest, which allows

investments to grow over time.

A) that taxes affect personal finance decisions

B) the time value of money

C) the importance of liquidity

D) that risk and return go hand in hand

Answer: BDiff: 2Topic: Principle 3: The time-value-of-money


14) If liquid funds are not available, an unexpected need, such as a job loss or injury may force you

to

A) cash in a longer-term investment. B) borrow money fast.

C) take on unexpected debt repayments. D) all of the above.

Answer: DDiff: 3Topic: Principle 5: Stuff happens, or the importance of liquidityAACSB: Analytical Thinking

15) Maiko lost her job and she was forced to sell a rental property because she did not have other

funds (liquid, emergency, etc) available to meet her financial obligations. What financial

principle best applies to this situation?

A) The time value of money

B) Waste not, want notsmart spending matters.

C) Mind games, financial personality, and your money

D) Stuff happens, the importance of liquidity.

Answer: DDiff: 3Topic: Principle 5: Stuff happens, or the importance of liquidityAACSB: Analytical Thinking



16) What aspect of financial planning might you discuss with a friend who buys fancy coffee drinks

twice a day, visits the mall at least once a week for recreational shopping, and prefers impulse

buying to carefully researched purchasing?

A) Just do it.

B) Nothing happens without a plan.

C) Mind games, financial personality, and your money

D) Waste not, want notsmart spending matters.

Answer: DDiff: 2Topic: Principle 6: Waste not, want not, smart spending mattersAACSB: Reflective Thinking

17) Which of the following falls under the category of mind games, financial personality, and your

money?

A) The sunk cost effect

B) Mental accounting

C) Viewing your tax refund as ʺmad moneyʺ

D) All of the above

Answer: DDiff: 2Topic: Principle 9: Mind games, your personality, and your moneyAACSB: Reflective Thinking

18) Leticia is twenty-two years old and she has all of her savings in a Certificate of Deposit (CD) at

the bank that currently pays an annual 1.5 percent yield. The account is protected by the FDIC

so it is virtually risk free. She hopes to use her savings for a down payment on a new house in

ten years. Inflation in house prices in her area has averaged 4 percent per year. What financial

principle does she need to pay better attention to?

A) Nothing happens without a plan.

B) Waste not, want not, smart spending matters.

C) Risk and return go hand in hand.

D) All of the above are correct.

Answer: CDiff: 3Topic: Principle 8: Risk and return go hand in handAACSB: Diverse and Multicultural Work Environments

19) Charlie is sixty-four years old and is looking forward to his retirement next year. He currently

has all of his 401(k) retirement money invested in the stock market. What financial principle

from Chapter 1 does he need to understand better?

A) Nothing happens without a plan.

B) Knowledge is the best protection.

C) Stuff happens, the importance of liquidity.

D) Risk and return go hand in hand.

Answer: DDiff: 3Topic: Principle 8: Risk and return go hand in handAACSB: Diverse and Multicultural Work Environments



20) In 2008, the Bear Stearns Company collapsed could not be saved and was sold to JP Morgan

Chase for $10 per share, a price far below its pre-crisis 52-week high of $133.20 per share. Prior

to the collapse, many of the companyʹs employees had all of their retirement money invested

only in Bear Stearns common stock. This was a very risky financial strategy for just such a

reason: What if the company dissolves? What financial principle from Chapter 1 did they need

to understand better?

A) Risk and return go hand in hand.

B) Nothing happens without a plan.

C) The time value of money

D) Stuff happens, the importance of liquidity.

Answer: ADiff: 3Topic: Principle 8: Risk and return go hand in handAACSB: Diverse and Multicultural Work Environments

21) Matthew bought a used car last month for $2,400. He just found out he needs a new

transmission that will cost $2,400 to install. He is asking you for advice as to what he should do.

What financial principle would you use to base your advice on?

A) Waste not, want not, smart spending matters.

B) Mind games, financial personality, and your money

C) Protect yourself from major catastrophes.

D) None of the above would be correct.

Answer: BDiff: 3Topic: Principle 9: Mind games, your personality, and your moneyAACSB: Reflective Thinking

22) Jessica is very proud of herself for having $5,000 in her savings account that pays 4 percent

interest. She currently has a balance of $2,300 on her credit card account that charges 21 percent

interest. Jessica thinks she is making a wise financial decision by keeping her money in her

savings account instead of paying off her credit card balance. What financial principle from

Chapter 1 would you use to give her good advice?

A) Mind games, financial personality, and your money

B) The time value of money

C) Taxes affect personal financial decisions.

D) Both A and C

Answer: DDiff: 3Topic: Principle 9: Mind games, your personality, and your moneyAACSB: Diverse and Multicultural Work Environments

23) Which of the following adheres to the financial principle ʺjust do it?ʺ

A) The amount you can spend is whatʹs left after you put aside your savings.

B) Pay yourself last.

C) Itʹs much easier to save than to spend.

D) All of the above

Answer: ADiff: 3Topic: Principle 10: Just do itAACSB: Reflective Thinking



24) A solid understanding of personal finance will

A) enable you to protect yourself from an incompetent investment advisor.

B) allow you to take advantage of changes in the economy.

C) give you the ability to make intelligent investments.

D) help you understand the importance of planning for your financial future.


Answer: EDiff: 3Topic: Principle 1: The best protection is knowledgeAACSB: Reflective Thinking

25) List the ten principles of personal finance.

Answer: Principle 1: The best protection is knowledge.

Principle 2: Nothing happens without a plan.

Principle 3: The time value of money

Principle 4: Taxes affect personal finance decisions.

Principle 5: Stuff happens, or the importance of liquidity.

Principle 6: Waste not, want notsmart spending matters.

Principle 7: Protect yourself against major catastrophes.

Principle 8: Risk and return go hand in hand.

Principle 9: Mind games, your financial personality, and your money

Principle 10: Just do it!Diff: 3Topic: Ten Principles of Personal FinanceAACSB: Diverse and Multicultural Work Environments


Chapter 2Measuring Your Financial Health and Making a Plan

2.1 Using a Balance Sheet to Measure Your Wealth

1) Insolvency results from earning more than you spend.

Answer: FALSEDiff: 2Topic: Net WorthAACSB: Reflective Thinking

2) In some cases insolvency can lead to bankruptcy.

Answer: TRUEDiff: 3Topic: Net WorthAACSB: Analytical Thinking

3) Net income is used in calculating oneʹs net worth.

Answer: FALSEDiff: 3Topic: Net WorthAACSB: Analytical Thinking

4) To calculate your net worth, subtract your total debt from your total assets.


5) According to the Keown book, the median net worth for American families in which the head of

the household is less than 35 years old is below $10,000.


6) A vehicle leased in your name is an example of a tangible asset that you would list on your

balance sheet.

Answer: FALSEDiff: 2Topic: Balance SheetAACSB: Analytical Thinking

7) The house that you are leasing from a landlord is an example of a tangible asset that you would

list on your balance sheet.

Answer: FALSEDiff: 2Topic: Balance SheetAACSB: Analytical Thinking



8) The term ʺfair market valueʺ refers to how the price of an asset has changed since its original

purchase.

Answer: FALSEDiff: 3Topic: Fair Market ValueAACSB: Analytical Thinking

9) Current liabilities are those that can typically be paid off in full within 12 months.

Answer: TRUEDiff: 1Topic: LiabilitiesAACSB: Analytical Thinking

10) To determine your net worth, subtract your liabilities from your positive net equity.

Answer: FALSEDiff: 2Topic: Net WorthAACSB: Analytical Thinking

11) Before you can hope to achieve your financial goals, you will need to first measure your current

financial health and develop a plan and a budget.

Answer: TRUEDiff: 1Topic: Nothing Happens without a PlanAACSB: Reflective Thinking

12) Planning and budgeting requires

A) control. B) financial restraint.

C) discipline. D) all of the above.

Answer: DDiff: 1Topic: BudgetAACSB: Analytical Thinking

13) The first section of a balance sheet represents your

A) net worth. B) financial goals. C) assets. D) liabilities.

Answer: CDiff: 2Topic: Balance SheetAACSB: Analytical Thinking

14) When measuring your current financial health it is important to create

A) positive net worth.

B) a personal balance sheet.

C) an income statement.

D) positive net income.

E) both B and C.

Answer: EDiff: 2Topic: Balance SheetAACSB: Analytical Thinking


Chapter 2 Measuring Your Financial Health and Making a Plan 25

15) Assets that you purchase for the purpose of accumulating wealth to satisfy your financial goals

are called

A) monetary assets. B) intangible assets.

C) investment assets. D) all of the above.


16) Liabilities are best described as

A) monetary items of value that you own.

B) financial debts and obligations that you owe.

C) your net worth.

D) assets that depreciate over time.

E) intangible obligations.

Answer: BDiff: 1Topic: LiabilitiesAACSB: Analytical Thinking

17) ________ can be more than or less than the price you paid for a given asset, depending on what

others are willing to pay for that asset today.

A) Net value B) Fair market value

C) Intrinsic value D) Sentimental value

Answer: BDiff: 3Topic: Fair Market ValueAACSB: Analytical Thinking

18) Your ________include cash, checking and savings account balances, and money market funds.

A) monetary assets B) tangible assets

C) physical assets D) investment assets

Answer: ADiff: 3Topic: AssetsAACSB: Analytical Thinking

19) The term ʺfair market valueʺ refers to

A) what an asset could be sold for today.

B) what you paid when you purchased an asset.

C) what an asset will be worth at some point in the future.

D) how the price of an asset has changed since its original purchase.

Answer: ADiff: 2Topic: Fair Market ValueAACSB: Analytical Thinking



20) The common thread among investment assets is that

A) they are purchased for the purpose of generating wealth.

B) they are purchased for oneʹs personal use, like a vehicle or residence.

C) they provide the liquidity needed in case of an emergency.

D) they must be easily turned into cash with little or no loss in value.

Answer: ADiff: 2Topic: AssetsAACSB: Diverse and Multicultural Work Environments

21) Your financial situation is insolvent when

A) your expenses exceed your income. B) your assets are less than your liabilities.

C) your net worth is positive. D) your debt ratio is too high.

Answer: BDiff: 3Topic: SolvencyAACSB: Analytical Thinking

22) Which of the following are not typically found on a balance sheet?

A) Monetary assets

B) Mortgage interest payments

C) Homeʹs current market value

D) Interest earned on a CD

E) Both B and D

Answer: EDiff: 2Topic: Balance SheetAACSB: Analytical Thinking

23) Which of the following items would not be included on a balance sheet?

A) Balances owed on your utility bills

B) Balances owed on your credit card(s)

C) Mortgage payment paid

D) Automobile loan balance

E) Student loan balance




24) Which financial planning document should you use to measure your current financial

condition?

A) Budget

B) Cash budget

C) Balance sheet

D) Income statement

E) Statement of financial ratios


25) Items on the balance sheet that represent amounts owed to others are termed

A) assets.

B) liabilities.

C) revenues.

D) expenses.


Answer: BDiff: 2Topic: LiabilitiesAACSB: Analytical Thinking

26) When including an asset such as a car on your balance sheet

A) list its current value as indicated in a blue book or site like www.edmunds.com.

B) list the original purchase price of the vehicle.

C) list the amount it would cost to purchase a new model of this vehicle.

D) none of the above.

Answer: ADiff: 1Topic: Blue BookAACSB: Analytical Thinking

27) A physical asset such as a high-definition, flat-screen TV or a Harley Davidson motorcycle is

called a(n)

A) financial asset. B) liability. C) tangible asset. D) investment.

Answer: CDiff: 2Topic: AssetsAACSB: Analytical Thinking



28) Describe the three sections included in a personal balance sheet.

Answer: A personal balance sheet consists of three parts: assets, liabilities, and net worth. Assets

include the value of monetary assets, investments, retirement plans, housing,

automobiles, personal property, and other assets. Liabilities consist of current bills, credit

card debt, home mortgages, and other long term debts such as automobile loans. Your net

worth, determined by subtracting liabilities from assets, is the part of your assets that are

free and clear of debt.Diff: 3Topic: Balance SheetAACSB: Analytical Thinking

29) Why is the balance sheet a useful tool?

Answer: The balance sheet is a useful tool to examine your current financial position. A financial

snapshot, the balance sheet tells you how much wealth you have accumulated as of a

certain date. The balance sheet also supplies the numbers for financial ratios that will help

you measure your financial health against common standards.Diff: 3Topic: Balance SheetAACSB: Analytical Thinking

2.2 Using an Income Statement to Trace Your Money

1) The interest charge on your credit card statement should be listed on your personal income

statement as a variable expense.

Answer: TRUEDiff: 3Topic: Income StatementAACSB: Analytical Thinking

2) An income statement tracks the amount of money you have coming in and going out over some

period of time, such as a month or a year.

Answer: TRUEDiff: 1Topic: Income StatementAACSB: Analytical Thinking

3) Your net worth, or your general level of financial worth, is found by

A) subtracting your expenses from your income.

B) dividing your monetary assets by your current liabilities.

C) subtracting your liabilities from your assets.

D) dividing monthly debt (less a mortgage payment) by monthly income.

E) subtracting current liabilities from monetary assets.

Answer: CDiff: 1Topic: Net WorthAACSB: Analytical Thinking



4) A personal income statement is prepared

A) on an accrual basis. B) on a cash basis.

C) based on actual cash flows. D) Both B and C.

Answer: DDiff: 2Topic: Income StatementAACSB: Analytical Thinking

5) Practical uses of an income statement include

A) determining whether you are spending more than you earn.

B) spotting problem areas of overspending.

C) determining if money is available for saving or investing.

D) knowing where your money is going.

E) all of the above

Answer: EDiff: 2Topic: Income StatementAACSB: Reflective Thinking

6) An expenditure over which you have no control and are obligated to make is a

A) repeating expenditure.

B) fixed expenditure.

C) constant expenditure.

D) long-term expenditure.

E) contractual expenditure.

Answer: BDiff: 1Topic: ExpendituresAACSB: Analytical Thinking

7) An expenditure that you can control over time and that you can manage is a(n)

A) variable expenditure.

B) fixed expenditure.

C) constant expenditure.

D) short-term expenditure.

E) adjustable expenditure.

Answer: ADiff: 1Topic: ExpendituresAACSB: Analytical Thinking



8) Which of the following might be found on an income statement?

A) Wages and salaries

B) Interest and dividends

C) Income taxes paid

D) Payroll taxes paid

E) All of the above

Answer: EDiff: 2Topic: Income StatementAACSB: Analytical Thinking

9) How would an income statement help you create a financial plan?

A) Spot potential areas of gambling.

B) Determines whether you are earning more than you spend

C) Determines your net worth

D) Allows you to track future income

Answer: BDiff: 3Topic: Income StatementAACSB: Reflective Thinking

10) Which type of expenditure would probably be the hardest for an individual to track?

A) Credit card

B) Cash

C) Checks written

D) Automatic payments

E) Direct deposits

Answer: BDiff: 2Topic: ExpendituresAACSB: Reflective Thinking

11) Which of the following would be included on a personal income statement?

A) Your 401(k) balance

B) Buying a flat-screen TV on credit

C) Making a payment to your credit card company

D) All of the above

Answer: CDiff: 3Topic: Cash FlowsAACSB: Analytical Thinking

12) If your liabilities are greater than the value of your assets you are considered

A) unstable. B) bankrupt. C) insolvent. D) unbalanced.




13) A statement that records where your money has come from and where it has gone over some

period of time is called a(n)

A) income statement. B) balance sheet.

C) statement of net worth. D) none of the above

Answer: ADiff: 2Topic: Income StatementAACSB: Analytical Thinking

14) An expenditure over which you have control and are not obligated to make, and which may

vary from month to month is called a ________ expenditure.

A) fixed B) flexible C) liquid D) vacillating


15) An expenditure over which you have no control, are obligated to make, and is generally at a

constant level each month is called a ________ expenditure.

A) fixed

B) flexible

C) stationary

D) discretionary


Answer: ADiff: 1Topic: ExpendituresAACSB: Analytical Thinking

16) Suppose that Jacobʹs assets include a motorcycle worth $12,000 and a checking account with a

$3,000 balance, while his liabilities include a credit card balance of $4,000 and a motorcycle loan

balance of $7,000. What is his net worth?

A) $4,000 B) $5,000 C) $7,000 D) $12,000

Answer: ADiff: 2Topic: Net WorthAACSB: Analytical Thinking

17) Suppose that Cathyʹs assets include an automobile worth $10,000 and a checking account with a

$5,000 balance, while her liabilities include a student loan balance of $2,000 and a car loan

balance of $8,000. What is her net worth?

A) $10,000 B) $8,000 C) $5,000 D) $2,000




18) What would happen to your net worth if you sold a tangible asset you owned for $1,000 and

used the money to pay off your credit card balance for $1,000?

A) Since your liabilities decreased, your net worth would increase by $1,000.

B) Since your assets decreased, your net worth would decrease by $1,000.

C) Your net worth would increase by $500.

D) Your net worth would remain the same.

Answer: DDiff: 3Topic: Net WorthAACSB: Analytical Thinking

19) From her annual salary of $72,000, Kierstan has $5,700 automatically deducted for insurance on

an annual basis. Additionally, $9,000 is deducted each year in taxes. When preparing her

personal income statement, what figure should Kierstan enter for her income?

A) $66,300 B) $57,300 C) $63,000 D) $72,000


20) From her annual salary of $60,000, Claudia has $4,500 automatically deducted for insurance on

an annual basis. Additionally, $7,500 is deducted each year in taxes. When preparing her

personal income statement, what figure should Claudia enter for her income?

A) $55,500 B) $48,000 C) $52,500 D) $60,000


21) Suppose that Davidʹs only assets are an automobile worth $10,000 and a checking account with

a $5,000 balance. His only liabilities are a student loan balance of $12,000 and a balance of $9,000

on his car loan. What is his net worth?

A) $21,000

B) $15,000

C) $6,000

D) Doug is currently insolvent with $6,000 negative net worth.

E) None of the above statements are correct.




22) Describe an income statement and its functions.

Answer: Answer: An income statement consists of three parts: income, expenses, and surplus

funds. Income includes revenue from all sources and all parties contributing to the

household. Typical expense items are housing, food, clothing and personal care,

charitable contributions, recreation, medical expenses, insurance, and transportation.

Surplus funds tell if you have any money left over at the end of the month or if you spent

more than you earned. An income statement shows an itemized list of expenditures and

allows you to isolate areas where you are over-spending. The statement is a good

planning tool for budgets and income tax preparation.Diff: 2Topic: Income StatementAACSB: Analytical Thinking

23) Does your use of debt affect your net worth?

Answer: Yes, although this depends on how you use credit. If you use credit to buy tangible assets

like home furnishings, cars, and real estate, then you will have equity in these assets as

you pay down your debt. If you use debt for daily living expenses, travel, and

entertainment, then you have nothing of value to offset your debt or liabilities.Diff: 3Topic: Net WorthAACSB: Analytical Thinking

24) How can an income statement help you stay solvent?

Answer: An income statement can help you stay solvent by indicating whether or not youʹre

earning more than you spend. If youʹre spending too much, your income statement will

show you exactly where your money is going, which will allow you to quickly spot any

problem areas. If you do not spend frivolously, your income statement will indicate how

much of your income is available for saving and for meeting financial goals.Diff: 3Topic: Income StatementAACSB: Reflective Thinking

2.3 Using Ratios: Financial Thermometers

1) Using financial ratios helps you quickly compare and analyze the raw data found in your

personal income statement and balance sheet.

Answer: TRUEDiff: 1Topic: RatiosAACSB: Analytical Thinking

2) A debt ratio is aimed at determining if you have adequate liquidity to meet emergencies.

Answer: FALSEDiff: 1Topic: RatiosAACSB: Analytical Thinking



3) An emergency fund, or rainy-day fund, is comprised of liquid assets sufficient to cover 3.5

years of expenditures.

Answer: FALSEDiff: 2Topic: Emergency FundAACSB: Analytical Thinking

4) According to the Keown book, an emergency fund consists of liquid assets that are sufficient to

cover ________ of expenditures.

A) 1 to 2 months B) 3 to 6 months

C) 9 to 12 months D) 18 to 36 months

Answer: BDiff: 2Topic: Emergency FundAACSB: Analytical Thinking

5) The purpose of using financial ratios is to

A) save space on your financial statements.

B) share your financial figures with your advisors.

C) help analyze your raw data to compare how well you are doing.

D) better understand how you are managing your financial resources.

E) both C and D.

Answer: EDiff: 3Topic: RatiosAACSB: Reflective Thinking

6) A(n) ________ is a reserve or rainy-day fund with money set aside to be used for unexpected

expenses or when normal income has been disrupted.

A) emergency fund B) umbrella fund

C) resources fund D) risk fund

Answer: ADiff: 2Topic: Emergency FundAACSB: Analytical Thinking

7) Which questions do financial ratios help you answer?

A) Do I have adequate liquidity to meet emergencies?

B) Do I have the ability to meet my debt obligations?

C) Am I saving as much as I think I am?

D) All of the above

E) A and B

Answer: DDiff: 2Topic: RatiosAACSB: Reflective Thinking



8) Your ________ is found by dividing monetary assets by current liabilities and is a good measure

of liquidity.

A) debt ratio B) current ratio C) net worth D) net cash flows

Answer: BDiff: 1Topic: RatiosAACSB: Analytical Thinking

9) Your ________ is found by dividing total debt or liabilities by total assets.

A) debt ratio B) current ratio C) net worth D) asset ratio

Answer: ADiff: 1Topic: RatiosAACSB: Analytical Thinking

10) Which of the following would you calculate if you were concerned about your financial

resources with regards to unplanned money emergencies?

A) Liability ratio

B) Debt ratio

C) Long-term debt coverage ratio

D) Current ratio

E) None of the above

Answer: DDiff: 2Topic: RatiosAACSB: Analytical Thinking

11) Suppose that you wanted to calculate a financial ratio to measure your liquidity. You would

most likely use the ________ ratio.

A) debt

B) long-term debt coverage

C) savings

D) current





12) Suppose that you were trying to determine how much income was available for future

monetary needs as well as for investments. Which of the following ratios would you most likely

use?

A) Current ratio

B) Debt ratio

C) Savings ratio

D) Total asset turnover


Answer: CDiff: 1Topic: RatiosAACSB: Analytical Thinking

13) The current ratio is a measure of liquidity that reflects

A) how many current assets you own free and clear.

B) your debt payments for the current period.

C) how many times you can pay off your current liabilities by using your liquid assets.

D) the portion of your total liabilities that are considered current liabilities.

Answer: CDiff: 3Topic: RatingAACSB: Analytical Thinking

14) Cameron has $17,000 in monetary assets and $4,000 in current liabilities. What is his current

ratio?

A) 17,000/4,000 B) .535 times C) 5 times D) 13,000/4,000


15) Kareem has $6000 in monetary assets and $2000 in current liabilities. What is his current ratio?

A) 2,000/6,000

B) .334 times

C) 6,000/2,000

D) 3 times

E) Both C and D are correct.

Answer: EDiff: 2Topic: RatiosAACSB: Analytical Thinking

16) Alysha has $500 in monetary assets and $5,000 in current liabilities. What is her current ratio?

A) .100 percent B) .10 times C) 100 percent D) 10 times




17) Henry currently has $1250 in monetary assets and also has $1250 in current liabilities. What is

his current ratio?

A) 1 time B) 100 percent C) 1 percent D) 0


18) If the people below, with their respective current ratios, were to lose their jobs today, which one

would have more time and more choices until he or she found another job?

A) Christy has a current ratio of 0.85 times.

B) Rick has a current ratio of 2.5 times.

C) Andrew has a current ratio of 1 time.

D) There is not enough information to answer this question.


19) Below are several people and their current ratios. If they were to lose their jobs today, which one

would probably experience financial stress and pressures the quickest?

A) Elmo has a current ratio of 0.5 times.

B) Andy has a current ratio of 2.1 times.

C) Dee has a current ratio of 1 time.



20) Sarah has $15,000 in monetary assets, $48,000 in annual living expenses, a $20,000 balance on

her car loan, and $60,000 of equity in her house. What is her monthʹs living expenses covered

ratio?

A) 1.125 times

B) 3.75 times

C) 3.0 times





21) Patty has $9,000 in monetary assets, annual living expenses of $36,000, a $12,000 car loan

balance, and $45,000 in equity in her house. What is her monthʹs living expenses covered ratio?

A) 1.125 times

B) 3.75 times

C) 3.0 times



22) Jorge has a debt ratio of 37 percent and Jose has a ratio of 102 percent. They both have the same

take-home pay every month. How can we describe their current financial situation?

A) Jorge is currently solvent.

B) Jose is currently insolvent.

C) Jorge probably has more money available to enjoy every month.

D) Jose probably doesnʹt have much money available to enjoy every month.

E) All of the above


23) Hectorʹs monthʹs living expenses covered ratio is 0.25 months. He just broke his leg and will not

be able to work for six weeks. Without a paycheck for six weeks, what will Hector most likely

experience?

A) He may have to liquidate some of his tangible or investment assets to keep current on his

monthly bills.

B) He doesnʹt have to worry because he has plenty of money in his savings accounts.

C) He may have to borrow some money to keep current on his monthly bills


E) Both A and C are realistic possibilities.

Answer: EDiff: 3Topic: RatiosAACSB: Reflective Thinking



Tim and Autumn Davis

Tim and Autumn Davis are trying to figure out their current financial health. They will pay off their car loan

in three years, their gross household income is $5,700 per month, and they receive $95 per month in interest

income from their investments. They have listed the following items from their most recent statements.

Savings account: $3,200

Checking account: $1,800

Credit card balance: $3,000

Car loan balance: $18,000

Car market value: $15,000

Furniture market value: $4,000

Stocks and bonds: $15,000

24) What is their current net worth?

A) $21,000 B) $39,000 C) $18,000 D) $(21,000)


25) Assuming that they have no current bills other than those that are listed, what is their current

ratio?

A) 0.79 times B) $5,000/$3,000

C) 2 times D) Not enough information available


26) What is their debt ratio?

A) 123 percent B) 3 times C) 1.23 times D) 0.54 percent


27) What is their monthʹs living expenses covered ratio?

A) 2 months

B) 1.23 months

C) 1.75 months

D) Not enough information to answer this question




Hector and Maria Montez

Hector and Maria Montez are trying to figure out their financial health. They will pay off their car loan in

three years, their gross household income is $3,800 per month, and they receive $75 per month in interest

income from their investments. They have listed the following items from their most recent statements.

Savings account: $1,200

Checking account: $800

Credit card balance: $1,000

Car loan balance: $12,000

Car market value: $8,000

Furniture; market value: $2,000

Stocks and bonds: $10,000

28) What is their current net worth?

A) $13,000 B) $22,000 C) $9,000 D) $35,000 E) $(13,000)


29) Assuming that they have no current bills other than those that are listed, what is their current

ratio?

A) 0.59 times

B) 2000/1000

C) 2 times

D) Both B and C are correct.

E) Not enough information available


30) What is their debt ratio?

A) 169 percent

B) 1.69 times

C) 0.59 percent

D) 0.59 times

E) 2 times




31) What is their monthʹs living expenses covered ratio?

A) 2 months

B) 2.44 months

C) 1.69 months

D) 0.5 months

E) Not enough information to answer this question


32) What questions do financial ratios help answer?

Answer: By calculating your current ratio you can answer the question, ʺDo I have adequate

liquidity to meet emergencies?ʺ Debt ratios answer, ʺDo I have the ability to meet my

debt obligations?ʺ ʺAm I saving as much as I think I am?ʺ is answered by the savings

ratio.Diff: 2Topic: RatiosAACSB: Reflective Thinking

33) How do you calculate the current ratio, debt ratio, and savings ratio?

Answer: Current ratio is calculated by dividing total current assets by total current liabilities. A

ratio of 1.0 will get you by, but a ratio of 2.0 or more is preferred. The debt ratio is

determined by dividing total debt or liabilities by total assets. The savings ratio is found

by dividing the income available for savings and investments by income available for

living expenses.Diff: 1Topic: RatiosAACSB: Analytical Thinking

34) Explain the relationship between the debt ratio and insolvency?

Answer: The debt ratio shows the relationship between your assets, or how much you own, and

your liabilities, or how much you owe. Your assets minus your liabilities equals your net

worth. If your debt ratio is a fraction below 1.0, then your assets are larger than your

debt, leaving you solvent with positive net worth. If your debt ratio is larger than 1.0,

then your debt is greater than your assets, leaving you insolvent with negative net worth.Diff: 3Topic: RatiosAACSB: Analytical Thinking



35) A financial ratio by itself is of little value. To what can you compare your financial ratios to

make them valuable financial planning tools?

Answer: Financial ratios can be compared to historical ratios, projected or budgeted ratios, expert

advice, or industry averages. If I knew my savings ratio for 2013 was 6 percent and my

savings ratio for 2015 is 8 percent, then I know I have made an improvement in freeing up

cash for savings and investment. If I budgeted my savings ratio for 2015 to be 10 percent

and it is currently running at 8 percent, then I know I am not on track to meet my

budgeted goals for the year. I can then analyze my income and expenditures to see why I

am not on track to meet my goals, or possibly my goals were not realistic based on

current conditions. If my savings ratio is currently 8 percent and the experts say that the

ideal or average savings ratio should be 15 percent, then I can measure how well Iʹm

doing compared to these benchmarks and adjust accordingly.Diff: 3Topic: RatiosAACSB: Analytical Thinking

2.4 Record Keeping

1) According to the Keown book, Mint and Level Money are two of the best smartphone apps for

tracking your spending and setting up a budget.

Answer: TRUEDiff: 2Topic: BudgetAACSB: Reflective Thinking

2) Which of the following is the best type of record-keeping system to use in maintaining financial

records?

A) Manual method with pencil and notebook

B) Computer software

C) Apps

D) All of the above

Answer: DDiff: 1Topic: Record KeepingAACSB: Reflective Thinking

3) According the Keown book, which Web-based personal financial planning website is known as

ʺthe best free way to manage your money?ʺ

A) Mint.com B) Levelmoney.com

C) YahooFinance.com D) WSJ.com




4) According to the Keown book, the most popular personal financial management program for

the PC is

A) Intuitʹs Quicken. B) MoneyGuidePro.

C) Financial Peace. D) Crown Financial.


5) A strong record-keeping system allows you to

A) track expenses.

B) know exactly how much youʹre spending.

C) know where youʹre spending your financial resources.

D) all of the above.

Answer: DDiff: 1Topic: Record KeepingAACSB: Analytical Thinking

6) According to the Keown book, what are the three primary reasons for maintaining financial

records?

Answer: First, without adequate records, it is extremely difficult to prepare taxes. Second, a strong

record-keeping system allows you to track expenses in order to know exactly how much

youʹre spending and where youʹre spending it. Without that knowledge, you will not

have control over your finances. Third, organized record-keeping makes it easier for

someone else to step in during an emergency and understand your financial situation.Diff: 3Topic: Record KeepingAACSB: Analytical Thinking

2.5 Putting It All Together: Budgeting

1) An estimate of your anticipated after-tax income available for living expenses is commonly

called take-home pay.

Answer: TRUEDiff: 2Topic: ExpendituresAACSB: Analytical Thinking

2) A budget is a process of setting spending goals for the upcoming month or year.

Answer: TRUEDiff: 2Topic: BudgetAACSB: Analytical Thinking



3) Having negative net income every once in a while is not such a bad thing as long as you have

planned for it.

Answer: TRUEDiff: 2Topic: Income ReturnsAACSB: Reflective Thinking

4) From the Keown book, you have learned that a budget

A) can be simple or sophisticated.

B) is a process of setting spending goals for the upcoming month or year.

C) is a plan for controlling cash inflows and outflows.

D) includes both actual and estimated expenses.


Answer: EDiff: 2Topic: BudgetAACSB: Reflective Thinking

5) Which of the following financial documents would you to use to create a financial plan?

A) Balance sheet

B) Income statement

C) Budget

D) Cash budget

E) All of the above


6) Suppose that you have been operating an online marketing business out of your home, and the

business has recently expanded beyond belief. Since you have neglected your personal finances

for some time, what would you do as a first step?

A) Separate your personal finances from the business finances.

B) Combine your personal finances and business finances to save time.

C) Rent a separate office for your business activities.

D) Purchase a software program to handle both your business and personal finance at the

same time.




7) A plan for controlling and forecasting your cash inflows and cash outflows is called a(n)

A) income statement.

B) balance sheet.

C) cash budget.

D) statement of changes in financial position.


Answer: CDiff: 1Topic: BudgetAACSB: Analytical Thinking

8) Bradley went shopping today and used his American Express credit card to buy a new pullover

sweater. He used his bank debit card to pay for a video game and bought some snack food with

cash. Which of these purchases are difficult to track and monitor on his budget?

A) The pullover sweater is difficult to track because it costs more than what he budgeted for

clothing this month.

B) The video games are difficult to track because he did not add a budget category for

electronics.

C) The snacks are difficult to track because cash transactions donʹt leave a paper trail.

D) Both A and B

Answer: CDiff: 2Topic: BudgetAACSB: Analytical Thinking

George and Betty

George and Betty, a middle-aged couple, have watched their savings account dwindle over the years. They

both make good incomes and canʹt understand why they arenʹt saving more each month. Below is their

financial information to complete an income statement.

Gross monthly income: $8,000

Income taxes withheld monthly: $2,300

Monthly interest income from investments: $100

Monthly insurance payments: $700

Monthly housing expenses: $4,500

Monthly food expenses: $800

Miscellaneous expenses: $400

9) What is George and Bettyʹs net income?

A) $1,700

B) $(600)

C) $(500)

D) $1600

E) Not enough information available to answer question




10) What is their current savings ratio?

A) 10.3 percent B) negative 10.3 percent

C) zero D) None of the above


11) George and Betty ask you for financial advice. What would you tell them to do?

A) They should hire a Certified Financial Planner to assist them.

B) Nothing. With their income they are in good shape financially.

C) They need to live within their means.

D) Both A and C would be good advice for them.

Answer: DDiff: 1Topic: Record KeepingAACSB: Analytical Thinking

12) Explain the steps in developing a cash budget.

Answer: First, determine your anticipated income by referring to last yearʹs adjusted income. Next,

estimate your level of taxes to determine after-tax income available for living expenses.

Add fixed and variable expense estimates together to determine your level of spending.

Last, subtract living expenditures from expected take-home pay to calculate income

available for savings and investment.Diff: 2Topic: BudgetAACSB: Analytical Thinking

13) Describe how to implement the ʺenvelopeʺ budgeting system.

Answer: For those new to budgeting or those with small amounts of self-discipline, the envelope

system is useful. Use a separate envelope for each major monthly expense, including one

for miscellaneous, and label each with the expense name. From the appropriate paycheck

or source of income, allocate the proper amount of money for each envelope. Use the

money in each envelope only for its intended use, and you should have enough to go

around. As soon as possible, add an envelope for savings and emergencies.Diff: 3Topic: Financial PlanningAACSB: Analytical Thinking



14) What are some benefits of using a mobile app coupled with a Web-based personal financial

planning website? Which two websites/apps are highly recommended by the author?

Answer: Many personal financial planning apps and websites allow you to keep an eye on your

financial moves. Several allow you to simultaneously track all bank accounts, credit

cards, retirement accounts, investments, and loans. Mint.com, a free app and website, is

one such tool. It also allows you to create a budget based on your actual spending and

helps you plan for your financial goals. Another example is Levelmoney.com. Free,

simple, and effective, Level Money works like a gas gauge, monitoring your spending

and keeping you from getting into financial trouble. Both Mint.com and Levelmoney.com

are highly recommended by the author.Diff: 3Topic: Financial PlanningAACSB: Information Technology

2.6 Hiring a Professional

1) Commission-only planners charge fees and collect commissions on products they recommend.

Answer: FALSEDiff: 1Topic: ProbateAACSB: Reflective Thinking

2) As long as a financial planner is certified you need not worry about his ability to provide you

with the correct financial plan for your situation.

Answer: FALSEDiff: 1Topic: Professional Financial PlannersAACSB: Reflective Thinking

3) ________ planners charge a fee that is reduced by the amount of the commissions they earn.

A) Fee-only B) Fee-and-commission

C) Fee-offset D) Commission-based

Answer: CDiff: 2Topic: Professional Financial PlannersAACSB: Analytical Thinking

4) Which of the following is a relevant question to ask a financial planner?

A) What are your credentials and professional designations?

B) Would you provide us with references?

C) Would you show us a similar financial plan you have done for someone else?

D) Will you provide us with a written estimate of your services and their cost?

E) All of the above

Answer: EDiff: 3Topic: Professional Financial PlannersAACSB: Reflective Thinking



5) Under what conditions should people hire a professional financial planner?

A) When they need someone to improve or validate the plan they prepared themselves

B) When they start receiving late payment penalties from their creditors

C) When it is apparent their financial planning skills are limited

D) When they run into complex tax or legal issues

E) All of the above

Answer: EDiff: 3Topic: Professional Financial PlannersAACSB: Reflective Thinking

6) What are the four choices in managing your financial affairs?

Answer: The most simple approach is to manage your finances yourself. A second choice is to

jointly plan your finances with a professional planner. A third choice is to let a

professional planner compile the entire plan together for you. If you develop your own

plan, you might want a professional planner to validate what you have done.Diff: 2Topic: Financial PlanningAACSB: Reflective Thinking

7) Prepare a list of questions to ask a prospective financial planner you are considering.

Answer: 1. How long have you been a financial planner?

2. What are your credentials and professional designations?

3. Do you actively participate in continuing education to keep up with the times?

4. How do you keep up with the latest financial changes?

5. Will you provide us with references?

6. Will you let me see a copy of a financial plan you created for someone else in similar

circumstances?

7. Who will work with you on my plan? Will the work be done by a junior staffer or a

computer program?

9. Are you paid through fees, commissions, or a combination? What are your fees and

commissions, how often are you paid, and how will your fees and commissions be

calculated?

10. Will you provide a written estimate of the services I expect and the cost of those

services?Diff: 2Topic: Professional Financial PlannersAACSB: Reflective Thinking

8) List the benefits a professional financial planner can offer.

Answer: A financial planner has the knowledge and skills to teach you the financial axioms. From

an objective point of view, the pro will be able to help you prepare balance sheets, income

statements, budgets, and financial ratios, as well as savings, investment, and retirement

plans that are realistic. A financial planner can save you time and costly mistakes. He or

she may suggest a computer software program to meet your individual needs, as well as

give tax advice.Diff: 2Topic: Professional Financial PlannersAACSB: Reflective Thinking



9) The experts say that, stereotypically, a fee-only financial planner is a better option than one who

earns commissions on what he or she sells you. Why is this sometimes true?

Answer: Because of the agency relationship and self-interested behavior, a commission-earning

financial planner may be more interested in the commissions he or she will earn versus

what is best for your personal needs. There is the potential for the planner to recommend

financial products that pay higher commissions, when these products may not be best

suited to your individual needs, or when there may be less expensive options available. A

fee-only planner has no such incentive, since the fees are not contingent on your financial

decisions. The fee-only planner knows that he or she must do a good job or you will not

continue to utilize their services or refer new business to them.Diff: 3Topic: Financial PlanningAACSB: Reflective Thinking


Chapter 3Understanding and Appreciating the Time Value of Money

3.1 Compound Interest and Future Values

1) Compounding is when the interest you have already earned on an investment earns interest.

Answer: TRUEDiff: 2Topic: CompoundingAACSB: Analytical Thinking

2) Your money grows faster as the compounding period becomes longer.

Answer: FALSEDiff: 3Topic: CompoundingAACSB: Analytical Thinking

3) An investment earning 12 percent interest per year should double in value in approximately

four years.

Answer: FALSEDiff: 2Topic: Rule of 72AACSB: Analytical Thinking

4) The present value of a financial asset is what you should be willing to pay today for that

financial asset.

Answer: TRUEDiff: 2Topic: Time Value of MoneyAACSB: Analytical Thinking

5) Time Value of Money calculations can be made much easier through the use of a financial

calculator.

Answer: TRUEDiff: 1Topic: Calculator SkillsAACSB: Information Technology

6) If you set your calculator to the ʺendʺ mode your calculator will assume cash flows occur at the

end of each time period.



Chapter 3 Understanding and Appreciating the Time Value of Money 51

7) The I/Y key on a financial calculator stores the information for the interest rate or the discount

rate per period.


8) You currently have $11,167 in your savings account. What interest rate do you need to earn in

order to have $20,000 in the account in 10 years?

A) 6%

B) 8%

C) 10%

D) There is not enough information to solve this question.

Answer: ADiff: 2Topic: Calculator SkillsAACSB: Analytical Thinking

9) The ________ Principle states that a dollar today is worth more than a dollar in the future.

A) Future value of money

B) Discounted value of money

C) Adjusted value of money

D) Time value of money

E) Annuity value of money

Answer: DDiff: 1Topic: Time Value of MoneyAACSB: Analytical Thinking

10) The current value in todayʹs dollars of a future sum of money is called

A) future value.

B) adjusted value.

C) compounded value.

D) present value.

E) discounted value.

Answer: DDiff: 1Topic: Present ValueAACSB: Analytical Thinking

11) The dollar value of an investment at some future point in time is also known as

A) future value.

B) present value.

C) compounded annuity.

D) the time value of money.

E) calculated value.

Answer: ADiff: 1Topic: Future ValueAACSB: Analytical Thinking



12) Allowing the interest that you earn on an investment to stay in the investment and to earn

interest on the interest you have already earned is called what?

A) The power of of present value

B) The power of compound interest

C) The power of simple interest

D) The power of time

E) The power of future value

Answer: BDiff: 1Topic: CompoundingAACSB: Analytical Thinking

13) A one-time investment of $1,500 at a 10 percent annual rate of return yields $2,196 in two years.

The $2,196 is known as the

A) present value.

B) compound value.

C) principal plus interest.

D) future value.

E) annuity value

Answer: DDiff: 3Topic: Future ValueAACSB: Analytical Thinking

14) John Madrid put $1,000 into a mutual fund yielding an 18% annual rate of return. Using the

Rule of 72, calculate approximately how long it will take for the investment to double in value.

A) Three years, four months

B) Three years and seven months

C) Four years

D) Four years and four months

E) Five years

Answer: CDiff: 2Topic: Rule of 72AACSB: Analytical Thinking

15) Samantha Jee put $3,000 into a mutual fund yielding a 12 percent annual rate of return. Using

the Rule of 72, calculate approximately how long it will take for the investment to double in

value.

A) Two years B) Two years and four months

C) Six years D) Seven years and four months




16) This helpful investment rule-of-thumb tells you approximately how many years it takes for a

sum of money to double in size.

A) Rule of compound interest

B) Rule of 72

C) Rule of 100

D) Rule of future value

E) Rule of annuity doubling

Answer: BDiff: 1Topic: Rule of 72AACSB: Diverse and Multicultural Work Environments

17) By the Rule of 72, what annual interest rate would be required to turn $100 into $200 in

approximately six years?

A) 4% B) 8% C) 12% D) 16%


18) Suppose that you invested $100 in a bank account that earned an annual rate of return of 10%.

How much would you have in that bank account at the end of 10 years?

A) $259.37 B) $238.55 C) $293.74 D) $214.46 E) $279.23


19) You have just placed $500 in a bank account that earns an annual rate of return of 6%. How

much will you have in that bank account after 6 years?

A) $652.48 B) $709.26 C) $787.66 D) $758.66 E) $801.68

Answer: BDiff: 2Topic: Future ValueAACSB: Analytical Thinking

20) As a future graduation present, you uncle has just placed $6,000 in a bank account that will earn

an annual rate of return of 6%. How much will be in that account when you graduate in four

years?

A) $7,731.55 B) $6,752.56 C) $6,247.70 D) $7,790.63 E) $7,574.86

Answer: EDiff: 3Topic: Future ValueAACSB: Analytical Thinking



21) Suppose that you placed $500 in a bank account at the end of each year for the next 10 years.

How much would be in that account at the end of the tenth year if the deposits earned an

annual rate of return of 8% each year?

A) $8,079.46 B) $5,400.00 C) $7,243.28 D) $6,355.04 E) $7,774.51

Answer: CDiff: 3Topic: Future ValueAACSB: Analytical Thinking

22) Suppose that you want to create a ʺcollege fundʺ for your newborn child and place $300 in a

bank account at the end of each of the next 20 years. If that account earns an annual rate of

return of 7%, how much will be in that account at the end of the twentieth year?

A) $13,420.00

B) $12,977.53

C) $13,178.20

D) $11,828.32

E) $12,298.65

Answer: EDiff: 3Topic: Future ValueAACSB: Analytical Thinking

23) Your great-uncle placed $500 a year in a bank account for your ʺcollege fundʺ for each of the

last 18 years. How much is now in your college account (at the end of the eighteenth year) if

your account earned an annual rate of return of 6%?

A) $15,452.83

B) $15,175.17

C) $16,427.17

D) $15,413.80

E) $15,546.18


24) Which financial planning concepts should be helpful to a couple planning for how much money

to start saving for their retirement?

A) Reinvesting

B) Compound interest

C) Future values

D) Present values

E) All of the above

Answer: EDiff: 3Topic: Time Value of MoneyAACSB: Analytical Thinking



25) A method by which one can compare cash flows across timeeither as what a future cash flow

is worth today (present value) or what an investment made today will be worth in the future

(future value)is called

A) time-value of money. B) compounding.

C) simple interest. D) opportunity cost.

Answer: ADiff: 2Topic: Time Value of MoneyAACSB: Analytical Thinking

26) You have been saving toward the purchase of a new mountain bike. Five years ago, you placed

$600 in a bank account, and you have since earned an annual rate of return of 12 percent. How

much do you now have in your account?

A) $1,057.41 B) $1,293.71 C) $978.70 D) $1,138.70


27) You have just remembered that four years ago you placed $1,000 in a bank account. If the bank

was paying an annual rate of return of 8% during that time, how much should you have in your

forgotten account?

A) $1,253.03 B) $1,360.49 C) $1,321.92 D) $1,301.92

Answer: BDiff: 2Topic: Future ValueAACSB: Analytical Thinking

28) Your great-aunt wants to help with your college graduation party. She has just placed $5,000

dollars in a bank account that will earn an annual rate of return of 6%. If you graduate in four

years, how much will be in your party account?

A) $7,120.89 B) $6,142.96 C) $5,960.47 D) $6,312.38


29) Suppose that you place $450 in a bank account each year for the next 20 years. How much

would be in your bank account at the end of the twentieth year if the deposits earned an annual

rate of return of 6% each year?

A) $9,540.00 B) $10,876.31 C) $14,729.44 D) $16,553.52




30) Suppose that you want to create a ʺretirement party fundʺ for yourself and place $50 in a bank

account for each of the next 20 years. If that account earns an annual rate of return of 7%, how

much will be in your retirement party fund at the end of the twentieth year?

A) $1,529.70 B) $2,679.22 C) $1,032.57 D) $2,049.77


31) Your daughter has been saving $500 a year for each of the last 10 years for her ʺsweet sixteenʺ

party. How much is now in her party account (at the end of the tenth year) if she earned an

annual rate of return of 6%?

A) $6,590.40 B) $7,680.04 C) $5,300.00 D) $8,714.84


32) If your bank pays you interest in the form of an annual rate of return of 10% over each of the

next five years, how much will your balance be if you make annual deposits of $400?

A) $2,248.37 B) $2,644.20 C) $2,516.31 D) $2,442.04


33) Using the Rule of 72, approximately how long will it take to double your money if you invest it

at 8% compounded annually?

A) 6 months

B) 9 months

C) 6 years

D) 9 years

E) It depends on the amount of the initial investment.


34) Using the Rule of 72, if it will take approximately 12 years for your money to double, at what

annually compounded interest rate is it invested?

A) 6% B) 8% C) 9% D) 12%




35) You invest $1,000 at age 20 at an annual rate of return of 12%. By the time you are 62 you will

have amassed approximately

A) $47,040. B) $67,214. C) $116,723. D) $504,000.

Answer: CDiff: 3Topic: Time Value of MoneyAACSB: Analytical Thinking

36) Describe the effects and benefits of compound interest.

Answer: Compounding interest means that interest earned on the principal of an investment or

savings vehicle is reinvested and will itself earn interest. Should the interest earned be

removed and not reinvested then you wonʹt accumulate a very large amount.Diff: 2Topic: CompoundingAACSB: Analytical Thinking

37) Why is the time value of money an important concept in financial planning?

Answer: The time value of money allows us to see the relationship between time and the value of

accumulated sums of money. We can clearly understand that starting a savings or

retirement plan at a younger age will create much more wealth than waiting to start it at a

later time. It also becomes clear that starting younger means saving a smaller monthly

amount and having the option of skipping some months or years later if it becomes

necessary to do so.Diff: 1Topic: Time Value of MoneyAACSB: Reflective Thinking

38) What are some practical uses of present and future values?

Answer: There are basically two practical uses for these values. Present values will tell you how

much must be saved or invested annually to achieve a future financial goal. It also works

for determining the monthly payment on a loan of a specified amount to be paid back in

the future. Future values show the total future accumulated values of specified sums of

money saved or invested now and into the future. Budgeting and financial planning

would be very difficult if not impossible without the time value of money skills.Diff: 2Topic: Time Value of MoneyAACSB: Reflective Thinking

39) A compound interest table is useful in solving a time value of money problem. Name the

variables involved.

Answer: The interest rate, the period of time involved, the sum of money involved, and the

frequency of compounding are variables to consider when using a compound interest

table.Diff: 1Topic: CompoundingAACSB: Analytical Thinking



3.2 Compounding and the Power of Time an Interest

1) A dollar received in the future is worth more than a dollar received today.

Answer: FALSEDiff: 1Topic: Time Value of MoneyAACSB: Analytical Thinking

2) The earlier you begin saving for your retirement, the easier it will be to reach your financial

goals for retirement.

Answer: TRUEDiff: 1Topic: Time Value of MoneyAACSB: Reflective Thinking

3) It is really pretty easy to create a valuable personal financial plan without understanding the

time value of money principle.

Answer: FALSEDiff: 2Topic: Time Value of MoneyAACSB: Reflective Thinking

4) Charlie is starting to save for his retirement now at age 20. If inflation averages 4% annually

until his retirement age and he earns an annual rate of return of 4% on his investments during

this period, then he should be able to enjoy a very comfortable retirement when he is retired.

Answer: FALSEDiff: 3Topic: InflationAACSB: Analytical Thinking

5) Small changes in the interest rate can have a dramatic impact on future values.

Answer: TRUEDiff: 3Topic: Time Value of MoneyAACSB: Diverse and Multicultural Work Environments

6) At the age of 20, James is starting to save for retirement. If inflation averages 4 percent annually

until his retirement age and he earns an average annual rate of return of 13 percent on his

investments during this period, he should be able to enjoy a comfortable retirement.

Answer: FALSEDiff: 3Topic: Time Value of MoneyAACSB: Analytical Thinking

7) Two of the most important factors in reaching your financial goals are the return on your

investments and the length of time you have until you need your money.




8) Generally speaking, regularly saving a little money when you are young can result in a large

final payoff.


9) It is not realistic for a 20-year-old to accumulate $1 million by the age of 65.


10) Most people achieve comfortable retirements by postponing saving until after age 50, when they

are able to save a large amount on a regular basis.


11) Your money will grow or compound ________ as the number of compounding periods per year

becomes ________.

A) faster; smaller

B) faster; larger

C) slower; larger

D) slower; compounded

E) none of the above are correct

Answer: BDiff: 3Topic: CompoundingAACSB: Analytical Thinking

12) Who will end up with the largest amount of money invested at an annual rate of return of 9%

over the next 42 years?

A) Jim saves $1,200 per year for the first 14 years and then stops putting any new money into

the account for the remaining 28 years.

B) Jeremy saves nothing for the first 14 years and saves $1,200 per year for the next 14 years

and then puts no more money into the account during the last 14 years.

C) Jerry saves nothing for the first 14 years and then saves $1,200 per year for the remaining

28 years.

D) Joey saves nothing for the first 14 years and then saves $1,500 per year for 14 years then

stops putting any new money into the account for the remaining 14 years.

E) John saves nothing for the first 10 years and saves $1,500 per year for the remaining 32

years.

Answer: ADiff: 3Topic: Calculator SkillsAACSB: Analytical Thinking



13) Why should you care about the power of compounding and the time value of money?

A) It is critical to obtaining your future financial goals.

B) The sooner you start saving for retirement, the less you have to save each year.

C) You may outlive your Social Security and employerʹs retirement plan.

D) It is possible to build a large estate for yourself, spouse, and children.

E) All of the above

Answer: EDiff: 3Topic: CompoundingAACSB: Reflective Thinking

14) Is it possible to save $585,000 for retirement instead of $310,000 without requiring much more to

be invested every month?

A) Probably not with inflation working against you

B) Depends upon the interest rate or return you earn on the investment as well as the number

of years until retirement

C) Absolutely not


Answer: BDiff: 2Topic: Time Value of MoneyAACSB: Diverse and Multicultural Work Environments

15) What is the annual interest rate earned on a deposit that grew from $250 to $502.84 over the last

5 years?

A) 15% B) 13% C) 11% D) 9%


16) Suppose that you had deposited $100 in a bank account for each of the last 5 years. What annual

interest rate is attached to this account if there is now (at the end of the fifth year) $758.92 in the

account?

A) 10% B) 16% C) 19% D) 21% E) 23%


17) What is the annual interest rate earned on a deposit that grew from $60 to $111.06 over the last 8

years?

A) 14% B) 12% C) 8% D) 6%




18) One day as you were going through some old memorabilia, you discovered an old savings

account in which you placed $100 twenty years ago. When you checked out the account, it

currently had a balance of $320.71. What annual rate of interest did you earn?

A) 12% B) 10% C) 8% D) 6%


Arnold Diaz

Arnold learned something very valuable as a teenager from his dad. He was told to invest $1,000 at 12%

interest at age 20 and leave it alone until age 65. Arnoldʹs dad knew that one strategy that wealthy people use

is to exercise self-discipline to never touch this long-term plan. Arnold is very happy he applied his dadʹs

advice.

19) Approximately how long will it take Arnoldʹs savings to grow into $2,000?

A) 60 months B) 5 years C) 8.5 years D) 6 years


20) If he sticks to this plan, Arnoldʹs savings will have grown to approximately ________ by age 62.

A) $116,723 B) $163,987 C) $9,646 D) $1,125,945


21) If Arnold were to leave his money in the account until he was 68, by approximately what

amount would the balance increase between his 62nd and 68th years?

A) $113,667 B) $1,096,471 C) $160,457 D) $1,973


22) If his savings account had earned a more conservative 9% annual rate of return, Arnoldʹs

savings would be approximately ________ less by age 68.

A) $4,132 B) $62,585 C) $167,805 D) $1,871,663




23) Suppose the investment rate of return were 18%. At this rate, when would Arnold reach the

$1,000,000 mark?

A) at age 42 B) at age 54 C) at age 62 D) at age 68

Answer: CDiff: 3Topic: Future ValueAACSB: Analytical Thinking

Enrique Martinez

As a teenager, Enrique learned a valuable lesson from his dad, who told him to invest $1,000 at 8 percent

interest at age 20 and leave the money alone until age 65. Enriqueʹs dad knew that one strategy used by

wealthy people is to exercise self-discipline and never touch a long-term savings plan. Enrique is happy to

apply his dadʹs advice.

24) Approximately how long will it take Enriqueʹs investment to grow into $2,000?

A) Seventy-two months B) Six years

C) Nine years D) Twelve years


25) If he sticks to the plan, Enriqueʹs savings will grow to approximately ________ by age 62.

A) $25,339 B) $31,920 C) $4,660 D) $148,780


26) If Enrique leaves the money in the account until he is 68, by approximately what amount would

the balance increase between his 62nd and 68th years?

A) $14,872 B) $108,569 C) $8,291 D) $35,551


27) If his savings account earns a more aggressive 14 percent annual rate of return, Enriqueʹs

savings will be worth approximately ________ more by age 68.

A) $4,145 B) $245,473 C) $498,596 D) $538,807




28) Suppose the annual rate of return is 15 percent. At this rate, when will Enrique reach the

$500,000 mark?

A) Age 45 B) Age 58 C) Age 65 D) Age 70


29) Describe the two factors that affect how much we need to save to achieve financial goals.

Answer: The two variable factors that affect total accumulation are the interest rate received and

the time period the savings/investment is allowed to accumulate. Increasing the interest

rate and/or the period of time to accumulate will create a much larger end product. By

decreasing either of these two factors, total accumulation will be decreased. Experiment

with increasing either of these factors and the results will be both apparent and amazing.Diff: 2Topic: Time Value of MoneyAACSB: Diverse and Multicultural Work Environments

30) List four reasons why you should care about the power of compounding and the time value of

money.

Answer: The concepts are critical to your efforts to achieve financial goals.

The sooner you start saving for retirement, the less you have to save each year.

You may outlive your Social Security benefits and employer retirement plans.

The concepts will help you develop a large estate for yourself, spouse, and children.Diff: 3Topic: CompoundingAACSB: Analytical Thinking

3.3 Present Value-Whatʹs It Worth in Todayʹs Dollars?

1) The present value interest factor is the inverse of the corresponding future value interest factor.


2) Present value lets us compare dollar values from different time periods.


3) The future value of a current investment earning a positive rate of return is always greater than

the present value of the investment.




4) The discount rate is the interest rate used to bring ________ back to ________.

A) current dollars; present dollars

B) future dollars; present dollars

C) current interest rate; present present interest rate

D) future interest rate; present interest rate

Answer: BDiff: 1Topic: Present ValueAACSB: Analytical Thinking

5) Which one of the following is the ʺenemyʺ of compound interest and makes it very difficult to

reach your financial goals?

A) Inflation

B) Annuity factor

C) Simple interest

D) Compound frequency


Answer: ADiff: 3Topic: CompoundingAACSB: Analytical Thinking

6) What is the present value today of $150 that will be received in four years from now if the

discount rate is 12%?

A) $76.03 B) $95.33 C) $116.90 D) $105.60 E) $83.39


7) Rasheed can afford a monthly car payment of $550 for 72 months at an annual interest rate of 7.5

percent. Which of the following is closest to the amount he will be able to borrow for a new car?

A) $3,984 B) $6,550 C) $31,810 D) $49,818

Answer: CDiff: 3Topic: Time Dimension of InvestingAACSB: Analytical Thinking

8) What is the present value of an IOU for $1,000 due to be paid in two years, if the discount rate is

8%?

A) $857.34 B) $766.40 C) $885.00 D) $683.26 E) $810.77

Answer: ADiff: 3Topic: Present ValueAACSB: Analytical Thinking



9) What is the price you would be willing to pay today for an IOU for $500 due in one year if you

want to earn at least 16%?

A) $480.00 B) $431.03 C) $450.00 D) $395.33 E) $418.23


10) At the end of each year for ten years you deposit $750 in an account that earns an annual rate of

return of 12%. What is the present value of these deposits?

A) $4,329.39 B) $5,241.48 C) $3,161.55 D) $4,237.67 E) $4,482.63

Answer: DDiff: 3Topic: Present ValueAACSB: Analytical Thinking

11) Samʹs uncle promised to give him $7,000 when he graduates from college three years from now.

Assuming an interest rate of 8 percent compounded annually, what is the value of Samʹs gift

right now?

A) $5,504.22 B) $5,510.78 C) $5,556.83 D) $5,555.55

Answer: CDiff: 3Topic: Present ValueAACSB: Analytical Thinking

12) Someone has offered you the opportunity to purchase an IOU. The IOU will pay back a total of

$500 in three years. How much would you be willing to pay for that IOU today if you want to

earn an annual rate of return of 16%?

A) $320.33 B) $422.63 C) $292.63 D) $380.45


13) What is the maximum that you would be willing to loan your brother for a $100 IOU if he

promises to pay you back at the end of the year? You want to earn an annual rate of return of

12%.

A) $82.00 B) $89.29 C) $92.73 D) $88.00


3.4 Annuities

1) A perpetuity is an annuity that continues forever.

Answer: TRUEDiff: 2Topic: AnnuityAACSB: Analytical Thinking



2) A compound annuity involves depositing or investing an equal sum of money at the end of each

time period for a certain number of time periods and allowing it to grow.

Answer: TRUEDiff: 1Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

3) An annuity is a series of unequal dollar payments coming at the end of each time period for a

specified number of time periods.

Answer: FALSEDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

4) With a mortgage loan of $150,000 at an annual percentage rate of 6% for 30 years, you will pay

over $150,000 in interest before your loan ends.

Answer: TRUEDiff: 3Topic: CompoundingAACSB: Analytical Thinking

5) With a 30-year mortgage loan of $100,000 at an annual interest rate of 7 percent, you will pay

less $135,000 in interest before your loan ends.

Answer: FALSEDiff: 3Topic: CompoundingAACSB: Analytical Thinking

6) In an amortized loan the earlier payments have a larger portion of the payment going to pay

interest and a smaller portion of the payment to pay down the principle.

Answer: TRUEDiff: 3Topic: Amortized LoanAACSB: Analytical Thinking

7) A compound annuity uses the principles of

A) reinvesting and present value.

B) compound interest and future value.

C) reinvesting and compound interest.

D) compound interest and present value.

E) amortization and reinvesting.

Answer: CDiff: 3Topic: AnnuityAACSB: Analytical Thinking



8) A series of equal dollar payments at the end of each period for ʺxʺ number of time periods is

A) an annuity.

B) a complex annuity.

C) an annuity due.

D) a deferred annuity.

E) an equal installment annuity.

Answer: ADiff: 1Topic: AnnuityAACSB: Analytical Thinking

9) What is the present value of $500 received at the end of each of the next five years worth to you

today at the appropriate discount rate of 6 percent?

A) $1,105 B) $1,850 C) $2,106 D) $2,778


10) What is the present value of an annual payment of $1,500 discounted back 15 years at an annual

rate of return of 3%?

A) $10,663.87 B) $12,334.56 C) $13,449.87 D) $17,906.90

Answer: DDiff: 3Topic: AnnuityAACSB: Analytical Thinking

11) What is the present value of an annual payment of $3,600 discounted back 12 years at an annual

rate of return of 5 percent?

A) $12,977.19 B) $31,907.71 C) $45,360.00 D) $57,301.66

Answer: BDiff: 3Topic: AnnuityAACSB: Analytical Thinking

12) What is the future value of a series of $500 annual payments received at the end of each of the

next 5 yearsʹ worth if they are invested at an annual rate of return of 6%?

A) $1,223.44 B) $2,176.65 C) $2,818.50 D) $3,309.76


13) What is the future value of a stream of $800 annual payments worth to the investor at the end of

10 years if these payments are invested at an annual rate of return of 8.5%?

A) $11,868.08 B) $12,195.22 C) $13,334.90 D) $13,667.88

Answer: ADiff: 3Topic: AnnuityAACSB: Analytical Thinking



14) What is the present value of a $1,000 payment at the end of each of the next 10 years discounted

back to the present at 5%?

A) $5,098 B) $7,722 C) $8,775 D) $9,112

Answer: BDiff: 3Topic: AnnuityAACSB: Analytical Thinking

15) Suppose that you want to purchase a car today. You can afford payments of $400 per month and

want to pay the loan back over the next five years. Assuming no down payment is required,

how much can you borrow if the bank will charge you an annual percentage rate of 12%

compounded monthly?

A) $16,726.68

B) $18,220.18

C) $24,667.87

D) $25,008.90

E) $17,982.02

Answer: EDiff: 3Topic: Present ValueAACSB: Analytical Thinking

16) How much can you borrow today if you can make payments of $3,600 a year for the next five

years and the interest rate is 10%?

A) $13,646.83

B) $12,235.32

C) $18,978.36

D) $15,797.84

E) $17,949.67


17) Slyʹs Used Cars just sold you a clunker (you need it to get to class on time). You financed the

$4,728.48 purchase price for 24 months. They said your payment would be $250. What interest

rate did they charge you (assume monthly compounding)?

A) 10% B) 12% C) 16% D) 19% E) 24%


18) What would be the interest rate on a loan of $9,981.78 that you paid off with annual payments of

$2,500 for each of the next five years?

A) 8.0% B) 10% C) 15% D) 21% E) 26%




19) You just purchased a premier lot in an exclusive neighborhood for your future home. The lot

cost $50,000, an amount you financed with a 96-month loan. If your interest rate is 9.25 percent

compounded monthly, which of the following is closest to your monthly payment?

A) $744.55 B) $853.60 C) $767.23 D) $739.02 E) $810.92


20) If Monica invests $15,750 at 8 percent annual interest, how much would she have after eight

years?

A) $29,152.15 B) $17,010.08 C) $32,354.22 D) $39,678.92


21) How much did you borrow if your annual payments are $5,000 for the next seven years and the

interest rate is 9%?

A) $25,164.76 B) $36,002.17 C) $19,140.20 D) $27,797.84


22) Suppose that you want to purchase some land to build a homestead in the future. You can

afford payments of $5,000 each year and want to pay the loan back over the next 20 years.

Assuming no down payment is required, how much can you borrow if the bank will charge you

an annual interest rate of 12%?

A) $100,985.45 B) $48,231.47 C) $37,347.22 D) $160,262.21

Answer: CDiff: 3Topic: Present ValueAACSB: Analytical Thinking

23) What would be the interest rate on a loan of $39,927.10 that you paid off with annual payments

of $10,000 for each of the next five years?

A) 8% B) 10% C) 15% D) 21% E) 26%


24) Car loans and mortgage loans are typical annuities in the form of

A) maturity loans. B) compound loans.

C) amortized loans. D) payment loans.

Answer: CDiff: 2Topic: Amortized LoanAACSB: Analytical Thinking



25) A perpetuity is an annuity where the payments

A) stop at maturity.

B) are delayed until maturity.

C) increase due to inflation.

D) never stop.

E) accrue until maturity.

Answer: DDiff: 2Topic: PerpetuityAACSB: Analytical Thinking

26) You just purchased a vacant lot for your future son-in-lawʹs home for $30,000. You financed

that amount over 120 months. What would your monthly payment be if your interest rate was

12% compounded monthly?

A) $430.41 B) $389.21 C) $231.22 D) $189.02


27) When a loan is paid off in equal installments, this is called a(n) ________ loan.

A) amortized

B) discounted

C) balloon

D) reverse annuity


Answer: ADiff: 1Topic: Amortized LoanAACSB: Analytical Thinking

28) Consider that you are paying back a fully amortized loan. Which of the following statements is

most correct?

A) Later loan payments involve larger amounts of principal repayment.

B) The actual loan payments vary from year to year.

C) After the last loan payment is made, there is still a large principal repayment remaining.

D) Early loan payments include smaller amounts of interest payments.

E) None of the above statements are true.

Answer: ADiff: 3Topic: Amortized LoanAACSB: Analytical Thinking



29) Suppose you borrowed $12,000 at an annual rate of 6 percent interest to buy a car and wish to

repay it in five equal payments at the end of each of the next five years. Which of the following

is the closest to the amount of each of these payments?

A) $2,364 B) $2,849 C) $2,544 D) $2,436

Answer: BDiff: 3Topic: Amortized LoanAACSB: Analytical Thinking

30) Assuming that you can afford a car payment of $400 for 36 months, which of the following is

closest to the annual interest rate you would need on a loan to borrow $12,000 for a new car?

A) 10.99 percent B) 11.26 percent C) 12.25 percent D) 12.99 percent


31) Jah-Malya can afford a car payment of $400 per month for 48 months at an annual rate of 8.25

percent interest. Which of the following is closest to the amount she will be able to borrow for a

new car?

A) $16,306 B) $4,741 C) $22,656 D) $12,997


32) Mark borrows $15,000 to buy a new car. His loan has an annual interest rate of 6.5%,

compounded monthly, and his monthly payment is $293.49. How much will he have paid in

interest when he has finished repaying his loan in 60 months?

A) $43.49 B) $1,575.50 C) $2,609.40 D) $17,609.40


33) Mark borrows $15,000 to buy a new car. His loan has an interest rate of 6.5%, compounded

monthly, and his monthly payment is $293.49. If instead his loan had an interest rate of 8%, how

much more would he have paid in interest by the time he finished repaying his loan in 60

months?

A) $225.00 B) $304.15 C) $639.60 D) $3,249.00




Adrian Clemons

Adrian, a single man who wants to buy a house in five years, read an article that recommended a down

payment of 20 percent. With a large income and little debt, Adrian can afford to save a substantial amount of

money every month. He is asking you for advice to help him reach his goal.

34) Adrian found a nice house today that is selling for $150,000. Assuming an inflation rate of 5

percent in the local real estate market, how much will this house sell for in five years?

A) $187,500 B) $191,442 C) $204,650 D) $157,500

Answer: BDiff: 2Topic: Time Value of MoneyAACSB: Analytical Thinking

35) Assume that Adrian will need $30,000 for his 20 percent down payment in five years. If he

locates an investment with a 9 percent rate of return that compounds annually, which of the

following is closest to the amount that he will have to save each year?

A) $6,003 B) $4,884 C) $5,187 D) $5,013


36) It is now five years later, and Adrian has saved enough money for a 20 percent down payment

on a house. He will have to borrow $135,000 in a 30-year loan with an annual interest rate of 6

percent compounded monthly. What will his monthly mortgage payment be?

A) $1,199.55 B) $809.39 C) $779.98 D) $397.50

Answer: BDiff: 2Topic: Time Value of MoneyAACSB: Analytical Thinking

37) Define an amortized loan and give two common examples.

Answer: An amortized loan is a loan paid off in equal installments. The loan amount is paid back

by spreading or amortizing the payments out over a certain time period based on a

specific interest rate. Two common examples are auto loans and home mortgages.Diff: 1Topic: Amortized LoanAACSB: Diverse and Multicultural Work Environments

38) List at least five common examples of annuities.

Answer: a one year lease on an apartment, your five year car loan, your parentsʹ mortgage

payments, monthly savings to reach a college education expense goal, a monthly

paycheck if you are on salary, and constant monthly contributions to retirement plans are

all examples of annuities.Diff: 1Topic: AnnuityAACSB: Reflective Thinking



39) For someone who has $100,000 to save for 20 years, would a 4% Certificate of Deposit that

compounds annually be a better deal than a 3.94% Certificate of Deposit that compounds

quarterly? Why?

Answer: With the 4% annual compounding, your $100,000 would compound into $219,112.31.

There would be 20 compounding periods at 4% per year and the interest would be

calculated at the end of every year. Your $4,000 in interest from year one would not earn

any interest until the end of year two ($160). With the quarterly compounding your

interest would start earning interest itself starting with the second quarter of year one.

There would be a total of 80 compounding periods (4 quarters per year times 20 years)

and this would mean that even with the lower interest rate, your money would grow to

$219,053.19 for a slight difference of $59.12!Diff: 3Topic: Time Value of MoneyAACSB: Analytical Thinking

40) What recommendations would you offer to someone who is trying to break poor financial

habits and save money in order to achieve his or her financial goals?

Answer: Recommendation one: First, gain an understanding of how compounding works–that as

the number of years and the interest rate you earn go up, so does the future value of an

investment.

Recommendation two: Think of savings as a ʺsnowball effect.ʺ You earn interest on your

initial investment, and those interest earnings and the initial investment both continue to

earn interest. When these earnings are extended over multiple decades, your money can

really add up. In other words, you want to start investing as soon as possible.

Recommendation three: Pay yourself–your future self, that is–first. To make this process

as painless as possible, automate the payments so that when your paycheck is deposited

into your bank account, a percentage is automatically transferred to a separate

investment account–perhaps your retirement account. Or ask your employerʹs payroll

department about a mandatory payroll deduction. It is much easier to save the money

that you never really see!Diff: 3Topic: Financial GoalsAACSB: Reflective Thinking


Chapter 4Tax Planning and Strategies

4.1 The Federal Income Tax Structure

1) Currently, the highest tax bracket for taxpayers is 37.5 percent.

Answer: FALSEDiff: 2Topic: Tax RatesAACSB: Reflective Thinking

2) Compared to the standard deduction, it is easier to calculate your itemized deductions.

Answer: FALSEDiff: 2Topic: DeductionsAACSB: Analytical Thinking

3) Your deductions as a single person have reduced your taxable income to $38,950, bringing you

into the 25 percent tax bracket. As such, your taxes will amount to 25 percent of your taxable

income of $38,950.

Answer: FALSEDiff: 3Topic: Tax RatesAACSB: Analytical Thinking

4) Taxes are collected on a pay-as-you-go basis.

Answer: TRUEDiff: 2Topic: Progressive TaxAACSB: Analytical Thinking

5) You pay taxes only when you sell stock and realize the gain.

Answer: TRUEDiff: 3Topic: Capital Gains/LossAACSB: Analytical Thinking

6) According the Keown book, most taxes, about 30 percent of individual income taxes, are

collected through withholding from wages.

Answer: FALSEDiff: 3Topic: TaxesAACSB: Analytical Thinking

7) In 2013 you purchased $1,800 of IBM stock and you sold it this year for $1,500. Since you lost

money on this transaction, there is no valid reason to include this on this yearʹs tax return.

Answer: FALSEDiff: 3Topic: Capital Gains/LossAACSB: Analytical Thinking


Chapter 4 Tax Planning and Strategies 75

8) In 2010 you purchased a share of stock for $125 and you sold it this year for $250. Legally, you

donʹt need to pay any taxes on this transaction.

Answer: FALSEDiff: 3Topic: Capital Gains TaxAACSB: Analytical Thinking

9) Adjusted gross income is your total gross income adjusted for inflation.

Answer: FALSEDiff: 1Topic: Adjusted Gross IncomeAACSB: Analytical Thinking

10) Bracket creep refers to an increase in marginal taxes caused by the impact of inflation.

Answer: TRUEDiff: 2Topic: Tax BracketsAACSB: Analytical Thinking

11) Only people in the higher tax brackets pay taxes on capital gains.

Answer: FALSEDiff: 3Topic: Capital Gains TaxAACSB: Analytical Thinking

12) For most tax payers, their average tax rate is lower than their marginal tax rate.

Answer: TRUEDiff: 3Topic: Marginal Tax RateAACSB: Analytical Thinking

13) If you are in a 25 percent tax bracket then every dollar of your adjusted gross income will be

taxed at 25 percent.

Answer: FALSEDiff: 3Topic: Progressive TaxAACSB: Analytical Thinking

14) A regressive tax rate is one that increases as you make more income.

Answer: FALSEDiff: 1Topic: Progressive TaxAACSB: Analytical Thinking

15) The impact of taxes are an important consideration in most of the financial decisions that you

will make.

Answer: TRUEDiff: 1Topic: Taxes Affect Personal Finance DecisionsAACSB: Reflective Thinking



16) Ashlyn is a single person with no dependents. She normally receives over $1,800 every year for

an income tax refund. She is having difficulty paying her monthly bills every month. What tax

advice would you give her?

A) She should increase her exemptions on her W-4 form at work.

B) She should pay her estimated taxes every quarter.

C) She needs to find some more tax deductions.

D) She needs to file as Head of Household status

Answer: ADiff: 3Topic: Taxes Affect Personal Finance DecisionsAACSB: Analytical Thinking

17) The movement into a higher tax bracket as a result of inflation increasing wages is called

A) bracket climbing. B) bracket migration.

C) bracket creep. D) bracket shifting.

Answer: CDiff: 1Topic: Tax BracketsAACSB: Analytical Thinking

18) If you are an unmarried taxpayer, with at least one child or dependent living with you, your

filing status should be

A) single. B) surviving spouse.

C) married filing separately. D) head of household.

Answer: DDiff: 2Topic: TaxesAACSB: Analytical Thinking

19) Assets you own, including such items as stocks, bonds, or real estate, are commonly termed

A) capital assets. B) monetary assets.

C) current assets. D) intangible assets.

Answer: ADiff: 1Topic: Capital AssetAACSB: Analytical Thinking

20) Income on which the payment of taxes is postponed until some future date is called

A) tax-delayed. B) tax-deferred.

C) tax-postponed. D) tax-tardy.

Answer: BDiff: 1Topic: Tax-Deferred




21) The percentage of the last dollar you earn that goes toward your taxes is your

A) tax deferral rate. B) base tax rate.

C) average tax rate. D) marginal tax rate.

Answer: DDiff: 2Topic: Tax RatesAACSB: Analytical Thinking

22) Deductions calculated using the federal tax form ʺSchedule Aʺ which are totaled and then

subtracted from taxable income are called

A) itemized deductions. B) standard deductions.

C) personal expenditures. D) personal exemptions.

Answer: ADiff: 2Topic: DeductionsAACSB: Analytical Thinking

23) An IRS-allowed reduction in your income for yourself, your spouse, and any dependents that is

subtracted before you compute your taxes is called a(n)

A) itemized exemptions. B) standard exemptions.

C) marital exemptions. D) personal exemptions.

Answer: DDiff: 1Topic: DeductionsAACSB: Analytical Thinking

24) Expenditures that are subtracted in an effort to calculate the lowest possible taxable income are

called

A) exemptions. B) deductions.

C) capital expenses. D) fixed expenses.

Answer: BDiff: 1Topic: DeductionsAACSB: Analytical Thinking

25) A tax system in which tax rates increase as income increases is called a(n) ________ system.

A) progressive tax B) universal tax

C) regressive tax D) prorated tax

Answer: ADiff: 1Topic: Progressive TaxAACSB: Analytical Thinking



26) Three years ago you purchased a share of CompUTech stock for $32, which you could sell today

at the current market price of $252. What would be your capital gain on the sale, ignoring

commissions?

A) $32 B) $220 C) $252 D) $284

Answer: BDiff: 3Topic: Capital Gains/LossAACSB: Analytical Thinking

27) You purchased 100 shares of I-Tech stock for $40 per share 3 years ago. If you sold those shares

today at the current market price of $150 per share, what would be your capital gain on the sale,

ignoring all commissions?

A) $110

B) $3,667

C) $7,333

D) $11,000


Answer: DDiff: 3Topic: Capital Gains/LossAACSB: Analytical Thinking

28) Five years ago, you purchased 200 shares of Go-Tech stock for $25 per share. If you sold those

shares today at the current market price of $90 per share, what would be your capital gain on

the sale, ignoring all commissions?

A) $115 B) $4,290 C) $8,710 D) $13,000


29) Assume that you have a marginal tax rate of 28 percent, a state income tax rate of 4 percent, and

have a city income tax rate of 1 percent. The tax for Social Security and Medicare is 7.65 percent.

What would be the effective marginal tax rate on your last dollar of earnings?

A) 28 percent

B) 32 percent

C) 33 percent

D) 40.65 percent

E) Cannot determine from the information provided




30) According the Keown book, most taxes–about ________ of individual income taxes–are collected

through withholding from wages.

A) 30 percent B) 50 percent C) 70 percent D) 90 percent

Answer: CDiff: 2Topic: TaxesAACSB: Analytical Thinking

31) You and spouse are filing a joint return. Your current deductions have reduced your taxable

income to $88,990, bringing you into the 25 percent tax bracket. The first dollars you earned will

be taxed at the ________ tax bracket.


Answer: ADiff: 2Topic: Tax BracketsAACSB: Analytical Thinking

32) According to the Tax Policy Center, approximately ________ of American households did not

pay any federal income taxes in the 2013 tax year.



33) You and spouse are filing a joint return. Your current deductions have reduced your taxable

income to $88,990, bringing you into the 25 percent tax bracket. The last dollars you earned will

be taxed at the ________ tax bracket.


Answer: CDiff: 2Topic: Tax BracketsAACSB: Analytical Thinking

34) Which of the methods listed below is not used by the IRS as a tax collection mechanism?

A) Paycheck withholdings

B) Audits held in your home or office

C) Quarterly estimated tax payments

D) Payments sent with your tax return

E) All of the above are used by the IRS to collect income taxes.

Answer: BDiff: 2Topic: TaxesAACSB: Analytical Thinking



35) Wilma Rudolph was given a cost of living raise and a merit raise at work this year. Her federal

income taxes will be paid at 25% instead of 15%. Wilma has experienced

A) bracket creep.

B) the inflation trap.

C) a capital gain.

D) a higher personal exemption rate.

E) an opportunity to change her filing status.

Answer: ADiff: 2Topic: Tax BracketsAACSB: Analytical Thinking

36) Craig Ripley sold his stock in Gandy Corporation for a price less than what he paid for it. Craig

will experience

A) a capital loss tax.

B) a capital gains tax.

C) a capital gain.

D) a capital loss.

E) bracket creep.


37) Contributing $2,000 into a tax-deferred retirement plan in a 28% tax bracket will save

A) $70.

B) $140.

C) $280.

D) $560.

E) It depends on the exemptions and deductions claimed.

Answer: DDiff: 3Topic: Tax-Deferred


38) Which of the following is an income tax filing status?

A) Divorced filing spouse

B) Married filing jointly and surviving spouses

C) Head of divorced household

D) All of the above are income tax filing statuses.




39) The amount of income taxes that you actually pay is based upon your

A) taxable income.

B) adjusted gross income.

C) gross income.

D) taxable income minus exemptions and deductions.

Answer: ADiff: 3Topic: Taxable IncomeAACSB: Diverse and Multicultural Work Environments

40) Which of the following is not allowed as a personal or dependency exemption?

A) Yourself

B) Your 26-year-old child, who lives at home and earns $27,000 a year

C) Your spouse, if youʹre filing a joint return

D) Your 75-year-old grandfather, whom you financially support


41) Why might someone choose to use itemized deductions instead of taking the standard

deduction offered by the IRS?

A) It is easier to calculate your itemized deductions versus the standard deduction.

B) You may have a lower tax liability if you itemize instead of using the standard deduction.

C) Married taxpayers must use the itemized deductions only.

D) Most computer tax software automatically itemizes deductions.

E) both B and C are correct.


42) Understanding how tax planning affects your personal finances is actually important for most

taxpayers, not just the wealthy, because

A) many people donʹt take advantage of all the deductions and tax credits they are entitled to.

B) many people pay higher taxes or receive smaller refunds than they need to.

C) the average American spends close to one-third of the year earning the money necessary

to pay his or her taxes.

D) only choices A and B.

E) all of the above choices.

Answer: EDiff: 2Topic: Tax PlanningAACSB: Analytical Thinking



43) Chase Cutter has a marginal tax rate of 33 percent, a state income tax rate of 3.5 percent, and a

city income tax rate of 0.5 percent. The tax for Social Security and Medicare is 7.65 percent. What

would be the effective marginal tax rate on your last dollar of earnings?

A) 33 percent B) 36.5 percent C) 39.6 percent D) 44.65 percent


44) Why is tax planning so important?

Answer: Most people donʹt seem to understand tax planning and donʹt keep up with all the

changes in tax law. Many pay several thousand dollars more in income taxes than they

really need to. The average American spends over one-third of each year earning money

to pay taxes. Planning is vital to pay your fair share and to keep your fair share,

regardless of income. In sum, tax planning is not just for the wealthy.Diff: 1Topic: Tax PlanningAACSB: Analytical Thinking

45) Name the categories of filing status.

Answer: Single status, married filing jointly or surviving spouse, married filing separately, and

head of household.Diff: 1Topic: TaxesAACSB: Analytical Thinking

46) Explain the ways income taxes are paid or collected.

Answer: Income taxes are generally paid as withholdings from paychecks. Other ways in which

taxes are collected include quarterly estimated taxes sent to the IRS, payments with tax

returns, and direct withholdings from stock dividends, retirement funds, and prizes or

gambling winnings.Diff: 1Topic: TaxesAACSB: Diverse and Multicultural Work Environments



47) Describe the four filing status classifications.

Answer: Married Filing Jointly and Surviving Spouses: You file a joint return with your spouse,

combining incomes and deductions into a single return. If your spouse dies, you can still

qualify for this status for up to two years after the year in which your spouse died if you

have a dependent child living with you, you pay more than half the cost of keeping up

your home, and you are not remarried. Of course, if you remarry, you can file a joint

return with your new spouse.

Married Filing Separately: Married couples also have the choice of filing separately.It is

hard to say ahead of time whether you will do better filing jointly or separately. The best

idea is to figure your taxes both ways and, of course, go with the lower number. This

status is often used when a couple is separated or in the process of getting a divorce.

Head of Household: Head of household status applies to someone who is unmarried and

has at least one child or relative living with him or her. The advantage of this status is

that your tax rate will be lower and your standard deduction will be higher than if you

had filed with single status. To qualify for head of household status, you must be

unmarried on the last day of the tax year, have paid more than half the cost of keeping up

your home, and have had a child or dependent live with you for at least half of the year.Diff: 3Topic: TaxesAACSB: Reflective Thinking

4.2 Other Taxes

1) Social Security is a voluntary insurance program administered by the federal government that

provides for you and your family in the event of death, disability, health problems, or

retirement.

Answer: FALSEDiff: 2Topic: Social SecurityAACSB: Analytical Thinking

2) The Federal Insurance Contributions Act (FICA) tax deducted from your salary goes to pay for

unemployment insurance.

Answer: FALSEDiff: 2Topic: TaxesAACSB: Diverse and Multicultural Work Environments

3) If you are self-employed, you have to pay both the employer and employee portions of FICA,

for a total rate of 20 percent.




4) Excise taxes

A) are imposed on specific purchases, such as alcohol and cigarettes.

B) are often aimed at reducing the consumption of the items being taxed.

C) are referred to as ʺsin taxesʺ in some cases.


Answer: DDiff: 3Topic: Tax RatesAACSB: Diverse and Multicultural Work Environments

5) FICA deductions from your paycheck are for which mandatory federal insurance programs?

A) Unemployment benefits

B) Social Security

C) Medicare

D) Medicaid

E) Both B and C

Answer: EDiff: 2Topic: Social SecurityAACSB: Analytical Thinking

6) The FICA tax is typically deducted from your salary at a rate of ________until your salary

reaches a point where it is no longer taxed at the rate of ________ for Social Security.

A) 6.20 percent; 1.45 percent B) 7.65 percent; 6.20 percent

C) 15.3 percent; 7.65 percent D) 20 percent; 10 percent


7) For 2014, the federal tax code allows an estate valued at up to $5.34 million to be transferred tax

free to any heir. If the estate is valued at more than $5.34 million, the amount over $5.34 million

will be taxed at

A) 25 percent. B) 30 percent. C) 40 percent. D) 55 percent.


4.3 Calculating Your Taxes

1) Tax credits reduce your taxes on a dollar-for-dollar basis.

Answer: TRUEDiff: 2Topic: Tax CreditAACSB: Analytical Thinking



2) Standard deductions need yearlong record-keeping and thorough and accurate documentation.

Answer: FALSEDiff: 2Topic: DeductibleAACSB: Analytical Thinking

3) The health care premium credit is available to low-income taxpayers who purchased coverage

through the Health Insurance Marketplace.

Answer: TRUEDiff: 2Topic: Tax CreditAACSB: Analytical Thinking

4) The Lifetime Learning tax credit is designed to help all taxpayers get at least a two-year degree.

Answer: FALSEDiff: 3Topic: Tax CreditAACSB: Reflective Thinking

5) A personal exemption is an approved deduction that you can make on your tax return for each

person supported by the income shown on your tax return.

Answer: TRUEDiff: 3Topic: DeductionsAACSB: Information Technology

6) ________ income is from activities in which the taxpayer does not actively participate.

A) Active

B) Portfolio

C) Passive

D) Investment

E) both C and D

Answer: CDiff: 2Topic: Taxable IncomeAACSB: Analytical Thinking

7) A child tax credit reduces the federal income tax you owe by up to $1,000 for each qualifying

child under the age of

A) 15. B) 17. C) 19. D) 21.

Answer: BDiff: 2Topic: Tax CreditAACSB: Analytical Thinking



8) Your dependent is claimed as an approved exemption on ________ tax return.

A) your

B) his or her own

C) the return they choose themselves

D) all of the above



9) Which of the following statements about portfolio income from investments that are not held in

a tax-deferred account, is accurate?

A) It is also called investment income.

B) It is normally in the form of dividends and interest.

C) It must be reported on your tax return.

D) It may be taxed at a lower rate than wages and salaries are.

E) All of the above

Answer: EDiff: 3Topic: Taxable IncomeAACSB: Information Technology

10) Who must file a federal income tax return?

A) Everyone with an earned income during the year

B) All heads of household

C) All American citizens

D) Individuals whose income meets federal guidelines

E) Only those who have to file a state income tax return

Answer: DDiff: 3Topic: TaxesAACSB: Information Technology

11) Which of the following are permissible itemized tax deductions?

A) Medical and dental expenses

B) Casualty and theft losses

C) Home mortgage interest

D) Gifts to charity

E) All of the above

Answer: EDiff: 2Topic: DeductionsAACSB: Information Technology



12) From the list below choose the item that is not a permissible tax deduction.

A) State, local, and real estate taxes

B) Home equity loan interest on debt up to $100,000

C) Auto, truck, or van loan interest

D) Interest on money borrowed to invest, within the IRS limits based on investment income

E) Unreimbursed job-related expenses and tax preparation costs within the IRS limits

Answer: CDiff: 3Topic: DeductionsAACSB: Information Technology

13) Which factors affect your choice between claiming itemized deductions and the standard

deduction?

A) Home ownership, as mortgage interest may exceed the standard deduction

B) More deductible expenses this year than last year, as a result of unforeseen circumstances

or planned ʺbunchingʺ of deductions

C) Ease and simplicity of filing

D) Year long recordkeeping to thoroughly and accurately document itemized deductions

E) All of the above

Answer: EDiff: 3Topic: DeductionsAACSB: Information Technology

14) Your base income tax liability can be determined by

A) using the alternative minimum tax worksheet, aimed at preventing the wealthy from

paying little or no taxes.

B) using the IRS tax tables provided in the instruction booklet.

C) using the IRS rate schedules for taxable incomes greater than $100,000.



Answer: DDiff: 3Topic: Taxable IncomeAACSB: Information Technology

15) The earned income credit serves as a negative income tax and is available to

A) anyone with an earned income as opposed to passive income.

B) low-income taxpayers.

C) only head of household status filers.

D) only senior citizens below the poverty line.

Answer: BDiff: 2Topic: Tax CreditAACSB: Information Technology



16) Danielle is a divorced single parent who is currently paying back a college loan, attending

graduate school part-time, and working full-time earning $42,000. She has custody and

provides all support for her child. Which of the following adjustments, deductions, or credits

might apply to her?

A) Adjustment for student loan interest

B) Child tax credit

C) Child and dependent care credit

D) Lifetime learning tax credit

E) All of the above

Answer: EDiff: 3Topic: DeductionsAACSB: Analytical Thinking

17) You wish to make a charitable contribution of $2,000 to a qualified organization. You are

currently in the 28 percent marginal tax bracket. By how much would this contribution lower

your tax bill assuming your other itemized deductions exceed the standard deduction?

A) $280.00 B) $560.00 C) $1,440.00 D) $2,000.00


18) You and your spouse have earned salary and wages of $41,750. In addition you have municipal

bond interest income of $600 and savings account and certificate of deposit interest income of

$800. You paid a total of $600 in interest on your student loan. Using only this information, what

is your adjusted gross income for tax purposes?

A) $43,150 B) $42,550 C) $42,350 D) $41,950

Answer: DDiff: 3Topic: Adjusted Gross IncomeAACSB: Analytical Thinking

19) Income that comes from wages or a business is called

A) investment income. B) active income.

C) passive income. D) portfolio income.

Answer: BDiff: 1Topic: Taxable IncomeAACSB: Information Technology

20) Which of the following would offset your tax liability in a direct dollar for dollar manner and

may actually increase your tax refund beyond the amount paid during the tax year?

A) Tax exemption B) Tax deduction

C) Tax credit D) Tax adjustment

Answer: CDiff: 1Topic: Tax CreditAACSB: Information Technology



21) Leticia is a single person who makes $45,000 per year. This year she paid $2,000 in student loan

interest, $1,500 in medical expenses, $7,200 in rent and $4,800 in car loan payments. She

contributes $3,600 per year to her 401(k) plan at work. Give her some tax advice.

A) Single people should always take the standard deduction.

B) People who have medical expenses should always itemize their deductions.

C) Calculate your taxes using both methods to see which provides a greater deduction.

D) You should itemize if you pay interest, since interest of any kind is tax deductible.

Answer: CDiff: 3Topic: Taxes Affect Personal Finance DecisionsAACSB: Reflective Thinking

Karen and Jeffrey Bosteins

Karen and her husband, Jeffrey, are facing a new income tax situation this year. She is a corporate accountant

and Jeffrey is an engineer. Their gross salaries total $89,000. Both graduated from four -year universities five

years ago and are still paying off large student loans. She is now attending school part-time to prepare for

the CPA exam. The Bosteins incurred considerable expenses in the process of adopting an infant this year,

and they have the ongoing expense of daycare. In January of last year they closed on their new home.

Although trained as an accountant, Karenʹs work has not involved income tax preparation. Help them

consider the following questions.

22) Which of the following credits would not apply to the Bosteins?

A) Adoption credit

B) Health care premium credit (childrenʹs version)

C) Child and dependent care credit

D) Lifetime Learning tax credit

Answer: BDiff: 3Topic: Tax CreditAACSB: Analytical Thinking

23) Additional items that may reduce the Bosteinsʹ tax burden might include

A) the child credit.

B) adjustment for the interest on their college loans.

C) earned income credit.

D) both A and B.

Answer: DDiff: 3Topic: Tax CreditAACSB: Analytical Thinking



24) The Bosteins

A) have no dependents to declare.

B) should use the married filing separately filing status.

C) should calculate their taxes itemizing and taking the standard deduction to see which is

greater.


Answer: CDiff: 3Topic: DeductionsAACSB: Information Technology

25) With a growing family, Karen and Jeffrey know they should start investing more to provide for

a secure future. Which of the following issues should they consider as they plan?

A) Interest paid on money borrowed to invest is an itemized deduction.

B) Contributions to tax-deferred retirement accounts avoid taxes in the current year and

grow tax-free until the time of withdrawal.

C) Qualified dividends and capital gains are taxed at a lower rate than ordinary income.

D) Municipal bond earnings are exempt from federal income tax.

E) All of the above

Answer: EDiff: 3Topic: Tax PlanningAACSB: Reflective Thinking

26) Since their taxes are becoming more complex, Jeffrey and Karen are concerned about making a

mistake or getting audited. They should

A) consult IRS Publication 17, Your Federal Income Tax, the IRS toll-free ʺhotline,ʺ or one of the

self-help tax publications to learn more about their tax situation.

B) choose an independent tax specialist to prepare their taxes, because there is more

consistency in their training and the quality for their work than that of nationally affiliated

specialists.

C) remember that the key to winning an audit is good records to verify the tax form

information.

D) Only choices A and C.

E) All of the above choices.

Answer: DDiff: 3Topic: TaxesAACSB: Reflective Thinking



Joseph Imamura

For many years Joseph paid someone else to file his income tax return. After taking a personal finance course

at his local college, Joseph feels he is ready to tackle it on his own for tax year 2014. Joseph is single with an

income of $43,000 and has no dependents. He has little interest income from savings, does not have a

personal IRA, and plans to itemize deductions. Joseph owns a home and travels a lot with his job. He pays

some of his own work-related expenses because his employer does not pay for all of them. His only personal

investments include 1,500 shares of stock he inherited from his uncle, which he does not intend to sell for

many years because the blue-chip company has a strong history of dividend income and share price

appreciation. However, he does contribute monthly to his 401(k) plan at work.

27) To help Joseph with his tax planning, he should carefully track and maintain records for all of

the following expenses during the tax year except

A) all expenses for prescribed health care needs that are not covered by insurance.

B) all job related expenses, especially those that are and are not reimbursed by his employer.

C) state and local income taxes, real estate taxes, and personal property taxes.

D) price appreciation, or increases from January 1 to December 31, for the 1,500 shares of

stock he owns.



28) Which of the following tax planning strategies could Joseph consider to reduce his future tax

bills?

A) Carefully track and maintain records for all itemized deduction categories to insure he is

maximizing his itemized deductions.

B) Establish a home equity credit line to finance other consumer credit, such as an auto

purchase.

C) Contribute as much as possible to a tax-deferred retirement account, such as his 401(k).

D) Invest in municipal bonds to receive tax-exempt income.

E) All of the above would be strategies available to Joseph to reduce his future taxes.

Answer: EDiff: 3Topic: TaxesAACSB: Analytical Thinking

29) Joseph can qualify for all of the following except the

A) mortgage interest payments deduction.

B) deduction for unreimbursed job-related expenses that are in excess of 2 percent of AGI.

C) Lifetime Learning Credit.

D) real estate property taxes deduction.

E) Joseph can qualify for all of the above to reduce his tax liability.

Answer: CDiff: 3Topic: DeductionsAACSB: Analytical Thinking



Samuel Ahn

Samuel Ahn recently graduated from college and started working in a promising career field. He has a little

money invested in a stock that pays no dividends. He lives in an apartment, is single, and has no dependents.

He has a $22,000 student loan balance and he paid $800 interest in 2014. He is considering going back to

school part-time for some additional computer classes. He does not have a personal IRA, and he contributed

2 percent of his $39,500 salary to his employerʹs 401(k) plan in 2014. As he completes his tax return for 2014,

use the information above and below to help him answer the following questions.

Standard deduction for 2014: $6,200

Personal exemption for 2014: $3,950

Tax brackets for 2014:

Taxable income range Tax rate

Up to $9,075 10 percent

More than $9,075 but under $36,900 15 percent

More than $36,900 but under $89,350 25 percent

30) What is Samuelʹs gross income for 2014?

A) $35,250 B) $22,500

C) $39,500 D) Not enough information to determine


31) What is Samuelʹs adjusted gross income for 2014?

A) $39,500 B) $32,500 C) $37,910 D) $38,700

Answer: CDiff: 2Topic: Adjusted Gross IncomeAACSB: Analytical Thinking

32) What is Samuelʹs taxable income for 2014?

A) $38,700 B) $29,350 C) $33,300 D) $27,760

Answer: DDiff: 3Topic: Taxable IncomeAACSB: Analytical Thinking

33) What is Samuelʹs total tax liability for 2014?

A) $5,351.25 B) $3,710.25 C) $4,541.25 D) $3,948.75

Answer: BDiff: 3Topic: Marginal Tax RateAACSB: Analytical Thinking



34) What is Samuelʹs marginal tax rate for his current level of taxable income?

A) 10% B) 15% C) 12.5% D) 25%

Answer: BDiff: 1Topic: Marginal Tax RateAACSB: Analytical Thinking

35) Samuelʹs average tax rate for 2014 is closest to which of the following?

A) 10% B) 15% C) 12.5% D) 25%

Answer: ADiff: 3Topic: Marginal Tax RateAACSB: Analytical Thinking

36) Based on Samuelʹs completed tax return, what advice would you give him to lower his tax

liability for 2015?

A) He should take the computer classes in 2015.

B) He should sell his stock.

C) He should increase his contributions to the 401(k) plan at work.

D) He should get a roommate and claim him as a dependant.

E) Both A and C are good advice.

Answer: EDiff: 3Topic: Principle 4: Taxes affect personal finance decisionsAACSB: Analytical Thinking

Richard and Katarina Bajorshik

Katarina and Richard are a busy young couple with a son, Caleb, who is 6 and twin daughters, Stacy and

Casey, who are actively exploring the world as four-year-olds. Before the twins were born, Katarina and

Richard bought their first home with plenty of indoor and outdoor space for a growing young family. The

Bajorshiks are concerned about their 2014 tax issues, but they are also committed to planning for the future of

their family. Next year Richard should be able to pay off the remaining balance of his law school student

loans. Contributing to Richardʹs Roth IRA is an annual priority. The following information reflects tax year

2014.

Gross income $98,712

Student loan interest $1,965

Richardʹs traditional IRA $1,500

Total itemized deductions $12,000

Standard deduction for 2014 $12,400

Personal exemption amount $3,950

Marginal tax bracket 25%

37) What is the Bajorshiksʹ adjusted gross income?

A) $98,712 B) $97,212 C) $96,747 D) $95,247 E) $83,462

Answer: DDiff: 3Topic: Adjusted Gross IncomeAACSB: Analytical Thinking



38) Approximately how much will the Bajorshiks save in 2014 income tax payments as a result of

Richardʹs student loan interest?

A) $1,965.00 B) $196.50 C) $491.25 D) $1,473.75 E) $0

Answer: CDiff: 3Topic: DeductionsAACSB: Analytical Thinking

39) Richard and Katarinaʹs filing status should be

A) head of household.

B) married filing jointly.

C) married filing separately.

D) single.

E) surviving spouse.

Answer: BDiff: 1Topic: TaxesAACSB: Information Technology

40) What is Richard and Katarinaʹs taxable income?

A) $63,097 B) $63,497 C) $79,297 D) $83,247 E) $98,712

Answer: ADiff: 3Topic: Taxable IncomeAACSB: Analytical Thinking

41) Although Richard and Katarina are a happily married couple, they joke that they could not

possibly remarry for at least two years following the year of the death of the other spouse

because

A) the surviving spouse would lose the tax advantage of married filing jointly status,

assuming at least one child was still a dependent and the surviving spouse was paying

more than half the cost of keeping up the home.

B) the surviving spouse would lose the exemption amount for the deceased spouse.

C) the surviving spouse would have to file as head of household.

D) neither spouse has sufficient life insurance to provide for the family.

Answer: ADiff: 3Topic: TaxesAACSB: Reflective Thinking

42) If the Bajorshiksʹ income does not exceed the phase-out level of $110,000 in 2014, by how much

will the child tax credit reduce their tax liability?

A) Their tax liability will be reduced by $750.

B) Their tax liability will be reduced by $2,000.

C) Their tax liability will be reduced by $2,100.

D) Their tax liability will be reduced by $3,000.

Answer: DDiff: 2Topic: Tax CreditAACSB: Analytical Thinking



43) Katarina worked as an ER nurse, and knows that demand for the job is high. However, prior to

returning to work, when the twins enter kindergarten, she will need to take classes on the latest

technological advancements. Which of the following tax planning strategies should the

Bajorshiks consider as they plan their financial future?

A) When Katrina returns to school, they should track school-related expenses and determine

eligibility for the Lifetime Learning credit.

B) While the children are under age 13, the Bajorshiks should track childcare expenses and

determine eligibility for the child and dependent care credit.

C) Both A and B are legitimate tax planning strategies that the couple should consider.

D) Neither A nor B is a tax planning strategy that is relevant to this coupleʹs situation.

Answer: CDiff: 3Topic: Tax PlanningAACSB: Analytical Thinking

44) Name and describe the four general categories that reduce your taxable income, therefore

reducing your tax liability.

Answer: Adjustments to income allow certain legal reductions in gross income. Examples include

IRA contributions, moving expenses, self-employment tax and retirement plans, and

alimony payments. Itemized deductions consist of medical and dental expenses, state,

local, and real estate taxes, home mortgage and investment interest payments, gifts to

charity, theft and casualty losses, and miscellaneous deductions. As an alternative to

itemizing deductions, the standard deduction may be used. Personal and dependency

exemptions serve to further reduce taxable income. Finally, credits are subtracted directly

from the tax liability, and while most credits are non-refundable, a few, such as the

earned income credit allow for a refund in excess of taxes paid. Examples of credits

include child and dependent care expenses, hope scholarship credit, lifetime learning

credit, child credit, the earned income credit., adoption credit, and the health care

premium credit. Note that the standard deduction amount and the exemption amount are

adjusted upward annually in response to inflation.Diff: 2Topic: Taxable IncomeAACSB: Reflective Thinking

45) Explain how to calculate your taxable income, and how to determine the need for a tax payment

or refund.

Answer: First, calculate total gross income by adding income from all taxable sources. Next,

subtract all adjustments, deductions (the itemized or standard amount), and exemptions

to calculate taxable income. On the basis of your taxable income, use the tax tables or tax

rate to determine your tax liability and then apply any tax credits that may apply. If the

amount of your tax liability is greater than the taxes withheld from you, then you owe the

IRS a tax payment for the difference. If the tax liability is smaller than what was already

withheld, then you are due a tax refund.Diff: 2Topic: Taxable IncomeAACSB: Reflective Thinking



46) Name the sources of tax-free income.

Answer: These sources include interest on municipal bonds, tax-free money market funds, gifts,

child support payments, welfare benefits, workersʹ compensation benefits, veteransʹ

benefits, federal income tax refunds, certain Social Security benefits, interest earned

inside a life insurance policy, earnings on an IRA, and inheritances.Diff: 1Topic: Taxable IncomeAACSB: Information Technology

47) Explain the concept of using the standard deduction or using itemized deductions.

Answer: The alternative to itemizing deductions is to take the standard deduction. The standard

deduction is the best estimate by the government of what the average person would be

able to deduct by itemizing. You donʹt need to figure your expenses and provide receipts

or justification. The standard deduction varies based on your filing status. Many people

have different situations that differentiates them from the average person.Diff: 2Topic: DeductionsAACSB: Analytical Thinking

48) Why are the various tax ʺcreditsʺ such a welcome relief?

Answer: Tax credits are subtracted directly from taxes due on a dollar-for-dollar basis. The credits

are not a deduction from income or a percentage of some entry in the tax form. Your final

income tax liability represents your base income tax less your tax credits. The bottom line

is a major savings in the tax burden.Diff: 2Topic: Tax CreditAACSB: Information Technology

49) What combination of deductions and exemptions can the typical full-time college student who

is employed during the summer, or perhaps during the school year, claim? Why?

Answer: The typical employed full-time college student, who is claimed as a dependency

exemption by his or her parents, can only claim the standard deduction to reduce tax

liability. A dependency exemption cannot be claimed for anyone who earns more than

the exemption amount. However, the income test does not apply to children under the

age of 19 or to full-time college students under the age of 24. Finally, the parents must

provide over half of the studentʹs support. Given the relationship, income, support, and

citizenship test, the parents can claim the dependent exemption. Because only one

exemption can be claimed on any tax form, the typical full-time college student is limited

to using the standard deduction to reduce his or her taxable income, and ultimately the

tax liability.Diff: 3Topic: DeductionsAACSB: Analytical Thinking



4.4 Other Filing Considerations

1) A key to calculating your taxes is deciding which Form 1050 to use: 1050EZ, 1050A, or 1050.


2) Form 1040EZ is aimed at those who have no dependents, whose taxable income is more than

$100,000 per year, and who donʹt itemize their deductions.


3) Which of the following is an advantage of filing electronically?

A) Faster refunds B) Quick electronic confirmation

C) More accurate returns D) All of the above


4) Free File is configured in a way that allows ________ of U.S. taxpayers who are eligible to use it.



5) Which of the statements about audits is false?

A) 1 percent of individual taxpayers are audited.

B) 23.57 percent of individuals earning between $500,000 and $1 million are audited.

C) 8.9 percent of individuals earning between $1 million and $5 million are audited.

D) 27.37 percent of individuals earning more than $10 million are audited.

Answer: BDiff: 3Topic: AuditAACSB: Analytical Thinking



6) Suppose that you are not able to complete your tax returns by April 15. Which of the following

statements is most accurate?

A) You must provide adequate need in tax court, requesting extension of the deadline.

B) You can apply for an automatic extension no questions asked, but you must enclose a

check in payment for estimated taxes due.

C) You may have an extension, and the taxes are not due until the extension expires.

D) You do not have to pay interest on any taxes due on April 15, provided that you have filed

for and have an approved extension prior to April 1 of the tax year.


7) The deadline to file your income tax return is ________ although an automatic extension may be

filed.

A) March 15 B) March 30 C) April 15 D) April 30


8) If you are unable to file your tax returns by the deadline, you may file form 4868, Application

for Automatic Extension of Time, and receive an extension of up to four months

A) upon approval. B) automatically.

C) if you meet the IRS requirements. D) none of the above


9) If you made a mistake, an amended tax return may be filed on Form

A) 1040. B) 1040A. C) 1040X. D) 1040ZX. E) 1040EZ.

Answer: CDiff: 1Topic: TaxesAACSB: Information Technology

10) Which of the following is a reason or reasons for the IRS to audit your tax return?

A) You were randomly selected as a matter of routine audits.

B) You were audited in the past.

C) There is something suspicious on your return.

D) You earn a lot of money.

E) any or all of the above

Answer: EDiff: 2Topic: AuditAACSB: Analytical Thinking



11) Six schedules are commonly used by taxpayers filing Form 1040. Give the title of each of these

six basic schedules: A, B, C, D, E, EIC.

Answer: Schedule A: Itemized Deductions

Schedule B: Interest and Dividend Income

Schedule C: Profit or Loss from Business

Schedule D: Capital Gains and Losses

Schedule E: Supplemental Income and Loss

Schedule EIC: Earned Income CreditDiff: 2Topic: TaxesAACSB: Reflective Thinking

12) What are the benefits of filing taxes electronically?

Answer: Faster refunds: Direct deposit can speed refunds to e-filers in as few as 10 days.

More accurate returns: IRS computers quickly and automatically check for errors or other

missing information, making e-filed returns more accurate and reducing the chance of

receiving an error letter from the IRS.

Quick electronic confirmation: Computer e-filers receive an acknowledgment that the IRS

has received their returns.

Reduced paperwork and the use of electronic signatures: There is nothing to mail to the

IRS.Diff: 3Topic: TaxesAACSB: Analytical Thinking

4.5 Model Taxpayers: The Taylors File Their 2013 Return

1) In chapter 4, Dianne Taylor won a 2013 Honda Accord on ʺThe Price is Rightʺ TV show. She has

to pay taxes on her prize. The taxes are based on the carʹs ________ value.

A) fair market B) residual

C) manufacturerʹs suggested retail price D) invoice

Answer: ADiff: 3Topic: TaxesAACSB: Analytical Thinking

2) Gross income is another name for ________ income.

A) expected B) total C) net D) value added

Answer: BDiff: 3Topic: Income ReturnsAACSB: Analytical Thinking



3) Which indicates the correct order for completing your tax returns?

A) Claim exemptions, calculate total tax, subtract deductions, subtract adjustments,

determine gross income

B) Subtract deductions, calculate total tax, claim exemptions, determine gross income,

subtract adjustments

C) Determine gross income, subtract adjustments, subtract deductions, claim exemptions,

calculate total tax

D) None of the above


4) For the Taylors, in chapter 4, they are allowed to take a tax credit of $1,000 per dependent child

off of their

A) total tax owed. B) exemptions counted.

C) adjustments retained. D) net income.


4.6 Tax Strategies to Lower Your Taxes

1) Claire currently makes $30,000 per year and is in a 15% tax bracket. If she contributes $1,800 to

her 401(k) plan at work, by how much will this lower her tax liability?

A) $270 B) $1,800 C) $4,500 D) $4,230


2) Elizabeth currently makes $45,000 per year and is in a 25% tax bracket. If she contributes $2,400

to her 401(k) plan at work, by how much will this lower her taxable income?

A) $7,500 B) $600 C) $2,400 D) $11,250


3) If youʹre in the 15% marginal tax bracket, what is the equivalent taxable yield on an 8%

municipal bond?

A) 9.41% B) 6.96% C) 8.15% D) 8.70%




4) If youʹre in the 25% marginal tax bracket, what is the equivalent taxable yield on an 10%

municipal bond?

A) 11.76 B) 13.33 C) 4.00 D) 12.50


5) When considering a principal residence as a tax shelter, remember that you can

A) purchase a house and deduct the mortgage interest.

B) maintain and improve your home, as $500,000 of capital gains for couples and $250,000 of

capital gains for single filers is exempt from taxation.

C) take out a home equity loan to pay for other debts, such as auto financing.

D) use all of these tax-saving strategies.

E) only A and C.


6) Which of the following is a source of tax-free income?

A) Welfare benefits

B) Earnings on your IRA

C) Federal income tax refunds

D) Child support payments

E) All of the above

Answer: EDiff: 2Topic: Taxable IncomeAACSB: Analytical Thinking

7) A source of tax-free income is

A) interest on municipal bonds.

B) inheritances.

C) foreign income incurred by U.S. citizens living and working abroad.

D) All of the above are sources of tax-free income.

Answer: DDiff: 3Topic: Taxable IncomeAACSB: Analytical Thinking

8) What are the five general tax strategies in tax planning?

Answer: -Maximize your deductions.

-Look to capital gains and dividend income, especially if you are in the top tax bracket.

-Shift income to family members in lower tax brackets.

-Seek out tax-exempt income.

-Defer taxes to the future.Diff: 3Topic: Tax PlanningAACSB: Reflective Thinking



9) What are two tax advantages of tax-deferred retirement plans?

Answer: (1) You donʹt pay taxes on the money you invest until such time as funds are withdrawn

from the retirement account resulting in recognition of taxable income.

(2) You donʹt pay interest on the earnings from your retirement account until such time as

funds are withdrawn from the retirement account resulting in recognition of taxable

income.Diff: 1Topic: Tax PlanningAACSB: Reflective Thinking

10) Strategies for maximizing deductions center on what three tactics?

Answer: (1) Using tax-deferred retirement programs to reduce taxes.

(2) Using your home as a tax shelter.

(3) Shifting and bunching deductions.

Each of these tactics has the same goal: to reduce taxable income to its minimum level.Diff: 2Topic: DeductionsAACSB: Reflective Thinking


Chapter 5Cash or Liquid Asset Management

5.1 Managing Liquid Assets

1) Two advantages of carrying cash are that itʹs easy to spend and many times you can even recall

where you spent it.

Answer: FALSEDiff: 2Topic: Cash ManagementAACSB: Analytical Thinking

2) One way to think of liquid assets is as a reservoir, with money moving in as wages are received

and moving out as living expenses are paid.

Answer: TRUEDiff: 3Topic: Liquid AssetsAACSB: Analytical Thinking

3) Because liquid assets can be turned into cash quickly and with little loss, they have little risk

associated with them and therefore provide a low rate of return for the consumer.

Answer: TRUEDiff: 3Topic: Cash ManagementAACSB: Diverse and Multicultural Work Environments

4) Liquid assets allow you to cover unplanned expenses without having to interrupt your

long-term investments or liquidate any tangible assets.

Answer: TRUEDiff: 2Topic: Liquid AssetsAACSB: Diverse and Multicultural Work Environments

5) Keeping your funds in liquid assets is riskier than keeping them in illiquid assets and therefore

investors require a higher expected rate of return on liquid assets.

Answer: FALSEDiff: 2Topic: Liquid AssetsAACSB: Diverse and Multicultural Work Environments

6) How do you compare cash management alternatives to determine which is best for you?

A) Compare returns using comparable interest rates.

B) Take into account their tax status.

C) Consider their safety or risk.


Answer: DDiff: 2Topic: Cash ManagementAACSB: Diverse and Multicultural Work Environments



7) Cash and investments that can be easily converted into cash are termed

A) capital assets.

B) liquid assets.

C) illiquid assets.

D) depositable assets.

E) None of the above are correct.

Answer: BDiff: 1Topic: Liquid AssetsAACSB: Diverse and Multicultural Work Environments

8) Liquid assets or funds are important to

A) cover unplanned expenses.

B) prevent interrupting your long-term investments.

C) prevent overdrafts in checking accounts.

D) cover some planned expenses.

E) All of the above are correct.

Answer: EDiff: 2Topic: Liquid AssetsAACSB: Diverse and Multicultural Work Environments

9) According to the Keown book, one way to think of liquid assets is as a(n)

A) reservoir, with money moving in as wages are received and moving out as living expenses

are paid.

B) apple tree farm: pick money off of the money tree whenever you need it.

C) garden: plant the seeds and the green is readily available.

D) wind current: easy come, easy go.

Answer: ADiff: 3Topic: Liquid AssetsAACSB: Analytical Thinking

10) Which of the following characteristics apply to liquid assets?

A) They are characterized by low returns. B) They involve low risk.

C) The temptation to spend is greater. D) All of the above are correct.

Answer: DDiff: 2Topic: Liquid AssetsAACSB: Diverse and Multicultural Work Environments


Chapter 5 Cash or Liquid Asset Management 105

11) What is involved with proper cash management?

Answer: Nothing happens without a plan. You need to start off with a budget to determine what

your monthly living expenses are and what your savings goals are. Once you determine

how much money you need in an emergency fund, then you need to determine the best

cash management options available to you. Do you need a checking account and what

other options do you need like an ATM card, Debit card and overdraft protection. How

much money do you need in your checking account to cover your living expenses and

not have any overdraft fees. Next, you need to determine how liquid your savings

accounts need to be for the rest of your emergency fund balance. Will an MMDA or a

MMMF give you a better return and meet your liquidity needs? Should you give up some

liquidity and purchase a CD and for how long? Your cash management goal is to

maximize your return while maintaining liquidity and minimizing transaction costs.Diff: 3Topic: Cash ManagementAACSB: Diverse and Multicultural Work Environments

12) Why are liquid assets important in cash management?

Answer: Cash management begins and ends with liquid assets. Keeping some money in liquid

assets is necessary for paying bills, normal living expenses, emergencies, and to prevent

dipping into long-term investments.Diff: 2Topic: Liquid AssetsAACSB: Diverse and Multicultural Work Environments

13) What is a risk associated with keeping liquid assets?

Answer: One risk is the more cash you have, the more youʹre tempted to spend. Access to cash or

even credit can open the door to impulse purchasing. This is the downside of liquidity,

which can also affect your cash management and budget. Cash management doesnʹt only

involve deciding where to keep your cash; it involves managing your money and staying

within your budget.Diff: 2Topic: Liquid AssetsAACSB: Analytical Thinking

5.2 Automating Savings: Pay Yourself First

1) It is best for college students to wait and begin saving once they are ʺmaking more money.ʺ

Answer: FALSEDiff: 1Topic: Pay Yourself FirstAACSB: Analytical Thinking

2) When you automate your savings you are less likely to spend those dollars because they never

become part of the funds in your checking account.

Answer: TRUEDiff: 1Topic: Cash ManagementAACSB: Analytical Thinking



3) It is wise to wait until you are earning a substantial amount of money before you establish a

disciplined financial plan for your future.

Answer: FALSEDiff: 1Topic: Cash ManagementAACSB: Analytical Thinking

4) When college students start saving early

A) in an account earning interest, they immediately put their money to work.

B) by automating their savings, they are less likely to spend money.

C) they can take advantage of the time value of money and achieve their financial goals.


Answer: DDiff: 2Topic: Pay Yourself FirstAACSB: Analytical Thinking

5) List two ways to pay yourself first.

Answer: You can easily use cash-management alternatives to automate your savings by having

income automatically deducted from your paycheck and placed into savings.

You can be financially disciplined and set aside money from every paycheck, monetary

gift, or other source of income. If money touches your hands, your first thought should be

to set aside a percentage in an interest-bearing account. Pay yourself first!Diff: 3Topic: Pay Yourself FirstAACSB: Reflective Thinking

5.3 Financial Institutions

1) With online banking, you are able to access your accounts and conduct business transactions

through the Internet, your mobile phone, and devices.

Answer: TRUEDiff: 3Topic: Checking AccountsAACSB: Information Technology

2) Nondeposit-type financial institutions are commonly referred to as mutual funds and brokerage

firms.

Answer: TRUEDiff: 3Topic: ATMAACSB: Information Technology

3) The deregulation of the 1980s has allowed brokerage firms to offer traditional banking services,

and has also let banks offer services formerly found only at investment companies.

Answer: TRUEDiff: 3Topic: Financial InstitutionsAACSB: Information Technology



4) Online banking simplifies cash management and budgeting for consumers.

Answer: TRUEDiff: 1Topic: Cash ManagementAACSB: Information Technology

5) Credit unions and Internet-only banks typically offer more attractive interest rates to both

borrowers and savers.

Answer: TRUEDiff: 2Topic: Financial InstitutionsAACSB: Information Technology

6) Brick-and-mortar banks typically offer superior interest rates for borrowers and savers.

Answer: FALSEDiff: 3Topic: Financial InstitutionsAACSB: Reflective Thinking

7) What is the name of an investment company that raises funds from investors, pools the money,

and invests in stocks or bonds?

A) Stockbrokerage firm B) Bond brokerage firm

C) Mutual fund firm D) Securities fund firm

Answer: CDiff: 1Topic: Mutual FundsAACSB: Diverse and Multicultural Work Environments

8) Which of the following financial institutions is a not-for-profit organization that is open only to

members of that institution and tends to offer more favorable interest rates to borrowers and

savers?

A) Savings bank

B) Commercial bank

C) Savings and loan association

D) Credit union


Answer: DDiff: 1Topic: Savings and Loans / ThriftsAACSB: Diverse and Multicultural Work Environments

9) Which of the following financial institutions were originally established to provide mortgage

loans to depositors?

A) Commercial banks B) Savings and loan associations

C) Internet banks D) Credit unions

Answer: BDiff: 1Topic: Savings and Loans / ThriftsAACSB: Information Technology



10) Financial institutions that provide traditional checking and savings accounts are commonly

referred to as

A) deposit-type financial institutions.

B) nondeposit-type financial institutions.

C) personal depository institutions.

D) financial brokerage companies.


Answer: ADiff: 1Topic: Financial InstitutionsAACSB: Information Technology

11) Credit unions and Internet-only banks typically offer

A) more attractive interest rates to both borrowers and savers.

B) less attractive interest rates to both borrowers and savers.

C) the same interest rates as brick-and-mortar banks.

D) Both A and C are correct.

Answer: ADiff: 3Topic: Financial InstitutionsAACSB: Analytical Thinking

12) Which of the following is an advantage of online and mobile banking?

A) The potential for subpar customer service

B) Accessibility to and management of your accounts

C) Minimal start-up time to establish access

D) Only operational during business hours

Answer: BDiff: 3Topic: Online and Mobile BankingAACSB: Analytical Thinking

13) Online and mobile banking allows you to do the following

A) access your accounts at any time of day. B) transfer funds between accounts.

C) pay bills and receive payments online. D) all of the above.

Answer: DDiff: 2Topic: Online and Mobile BankingAACSB: Analytical Thinking

14) List the common deposit-type financial institutions.

Answer: - Commercial banks

- Savings and Loan Associations

- Savings banks

- Credit unionsDiff: 1Topic: Financial InstitutionsAACSB: Analytical Thinking



15) Once you have examined a financial institutionʹs service and convenience you will want to ask

three questions about their cash management alternatives. What are they?

Answer: - What is the safety or risk involved?

- How will they correlate with my tax status?

- What is their comparable rate of return?Diff: 1Topic: Financial InstitutionsAACSB: Analytical Thinking

16) What are the four questions you should answer when looking for a financial institution?

Answer: You will want to know if it offers the kind of service you need and want. You will ask if

your money will be safe. The costs and returns associated with the services you want are

concerns. Last, you will want to know if it offers the personal service and convenience

you seek.Diff: 1Topic: Financial InstitutionsAACSB: Reflective Thinking

17) Explain the advantages of credit unions. Are there any disadvantages to them?

Answer: Credit unions enjoy a tax-exempt status because they are not-for-profit organizations.

As such, they are generally able to operate on a more efficient, smaller scale and pay their

depositors more than commercial banks. They tend to have lower fees and minimum

balances associated with their accounts. Their loans tend to be at favorable rates. They

tend to be handy, generally close to work, and offer many of the same services as banks.

The one disadvantage is that they are reluctant to provide home mortgage loans. This

could be a problem when all of your accounts are at the credit union and you must seek a

home loan at an institution that is unfamiliar with you.Diff: 3Topic: Savings and Loans / ThriftsAACSB: Reflective Thinking

18) List five features available through online and mobile banking.

Answer: 1. Access your accounts at any time of day.

2. Check your balances and see when checks have cleared and deposits have been

made.

3. Transfer funds between accounts.

4. Download your financial information directly into your personal financial or tax

software.

5. Pay bills and receive payments online.Diff: 2Topic: Online and Mobile BankingAACSB: Reflective Thinking



19) Describe the advantages of online and mobile banking.

Answer: Advantages of Online and Mobile Banking

Personal financial management support: You can import data into a personal finance

program such as Mint.com, Quicken, or TurboTax.

Convenience: Anytime and anywhere, you can view and track your accounts, pay bills,

and view up-to-the-minute credit card activity.

Efficiency: From a single secure site, you can access and manage all of your bank

accounts, including IRAs, CDs, and even securities, and transfer funds between your

checking and savings accounts or to another customerʹs account.

Effectiveness: Many online and mobile banking sites provide stock quotes, rate alerts, and

personal financial management support, and allow you to import data into a personal

finance program such as Mint.com.Diff: 3Topic: Online and Mobile BankingAACSB: Reflective Thinking

20) Describe the disadvantages of online and mobile banking.

Answer: Disadvantages of Online and Mobile Banking

Start-up time: It takes time and effort to register for your bankʹs online and mobile

program. If you are setting up an account together with a spouse, you may have to sign a

durable power of attorney before the bank will display all of your holdings together.

Adapting: Banking sites can be difficult to navigate at first, so expect to spend some time

working through the tutorials or finding your way around the site or app. In addition,

these sites periodically change, which may require reentering data.

Feeling comfortable: Many people just donʹt feel comfortable banking online. Regardless

of your comfort level, you should always print the transaction receipt and keep it with

your bank records until the transaction shows up on your bank statement.

Customer service: The potential for poor customer service is a downside to online and

mobile banking.Diff: 3Topic: Online and Mobile BankingAACSB: Reflective Thinking

5.4 Cash Management Alternatives

1) T-bills are extremely safe investments, having been issued by the federal government.

Answer: TRUEDiff: 2Topic: Treasury BillsAACSB: Analytical Thinking

2) The interest rate earned on a money market deposit account is generally higher than the interest

earned on a Bank savings account.

Answer: TRUEDiff: 1Topic: Deposit AccountsAACSB: Analytical Thinking



3) One of the advantages of T-Bills is that they are exempt from federal taxes but subject to state

income taxes.

Answer: FALSEDiff: 2Topic: Treasury BillsAACSB: Analytical Thinking

4) What are short-term notes of debt issued by the federal government commonly called?

A) T-Bills B) T-Notes C) T-Bonds D) T-Accounts

Answer: ADiff: 1Topic: Treasury BillsAACSB: Analytical Thinking

5) What is the name for comprehensive financial services packages offered by brokerage firms?

A) Asset management accounts B) Comprehensive management accounts

C) Platinum management accounts D) Consolidated management accounts

Answer: ADiff: 1Topic: Cash ManagementAACSB: Analytical Thinking

6) Money-market mutual funds (MMMFs) provide an alternative to traditional liquid investments

offered by financial institutions. What are/is the advantage(s) of an MMMF?

A) High interest rates

B) Check-writing privileges

C) Minimal risk

D) Conveniencedeposits made through payroll deductions


Answer: EDiff: 1Topic: Deposit AccountsAACSB: Analytical Thinking

7) A savings alternative that pays a fixed rate of interest while keeping your funds on deposit for a

contracted period of time that can range from 30 days to several years is called a

A) demand deposit.

B) negotiable order of withdrawal deposit.

C) term deposit.

D) certificate of deposit.


Answer: DDiff: 1Topic: Certificates of DepositAACSB: Diverse and Multicultural Work Environments



8) What is another name for an interest-bearing checking account?

A) DIFI B) IBC C) NOW D) CWI

Answer: CDiff: 1Topic: Deposit AccountsAACSB: Analytical Thinking

9) Which of the following is not an advantage of a CD as a cash management alternative?

A) CDs have fixed interest rates, which are beneficial if interest rates drop.

B) CDs offer a wide selection of maturities.

C) CDs are insured.

D) CDs offer liquidity.

E) CDs are convenient to purchase.

Answer: DDiff: 2Topic: Certificates of DepositAACSB: Analytical Thinking

10) Pick the advantage of a certificates of deposit from this list of possibilities.

A) The interest paid is compounded daily.

B) Early withdrawals after 30 days do not incur a penalty.

C) Interest rates are generally higher than typical savings accounts.

D) They earn the APY and not the APR.

Answer: CDiff: 3Topic: Certificates of DepositAACSB: Analytical Thinking

11) Money Market Deposit Accounts enjoy one advantage over savings accounts found in

commercial banks. This advantage is

A) a variable rate that is generally higher.

B) lower fees and smaller minimum balances.

C) greater liquidity.

D) unlimited check-writing privileges.

Answer: ADiff: 1Topic: Deposit AccountsAACSB: Analytical Thinking

12) NOW accounts offer an option to traditional demand deposits. All of the following are

characteristics of NOW accounts except one. Which is it?

A) You must generally maintain high minimum balances.

B) There is a monthly fee associated with them.

C) The interest rate is generally higher than other savings accounts.

D) The interest rate is generally lower than other cash management alternatives.

Answer: CDiff: 3Topic: Deposit AccountsAACSB: Analytical Thinking



13) Money market mutual funds provide attractive competition for bank deposits because

A) their low fees are affordable for almost anyone.

B) they are convenient to purchase and use.

C) their short term, higher returns are generally regarded as practically risk-free.

D) they are fully insured.


Answer: CDiff: 3Topic: Mutual FundsAACSB: Analytical Thinking

14) Briefly describe each of the cash management alternatives discussed in this chapter.

Answer: a. Demand deposit a type of checking account on which no interest is paid

b. NOW account a checking account on which you earn interest on the balance

c. Savings account a deposit account that pays interest

d. Money market deposit account a bank account that provides a rate of interest that

varies with the current market rate of interest

e. Certificates of deposit savings alternatives that pay a fixed rate of interest while

keeping the funds on deposit for a set period of time that can range from 30 days to

several years

f. Money market mutual funds mutual funds that invest in short-term (generally with a

maturity of less than 90 days) notes of very high denomination

g. Asset management account a comprehensive financial services package offered by a

brokerage firm

h. U.S. Treasury Bills or T-Bills short-term notes of debt issued by the federal

government with maturities ranging from 1 month to 12 months

i. Series EE bonds a type of government security that is actually a loan to the

government on which you receive interest. The interest accrues every 6 months but

generally the holders let it compound until they redeem the bond.Diff: 2Topic: Cash ManagementAACSB: Analytical Thinking

5.5 Comparing Cash Management Alternatives

1) A tax free investment will always have a higher after-tax return than a taxable investment.

Answer: FALSEDiff: 2Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

2) The APY is the APR after taxes.

Answer: FALSEDiff: 2Topic: ReturnsAACSB: Analytical Thinking



3) The National Credit Union Association is a federal agency that insures deposits at credit unions.

Answer: TRUEDiff: 1Topic: Deposit InsuranceAACSB: Analytical Thinking

4) When comparing returns on cash management investment alternatives, it is important to make

sure that the rates you compare are all on the same tax basis.

Answer: TRUEDiff: 1Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

5) The APY can never be the same as the APR.


6) When you are considering different investment options and want to maximize your returns, be

sure to compare the investmentsʹ

A) quoted rates. B) APRs.

C) APYs. D) None of the above

Answer: CDiff: 3Topic: Annual Percentage RateAACSB: Diverse and Multicultural Work Environments

7) The ________ converts interest rates compounded for different periods into comparable annual

rates, allowing you to compare interest rates easily.

A) APR B) APY C) YTD D) YAY

Answer: BDiff: 3Topic: Annual Percentage RateAACSB: Diverse and Multicultural Work Environments

8) The Truth in Savings Act of 1993

A) helps investors compare interest rates on investment options.

B) requires that all institutions publish only annually compounded APRs.

C) ensures that all investments are federally insured.


Answer: ADiff: 2Topic: Cash ManagementAACSB: Diverse and Multicultural Work Environments



9) You have $5,000 in a 36 month Certificate of Deposit that has an APR of 3.75%. If inflation

averages 4.25% during these 36 months, what is the real return on your CD?

A) 3.75 percent B) 8.0 percent

C) Negative .50 percent D) Negative 8.0 percent

Answer: CDiff: 2Topic: InflationAACSB: Analytical Thinking

10) You are considering an MMMF. The fund is taxable and pays 8.5% interest. If your top federal

tax bracket is 25% and you live in a state that doesnʹt impose income taxes, what after-tax

return would you realize from this investment?

A) 6.38% B) 2.13% C) 7.44% D) 8.25%

Answer: ADiff: 3Topic: Principle 4: Taxes affect personal finance decisionsAACSB: Analytical Thinking

11) What is the FDIC?

A) Federal Deposit Insurance Corporation

B) Federal Deposit Insurance Collective

C) Federal Depository Insurance Committee

D) Federal Department of Insurance and Compensation


Answer: ADiff: 1Topic: Deposit InsuranceAACSB: Analytical Thinking

12) You are examining two different MMMFs. Fund A is tax-exempt and pays 7%. Fund B is

taxable and pays 9.5%. You live in a state that imposes no income taxes and you are in the 25%

federal tax bracket. Which of these two alternatives is better?

A) Find A is the better choice.

B) Fund B is the better choice.

C) Fund A and Fund B are equal so they both are a wise choice.

D) Neither Fund A nor Fund B are wise choices.

Answer: BDiff: 3Topic: ReturnsAACSB: Analytical Thinking



13) You are examining two different MMMFs. Fund A is tax-exempt and pays 5%. Fund B is

taxable and pays 6%. You live in a state that imposes no income taxes and are in a 28% federal

tax bracket. At what tax rate would the two funds have identical yields?

A) 16.67%

B) 17.76%

C) 20.23%

D) 28.00%

E) Cannot determine from the information provided

Answer: ADiff: 3Topic: ReturnsAACSB: Analytical Thinking

14) You are considering the purchase of one of two different investments. Investment A is tax

exempt and pays 6%. Investment B is taxable and pays 8.33%. You live in a state that imposes

no income taxes and are in a 28% federal tax bracket and want to earn the highest after tax

return possible. Which of the following is true? (round to two decimal places)

A) Investment A is preferred.

B) Investment B is preferred.

C) Investments A and B have identical after tax yields.

D) Investments A and B have identical APYs.

E) Not enough information has been provided.

Answer: CDiff: 3Topic: ReturnsAACSB: Analytical Thinking

15) Why is it important to convert interest rates into the APY on different accounts and with

different banks?

A) Some banks and accounts pay higher advertised rates.

B) The same advertised rate will vary with different compounding periods.

C) The Truth in Savings Act of 1993 omits this comparison.

D) With FDIC Banks it is not necessary to convert interest rates for comparison.


16) Please choose the method to use when calculating the after-tax return.

A) Taxable return (1 + marginal tax rate) - nontaxable return

B) Taxable return (marginal tax rate - 1) - nontaxable return

C) Nontaxable return (1 - marginal tax rate) + taxable return

D) Taxable return (1 - marginal tax rate) + nontaxable return

E) Nontaxable return (1 + marginal tax rate) - taxable return

Answer: DDiff: 3Topic: ReturnsAACSB: Analytical Thinking



17) What is the importance of the APY?

Answer: Understanding the impact of compounding frequency on the actual or effective rate of

return is essential to Personal Finance. There are many different investment options

available at different Institutions that make it hard to determine which is the best one for

you. By converting the APRs into APYs it allows you to make the best choice to maximize

your returns.Diff: 2Topic: ReturnsAACSB: Reflective Thinking

5.6 Establishing and Using a Checking Account

1) Your bank may offer a line of credit, a credit card, or a link to your savings account to cover

transactions when you overdraw your account.

Answer: TRUEDiff: 2Topic: Financial InstitutionsAACSB: Analytical Thinking

2) For a consumer who does not have a checking account a prepaid debit card is a means of paying

for goods and services.


3) If you only use your debit card and ATM card and rarely write paper checks, overdraft

protection is still a good thing to have.

Answer: TRUEDiff: 3Topic: Checking AccountsAACSB: Reflective Thinking

4) A travelerʹs check is a personal check that has been certified as being good by the financial

institution on which it is drawn.

Answer: FALSEDiff: 2Topic: Financial InstitutionsAACSB: Information Technology

5) Overdraft protection is an automatic loan made to your checking account whenever your

account does not contain enough cash to cover the checks that you have written against it.




6) A money order is typically less liquid than a personal check.

Answer: FALSEDiff: 2Topic: Liquid AssetsAACSB: Diverse and Multicultural Work Environments

7) When you use your debit card or ATM card, you should enter the transaction into your check

register.

Answer: TRUEDiff: 3Topic: Checking AccountsAACSB: Reflective Thinking

8) Many banks offer free checking accounts. What may be the opportunity costs associated with

free checking?

A) Low interest rates B) Overdraft protection

C) High minimum balance requirements D) Both A and C are correct answers.

Answer: DDiff: 2Topic: Checking AccountsAACSB: Information Technology

9) With online banking and EFT, many people donʹt really need checks anymore. If you seldom

need a paper check for transactions, what option is available to you that may be cheaper than

maintaining a checking account?

A) Certified checks B) Cashiers checks

C) Money orders D) Both B and C are good options.

Answer: DDiff: 2Topic: Checking AccountsAACSB: Information Technology

10) Suppose that you go to a bank at which you have no account, give the bank cash, and in return

obtain a check drawn against that bank which you will use to pay someone else. This is called a

A) cashierʹs check. B) certified check.

C) travelerʹs check. D) None of the above are correct.

Answer: ADiff: 2Topic: Cashierʹs CheckAACSB: Information Technology



11) What is the name for an automatic loan made to your checking account whenever your account

does not contain enough cash to cover the checks that you have written against it?

A) No fee checking coverage

B) Overdraft protection

C) Automatic check coverage (ACC)

D) Draft-free checking

E) None of the above are correct answers.

Answer: BDiff: 1Topic: Overdraft ProtectionAACSB: Information Technology

12) Which of the following is not a common fee arrangement for checking accounts?

A) Monthly fee

B) Minimum balance requirement

C) Variable interest rates to reflect fee activity

D) Charge per check

E) Balance-dependent scaled fees

Answer: CDiff: 2Topic: Checking AccountsAACSB: Information Technology

13) Four banking conveniences are listed below. Which one is not typical?

A) Safety deposit boxes

B) Online banking services

C) Direct deposit

D) Overdraft protection

E) All of the above are typical banking conveniences.

Answer: EDiff: 1Topic: Financial InstitutionsAACSB: Analytical Thinking

14) Brenda White had her bank certify one of her personal checks as being good. Which type of

check has been issued?

A) Travelerʹs check

B) Certified check

C) Cashierʹs check

D) Money order

E) Audited check

Answer: BDiff: 2Topic: Certified CheckAACSB: Information Technology



15) Name the three Cs of choosing a financial institution.

Answer: a. cost

b. convenience

c. considerationDiff: 1Topic: Financial InstitutionsAACSB: Reflective Thinking

5.7 Electronic Funds Transfers

1) A debit card is the same thing as a smart card.

Answer: FALSEDiff: 3Topic: Debit CardsAACSB: Information Technology

2) Virginia Techʹs Hokie Passport is an example of a smart card.

Answer: TRUEDiff: 2Topic: Smart CardAACSB: Information Technology

3) A debit card, also known as a memory card, can hold ID information, insurance information,

and medical history.


4) Card-blocking occurs when you use a debit card (or credit card) to check into a hotel or rent a

car and the anticipated expenses are blocked–in effect, placing a hold on the money.

Answer: TRUEDiff: 3Topic: Debit CardsAACSB: Information Technology

5) A store-valued card, only used at one store for one purpose, is known as an ʺopen-loopʺ card.


6) A debit card is something of a cross between a credit card and a checking account.

Answer: TRUEDiff: 3Topic: ATMAACSB: Information Technology



7) Electronic funds transfer applies to which of the following?

A) Debit cards

B) Smart cards

C) Direct deposit

D) ATM

E) All of the above are correct answers.

Answer: EDiff: 1Topic: Electronic Funds TransferAACSB: Information Technology

8) When using an ATM, keep in mind that

A) computer errors can occur.

B) it is never safe to deposit cash in an ATM.

C) you should report electronic transaction mistakes to the bank immediately.

D) human problems in handling the transactions can occur.


Answer: EDiff: 2Topic: ATMAACSB: Reflective Thinking

9) Your bank, First Bank, charges you $1.50 every time you use an ATM that is not owned by

them. Unfortunately, there is no First Bank ATM near your school. There is a Second Bank ATM

in the Student Center, which you use several times a week to withdraw $10 at a time for lunch,

video games, etc. What is the best piece of advice regarding these transactions?

A) They will make it hard to balance your account since these transactions wonʹt show up on

your monthly statements.

B) Theyʹre OK as long as you enter the transactions in your check register.

C) Avoid them since you are effectively paying 15% interest to access your cash.

D) Make sure you have overdraft protection on your account.

Answer: CDiff: 2Topic: ATMAACSB: Reflective Thinking



Christopher Garcia

Christopher just received his checking account statement from his bank. He has a NOW account with free

checking that pays 0.75% APR on the balance and requires a $500 minimum balance. His statement shows

that he currently has a balance of $3,950. In looking at his statement he notices that his car payment check for

$400 is still outstanding, and that his recently received payroll deposit of $3,600 had not posted at the time

the statement was created. His normal living expenses average $1,500 per month including his car payment.

Other than his car loan, he rarely writes any checks as he prefers to use his debit card and ATM card for

day-to-day living expenses. He pays his credit card balance in full every month. Other than his checking

account he does not own any investments. He has always dreamed of owning a house, and would like to buy

one within the next five years. He has access to a 401(k) pension plan at work where his employer will match

contributions up to 6% of his salary. He currently contributes 2% of his salary to this plan.

10) After balancing his checking account, what will his current balance be today?

A) $3,950 B) $7,550 C) $3,550 D) $7,150 E) $9,500

Answer: DDiff: 2Topic: Financial InstitutionsAACSB: Analytical Thinking

11) How is Christopher doing with his cash management?

A) He is doing pretty well since he has a lot of cash in his checking account.

B) He is doing pretty well since he pays his credit cards in full every month.

C) He is not maximizing his returns on his liquid assets.

D) He has a good checking account.

E) All but C are correct answers.

Answer: CDiff: 3Topic: Savings and Loans / ThriftsAACSB: Reflective Thinking

12) What would you recommend to Christopher concerning his cash management?

A) He should set up EFT payments for his auto loan.

B) He should switch his current account to a Money Market Deposit Account.

C) He should give up some liquidity.

D) All the above are correct.

E) All but C are correct.

Answer: DDiff: 3Topic: Treasury BillsAACSB: Reflective Thinking



13) Christopher has not received an Income Tax refund in 4 years. Is there anything you could

recommend to him?

A) No, without dependents there is not much he can do now.

B) He should increase his 401(k) contributions to 6% of his salary.

C) He should itemize his deductions.

D) He should change his W-2 form and claim more deductions.

E) All but A are good recommendations.

Answer: BDiff: 3Topic: Principle 4: Taxes affect personal finance decisionsAACSB: Reflective Thinking

14) What recommendations would you give Christopher concerning his cash management?

A) Create a budget and set some savings goals.

B) Automate a savings plan using EFT.

C) Set up an account at a mutual fund company.

D) All of the above are good recommendations.

E) All of the above except C are good recommendations.

Answer: DDiff: 3Topic: Cash ManagementAACSB: Reflective Thinking

15) What recommendations would you give Christopher about his goal of buying a house in five

years?

A) You donʹt have enough income to consider buying a house.

B) You need to develop a savings plan.

C) You need to estimate what a down payment would be.

D) You should switch to a Savings and Loan Association.

E) Both B and C are good answers.

Answer: EDiff: 3Topic: Cash ManagementAACSB: Reflective Thinking

16) Christopher would like to have $20,000 for a house down payment seven years from now. How

much money would he need to save every quarter in an investment that pays 9% APR

compounded quarterly?

A) $2,173.81 B) $171.78 C) $520.51 D) $509.05

Answer: CDiff: 3Topic: Calculator SkillsAACSB: Analytical Thinking



John and Maile Johnson

The Johnson family is very conservative financially. They have a retirement plan where John works and

share a joint checking account at their bank. They keep a lot of money in their checking account to cover

short-term needs and emergencies. Both of them want to step up to a higher interest rate than a checking or

savings account pays, and at the same time stay with their bank.

17) What would be your suggestion for the next account John and Maile should open?

A) Series EE bonds

B) Certificates of deposit

C) Money market deposit account

D) Money market mutual funds

E) Both B and C

Answer: EDiff: 3Topic: Cash ManagementAACSB: Analytical Thinking

18) Which of the following is not an advantage of a CD as a cash management alternative for John

and Maile?

A) High interest rate

B) Fixed rate of interest

C) It is insured.

D) Pays money market interest rates

E) Lends itself well to automated payroll deduction plan

Answer: DDiff: 2Topic: Certificates of DepositAACSB: Analytical Thinking

19) For John and Maile, money market deposit accounts may offer some advantages. Select the one

or ones below that would be the most valuable to John and Maile.

A) They are insured.

B) They may have limited checking privileges.

C) They have relatively attractive rates of return.

D) They have variable market interest rates.

E) All of the above are advantages.

Answer: EDiff: 2Topic: Deposit AccountsAACSB: Reflective Thinking



20) What financial principle do they need to understand better?

A) The time value of money

B) Taxes affect personal finance decisions.

C) Risk and return go hand in hand.

D) All of the above are important to their situation.

Answer: DDiff: 3Topic: ReturnsAACSB: Reflective Thinking

21) The Johnsons have been thinking about the financial principle - Pay Yourself First. Being very

conservative, they might consider having their bank

A) sell them a risky mutual fund.

B) send them a monthly reminder to make a deposit in their 401(k).

C) do a direct deposit of Johnʹs paycheck into their checking account.

D) do a direct deposit of some of Johnʹs paycheck into a savings fund.

Answer: DDiff: 2Topic: Cash ManagementAACSB: Reflective Thinking

22) Is EFT always a good thing? List some potential problems with EFT.

Answer: EFT makes our lives easier and better as long as you learn how to use it effectively. One

of the problems is better access of our money. Having unlimited access to our money may

cause problems with budgeting and impulsive spending. It also requires good record

keeping to make sure that you know how much money is left in your accounts to prevent

overdraft fees. When you write a check you have control over your money as far as the

amount and the timing of the withdrawal. With EFT payments for your bills and loans

you are giving up control of your money.Diff: 2Topic: Cash ManagementAACSB: Reflective Thinking

23) List three cash management resources that are used to electronically transfer money.

Answer: An automated teller machine (ATM) or cash machine provides cash instantly and can be

accessed through a credit or debit card.

A debit card is something of a cross between a credit card and a checking account. Itʹs

like a credit card in that itʹs a plastic card you can use instead of cash, but it works more

like a checking account.

Smart cards, sometimes called memory cards or electronic wallets, are a variation of

debit cards. Instead of withdrawing funds from a designated account with a bank, you

withdraw funds from an account thatʹs magnetically stored on the smart card.Diff: 2Topic: Cash ManagementAACSB: Information Technology



24) Explain the two types of gift, or stored value, cards.

Answer: There are two kinds of gift, or stored value, cards. The first is the single-purpose, or

ʺclosed-loop,ʺ card, which can be used only at one store for one purpose. The second is

the multipurpose, or ʺopen-loop,ʺ card, which can be used at most locations, just like a

credit card. This type of card is becoming more and more common. Many employees

receive their paychecks on a stored value card. More than 1,000 companies, including

Walmart, FedEx, McDonaldʹs, U-Haul, UPS, Coca-Cola, Blockbuster Video, and Dennyʹs,

offer to pay employees with Visa Payroll cards, which are a form of stored value cards,

instead of checks.Diff: 3Topic: Electronic Funds TransferAACSB: Information Technology

25) List one advantage to paying bills automatically.

Answer: Using automatic withdrawals to pay your bills will prevent late payments. However, if

you do automate bill payment, make sure you take the time to read your bills–you must

know where your money is going, and you must know exactly how much money is being

withdrawn.Diff: 2Topic: Financial PlanningAACSB: Information Technology

26) What are some tips to help you start managing your cash and achieving financial control?

Answer: Create an emergency fund before you have an emergency.

Be careful when you bank online.

Make sure you use a strong password and a secure network.

Never pay bills from public Wi-Fi hotspots.

Pay your bills online.

If possible, have your bills automatically paid.

Use online alerts to your advantage. Sent to your mobile phone or e-mail address, online

alerts can provide you with peace of mind, protect your credit score, and save you

money.Diff: 2Topic: Financial PlanningAACSB: Reflective Thinking


Chapter 6Using Credit Cards: The Role of Open Credit

6.1 A First Look at Credit Cards and Open Credit

1) Taking a cash advance on your credit card for daily living expenses may not be a wise financial

decision because interest begins on the cash advance balance amount immediately.

Answer: TRUEDiff: 3Topic: DebtAACSB: Analytical Thinking

2) Using your credit cards for cash advances is a relatively cheap way to borrow money because

you usually do not start paying interest until the next billing period.

Answer: FALSEDiff: 1Topic: Cash Advance FeeAACSB: Analytical Thinking

3) Cash advances generally require an upfront fee of 4 to 6 percent of the amount advanced.


4) Changes to credit card policies and rates are usually announced via ʺbill addendums,ʺ which are

notices enclosed with your bill.


5) Late library fines and unpaid parking tickets can hurt your credit score.

Answer: TRUEDiff: 3Topic: Credit ScoringAACSB: Reflective Thinking

6) One of the unpleasant secrets of using your credit card for a cash advance is that the APR on the

cash advance is typically lower than the APR for normal purchases.

Answer: FALSEDiff: 3Topic: Cash Advance FeeAACSB: Information Technology

7) Most credit cards offer a 31- to 35-day grace period from the date of the bill to make payments.

Answer: FALSEDiff: 2Topic: Grace PeriodAACSB: Analytical Thinking



8) According to the Bankcard Holders Association of America, about 95 percent of all bank card

issuers use the adjusted balance method.

Answer: FALSEDiff: 3Topic: Adjusted Balance MethodAACSB: Analytical Thinking

9) The average daily balance method calculates interest payments based on the ending balance of

the previous period.

Answer: FALSEDiff: 1Topic: Average Daily Balance MethodAACSB: Analytical Thinking

10) Due to compounding frequency, the actual interest rate or APY you pay is higher than the

advertised interest rate or APR.

Answer: TRUEDiff: 2Topic: Annual Percentage RateAACSB: Analytical Thinking

11) For the average consumer there is usually a set limit on open or revolving credit accounts.

Answer: TRUEDiff: 1Topic: Open Credit / Revolving CreditAACSB: Analytical Thinking

12) Credit purchases made for personal needs like home mortgages or car loans are referred to as

revolving credit.

Answer: FALSEDiff: 1Topic: Consumer CreditAACSB: Analytical Thinking

13) Financially savvy people take advantage of the grace period on major purchases and pay the

balance off in full; thus avoiding finance charges.

Answer: TRUEDiff: 3Topic: Grace PeriodAACSB: Analytical Thinking

14) There is no cash advance fee when you use your credit card at an ATM machine.

Answer: FALSEDiff: 3Topic: Cash Advance FeeAACSB: Information Technology


Chapter 6 Using Credit Cards: The Role of Open Credit 129

15) Over 70% of the 25 biggest credit card issuers do not charge annual fees.


16) The use of credit involves receiving cash, goods, or services with an obligation to pay later.

Which statement is not an opening line to the use of credit in a shopperʹs language?

A) ʺCharge it.ʺ B) ʺPut it on my account.ʺ

C) ʺPut it on my debit.ʺ D) ʺIʹll pay for it with plastic.ʺ

Answer: CDiff: 3Topic: DebtAACSB: Analytical Thinking

17) The main factor that determines the cost of a line of credit is the ________, which is also

considered the true simple interest rate paid over the life of the loan.

A) annual merchant rate (AMR) B) teaser rate

C) annual percentage rate (APR) D) penalty rate


18) Most credit cards have a ________ grace period from the date of the bill to make payments.

A) 1- to 15-day B) 5- to 20-day C) 21 to 25-day D) 31- to 35-day

Answer: CDiff: 3Topic: Grace PeriodAACSB: Analytical Thinking

19) Typically, an annual fee charge ranges from $10 to $100, but the American Express Centurion

Card charges a ________ annual fee–and thereʹs also a ________ initiation fee for the first year.

A) $0; $0 B) $25; $75 C) $250; $750 D) $2,500; $7,500

Answer: DDiff: 3Topic: Annual feeAACSB: Information Technology

20) The ________ is the percentage of the credit card sale that the retailer owes to the credit card

company.

A) retailer credit acceptance fee B) card usage allowance

C) merchantʹs discount fee D) franchise fee

Answer: CDiff: 2Topic: Merchantʹs Discount FeeAACSB: Diverse and Multicultural Work Environments



21) According to the Bankcard Holders Association of America, about 95 percent of all bank card

issuers use the

A) adjusted balance method. B) previous balance method.

C) average daily balance method. D) daily double balance method.

Answer: CDiff: 3Topic: Average Daily Balance MethodAACSB: Analytical Thinking

22) Typically, the credit card issuer allows you a grace period, which means

A) you do not have to make a payment during the current month.

B) you are not charged any interest during this grace period.

C) you must pay your balance off in full to benefit from the grace period.

D) interest charges are reduced during this time.

E) both B and C apply.

Answer: EDiff: 2Topic: Grace PeriodAACSB: Information Technology

23) Which of the following apply to getting a cash advance with a credit card?

A) Cash advances are available at ATM machines.

B) You begin paying interest immediately.

C) There may be a cash advance fee.

D) The interest rate may be higher than on regular purchases.

E) All of the above

Answer: EDiff: 2Topic: Cash Advance FeeAACSB: Analytical Thinking

24) Which method sums the outstanding balances owed each day during the billing period and

divides by the number of days in the period?

A) Average daily balance

B) Previous balance

C) Adjusted balance

D) Balance calculation method

E) Simple interest

Answer: ADiff: 1Topic: Average Daily Balance MethodAACSB: Analytical Thinking



25) On October 1st Joe charged $900 to his credit card, on October 10th he charged another $1,300 to

his credit card, and on October 15th he charged an additional $100. His credit card charges him

an Annual Percentage Rate (APR) of 18% compounded monthly. Using the Average Daily

Balance Method calculate Joeʹs finance charge for the month of October.

A) $7.12

B) $28.16

C) $212.36

D) $523.14

E) None of the above are correct answers.

Answer: BDiff: 3Topic: Previous Balance MethodAACSB: Analytical Thinking

26) Credit cards are a form of ________ credit.

A) close ended B) revolving C) installment D) service

Answer: BDiff: 2Topic: Open Credit / Revolving CreditAACSB: Information Technology

27) Jessica always thought the grace-period feature of her credit card was a wonderful idea because

her charges were interest-free during the grace period. After taking Dr. Art Keownʹs personal

finance course, she learned this startling truth about grace periods.

A) Grace periods are actually beneficial to the credit card company.

B) There are higher fees associated with grace periods.

C) Most banks eliminate their grace period on new purchases if you donʹt pay your balance in

full.

D) All credit cards carry a grace period.

Answer: CDiff: 3Topic: Grace PeriodAACSB: Diverse and Multicultural Work Environments

28) The Truth In Lending Act requires that all consumer credit agreements disclose the ________ in

bold print?

A) Effective Annual Rate (EAR) B) Annual Percentage Rate (APR)

C) Monthly Stated Rate (MSR) D) Nominal Interest Rate (NIR)

Answer: BDiff: 1Topic: Annual Percentage RateAACSB: Information Technology



29) When you use a credit card at a store, the store is generally charged a fee ranging from 1.5% to

5%. What is this fee called?

A) Merchant discount fee B) Merchant back-end charge

C) Merchant rate D) Discount rate

Answer: ADiff: 2Topic: Merchantʹs Discount FeeAACSB: Diverse and Multicultural Work Environments

30) Changes to your credit card policies and rates are usually announced via ʺ________ʺ; which are

notices enclosed with your bill.

A) bill addendums B) policy wards

C) bill stuffers D) regal notices

Answer: CDiff: 2Topic: DebtAACSB: Information Technology

31) Assume a 31-day month to calculate your average daily balance for your credit card bill. Your

daily balance for the first 10 days was $1,400, for the next 10 days was $1900, and for the last 10

days was $2700. What will your average daily balance be at the end of the month?

A) $1935.48 B) $19.35 C) $193.58 D) $1.94

Answer: ADiff: 3Topic: Average Daily Balance MethodAACSB: Analytical Thinking

32) Assuming the APR on your credit card is 18% and your average daily balance this month was

$10,000, what will your interest or finance charges for the month be?

A) $180 B) $60 C) $150 D) $1.50

Answer: CDiff: 2Topic: Average Daily Balance MethodAACSB: Analytical Thinking

33) Assuming the APR on your credit card is 24 percent and your average daily balance this month

was $8,000, what will your interest or finance charges for the month be?

A) $1.92 B) $240 C) $192 D) $160

Answer: DDiff: 2Topic: Average Daily Balance MethodAACSB: Analytical Thinking

34) More than ________ of the 25 biggest credit card issuers do not charge annual fees.


Answer: CDiff: 3Topic: Annual feeAACSB: Analytical Thinking



35) One of the unpleasant secrets about using your credit card for a cash advance is that

A) there is usually a 6 to 8 percent upfront fee on the amount.

B) the APR on the cash advance is typically lower than the APR for normal purchases.

C) payments do not apply to cash advance balances unless the balance for regular credit

purchases is zero.

D) All but B apply to cash advances.

Answer: CDiff: 3Topic: Cash Advance FeeAACSB: Analytical Thinking

36) The ________ is the interest rate you pay on your balance if you donʹt make your minimum

payments on time.

A) penalty rate B) late rate

C) cash advance rate D) over-the-limit rate

Answer: ADiff: 3Topic: Penalty RateAACSB: Analytical Thinking

37) In an emergency, you used your credit card for a $500 cash advance. You just received your

statement and your total balance due is $1,859, and the cash advance was the most recent

charge. You want to be sure to pay for the cash advance so you send in a payment of $700. Your

credit card has an APR of 12 percent. How much of your payment will apply to the

cash-advance balance?

A) Because it was the most recent charge, $500 of the payment will apply to the cash-advance

balance.

B) It doesnʹt make any difference because the $1,859 balance includes the cash advance, the

$700 payment will lower your total balance regardless, so the amount applied to the

cash-advance balance is irrelevant.

C) There isnʹt enough information to answer the question, because the answer depends on the

cash advanceʹs interest rate.


Answer: DDiff: 3Topic: Cash Advance FeeAACSB: Analytical Thinking



38) Michael has a credit limit and a balance of $3,000 on his Visa card. His car broke down, he

charged the $500 repairs to his Visa which he knows put him over his credit limit for the month.

His payment is due on the 20th so he made sure that he had his $750 payment to the post office

on the 20th. Most likely, what penalties or fees, if any, will he incur?

A) Only the penalty APR, depending on his credit card company.

B) Only the over-the-limit fee.

C) Only the late fee, since his payment will lower his balance below his credit limit.

D) He will likely incur the penalty APR, as well as an over-the-limit fee and a late fee

because VISA has to receive his payment in its office by the 20th, not have it postmarked

by the 20th.

E) None of the above choices accurately describes the situation.

Answer: DDiff: 3Topic: DebtAACSB: Analytical Thinking

39) Sometimes retailers will give you up to a 5% discount if you pay cash for their products instead

of using your credit card. Why?

A) It is just good customer service, especially for repeat customers.

B) They are getting close to their monthly charge limit and donʹt want to go over it.

C) They are saving on the merchants discount fee so they pass the savings on to you.

D) Its much less paper work to process cash transactions.

Answer: CDiff: 3Topic: Merchantʹs Discount FeeAACSB: Diverse and Multicultural Work Environments

Bradley Clemons

Bradley currently has a Visa card from his bank with the following terms: 21 percent on purchases, 25 percent

on cash advances with a 3 percent cash-advance fee on the amount, and a default or penalty rate of 33

percent. His current statement shows a balance of $9,000. Lately, he has been having a hard time paying more

than the minimum payment of 3 percent of his balance.

40) What is Bradleyʹs minimum payment?

A) $158 B) $189 C) $270 D) $1,890


41) What is the current APY on this credit card?

A) 21 percent B) 22.99 percent C) 23.14 percent D) 24 percent

Answer: CDiff: 3Topic: Annual Percentage RateAACSB: Analytical Thinking



42) What is the APY on Bradleyʹs default, or penalty, rate?

A) 33 percent B) 33.50 percent C) 38.48 percent D) 42.96 percent

Answer: CDiff: 3Topic: Annual Percentage RateAACSB: Analytical Thinking

43) If Bradley buys a new game console for $560 this month and sends in a credit card payment of

$950 when he gets his statement, how much interest will he pay on the game console for the

month?

A) 21 percent

B) 1.75 percent

C) 3 percent

D) None, since he paid for the game console in full during the grace period.

Answer: BDiff: 3Topic: Grace PeriodAACSB: Analytical Thinking

Monty Head

Monty currently has a Visa card from his bank with the following terms: 18% on purchases, 24% on cash

advances with a 4% cash advance fee on the amount, and a default or penalty rate of 36%. His current

statement shows a balance of $6,000. So far he has only taken one cash advance, withdrawing $1,000 from a

casino in Las Vegas a year ago, which he has already paid off. Lately he has been having a hard time paying

more than the minimum payment of 4% of his balance. The only assets he owns are a seven-year-old car and

a $2,500 certificate of deposit that has a 5% APR.

44) What will be Montyʹs minimum payment due?

A) $90

B) $20

C) $240

D) $1,080



45) What is the current APY on this credit card?

A) 18%

B) 18.66%

C) 18.99%

D) 19.56%


Answer: DDiff: 3Topic: Annual Percentage RateAACSB: Analytical Thinking



46) What is the APY on Montyʹs default or penalty rate?

A) 36% B) 36.99% C) 42.58% D) 48.66%

Answer: CDiff: 3Topic: Cash Advance FeeAACSB: Analytical Thinking

47) If Monty buys a new television for $800 this month and sends in a credit card payment of $1,200

when he gets his statement, how much interest will he pay on the television for the month?

A) 18%

B) 1.5%

C) None, since he paid for the television in full during the grace period.

D) None of the above answers is correct.

Answer: BDiff: 3Topic: Grace PeriodAACSB: Analytical Thinking

48) Using the Adjusted Balance Method: If Monty sends in a payment for $1,000, how much will the

finance charge be on his remaining balance? (Use the $6,000 balance for your calculations.)

A) $75

B) $90

C) $110

D) There is not enough information to solve this question.

Answer: ADiff: 3Topic: Interest RatesAACSB: Analytical Thinking

49) It is now three months later and Monty has missed two payments in a row and he is now

paying the default or penalty rate on his balance. How much interest per month will Monty be

accruing on his unpaid balance?

A) 18% B) 1.5% C) 36% D) 3%

Answer: DDiff: 3Topic: Interest RatesAACSB: Analytical Thinking

50) What advice would you give to Monty concerning his use of credit cards?

A) Learn to live within your means.

B) Learn the difference between a want and a needgambling in Vegas is not a need.

C) Seek out a non-profit credit counseling company.

D) All of the above

Answer: DDiff: 3Topic: Annual Percentage RateAACSB: Reflective Thinking



51) When you withdraw cash from an ATM using your credit card

A) you begin paying interest immediately.

B) you are not charged any interest until after the date the payment is due.

C) the interest fee is lower than that for purchases.

D) youʹre using a relatively inexpensive way to borrow money.

Answer: ADiff: 2Topic: DebtAACSB: Analytical Thinking

52) Teaser rates are very low. How long do they last? Is there any real benefit in them?

Answer: Introductory teaser rates can be as low as 0.0%. They last from 6-12 months. The real

benefit in using them is the interest saved during the introductory period. At the end of

the period, the rates will dramatically increase. At this time, pay the balance off with a

lower interest option. Just be sure to time it right.Diff: 1Topic: Annual Percentage RateAACSB: Analytical Thinking

53) Compare and contrast the average, previous, and adjusted balance methods.

Answer: The average daily balance method calculates interest by summing the outstanding

balances owed each day during the billing period and dividing by the number of days in

the period. The previous balance method simply bases interest on the outstanding

balance at the end of the previous billing period. Interest is calculated using the adjusted

balance method by charging against the balance at the end of the previous billing period

less any payments and returns made.Diff: 2Topic: Adjusted Balance MethodAACSB: Analytical Thinking

54) List the three primary methods used to determine interest charges on an unpaid credit card

balance.

Answer: (1) the average daily balance method

(2) the previous balance method

(3) the adjusted balance methodDiff: 2Topic: DebtAACSB: Reflective Thinking



55) Describe the three primary methods used to determine interest charges on an unpaid credit card

balance.

Answer: Average daily balance method: Your average daily balance is calculated by adding up

your daily balances during the billing period and dividing the sum by the number of

billing-period days. Interest payments are based on this average balance. The Bankcard

Holders Association of America reports that this method is used by about 95 percent of

all bank card issuers.

Previous balance method: Interest payments are charged against the amount owed at the

end of the previous billing period, without taking into account the amount of the current

monthʹs payments. This method is relatively simple, but itʹs also expensive for the credit

card holder.

Adjusted balance method: Interest is charged against the previous monthʹs balance only

after any payments have been subtracted. Because interest isnʹt charged on payments,

this method results in lower interest charges than the previous balance method.Diff: 3Topic: DebtAACSB: Reflective Thinking

56) Using your credit card for a cash advance in an emergency is probably a good idea. Using cash

advances for non-emergencies is a terrible idea. Explain the characteristics that make cash

advances very dangerous.

Answer: For starters, it shows that you are not managing your personal finances very well. Using

cash advances for day to day living expenses means that you are not following a budget

and you are living outside of your means. Normally there is an upfront fee of several

percent on the amount of the cash advance. The APR for cash advances is higher than the

APR for regular purchases. None of your payments apply to the cash advance balance

until you have paid your other balances in full first. Since a majority of people never pay

off their credit card balance, then they are paying a very high APR on their cash advance

balance for a very, very long time.Diff: 1Topic: Cash Advance FeeAACSB: Analytical Thinking

6.2 The Pros and Cons of Credit Cards

1) Your credit card company is required to send you a notice 45 days before they can increase your

interest rate, change certain fees (such as annual fees, cash-advance fees, and late fees), or make

other significant changes to the terms of your card.

Answer: TRUEDiff: 3Topic: Credit CARD ActAACSB: Analytical Thinking

2) The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act established fee caps

for cards. Card fees cannot total more than ________ of the initial credit limit.


Answer: ADiff: 3Topic: Credit CARD ActAACSB: Reflective Thinking



3) Your credit card company is required to send you a notice ________ before they can increase

your interest rate, change certain fees (such as annual fees, cash advance fees, and late fees), or

make other significant changes to the terms of your card.

A) 1 day B) 15 days C) 45 days D) 60 days

Answer: CDiff: 3Topic: Credit BureauAACSB: Reflective Thinking

4) Which of the following is an advantage of credit cards?

A) They make it easy to lose control of spending.

B) In general they are an expensive way to borrow money.

C) They allow the consumer the ability to rent cars and make online reservations.

D) Using them means you will have less spendable money in the future.

Answer: CDiff: 2Topic: DebtAACSB: Reflective Thinking

5) Your credit card company cannot increase your rate for the first 12 months after you open an

account unless

A) your card has a fixed interest rate tied to an index and the index goes down.

B) your cardʹs introductory rate expires and your rate reverts to the ʺgo-toʺ rate the company

disclosed when you got the card.

C) you are more than 15 days late in paying your bill.


Answer: BDiff: 3Topic: Credit CARD ActAACSB: Analytical Thinking

6) Which of the following is a disadvantage of credit cards?

A) Allows for consumption before the purchase is fully paid for

B) Emergency use

C) Allows for online shopping

D) The finance charge that accrues on the account if not paid off in full each month

Answer: DDiff: 2Topic: DebtAACSB: Reflective Thinking



7) Research has determined that undergraduate college students tend to behave in similar

manners with regards to their credit card usage. As noted in Chapter 6, which of the following

behaviors are indicative of undergraduate studentsʹ credit card behaviors?

A) Their parents do not frequently pay their credit card balances for them.

B) They make more than their minimum payment each month but still tend to carry a balance

on their cards.

C) They pay off all of their cards in full each month.

D) They make more than the required minimum payment on 90% of all other cards each

month.

Answer: BDiff: 2Topic: DebtAACSB: Reflective Thinking

8) List the five benefits or advantages associated with credit cards. What are the two major

disadvantages?

Answer: Credit cards are convenient and easy to use when shopping. They are great for

emergency use and they allow for consumption before the purchase is fully paid for.

They allow for consolidation of bills and also act as a source of interest-free credit.

Additional pros include using the cards as a source of free benefits, as identification, for

making reservations, a means to purchase before the price goes up.

Two major disadvantages include making it easy to lose control of spending and being

an expensive way to borrow money.Diff: 2Topic: DebtAACSB: Diverse and Multicultural Work Environments

9) List five components of the Credit Card Accountability, Responsibility, and Disclosure (CARD)

Act.

Answer: 1. Notification of schedule for payoff

2. Increased rates apply only to new charges

3. Restrictions on over-the-limit transactions

4. Caps on high-fee cards

5. Protections for underage consumersDiff: 3Topic: Credit CARD ActAACSB: Reflective Thinking

6.3 Choosing a Source of Open Credit

1) A convenience user of credit cards is someone who pays off the credit card balance each month.

Answer: TRUEDiff: 1Topic: DebtAACSB: Diverse and Multicultural Work Environments



2) Most credit users are more interested in free benefits than low APRs.

Answer: FALSEDiff: 2Topic: Annual Percentage RateAACSB: Analytical Thinking

3) A single-purpose card is a credit card that can be used only at a specific company.

Answer: TRUEDiff: 1Topic: Single-Purpose Card

AACSB: Diverse and Multicultural Work Environments

4) A secured credit card is a good tool to help establish credit.


5) Only Prestige or Premium credit cards offer a grace period.

Answer: FALSEDiff: 3Topic: DebtAACSB: Diverse and Multicultural Work Environments

6) Crystal tried to use her Macyʹs credit card at Target but was unsuccessful because her Macyʹs

credit card is a single-purpose card and can only be used at Macyʹs.

Answer: TRUEDiff: 3Topic: Single-Purpose Card

AACSB: Information Technology

7) Angela tried to use her Macyʹs credit card at Target but was unsuccessful because Target only

accepts Target credit cards.

Answer: FALSEDiff: 3Topic: DebtAACSB: Information Technology

8) A convenience user doesnʹt really care what the APY is on their credit cards.


9) To a credit user, the perks and benefits are the most important determinant when choosing a

credit card.

Answer: FALSEDiff: 3Topic: DebtAACSB: Reflective Thinking



10) For the convenience credit card user the interest rate is

A) irresistible. B) irrelevant. C) irregular. D) intimidating.

Answer: BDiff: 3Topic: DebtAACSB: Diverse and Multicultural Work Environments

11) Which of the following are important to convenience users of credit cards?

A) Low annual fee

B) Interest-free grace period

C) Card benefits and perks

D) Only A and B

E) All of the above

Answer: EDiff: 3Topic: DebtAACSB: Diverse and Multicultural Work Environments

12) The choice of a credit card is a matter of personal credit card philosophy. If you are a credit user,

the most important decision factor is the cardʹs

A) length of grace period.

B) annual fee.

C) APR on the unpaid balance.

D) minimum payment.

E) late payment fee.

Answer: CDiff: 2Topic: Annual Percentage RateAACSB: Diverse and Multicultural Work Environments

13) A(n) ________ card is a credit card that does not offer revolving credit and requires full payment

of the balance at the end of each month.

A) T&E

B) premium

C) affinity

D) traditional charge account

E) single-purpose

Answer: ADiff: 2Topic: Travel and Entertainment CardAACSB: Information Technology



14) Which of the following is not a single-purpose credit card?

A) Shell Oil

B) Wells Fargo Visa

C) Toys R Us

D) Target

E) Macyʹs

Answer: BDiff: 1Topic: Single-Purpose Card

AACSB: Information Technology

15) What is the main distinguishing feature(s) for T&E cards?

A) They do not offer revolving credit.

B) The full balance must be paid each month.

C) There is no annual fee.

D) Both A and B above

E) Both A and C above

Answer: DDiff: 3Topic: Travel and Entertainment CardAACSB: Analytical Thinking

16) Credit cards issued in conjunction with particular charities or organizations, like the Sierra Club

or the Humane Society, that send a portion of their annual fee or percentage of their purchases

back to the sponsoring organization are known as

A) premium cards. B) prestige cards.

C) affinity cards. D) secured credit cards.

Answer: CDiff: 2Topic: Affinity CardAACSB: Information Technology

17) What type of a credit card is issued in partnership with a specific charity or organization, such

as Mothers Against Drunk Driving (MADD), the National Rifle Association (NRA), or a college

or university?

A) Prestige card B) Affinity card

C) Travel and entertainment card D) Social responsibility card

Answer: BDiff: 3Topic: Affinity CardAACSB: Information Technology



18) The major differences between a premium prestige card and a regular credit card include

A) higher interest rates.

B) higher credit limits.

C) additional perks and benefits.

D) both A and B above

E) both B and C above

Answer: EDiff: 3Topic: Premium Card / Prestige CardAACSB: Analytical Thinking

19) Which of the following statements is most correct regarding a secured credit card?

A) It is a valuable form of credit insurance you are protected against loss if the card is lost

or stolen.

B) It is useful to someone who has bad credit or no credit established yet.

C) It provides a higher level of user security, using technology to prevent illegal use.

D) Compared to non-secured credit cards, it always carries a much lower rate of interest.

Answer: BDiff: 2Topic: Secured Credit CardAACSB: Analytical Thinking

Jerome Hanesworth

Jerome has three major credit cards and makes payments on them each month. He has had one of them for

six years, another for three years, and the last for eleven months. Making just the minimum payment has

become automatic at this point, and Jerome barely even looks at the statements. Jerome is beginning to think

that his approach to credit may be faulty, and he wants to find out how to adjust it. He just applied for two

additional credit cards.

20) Jerome would be considered a

A) credit user.

B) convenience user.

C) combination credit and convenience user.

D) T&E card user.

Answer: ADiff: 2Topic: DebtAACSB: Reflective Thinking

21) Based on his credit card usage, which of the following aspects of a credit card should be most

important to Jerome?

A) The APR on the unpaid balance

B) A low annual fee

C) Perks and benefits, like frequent flier miles

D) None of the above are important to Jerome.




22) Most likely, Jerome is

A) unaware of how much of his payments go toward interest.

B) not getting the benefits of a grace period.

C) obligating his future income.


Answer: DDiff: 2Topic: DebtAACSB: Reflective Thinking

23) What advice might you give to Jerome?

A) Keep making timely, minimum payments.

B) Get a cash advance to pay down the balances on the cards.

C) Consider using savings to pay off current credit card debt.

D) All of this advice would be helpful to Jerome.


24) List the three types of credit card users.

Answer: 1. Credit user

2. Convenience user

3. Convenience and credit userDiff: 2Topic: DebtAACSB: Reflective Thinking

25) Briefly describe the three credit card users.

Answer: A credit user generally carries an unpaid balance from month to month. Most credit users

donʹt use the grace period, and the annual fee pales in comparison to the amount of

interest they pay annually. If youʹre a credit user, the most important decision factor is the

APR, or interest rate, on the unpaid balance, because it will be the largest credit expense

you face.

A convenience user is someone who pays off their credit card balance each month, so the

interest rate is irrelevant. Convenience users look for a credit card with a low annual fee

and an interest-free grace period.

A convenience and credit user is someone who generally, but not always, pays off all of

the balance each month. Their ideal card is one with an interest free grace period, a low

interest rate on the unpaid balance, and no annual fee.Diff: 3Topic: DebtAACSB: Reflective Thinking



6.4 Getting a Credit Card

1) Credit card companies send out a whopping 6 billion credit card offers annually–roughly 60

offers per U.S. household!


2) Credit card issuers are free to set up shop near large university campuses and offer free gifts

–anything from free or discounted flights to free Frisbees.

Answer: FALSEDiff: 3Topic: Credit CARD ActAACSB: Reflective Thinking

3) Everyone who accessed your credit report within the last seven years appears in an ʺinquiryʺ list

that appears on your credit report.

Answer: FALSEDiff: 3Topic: DebtAACSB: Analytical Thinking

4) According to a Nellie Mae study, 93 percent of graduate students would have liked more

information on financial management topics before they started school and would like financial

management education made available to them now.

Answer: TRUEDiff: 3Topic: Financial ChallengesAACSB: Diverse and Multicultural Work Environments

5) One of the more important factors in determining your credit score is the length of your credit

history.

Answer: TRUEDiff: 3Topic: Credit ScoringAACSB: Analytical Thinking

6) It is against the law for your potential employer to use your credit score for employment

considerations.

Answer: FALSEDiff: 3Topic: Credit ScoringAACSB: Diverse and Multicultural Work Environments

7) Your credit score may affect how much you pay for health insurance.

Answer: FALSEDiff: 3Topic: Credit ScoringAACSB: Diverse and Multicultural Work Environments



8) A credit bureau is a private organization that maintains credit information on individuals,

which it allows subscribers to access for a fee.

Answer: TRUEDiff: 1Topic: Credit BureauAACSB: Information Technology

9) Getting a credit card while a college student is an excellent idea because

A) it helps you learn about credit.

B) you can shop online and make reservations.

C) it works well for emergencies.

D) when used correctly it allows you to build up a solid credit history.


Answer: EDiff: 2Topic: DebtAACSB: Analytical Thinking

10) One of the following lists constitutes the five Cs of credit. Select the correct one.

A) Character, capacity, capital, collateral, characteristics

B) Character, capacity, capital, collateral, co-insurance

C) Character, capacity, capital, collateral, careful

D) Character, capacity, capital, collateral, conditions

E) Character, capacity, capital, collateral, credence


11) A company that gathers and sells consumersʹ financial history to creditors is a

A) credit card company.

B) credit bureau.

C) credit investigation bureau.

D) credit recovery firm.

E) credit issuance firm.

Answer: BDiff: 1Topic: Credit BureauAACSB: Information Technology

12) ________ is not information generally found in your credit report.

A) Employment information

B) Personal credit history

C) College attended, grades, etc.

D) Your public financial history

E) Past inquiries regarding your credit report

Answer: CDiff: 2Topic: Credit ScoringAACSB: Information Technology



13) By law you have certain rights in connection with the credit bureau. They are

A) the right to view your personal credit report.

B) the right to point out errors found in your file.

C) the right to request the credit bureau to correct mistakes in your file.

D) the right to file a statement presenting your view of a disputed issue.


Answer: EDiff: 3Topic: Credit BureauAACSB: Information Technology

14) Your credit score affects

A) the rate you pay on your credit cards.

B) the size of your credit line.

C) your mortgage rate.

D) the amount of junk mail offering additional credit cards that you receive.


Answer: EDiff: 3Topic: Credit ScoringAACSB: Information Technology

15) Credit scoring is

A) quite expensive for the lender.

B) not a flawless method of determining creditworthiness.

C) an inefficient but necessary process.


Answer: BDiff: 3Topic: Credit ScoringAACSB: Diverse and Multicultural Work Environments

16) A low FICO score

A) is a good credit score.

B) can cost you quite a bit when you get a mortgage loan.

C) may result in a credit card rate half the rate of that paid by those with a high FICO score.

D) is the only factor the lender considers when determining whether to give you credit.

Answer: BDiff: 3Topic: Credit ScoringAACSB: Diverse and Multicultural Work Environments



17) The process of mathematically evaluating your creditworthiness to obtain credit is called

A) credit scoring.

B) credit evaluation.

C) credit references.

D) credit history.

E) credit statistics.

Answer: ADiff: 1Topic: Credit ScoringAACSB: Information Technology

18) Which of the five Cs of credit would your actual home be in relation to your mortgage?

A) Character

B) Capacity

C) Collateral

D) Capital

E) Conditions


19) Roxanne has always maintained an excellent credit rating over the years. She has an annual

income of $23,000, has lived at her current residence three years, and has worked at the same job

for eight years. Susan works in a clerical position, has two credit cards and maintains two bank

accounts. Which one of the following items of evaluation would Roxanne score the highest on?

A) Employment history B) Annual income

C) Length of residence D) All of the above are correct answers.

Answer: ADiff: 3Topic: Credit ScoringAACSB: Analytical Thinking

20) What rights would a college friend of yours have whose credit card application was denied?

A) The right to view her credit report

B) The right to have the file be accurate

C) The right to point out errors in her file

D) The right to request mistakes in the file be corrected


Answer: EDiff: 1Topic: Credit ScoringAACSB: Analytical Thinking



21) Which of the following is not a typical potential problem that can occur in a credit bureau file?

A) You may be mixed up with someone else with a similar name.

B) Accounts may be listed as still open that are actually closed.

C) Accounts may be listed that you never had.

D) The wrong credit bureau handles your case.

E) A creditor may fail to report a payment or payments.

Answer: DDiff: 3Topic: Credit BureauAACSB: Information Technology

22) Cedrickʹs credit card was stolen, and he did not realize that it was stolen until he received his

most recent billing statement. He contacted the credit card company immediately after he read

his statement. Fraudulent charges were as follows: $250 for a Blue-ray player, $600 for a new set

of tires, $200 cash withdrawal, and $40 in interest charges on the above items. He did not carry

credit card insurance. How much is Cedrickʹs potential maximum liability?

A) $40.00 B) $50.00 C) $850.00 D) $1,050.00 E) $1,090.00

Answer: BDiff: 3Topic: Credit FraudAACSB: Analytical Thinking

23) The lowest FICO a consumer can achieve is

A) 250. B) 300. C) 400. D) 505.

Answer: BDiff: 2Topic: Credit ScoringAACSB: Analytical Thinking

24) Consider the ʺFive Cs of Credit.ʺ The category that considers the size of your investment

holding or portfolio is

A) collateral.

B) capital.

C) capacity.

D) character.


Answer: BDiff: 2Topic: Credit ScoringAACSB: Reflective Thinking



25) Consider the ʺFive Cs of Credit.ʺ The category that considers your current income level and

current borrowing level is

A) collateral.

B) capital.

C) capacity.

D) character.


Answer: CDiff: 2Topic: Credit ScoringAACSB: Reflective Thinking

26) Which of the following regarding credit application analysis is incorrect?

A) Bankruptcy remains a mark against you for a period of ten years after it occurs.

B) Credit card issuers normally assign a minimal acceptable credit cutoff score.

C) Lenders may not discriminate on the basis of age.

D) You are entitled to one free copy of your credit report each year from the three major

credit bureaus.

E) None of the above statements is incorrect; all of the above are true statements.


27) How long do you have to begin an investigation into a billing problem under the Fair Credit

Billing Act?

A) 15 days B) 20 days C) 30 days D) 60 days

Answer: DDiff: 2Topic: Credit FraudAACSB: Information Technology

28) Credit card insurance is usually unnecessary since your liability on credit card losses is limited

by law to

A) $ 0 B) $50 C) $100 D) $500

Answer: BDiff: 1Topic: Credit FraudAACSB: Information Technology



29) Mary is 38 years old and many of her friends have gotten into trouble using their credit cards to

buy things they canʹt afford. She feels lucky that her grandmother told her that credit is

dangerous and that she should always pay cash for everything. So far, Mary has never had

credit in her name and even paid cash for her car. From a personal finance perspective, what

advice would you give to Mary?

A) Nothing, it looks like we all could take advice from her!

B) Make sure that you keep a lot of money in liquid investments in case of an emergency.

C) Itʹs great that you donʹt owe any money, but you really need to establish credit in your

name so you will have it if you need it in the future.

D) You might want to talk with your insurance agent because having no credit history is

probably causing you to pay higher rates for your insurance.

E) Both C and D would be good advice for Mary.

Answer: EDiff: 3Topic: Credit ScoringAACSB: Reflective Thinking

30) One of the five Cʹs of credit is capacity. Most likely, what information would potential creditors

consider in evaluating your capacity?

A) Your marital status

B) Your age

C) Your leverage ratios

D) Your liquidity ratios

E) Both C and D are correct answers.


31) Angela noticed a list of creditors at the bottom of her credit report. Some of the inquiries were

voluntary and some were involuntary. What is the difference between the two?

A) Voluntary inquiries are due to your own credit requests; while involuntary inquiries are

typically by creditors who seek to offer you a preapproved credit offer.

B) Involuntary inquiries are due to your own credit requests; while voluntary inquiries are

typically by creditors who seek to offer you a preapproved credit offer.




32) The CARD Act of 2009 toned down the actions of credit card issuers by

A) banning the issuance of credit cards to persons under 18, unless the borrower can show

proof that he or she can repay the credit card loans independently.

B) banning credit card issuers from locating themselves ʺnear campusʺ (defined as within 50

feet).

C) banning the issuance of credit cards to persons under 18, unless someone over 25 co-signs

on the account.

D) banning offers of freebies such as free pizza and T-shirts.

Answer: DDiff: 3Topic: Credit CARD ActAACSB: Reflective Thinking

33) According to the Keown book, the national average FICO score is around

A) 650. B) 711. C) 759. D) 777.

Answer: BDiff: 3Topic: Credit ScoringAACSB: Reflective Thinking

34) According to a Nellie Mae study, ________ of graduate students would have liked more

information on financial management topics before they started school and would like financial

management education made available to them now.


Answer: DDiff: 3Topic: Financial ChallengesAACSB: Diverse and Multicultural Work Environments

35) ________ occurs when someone, without your knowledge or consent, uses your name, address,

Social Security number, bank or credit card account number, or other identifying information to

commit fraud or other crimes.

A) Phishing B) Dumpster diving

C) Identity theft D) Data breach

Answer: CDiff: 2Topic: Identity TheftAACSB: Analytical Thinking

36) The ________ provides a single location for financial protection and oversight–and its mandate

is to help consumers make better decisions.

A) Center For the People Bureau (CFPB)

B) Consortium of Fiscal Protection Bureau (CFPB)

C) Consumer Financial Protection Bureau (CFPB)

D) Consumer Fiscal Protocol Bureau (CFPB)

Answer: CDiff: 2Topic: Consumer Financial Protection Bureau (CFPB)AACSB: Reflective Thinking



37) The Consumer Financial Protection Bureau was created with the oversight authority necessary

to ensure that

A) consumer financial markets work.

B) the prices and risks for credit products and other consumer financial services are easy to

understand.

C) the prices and risks for mortgages, credit cards, and other kinds of financial products and

services are clear.


Answer: DDiff: 2Topic: Consumer Financial Protection Bureau (CFPB)AACSB: Analytical Thinking

38) Josh was sued by his former business partner. He lost the case and has to pay his former partner

$10,000. He has not yet done so and is refusing to do so. Josh is applying for a mortgage for a

new home. Should he be worried about the lawsuit impacting his mortgage application?

A) No, this kind of information is not contained on oneʹs credit report.

B) Absolutely, this kind of information is contained on oneʹs credit report.

Answer: BDiff: 3Topic: DebtAACSB: Reflective Thinking

39) Leon is 28 years old and pays cash for everything he buys. He has never had credit in his name

and never missed or been late on any bills he has ever had. He recently went online to check

what his credit score was. Where do you think his credit score would be?

A) over 800 B) between 700 and 799

C) between 600 and 699 D) None of the above

Answer: DDiff: 3Topic: Credit ScoringAACSB: Information Technology

40) Nico likes to go shopping. Every time he goes to a new store, he fills out an application for a

store credit card so that he can get a 20 percent discount on his purchases that day. Yesterday,

when he was trying to buy a new car, the dealer turned down his credit request. Nico canʹt

understand why, because he thought he had good credit. If you looked at his credit report, what

is the most likely reason he was denied credit?

A) Nine years ago, a lender referred his debt to a collection agency.

B) He has only worked for his current employer for nine months.

C) He has too many recent inquiries on his credit report.

D) There is not enough information available to answer this question.

Answer: CDiff: 3Topic: Credit ScoringAACSB: Analytical Thinking



41) Tawnya currently has six bank credit cards, five retailer credit cards, and a T&E card left over

from when she was in sales. She wants to make sure her credit score is as high as it can be. What

advice would you give her to improve her credit score?

A) Transfer all of her balances to the card with the lowest APR.

B) Increase the credit limit on her bank cards.

C) Cancel eight of the newest cards she has, keep at least one bank card.


Answer: CDiff: 3Topic: Credit ScoringAACSB: Reflective Thinking

42) The Fair and Accurate Credit Transactions Act (FACT) allows everyone to a free copy of their

credit report every year. Why is it a good idea to check your credit report every year?

A) To make sure that there are no errors on it

B) To make sure that someone has not stolen your identity

C) To challenge any unauthorized entries

D) All of the above are good reasons.

Answer: DDiff: 2Topic: Credit FraudAACSB: Reflective Thinking

Susan Harris

Susan has always maintained an excellent credit rating over the years. She has an annual income of $63,000,

has lived at her current residence thirteen years, and has worked at the same job for eight years. Susan works

in a clerical position, has two credit cards and maintains two bank accounts. Susan is very conservative and

has all of her savings ($12,000) in a NOW account at her local bank. One of her credit cards has a balance of

$550 and has an APR of 23%. Susan has been making monthly minimum payments on the credit card. Out of

curiosity she would like to know how her credit card companies judge her creditworthiness and what she can

do to improve her financial situation.

43) Which one of the following items of evaluation would Susan score the highest on?

A) Employment history B) Annual income

C) Length of residence D) None of the above

Answer: CDiff: 3Topic: Credit ScoringAACSB: Analytical Thinking

44) What should Susan do in regards to her credit card balance?

A) She should continue to make minimum monthly payments.

B) She should pay half of the balance this month and the remaining balance next month.

C) She should take out a small loan to pay off the credit card.

D) She should use some of her savings to pay off the balance in full immediately.




45) Susan was considering obtaining a new credit card but was told that too many applications for

credit can cause oneʹs FICO score to decrease?


46) Susan has never seen a copy of her credit report. Which of the following is not a credit bureau?

A) Experian B) TransUnion C) Equifax D) Equitax

Answer: DDiff: 3Topic: Credit BureauAACSB: Analytical Thinking

47) Susan is not married and a female. Which of the following Consumer Credit Laws prohibits

credit discrimination on the basis of her status?

A) The Truth in Lending Act B) The Fair Debt Collections Practices Act

C) The Equal Opportunity Act D) The Fair Billing Act


48) List four ways to avoid credit card fraud.

Answer: 1. Save all your credit card receipts and compare them to your bill.

2. Use caution and care in giving your credit card number over the phone.

3. Never leave a store without your card.

4. Do not let the store clerk keep your receipt to throw in the waste basket.Diff: 1Topic: Credit FraudAACSB: Reflective Thinking

49) What vital areas are typically evaluated in ʺscoringʺ?

Answer: The important vital areas include:

- annual income

- length of residence

- housing situation

- length of time on job

- type of employment

- current age

- number of bank accounts

- number of credit cards

- credit history

- telephone ownershipDiff: 2Topic: Credit ScoringAACSB: Reflective Thinking



50) What is the difference between voluntary and involuntary inquires?

Answer: Voluntary inquiries are spurred by your own requests for credit. Involuntary inquiries

occur when lenders request your report so that they can extend you a preapproved credit

offer.Diff: 2Topic: Credit ScoringAACSB: Reflective Thinking

51) What four steps should you take if you think your identity has been stolen?

Answer: STEP 1: Contact the fraud department of any one of the three major credit bureaus to

place a fraud alert on your credit file.

STEP 2: Close the accounts that you know or believe have been tampered with or opened

fraudulently.

STEP 3: File a police report.

STEP 4: File a complaint with the Federal Trade Commission at the federal governmentʹs

consumer information website (http://www.consumer.gov).Diff: 2Topic: Identity TheftAACSB: Reflective Thinking

52) Describe four ways to prevent identity theft.

Answer: Keep a detailed list of all your credit and debit cards and other accounts, including the

24-hour customer service phone number for each. This information will help you quickly

cancel your accounts and minimize the danger to your finances.

Donʹt carry documents that include your Social Security number or any PINs, passwords,

or access codes for bank or credit cards.

Keep your birth certificate, passport, and Social Security card in a fireproof strongbox in

your home or in a safety-deposit box. If you lose your driverʹs license, these documents

will be your only official forms of identification.

At least once a year, contact the three national credit bureausTransUnion, Experian, and

Equifaxto check your credit report for suspicious activity.Diff: 3Topic: Identity TheftAACSB: Reflective Thinking

53) Your credit score is possibly the most important number that affects your life. How does your

credit score affect you?

Answer: Your credit score is used by potential creditors to determine whether or not they are

willing to give you credit, what APR they will charge you, and what your credit limit will

be. The Insurance Industry is also now using your credit score to determine whether or

not they will insure you, for how much, and at what rate to determine your premiums.

Many employers are using a personʹs credit score to make hiring or promotion decisions.Diff: 3Topic: Credit ScoringAACSB: Reflective Thinking



54) Why is it important for young people to establish a good credit history as soon as possible?

Answer: People that have not established any credit in their name do not have a credit report or

credit score established. Potential creditors will have to assume that you are a high risk

until you actually demonstrate good credit behaviors. This means you may be denied

credit or will pay a higher APR and have a lower credit limit than you may want or need.

You will also pay higher rates for your personal insurance until you have established a

good credit score. Many employers also use credit scores for employment decisions and

not having one may place you at a disadvantage.Diff: 3Topic: Credit ScoringAACSB: Reflective Thinking

6.5 Controlling and Managing Your Credit Cards and Open Credit

1) Non-profit Credit Counselors should be avoided due to their high fees.

Answer: FALSEDiff: 3Topic: Credit CounselorAACSB: Ethical Understanding and Reasoning

2) People with high credit card balances still need to invest money on a regular basis.

Answer: FALSEDiff: 3Topic: DebtAACSB: Analytical Thinking

3) Only a Credit Repair company can remove inaccurate data from your credit report.

Answer: FALSEDiff: 3Topic: Credit CounselorAACSB: Information Technology

4) Wally currently has a balance of $14,500 on his credit cards and he is having a hard time making

the minimum payments on them. He has missed several payments and is now paying the

default APR of 29.99%. He and his wife own a nice home with $40,000 in equity. They have

$7,500 in a certificate of deposit with a 4% APR. He has come to you in tears asking for advice.

What would you tell him to do?

A) Seek out a non-profit credit counseling company.

B) Cash out his CD and pay down his credit cards.

C) Become a convenience user, and maintain just one credit card.

D) Take out an equity loan on the house.

E) All of the above

Answer: EDiff: 2Topic: DebtAACSB: Reflective Thinking



5) Having completed a personal finance class, you are now ready to give some advice to your

free-spending friends. Which one is unwise?

A) Reduce the credit card balance.

B) Resolve any billing errors.

C) Quit using credit cards altogether.

D) Look for trouble signs in credit card spending.

E) Control your spending through discipline.


6) Which of the following is the best strategy for controlling and managing your credit cards and

open debt?

A) Reduce your balance.

B) Resolve billing errors.

C) Protect against fraud.

D) Look for trouble signs in credit card spending.

E) All are good strategies.


7) When you find you cannot pay your credit card bills you must take action! Which option is

advisable?

A) Adjust your budget to allow for more money to pay for the cards.

B) Change to a less expensive credit card or cards.

C) Use a secured loan or home equity loan to get a lower interest rate to pay the cards off.

D) Use savings to pay off some or all of current credit card debt.

E) All of the above


8) What can you do if you cannot pay your credit card bills?

Answer: Adjust your budget to allow more money to pay the bill. You can change to a less

expensive card, use savings to pay off a balance, or use a secured loan or a home equity

loan to obtain a lower rate or payment.Diff: 2Topic: DebtAACSB: Analytical Thinking



9) List five signs that you have the credit card habit.

Answer: - You only make the minimum payment each month.

- You have reached the credit/spending limit on one or more cards.

- You are using savings to pay for credit card payments.

- You do not keep track of your credit card spending as it occurs.

- You get cash advances because there is not enough money in your checking account.Diff: 1Topic: DebtAACSB: Reflective Thinking


Chapter 7Student and Consumer Loans: The Role of Planned Borrowing

7.1 Consumer Loans-Your Choices

1) Consumer loans are less formal than credit cards and/or other open credit.

Answer: FALSEDiff: 2Topic: Open Credit / Revolving CreditAACSB: Analytical Thinking

2) Consumer loans can range from unsecured, fixed-rate, single-payment loans to secured,

variable-rate, installment loans.

Answer: TRUEDiff: 2Topic: Consumer LoanAACSB: Analytical Thinking

3) Bridge loans provide short-term funding until longer-term or additional financing is found.

Answer: TRUEDiff: 1Topic: Bridge LoanAACSB: Information Technology

4) Unsecured loans are generally less risky to lenders than secured loans. Therefore secured loans

typically charge a higher APR than unsecured loans.

Answer: FALSEDiff: 1Topic: Unsecured LoanAACSB: Reflective Thinking

5) Defaulting on a secured loan may lead to the collateral being repossessed.

Answer: TRUEDiff: 2Topic: Secured LoanAACSB: Analytical Thinking

6) A balloon loan calls for repayment of both interest and principal at regular intervals, with the

payment levels set so that the loan expires at a preset date.

Answer: FALSEDiff: 1Topic: Single Payment Loan / Balloon LoanAACSB: Analytical Thinking

7) If your before-tax cost of a home equity loan is 12 percent and you are in the 30 percent

marginal tax bracket, your after-tax cost of the home equity loan is 9 percent.

Answer: FALSEDiff: 3Topic: Interest RatesAACSB: Analytical Thinking



8) Variable-rate loans tied to long-term rates expose you to more risk of rate changes than

variable-rate loans tied to short-term rates.

Answer: FALSEDiff: 2Topic: Variable Interest Rate LoanAACSB: Analytical Thinking

9) A recourse clause defines whatever actions a lender can take to recover money from you in case

you default on the loan.

Answer: TRUEDiff: 1Topic: Recourse ClauseAACSB: Diverse and Multicultural Work Environments

10) An acceleration clause states that if you default on a secured loan, not only can the lender

repossess whatever is secured, but if the sale of the asset does not cover what you owe, you can

also be billed for the difference.

Answer: FALSEDiff: 2Topic: Acceleration ClauseAACSB: Diverse and Multicultural Work Environments

11) According to the Keown book, a(n) ________ is a loan involving a formal contract that details

exactly how much youʹre borrowing and when and how youʹre going to pay the loan back.

A) balloon loan B) consumer loan

C) bridge loan D) installment loan

Answer: BDiff: 1Topic: Consumer LoanAACSB: Analytical Thinking

12) An example of a consumer loan is a(n)

A) unsecured loan. B) pre-payment loan.

C) interim loan. D) both A and C.

Answer: DDiff: 2Topic: Consumer LoanAACSB: Analytical Thinking

13) Which statement is false regarding consumer loans?

A) Consumer loans are usually used for bigger purchases.

B) Consumer loans can range from open credit to credit cards.

C) Consumer loans are sometimes called ʺplanned borrowing.ʺ

D) Consumer loans can range from single-payment loans to installment loans.

Answer: BDiff: 3Topic: Consumer LoanAACSB: Analytical Thinking


Chapter 7 Student and Consumer Loans: The Role of Planned Borrowing 163

14) Which of the following is the correct formula to calculate the after-tax cost of a home equity

loan?

A) After-tax cost of a home equity loan = before-tax cost (1 + marginal tax rate)

B) After-tax cost of a home equity loan = before-tax cost (1 - marginal tax rate)

Answer: BDiff: 3Topic: Home Equity LoanAACSB: Analytical Thinking

15) A short-term loan that provides funding until a longer-term loan can be secured is called a(n)

A) bridge loan. B) gap loan.

C) straddle loan. D) amortized loan.

Answer: ADiff: 1Topic: Bridge LoanAACSB: Analytical Thinking

16) A(n) ________ loan calls for the repayment of both the interest and the principal at regular

intervals and is commonly referred to as loan amortization.

A) term

B) simple interest

C) installment

D) personal


Answer: CDiff: 1Topic: Installment LoanAACSB: Analytical Thinking

17) You are considering building a new deck on your home, what factors should you consider when

deciding whether to borrow the money or take the money out of your savings account?

A) You should compare the after-tax return on your savings with the after-tax APR on your

loan.

B) Itʹs simple, if you can afford to pay cash then you should not take out the loan.

C) What impact the savings withdrawal will have on your liquidity.


Answer: DDiff: 2Topic: FinancingAACSB: Reflective Thinking



18) Which of the following characterize secured loans?

A) They are typically easier to get.

B) Interest rates tend to be lower than unsecured loans.

C) They reduce the lenderʹs risk.

D) They are backed with either physical or investment assets.

E) All of the above

Answer: EDiff: 1Topic: Secured LoanAACSB: Reflective Thinking

19) A ________ is tied to a market interest rate, such as the prime rate or the six-month Treasury bill

rate.

A) prime-rate loan B) convertible-rate loan

C) flexible-rate loan D) variable-rate loan

Answer: DDiff: 1Topic: Variable Interest Rate LoanAACSB: Diverse and Multicultural Work Environments

20) Variable-rate loans

A) usually have rate caps that prevent them from varying too much.

B) always adjust every month.

C) are never a better option than fixed-rate loans.


Answer: ADiff: 2Topic: Variable Interest Rate LoanAACSB: Diverse and Multicultural Work Environments

21) What are the risks to the borrower with adjustable-rate loans?

A) During times of inflation your salary may increase during the term of the loan.

B) That the market rates of interest may increase during the term of the loan.

C) It is harder to budget for loan payments that may increase during the term of the loan.


Answer: DDiff: 2Topic: Variable Interest Rate LoanAACSB: Analytical Thinking



22) Alice has fallen behind on her signature loan. She recently received a notice from the lender that

her wages were going to be garnished to pay off the debt. What is the loan clause that allows the

lender to take this action against Alice because she was in default?

A) Recovery clause

B) Default clause

C) Recourse clause

D) Deficiency payments clause


Answer: CDiff: 1Topic: Recourse ClauseAACSB: Diverse and Multicultural Work Environments

23) What is the loan clause stating that if you default on a secured loan, the lender can repossess

whatever is secured, as well as bill you for the difference if that repossession does not cover

what you owe?

A) Insurance clause

B) Default clause

C) Recourse clause

D) Deficiency payments clause


Answer: DDiff: 2Topic: DefaultAACSB: Diverse and Multicultural Work Environments

24) What is your potential liability from the deficiency payments clause if you default?

A) Nothing, since the loan is in default it invalidates all loan clauses.

B) You will have to pay any legal or repossession fees incurred by the lender.

C) You will have to pay the remainder of the loan balance if the proceeds from the

repossession are not sufficient to pay off the loan.


Answer: DDiff: 3Topic: Loan ContractAACSB: Diverse and Multicultural Work Environments

25) Joshua recently purchased a new home. His lender required him to purchase credit life

insurance on the loan in the event that he died before the mortgage is paid off. What is the loan

clause that allows his lender to require him to purchase this additional insurance.

A) Insurance agreement clause

B) Default contingency clause

C) Early payment clause

D) Recourse clause


Answer: ADiff: 2Topic: Acceleration ClauseAACSB: Diverse and Multicultural Work Environments



26) Suppose you borrowed the money you needed to purchase an automobile and then failed to

make a scheduled payment by the due date. Technically, you

A) are bankrupt.

B) are in default.

C) are usually not given a chance to make good on the overdue payment.

D) none of the above

Answer: BDiff: 1Topic: DefaultAACSB: Diverse and Multicultural Work Environments

27) The ʺRepo Manʺ recently repossessed your car for failure to make payments. You still owed

$5,000 on the loan, but since it was always broken, you were glad to get rid of it anyway. The

bank sold the car at a wholesale auction for $3,000. The bank also paid the ʺRepo Manʺ $200 and

paid attorney fees of $300. Based on the deficiency payments clause in your loan, what are you

liable for?

A) $0; repossession means the bank must ʺeliminateʺ the debt

B) $500

C) $2,000

D) $2,500


Answer: DDiff: 3Topic: DefaultAACSB: Analytical Thinking

28) What is the name of the formal document that outlines the legal obligations of both the lender

and the borrower?

A) Default

B) Claim

C) Debenture

D) Note

E) Tort


29) Which one of these clauses is not found in a typical loan contract?

A) Recourse

B) Deficiency payments

C) Acceleration

D) Withdrawal terms

E) Insurance agreement




30) The loan contract is a formal document called a(n) ________ and may contain a(n) ________

specifying who retains control over the item being purchased in the case of default.

A) agreement, insurance clause

B) indenture, security agreement

C) note, security agreement

D) agreement, indenture

E) note, legal transaction

Answer: CDiff: 3Topic: Loan ContractAACSB: Analytical Thinking

31) The quoted rate on a home equity loan is 10% and you are in a 28% marginal tax bracket. What

is the effective after-tax rate on this loan?

A) 7.2%

B) 5.4%

C) 4.1%

D) 2.8%


Answer: ADiff: 2Topic: Home Equity LoanAACSB: Analytical Thinking

32) You are considering a home equity loan. Your marginal tax bracket is 25%. You want to borrow

$30,000 and are quoted an APR of 10%. How much money would you save in taxes each year if

you use the tax-deductible home equity loan?

A) $1,300 B) $920

C) $750 D) None of the above

Answer: CDiff: 2Topic: Home Equity LoanAACSB: Analytical Thinking

33) What happens when you default on a car loan where your Title is held as collateral?

A) You damage your credit history but you keep the car.

B) You lose the car and damage your credit history.

C) You face liability under the deficiency payments clause.

D) Only choices B and C are correct.

E) All of the above choices are correct.

Answer: DDiff: 2Topic: Automobile LoanAACSB: Reflective Thinking



34) If you own a home with a market value of $175,000 and you have an outstanding balance on

your mortgage of $60,000, your home equity is

A) $57,500. B) $97,750. C) $115,000. D) $235,000.

Answer: CDiff: 3Topic: Home Equity LoanAACSB: Analytical Thinking

35) Home equity/second mortgage loans have two important advantages over most other types of

loans. They are

A) tax deductibility of payments and longer terms.

B) tax deductibility of interest and lower interest rates.

C) no risk for borrower and less amortization.

D) increase in future financing flexibility and no recourse clause.


Answer: BDiff: 2Topic: Home Equity LoanAACSB: Analytical Thinking

36) Explain the purpose of a convertible loan.

Answer: A convertible loan has the potential of overcoming the disadvantages (to the borrower) of

variable-rate and fixed-rate loans. The borrower can enjoy the lower cost of a

variable-rate loan while still being able to lock in the savings of a fixed-rate loan when a

low interest rate comes along.Diff: 2Topic: Convertible LoanAACSB: Reflective Thinking

37) Name the advantages and disadvantages of an unsecured loan.

Answer: Unsecured loans require no collateral, only a signature. Larger unsecured loans are

generally given only to borrowers with excellent credit histories. The major fault with

these type of loans is that they require higher interest rates.Diff: 1Topic: Unsecured LoanAACSB: Reflective Thinking

38) Describe the four major parts of a typical loan contract.

Answer: The loan contract will contain an insurance agreement clause which requires you (the

borrower) to purchase credit life insurance to pay off the loan in the event of your death.

An acceleration clause states that if you miss one payment, the entire loan comes due

immediately. Usually, however, the lender will give you some time to catch up on the

payments. The deficiency payments clause requires that if you default on a secured loan,

not only can the lender repossess whatever is secured, but if when that asset is sold it

does not cover what you owe, you can be billed for the difference. A recourse clause

defines what actions a lender can take to claim money from you in case you default on

the loan.Diff: 1Topic: Loan ContractAACSB: Reflective Thinking



39) What is the distinguishing feature of an automobile loan?

Answer: The automobile is used as collateral and will be repossessed if the borrower defaults on

the loan. The duration of these loans is usually very short, often for only 24 to 60 months.

Although they can be as long as 72 months. Some lenders offer a very low 3% or less

interest rate for this purpose.Diff: 1Topic: Automobile LoanAACSB: Analytical Thinking

40) What are the advantages of a home equity loan, and what, if any, are the disadvantages?

Answer: It is usually easier and less expensive to obtain a home equity loan than other types of

loans. After securing a home equity line of credit, you merely ask for the money each time

you need some, without reapplying for it. The interest you pay is usually a tax deduction,

within income limitations. The one major disadvantage is that you place a lien on your

home.Diff: 2Topic: Home Equity LoanAACSB: Reflective Thinking

7.2 Cost and Early Payment of Consumer Loans

1) A payday loan is a reasonable option if you need a luxury item like a big screen TV.

Answer: FALSEDiff: 3Topic: Payday LoansAACSB: Diverse and Multicultural Work Environments

2) Payday loans are a dangerous way to borrow money, and charge an annual interest rate of

almost 400%.

Answer: TRUEDiff: 3Topic: Payday LoansAACSB: Diverse and Multicultural Work Environments

3) The simple interest method is the most common method of calculating payments on an

installment loan.

Answer: TRUEDiff: 3Topic: Variable Interest Rate LoanAACSB: Diverse and Multicultural Work Environments

4) Loans using the add-on method are a relative bargain, and should be sought out.

Answer: FALSEDiff: 3Topic: Fixed-Interest Rate Loan




5) The annual percentage rate is the simple percentage cost of all finance charges over the life of

the loan on an annual basis.

Answer: TRUEDiff: 1Topic: Annual Percentage RateAACSB: Diverse and Multicultural Work Environments

6) With a discount method single-payment loan, the entire interest charge is subtracted from the

principal before you receive the money, and at maturity you repay the principal.

Answer: TRUEDiff: 1Topic: Single Payment Loan / Balloon LoanAACSB: Analytical Thinking

7) Ronald is borrowing $20,000 using the discount method. His bank is offering him an annual

percentage rate of 8.5% and he is taking out the loan for 24 months. How large of a check will

Ronald receive from this loan when he leaves the bank? How much will he repay?

A) $20,000; $23,400 B) $16,600; $20,000

Answer: BDiff: 2Topic: FinancingAACSB: Analytical Thinking

8) The APR is larger when money is lent under the discount method than when it is lent under the

simple interest method.

Answer: TRUEDiff: 1Topic: Fixed-Interest Rate Loan


9) Amortization refers to the process in which a large proportion of the early payments of an

installment loan goes to cover interest, and the later payments have a larger proportion going

towards the payment of principal.

Answer: TRUEDiff: 2Topic: AmortizationAACSB: Analytical Thinking

10) Which of the following is not required by law to be on a loan disclosure statement?

A) Annual percentage rate

B) All finance charges

C) The total amount financed

D) The total amount of payments

E) All of the above are required.

Answer: EDiff: 2Topic: Loan Disclosure StatementAACSB: Analytical Thinking



11) The finance charges for a loan may include

A) fees for a credit check.

B) required insurance fees.

C) interest payments.

D) only choices A and B.

E) All of the above choices.


12) Fred ran short on cash and borrowed $300 through a Payday Loan company. The company

charged him a fee of $60 to borrow the $300 for 14 days. Using the simple interest method

calculate what interest rate was Fred charged for the aforementioned loan.

A) 5.21% B) 52.13%

C) 521.29% D) None of the above

Answer: CDiff: 2Topic: Payday LoansAACSB: Analytical Thinking

13) Payday lenders

A) make money by providing one-time assistance during a time of financial need.

B) make money by keeping borrowers in debt.

C) encourage repeat borrowing.


Answer: DDiff: 2Topic: Payday LoansAACSB: Diverse and Multicultural Work Environments

14) Veronica was offered a loan using the discount method of calculation by her bank. She will

borrow $10,000 for one year at an APR of 11%. How large will the check be that Veronica

receives? How much must she repay?

A) $11,100; $11,100

B) $10,000; $11,100

C) $8,900; $11,100

D) $8,900; $10,000

E) None of the above is correct.

Answer: DDiff: 2Topic: Payday LoansAACSB: Analytical Thinking



15) In driving around town one day, you noticed most of the payday loan companies were located

close to the college and the local military base and there were none out in the newer

neighborhoods. Why do you think this is so?

A) The rent on these locations is less expensive.

B) Payday lenders tend to focus on less experienced borrowers who typically donʹt make a lot

of money.

C) Because their terms are so affordable people with low incomes really take advantage of

them.

D) There are zoning laws that require these types of locations for these types of services.

Answer: BDiff: 3Topic: Payday LoansAACSB: Analytical Thinking

16) Steven is beginning a new job but has not yet been paid. He needs $400 to pay his rent this

month. Steven is going to borrow the money through a Payday Loan establishment. They are

charging him an $80 fee to borrow the money for 10 days until he receives his first paycheck.

What is the actual interest rate that Steven is being charged?

A) 7.3%

B) 73.0%

C) 730.0%.

D) .073%


Answer: CDiff: 1Topic: Payday LoansAACSB: Analytical Thinking

17) A rule to determine what proportion of each loan payment is principal and interest is

A) the law of 72.

B) the N-ratio method.

C) the rule of 78.

D) the principal-interest mix.

E) the add-on method.


18) A simple interest installment loan calculates interest on the unpaid balance. An add-on

A) calculates the same way with the addition of a factor.

B) calculates interest on the original balance.

C) is less costly.

D) is more costly.

E) both B and D.

Answer: EDiff: 3Topic: Interest RatesAACSB: Analytical Thinking



19) Congratulations! You have just graduated from college and are determining what your monthly

student loan payments will be. After consolidating all of your loans, you have a balance of

$18,000. At 8% APR for 10 years, what will your monthly payments be?

A) $1,866.66 B) $161.50 C) $218.39 D) $1,440.14

Answer: CDiff: 3Topic: Principle 3: The time-value-of-money


20) You just bought a car and borrowed $15,000 for 5 years at 8% APR. Using the simple interest

method; by the time you pay off this loan your total finance costs will be closest to which of the

following?

A) $6,000 B) $3,249 C) $3,784 D) $1,200


21) A loan that is paid back in a single lump sum payment at the due date of the loan is commonly

called a(n)

A) fully amortized loan.

B) balloon loan.

C) installment loan.

D) secured loan.


Answer: BDiff: 1Topic: Single Payment Loan / Balloon LoanAACSB: Analytical Thinking

22) You are headed to the mountains for some climbing this summer and you need some gear. The

local mountaineering shop is offering 6% financing on all purchases before the end of the

month. Your savings account is currently paying 5%, and you are in a marginal tax bracket of

28%. Which of the following is true?

A) Borrow from the mountain shop it is cheaper.

B) Take the money out of savings it is cheaper.

C) It does not matter where you get the money; it will cost the same.

D) You should seek competent financial help.

E) None of the above are true.

Answer: BDiff: 2Topic: Interest RatesAACSB: Analytical Thinking



23) Your brother, a banker, has just approved a loan for you, an add-on interest loan. You will

borrow $2,000 for one year with a 12% annual interest rate. What is your monthly payment?

A) $166.67

B) $186.67

C) $240.00

D) $256.78


Answer: BDiff: 3Topic: Interest RatesAACSB: Analytical Thinking

24) What is the name of the interest rate banks charge to their most creditworthy customers?

A) Main rate

B) Blue chip rate

C) Prime rate

D) Premier rate


Answer: CDiff: 1Topic: Prime RateAACSB: Reflective Thinking

25) You just received a loan from your banker to buy seed and plant your alfalfa field. The loan is a

discount loan and is for $5,000 for 1 year and the quoted rate was 10%. What is your APR?

A) 10.00%

B) 11.11%

C) 12.23%

D) 14.33%



26) Calculate the interest on $6,000 borrowed at an annual rate of 9% under the simple interest loan

method for 9 months.

A) $270 B) $360 C) $405 D) $450 E) $540

Answer: CDiff: 3Topic: Interest RatesAACSB: Analytical Thinking



27) Gary is taking out a $5,000 loan for 1 year at an APR of 12%. His bank has offered him a loan

using the add-on method. Using first the financial calculator method and the add-on method

calculate Garyʹs monthly loan payment.

A) $444.24; $466.67 B) $475.00; $448.94

Answer: ADiff: 2Topic: FinancingAACSB: Analytical Thinking

28) The ________ is the true simple interest rate paid over the life of a loan and provides a

reasonable approximation for the true cost of borrowing.

A) APP

B) APR

C) ADR

D) ARR


Answer: BDiff: 1Topic: Annual Percentage RateAACSB: Analytical Thinking

29) You have just obtained a personal loan for a new home movie system under the simple interest

method. You have borrowed $12,000 for 9 months at an annual rate of 10%. Your marginal tax

rate is 28%. What are the total interest charges you would pay if the loan is paid off on time?

A) $1,200

B) $1,080

C) $900

D) $648


Answer: CDiff: 2Topic: Interest RatesAACSB: Analytical Thinking

30) Which is better, a fixed-rate loan or a variable-rate loan?

A) A fixed-rate loan, because the lender bears the risk that interest rates will go up

B) A fixed-rate loan, because they generally cost less than variable-rate loans

C) A variable-rate loan, because they generally cost less than fixed-rate loans

D) A variable rate loan, because the lender bears the risk that interest rates will go up

E) Neither is necessarily better; the choice illustrates the ʺrisk and return go hand in handʺ

principle.

Answer: EDiff: 3Topic: Variable Interest Rate LoanAACSB: Analytical Thinking



31) What strategy should you use to obtain the lowest possible APR on a loan?

A) Get a variable-rate loan.

B) Keep the term (length) of the loan as short as possible.

C) Make a large down payment.

D) Provide collateral.

E) All of the above

Answer: EDiff: 3Topic: Interest RatesAACSB: Diverse and Multicultural Work Environments

32) Give five things you can do to obtain the most favorable rates on loans, which in essence will

allow you to lower the lenderʹs risk.

Answer: - Develop a strong credit rating.

- Use a variable-rate loan.

- Keep the term of the loan as short as possible.

- Provide collateral for the loan.

- Put a large down payment toward the purchase.Diff: 2Topic: Credit RiskAACSB: Reflective Thinking

33) Explain why add-on installment loans are more expensive than simple interest loans.

Answer: The add-on method generally results in an APR of close to twice the level of the stated

interest rate because you are paying interest on the original principal over the entire life

of the loan. Even though the amount of outstanding principal keeps decreasing as you

pay back the loan, you still pay interest on the entire amount you originally borrowed.Diff: 2Topic: Installment LoanAACSB: Reflective Thinking

34) Why is the discount method more costly than the simple interest method on a single-payment

loan?

Answer: Under the discount method, with the interest taken out before you receive the loan, you

actually receive a smaller principal than the stated principal of the loan.Diff: 2Topic: Single Payment Loan / Balloon LoanAACSB: Analytical Thinking

7.3 Getting the Best Rate on Your Consumer Loans

1) Which of the following does not require you to have a good credit rating to issue you a loan?

A) Your family

B) Savings and loan

C) Commercial bank

D) All of the above require a good credit rating to issue a loan.

Answer: ADiff: 2Topic: Finance CompanyAACSB: Reflective Thinking



2) Which of the following statements would most correctly complete the following sentence? As

the interest rate on a loan increases

A) the loan maturity would decrease (other things held constant).

B) the payment amount would decrease (other things held constant).

C) the amoritization would increase (other things held constant).

D) the payment amount would increase (other things held constant).


Answer: DDiff: 2Topic: Interest RatesAACSB: Analytical Thinking

3) Which of the following statements regarding the risk-return relationship is most accurate?

A) Lower credit scores are associated with lower APRs.

B) Higher credit scores are associated with lower APRs.

C) Longer loan length is associated with lower APRs.

D) Shorter loan length is associated with higher APRs.

E) Both B and D are correct.

Answer: BDiff: 2Topic: Principle 8: Risk and return go hand in handAACSB: Diverse and Multicultural Work Environments

4) With a(n) ________ installment loan, interest charges are calculated using the original balance,

and these charges are then added to the loan.

A) simple interest method

B) partial amortization method

C) discount method

D) add-on method


Answer: DDiff: 2Topic: Installment LoanAACSB: Diverse and Multicultural Work Environments

5) Of the following possible sources of credit, which typically has the lowest borrowing rates?

A) Savings and loans B) Personal finance company

C) Credit union D) Commercial bank

Answer: CDiff: 2Topic: Consumer LoanAACSB: Information Technology



6) What is the type of loan where the entire interest charge is subtracted from the loan principal

before you receive the money, and at maturity you repay the entire principal?

A) Simple interest method

B) Partial amortization method

C) Discount method

D) Add-on method


Answer: CDiff: 2Topic: Single Payment Loan / Balloon LoanAACSB: Analytical Thinking

7) Nealʹs life insurance policy has a cash value of $100,000. He wants to purchase a second home to

rent out. How much can Neal borrow against the surrender value of his life insurance policy?

A) $50,000 B) $75,000 C) $95,000 D) $100,000

Answer: CDiff: 3Topic: Finance CompanyAACSB: Analytical Thinking

8) List examples of loans or loan sources that fit into the categories of inexpensive, more expensive,

and most expensive.

Answer: - Inexpensive: family, home equity loans, secured loans, loans against the cash value of

life insurance

- More expensive: credit unions, S&Ls and commercial banks, unsecured loans

- Most expensive: financing from retail stores, finance and small loan companiesDiff: 2Topic: Interest RatesAACSB: Analytical Thinking

9) Why is the debt limit ratio and 28/36 rule more important to conservative lenders like Banks and

Credit Unions and not so important for lenders like small Finance companies and Payday

lenders?

Answer: Principle 8 states that risk and return go hand in hand. With the conservative lenders like

Banks and Credit Unions, they are lending their depositors money and not their own

money. They are also regulated by the FDIC and NCUA. This means that they generally

will not lend money to people with no or poor credit or collateral, itʹs just too risky for

them to do so. With the other, more aggressive lenders, itʹs their investorsʹ money. These

investors voluntarily provide money to earn the higher return associated with riskier

loans. Even if a portion of the loans fail, the return on the performing loans outweighs the

losses. These aggressive lenders take advantage of desperate or naive people who canʹt

borrow from the conservative lenders for whatever reasons. Desperate and naive people

do desperate and naive things, many times causing severe financial distress.Diff: 3Topic: Financial InstitutionsAACSB: Analytical Thinking



7.4 Controlling Your Use of Debt

1) The 28/36 rule says that as long as your total debt payments are under 36 percent of your gross

income then you are not overextended.

Answer: TRUEDiff: 3Topic: Debt Limit RatioAACSB: Analytical Thinking

2) Lenders tend to like to see borrowers put down large down payments for loans because this is

seen as increasing the borrowerʹs desire to pay off the loan since the borrower now has equity in

the collateral.

Answer: TRUEDiff: 2Topic: Credit RiskAACSB: Analytical Thinking

3) Not having health insurance could lead to filing for bankruptcy if one has incurred large

medical expenses and is unable to pay these bills off in a timely manner.

Answer: TRUEDiff: 3Topic: BankruptcyAACSB: Analytical Thinking

4) Debt consolidation loans are very appealing because

A) they offer liquidation to those who are in good standing with their creditors.

B) they offer hope to those who canʹt keep up with their current payment schedules.

C) they offer relinquishment of all debts and financial obligations to those who canʹt keep up

with their current payment schedules.

D) all of the above

Answer: BDiff: 3Topic: Debt Consolidation LoanAACSB: Reflective Thinking

5) Suppose that you are interested in buying a home, but are unsure of how much you can afford.

What is the best way to determine your prospects for obtaining a mortgage?

A) Calculate your debt limit ratio.

B) Figure the 28/36 rule.

C) Determine what your mortgage payment will be.

D) Determine what your income taxes will be.

E) Both B and C are correct answers.

Answer: EDiff: 2Topic: Credit RiskAACSB: Analytical Thinking



6) Many lenders use the 28/36 rule in evaluating mortgage applications. If your mortgage payment

itself is 28% of your gross income, that means that the remainder of your monthly debt must be

________% or less.

A) 6 B) 7 C) 8 D) 28 E) 36

Answer: CDiff: 2Topic: Debt Limit RatioAACSB: Analytical Thinking

7) Many lenders will hold Dave to the 28/36 rule in evaluating his application for a mortgage.

What does the 36 mean?

A) A down payment of 36 months is required.

B) A down payment of 36% is required.

C) Debt payments including mortgage must be less than 36% of his gross monthly income.

D) Debt payments must be less than 36% of his monthly take-home pay.

E) Mortgage insurance is required during the first 36 months of the loan.

Answer: CDiff: 2Topic: Credit RiskAACSB: Analytical Thinking

8) Sharry is interested in buying her first home. Currently her monthly gross income is $3,000.

From this she makes a car payment of $240, a personal loan payment of $300 and a student loan

payment of $85. Based on this information would a bank approve Sharry for a mortgage?

A) Yes B) No

Answer: BDiff: 3Topic: Debt Limit RatioAACSB: Analytical Thinking

9) Brenda found out that reputable lenders use the 28/36 rule when determining mortgage

qualification. Brenda currently grosses $6,000 per month. From this she pays a $200 car

payment; a personal loan of $100 and a student loan payment of $90. Based on this information,

would Brenda qualify for a mortgage?

A) Yes B) No

Answer: ADiff: 2Topic: Credit RiskAACSB: Analytical Thinking

10) What will the courts do if you file Chapter 7 personal bankruptcy?

A) Confiscate most of your assets.

B) Liquidate most of your assets to pay off creditors.

C) Eliminate most of your debts.

D) Allow you a chance to start again financially.

E) all of the above

Answer: EDiff: 3Topic: BankruptcyAACSB: Analytical Thinking



11) A Chapter 13 personal bankruptcy is characterized by all of the following except

A) you continue to pay at least a portion of most of your debts.

B) you maintain title and possession of your assets.

C) your creditors vote on restructuring your debt repayments.

D) a new debt repayment schedule is determined.

E) you get relief from harassment by bill collectors.

Answer: CDiff: 3Topic: BankruptcyAACSB: Analytical Thinking

12) What can a couple seeking to get out of debt do?

A) Avoid future use of credit card debt, except on a emergency basis.

B) Use savings to pay off current debt.

C) See if their creditors will restructure their loans.

D) Seek help from a reputable credit counselor.


Answer: EDiff: 2Topic: Credit CounselorAACSB: Reflective Thinking

13) Which of these are possible options for most people who cannot pay their bills?

A) Get help from a credit counselor.

B) Obtain a debt consolidation loan.

C) Declare Chapter 13 personal bankruptcy.

D) Declare Chapter 7 personal bankruptcy.

E) All of the above are possible options.

Answer: EDiff: 2Topic: Credit CounselorAACSB: Reflective Thinking

14) What are some of the leading causes of bankruptcy?

Answer: Major illness: This generally comes with major costs and can mean the loss of a job.

Credit: Easy availability of credit leads to living beyond your means.

Divorce: Itʹs expensive, what with lawyers, child support, alimony, and splitting up

assets.

Job loss: Bills continue to come in, and with no income, savings can be wiped out.Diff: 2Topic: BankruptcyAACSB: Application of Knowledge



15) How do you know how much debt you can comfortably afford?

Answer: By applying the debt limit ratio you can see, from a lenderʹs point of view, the limitation

on consumer debt. It is calculated by dividing your monthly non-mortgage debt

payments by your total monthly take-home pay. Ideally, it should be below 15% because

you will still have some borrowing reserve for emergencies and the unexpected, and it

will be easier to obtain additional borrowing. You should put a maximum of 20% on

consumer debt. Once you pass this point, it will be difficult to borrow more, and your

ability to meet your monthly financial obligations will be severely limited.Diff: 2Topic: Debt Limit RatioAACSB: Reflective Thinking

16) Debt consolidation loans can be a very good thing for some people but they can also be

dangerous to some. Explain the benefits and dangers of a debt consolidation loan.

Answer: If you are fortunate enough to have sufficient collateral and credit score to obtain a

consolidation loan with an affordable APR and term, you can generally lower your

monthly payments, especially when eliminating expensive credit card debt. You have to

choose however, whether the fixed payment commitment of an installment loan and,

possibly, higher finance charges over the length of the loan outweigh the financial

pressures of the original debt. You also have to weigh your personal discipline and self

control to not run up new debt on top of the consolidation loan. Some unfortunate people

end up worse off with additional debt than when they started. If you use the equity in

your home for collateral for the new loan, now you have put your home in financial

jeopardy. The non-profit Credit Counselors recommend cutting up your credit cards to

remove the temptation.Diff: 3Topic: Debt Consolidation LoanAACSB: Reflective Thinking

17) Samuel is having financial troubles. He owes a significant amount of money to his ex-wife for

child support payments, he is also behind on his student loans and has not paid his taxes for the

last five years. Sam is considering filing for personal bankruptcy. Why might this not be a wise

financial decision for him?

Answer: This would not be wise decision because none of his listed debt: child support, student

loans and back taxes are dischargeable through a bankruptcy filing. He cannot get away

from paying these debts.Diff: 3Topic: BankruptcyAACSB: Analytical Thinking

7.5 Student Loans and Paying for College

1) Today, about 75 percent of high school graduates choose to attend four-year colleges,

community colleges, technical schools, or the workforce.

Answer: FALSEDiff: 1Topic: Student LoanAACSB: Analytical Thinking



2) Student who are awarded grants must pay back a percentage of the amount after graduation.

Answer: FALSEDiff: 2Topic: Student LoanAACSB: Analytical Thinking

3) Income-based repayment plans are based on a percentage of discretionary income, not the

amount owed, and provide a 25-year term of payments before loan forgiveness.

Answer: TRUEDiff: 2Topic: Student LoanAACSB: Analytical Thinking

4) A 529 plan is a tax-advantaged savings plan designed to encourage parents to save for future

college costs for their children. The plan comes in two forms: pre-paid tuition plans and college

savings plans.

Answer: TRUEDiff: 3Topic: Savings for CollegeAACSB: Analytical Thinking

5) Direct subsidized loans are made only to undergraduates who demonstrate financial need.


6) The interest that you pay on your student loans will lower your taxable income if you meet IRS

guidelines.


7) Student loans are loans with federally subsidized interest rates given, based on financial need,

to students making satisfactory progress in their degree programs.

Answer: TRUEDiff: 1Topic: Student LoanAACSB: Information Technology

8) Under a Stafford Loan, parents borrow money for their childʹs education.

Answer: FALSEDiff: 3Topic: Student LoanAACSB: Information Technology



9) Under a Federal Direct Loan, you donʹt begin making payments until six months after

graduation.

Answer: TRUEDiff: 3Topic: Student LoanAACSB: Information Technology

10) Student loans are a smart source of financing for school because you only pay part of the

interest charges and the rest is subsidized by the lender.

Answer: FALSEDiff: 1Topic: Student LoanAACSB: Diverse and Multicultural Work Environments

11) Frank ran up a large credit card bill as an undergraduate student, he also took out as much in

student loans as possible. He is now unable to pay his credit card debt and his student loan

debt. However, he has decided to declare bankruptcy to eliminate his debt. Frank will be able to

eliminate his federally subsidized student loan debt by declaring bankruptcy.

Answer: FALSEDiff: 3Topic: Student LoanAACSB: Diverse and Multicultural Work Environments

12) The ________ is the automatic repayment plan with a 10-year term.

A) extended repayment B) standard repayment

C) income-based repayment D) graduated repayment

Answer: BDiff: 1Topic: Student LoanAACSB: Analytical Thinking

13) ________ is when a borrower is allowed to temporarily stop making student loan payments for

a qualified reason such as an illness, financial hardship, or serving in a medical or dental

internship or residency.

A) Deferment B) Delinquency C) Forbearance D) Default

Answer: CDiff: 2Topic: Student LoanAACSB: Analytical Thinking



14) When borrowing for college, one thing to keep in mind is that youʹre not just paying for one

year of school. About half of all colleges practice what is called ʺfront loading of grants,ʺ which

means that

A) grants awarded in the fall will be worth more than grants awarded in the spring semester.

B) your grants as a freshman will be more generous than your grants as a sophomore, junior,

or senior.

C) your grants will progressively increase as your graduation date approaches.

D) the more your parents or guardians pay upfront for your college expenses, the less grants

you will receive.


15) Which statement is true regarding direct unsubsidized loans?

A) The federal government pays the loanʹs interest while the student is still in school.

B) Such loans are made to undergraduate, graduate, and professional students.

C) Students have to demonstrate financial need in order to receive the loans.

D) All of the above are true.


16) When do the payments on a Stafford Loan begin?

A) When your school receives the money from the government

B) When your loan balance gets over $5,000

C) You can choose when your payments begin anytime within 24 months of your graduation

date.

D) None of the above is correct.

Answer: DDiff: 3Topic: Student LoanAACSB: Diverse and Multicultural Work Environments

17) A federal direct subsidized loan has tremendous advantages over other types of loans,

including

A) the interest is deferred while you are in school.

B) they have low monthly payments and a 20% balloon payment after 5 years.

C) they use the add-on method to determine your monthly payment.


Answer: ADiff: 3Topic: Student LoanAACSB: Analytical Thinking



18) An advantage that direct or subsidized student loans have over other types of loans is

A) the after-tax interest rates are very attractive compared with other loans.

B) you can borrow at a below-market rate, regardless of your credit situation.

C) in an emergency, you can declare bankruptcy and avoid repayment.

D) you have the rest of your life to pay it back.

E) both A and B are correct.

Answer: EDiff: 2Topic: Student LoanAACSB: Diverse and Multicultural Work Environments

19) Name the four common loans available for college students.

Answer: The four common loans include the Stafford Loan, Perkins Loan, Parent Loan, and

Supplemental Loan for Students.Diff: 1Topic: Student LoanAACSB: Analytical Thinking

20) What are the opportunity costs associated with Student loans?

Answer: Depending on the amount you borrow and how long you are in school, you may end up

with a fairly large loan balance to repay upon completion or termination of your

education. Ideally, your education will allow you to obtain a decent salary that is

sufficient to allow you a good standard of living while repaying the loan. Regardless,

student loan payments are included in the debt limit ratio and 28/36 rule so they may

prevent you from obtaining additional credit or a mortgage until you payoff the student

loan. Student loan payments can be a burden on young families with children. You canʹt

avoid or evade student loan debt via bankruptcy either.Diff: 3Topic: Student LoanAACSB: Reflective Thinking

21) Name two tax credits available to help offset education costs.

Answer: American Opportunity Credit: allows you to claim $2,500 per year for the first four years.

Lifetime Learning Credit: allows you to claim $2,000 per year for college costs.Diff: 1Topic: Tax CreditAACSB: Application of Knowledge

22) According to the Keown book, how do you finance your college education without mortgaging

your future?

Answer: The answer is to understand:

The consequences of your choice of school and of your course of study.

The costs, including tuition and living expenses, and how to borrow less and borrow

smarter.

How to manage your money well while on campus.

How to repay your loans without sacrificing your financial goals.Diff: 2Topic: Student LoanAACSB: Analytical Thinking



23) List three reasons why a student-loan borrower may be granted a deferment.

Answer: The borrower might receive a deferment if he or she is enrolled at least half-time in

school, is unemployed, or meets hardship standards.Diff: 2Topic: Student LoanAACSB: Analytical Thinking

24) Describe the four types of student-loan repayment plans.

Answer: Standard repayment (10-year term; you pay the lowest amount of interest): this is the

automatic repayment plan, unless you choose another plan.

Extended repayment (10- to 30-year term): additional number of payments and additional

interest paid.

Income-based repayment (25-year term of payments before loan forgiveness): based on a

percentage of discretionary income, not the amount owed; yields low monthly payments

but additional interest paid.

Graduated repayment (25- to 30-year term of payments before loan forgiveness): starts

low, with monthly payment increasing every two years; yields low monthly payments

but additional interest paid.Diff: 3Topic: Student LoanAACSB: Analytical Thinking

25) Describe in detail the characteristics of the direct subsidized and unsubsidized student loans

from the Federal government.

Answer: Based on income limitations, you may qualify for the direct, subsidized loan from the

government. With these loans, the government pays your interest on your loan

disbursements while you are actively enrolled in school. This prevents the interest on

your loans from accruing interest while you are still a student. Six months after you

complete your degree program or withdraw from school, your loan amoritization

payments with interest will start. With a direct, unsubsidized loan, the interest starts

accruing every time you receive a disbursement, resulting in the interest accruing interest

while you are in school leaving you with a larger loan balance and payments when you

start paying the loan back.Diff: 3Topic: Student LoanAACSB: Reflective Thinking


Chapter 8The Home and Automobile Decision

8.1 Smart Buying

1) Carrying credit cards can increase impulse purchasing.

Answer: TRUEDiff: 1Topic: Smart BuyingAACSB: Reflective Thinking

2) Smart buying means buying what you want first and figuring out how youʹll pay for it later.

Answer: FALSEDiff: 1Topic: Smart BuyingAACSB: Reflective Thinking

3) Smart buying means enjoying the highest standard of living that you can based on your income

and budget.

Answer: TRUEDiff: 1Topic: Smart BuyingAACSB: Reflective Thinking

4) When making a smart purchase you donʹt need to consider such charges as delivery fees,

installation fees or service costs as these are already included in the purchase price.

Answer: FALSEDiff: 2Topic: Smart BuyingAACSB: Analytical Thinking

5) How can you benefit from following the smart buying steps?

A) Smart buying allows a higher standard of living because you make smarter purchases.

B) Smart buying allows you to buy what you want when you want it.

C) Smart buying helps you maintain your budget.


Answer: DDiff: 2Topic: Smart BuyingAACSB: Reflective Thinking

6) ________ is a publication that provides unbiased ratings and recommendations for a host of

products and services

A) USA Consumer B) Consumer Reports

C) People Magazine D) Bloomberg Weekly

Answer: BDiff: 1Topic: Smart BuyingAACSB: Reflective Thinking


Chapter 8 The Home and Automobile Decision 189

7) Name the steps in smart buying.

Answer: Step 1: Differentiate want from need

Step 2: Do your homework.

Step 3: Make your purchase.

Step 4: Maintain your purchase.Diff: 1Topic: Smart BuyingAACSB: Reflective Thinking

8) Give at least six tips on smart buying.

Answer: Take advantage of sales, but compare prices.

Donʹt assume an item is a bargain just because it is advertised as one.

Donʹt rush into a large purchase because the ʺprice is only good today.ʺ

Be aware of extra charges and add them into the total cost.

Ask about the sellerʹs refund and exchange policy.

Always read a contract before signing it.

Walk out or hang up on high-pressure sales tactics.

Donʹt do business over the phone with companies you donʹt know.Diff: 1Topic: Smart BuyingAACSB: Reflective Thinking

9) How does smart buying improve your standard of living?

Answer: Following smart buying prevents you from wasting your money on impulsive purchases

that you may not need or with features you donʹt really need or at a higher price than you

should pay. By saving money this way it makes it easier to stick with your budget and

savings goals and still buy other products that you will enjoy. Smart buying is not

necessarily being frugal or stingy it just means getting the most value out of your limited

budget. Proper maintenance of products prolongs their useful life freeing up money that

would go to replacement for some other worthwhile use.Diff: 3Topic: Smart BuyingAACSB: Reflective Thinking

10) According to the Keown Book, what are some tips on making a complaint to a company?

Answer: A good strategy is to write a brief, concise letter describing the problem and stating

exactly how you would like the matter to be resolved. Avoid writing an angry, sarcastic,

or threatening letter. When possible, include copies of all documents regarding your

problem; be sure to keep the originals. Maintain a record of whom you spoke to, along

with dates and times of your contact.Diff: 3Topic: Smart BuyingAACSB: Reflective Thinking



8.2 Smart Buying in Action: Buying a Vehicle

1) Automobile leasing is actually just a long-term rental agreement with the lessor.

Answer: TRUEDiff: 2Topic: Automobile LeasingAACSB: Diverse and Multicultural Work Environments

2) According to Edmunds.com, a new carʹs value declines by 15 to 19 percent in the first minute of

ownership after you leave the lot.

Answer: FALSEDiff: 2Topic: Smart Buying AutomobilesAACSB: Analytical Thinking

3) Open-end leases are leases in which you return the vehicle at the end of the lease and you have

no further responsibilities.

Answer: FALSEDiff: 2Topic: Automobile LeasingAACSB: Analytical Thinking

4) An automobile warranty provides coverage for the basic parts against manufacturerʹs defects

for a set period of time or miles.

Answer: TRUEDiff: 1Topic: Smart Buying AutomobilesAACSB: Analytical Thinking

5) Evaluating whether you need or simply want a sun roof is an example of using the smart

buying steps.

Answer: TRUEDiff: 1Topic: Smart Buying AutomobilesAACSB: Reflective Thinking

6) The monthly payments on a 36-month lease on a car will often be smaller than the monthly

payments on a 36-month loan to purchase the car.

Answer: TRUEDiff: 1Topic: Automobile LeasingAACSB: Analytical Thinking

7) Leasing a car may make sense if you drive over 25,000 miles a year.

Answer: FALSEDiff: 3Topic: Automobile LeasingAACSB: Analytical Thinking



8) The first step at the car dealership is to negotiate the best price that you can on the car that you

need.


9) A 48-month lease on a car with a 36-month manufacturerʹs warranty is a gamble.


10) For most cars, the manufacturerʹs warranty extends through the first seven years of ownership

or the first 70,000 miles, whichever comes first.

Answer: FALSEDiff: 3Topic: Smart Buying AutomobilesAACSB: Diverse and Multicultural Work Environments

11) Stretching a car loan from 48 months to 60 months means the car will end up costing you more

when you have paid in full.


12) Stretching a car loan from 48 months to 60 months means the car will end up resulting in a

smaller monthly payment.


13) Suppose that you are at the end of your automobile lease. The leasing company has just

informed you that the carʹs market value is greater than its residual value and they will be

sending you a refund. What type of lease did you have?

A) Closed-end lease

B) Open-end lease

C) Walk-away lease

D) Residual lease


Answer: BDiff: 1Topic: Automobile LeasingAACSB: Analytical Thinking



14) You have been having significant problems with your new car. Every time you turn around

something is breaking or not working properly. Fortunately, the ʺlemon lawsʺ are there to help.

Which of the following is not one of the criteria for application of the lemon laws?

A) You have made at least four attempts to solve the problem.

B) Your car has been out of service for at least 30 days during the first year after purchase.

C) You have under 12,000 miles on the car.

D) You must return the vehicle to the original dealership.

Answer: DDiff: 3Topic: Smart Buying AutomobilesAACSB: Analytical Thinking

15) Which of the following factors plays a role in determining the monthly lease payment of a car?

A) The agreed-upon price of the vehicle

B) The length of the lease

C) Your down payment plus any trade-in allowance or rebate

D) The value of the vehicle at the end of the lease

E) All of the above

Answer: EDiff: 3Topic: Automobile LeasingAACSB: Analytical Thinking

16) Another name for a closed-end lease is a(n)

A) take-out lease.

B) walk-away lease.

C) end-purchase lease.

D) terminal lease.


Answer: BDiff: 1Topic: Automobile LeasingAACSB: Analytical Thinking

17) In auto sales, a ________ is an amount of money, generally in the 2% to 3% range, that the

manufacturer gives the dealer for selling an automobile.

A) holdback

B) rebate

C) kickback

D) markup


Answer: ADiff: 1Topic: Smart Buying AutomobilesAACSB: Diverse and Multicultural Work Environments



18) Suppose that you were thinking about leasing a new vehicle. Which of the following should not

be an important consideration?

A) I drive less than 15,000 miles annually.

B) I like to get a new car every few years.

C) I dislike the hassle of trading-in or selling cars.

D) Itʹs the only way I can afford the vehicle that I want.

E) I dislike the hassle of maintenance.

Answer: DDiff: 3Topic: Automobile LeasingAACSB: Reflective Thinking

19) You disagree with Ed ʺShiftyʺ Smith, a car salesperson, on the price of an open-end lease. He

says the depreciation charge is only $6,000. What is the actual depreciation charge for a car now

worth $23,000 that is expected to drop in value to $15,000 in two years?

A) $7,000 B) $7,500 C) $8,000 D) $11,500 E) $15,500

Answer: CDiff: 2Topic: Automobile LeasingAACSB: Analytical Thinking

20) Billy has chosen to purchase a new vehicle. The vehicle costs $15,000. His APR is 10% and he

will be financing the vehicle for 36 months. How much will Billy pay each month for his new

vehicle?

A) $484.01 B) $296.35 C) $312.66 D) $405.29 E) $496.33

Answer: ADiff: 1Topic: Automobile LoanAACSB: Analytical Thinking

21) Abraham is buying a new truck. The sale price for the truck is $23,410. His bank is loaning him

the money at an APR of 6.5 for 5 years. How much will Abrahamʹs monthly truck payment be?

A) $229.36 B) $375.88 C) $307.65 D) $402.35 E) $458.04

Answer: EDiff: 2Topic: Automobile LoanAACSB: Analytical Thinking

22) Over the past decade, the number of new car sales are down and the number of new car leases

are up. What is probably the main reason why this is true?

A) The salesman makes a higher commission when cars are leased.

B) The manufacturers prefer it when people lease instead of purchase.

C) New cars are getting so expensive that the average person canʹt afford to buy them.

D) Both A and B are correct.

Answer: CDiff: 3Topic: Automobile LeasingAACSB: Diverse and Multicultural Work Environments



23) What kind of valuable information can you find online at websites such as Edmunds.com or

Autosite.com concerning smart buying for automobiles?

A) The dealer cost and dealer holdback for the automobile you are interested in.

B) The trade-in value on your current automobile.

C) The final price you will pay for the automobile at the dealership.

D) Only A and B are correct.


Answer: DDiff: 3Topic: Smart Buying AutomobilesAACSB: Information Technology

24) Congratulations! You have just agreed on the final price for your new car and now you have to

finance the purchase. The negotiated price of the new car is $18,500 and you will receive $5,500

for your trade-in. What will your monthly payment be on a 48-month loan with a 7% APR?

A) $281.25 B) $311.30 C) $385.42 D) $443.01


25) If you are considering purchasing a used car you should

A) do some research so youʹll know a fair price for the vehicle youʹre looking for.

B) ask questions about the mechanical history of the car, including whether it has been in any

accidents.

C) have the car inspected by a mechanic before you purchase it.

D) all of the above

Answer: DDiff: 3Topic: Smart Buying AutomobilesAACSB: Reflective Thinking

26) Candice is purchasing a new Jeep. She has the price negotiated down to what she thought was

the lowest possible price until she heard that her Jeep has a holdback amount of 3%. Is it fair for

Candice to ask the dealership to take the holdback amount off her final sales price?

A) Absolutely, this would decrease the mark up price of the Jeep and save Candice additional

dollars.

B) No. The dealership would most likely lose money on the sale.

Answer: ADiff: 1Topic: Smart Buying AutomobilesAACSB: Analytical Thinking



27) List the four steps in the automobile decision.

Answer: Step 1: Differentiate want from need.

Step 2: Do your homework.

Step 3: Make the purchase.

Step 4: Maintain the purchase.Diff: 1Topic: Smart Buying AutomobilesAACSB: Reflective Thinking

28) Rob Roy is toying with the idea of buying a used car every three years instead of leasing or

buying a new one. Assuming he can find a one-owner with low miles in good condition, what

advantages might he enjoy?

Answer: Today, there are many good used cars on the market because so many people are leasing

new cars instead of buying them. When the leases are up, the dealers put them on the

ʺpre-ownedʺ lot. In general, a used car costs less and requires less down payment. A used

car tends to decline in value much more slowly than a new car. A used car can be a real

money saver. The savings from buying a used car instead of a new one every three years

have been estimated to be between $1,500 and $2,000 per year, which will put more

dollars in your pocket to spend on other things you want.Diff: 2Topic: Smart Buying AutomobilesAACSB: Reflective Thinking

29) List the factors that go into a monthly lease payment and tell how the dollar value of a lease is

calculated.

Answer: -the agreed-upon price

-any other up-front fees

-down payment plus any trade-in allowance or rebate

-value of the vehicle at the end of the lease

-rent or finance charges

-length of the lease

The dollar value of the lease is found by subtracting the projected value of the car at the

end of the lease from the current market value upon signing the lease.Diff: 3Topic: Automobile LeasingAACSB: Analytical Thinking

30) Describe the keys to obtaining a ʺgoodʺ lease.

Answer: First, negotiate a fair agreed-upon value for the car. Be sure to see that the warranty

covers the entire lease period so you do not have to pay for major repairs. Make sure that

ʺnormal wear and tearʺ is defined in the contract and that you understand the

termination fees. Make sure you have adequate insurance protection. Last, find a car that

does not depreciate quickly and has a low rent or finance charge.Diff: 3Topic: Automobile LeasingAACSB: Analytical Thinking



31) What are the basic financing options when considering a new vehicle?

Answer: The basic options are to pay cash, trade evenly, borrow money, lease, trade up and pay

the extra, trade down and get the difference.Diff: 1Topic: Smart Buying AutomobilesAACSB: Analytical Thinking

32) Write a paragraph giving at least five important tips on buying a new car.

Answer: Find out the dealerʹs invoice price for the vehicle and negotiate a price. Check out all

rebates and discounts. Get price quotes from several dealers. Keep your trade-in

negotiations separate from the main deal. Compare financing from several sources before

you sign the contract. Think twice about adding extra options and agreements.Diff: 2Topic: Smart Buying AutomobilesAACSB: Reflective Thinking

33) Bridgette Rojeau has found a beautiful late model used car on a dealerʹs lot. It is just what she

has always wanted. Give her seven tips on buying this dream car.

Answer: Check newspaper ads and used-car guides at a local library to know what is a fair price

for the car you want. Remember, prices are negotiable. Look up factory repair recalls for

this model. Shop during daylight hours so you can see what you are getting. Always take

a long test drive, driving it in town and out on the road. Check all workable parts that

you understand yourself. Have an independent mechanic inspect the car thoroughly

before buying it and expect to pay him or her for it. Ask questions about the previous

owner and mechanical history of the vehicle. Check to see if there is an original warranty.Diff: 2Topic: Smart Buying AutomobilesAACSB: Reflective Thinking

34) Why is it that you should not tell the salesperson what you want your monthly payment to be

before you negotiate the final price on the car?

Answer: A good salesperson can make the car payment come out where you want it to be by

either convincing you to lease instead of purchase or by stretching the term of the lease or

the loan. If you are financing the loan with the dealership and they know your APR, your

payment, length of loan you desire, then using Time Value of Money skills they can

easily calculate how much to charge you for the vehicle.Diff: 2Topic: Smart Buying AutomobilesAACSB: Analytical Thinking

35) Name six factors that will determine your monthly lease payment.

Answer: 1. The agreed-upon price of the vehicle

2. Upfront fees, such as taxes, insurance, or service contracts

3. Your down payment plus any trade-in allowance or rebate

4. The value of the vehicle at the end of the lease

5. The rent or finance charges

6. The length of the leaseDiff: 2Topic: Automobile LeasingAACSB: Application of Knowledge



36) Leasing a car may make sense for some people but there are disadvantages to leasing. What are

the disadvantages to leasing a car verses purchasing the car outright?

Answer: When you lease the car you never build equity into the asset. This limits your choices

when the lease expires. You either have to buy the car you leased at the purchase option

or you have to get another car. The problem is that you donʹt have a car to trade-in so

most people end up leasing another car instead of buying. When you purchase a car, you

eventually build equity and own the car outright after you have paid off the loan. Now

you have choices where you can just keep the car with no more payments or trade the car

in towards another car, reducing the financing needs for the new car.Diff: 3Topic: Automobile LeasingAACSB: Reflective Thinking

8.3 Smart Buying in Action: Housing

1) A co-op is an apartment building owned by a corporation where residents of the building are

stock holders. When you buy into a co-op, you buy shares that reflect the dollar value of your

space. The larger and more desirable the space you want requires purchase of more shares.

Answer: TRUEDiff: 1Topic: CondominiumAACSB: Diverse and Multicultural Work Environments

2) If you are the type of person who wants complete control over the style and decoration of your

home, then a condominium or cooperative would be an appropriate housing decision for you.

Answer: FALSEDiff: 1Topic: CondominiumAACSB: Analytical Thinking

3) If the roof of your condominium building needs expensive repairs, then the condominium

board will pay for repairs at no expense to you.

Answer: FALSEDiff: 3Topic: CondominiumAACSB: Diverse and Multicultural Work Environments

4) An assessment is a voluntary contribution by the condominium owners.

Answer: FALSEDiff: 3Topic: CondominiumAACSB: Analytical Thinking

5) The common areas in a condominium complex may include swimming pools, parking lots, and

grounds.

Answer: TRUEDiff: 3Topic: CondominiumAACSB: Analytical Thinking



6) A condominium is a good choice of housing for someone seeking an affordable,

low-maintenance situation with some shared amenities.

Answer: TRUEDiff: 3Topic: CondominiumAACSB: Reflective Thinking

7) The Internet can help you research neighborhoods and find a community in which youʹd like to

live.

Answer: TRUEDiff: 3Topic: Smart Buying HousingAACSB: Analytical Thinking

8) For many consumers, a good school district is an important consideration when purchasing a

home.

Answer: TRUEDiff: 3Topic: Smart Buying HousingAACSB: Reflective Thinking

9) A co-op would be a wise choice for a consumer who wishes to pay no property taxes.

Answer: FALSEDiff: 3Topic: Smart Buying HousingAACSB: Analytical Thinking

10) The typical down payment is 20% for traditional mortgage loans.

Answer: TRUEDiff: 1Topic: Smart Buying HousingAACSB: Analytical Thinking

11) Because a co-op is technically not a ʺhomeʺ it does not charge a homeownerʹs fee.

Answer: FALSEDiff: 1Topic: Smart Buying HousingAACSB: Analytical Thinking

12) Special assessments are fees that can be charged to cooperative shareholders and condominium

owners to cover large maintenance and repair items.

Answer: TRUEDiff: 1Topic: CondominiumAACSB: Analytical Thinking

13) A down payment is the initial buyerʹs equity in the asset being purchased.

Answer: TRUEDiff: 2Topic: Down PaymentAACSB: Diverse and Multicultural Work Environments



14) An appraisal is an estimate of what your home and property are worth.

Answer: TRUEDiff: 3Topic: Smart Buying HousingAACSB: Diverse and Multicultural Work Environments

15) A loan origination fee is a fee paid to the lender, generally in the $1,200 to $1,300 range, and

covers some of their costs of processing and finalizing the loan.

Answer: FALSEDiff: 1Topic: Mortgage LoanAACSB: Information Technology

16) A title search fee is paid to an attorney or title company for searching ownership records to

make sure the person selling you the property really owns it.

Answer: TRUEDiff: 1Topic: Closing CostsAACSB: Information Technology

17) You, not your lender, should determine the amount you want to borrow for a mortgage.

Answer: TRUEDiff: 2Topic: Smart Buying HousingAACSB: Reflective Thinking

18) An appraisal is a typical but not required part of the mortgage approval process.

Answer: FALSEDiff: 2Topic: Mortgage LoanAACSB: Analytical Thinking

19) In many states rental deposits are to be kept in a bank account separate from the landlordʹs

general funds.

Answer: TRUEDiff: 2Topic: Deposit AccountsAACSB: Analytical Thinking

20) A mortgage with a 20% down payment will have a higher APR than one with less than 20%

down.

Answer: FALSEDiff: 2Topic: Mortgage LoanAACSB: Diverse and Multicultural Work Environments



21) A mortgage for less than 80% of the appraised value of the home will not require PMI insurance

because they default less often.

Answer: TRUEDiff: 2Topic: Private Mortgage InsuranceAACSB: Diverse and Multicultural Work Environments

22) Itʹs advisable to always take the biggest loan that a lender will give you.


23) PITI stands for the total of your monthly principal, income, taxes, and insurance.

Answer: FALSEDiff: 3Topic: PITIAACSB: Analytical Thinking

24) Which should you consider when house hunting?

A) The selling price B) The neighborhood

C) The school district D) All of the above

Answer: DDiff: 3Topic: Smart Buying HousingAACSB: Diverse and Multicultural Work Environments

25) What drawbacks might a co-op have over a house for a family of eight who are relocating to a

new area and need to purchase a home?

A) More expensive to purchase

B) More expensive to operate and maintain

C) Less freedom to make changes and less privacy

D) No ownership of shares in the corporation

Answer: CDiff: 3Topic: CondominiumAACSB: Analytical Thinking

26) Which of the following is not an advantage of living in a condo?

A) Limited maintenance

B) Building equity for resale and investment

C) Direct ownership of a specific unit

D) Freedom from neighbors

Answer: DDiff: 2Topic: CondominiumAACSB: Analytical Thinking



27) Which one of the following is not a key to finding housing that fits your needs?

A) Location

B) Deciding what features you are looking for

C) Present needs

D) Insurance costs

E) Future needs

Answer: DDiff: 2Topic: Smart Buying HousingAACSB: Reflective Thinking

28) In evaluating your financial history, lenders generally focus on which of the following?

A) Your income B) Your credit report

C) Your FICO score D) All of the above

Answer: DDiff: 2Topic: Smart Buying HousingAACSB: Diverse and Multicultural Work Environments

29) What would be the best housing choice for a young family with children?

A) A home in a questionable school district.

B) A condominium that caters to young adults with active lifestyles.

C) A co-op with little privacy.

D) A house in a neighborhood with families that have children.


30) Which of the following housing alternatives puts the responsibility for maintenance and repairs

on the occupant?

A) Home ownership B) A co-op

C) A condo D) A rental unit

Answer: ADiff: 2Topic: Smart Buying HousingAACSB: Analytical Thinking

31) PITI stands for the total of your monthly

A) principal, income, taxes, and insurance.

B) principal, interest, taxes, and insurance.

C) principal, interest, taxes, and income.

D) premiums, interest, taxes, and insurance.

Answer: BDiff: 2Topic: PITIAACSB: Reflective Thinking



32) When following smart buying to purchase a home you should

A) create a budget and determine what PITI you can afford.

B) check out your FICO score and get a copy of your credit report.

C) look at your overall financial plan to determine how big a loan you should take on.

D) determine how much of a down payment you can afford.


Answer: EDiff: 2Topic: Smart Buying HousingAACSB: Reflective Thinking

33) Jackie is considering obtaining a mortgage of $333,000. A lower APR is available, but she must

pay 1.75 points to buy the rate down. How much must Jackie pay in dollars?

A) $1,357 B) $3,300 C) $5,828 D) $8,333

Answer: CDiff: 3Topic: PointsAACSB: Application of Knowledge

34) Private mortgage insurance typically is not needed with a down payment of 20% or larger.

Why?

A) Not true, all mortgage loans require PMI.

B) Buyers who have large down payments donʹt choose the extra insurance.

C) Buyers who invest large down payments are more motivated to make their mortgage

payments.

D) All of the above


Answer: CDiff: 3Topic: Private Mortgage InsuranceAACSB: Diverse and Multicultural Work Environments

35) You are a newlywed, and you and your spouse have just found your dream home. Problem is,

you do not have 20% for a down payment on the house. You will probably need to obtain

A) EAR.

B) PMI.

C) PTI.

D) APR.


Answer: BDiff: 1Topic: Private Mortgage InsuranceAACSB: Diverse and Multicultural Work Environments



36) You are considering the purchase of an acre of land out in the country to build your future

house on. You pay for an investigation of the public record to determine the current legal owner

of the property. This is called a(n)

A) legal entity search.

B) title search.

C) appraisal search.

D) escrow search.


Answer: BDiff: 1Topic: Title SearchAACSB: Information Technology

37) You have just obtained a mortgage to purchase your home. The ________ that you paid to

obtain the loan are charges that must be paid at the time of the sale and serve to raise the

effective cost of the loan.

A) points

B) closing fees

C) escrow fees

D) security fees


Answer: ADiff: 1Topic: PointsAACSB: Analytical Thinking

38) You are in the process of purchasing a new home. Expenses that the buyer and seller incur

when finalizing the transfer of the ownership of the house are called

A) end costs.

B) finalization costs.

C) transfer fees.

D) closing costs.


Answer: DDiff: 1Topic: Closing CostsAACSB: Diverse and Multicultural Work Environments

39) You are considering obtaining a mortgage of $220,000. A lower APR is available, but you must

pay 2 points to buy the rate down. How much must you pay in dollars?

A) $1,100 B) $2,200 C) $3,300 D) $4,400 E) $6,600

Answer: DDiff: 2Topic: PointsAACSB: Analytical Thinking



40) How much would the monthly payment be on a mortgage of $250,000 for 30 years at a rate of

6.0%?

A) $1,498.87 B) $1,779.48 C) $743.66 D) $721.73 E) $1,450.03

Answer: ADiff: 2Topic: Mortgage Loan PaymentsAACSB: Analytical Thinking

41) With private mortgage insurance, many lenders will allow you to borrow more than 80% of the

appraised value of the home. What is the purpose of this action?

A) The insurance will pay for damages to the home during the course of the mortgage.

B) It is required by federal and state law.

C) It protects the lender in the event the borrower is unable to make the mortgage payments.

D) It protects the borrower from foreclosure.


Answer: CDiff: 1Topic: Private Mortgage InsuranceAACSB: Diverse and Multicultural Work Environments

42) Select the one cost that is not involved in home ownership.

A) Down payment

B) Closing/settlement costs

C) Rental deposit

D) Points/discount points

E) Loan origination fee

Answer: CDiff: 1Topic: Smart Buying HousingAACSB: Analytical Thinking

43) When you decide to buy a home, which of these questions should be answered?

A) What is the maximum amount that a bank will lend me?

B) Should I borrow up to this maximum?

C) How big of a down payment can I afford?

D) All of the above




44) Bob and Marilyn Hartin know the bank will carefully evaluate their situation before lending

them the money for the mortgage for their new home. Which is not a consideration?

A) Their financial history

B) The number of children they have

C) Their level of debt

D) Their ability to pay

E) Appraised home value

Answer: BDiff: 2Topic: Mortgage LoanAACSB: Analytical Thinking

45) Name the items that are deposited in an escrow account.

A) Principal, interest, title fee, insurance

B) Utility payments, homeownerʹs association dues

C) Property taxes, property insurance

D) PMI premiums, homeownerʹs association dues

E) Liens, closing costs, points

Answer: CDiff: 2Topic: EscrowAACSB: Analytical Thinking

46) Which of the following is not a recurring housing cost?

A) Mortgage payments

B) PITI

C) Points

D) Maintenance and operating costs

E) Homeownerʹs insurance

Answer: CDiff: 2Topic: Smart Buying HousingAACSB: Diverse and Multicultural Work Environments

47) Name the steps in the housing decision.

Answer: Step 1: Pre-shopping homework

Step 2: The selection process

Step 3: Make the purchase

Step 4: Post-purchase activitiesDiff: 1Topic: Smart Buying HousingAACSB: Analytical Thinking



48) What are the common options for housing?

Answer: -Purchase a home.

-Buy into a cooperative.

-Purchase a condo.

-Rent an apartment.Diff: 1Topic: Smart Buying HousingAACSB: Analytical Thinking

49) Give the major financial advantages of home ownership.

Answer: Owning a home is one of the only true tax shelters left today. You can deduct the

mortgage interest, property taxes, and home equity loan interest (in most cases). You may

find the monthly mortgage payment actually less than a monthly rental, thus improving

your cash flow. For most people, the home is the single largest investment they will

make. By following the smart buying principles most homes will appreciate in value

while at the same time the mortgage is being reduced leaving a sizeable amount of equity

over time. Many people enjoy the independence and pride of ownership in their own

home. Remodeling and landscaping decisions, for the most part, are up to the ownerʹs

discretion and imagination.Diff: 2Topic: Smart Buying HousingAACSB: Analytical Thinking

50) What are the main financial questions you should ask yourself prior to purchasing a home?

Answer: 1. What is the maximum amount the lender will allow me to have?

2. Should I borrow up to this maximum?

3. How big of a down payment can I afford?

4. What type of mortgage best suits my needs?

5. Do I have adequate income to pay all the bills and still maintain my standard of living

and long term savings goals?Diff: 3Topic: Smart Buying HousingAACSB: Reflective Thinking

51) Why is important to determine your housing needs not only for the present but also for the next

several years?

Answer: The closing costs and selling fees associated with buying and selling a home are very

high. It is not realistic to think that a home will appreciate enough in a few years to

recover these costs. Having to sell a house after a few years may result in a sizeable

capital loss.Diff: 3Topic: Smart Buying HousingAACSB: Analytical Thinking



52) Provide the most common one-time or initial costs involved in buying a house.

Answer: A down payment will be required. Closing or settlement costs must be paid. Other costs

include points, loan origination fee, loan application fee, appraisal fee, title search, and

title insurance. In addition, there may be an attorneyʹs fee, recording fee, credit report

charge, termite and radon inspection fee, and a notary fee.Diff: 2Topic: Smart Buying HousingAACSB: Analytical Thinking

8.4 Renting Versus Buying

1) From a financial perspective, the decision of whether to rent or buy is tied to how long to plan to

live in the home.

Answer: TRUEDiff: 2Topic: Buying versus Leasing HousingAACSB: Analytical Thinking

2) Buying a home generally isnʹt desirable if you donʹt intend to stay in it for more than two or

three years.


3) Whether or not you itemize your tax deductions, you reap tax benefits due to the tax

deductibility of the interest payments on your mortgage.

Answer: FALSEDiff: 2Topic: Buying versus Leasing HousingAACSB: Analytical Thinking

4) If you have just been transferred to a new city and plan to live in your new location for many

years, buying a house is generally a better option than leasing for the first year.


5) One of the main barriers to home ownership is the down payment.

Answer: TRUEDiff: 2Topic: Down PaymentAACSB: Diverse and Multicultural Work Environments

6) Young, single people often live in rental housing, since they may not yet have the funds to

purchase a home.

Answer: TRUEDiff: 2Topic: Buying versus Leasing HousingAACSB: Diverse and Multicultural Work Environments



7) If you are not yet committed to living in a particular geographic region, rental housing is a good

option for you.

Answer: TRUEDiff: 2Topic: Buying versus Leasing HousingAACSB: Reflective Thinking

8) The majority of people never live in rental housing.

Answer: FALSEDiff: 2Topic: Buying versus Leasing HousingAACSB: Reflective Thinking

9) Being able to move with minimum inconvenience is an appealing aspect of buying a home.

Answer: FALSEDiff: 2Topic: Buying versus Leasing HousingAACSB: Reflective Thinking

10) Most home owners have complete autonomy to remodel their dwelling to suit their own needs

and tastes.

Answer: TRUEDiff: 2Topic: Buying versus Leasing HousingAACSB: Reflective Thinking

11) The largest cost associated with renting a home is the rent itself.


12) Tenants are guaranteed to get their full deposit back no matter the condition of the unit upon

moving out.

Answer: FALSEDiff: 2Topic: Buying versus Leasing HousingAACSB: Analytical Thinking

13) Nancy Wong has decided to move from her apartment into a house she is purchasing. She

wants to enjoy the advantages of home ownership, such as

A) a chance to build equity and wealth.

B) greater control over decorations and home improvement.

C) mortgage interest will probably be a tax deduction.

D) over time being able to take out a home equity loan to enjoy a tax deduction.


Answer: EDiff: 2Topic: Buying versus Leasing HousingAACSB: Analytical Thinking



14) All of the following are advantages of renting versus buying a home except

A) mobility.

B) no property taxes.

C) not responsible for home repairs or maintenance.

D) control over remodeling and decorating decisions.

E) no risk of falling housing prices.

Answer: DDiff: 3Topic: Buying versus Leasing HousingAACSB: Diverse and Multicultural Work Environments

15) What questions should you answer before deciding to purchase a house?

A) Will my life be stable or in transition in the next few years?

B) Is my job and the company I work for stable and secure?

C) Do I understand the responsibilities of home ownership?


Answer: DDiff: 3Topic: Buying versus Leasing HousingAACSB: Reflective Thinking

16) What is not a benefit normally associated with home ownership?

A) Tax advantages for those who qualify

B) Flexibility to respond to employment opportunities

C) Ability to build equity and net worth

D) A potential source of collateral for future loans

Answer: BDiff: 3Topic: Buying versus Leasing HousingAACSB: Diverse and Multicultural Work Environments

17) When is it advantageous to rent instead of buy?

Answer: Renting is a good plan when you plan to stay in the house less than three years. If your

job situation is not stable and you dislike the hassle of buying and selling, this may be the

thing for you to do. Also, if you do not have a down payment saved up, you have no

other choice.Diff: 2Topic: Buying versus Leasing HousingAACSB: Analytical Thinking

18) What factors should be considered before signing a lease?

Answer: -Determine what you can afford (ideally less than 25% of your take-home pay).

-Make sure the location is right.

-Understand the lease and feel comfortable with it.

-Never agree to verbal promises. Put all of them in writing.

-Determine if the landlord is reliable.

-Obtain renterʹs insurance before moving in.Diff: 3Topic: Buying versus Leasing HousingAACSB: Analytical Thinking



19) Why may it be a good idea for newlyweds to lease a few years before purchasing a home

together?

Answer: There are several good reasons for newlywed couples to delay purchasing their first

home together. The closing and selling costs associated with purchasing and selling a

home are substantial costs that generally canʹt be recovered if forced to sell within a few

years. Possibly living together for a while will identify if the marriage will work out for

the long run, both from an emotional and financial perspective. Possibly they can live

cheaper in a leased home allowing them to pay off past debts and save up a larger down

payment. Possibly they will have a better idea of when they want to start a family which

would have a big impact on the type of home they would need with children.Diff: 3Topic: Buying versus Leasing HousingAACSB: Reflective Thinking

8.5 Determining What You Can Afford

1) As a general rule, your PITI shouldnʹt exceed 28% of your pretax monthly income.

Answer: TRUEDiff: 3Topic: PITIAACSB: Analytical Thinking

2) PITI is a one-time, initial cost of home ownership.

Answer: FALSEDiff: 3Topic: PITIAACSB: Analytical Thinking

3) As a rule of thumb, your PITI costs shouldnʹt exceed ________ of your pretax monthly income.


Answer: CDiff: 3Topic: PITIAACSB: Analytical Thinking

4) You have an annual gross income of $36,000. Using the 28/36 rule for maximum mortgage

payment (PITI) estimation, what is your maximum PITI payment using your monthly gross

income as a guide (28%)?

A) $840 B) $1,080 C) $680 D) $640 E) $880

Answer: ADiff: 3Topic: PITIAACSB: Analytical Thinking



5) Juanita has determined that the PITI on the house she would like to purchase will be $1,260 per

month. What is the minimum gross salary she will need to qualify for a mortgage from a

reputable lender?

A) $6,300 per month B) $4,500 per month

C) $3,500 per month D) $5,040 per month

Answer: BDiff: 3Topic: 28/36 RuleAACSB: Analytical Thinking

6) Tran currently makes $4,500 per month in gross income. He has a student loan payment of $250

per month and a car loan of $450 per month. His credit card payments average $300 per month.

What is the largest PITI he could qualify for with a reputable lender?

A) $620 B) $900 C) $1,260 D) $1,620

Answer: ADiff: 3Topic: 28/36 RuleAACSB: Analytical Thinking

7) Bob and Mary Kay have gross household income of $7,000 per month. They both have great

credit scores and the home they are interested in buying appraised higher than the selling price.

They have combined monthly debt payments of $300 in student loans, $650 in car loans, and

they pay their credit cards in full every month. The PITI on the new home will be $1,800 per

month. Before they pay the $250 loan application fee, they are asking you for your opinion on

whether they will get approved for a mortgage. What will you advise them?

A) Based on the 28 percent rule they can afford the $1,800 PITI and will be approved for the

mortgage.

B) Based on the 28 percent rule they cannot afford the $1,800 PITI and will be denied the

mortgage.

C) Based on the 36 percent rule they will be approved for the mortgage.

D) Based on the 36 percent rule they have too much other debt and will be denied the

mortgage.

Answer: DDiff: 3Topic: 28/36 RuleAACSB: Analytical Thinking

8) Your friends just told you that they were denied a mortgage by their bank. The loan officer told

them that they did not pass the 36 percent rule. They are confused and want you to explain

what happened?

A) The house you were looking at was more expensive than you can comfortably afford.

B) You need to come up with a larger down payment.

C) You pay too much in other debt payments every month.

D) All of the above could be correct.

E) None of the above could be correct.

Answer: DDiff: 3Topic: 28/36 RuleAACSB: Analytical Thinking



9) You are planning on starting your own business in 18 months and you intend to purchase a new

home. You have looked carefully at your budget and have determined that you can afford a

PITI of $900 per month. Your banker has told you that you can easily qualify for a PITI of $1,150

per month. Which of the following is the most reasonable explanation for this discrepancy?

A) Your banker knows you really would be happier in a more expensive house.

B) Your banker is not aware of your other long-term financial goals.

C) Your bankerʹs number is more accurate than your number.

D) None of the above is a reasonable explanation.

Answer: BDiff: 3Topic: Smart Buying HousingAACSB: Analytical Thinking

Hector and Maria Gonzales

Hector a Maria have been married for almost one year now and are thinking about buying a house. Maria is

an executive for a large, multi-national corporation with offices around the world. She has been told by her

company that she will be transferred to a new location every three years. Hector is a car salesman and he is

willing to move to wherever Maria gets transferred. Together they make $8,000 in gross monthly income and

pay 40% in taxes and withholdings every month. Between them they have monthly payment of $400 in

student loans and $700 in car loans, and their credit cards payments average $450 per month. They currently

lease a luxury condo for $1,400 per month. They travel to Cancun every Christmas. Since they both work a lot

of hours, they eat out at restaurants for most meals. They currently have nothing in savings but Hectorʹs

grandparents have said they will give them a 20% down payment for the new home.

10) Based on their incomes, how large of a PITI can they comfortably afford to pay?

A) Based on the 28 percent rule, they can afford $2,240 per month.

B) Based on the 36 percent rule, they can afford $2,880 per month.

C) Based on the 28 percent rule, they can afford $1,344 per month.

D) Based on the 36 percent rule, they can afford $1,728 per month.


11) They saw in the newspaper that they can get a fixed rate mortgage for 6.65% or a two-year

ARM with an initial rate of 5.50%. Which is true about their mortgage choices?

A) The fixed-rate mortgage has an attractive rate but is more risky for them.

B) The ARM initial rate is lower so their PITI will be lower.

C) Due to Mariaʹs job the ARM would be the better choice.


Answer: DDiff: 3Topic: Adjustable Rate MortgagesAACSB: Analytical Thinking



12) They have found a very nice town house available for $200,000. Assuming a 20% down

payment and a 30-year fixed rate mortgage at 6.65%, what will their PITI be? Annual property

taxes are $2,400 and homeownerʹs insurance premium is $900 per year.

A) $1,027.14 B) $1,283.93 C) $1,302.14 D) $1,558.93

Answer: CDiff: 3Topic: PITIAACSB: Analytical Thinking

13) Assuming a PITI of approximately $1,300 for the townhouse, will they be approved for a

mortgage?

A) No, based on the amount of their existing debt they will not be approved.

B) No, based on the 28 percent rule they will not be approved.

C) Yes, based on the 36 percent rule they will be approved.

D) Yes, based solely on their combined income they will be approved.

Answer: CDiff: 3Topic: 28/36 RuleAACSB: Analytical Thinking

14) According to the 28 percent rule, Natasha can afford a maximum PITI of $1,400. What is her

gross monthly income?

A) $2,800 B) $3,888 C) $5,000 D) $5,600 E) $39,200

Answer: CDiff: 3Topic: 28/36 RuleAACSB: Analytical Thinking

15) Augustʹs gross monthly income is $4,600. If according to the rule of 36 he can afford a maximum

PITI of $1,125, what must his monthly consumer credit debt be?

A) $531 B) $163 C) $417 D) $383


16) Regardless of what a potential borrower thinks he or she can afford, banks and other lenders

impose a maximum amount that they will lend to a borrower based on the personʹs income and

current debt levels. According the Keown book, what three factors do lenders look at when

evaluating a potential borrower?

Answer: 1. Financial history

2. Ability to pay

3. Appraised value of the home that the borrower is interested in buyingDiff: 2Topic: LendingAACSB: Reflective Thinking



17) Explain why the 28/36 percent rule is so important to understand.

Answer: A reputable lender wants to make sure that they will get their money back. They do not

want a borrower to be unable to comfortably afford to make their mortgage payments.

Statistics have shown that borrowers cannot comfortably afford to make debt payments

more than the 28/36 percent rule allows. Any more than this and the borrower cannot

afford to enjoy their lives or save money for other goals. The 28/36 rule allows for a safety

buffer that allows the borrower to handle unplanned emergencies without forcing them

to miss their mortgage payments. Statistics show that borrowers within these debt limits

default less often on their mortgages.Diff: 3Topic: 28/36 RuleAACSB: Analytical Thinking

8.6 Financing the Purchase-The Mortgage

1) Private mortgage insurance protects the lender in the event that the borrower is unable to make

the mortgage payments.

Answer: TRUEDiff: 2Topic: Private Mortgage InsuranceAACSB: Analytical Thinking

2) The two most common types of two-step mortgages are the 8/22 and 12/18, in which lenders

offer a lower interest rate for the first 8 or 12 years and then adjust the rate for the remaining 22

or 18 years.

Answer: FALSEDiff: 3Topic: Adjustable Rate MortgagesAACSB: Analytical Thinking

3) A real estate short sale is a sale of property where the proceeds from the sale exceed the balance

owed on the property.

Answer: FALSEDiff: 2Topic: Short SellingAACSB: Analytical Thinking

4) Mortgage bankers originate mortgage loans, sell them to banks, pension funds, and insurance

companies, and service or collect all the monthly mortgage payments.

Answer: TRUEDiff: 1Topic: Mortgage BankerAACSB: Diverse and Multicultural Work Environments

5) A fixed-rate mortgage is harder to budget for than an adjustable rate mortgage.




6) A subprime mortgage is a mortgage with an APR below the prime rate.

Answer: FALSEDiff: 1Topic: Non-Conventional Mortgages


7) An adjustable rate mortgage (ARM) is always a wise financial decision for young consumers

because their incomes will be adjusting as well.

Answer: FALSEDiff: 1Topic: Adjustable Rate MortgagesAACSB: Diverse and Multicultural Work Environments

8) A mortgage broker earns income based on fees or commissions on the loans they broker.

Answer: TRUEDiff: 2Topic: Mortgage BrokerAACSB: Diverse and Multicultural Work Environments

9) Subprime mortgages are mortgages taken out by people with low credit scores.

Answer: TRUEDiff: 3Topic: Non-Conventional Mortgages


10) You can only get an ARM loan from a predatory lender.


11) From a borrowerʹs perspective, youʹre better off with an ARM if interest rates rise.


12) Most predatory lenders offer prepayment privileges with their mortgages.



13) A mortgage with an APR higher than normal is a subprime mortgage.





14) An assumable loan is one that can be transferred to a new buyer who simply takes over the loan

obligations.



15) The prepayment privilege allows the borrower to make early cash payments toward the

principal balance on their loan.



16) The rate cap on an ARM sets a dollar limit on how much your monthly payment can increase

during any adjustment period.


17) The best time to get an ARM is when the market rates of interest are high.

Answer: TRUEDiff: 3Topic: Adjustable Rate MortgagesAACSB: Diverse and Multicultural Work Environments

18) Someone who plans on selling his or her home within the next 3 years should get a fixed -rate

mortgage.


19) Itʹs best to have an ARM with the longest adjustment interval available.


20) The rate cap on an ARM protects the borrower.


21) The initial rate on an adjustable rate mortgage (ARM) is sometimes called the teaser rate.




22) The safest place to get a mortgage is at your bank, credit union, or savings and loan institution.

Answer: TRUEDiff: 3Topic: Conventional MortgagesAACSB: Diverse and Multicultural Work Environments

23) Subprime mortgages are illegal.



24) Sandra Smith wants to know the purpose of a title search. What would you tell her?

A) To gain a clear title to the property

B) To make sure the person selling the property really owns it

C) To protect you against challenges to the title

D) All of the above

Answer: DDiff: 3Topic: Title SearchAACSB: Analytical Thinking

25) Jeremy does not like the idea of paying points. A point is actually

A) one percent of the selling price of the house.

B) one percent of the amount financed with the mortgage.

C) one percent of the selling price minus the realtorʹs fee.

D) one percent of the taxable value of the house and property.


Answer: BDiff: 2Topic: Mortgage LoanAACSB: Diverse and Multicultural Work Environments

26) Which of the following is not a one-time fee connected with purchasing a house?

A) Down payment

B) Private mortgage insurance

C) Closing costs

D) Points

E) Origination fee




27) When planning your budget to determine how much your home will cost you every month,

which of the following should you include in your planning?

A) Closing costs B) PITI

C) Discount points D) All of the above


28) Kathy is buying her first home. She is financing a total of $185,000 at an APR of 5% for 25 years.

How much are her monthly payments?

A) $952.33 B) $1,081.49 C) $1,441.23 D) $1,664.85

Answer: BDiff: 3Topic: Mortgage Loan PaymentsAACSB: Analytical Thinking

29) Abigail is financing her first home. She is borrowing $125,000. Her bank is loaning her the

money for 15 years at an APR of 5.7%. What will Abigailʹs monthly mortgage payment be?

A) $958.75 B) $998.22 C) $1,001.44 D) $1,034.67

Answer: DDiff: 3Topic: Mortgage Loan PaymentsAACSB: Analytical Thinking

30) Which of these is not an advantage associated with an assumable loan?

A) The new buyer does not incur the closing costs of a new loan.

B) The new buyer may be able to get a lower interest rate than the current market rate.

C) It is easier for the seller to sell the home.

D) The new buyer does not have to qualify for the loan.

Answer: DDiff: 3Topic: Mortgage LoanAACSB: Analytical Thinking

31) A deposit included with an offer to buy that assures the seller that the buyer is serious about

buying the house is called

A) assurance deposit.

B) buyerʹs assurance.

C) home deposit.

D) earnest money.


Answer: DDiff: 1Topic: Earnest MoneyAACSB: Analytical Thinking



32) A situation in which the monthly payments are less than the interest that is due on the loan, and

the unpaid interest is thus added to the principal is called

A) partial amortization.

B) negative amortization.

C) reverse amortization.

D) decaying amortization.


Answer: BDiff: 2Topic: Non-Conventional Mortgages


33) A mortgage loan in which the interest rate charged fluctuates with the level of current interest

rates is called a(n)

A) MRA.

B) MAR.

C) RAM.

D) ARM.


Answer: DDiff: 1Topic: Adjustable Rate MortgagesAACSB: Information Technology

34) A ________ is a middleman who, for a fee, secures mortgage loans for borrowers, but does not

actually make those mortgage loans.

A) mortgage banker

B) mortgage broker

C) mortgagee

D) mortgagor


Answer: BDiff: 2Topic: Mortgage BrokerAACSB: Analytical Thinking

35) A ________ typically originates mortgage loans with funds from other investors, such as

pension funds.

A) mortgage banker

B) mortgage broker

C) mortgagee

D) mortgagor


Answer: ADiff: 1Topic: Mortgage BankerAACSB: Information Technology



36) You currently have an ARM that is charging you 7% with an index rate of 4%, a margin of 3%,

and a periodic annual cap of 3.0%. Assume that rates have now increased by 2% during the last

seven months. What rate will your ARM be adjusted to?

A) will remain at 7% fixed rate

B) 8%

C) 9%

D) 10%

E) 11%

Answer: CDiff: 2Topic: Mortgage LoanAACSB: Analytical Thinking

37) The two primary advantages of a 15-year mortgage over a 30-year mortgage are

A) lower payments and prepayment privileges.

B) lower interest rate and lesser interest charges over the life of the loan.

C) greater financial flexibility and no prepayment penalties.

D) easier qualification criteria and more affordable initially.


Answer: BDiff: 3Topic: Mortgage LoanAACSB: Diverse and Multicultural Work Environments

38) The advantages of a fixed-rate mortgage over an ARM include

A) no private mortgage insurance required.

B) fixed payments that are easier to budget for.

C) less worry about the loan reaching the rate and payment caps.


E) both B and C.

Answer: EDiff: 2Topic: Adjustable Rate MortgagesAACSB: Diverse and Multicultural Work Environments

39) Daniel is due to receive the balance of his trust fund in 5 years; as a result he has taken out a(n)

________ mortgage where he has made small payments for several years and will pay off the

balance in one large payment with his trust funds.

A) ARM

B) graduated payment

C) shared appreciation

D) fixed rate

E) balloon payment

Answer: EDiff: 2Topic: Adjustable Rate MortgagesAACSB: Analytical Thinking



40) The ________ mortgage sets the payments in advance in such a way that they rise steadily for 5

to 10 years, then level off to allow a person to buy a home earlier in life.

A) balloon payment

B) growing equity


D) graduated payment

E) conventional

Answer: DDiff: 3Topic: Non-Conventional Mortgages


41) A ________ mortgage is designed to let the homeowner pay off the mortgage early. Payments

begin at the 30-year fixed rate, then increase each year.

A) balloon payment

B) growing equity


D) graduated payments

E) conventional

Answer: BDiff: 2Topic: Non-Conventional Mortgages


42) Rhonda is buying a second home to use as income property. She is financing 75% of the homeʹs

$100,000 value. Her bank is loaning her the money for 10 years at an APR of 4.5%. How much

are Rhondaʹs mortgage payments?

A) $441.28 B) $598.74 C) $777.28 D) $958.44 E) $1,014.33

Answer: CDiff: 3Topic: Mortgage Loan PaymentsAACSB: Analytical Thinking

43) Salvadore Dobraseri is a military veteran and has been told by a friend to check out a VA or

FHA loan for the purchase of the home he and his wife are interested in. Why should he?

A) Generally, they will pay a lower interest rate.

B) A smaller down payment is required.

C) There are less strict financial requirements for the loan.

D) Veterans are required to obtain this type of mortgage.

E) A, B, and C above

Answer: EDiff: 2Topic: Mortgage LoanAACSB: Diverse and Multicultural Work Environments



44) With a(n) ________ mortgage, you make relatively small monthly payments for several years,

after which the loan comes due and you must pay it off in one large payment.

A) growing equity B) option payment ARM

C) interest only D) balloon payment

Answer: DDiff: 3Topic: Non-Conventional Mortgages


45) Ben recently paid off his school loans and is looking to buy a home. He has qualified for an APR

of 5.2% and plans on making payments for the next 15 years. He anticipates he can afford a

monthly payment of $660.00. How much of a mortgage can Ben afford?

A) $60,000

B) $82,371

C) $87,440

D) $91,000


Answer: BDiff: 3Topic: Mortgage Loan PaymentsAACSB: Analytical Thinking

46) Thomas took a new job in Iowa. He is buying his first home. He has qualified for an APR of

4.6%. He plans on making payments for the next 20 years. He anticipates that he can afford a

payment of $550.00. How much of a mortgage will Thomas qualify for?

A) $56,990 B) $75,210 C) $86,199 D) $110,224

Answer: CDiff: 2Topic: Mortgage Loan PaymentsAACSB: Analytical Thinking

47) Subprime, or nonprime, mortgages are taken out by borrowers with low credit scores, ________

of these mortgages carry adjustable rates.



48) According to the Keown book, how does a consumer avoid predatory lending?

A) Regulation B) Legal action C) Knowledge D) Steering

Answer: CDiff: 1Topic: Predatory LendingAACSB: Analytical Thinking



49) Private mortgage insurance is designed to protect the

A) borrower. B) lender.

C) lien holder. D) all of the above.

Answer: BDiff: 2Topic: Private Mortgage InsuranceAACSB: Analytical Thinking

50) The two most common types of two-step mortgages are the

A) 1/29 and 3/27. B) 5/25 and 7/23.

C) 8/22 and 12/18. D) 13/17 and 15/15.

Answer: BDiff: 3Topic: Adjustable Rate MortgagesAACSB: Reflective Thinking

51) A(n) ________ ARM combines the aspects of fixed-rate and adjustable-rate mortgages.

A) two-step B) convertible

C) reduction-option D) option payment

Answer: ADiff: 3Topic: Adjustable Rate MortgagesAACSB: Diverse and Multicultural Work Environments

52) Your mortgage is an ARM with a 1 year adjustment interval, 4% margin, and a 2% periodic cap.

Your initial APR on this loan was 4.5%. Over the last 5 years the market rates of interest have

risen dramatically. The current interest rate index for your loan is 8.5 %. What APR are your

monthly payments being calculated on today?

A) 4.5% B) 8.5% C) 10.5% D) 12.5%


53) Your ARM has a two year adjustment interval, 4% margin, 2% periodic rate cap and a 6%

lifetime cap. This year the market interest index increased by 2.75%. What will happen to your

APR on this loan?

A) It will increase by 2% B) It will increase by 2.75%

C) It will increase by 4% D) It will increase by 6%

Answer: ADiff: 3Topic: Adjustable Rate MortgagesAACSB: Analytical Thinking



54) You have an option on an ARM that has a two-year adjustment interval, 4% margin, 2%

periodic rate cap and a 6% lifetime cap. The current initial rate is 5.35%. You can also get a

30-year, fixed-rate mortgage for 6.65%. You plan on staying in this home for at least 10 years.

What would be your best choice?

A) Probably the ARM loan since your PITI would be lower.

B) Probably the ARM loan since your PITI would be lower and the market rates of interest

could get lower.

C) Probably the fixed-rate loan because your PITI will be lower.

D) Probably the fixed-rate loan because it is easier to budget for and it is less risky for you.


55) Jessica is buying her first new home. The home has been appraised at $330,000. For Jessica to not

have to pay private mortgage insurance she must come up with a down payment of

A) $33,000. B) $66,600. C) $20,000. D) $80,000.

Answer: BDiff: 3Topic: Smart Buying HousingAACSB: Analytical Thinking

56) Describe four ways to come up with the down payment money for buying a house.

Answer: Saving the money while renting is a wise thing to do. Ask for gifts/funds from friends

and family. Try to reduce the down payment by applying for a VA, FHA, or FmHA loan.

Look at selling any unnecessary assets or investments. Set up a budget and savings plan

to achieve this goal.Diff: 2Topic: Smart Buying HousingAACSB: Analytical Thinking

57) Explain the recurring costs of home ownership and why you need to budget for them.

Answer: Making sure that you can comfortably afford your house every month is very important.

The obvious recurring cost is your PITI. Donʹt forget the PMI premiums also. Monthly

utility bills, landscape maintenance and snow removal costs can also add up. Property

taxes and homeowners insurance premiums increase every year effecting your escrow

requirements. Maintenance and repairs are an ongoing expense when owning a home.Diff: 3Topic: Smart Buying HousingAACSB: Analytical Thinking



58) Why should you set a goal to eventually be able to put at least 20% down on purchasing a

home?

Answer: Statistics show that a borrower who makes a large down payment defaults less often than

one with a smaller down payment. The risk-return trade-off means that mortgages with

20% down will carry a lower APR and, generally, will not require PMI insurance. This

means that your monthly payment will be lower allowing you to save money on finance

costs and use that money for other living or savings needs.Diff: 3Topic: Smart Buying HousingAACSB: Reflective Thinking

59) An attorney will draw up a contract for the purchase of a house. What provisions should you

have in it?

Answer: -the price, method of payment, buyer and seller, date on which buyer will take

possession

-a clear legal description of the property

-legal title to the house must be free of all liens, encumbrances and who pays for search

-certification that house is free of termite or radon problems

-a contingent on suitable funding clause

-the proportion of utilities, insurance, taxes, and interest paid by buyer and seller

-condition of the house at point of transfer

-any other agreementsDiff: 2Topic: PurchasingAACSB: Analytical Thinking

60) Tell about the advantages of a shorter-term mortgage over a 30-year one.

Answer: A lower interest rate is common with a shorter term. This move provides a discipline to

force savings. It will save quite a bit of interest over the life of the mortgage. The equity is

built up at a faster rate. Last, the increased equity may allow you to trade up to a more

expensive house later.Diff: 2Topic: Mortgage LoanAACSB: Diverse and Multicultural Work Environments

61) What are some factors that determine whether a homeowner should refinance?

Answer: The typical rule of thumb is to refinance when interest rates fall by 2%. You should ask

yourself if you will live in the house long enough to offset the new closing costs. Will the

interest savings overcome the refinancing expenses involved? If so, it may be a good

move in the long run.Diff: 2Topic: FinancingAACSB: Diverse and Multicultural Work Environments



62) What are the common mortgage loan options?

Answer: -balloon payment

-graduated payment

-growing equity

-shared appreciation

-fixed rate

-adjustable rateDiff: 1Topic: Mortgage LoanAACSB: Analytical Thinking

63) List three pros of an assumable loan.

Answer: -The buyer does not incur the costs of obtaining a new loan.

-The buyer may be able to obtain a lower interest rate.

-It is easier to sell the home.Diff: 1Topic: Mortgage LoanAACSB: Reflective Thinking

64) Are there any advantages in government-backed loans? Any disadvantages?

Answer: Yes, there are three advantages. One, the interest rate typically is less. Two, a smaller

down payment is required. Three, there are less strict financial requirements. There are

also three drawbacks. One, there is more paperwork required to qualify for the loan.

Second, the closing costs are higher. Third, there are limits on the amount of funding that

can be obtained.Diff: 2Topic: Mortgage LoanAACSB: Diverse and Multicultural Work Environments

65) What are the typical sources of mortgages?

Answer: The list includes commercial banks, S&Ls, credit unions, mutual savings banks, mortgage

bankers, and mortgage brokers.Diff: 1Topic: Mortgage LoanAACSB: Diverse and Multicultural Work Environments


Chapter 9Life and Health Insurance

9.1 The Importance of Insurance

1) When the Affordable Care Act is fully implemented, 100 percent of Americans will have health

care insurance.

Answer: FALSEDiff: 1Topic: Affordable Care ActAACSB: Analytical Thinking

2) Life insurance and health insurance are designed to transfer the catastrophic risk you canʹt

afford to keep onto the insurance companies.

Answer: TRUEDiff: 3Topic: InsuranceAACSB: Diverse and Multicultural Work Environments

3) An insurance policy is a contract with an insurance company that spells out what losses are

covered, what the policy costs, and who receives the payment if a loss occurs.


4) Actuaries are statisticians who specialize in estimating the probability of death based on

personal characteristics, such as your age and general health, as well as lifestyle specifics such as

whether or not you exercise.

Answer: TRUEDiff: 1Topic: ActuariesAACSB: Information Technology

5) Currently only 10% of Americans receive some type of government health care entitlements

such as Medicaid or Medicare.

Answer: FALSEDiff: 1Topic: Life InsuranceAACSB: Analytical Thinking

6) The beneficiary is the individual designated by the owner of the life insurance policy to receive

the insurance policyʹs proceeds upon the death of the insured.

Answer: TRUEDiff: 1Topic: Life InsuranceAACSB: Analytical Thinking



7) The Patient Protection and Affordable Care Act was signed into law in 2010; however many of

its aspects do not go into effect until 2020.

Answer: FALSEDiff: 1Topic: InsuranceAACSB: Diverse and Multicultural Work Environments

8) All life insurance policies should have a contingent beneficiary designated.

Answer: TRUEDiff: 1Topic: Life InsuranceAACSB: Diverse and Multicultural Work Environments

9) In dealing with risk, one can either avoid it, manage it, or transfer it for a fee.


10) Life insurance is not meant to benefit you, its purpose is to protect others in the event of your

death.


11) One of the reasons insurance is so expensive is due to the expense of developing, testing and

verifying new drugs. This cost is passed on to consumers.

Answer: TRUEDiff: 1Topic: Health InsuranceAACSB: Diverse and Multicultural Work Environments

12) Statisticians who specialize in estimating the probability of death based on personal

characteristics are called

A) morbidity analysts.

B) actuaries.

C) insurance analysts.

D) morbidity statisticians.


Answer: BDiff: 1Topic: ActuariesAACSB: Analytical Thinking


Chapter 9 Life and Health Insurance 229

13) Sharing the financial consequences associated with risk in the insurance industry is sometimes

called

A) risk pooling.

B) risk deferring.

C) risk migration.

D) risk splitting.


Answer: ADiff: 1Topic: Risk PoolingAACSB: Reflective Thinking

14) Wayne and Sarah are trying to manage the risk they face in life a best as they can. They are

following Principle 7 which states

A) the best protection is knowledge.

B) protect yourself against major catastrophes.

C) nothing happens without a plan.

D) diversification reduces risk.

E) the best insurance is prevention.

Answer: BDiff: 1Topic: InsuranceAACSB: Reflective Thinking

15) Life insurance may not be necessary if

A) youʹre single and donʹt have any dependents.

B) youʹre married, a double-income couple, with no children.

C) youʹre married but arenʹt employed.

D) youʹre retired.


Answer: EDiff: 3Topic: Life InsuranceAACSB: Reflective Thinking

16) Andrew and Alice have health issues that may be passed on to their children. When the children

are born would they be wise to obtain life insurance immediately on the infants prior to any of

the medical conditions arising?

A) Yes, this would be wise as the infant is not likely to have to pass a physical exam.

B) No, they should wait until the child is an adult and let him or her decide if she or he wants

insurance.

Answer: ADiff: 3Topic: Life InsuranceAACSB: Reflective Thinking



17) The individual designated by the owner of the life insurance policy to receive the policyʹs

proceeds upon the death of the insured is called the

A) policy holder. B) beneficiary. C) insured. D) actuary.

Answer: BDiff: 3Topic: Life InsuranceAACSB: Analytical Thinking

18) What is the main purpose of life insurance?

Answer: The main purpose of life insurance is to transfer the risk of a premature death onto the

insurance company. The named insured is someone whose loss will create a financial or

emotional loss to the beneficiaries of the policy.Diff: 2Topic: Life InsuranceAACSB: Reflective Thinking

19) What are some good reasons for a young, healthy, single person to purchase life insurance?

Answer: The best time to purchase life insurance is when you are young and healthy since the

premiums will be the lowest possible. Funerals today are very expensive so why would

you want to be a financial burden on your family if you die? At least with a good

insurance foundation in place, you will have some insurance in force regardless of your

health.Diff: 3Topic: Life InsuranceAACSB: Reflective Thinking

20) Why is being the policy owner so important?

Answer: The policy owner controls the decisions concerning the policy itself. They determine who

the beneficiaries will be and they determine the settlement options. They are also the one

the insurance company contacts if there are missed payments or pending cancellation.Diff: 3Topic: Life InsuranceAACSB: Analytical Thinking

21) Why is the beneficiary decision so important when buying life insurance?

Answer: The beneficiary is the person or persons who will receive the death benefit of the

insurance policy. The beneficiary designation supercedes your Will. It is critically

important that you double check your beneficiary designation every time you have a life

changing event such as marriage, divorce or the birth of children. Sadly, many

ex-spouses receive the death benefit because the policy owner forgot to make appropriate

changes to their beneficiary designation.Diff: 3Topic: BeneficiaryAACSB: Analytical Thinking



9.2 Determining Your Life Insurance Needs

1) Using the earnings multiple approach is determining the present value of an annuity as a means

to determine the face value of the insurance policy one needs to purchase.

Answer: TRUEDiff: 3Topic: Earnings Multiple ApproachAACSB: Analytical Thinking

2) With the needs approach, you should take into consideration any additional insurance policies

that have been taken out on your life.

Answer: TRUEDiff: 3Topic: Needs ApproachAACSB: Reflective Thinking

3) The earnings multiple approach is based on the notion that you want to replace a stream of

annual income thatʹs lost due to the death of a breadwinner.

Answer: TRUEDiff: 3Topic: Needs ApproachAACSB: Diverse and Multicultural Work Environments

4) Sandra is terrible at saving; therefore her insurance advisor suggested a term life insurance

policy for her since it has a saving/investing aspect.

Answer: FALSEDiff: 3Topic: Term Life InsuranceAACSB: Analytical Thinking

5) A disadvantage of term insurance is that the cost rises each time the policy is renewed.

Answer: TRUEDiff: 2Topic: Term Life InsuranceAACSB: Analytical Thinking

6) With decreasing term life insurance, the face amount of the policy remains constant, but the

premiums decrease.


7) Convertible term life insurance can be converted into cash-value life insurance, depending on

the insuredʹs medical condition pending a medical exam.

Answer: FALSEDiff: 2Topic: Whole Life InsuranceAACSB: Analytical Thinking



8) Roxanne has been stricken with a muscular degeneration disease that may potentially shorten

her life span. However, she chose a renewable term insurance policy because she is able to be

continually renew the policy for an agreed-upon period, regardless of her deteriorating

condition.


9) With term life insurance, the beneficiary receives a fixed death benefit.


10) One of the best features of term insurance is that you are able to borrow against the face value.


11) The nonforfeiture right gives the policyholder the cash value of the policy in exchange for the

policyholder giving up his or her right to a death benefit.

Answer: TRUEDiff: 3Topic: Cash ValueAACSB: Analytical Thinking

12) The policy owner must pay the premium during the grace period or they forfeit the policy.

Answer: TRUEDiff: 3Topic: Grace PeriodAACSB: Diverse and Multicultural Work Environments

13) The suicide clause will pay double the face value to the beneficiary if the named insured

commits suicide.


14) Most life insurance settlements are based on the named insured dying from an accidental death.




15) A guaranteed insurability rider allows you to increase your face value even if your health fails.


16) Term life insurance provides protection for a specified amount of time; typically 1-30 years.


17) According to the Keown book, two recommended online insurance quote services are

accuquote.com and insure.com.


18) According to the Keown book, 50 percent of U.S. households have no life insurance coverage.


19) Suppose that you have decided to buy some life insurance. Which method of determining your

life insurance needs calculates the annual loss of income stream?

A) Needs approach B) Earnings multiple approach

C) Limited term approach D) Whole life approach

Answer: BDiff: 2Topic: Earnings Multiple ApproachAACSB: Analytical Thinking

20) For which of these situations is life insurance a good idea?

A) Married with children

B) Married, single-income couple with no children

C) Single with no dependents

D) Only A and B

E) All of the above

Answer: DDiff: 3Topic: Life InsuranceAACSB: Analytical Thinking

21) According to the Keown book, ________of U.S. households have no life insurance coverage.





22) You know you desperately need life insurance but donʹt have much money available for

premiums. What is the best thing you can do to find affordable insurance?

A) Buy directly from the insurance company.

B) Buy term insurance.

C) Use the Internet to shop around for the best quotes.

D) All of the above

Answer: DDiff: 2Topic: Life InsuranceAACSB: Reflective Thinking

23) Your agent has told you to think about immediate needs at the time of death, debt elimination

funds, immediate transitional funds, dependency expenses, spousal life income, educational

expenses for the children, and retirement income. What has he described?

A) The multiple earnings need approach

B) The needs approach

C) The standard approach

D) The combination approach

E) The long-term approach

Answer: BDiff: 2Topic: Needs ApproachAACSB: Reflective Thinking

24) John purchases a life insurance policy on his wife Betty where he pays the premium and he will

receive the life insurance money when she dies. John is both the ________ and the ________ who

will receive the ________ upon the death of Betty, the ________.

A) insured; beneficiary; money; policyholder

B) policy owner; beneficiary; face amount; insured

C) policy owner; insured; face amount; beneficiary

D) beneficiary; premium payer; face amount; policy holder



25) Life insurance buying is a new experience for many people. Which of the following is not a basic

consideration when determining life insurance needs?

A) Whether or not you need life insurance at this time

B) The amount of coverage you need now and in the future

C) The settlement options

D) The type of life insurance that fits your needs

E) Shopping around for the best agent and price

Answer: CDiff: 3Topic: Life InsuranceAACSB: Analytical Thinking



26) Sally brings home $50,000 a year to help provide financial support to her family, comprised of

her husband and two children. She is considering purchasing life insurance. Using the earnings

multiple approach, how much coverage should she purchase using a discount rate of 5% to

replace 10 years of earnings.

A) $500,000 B) $386,000 C) $340,005 D) $301,148


27) Using the needs approach to determine the amount of coverage looks from the perspective of

the

A) policy owner. B) named insured.

C) beneficiary. D) salesman.

Answer: CDiff: 3Topic: Needs ApproachAACSB: Reflective Thinking

28) Riley knows her ex-husband would not think about taking out a life insurance policy on himself

to protect their two children in the event of his untimely death. As a result, Riley is taking out a

policy on him and paying for it herself. That makes Riley the ________ and her children are the

________.

A) insured, policy holders

B) policy owner, beneficiaries

C) beneficiary, policy holders

D) insured, policy owners


Answer: BDiff: 2Topic: Life InsuranceAACSB: Reflective Thinking

29) With decreasing term insurance

A) the premiums remain constant, but the face amount of the policy declines.

B) the premiums decline, and the face amount of the policy declines.

C) the premiums remain constant, and the face amount of the policy remains constant.

D) the premiums decline, and the face amount of the policy increases.

Answer: ADiff: 2Topic: Term Life InsuranceAACSB: Analytical Thinking



30) ________ is insurance that provides permanent insurance coverage as whole life does; however

the policyholder, not the insurance company, takes on the investment risk.

A) Variable life insurance B) Universal life insurance

C) Convertible life insurance D) None of the above

Answer: ADiff: 2Topic: Credit Life InsuranceAACSB: Analytical Thinking

31) What are the advantages of term life insurance?

A) It allows you to increase your insurance coverage for specific reasons and specific time

periods.

B) With decreasing term coverage, your premiums get smaller as you get older.

C) It has no investment feature so it costs less than other forms of insurance.


E) Only A and C are correct.

Answer: EDiff: 2Topic: Term Life InsuranceAACSB: Analytical Thinking

32) Statisticians who specialize in estimating the probability of death based on personal

characteristics are known as

A) insurance adjusters. B) vultures.

C) actuaries. D) beneficiaries.

Answer: CDiff: 3Topic: InsuranceAACSB: Analytical Thinking

33) The settlement option that provides for ongoing payments for a period of time is called

A) an annuity. B) a reverse premium.

C) a premium payout. D) an annual premium.

Answer: ADiff: 2Topic: Settlement ClauseAACSB: Analytical Thinking

34) The needs approach to determining life insurance amounts considers which of the following?

A) Immediate financial needs B) Debt elimination funds

C) Dependency expenses D) All of the above

Answer: DDiff: 3Topic: Life InsuranceAACSB: Analytical Thinking



35) Cash value policies include a ________ clause that allows you to borrow against the cash value

of the policy.

A) reinstatement B) liquidity C) loan D) grace period

Answer: CDiff: 3Topic: Cash ValueAACSB: Analytical Thinking

36) What are the risks associated with term insurance policies?

A) You may need to have insurance coverage past the term expiration date.

B) The cash value does not earn a decent return.

C) The renewal premium may be cost prohibitive.


Answer: DDiff: 3Topic: Term Life InsuranceAACSB: Reflective Thinking

37) What are the disadvantages of group term insurance?

A) The premiums are usually subsidized by the employer.

B) The cost to covert from group coverage to individual coverage if you leave the company

may be cost prohibitive.

C) Relying on group insurance may hinder your decision to leave the company.


Answer: DDiff: 3Topic: Group InsuranceAACSB: Analytical Thinking

38) What are the main features of whole life insurance?

A) The premiums stay constant for your entire life.

B) The nonforfeiture right allows you access to the cash value account if needed.

C) It provides your with permanent insurance regardless of age and health issues.


E) All but B are correct.

Answer: DDiff: 2Topic: Whole Life InsuranceAACSB: Reflective Thinking

39) What is the purpose of companies such as A.M. Best, Moodyʹs and Standard & Poorʹs?

A) They sell life insurance directly to consumers without agents.

B) They evaluate and rate the financial stability of the insurance industry.

C) They provide reinsurance coverage to the insurance industry.

D) They sell low cost term insurance via the Internet.

Answer: BDiff: 2Topic: InsuranceAACSB: Analytical Thinking



40) Most likely, when you apply for life insurance, you will have to fill out a detailed medical

history and take a physical exam. Why is this true?

A) The insurance company wants to see if you have any pre-existing conditions.

B) It prevents sick people from purchasing insurance.

C) It determines how you will be rated and what premiums you will pay.

D) All of the above


Answer: EDiff: 3Topic: Life InsuranceAACSB: Analytical Thinking

41) Typically, who should buy life insurance?

Answer: Couples or single parents with children need life insurance. Couples with no children

that have a single income also need coverage. When you own your own business or have

an extremely large estate you need life insurance.Diff: 1Topic: Life InsuranceAACSB: Analytical Thinking

42) List five questions you should ask in an attempt to determine life insurance needs.

Answer: -How long after your death do you want to ensure your surviving spouseʹs financial

stability?

-Will your surviving spouse be earning any income?

-Is a drop in your surviving spouse or childrenʹs lifestyle acceptable?

-Do you want to provide funding for your childrenʹs college education?

-Do you want to immediately pay for the home mortgage and other debts?

-Do you want life insurance to pay for any estate taxes that might be due?Diff: 1Topic: Life InsuranceAACSB: Reflective Thinking

43) The needs approach attempts to determine the amount of funds necessary to meet the needs of a

family after the death of the primary breadwinner. Name the seven common family needs.

Answer: 1. cleanup funds

2. debt elimination

3. immediate transition

4. dependency expenses

5. spousal life income

6. educational expenses for children

7. retirement incomeDiff: 1Topic: Needs ApproachAACSB: Reflective Thinking



44) What factors should be considered when selecting a life insurance policy?

Answer: Select an agent who will work for you; that is, meet your needs, not his or hers. Choose a

company that is highly rated by one of the independent rating firms such as A.M. Best. Be

sure to compare costs and choose a policy with a low cost index. Carefully select the

amount of life insurance needed, the type of policy, and the method of premium

payments.

Make sure the beneficiary designation is correct. Choose between using an advisor

(agent) or buying direct from a company.Diff: 2Topic: Life InsuranceAACSB: Reflective Thinking

45) Define policy rider and describe the purpose of the five basic ones.

Answer: A rider is a special provision that may be added to your policy, which either provides

extra benefits or limits the companyʹs liability under certain conditions. A waiver of

premium for disability rider allows your insurance protection to stay in place by paying

your premiums if you become disabled before you reach a certain age, usually 65. An

accidental death benefit rider or multiple indemnity rider doubles or triples the death

benefit when the insured dies from an accident rather than from natural causes.

The guaranteed insurability rider gives the right to increase your life insurance protection

in the future without a medical examination. A cost-of-living adjustment rider increases

the death benefit at the same rate as inflation without forcing you to pass a medical exam.

Some cash-value policies allow for living benefits; that is, this rider allows for early

payout of a percentage of the anticipated death benefits for the terminally ill, enabling

them to pay medical bills, etc.Diff: 2Topic: RiderAACSB: Reflective Thinking

46) Briefly explain the four common settlement options.

Answer: 1. The lump-sum settlement gives a beneficiary the entire death benefit in one large

check.

2. An interest-only settlement provides payment of interest while the company holds

the principal.

3. The installment-payments option pays the beneficiary both principal and interest

over a fixed period or in fixed payments.

4. A life annuity option gives the beneficiary an income for life, generally in a monthly

check.Diff: 1Topic: Settlement ClauseAACSB: Reflective Thinking



47) It should be everyoneʹs goal to become self-insured when it comes to Life insurance. Explain

how and why this should be?

Answer: When most people are young, they have negative or low net worth because they have

few assets and higher levels of debt. When they become financially responsible for

someone else, then they need to cover the risk of their death by purchasing Life insurance

to replace their lost financial support. As a person goes through the Financial Life Cycle,

they generally acquire more assets, especially Investment assets that appreciate in value,

and they tend to pay off most of their debt, developing positive net worth. At middle age

their dependent children have grown up and are now independent. Their mortgage is

paid off and they have substantial assets, especially in their retirement accounts. Their

spouse would be able to live comfortably off these investments so the loss of the financial

support of the breadwinner would not be a catastrophic loss. At later ages, Term

insurance premiums become prohibitive. There is really no reason to maintain life

insurance coverage for the average person at this time.Diff: 3Topic: Life InsuranceAACSB: Reflective Thinking

48) Why is it critically important to check out the financial health of a Life Insurance Company

through a ratings company like A.M. Best before you purchase the insurance?

Answer: When you purchase a life insurance policy, you are basically entering into a partnership

with the Insurance Company that may last for 40+ years or more. You want to make

certain that this company or partner will be there when your beneficiaries desperately

need the death benefit of the policy. It is not unusual for Insurance companies to become

insolvent and fail. It is not unusual for Insurance scams to happen, especially via the

internet. Ratings companies evaluate the financial health of the Insurance company and

their ratings are a good predictor of the ability of the Insurance company to remain

solvent for many years into the future. There would be nothing worse than for your

Insurance company to fail after you have paid premiums for many years and you have

developed a pre-existing health condition during this time. Now you may have a hard

time finding a new Insurance company or the premium may be cost prohibitive due to

age and health.Diff: 3Topic: InsuranceAACSB: Analytical Thinking

9.3 Major Types of Life Insurance

1) The primary advantage of term insurance is a flexible premium.


2) Term life insurance has a life insurance component and a savings plan.




3) Cash-value insurance is any policy that provides both a death benefit and an opportunity to

accumulate cash value.


4) The money that the policy holder is entitled to if the policy is terminated is known as the face

value.


5) With decreasing term insurance, each time the term insurance is renewed the premium

decreases.


6) A universal life insurance policy is a type of cash-value insurance combining term insurance

with a tax-deferred savings feature in a package in which both the premiums and the benefits

are flexible.

Answer: TRUEDiff: 1Topic: Universal Life InsuranceAACSB: Analytical Thinking

7) The advantage of whole life insurance is that it is generally cheaper than term life insurance per

dollar of coverage.


8) Practically all insurance contracts include a suicide clause stating that the insurance company

wonʹt pay off for suicide deaths that occur within the first five years of the contract.


9) The primary advantage of term insurance is

A) a flexible premium. B) a savings component.

C) affordability. D) convertibility.

Answer: CDiff: 1Topic: Term Life InsuranceAACSB: Analytical Thinking



10) The coverage grace period gives you an extension of generally ________ in which to make your

premium payment without cancelling your policy.

A) 15 days B) 30 days C) 45 days D) 60 days


11) The incontestability clause states that the insurance company cannot dispute the validity of the

contract after a specified period of time, usually

A) one year. B) two years. C) five years. D) 10 years


12) Which of the following is not an insurance rating service?

A) Weiss B) Moodyʹs

C) Standards & Fitch D) A.M. Best


13) Jenny and Joey have seven children and are expecting another. Joey is the primary income

provider for his family, and the couple recognizes that the growing family is in need of life

insurance. To begin the agent search process, Jenny and Joey make a list of prospects from

reputable companies. Both Jenny and Joey prefer to speak to an agent with a life insurance

certification. What life insurance agent designation do you recommend?

A) CLU B) LICA C) AIA D) CIR

Answer: ADiff: 3Topic: Life InsuranceAACSB: Application of Knowledge

14) A method of determining how much life insurance you require based on funds your family

would require to maintain its lifestyle after your death is called the

A) earnings multiple approach.

B) needs approach.

C) cash liquidity approach.

D) funds analysis approach.


Answer: BDiff: 1Topic: Needs ApproachAACSB: Analytical Thinking



15) Your agent argues in favor of cash-value life insurance. You counteract with term to

A) have a larger policy and keep things simple.

B) enjoy a relatively low cost per each $1,000 of coverage.

C) have a lot of insurance at affordable prices when you need it the most.

D) save the difference you would pay, invest it, and come out ahead.



16) Joleene is a single parent with two children and earns $45,000 per year. She is purchasing term

life insurance for 15 years until her youngest child is self supporting. Assuming her survivors

can receive a 3% after-tax, inflation return on insurance proceeds, use the earnings multiple

approach to calculate the face value of Joleeneʹs policy.

A) $33,445

B) $547,851

C) $397,548

D) $556,668



17) Using the earnings multiple approach calculate how much life insurance Heather and Robert

need to take out on Heather. She earns $80,000 and is 37 years old. They want coverage until she

retires at age 67. Robert is sure he can get an annual rate of return on the policy settlement of

8%. They have no children.

A) $1,004,227

B) $997,553

C) $854,214

D) $630,417


Answer: DDiff: 3Topic: Term Life InsuranceAACSB: Analytical Thinking

18) Billyʹs occupation is a potentially dangerous one he is a skydiving instructor. His agent

pointed out that the monthly premiums will be high. Billy wants a lot of value for his money.

He could take advantage of ________ life insurance at this time to save money.

A) universal B) variable C) term D) credit E) whole

Answer: CDiff: 1Topic: Term Life InsuranceAACSB: Analytical Thinking



19) Sonny Coltraine was told by a friend that universal life is the best policy. He will find that

A) it will have a tax-deferred savings feature.

B) death benefits are not taxable income.

C) death benefits and premiums are fixed.

D) death benefits and premiums are flexible.

E) A, B, and D above.

Answer: EDiff: 2Topic: Universal Life InsuranceAACSB: Analytical Thinking

20) Charles is the sole beneficiary of his late uncleʹs life insurance policy. The face value of the

policy is $785,000. Charles has decided to accept annual annuity payments of $95,000. The

interest rate on the policy is 5%. How many annual payments will Charles receive from this

policy?

A) 7.08 years worth of payments B) 8.26 years worth of payments

C) 10.92 years worth of payments D) None of the above

Answer: CDiff: 3Topic: Insurance AgentsAACSB: Analytical Thinking

21) You might consider another insurance agent if your agent uses the ________ method to analyze

the costs of a policy.

A) TNC

B) IANC

C) NCO

D) TLC


Answer: ADiff: 3Topic: Life InsuranceAACSB: Analytical Thinking

22) You want to get a good buy on your life insurance contract. You find a book that compares

insurance costs by incorporating the time value of money into its calculations. This method

allows you to select wisely using the

A) interest-adjusted net cost method. B) traditional net cost method.

C) variable method. D) comparison cost index.




23) Barry Blair wants to select a good life insurance agent. His dad has had several negative

experiences with life insurance agents in the past. What should Barry consider when selecting

an agent?

A) Has a professional designation

B) Is a full-time agent

C) Has the necessary experience and training

D) Has references

E) All of the above

Answer: EDiff: 2Topic: Insurance AgentsAACSB: Analytical Thinking

24) Suppose that you earn $50,000 annually. You expect expenses to drop by 22% for your family in

the event of your death. Currently, if you die, you want to provide for your family for at least 15

more years, and the applicable after-tax and inflation return assumed is 5%. Using the earnings

multiple approach provided in your textbook, what would be the amount of life insurance that

you should purchase?

A) $301,080 B) $404,820 C) $485,940 D) $500,000 E) 519,000


25) A.M. Best, Standard & Poorʹs, Moodyʹs, and Weiss perform a vital service for the insurance

industry. What do they do?

A) They rate the quality level and performance of each company.

B) They tell you the best price deals.

C) They provide information on the best policies.

D) They provide a listing of all agents.

E) They provide a listing of all agents who have violated insurance laws.

Answer: ADiff: 1Topic: RatingAACSB: Analytical Thinking

26) Alice and Tommy have 3 dependent children. Alice earns $125,000 per year. They are taking out

insurance on Alice for the next 30 years. Tommy expects to get a 9.25% rate of return on the life

insurance payoff. Using the earnings multiple approach calculate how much life insurance they

need to take out on Alice.

A) $987,440

B) $1,005,011

C) $1,105,447

D) $2,228,553


Answer: BDiff: 3Topic: Guaranteed RenewabilityAACSB: Analytical Thinking



27) Suppose that your husband was killed in a bank robbery. Which of the following is not one of

the typical settlement options that would be available?

A) Installment-payments

B) Interest-only

C) Conversion of spousal insurance

D) Lump-sum

E) Life annuity

Answer: CDiff: 3Topic: Settlement ClauseAACSB: Analytical Thinking

28) Letʹs assume you are the beneficiary of your great Auntʹs life insurance policy. Sadly she passed

away yesterday. You elect to receive annual payments from this policy for the next 20 years. The

settlement amount is $500,000 and the interest accruing on the policy is an annual 8%. What will

be your annual life insurance annuity payments?

A) $10,923 B) $50,926 C) $72,551 D) $98,934

Answer: BDiff: 3Topic: InsuranceAACSB: Analytical Thinking

29) Nancy and Leonard are married. They have two children who will be financially dependent for

the next 20 years. They are taking out life insurance on Leonard, the bread winner and earns an

annual salary of $80,000. Nancy is sure she is able to get a 9.5% rate of return on the policy

settlement. Using the earnings multiple approach calculate how much life insurance they should

take out on Leonard.

A) $1,038,225

B) $1,704,952

C) $549,893

D) $301,471


Answer: CDiff: 3Topic: RiderAACSB: Analytical Thinking

30) Luke is 30 years old and earns an annual salary of $55,000. His wife wants to take out a life

insurance policy on him until he turns 67. Using the earnings multiple approach, how large

should the face value of his insurance policy beassuming his wife can earn an annual rate of

return of 8.5% on his life insurance pay off?

A) $223,985

B) $1,225,462

C) $430,803

D) $6,154,330





31) Brendaʹs husband Bob died last week. Her agent told her she could receive the death proceeds

tax-free and a monthly check until her death. He is talking about the ________ settlement

option.

A) lump-sum

B) life annuity

C) interest-only

D) installment-payments

E) tax-free

Answer: BDiff: 2Topic: Settlement ClauseAACSB: Analytical Thinking

32) Javier Jimenez was pleasantly surprised to find out that within three to five years after

expiration of a previous life insurance policy, he can

A) change beneficiaries.

B) void the grace period.

C) reinstate the policy subject to current qualifications.

D) change the incontestability clause.

E) both A and D above.


33) All of the following are types of life insurance annuity settlements except

A) straight life annuity.

B) period certain annuity.

C) refund annuity.

D) joint life and survivorship annuity.

E) variable annuity.


34) Choose the option(s) available in the nonforfeiture clause of a cash-value life policy.

A) Exchange the policy for a paid-up term policy of equal face value.

B) Receive the policyʹs cash value.

C) Retain rights to a death benefit.

D) Exchange the policyʹs cash value for a paid-up policy with a reduced face value.

E) A, B, and D above

Answer: EDiff: 3Topic: Nonforfeiture ClauseAACSB: Analytical Thinking



35) The ________ rider increases your death benefits at the same rate as inflation without forcing

you to complete a new medical exam.

A) waiver of premium for disability

B) living benefits

C) cost-of-living adjustment (COLA)

D) guaranteed insurability

E) accidental death benefit

Answer: CDiff: 1Topic: Whole Life InsuranceAACSB: Analytical Thinking

36) The policy feature that allows you to pay the premium late but still retain coverage is known as

the

A) loan clause.

B) nonforfeiture clause.

C) incontestability clause.

D) grace period.

E) policy reinstatement clause.

Answer: DDiff: 1Topic: Grace PeriodAACSB: Analytical Thinking

37) At what point does whole life insurance pay the death benefit?

A) When the insured turns 100 years old

B) When the maximum stated age is reached by the insured

C) Upon due proof of death of the insured

D) When the cash value equals the death benefit

E) Either A, B, or C above

Answer: EDiff: 2Topic: Whole Life InsuranceAACSB: Analytical Thinking

38) Special provisions that may be added to your policy which either provide extra benefits to the

beneficiary or limit the companyʹs liability under certain conditions are known as

A) alternative provisions.

B) secondary provisions.

C) riders.

D) attachments.


Answer: CDiff: 1Topic: RiderAACSB: Analytical Thinking



39) Which of the following factors is connected with convertible term life insurance?

A) A medical exam is not required.

B) It helps make a smooth transition from term to cash-value insurance.

C) There is a corresponding increase in premium cost.

D) Generally, the conversion feature is only offered during the first two years.

E) All of the above

Answer: EDiff: 3Topic: Term Life InsuranceAACSB: Analytical Thinking

40) The alternative ways that a beneficiary can choose to receive the policy benefits upon the death

of the insured are called

A) premium options.

B) settlement options.

C) terminal options.

D) residual options.


Answer: BDiff: 1Topic: Settlement ClauseAACSB: Analytical Thinking

41) Sally Heath has the option of obtaining life insurance through her place of employment. She will

not need to take a physical exam. This type of policy would be a/an ________ policy.

A) universal life

B) employerʹs life

C) renewable term life

D) group term life

E) intermediate term life

Answer: DDiff: 2Topic: Term Life InsuranceAACSB: Analytical Thinking

42) The ________ is the right of the policyholder to choose to receive the policyʹs cash value in

exchange for the policyholder giving up his or her right to a death benefit.

A) nonforfeiture right

B) cash exchange right

C) cash-out privilege

D) residual cash right


Answer: ADiff: 2Topic: Nonforfeiture ClauseAACSB: Analytical Thinking



43) Which of these life insurance plans holds the annual premium constant but decreases the face

value of the policy each year?

A) Decreasing term

B) Credit life

C) Mortgage life

D) Universal life

E) All of the above


44) You are considering the need for insurance. You desire a policy that provides permanent

protection, has a fixed premium, and provides a fixed death benefit. What type of policy would

you purchase?

A) Term insurance

B) Fixed premium insurance

C) Whole life insurance

D) Universal life insurance


Answer: CDiff: 1Topic: Whole Life InsuranceAACSB: Analytical Thinking

45) Which of the following term plans is intended to cover an individualʹs outstanding debt?

A) Renewable term

B) Reentry term

C) Credit life

D) Mortgage life

E) Both C and D above


46) What is the name of the insurance policy that pays your beneficiary a specific amount of money

if you die while covered by the policy, and this coverage is for a set number of years and must

be renewed when it expires?

A) Term insurance

B) Fixed premium insurance

C) Cash-value insurance

D) Universal life insurance


Answer: ADiff: 1Topic: Term Life InsuranceAACSB: Analytical Thinking



47) Upon examining her life insurance policy, Sylvia found the cash value amount to be fixed rather

than dependent upon other variables. Sylvia has a ________ insurance policy.

A) whole life

B) term life

C) decreasing term

D) variable life

E) universal life

Answer: ADiff: 3Topic: Whole Life InsuranceAACSB: Analytical Thinking

48) Of the following life insurance policies term, whole life, universal life, variable life two have

fixed death benefits. Which are they?

A) Term and variable life

B) Term and universal life

C) Term and whole life

D) Whole life and universal life

E) Whole life and variable life


49) Which of the following is not a cash-value life insurance plan?

A) Whole life B) Universal life C) Term life D) Variable life


50) When is convertible term life a good idea?

Answer: Convertible term life allows you to enjoy a lower premium when younger to fit your

budget and allows you to smoothly change to a more permanent type of coverage later in

life. It is also great because it allows you to convert to an individual policy in the event

you lose your job and want to continue the policy.Diff: 1Topic: Term Life InsuranceAACSB: Analytical Thinking



51) Name and briefly describe the ten features found in almost all life insurance contracts.

Answer: 1. The beneficiary provision allows for a primary and contingent beneficiary to receive

the death proceeds (face amount) upon the insuredʹs death.

2. A grace period is an automatic extension for premium payments, generally 30 or 31

days after the premium is due.

3. The loan clause allows for loans, generally at a guaranteed rate, against the cash

value of the policy.

4. A non-forfeiture clause gives the policyholder the cash value in exchange for the

policyʹs termination, or allows exchanging the cash value for a paid-up policy with a

reduced face value, or allows exchanging the policyʹs face value for a paid-up term

policy.

5. The policy reinstatement clause provides the conditions for restoring a lapsed policy

to its full rights, force, and effect.

6. A change of policy clause stipulates the conditions and allows the policyholder to

change the form of the policy.

7. The suicide clause states that the insurance will not pay the death benefit for suicide

during the first two years.

8. A payment of premium clause defines the alternatives for paying the premiums and

allows for a change in payment methods.

9. The incontestability clause ensures that the insurance company cannot dispute the

validity of the contract after it has been in force for a specified number of years, usually 2.

10. A list of settlement options gives the beneficiary options for receiving the policy

benefits.Diff: 3Topic: Life InsuranceAACSB: Analytical Thinking

52) What are some drawbacks of term life insurance?

Answer: Term life insurance becomes very costly in later years and is prohibitive for most people

at that time. It has no cash-value build-up. You cannot use the cash value to pay the

premiums later.Diff: 1Topic: Life InsuranceAACSB: Analytical Thinking

53) How is variable life different from universal life and term insurance? Who is it best suited for?

Answer: Like universal life, it has a cash value with flexible premiums and death benefits. Unlike

universal life, the cash value and death benefit are tied to and vary according to the

performance of a set of investments that are chosen by the policyholder. Term life in any

of its forms has none of these features. Variable life is aimed at individuals who want to

manage their own investments and are willing to take associated risks.Diff: 2Topic: Variable Life InsuranceAACSB: Analytical Thinking



54) Tell about the pros of group term life insurance.

Answer: Group term life is often less expensive than an individual policy, especially if you are

older or less healthy. Uninsurable individuals are able to get relatively low-cost

insurance whereas they would not otherwise. You may be able to get more coverage for

the same or less money.Diff: 1Topic: Term Life InsuranceAACSB: Analytical Thinking

55) Describe the major difference between renewable term and group term versus decreasing term

and credit/mortgage group life insurance.

Answer: Renewable term and group term are generally level insurance amounts the face

amount of life insurance does not change over time. Decreasing term and credit mortgage

group face amounts usually do decrease over time to match the amount of outstanding

debt.Diff: 2Topic: Life InsuranceAACSB: Analytical Thinking

56) Explain the advantage of reentry term life insurance.

Answer: Reentry term is guaranteed renewable at one of two possible premium levels. If you pass

a medical exam, you qualify for the lower premium. In other words, you reenter the same

policy at a cost that would not otherwise be available.Diff: 2Topic: Term Life InsuranceAACSB: Analytical Thinking

57) What is the major advantage of universal life insurance at any age?

Answer: Universal life allows for flexible premium payments so that policyholders can vary the

amount and timing of their payments as their financial needs change.Diff: 1Topic: Universal Life InsuranceAACSB: Analytical Thinking

58) Which of the types of cash-value policies are permanent insurance?

Answer: Whole life, universal life, and variable life are permanent types of life insurance.Diff: 1Topic: Life InsuranceAACSB: Analytical Thinking

59) What are the two basic forms of variable life insurance?

Answer: The two basic forms of variable life are straight variable life and variable universal life.Diff: 1Topic: Variable Life InsuranceAACSB: Analytical Thinking



9.4 Health Insurance

1) One of the provisions of the Affordable Care Act is to prevent insurance companies from

denying coverage to consumers with preexisting conditions.

Answer: TRUEDiff: 1Topic: Affordable Care ActAACSB: Analytical Thinking

2) Health insurance not only pays for your medical bills but also provides you with replacement

income while you are unable to work.

Answer: FALSEDiff: 1Topic: Health InsuranceAACSB: Analytical Thinking

3) If you can afford health insurance but donʹt have it, you may have to pay a fee or penalty.

Answer: TRUEDiff: 1Topic: Health InsuranceAACSB: Analytical Thinking

4) Compared to those of normal weight, the 34 percent of Americans who are considered obese

incur $1,429 per year in additional medical costs, and the average hospital bill for a heart attack

is $54,400.


5) Most major health care policies cover hospital, surgical, and physician coverages.

Answer: TRUEDiff: 1Topic: Major Medical Expense InsuranceAACSB: Analytical Thinking

6) Sallyʹs employerʹs insurance company does not offer eye insurance. She has always had 20/20

vision and as a healthy 24 year old assumes her eyes will not change drastically. Should she

purchase a vision policy since her employer does not offer such a plan?

A) Yes B) No

Answer: BDiff: 2Topic: Health InsuranceAACSB: Analytical Thinking

7) Traditional, fee-for-service plans are becoming rarer due to rising health care costs.




8) Under a managed health care or prepaid plan you have a good deal of freedom to choose your

doctors and hospitals.

Answer: FALSEDiff: 1Topic: Health Maintenance OrganizationAACSB: Analytical Thinking

9) Under a traditional indemnity plan, most of your expenses are already covered and donʹt need

to be reimbursed, but youʹre limited to receiving health care from a specified group of

participating providers.

Answer: FALSEDiff: 2Topic: Health InsuranceAACSB: Analytical Thinking

10) With a PPO, it is much more expensive to go to out of network healthcare providers.

Answer: TRUEDiff: 2Topic: Preferred Provider OrganizationAACSB: Analytical Thinking

11) Group insurance premiums are generally more expensive than individual policies with the same

coverage.

Answer: FALSEDiff: 2Topic: Group InsuranceAACSB: Analytical Thinking

12) Your insuranceʹs copayment and deductible are the expenses that the insured must pay before

the insurance company will pay any benefits.


13) If your employer doesnʹt provide them, then it might not be a financially wise decision to

purchase dental and eye insurance.


14) An HSA is a good form of health care coverage for young, healthy people who rarely get sick.

Answer: TRUEDiff: 3Topic: Health Savings AccountsAACSB: Analytical Thinking



15) There are some health care providers who do not accept flexible spending account payments.

Answer: FALSEDiff: 3Topic: Flexible Spending AccountAACSB: Analytical Thinking

16) A flexible spending account saves you money on qualifying healthcare and childcare expenses.

Answer: TRUEDiff: 2Topic: Flexible Spending AccountAACSB: Analytical Thinking

17) The main disadvantage of a flexible spending plan is that you may lose any money remaining in

the account at the end of the fiscal year.

Answer: TRUEDiff: 2Topic: Flexible Spending AccountAACSB: Analytical Thinking

18) With COBRA coverage, the employer pays the premiums.

Answer: FALSEDiff: 3Topic: COBRAAACSB: Analytical Thinking

19) According to the Affordable Care Act, children are allowed to stay on their parents insurance

policy until they turn

A) 21. B) 22. C) 24. D) 26.

Answer: DDiff: 2Topic: Affordable Care ActAACSB: Analytical Thinking

20) According to the Keown book, which statement(s) reflect(s) the purpose of the Affordable Care

Act?

I. Improve quality and lower costs of health insurance

II. Provide new consumer protections

III. Minimize discrepancies in pre-existing condition costs

IV. Increase access to affordable health care

V. Hold insurance companies accountable

A) I Only

B) I, II, and V

C) I, III, and IV

D) I, II, IV, and V

E) I, II, III, IV, and V

Answer: DDiff: 3Topic: Affordable Care ActAACSB: Analytical Thinking



21) The Health Insurance Marketplace is a new way for people to buy health insurance. To make

plans easier to compare, the website presents plans in five categories with varying levels of

cost-sharing. Which of the following plans is not offered?

A) Silver: Your plan pays 70 percent, you pay 30 percent.

B) Gold: Your plan pays 80 percent, you pay 20 percent.

C) Platinum: Your plan pays 90 percent, you pay 10 percent.

D) Titanium: Your plan pays 100 percent, you pay nothing.

E) Catastrophic: A coverage option if you are under 30 or have very low income.

Answer: DDiff: 3Topic: Affordable Care ActAACSB: Application of Knowledge

22) The best strategy for health insurance coverage is to purchase a comprehensive policy. Of the

following, which additional coverage should you not buy if it is not provided at work or in your

individual policy?

A) Accident

B) Terminal disease

C) Dental

D) Eyewear

E) You should not buy any of the above if your employer does not provide them.

Answer: EDiff: 2Topic: Health InsuranceAACSB: Analytical Thinking

23) Surgical insurance covers the cost of surgery. A surgical policy generally lists which of the

following?

A) The specific operations it will cover

B) The maximum dollar amount that will be paid for each operation

C) The dollar amount that will be paid to the surgeon for the operation

D) All of the above

Answer: DDiff: 3Topic: Health InsuranceAACSB: Analytical Thinking

24) Hospital insurance is generally part of every insurance plan. It covers the costs associated with a

hospital stay including

A) room charges.

B) nursing costs.

C) drugs supplied by the hospital.


E) Only A and B are correct.

Answer: DDiff: 3Topic: Health InsuranceAACSB: Analytical Thinking



25) Insurance that covers medical costs beyond those covered by basic health insurance is

A) major medical insurance. B) catastrophic insurance.

C) premium insurance. D) none of the above.

Answer: ADiff: 2Topic: Health InsuranceAACSB: Analytical Thinking

26) Genevieveʹs husband died from lung cancer. As a result, she purchased additional ________

insurance.

A) accident

B) dread disease

C) dental

D) eyewear

E) all of the above

Answer: BDiff: 2Topic: Health InsuranceAACSB: Analytical Thinking

27) Your entire family was injured in an automobile accident, some more seriously than others. If

any member of your family became disabled to a greater extent, where might you look for

disability benefits?

A) Workerʹs Compensation

B) Social Security

C) Medicare

D) Medicaid

E) Both B and D above

Answer: EDiff: 3Topic: MedicareAACSB: Analytical Thinking

28) James is employed by the university. Yesterday he fell outside of his office due to water on the

floor. He broke his leg in two places. What type of health care plan will cover Jamesʹ expenses?

A) Workerʹs Compensation.

B) Medicaid.

C) Medicare.

D) Medigap.


Answer: ADiff: 2Topic: Workerʹs CompensationAACSB: Analytical Thinking



29) A ________ is a savings plan offered by some employers that allows each employee to have

pretax earnings deposited into a specially designated account for paying qualified medical and

dependant care bills.

A) medical distribution account

B) planned provider account

C) group practice plan

D) flexible spending account

E) planned reimbursement account

Answer: DDiff: 2Topic: Flexible Spending AccountAACSB: Analytical Thinking

30) Veronica was recently diagnosed with a heart condition. Her doctorʹs bill was $4,200 for the

diagnostics. Her policy has a $250 deductible and a 80/20 coinsurance provision up to $10,000

and then the insurance pays 100% thereafter. In total, how much will Veronica pay for her

diagnosis?

A) $250 B) $4,200 C) $1,040 D) $10,000

Answer: CDiff: 1Topic: DeductibleAACSB: Analytical Thinking

31) Sylvester and JoAnn have both been laid off work during the last year and are now very poor.

They found out that needy families can receive medical benefits through Medicaid. In addition,

JoAnn found out that Medicaid can be used

A) by the aged.

B) by the blind.

C) by disabled persons.

D) for Medicare premiums, deductibles, and co-payments.


Answer: EDiff: 2Topic: MedicaidAACSB: Analytical Thinking

32) Medicare part ________ pays for doctorʹs fees/medical services/supplies, while part ________

pays for hospital insurance benefits.

A) B; A

B) A; B

C) A; C

D) B; C


Answer: ADiff: 2Topic: MedicareAACSB: Analytical Thinking



33) Suppose that you wanted to purchase insurance that is sold by a private insurance company

that will help bridge the gap in your Medicare coverage. You would purchase what type of

insurance?

A) Medicare Additional insurance

B) Medigap insurance

C) Medicare Plus insurance

D) Medicare Bridge insurance


Answer: BDiff: 1Topic: Medigap InsuranceAACSB: Analytical Thinking

34) Which of the following is a government-sponsored health care plan?

A) Medicare

B) Medicaid

C) Workerʹs Compensation

D) A and B only

E) A, B, and C

Answer: EDiff: 3Topic: Workerʹs CompensationAACSB: Analytical Thinking

35) Which of the following statements is true about individual health care policies versus group

healthcare policies?

A) You may be required to take a physical exam.

B) They tend to be less costly than group plans.

C) You may need one as a supplement to your group policy.

D) They are tailor-made for you.


Answer: EDiff: 3Topic: Group InsuranceAACSB: Analytical Thinking

36) Individual practice association, group practice, and point-of-service plans are the three basic

types of

A) Blue Cross Blue Shield plans.

B) traditional indemnity plans.

C) major medical expense plans.

D) health maintenance organizations.

E) fee-for-service policies.

Answer: DDiff: 2Topic: Health Maintenance OrganizationAACSB: Analytical Thinking



37) Managed health care/prepaid care plans differ from fee-for-service or traditional indemnity

plans in that they

A) automatically file the claims for you.

B) require you to see only a specified group of doctors, hospitals, and clinics.

C) are more expensive to operate and cost you more money.

D) are less efficient.

E) both A and B above.

Answer: EDiff: 3Topic: Managed Health CareAACSB: Analytical Thinking

38) The difference between an individual practice association plan (IPA) and a group practice plan

is that

A) an IPA is made up of a group of independent doctors who work out of their own offices;

while a group practice plan confines doctors to the same central, shared facility.

B) a group practice plan is made up of a group of independent doctors who work out of their

own offices; while an IPA confines doctors to the same central, shared facility.


39) Your health care coverage is with a PPO. For approved, in-network providers your deductible

is $500 and your coinsurance provision is 80%. For out-of-network providers, your deductible

is $1,000 and your coinsurance provision is 70%. Assume there is no co-pay provision and you

have no other claims this calendar year. You have decided to go to a specialist that is not in the

network and the bill is $1,400. How much will you have to pay out-of-pocket?

A) $1,400 B) $1,120 C) $420 D) $1,320

Answer: BDiff: 3Topic: Preferred Provider OrganizationAACSB: Analytical Thinking

40) Your grandmother has just turned 65 years old and is now eligible for Medicare. She asks you

whether or not she should also purchase Medigap insurance. What would you tell her to do?

A) No, Medicare is a very comprehensive coverage so you wonʹt need any additional

coverage.

B) Yes, Medicare is very complicated and there are areas not covered so it would be a good

idea to purchase additional coverage.

Answer: BDiff: 2Topic: Medigap InsuranceAACSB: Analytical Thinking



41) Group health insurance

A) refers to the way the health insurance is sold rather than to the characteristics of the policy.

B) tends to be more expensive.

C) reflects the age and health of the policyholder.


Answer: ADiff: 3Topic: Group InsuranceAACSB: Analytical Thinking

42) When firms allow employees to ʺopt outʺ regarding health care, employees

A) are offered a cash incentive for electing not to cover their families under the company

health plan.

B) are not eligible to participate if their spouse has health insurance.

C) are only eligible to participate if they are single.



43) An employer-sponsored medical plan that allows each employee to have pretax earnings

deposited into a specially designated account for the purposes of paying specific types of

expenses is called a

A) flexible spending account.

B) medical emergency account.

C) medical contingency account.

D) pre-tax contingency account.


Answer: ADiff: 1Topic: Flexible Spending AccountAACSB: Analytical Thinking

44) Under COBRA, if you work for a company with at least 20 employees, you will be given the

opportunity to continue your health insurance coverage for ________ after you leave the

company, depending on why you left.

A) zero to six months

B) 6-12 months

C) 72-84 months

D) 18-36 months


Answer: DDiff: 1Topic: COBRAAACSB: Analytical Thinking



45) For every $100 set aside in a flexible spending account, taxable income is reduced by

A) $10.

B) $25.

C) $50.

D) $100.

E) not enough information available.

Answer: DDiff: 3Topic: Flexible Spending AccountAACSB: Analytical Thinking

46) All of the following are true regarding Health Savings Accounts except

A) they allow individuals to pay for current health care expenses on a tax-free basis.

B) they allow individuals to save for future health care expenses on a tax-free basis.

C) balances in HSAs earn interest before they are spent.

D) unspent HSA funds are lost as the end of the year.

Answer: DDiff: 3Topic: Health Savings AccountsAACSB: Analytical Thinking

47) Congress worked diligently in 2010 to pass a health care bill designed to make sure that almost

all Americans have health insurance coverage. What is the official name of this act?

A) Obamacare

B) American Insurance All Act

C) Patient Protection and Affordable Care Act


Answer: CDiff: 3Topic: Health InsuranceAACSB: Analytical Thinking

48) Why are health care costs so expensive at this time?

Answer: There are several reasons why health care is so expensive. For one, there seems to be a

lack of incentives for providers of health care to economize. There is no incentive for

patients to exercise restraint in visits and medical billing. It is very costly to develop, test,

and certify new drugs. The cost of litigation from malpractice suits has skyrocketed.Diff: 2Topic: Health CareAACSB: Analytical Thinking



49) Describe the pros and cons of major medical insurance.

Answer: Major medical covers medical costs beyond those covered by basic health insurance. It

offsets the financial effects of a catastrophic illness or injury. It takes over where basic

health insurance leaves off. Most plans cover a lifetime cap large enough for most needs.

This type of plan does not provide complete coverage. There is a deductible and a

co-payment provision. The lifetime cap of $250,000 limits the coverage for more costly

bills. Consider an add-on policy that provides protection of up to at least $1 million.Diff: 2Topic: Health InsuranceAACSB: Reflective Thinking

50) Briefly explain the different types of health insurance.

Answer: Most health insurance is basic health insurance, which includes a combination of hospital,

surgical, and physician expense insurance. Hospital insurance covers the costs associated

with a hospital stay, including room charges, nursing costs, operating room fees, and

drugs supplied by the hospital. Surgical insurance covers the cost of surgery. Physician

expense covers the physicianʹs fees outside of surgery. Major medical covers medical

costs beyond those covered by basic health insurance.Diff: 1Topic: Health InsuranceAACSB: Analytical Thinking

51) Why is health insurance so necessary today?

Answer: Health insurance is necessary to pay for the bills associated with sickness and injury. No

one can pay for medical expenses out of his or her income. Even the wealthy will

eventually exhaust their resources when paying for a lengthy illness or accident. The

health care providers and facilities could not afford to stay open without some means of

being compensated for their efforts. Health care insurance seems to be the best way to do

this. Without this insurance the quality of health care would go down or not be available

to the extent we need it.Diff: 2Topic: Health InsuranceAACSB: Analytical Thinking

52) Explain the purpose of the government-sponsored health care plans.

Answer: Workerʹs Compensation plans are governed by individual state laws and cover most

employees. Benefits are paid for injuries and illnesses incurred on the job. Medicare

covers disabled persons and persons 65 and older. Part A is mandatory, is free of charge,

and provides hospital benefits. Part B is voluntary, is paid for by the individual, and

covers doctorsʹ fees and a wide range of medical services and supplies. Medicaid

provides medical care for the aged, blind, and disabled as well as to needy families with

dependent children. Medicaid payments go toward Medicare premiums, deductibles,

and co-payments.Diff: 2Topic: Workerʹs CompensationAACSB: Analytical Thinking



53) Compare and contrast group and individual health insurance policies.

Answer: Group insurance, which is insurance available at work or through some organization, is

generally preferable to an individual policy. Most employer group plans do not require a

physical exam; however, association or professional groups do require an exam. Group

insurance is usually 15% to 40% less costly than an individual plan because of its

bargaining power. Just the same, if you are in good health and in a safe occupation,

sometimes an individual policy is less costly.

An individual policy has the advantage of being tailor-made for you or your family.

They tend in general to offer the same coverage as group plans. Since they are expensive,

shop around. If you cannot get group coverage, get a comprehensive personal plan. The

plans are also handy for acting as a supplement to a group policy.Diff: 2Topic: Health InsuranceAACSB: Analytical Thinking

54) Tell how a PPO is different from a fee-for-service or HMO plan.

Answer: A preferred provider organization is a bit like a cross between a traditional

fee-for-service plan and an HMO. Under a PPO, an employer or insurer negotiates with

a group of doctors and hospitals to provide health care for its employees or members at

reduced rates. Those doctors and hospitals that agree to the reduced pricing system

become members of the PPO.Diff: 1Topic: PPOAACSB: Analytical Thinking

55) Compare and contrast the three basic types of HMOs.

Answer: An individual practice association plan is made up of independent doctors who are paid

by the HMO as well as have their own private practice. Patients go to the doctorsʹ regular

offices and receive their medical treatment there. With a group practice plan, doctors are

generally employed directly by the HMO and work out of a central, shared facility. The

members can receive their medical treatment only from these doctors and only at these

central facilities. A point-of-service plan allows its members to seek medical treatment

from both HMO-affiliated doctors and non-HMO-affiliated doctors.Diff: 1Topic: Health Maintenance OrganizationAACSB: Analytical Thinking

56) Compare and contrast fee-for-service and managed health care plans.

Answer: Fee-for-service or traditional indemnity plans provide reimbursement for all or part of

your medical expenditures. In general, they give you a good deal of freedom to choose

your doctor and hospital. Managed health care or prepaid care plans entitle you to the

health care of a specified group of participating doctors, hospitals, and clinics. The plans

are generally offered by health maintenance organizations or variations of them.Diff: 2Topic: Managed Health CareAACSB: Analytical Thinking



57) Provide seven tips on shopping for any health care insurance.

Answer: 1. Enroll in your group plan at work.

2. If there is no group plan, purchase the best individual one you can afford.

3. Donʹt be without health care insurance.

4. Donʹt cancel your present plan until the new one comes into effect.

5. Consider only a highly rated company.

6. Look for companies that provide fast, fair, and courteous claim service.

7. Get comprehensive health insurance.

8. Take as high a deductible and coinsurance payment as you can afford, so as to reduce

costs.Diff: 2Topic: Health CareAACSB: Reflective Thinking

58) Explain the advantages and disadvantages of medical reimbursement accounts.

Answer: An employee is allowed to deposit pretax earnings into a specially designed account for

paying health care costs. In addition to tax savings on unreimbursed health care costs, an

MRA allows pretax dollars to pay for other medical expenses that many health care

plans do not cover, such as eyeglasses and orthodontia expenses.

The biggest drawback to this plan is that any contributions to the flexible spending

account not used by the end of the year are lost. Care must be taken to set aside the

amount of funds that approximate the bills that will be incurred.Diff: 2Topic: Medical Reimbursement AccountAACSB: Reflective Thinking

59) How does the concept of ʺopting outʺ work?

Answer: An employer may offer employees a cash incentive to either opt out of the firmʹs health

care plan or to elect not to cover their families. This provides a way for a company to

reduce health care costs and increase profits. If your spouse has health care coverage

where she or he works, opting out may be an alternative. If you opt out, will you be able

to reenroll in the plan at a future date? This is a key question, for you do not want to be

without health care insurance.Diff: 2Topic: Health InsuranceAACSB: Reflective Thinking

60) What can each of us do in our personal lives to control health care costs?

Answer: We can stay healthier by adopting and living the following practices:

-Have regular health care check-ups.

-Quit smoking.

-Exercise regularly.

-Eat healthy.

-Reduce or eliminate alcohol consumption.

-Reduce stress.

-Get adequate rest.Diff: 2Topic: Health CareAACSB: Reflective Thinking



61) List the required health benefits that health care plans must provide under the Affordable Care

Act.

Answer: -Ambulatory patient services

-Emergency services

-Hospitalization

-Maternity and newborn care

-Mental health and substance abuse disorder services

-Prescription drugs

-Laboratory services

-Preventive and wellness services

-Pediatric services

-Rehabilitative and habilitative services and devicesDiff: 2Topic: Affordable Care ActAACSB: Analytical Thinking

62) List the plans and payment percentages offered in the Health Insurance Marketplace.

Answer: Bronze: Your plan pays 60 percent, you pay 40 percent.

Silver: Your plan pays 70 percent, you pay 30 percent.

Gold: Your plan pays 80 percent, you pay 20 percent.

Platinum: Your plan pays 90 percent, you pay 10 percent.

Catastrophic: A coverage option if you are under 30 or have very low income.Diff: 3Topic: Affordable Care ActAACSB: Application of Knowledge

9.5 Disability Insurance

1) Only a long-term disability policy makes sense, because only it protects against financial

catastrophe.

Answer: TRUEDiff: 3Topic: Disability InsuranceAACSB: Analytical Thinking

2) Long-term disability will replace 100% of your income while you are unable to return to work.

Answer: FALSEDiff: 2Topic: Disability InsuranceAACSB: Analytical Thinking

3) With some disability income policies, you may receive partial benefits if you are able to return

to work with a part-time schedule.

Answer: TRUEDiff: 2Topic: Disability InsuranceAACSB: Analytical Thinking



4) If you have a good comprehensive health care policy, paying extra for disability income

coverage is not a good use of your scarce insurance budget.

Answer: FALSEDiff: 2Topic: Disability InsuranceAACSB: Diverse and Multicultural Work Environments

5) With short-term disability coverage, payments will continue to age 65.

Answer: FALSEDiff: 2Topic: Disability InsuranceAACSB: Analytical Thinking

6) Health insurance that provides payments to the insured in the event that the insuredʹs income is

interrupted by illness, sickness, or accident is called ________ insurance.

A) accident and sickness B) disability

C) income interruption D) unemployment

Answer: BDiff: 1Topic: Disability InsuranceAACSB: Analytical Thinking

7) Short-term disability insurance generally provides benefits on disabilities from ________ after a

short wait of ________ days.

A) one day to three months; zero

B) 30 days to three months; 7

C) three month to six months; 8 to 10

D) six months to two years; 8 to 30


Answer: DDiff: 2Topic: Disability InsuranceAACSB: Analytical Thinking

8) Some disability insurance policies offer residual or partial payments when returning to work

part-time. These payments are especially desirable for those who are

A) under the age of 40.

B) over the age of 50.

C) one year away from retirement.

D) self-employed.





9) The waiting or elimination period on oneʹs disability insurance refers to the period after the

disability during which no benefits can occur. The waiting period is equivalent to

A) the cost of oneʹs total premium.

B) oneʹs annual salary.

C) oneʹs median income.

D) 6 months of oneʹs salary.

E) the deductible for oneʹs health care policy.

Answer: EDiff: 3Topic: Disability InsuranceAACSB: Analytical Thinking

10) Policies define people as disabled if they canʹt perform

A) the duties of their own occupation.

B) the duties of any occupation for which they are reasonably suited.

C) their own occupation for the first two years of their disability, and thereafter if they canʹt

perform any occupation for which they are reasonably suited.

D) All of the above could be correct, it varies with the policy.


11) Who needs disability insurance?

A) Anyone who relies on income from a job

B) Only people who are married

C) Only people who have dependents

D) Only people who have no investment income

Answer: ADiff: 2Topic: Disability InsuranceAACSB: Analytical Thinking

12) Which of the following does not offer some form of disability insurance?

A) Employer benefit package

B) Individual health policy

C) Medicare

D) Workerʹs Comp

E) Social Security

Answer: CDiff: 2Topic: Disability InsuranceAACSB: Analytical Thinking



13) Why are so many people without disability insurance?

A) Employers donʹt supply it.

B) People donʹt know about it.

C) The price is prohibitive for most people.

D) They cannot qualify for it.

E) It may not be available in their state.

Answer: CDiff: 2Topic: Disability InsuranceAACSB: Analytical Thinking

14) Describe the disability insurance features that make sense.

Answer: 1. Choose a plan with a definition of disability that is to your advantage.

2. Consider partial or residual payments when returning to work part-time.

3. Given a choice between short-term and long-term benefit durations, choose

long-term.

4. Choose a waiting/elimination period that is economical generally three months.

5. Itʹs a good idea to have a waiver of premium to pay the premium when disabled.

6. Get guaranteed renewable and noncancellable when you can afford it.

7. Obtain rehabilitation coverage to allow for retraining benefits.Diff: 2Topic: Disability InsuranceAACSB: Analytical Thinking

15) Define disability insurance and give the common sources of it.

Answer: Disability insurance is earning-power insurance for anyone who relies on income from a

job for financial support. It is generally available to replace most of your monthly income

when you become disabled due to injury or illness.

Workersʹ Comp provides benefits when the disability is work-related. Social Security

gives benefits when the disability lasts for more than five months and is expected to last

for more than one year. Employer-sponsored plans can cover short-term and long-term

disabilities. If a plan is not available at work, you might consider an individual plan that

would offset your loss.Diff: 2Topic: Disability InsuranceAACSB: Information Technology

9.6 Long-Term Care Insurance

1) Long-term care insurance provides money to help pay for nursing home and home health care

expenses.

Answer: TRUEDiff: 2Topic: Long-Term Care Insurance




2) Long-term care insurance may not be a good buy for people under the age of 40.

Answer: TRUEDiff: 3Topic: Long-Term Care Insurance


3) You should only consider a long-term care policy that includes coverage for Alzheimerʹs and

Parkinsonʹs disease. It should also include which of the following provisions?

A) Type of care

B) Benefit and waiting period

C) Inflation adjustment

D) Waiver of premium

E) All of the above

Answer: EDiff: 3Topic: Long-Term Care Insurance


4) Most long-term care policies require the insured to be unable to perform one or more activities

of daily living (ADLs) without assistance. Which of these is included?

A) Walking

B) Eating

C) Exercising

D) Dressing

E) A, B, and D are included.

Answer: EDiff: 3Topic: Long-Term Care Insurance


5) Why is long-term care insurance needed?

A) It is not covered by major medical insurance.

B) It is not covered under Medicare.

C) Life expectancies have increased.

D) All of the above


Answer: DDiff: 2Topic: Long-Term Care Insurance




6) Which statement is false regarding benefit periods on long-term health care insurance?

A) Long-term health care coverage can range all the way from one year to a lifetime.

B) The average stay in a nursing home is 2.44 years.

C) The recommended minimum benefit period is six to nine years.

D) Because women tend to spend longer periods of time in nursing care compared to men,

women should consider a longer benefit period.

Answer: CDiff: 3Topic: Long-Term Care Insurance


7) Define long-term care insurance and describe its basic features.

Answer: Long-term care insurance pays for nursing home expenses and home health care. These

plans protect you from the high costs of hiring someone to take care of you in a nursing

home or at your own home. Carefully shop around because these types of policies are

laden with exceptions and conditions to meet. Most policies require you to be unable to

perform one or more ʺactivities of daily livingʺ without assistance. Consider only policies

that cover Alzheimerʹs and Parkinsonʹs disease.

The basic features include:

1. Investigate the type of care. Check to see if you are covered in a nursing home only or

if the insurance extends to home care, adult day care, and hospital care.

2. The length of the benefit period is important, especially for women who live longer.

Get a minimum of three to six years of coverage when taking out the policy.

3. The cost of the waiting period varies with the length. Take as long of a period as you

can afford at least 100 days.

4. Be sure to include an inflation adjustment provision to cover the rising future costs.

5. The waiver of premium lets your insurance company pay for the premiums while

you are receiving benefits. This is optional and is too costly to be included in general.Diff: 2Topic: Long-Term Care Insurance



Chapter 10Property and Liability Insurance

10.1 Protecting Your Home

1) Property insurance protects you from the financial risk associated with property losses.

Answer: TRUEDiff: 1Topic: Property InsuranceAACSB: Diverse and Multicultural Work Environments

2) An HO-4 policy is a renterʹs insurance policy that protects the renterʹs personal property.

Answer: TRUEDiff: 1Topic: Renters InsuranceAACSB: Diverse and Multicultural Work Environments

3) An HO-3 policy is a special form of homeownerʹs insurance policy that offers open perils

protection except for those perils specifically excluded.

Answer: TRUEDiff: 1Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

4) In the United States, the first type of homeownerʹs insurance was fire insurance, offered in 1935

by a small company in Charleston, South Carolina.

Answer: FALSEDiff: 1Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

5) An attached garage is covered under Coverage B: Other structures.


6) Angelaʹs home became overrun with termites. She had to stay in an apartment temporarily

while her home was being fixed. The provision on her home owners policy that covers her

expenses while she is not able to live in her home is known as: Coverage D: Loss of Use.




7) Your backyard shed was damaged by a windstorm. Your coverage is based under Coverage D:

Loss of Use.


8) While you were walking your dog, she bit a child. Medical treatment for the child would fall

under Coverage C: Personal Property.

Answer: FALSEDiff: 1Topic: Liability InsuranceAACSB: Diverse and Multicultural Work Environments

9) Personal liability insurance protects you from financial losses incurred if someone is injured on

your property or as a result of your actions.


10) Brandi thought it quite funny to have a decorative outhouse put on her property as a

conversation piece. This structure is covered under Coverage A: Dwelling on her home owners

policy.


11) Renterʹs insurance includes liability insurance.

Answer: FALSEDiff: 1Topic: Renters InsuranceAACSB: Analytical Thinking

12) The inflation guard endorsement on your homeowners insurance policy automatically decreases

your policy premiums each year due to the inflation rate.

Answer: FALSEDiff: 1Topic: EndorsementAACSB: Analytical Thinking

13) Flood protection insurance is generally administered and subsidized by the federal government

through the Department of Housing and Urban Development.

Answer: TRUEDiff: 1Topic: Flood InsuranceAACSB: Analytical Thinking


Chapter 10 Property and Liability Insurance 275

14) Generally, a personal umbrella policy is an expensive policy that provides excess liability

insurance over basic underlying contracts.

Answer: FALSEDiff: 2Topic: Umbrella PolicyAACSB: Analytical Thinking

15) Fire, theft, and windstorm damage are examples of

A) perils. B) hazards.

C) miscellaneous mishaps. D) liabilities.

Answer: ADiff: 1Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

16) John Murphy experienced a freak storm that damaged his roof and allowed water to leak into

the house. The agent and adjuster said the peril was not covered under his HO-2 policy. John

wishes he had taken out an ________ policy.

A) HO-1 B) HO-3 C) HO-4 D) HO-5 E) HO-6

Answer: BDiff: 3Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

17) John Meadow rents an apartment and wants tenantʹs insurance or an ________ policy.

A) HO-1 B) HO-2 C) HO-3 D) HO-4 E) HO-6

Answer: DDiff: 1Topic: Renters InsuranceAACSB: Analytical Thinking

18) Your apartment building burned down while you were on vacation. Fortunately, you have

renterʹs insurance. What will your policy cover?

A) Any damages to the building structure

B) Your neighborʹs personal property

C) Your hotel and additional expenses based on a percentage of your property coverage



Answer: CDiff: 2Topic: Renters InsuranceAACSB: Analytical Thinking



19) Your boyfriend is living in an apartment complex that has had a recent rash of robberies. He has

$5,000 worth of rare coins. What should he do to protect himself in case of a robbery?

A) Take a written and video tape inventory of his property.

B) Add a personal articles floater to his policy.

C) Take out personal property replacement cost coverage.

D) Only B and C above


Answer: EDiff: 3Topic: Renters InsuranceAACSB: Analytical Thinking

20) Which of the following is not a consideration in determining the amount of homeownerʹs

insurance a person needs?

A) Cover the entire replacement cost in the event of a complete loss.

B) Match the insurance coverage of similar homes in your neighborhood.

C) Protect against the effect of inflation eroding away your coverage.

D) Purchase flood or earthquake coverage if you are in an area prone to these occurrences.

E) Determine if detached structures are adequately covered under standard policies.

Answer: BDiff: 3Topic: Homeownerʹs InsuranceAACSB: Diverse and Multicultural Work Environments

21) The purpose of a personal umbrella policy, as an addition to your homeownerʹs policy, is

primarily to protect you from

A) acts of God, such as falling objects, hail, etc.

B) flood damage.

C) lawsuits and judgments.

D) faulty construction of your home.

E) contested title to your property.

Answer: CDiff: 2Topic: Liability InsuranceAACSB: Analytical Thinking

22) You have recently inherited a sum of money. You are purchasing an old Victorian home which

was built in 1856. The type of insurance needed on the house would be

A) HO-1. B) HO-4. C) HO-6. D) HO-8.

Answer: DDiff: 2Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking



23) Your best friendʹs apartment has just been robbed, and he had no insurance. What would you

suggest to your friend to better protect himself from such losses in the future?

A) Purchase renterʹs insurance and add a personal articles floater.

B) Take out personal property replacement cost coverage.

C) Take a written and video tape inventory of your property.

D) Only B and C above


Answer: EDiff: 3Topic: Renters InsuranceAACSB: Analytical Thinking

24) Suppose burglars trashed your apartment and stole your personal property. Your rent is $350

per month and you had to live in another apartment house for two months while the landlord

had the apartment put back into livable condition. Under which section of an HO policy would

you be covered and how much would you recover because of the move?

A) Section I coverage C, $350

B) Section I coverage C, $700

C) Section I coverage D, $350

D) Section I coverage D, $700

E) Section II coverage, $350


25) On your home owners policy ________ protects any personal property thatʹs owned or used by

the policyholder, regardless of the location of this property. In other words, if youʹre on a

vacation

in Hawaii and someone hits you with a pineapple and steals your suitcase, your personal

property is still covered.

A) Coverage A

B) Coverage B

C) Coverage C

D) Coverage D





26) The disadvantage of actual cash value coverage of personal property compared to replacement

cost coverage is that it

A) will reimburse you for replacement cost minus estimated depreciation.

B) will reimburse you for the cash value of a new item.

C) must be reported as a loss on your tax return.

D) does not have to be reported as a loss on your tax return.



27) If you wanted to obtain an endorsement that automatically updates the level of property

coverage based on an index of replacement costs that continually updates the cost of building a

home, you would ask for a(n)

A) inflation guard.

B) automatic adjustment policy.

C) replacement cost index.

D) continual adjustment policy.


Answer: ADiff: 1Topic: Homeownerʹs InsuranceAACSB: Diverse and Multicultural Work Environments

28) Reggie was hosting a BBQ when the deck fell off his house. Several of his friends were hurt in

the accident. Luckily for Reggie he has ________ coverage on his home ownerʹs insurance.

A) personal articles B) loss of use

C) personal liability D) none of the above

Answer: CDiff: 3Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

29) When you purchase a(n) ________, you are obtaining an extension to a homeownerʹs insurance

policy that provides coverage for all personal property regardless of where it is located.

A) uninsured property addendum

B) property addendum

C) personal rider

D) personal articles floater


Answer: DDiff: 1Topic: FloaterAACSB: Diverse and Multicultural Work Environments



30) Antoine LaDuke suffered a major loss on his older home due to mud from a flood. Although he

had homeownerʹs insurance, what was the probable reason he was not covered?

A) His home was probably too expensive.

B) His policy excluded flood-related damages.

C) This is a personal liability issue.

D) Older homes are excluded from flood-related damages.

Answer: BDiff: 2Topic: Flood InsuranceAACSB: Analytical Thinking

31) Insurers in California are required to offer ________ coverage to consumers due to the

substantial risk factors in that state.

A) renters

B) liability

C) inflation

D) earthquake

E) bankruptcy

Answer: DDiff: 1Topic: Homeownerʹs InsuranceAACSB: Diverse and Multicultural Work Environments

32) Supplemental coverage for homeownerʹs insurance is available through endorsements. Which

one of the following is not a common form of additional coverage?

A) Personal articles floaters

B) Earthquake coverage

C) Flood protection

D) Medical payments

E) Inflation guard


33) Wilber Robinson found out that his homeownerʹs coverage comes in handy when a neighbor

steps on a garden rake and it flips up and causes a concussion. Josh did just that and spent two

weeks in the hospital running up a $23,000 bill. Josh was covered under

A) section II medical payments.

B) section II personal liability.

C) section I loss of use.

D) added liability insurance.

E) the 80 percent rule.

Answer: BDiff: 3Topic: Liability InsuranceAACSB: Analytical Thinking



34) The replacement value of the house less accumulated depreciation (which is the decline in value

over time due to wear and tear) is known as

A) actual cash value.

B) replacement value.

C) market value.

D) depreciation.



35) Amy Lambertʹs home is insured for $85,000 and her detached garage is destroyed by a

windstorm. She hopes to collect $11,850 under her homeownerʹs policy. What will happen?

A) Amy will receive $11,850 under Coverage B: Other structures

B) Amy will receive $11,850 under Coverage A: Dwelling

C) Amy will receive $8,500 under Coverage B: Other structures

D) Amy will receive $8,500 under Coverage A: Dwelling

E) Amy will receive $11,850 under Coverage C: Personal property


36) Coverage A: Dwelling protects

A) personal property in a dwelling.

B) unattached structures on the dwelling site.

C) your home.

D) any attachments to your home.

E) both C and D above

Answer: EDiff: 2Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

37) Alfred lost his 3-year-old camera. It cost him $200 three years ago and had a life expectancy of

6 years. Alfred has actual cash value insurance on this camera, which means his insurance

company will issue him a check for ________ for his loss. A new camera costs $150.

A) $75 B) $150

C) $200 D) none of the above

Answer: ADiff: 1Topic: Property InsuranceAACSB: Analytical Thinking



38) You have the most popular house on the block for the neighborhood children to play at. You

have a trampoline, tree fort and jungle gym. Your family also has two large German shepherd

dogs. What should you consider given the described situation?

A) Purchasing personal property replacement cost coverage

B) Purchasing earthquake coverage

C) Purchasing an umbrella policy


Answer: CDiff: 1Topic: Liability InsuranceAACSB: Reflective Thinking

39) What is the main difference between replacement cost coverage and actual cash value coverage?

A) Replacement cost coverage does not consider depreciation.

B) Actual cash value does not consider depreciation.

C) Replacement cost coverage requires an endorsement to your policy



Answer: EDiff: 3Topic: EndorsementAACSB: Analytical Thinking

40) Explain Section I: Property Coverage for HO-2 and HO-3 policies.

Answer: Section I covers four major areas important to all homeowners:

-Coverage A: Dwelling protects the house and any attachments to it.

-Coverage B: Other structures protects other structures on the premises that are not

attached to the house for 10% of the insurance on the house itself.

-Coverage C: Personal property insures any personal property that is owned or used by

the policyholder, regardless of the location of this property.

-Coverage D: Loss of use provides benefits, such as temporarily living elsewhere, if your

home cannot be used due to an insured loss.Diff: 2Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking



41) Describe each of the six HO packaged policies. Which one is the most common?

Answer: HO-1 is the basic form. It provides very narrow coverage and is the least expensive.

HO-2 is the broad form of coverage and protects against named perils. It is more

extensive than HO-1.

HO-3, the special form, has the advantage of insuring against open perils, meaning it

covers many perils not specifically mentioned in the policy. It is the costliest of the three

thus far mentioned.

HO-6 covers condo and co-op owners. It insures like renterʹs insurance plus it covers

structural improvements and alterations.

HO-8 is modified coverage for older homes with expensive replacement costs.

HO-4 is renterʹs insurance that provides protection for personal property, liability, and

loss of use only.Diff: 2Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

42) Provide an explanation of Section II: Personal Liability Coverage.

Answer: This part of a homeownerʹs insurance policy covers personal liability insurance to protect

the insured and family members from the financial loss incurred if someone is injured on

their property or as a result of their actions. It also covers medical expenses and liability

suits.Diff: 1Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

43) Most companies allow six endorsements or supplemental coverages to meet their customersʹ

needs. Name and describe the six. Which one is unique and stands apart from the others?

Answer: -Personal articles floaters provide additional and extended coverage for all personal

property. It is especially meant for expensive items and collections.

-Earthquake coverage is available in any state and is recommended for earthquake areas.

-Flood protection covers flood, mudslide, and some water erosion damage

-Inflation guard automatically updates your amount of coverage based on an index.

-Personal property replacement cost pays for a new item and not for a used one.

-Added liability protects you from judgments and lawsuits in excess of $100,000. It is

also available for business and professional use of the home

The flood protection is unique in that it is generally administered and subsidized by the

federal government. A community must apply and be approved by the Department of

Housing and Urban Development. At that point insurers can offer the coverage with

limits of $250,000 on dwellings and an additional $100,000 on contents.Diff: 2Topic: EndorsementAACSB: Reflective Thinking



44) Describe the difference between actual cash value and replacement value.

Answer: Homeownerʹs insurance is set up to pay the policyholder the actual cash value of the loss.

The actual cash value, which is the replacement cost minus estimated depreciation

(wear-and-tear costs), can be well below the cost of replacing the asset. As an alternative,

most homeownerʹs policies come with optional replacement cost coverage, which

provides for the actual replacement cost of a stolen or destroyed item as opposed to the

actual cash value.Diff: 2Topic: Liability InsuranceAACSB: Analytical Thinking

10.2 Your Insurance Needs

1) One healthy way to reduce your insurance premiums is to quit smoking.

Answer: FALSEDiff: 1Topic: InsuranceAACSB: Diverse and Multicultural Work Environments

2) A lower insurance credit score generally results in lower homeownerʹs insurance rates.

Answer: FALSEDiff: 1Topic: Insurance Credit ScoreAACSB: Diverse and Multicultural Work Environments

3) One way to lower the premiums you pay on your insurance is to have a higher deductible.

Answer: TRUEDiff: 1Topic: Property InsuranceAACSB: Diverse and Multicultural Work Environments

4) Your insurance credit score depends on, among other things, your payment history and the

types of credit used.

Answer: TRUEDiff: 1Topic: Insurance Credit ScoreAACSB: Diverse and Multicultural Work Environments

5) Barbara is over 55 so she qualifies for additional home ownerʹs insurance discounts.

Answer: TRUEDiff: 1Topic: Homeownerʹs InsuranceAACSB: Diverse and Multicultural Work Environments

6) Since most homeownersʹ claims are for relatively small amounts, high deductibles will keep

your insurance costs down.

Answer: TRUEDiff: 1Topic: Homeownerʹs InsuranceAACSB: Diverse and Multicultural Work Environments



7) The coinsurance provision requires that the insurance company will pay a portion of your

financial losses in the event of a catastrophe.

Answer: FALSEDiff: 1Topic: Insurance Credit ScoreAACSB: Analytical Thinking

8) A(n) ________ is an insurance company that distributes its products to customers without the

use of agents.

A) direct writer B) private writer C) underwriter D) public writer

Answer: ADiff: 1Topic: Insurance AgentsAACSB: Analytical Thinking

9) Your home and property have a market value of $200,000. Since you want to make sure that you

meet the coinsurance provisions, you should have at least ________ of insurance.

A) $160,000

B) $180,000

C) $200,000

D) $220,000



10) What determines the cost of your homeownerʹs insurance?

A) The location of your home B) The type of structure

C) The level of coverage and policy type D) All of the above


11) Lisa and Eric want to keep the cost down on the homeownerʹs insurance they will need. After

talking to their parents they developed a list of ways to do so. Identify the one mistake on it.

A) Take as high a deductible as you can afford to self insure.

B) Install an adequate security system.

C) Pay your insurance premiums quarterly.

D) Install adequate smoke detectors.

E) Insure your cars with the homeownerʹs company.




12) Lisa and Eric were notified that replacement cost coverage is in effect on a home ownerʹs policy

only if the home is insured for at least 80% of its replacement cost. This provision is known as

the

A) Replacement Cost Rule. B) 80 Percent Rule.

C) Replacement Cost Provision. D) none of the above.

Answer: BDiff: 2Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

13) Suppose Lisa and Eric do not purchase an adequate amount of insurance on their home. In the

event of a claim, they would pay a portion of it. This is the

A) inflation guard.

B) added liability.

C) replacement cost.

D) coinsurance provision.

E) 70 percent rule.


14) Eric and Lisa Lambert are purchasing a home for the first time. Their insurance company wants

them to insure at least ________ of the homeʹs full replacement cost.

A) 70% B) 75% C) 80% D) 85% E) 90%

Answer: CDiff: 2Topic: Homeownerʹs InsuranceAACSB: Diverse and Multicultural Work Environments

15) Your home and property have a market value of $240,000. To meet the coinsurance provision,

you would need at least ________ of insurance.

A) $144,000

B) $168,000

C) $192,000

D) $216,000





16) The ________ is the amount that you agree to pay before insurance coverage kicks in.

A) pro rata share

B) gratis

C) allowance

D) deductible


Answer: DDiff: 1Topic: DeductibleAACSB: Analytical Thinking

17) Which of the following statements best describes the 80 percent rule?

A) Your home is covered for 80 percent of its original value, regardless of replacement cost.

B) Your home is covered for replacement cost, provided the total premiums paid are less than

80 percent of the outstanding premiums due.

C) Replacement cost coverage is only effective if your home is insured for at least 80 percent

of its replacement cost.

D) Your house cannot be replaced if its replacement cost is less than 80 percent of assessed

market value.



18) Which of the following statements is true?

A) The lower your insurance credit score, the higher your homeownerʹs insurance rate will

be.

B) The higher your insurance credit score, the higher your homeownerʹs insurance rate will

be.


19) What factors are considered when insurance companies decide what rates to charge you for

homeownerʹs insurance?

A) Whether you have an in-home sprinkler system

B) What type of building materials were used in the house

C) Your credit score






20) Pretend you are an insurance agent. Explain the coinsurance and 80 percent rule to a client.

Answer: The coinsurance provision requires you to pay a portion of your own losses if you do not

purchase an adequate level of insurance. Most companies also require you to carry at

least 80 percent of your homeʹs full replacement cost. This 80 percent rule applies to

losses on your dwelling only and not to personal property. If you insure for less than 80

percent of the replacement value, you will receive the greater of these two:

-the actual cash value of the portion of your house that was destroyed

or

-The amount of insurance purchased

80% of replacement cost of loss × the amount

Diff: 2Topic: Homeownerʹs InsuranceAACSB: Analytical Thinking

21) Outline the considerations for choosing the amount of homeownerʹs insurance you need.

Answer: Purchase enough homeownerʹs insurance to cover:

-the replacement value of your home in the event of a complete loss

-the effects of inflation eroding away your coverage

-flood and earthquake damage if you are in such an area

-detached structures or elaborate landscaping

-home office for business and professional use

-all of your personal property

-for most people replacement cost is a good idea

-valuable possessions that need special protection need a floater

-assets that are much greater than the liability limits on your present policy

-personal property when you are rentingDiff: 2Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

22) To make sure all of your personal property is paid for in the event of a loss, it is a good idea to

make an inventory of all household contents. Tell what should be included.

Answer: To establish proof of ownership and the value of your assets, use a detailed inventory. It

should include the date of purchase, the cost, the model and serial number, and the brand

name. Make both a written and a videotape inventory.Diff: 1Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking



23) Give the three basic factors that determine the cost of your homeownerʹs insurance. List the

possible ways of saving money on premiums.

Answer: The three basic factors are: (1) the location of your home, (2) its type of structure, and (3)

your level of coverage and policy type. Possible ways of saving on premiums include:

-Take as high of a deductible as you can afford.

-Install a security system, smoke detectors, and fire extinguishers.

-Ask for a multiple policy discount with your car insurer-pay premiums annually.

-Ask for other discounts.

-Consider a direct writer.

-Shop around and get bids from several agents.

-Doublecheck your policy to make sure you have the coverage you need.Diff: 2Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

10.3 Making Your Coverage Work

1) While transporting your TV to the repair shop, someone stole it from your car. Your TV is

covered under your homeownerʹs coverage.

Answer: TRUEDiff: 1Topic: Property InsuranceAACSB: Analytical Thinking

2) Your home was damaged by a hail storm. This will require a police report in order for you to

file a claim.

Answer: FALSEDiff: 2Topic: Insurance CompanyAACSB: Analytical Thinking

3) Since there were no witnesses to the robbery at your apartment, there is no reason to contact the

police.


4) For structural damage to your dwelling, it would be a good idea to request for an estimate from

a qualified contractor before accepting the check from your insurance company.

Answer: TRUEDiff: 2Topic: Insurance CompanyAACSB: Reflective Thinking



5) You should not alter or repair any physical damages to your property until after the claims

adjuster has investigated the loss.


6) Felixʹs $2,000 TV was stolen. He has no record of its purchase, however, he knows his insurance

company will reimburse him the full value of the TV.


7) A homeownerʹs personal inventory will help you maximize your insurance claims in case of

loss.

Answer: TRUEDiff: 3Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

8) Your written or video inventory of your assets should be kept in a safe place such as a lock box

at your bank.

Answer: TRUEDiff: 1Topic: Insurance CompanyAACSB: Reflective Thinking

9) To be properly reimbursed for the loss of personal property in your home, you should take a

written inventory of household contents and a video tape of these contents. You should have a

written description and an oral description that includes which of the following?

A) Date of purchase

B) The cost of each item

C) Model number and brand name

D) Serial number

E) All of the above

Answer: EDiff: 2Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

10) While you were visiting a friend, someone robbed their apartment and stole your laptop

computer. Unfortunately, they did not have renterʹs insurance. Where can you look for help to

replace your computer?

A) The landlordʹs loss of use coverage B) Your homeownerʹs insurance policy

C) Your friend through small claims court D) None of the above are correct.

Answer: BDiff: 3Topic: Renters InsuranceAACSB: Analytical Thinking



11) According to the Keown book, why donʹt renters typically have renterʹs insurance?

A) They felt the insurance was too expensive.

B) They didnʹt know they needed coverage.

C) They have never heard of such insurance.

D) All of the above


12) In the event of a loss you should do all of the following except

A) report your loss immediately.

B) refrain from making any repairs until the claims adjuster has seen the damage.

C) make a detailed list of everything that is lost or damaged.

D) maintain records of the insurance settlement process.

Answer: BDiff: 2Topic: Insurance CompanyAACSB: Analytical Thinking

13) To effectively collect on a loss when filing a homeownerʹs claim, the first step should be

A) to make temporary repairs to protect your property.

B) confirm the adjusterʹs estimate.

C) make a detailed list of everything lost or damaged.

D) maintain records of the insurance settlement process, especially expenses.

E) report your loss to your insurance agent, and the police if applicable.

Answer: EDiff: 3Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

14) Your home is hit by a strong wind storm that causes serious damage to one end of it. The rest of

your home is livable. What do you do?

Answer: Report your loss immediately. Next, make a detailed list of everything damaged or gone.

Make temporary repairs to protect your property. Maintain records of the insurance

settlement process, especially expenses. Be sure to confirm the adjusterʹs estimate with a

building contractor.Diff: 1Topic: Homeownerʹs InsuranceAACSB: Reflective Thinking

10.4 Automobile Insurance

1) With PAP coverage, if youʹre driving a car you donʹt own, your medical expenses wonʹt be

covered but those of other injured passengers or pedestrians will be.

Answer: FALSEDiff: 3Topic: Medical Expenses CoverageAACSB: Reflective Thinking



2) It is possible to have a different deductible for collision loss than you have for comprehensive

physical damages.

Answer: TRUEDiff: 2Topic: Collision Loss CoverageAACSB: Analytical Thinking

3) With no-fault insurance you can still sue for ʺpain and sufferingʺ but only if the other driver

was at fault.

Answer: TRUEDiff: 2Topic: No Fault CoverageAACSB: Analytical Thinking

4) In 2014, at least 26 percent of all auto collisions involved cell phones.

Answer: TRUEDiff: 2Topic: Personal Automobile PolicyAACSB: Analytical Thinking

5) Under standard PAP coverage, youʹre not covered when you are using a vehicle without the

permission of its owner.


6) Each automobile policy contains both liability and property damage coverage.

Answer: TRUEDiff: 2Topic: InsuranceAACSB: Analytical Thinking

7) On your automobile insurance policy, medical expense coverage doesnʹt have per person limits.

Answer: FALSEDiff: 2Topic: Collision Loss CoverageAACSB: Analytical Thinking

8) For drivers who have liability coverage only, they are self insured for damages to their personal

car.

Answer: FALSEDiff: 2Topic: Liability InsuranceAACSB: Analytical Thinking



9) Most professional financial planners recommend that you carry $1,000,000 of bodily injury

liability coverage per person.

Answer: FALSEDiff: 3Topic: Liability InsuranceAACSB: Analytical Thinking

10) Comprehensive physical damage coverage would cover damage if your car were hit in a

parking lot.


11) The greater your financial assets, the less automobile insurance coverage you should carry

because you can afford the financial loss.

Answer: FALSEDiff: 3Topic: Collision Loss CoverageAACSB: Analytical Thinking

12) In addition to paying the policy limits for the damages you caused, the insurer also agrees

under Part A to defend you in any civil cases arising from the accident and to pay all legal costs.


13) Combined single limit liability coverage allows for either separate coverage limits for bodily

injury and property damage, split-coverage limits per person, or both.

Answer: FALSEDiff: 1Topic: Personal Automobile PolicyAACSB: Reflective Thinking

14) Uninsured motoristʹs protection coverage provides coverage for injuries caused by an uninsured

motorist, a negligent driver whose insurance company is not solvent, or a hit-and-run driver.

Answer: TRUEDiff: 1Topic: Uninsured Motorists CoverageAACSB: Analytical Thinking

15) The recommended limit on both collision and comprehensive physical coverage damage is the

cash value of your automobile.




16) No-fault insurance only pays for your losses if you were not at fault in the accident.

Answer: FALSEDiff: 1Topic: No Fault CoverageAACSB: Reflective Thinking

17) Charlie drives his own vehicle as a taxi on weekends in his home town. With his PAP coverage,

his automobile is covered since he is carrying passengers for a fee.

Answer: FALSEDiff: 3Topic: Personal Automobile PolicyAACSB: Analytical Thinking

18) Two of the determinants of the cost of your automobile insurance are the use and type of your

automobile.


19) For a minor traffic accident, it is not necessary to call the police if you plan on submitting a claim

to your insurance company.

Answer: FALSEDiff: 2Topic: Automobile AccidentsAACSB: Analytical Thinking

20) Heather was advised to take a defensive driving course as a means to reduce her annual auto

insurance premium. Is this a true or a false suggestion?

Answer: TRUEDiff: 3Topic: Automobile AccidentsAACSB: Analytical Thinking

21) Rosemary was hit by another vehicle on the way home from work. She believes the other driver

was under the influence of alcohol. Rosemary is not within her rights to demand that the other

driver take an alcohol test.

Answer: FALSEDiff: 3Topic: Automobile AccidentsAACSB: Analytical Thinking

22) In you are involved in an automobile accident and suspect the other driver may have been

driving under the influence, you should request that the police perform sobriety tests on both of

you.

Answer: TRUEDiff: 3Topic: Automobile AccidentsAACSB: Analytical Thinking



23) The use of insurance credit scoring is more common with the sale of homeownerʹs insurance

coverage than it is with automobile insurance coverage.

Answer: FALSEDiff: 2Topic: Automobile InsuranceAACSB: Analytical Thinking

24) Driving at 55 miles per hour for five seconds–the minimum amount of time that texting takes

your attention off of the road–youʹll travel the length of a football field without looking.

Answer: TRUEDiff: 2Topic: Automobile InsuranceAACSB: Analytical Thinking

25) Most professional financial planners recommend carrying at least $100,000 in bodily injury

liability coverage per person, $300,000 in bodily injury liability coverage for all persons, and

$100,000 in property damage liability coverage.

Answer: TRUEDiff: 3Topic: Automobile InsuranceAACSB: Analytical Thinking

26) Which of the following is a way for consumers to keep their automobile insurance rates down?

A) Improve their driving records. B) Lower their deductibles.

C) Consider only high-quality insurers. D) Both A and C

Answer: DDiff: 2Topic: Automobile InsuranceAACSB: Analytical Thinking

27) If you have a significant amount of assets, most financial planners recommend the following

automobile liability insurance limits.

A) 50/100/25 B) 100/300/100 C) 250/500/100 D) 500/1,000/250

Answer: CDiff: 3Topic: Automobile InsuranceAACSB: Reflective Thinking

28) Deon tried to merge onto the Atlantic Expressway and caused a three-car accident. He has

automobile insurance with limits of 50/100/25. What is the maximum amount that his insurance

company will pay for the bodily injury liability claims?

A) $50,000 B) $75,000 C) $100,000 D) $125,000

Answer: CDiff: 3Topic: Automobile InsuranceAACSB: Application of Knowledge



29) A teenage driver crashes her parentsʹ minivan into an office building, causing $85,000 in

damage to the building. The automobile liability insurance limits are 100/250/75. How will the

damages be allocated between the driver and the insurance company?

A) The driver will be responsible for $85,000.

B) The driver will be responsible for $75,000, the insurance company for $10,000.

C) The driver will be responsible for $10,000, the insurance company for $75,000.

D) The insurance company will be responsible for $85,000.

Answer: CDiff: 3Topic: Automobile InsuranceAACSB: Application of Knowledge

30) You had several of your sonʹs friends over last night for a sleepover. While dropping off their

child, one of the parents did not see your basketball hoop and smashed it beyond repair with

her car. Where would you look for damage payment?

A) The driverʹs homeownerʹs insurance

B) Section II of the driverʹs homeownerʹs insurance

C) The driverʹs automobile liability coverage

D) The driverʹs automobile comprehensive insurance

E) The driverʹs automobile collision insurance


31) Which of the following is not a determinant of the cost of your automobile insurance rates?

A) Your age

B) Your credit score

C) Your driving record

D) Your marital status

E) The number of children that you have

Answer: EDiff: 1Topic: Personal Automobile PolicyAACSB: Diverse and Multicultural Work Environments

32) Which of the following are among the most common driver distractions that lead to insurance

claims?

A) Talking on cell phones

B) Applying make-up or shaving

C) Reading something

D) Eating something

E) All of the above are cited as the most common driver distractions.

Answer: EDiff: 1Topic: Liability InsuranceAACSB: Reflective Thinking



33) You were standing on the sidewalk waiting for a bus when a car lost control, jumped the curb,

and hit you in the leg causing medical injuries. Which of the following provides reimbursement

for your medical expenses?

A) The driverʹs collision coverage.

B) The driverʹs liability coverage.

C) Your comprehensive physical damages coverage.

D) Your medical expenses coverage


Answer: EDiff: 3Topic: Medical Expenses CoverageAACSB: Analytical Thinking

34) Which of the following are not discounts for PAP coverage?

A) Good student discount

B) Anti-theft equipment discount

C) Low miles per gallon discount

D) Accident free discount

E) All of the above are discounts for PAP.

Answer: CDiff: 3Topic: Personal Automobile PolicyAACSB: Analytical Thinking

35) Which of the following will most likely pay the least for automobile insurance, assuming they

all drive identical cars?

A) A 29-year-old woman with a good credit score and driving record

B) A 55-year-old woman with two drunk driving arrests

C) A 32-year-old married man with bad credit and a bad driving record

D) A 20-year-old man who drives 50,000 miles per year and lives in a big city

Answer: ADiff: 3Topic: Personal Automobile PolicyAACSB: Analytical Thinking

36) What should a 20-year-old man consider when he is thinking about purchasing a new car?

A) The sportier the car he purchases is, the more his insurance will cost.

B) Because of his demographics, he will pay higher rates for car insurance.

C) The type of car he purchases could have a dramatic impact on the cost of his insurance.


E) All but A are correct.

Answer: DDiff: 3Topic: Personal Automobile PolicyAACSB: Reflective Thinking



37) What characteristics will affect the cost of your car insurance?

A) The type of automobile you drive

B) Where you reside

C) How many miles you drive

D) All of the above


Answer: DDiff: 3Topic: Personal Automobile PolicyAACSB: Analytical Thinking

38) Young ________ generally pay the most for their insurance, because they have a statistically

greater chance of having an accident.

A) married females B) unmarried males

C) married males D) unmarried females

Answer: BDiff: 3Topic: Personal Automobile PolicyAACSB: Analytical Thinking

39) Why is it a good idea for you to purchase uninsured and underinsured motorist coverage?

A) 15% of drivers have no automobile insurance.

B) A majority of drivers only carry the legal minimum liability coverage.

C) This coverage protects you and your passengers for medical expenses.


Answer: DDiff: 3Topic: Uninsured Motorists CoverageAACSB: Diverse and Multicultural Work Environments

40) You have liability only coverage on your car. It was damaged in the parking lot by a

hit-and-run driver. What coverage do you have for your damages?

A) Their collision coverage B) Their liability coverage

C) Your liability coverage D) None of the above

Answer: DDiff: 3Topic: Liability InsuranceAACSB: Analytical Thinking

41) Which of the following could increase the cost of your auto insurance?

A) Driving a sportier car

B) Driving more miles per year

C) Decreasing the amount of your deductible

D) All of the above




42) What is it about liability coverage that makes it so important?

A) There is no way to know in advance what your potential liability loss will be.

B) Huge sums of money are handed out in settlements over lawsuits over auto accidents.

C) This coverage will pay all legal costs should you be involved in a civil case arising from an

accident.



43) What are the areas covered in Part A: Liability coverage in a personal automobile policy?

A) Bodily injury, property damage, judgments awarded, court costs, legal defense fees

B) Bodily injury, property damage, court costs, legal defense fees, bail bond

C) Bodily injury, property damage, legal defense fees, bail bond, loss of wages

D) Bodily injury, judgments awarded, court costs, loss of wages

E) Judgments awarded, property damage, court costs, legal defense fees, bail bond

Answer: ADiff: 3Topic: Liability InsuranceAACSB: Analytical Thinking

44) Toldae and Natasha were driving their friends home when they rear-ended another car. They

are worried about paying for the medical bills and possibly getting sued. Who will be covered

under their Part B: Medical expense coverage?

A) Toldae, Natasha, and the people in the car they hit

B) Toldae, Natasha, and their friends

C) Their friends and the people in the other car

D) The driver and their friends

E) The driver and the people in the other car

Answer: BDiff: 3Topic: Medical Expenses CoverageAACSB: Analytical Thinking

45) Francis was just learning to drive. She forgot to put the car into park and it rolled down the

driveway and into the neighborʹs automobile. What part of her automobile insurance policy will

cover the damage to her neighborʹs automobile?

A) Part A: liability coverage

B) Part B: medical expense coverage

C) Part C: uninsured motorists coverage

D) Part D: damage to your automobile coverage

Answer: ADiff: 3Topic: Automobile AccidentsAACSB: Analytical Thinking



46) Verci and Banok skidded on the ice and hit a telephone pole. Their car suffered severe damage

to the front end. This expense will be covered under part D called

A) liability coverage. B) damage to your automobile coverage.

C) underinsured damage coverage. D) property damage coverage.

Answer: BDiff: 2Topic: Collision Loss CoverageAACSB: Analytical Thinking

47) ________ auto insurance pays for your losses and the losses suffered by your passengers, while

the other driverʹs insurance would pay for his or her losses. This arrangement is made to keep

insurance costs down, especially for settling claims.

A) Comprehensive

B) No-fault

C) Your fault

D) PAP

E) PIP

Answer: BDiff: 2Topic: No Fault CoverageAACSB: Analytical Thinking

48) Elvis drove expensive cars. Which of the following was not a determinant in his automobile

insurance costs?

A) Type of vehicle

B) His personal characteristics

C) His driving record

D) Where he lived

E) All of the above WERE determinants in the cost of his auto insurance.

Answer: EDiff: 2Topic: Personal Automobile PolicyAACSB: Reflective Thinking

49) Suppose that, during a party, one of your guests drove their car into the corner of your garage

while turning around. Where would you look for damage payment to fix your garage?

A) Their homeownerʹs insurance

B) Your homeownerʹs insurance

C) Your guestʹs PAP liability coverage

D) Your guestʹs PAP comprehensive insurance

E) Your guestʹs PAP collision insurance




50) Valerie was very angry at her soon to be exhusband and when she found his expensive sports

car at his girlfriendʹs home she rammed into it with her pickup truck. Will her insurance policy

cover the damage to her vehicle?

A) Yes, she has full coverage.

B) No, one of the exclusions on her policy says it will not cover if the damage was intentional.


51) ________ would provide coverage for you against injuries caused by a negligent driver whose

insurance company is insolvent.

A) Collision coverage

B) Personal liability coverage

C) Negligent driver rider

D) Uninsured motoristʹs protection coverage


Answer: DDiff: 2Topic: Uninsured Motorists CoverageAACSB: Analytical Thinking

52) Uninsured motorists coverage

A) can be purchased by uninsured drivers after an accident to retroactively cover their losses.

B) will not provide coverage if the other driverʹs insurance company is insolvent.

C) will cover injuries caused by a hit-and-run driver.

D) All of the above are true.

Answer: CDiff: 3Topic: Uninsured Motorists CoverageAACSB: Analytical Thinking

53) What type of auto insurance protects you in the case of accident regardless of who caused the

accident?

A) No-cause insurance

B) No-fault insurance

C) No-litigation insurance

D) Cause-free insurance





54) In general, which of the following is true regarding the amount of liability insurance you should

carry?

A) It should never be greater than your stateʹs minimum.

B) It should be inversely proportional to your net worth.

C) The greater your assets, the more coverage you should carry.

D) None of the above are correct.


55) Rosanne was in a car crash a few years ago that left her with hearing loss. She has decided to

sue the owner of the other automobile for the medical costs of recovering her hearing. How

many years, from the date of the crash, does she have to file a claim for the expenses?

A) 1 year

B) 2 years

C) 3 years

D) 4 years

E) There is no time limit for filing for medical expenses.

Answer: CDiff: 2Topic: Automobile AccidentsAACSB: Analytical Thinking

56) In your many travels, you have suddenly found yourself in an auto accident the very first one

where you are at fault. Both cars are blocking a bridge with heavy city traffic. What should you

do?

A) Stay at the scene of the accident have someone call the police and get medical help.

B) Move the cars to a safe place so no one else gets hit.

C) Call a lawyer to meet you at the scene of the accident.

D) Refrain from admitting guilt or signing anything.

E) All of the above except C

Answer: EDiff: 2Topic: Automobile AccidentsAACSB: Analytical Thinking

57) With automobile insurance damage claims, Insurance companies will use the concept of

ʺcontributory negligenceʺ to determine how much to pay in damages. What does this concept

mean?

Answer: The term contributory negligence deals with the fact that some driverʹs behaviors actually

contributed to the accident and that these behaviors are not insured by the basic PAP.

Things like speeding, driving too fast for conditions, running a red light, not wearing a

seat belt or driving under the influence of drugs or alcohol contributed to the accident

occurring. Since the driver was determined to be negligent in causing the wreck, then the

Insurance company will reduce their payout accordingly.Diff: 3Topic: Personal Automobile PolicyAACSB: Reflective Thinking



58) You plan to purchase a personal automobile policy on your new car. You want to be able to

understand the four basic parts, which are:

Answer: Part A: Liability coverage provides protection for you if you are legally liable for bodily

injury and property damage caused by your automobile. It includes payment for any

judgment awarded, court costs, and legal defense fees.

Part B: Medical expense coverage pays medical bills and funeral expenses, with limits

per person, for you and your passengers.

Part C: Uninsured motoristʹs protection coverage protects you by covering bodily injury

and property damage caused by drivers without liability insurance. It is required in

many states.

Part D: Damage to your automobile provides coverage for collision with another vehicle

or an object. With collision insurance, losses are covered regardless of whose fault it is.Diff: 1Topic: Personal Automobile PolicyAACSB: Reflective Thinking

59) The personal automobile policy (PAP) provides broad coverage, but there are a number of

standard exceptions. Give five of them here.

Answer: You are not covered when:

-intentional injury or damage is involved

-using a vehicle without permission of the owner

-using a vehicle with fewer than four wheels

-driving another personʹs car that is provided for you on a regular basis

-you own the automobile but do not have it listed on your insurance policy

-you are carrying passengers for a fee

-driving in a race or speed contestDiff: 2Topic: Personal Automobile PolicyAACSB: Analytical Thinking

60) You want to make an informed choice in buying auto insurance. You have studied the major

cost determinants. Write a report in first person telling how they will affect you.

Answer: The sportier and more high-powered car I own, the more my insurance will cost. I will

consider an economical one. The less I drive my car to work and other places, the less it

will cost to own a PAP. My age, sex, marital status will have a direct effect on my rates.

Being a young, single male will cost me plenty. The fewer traffic accidents and tickets I

have had, the less my insurance will cost, and vice versa. My premiums will be less

because I live in a rural area. My friends who live in urban areas will pay more. By

installing certain safety features and showing I possess personal characteristics that

identify me as a safe driver, I will save even more.Diff: 2Topic: Personal Automobile PolicyAACSB: Analytical Thinking



61) You want to keep your insurance costs down on your car. Prepare a list of things to ask your

agent and to do in general.

Answer: 1. Is your company a high-quality, top-rated firm by A.M. Best?

2. Do you give the standard discounts for nonsmokers, nondrinkers, driving school

grads, good students, car poolers, etc.?

3. Do you give a good discount for higher deductibles?

4. Can you help me keep adequate liability insurance?

5. Do I really need all of these policy features?

6. I will shop around and improve my driving record.Diff: 2Topic: Personal Automobile PolicyAACSB: Reflective Thinking

62) Your assignment is to explain the basis for no-fault insurance. Do so in one brief, but thorough,

paragraph.

Answer: Over half the states have instituted some variation of no-fault auto insurance. The theory

behind this concept is that your insurance company should pay for your losses,

regardless of who is at fault for the accident. All of the legal expenses associated with

attaching blame would then be lifted and insurance coverage should be less costly.

Insurance companies are always looking for ways to keep the costs down, particularly

settling claims.Diff: 2Topic: No Fault CoverageAACSB: Analytical Thinking

63) You made a list of things to do when involved in an auto accident but you lost it. You have

just been in a wreck with another vehicle. What are five important things to do now?

Answer: 1. Get help for the injured and have someone call the police and an ambulance.

2. Move your car to a safe place, if possible, to prevent further accidents.

3. Get the names and addresses and license plate numbers of all vehicles involved.

4. Cooperate with the police.

5. Insist on alcohol tests if you suspect drinking was involved.Diff: 1Topic: Automobile AccidentsAACSB: Reflective Thinking

64) List seven general ways you can keep your automobile insurance rates down while ensuring

complete coverage.

Answer: 1. Shop comparatively.

2. Consider only high-quality insurers.

3. Take advantage of discounts.

4. Buy a car thatʹs relatively inexpensive to insure.

5. Improve your driving record.

6. Raise your deductibles.

7. Keep adequate liability insurance.Diff: 3Topic: Automobile InsuranceAACSB: Analytical Thinking



65) List the most common automobile insurance discounts.

Answer: Accident-free discount

Multiple-automobiles discount

Low annual mileage discount

Multi-policy discount

Low ʺdamageabilityʺ discount

Good-student discount

Over-50 discount

Defensive-driving course completion discount

Passive-restraints discount

Non-commuter or carpooler discount

Antitheft-devices discountDiff: 2Topic: Automobile Insurance DiscountsAACSB: Analytical Thinking

66) Briefly describe the most common automobile insurance discounts.

Answer: Accident free: A 10 percent discount on most coverage after three years without a

chargeable accident. After six years, the discount rises to 15 percent.

Multiple automobiles: a 15 percent discount for insuring more than one car with the

same company.

Low annual mileage: a 15 percent discount if you drive fewer than 7,500 miles per year.

Automobile and homeownerʹs together: 5 to 15 percent off of both policies, if the policies

are with the same company.

Low ʺdamageabilityʺ: 10 to 30 percent off of collision and comprehensive premiums if

the car is statistically less likely to result in an expensive claim because it is cheaper to

repair or less appealing to thieves.

Good student: Up to a 25 percent discount for unmarried drivers under 25 years old who

rank in the top 20 percent of their class, have a B average, or are on the honor roll.

Over 50: A 10 percent discount off of the usual adult rate if you are more than 50 years

old.

Defensive driving course: A 5 percent discount if you complete a defensive-driving

course (which often only applies to drivers 55 years of age or older).

Passive restraints: Up to a 40 percent discount on some coverage if you have air bags or

automatic seatbelts. Antilock brakes also add a 5 percent discount.

Non-commuter or carpooler: A 15 percent discount if you drive less than 30 miles to and

from work each day.

Antitheft devices: A 15 percent discount, depending on where you live and the type of

device you employ.Diff: 3Topic: Automobile Insurance DiscountsAACSB: Analytical Thinking


Chapter 11Investment Basics

11.1 Before You Invest

1) As the owner of a corporate bond this means I hold an ownership position within that

corporation.

Answer: FALSEDiff: 1Topic: BondsAACSB: Diverse and Multicultural Work Environments

2) Real estate investments are more liquid than stocks most of the time.

Answer: FALSEDiff: 1Topic: Real EstateAACSB: Analytical Thinking

3) Investing in bonds is generally less risky than investing in stocks.

Answer: TRUEDiff: 1Topic: BondsAACSB: Diverse and Multicultural Work Environments

4) Stocks represent a legal obligation for the issuing company to pay dividends, whether the

company has made a profit or not.

Answer: FALSEDiff: 1Topic: StocksAACSB: Diverse and Multicultural Work Environments

5) Bonds are always a safe investment if held to maturity.


6) To begin your savings plan it is a good idea to set aside your savings first and only spend what

is left over.

Answer: TRUEDiff: 1Topic: Financial GoalsAACSB: Reflective Thinking

7) On the TV show ʺThe Big Bang Theoryʺ the main characters are frequently seen purchasing

comic books. Purchasing rare comic books is an example of investing.

Answer: FALSEDiff: 1Topic: SpeculationAACSB: Analytical Thinking



8) An option gives you the right to buy or sell the underlying asset at a set price on or before the

optionʹs maturity date.

Answer: TRUEDiff: 1Topic: DerivativesAACSB: Diverse and Multicultural Work Environments

9) Investing in assets such as collectable Barbie Dolls or Beanie Babies are both example of

speculating.

Answer: TRUEDiff: 1Topic: InvestmentAACSB: Diverse and Multicultural Work Environments

10) Purchasing derivatives is a form of speculating.

Answer: TRUEDiff: 1Topic: DerivativesAACSB: Diverse and Multicultural Work Environments

11) Long-term capital gains have favorable tax treatment over earned income.

Answer: TRUEDiff: 1Topic: Capital Gains/LossAACSB: Information Technology

12) A lending type investment, such as a corporate bond, represents a legal obligation for the issuer

to pay its creditors back.

Answer: TRUEDiff: 1Topic: LendingAACSB: Diverse and Multicultural Work Environments

13) A typical bond will pay annual coupon payments until it matures, at which time it will

surrender its par value to the owner of the bond.

Answer: TRUEDiff: 1Topic: BondsAACSB: Analytical Thinking

14) If the corporation that issued a bond goes bankrupt, the bondholders are paid before stock

holders are paid from any remaining assets of the corporation.



Chapter 11 Investment Basics 307

15) A company that doesnʹt make a dividend payment is insolvent and may be forced into

bankruptcy by the stockholders.

Answer: FALSEDiff: 3Topic: StocksAACSB: Diverse and Multicultural Work Environments

16) The rate of return on an investment is calculated by dividing the capital gain or loss plus the

cash flows by the initial investment amount.

Answer: TRUEDiff: 3Topic: ReturnsAACSB: Analytical Thinking

17) Investing in bonds tends to be riskier financial strategy than investing in common stocks.


18) Which of the following investors will potentially receive dividends on their investments?

A) Bondholders

B) Stockholders

C) Debt holders

D) Derivative holders


Answer: BDiff: 2Topic: DividendsAACSB: Analytical Thinking

19) An investor owns stock from seven different companies, two rental houses, and three

government bonds. Together these assets are considered to be the investorʹs

A) collection.

B) derivative holding.

C) asset class.

D) portfolio.


Answer: DDiff: 1Topic: PortfolioAACSB: Diverse and Multicultural Work Environments



20) The ________ date is the date at which the bond issuer must repay the loan or borrowed funds.

A) premium

B) ending

C) completion

D) maturity


Answer: DDiff: 1Topic: Maturity DateAACSB: Information Technology

21) Suppose that you purchased a machine several years ago for your company. You recently sold

the machine for more than you paid. This is an example of a

A) capital carry-forward.

B) non-taxable gain.

C) capital gain.

D) windfall.


Answer: CDiff: 1Topic: Capital Gains/LossAACSB: Analytical Thinking

22) The ________ is the stated amount on the face of a bond, which the firm is to repay at the

maturity date.

A) historical value

B) debt price

C) par value

D) relevant value


Answer: CDiff: 1Topic: BondsAACSB: Information Technology

23) The ________ rate is the interest to be paid annually on a bond as a percentage of its par value.

A) base

B) coupon interest

C) face interest

D) compound interest


Answer: BDiff: 2Topic: BondsAACSB: Information Technology



24) You are considered to be engaging in ________ when you purchase an asset whose value

depends solely on supply and demand.

A) investing

B) speculation

C) hedging

D) optioning


Answer: BDiff: 1Topic: SpeculationAACSB: Diverse and Multicultural Work Environments

25) A security whose value is based solely on the value of other assets is called a ________ security.

A) capital option

B) hedging

C) derivative

D) alternative asset


Answer: CDiff: 1Topic: DerivativesAACSB: Diverse and Multicultural Work Environments

26) When you purchase an asset that generates a return, it is generally considered to be

A) an investment.

B) speculation.

C) a windfall.

D) an expected returner.


Answer: ADiff: 1Topic: InvestmentAACSB: Diverse and Multicultural Work Environments

27) If you bought a 20-year bond issued by the government, with a par value of $1,000 and an

interest rate of 8%. At maturity you will be returned the principal of

A) $80. B) $500. C) $800. D) $1,000. E) $1,600.

Answer: DDiff: 3Topic: BondsAACSB: Analytical Thinking



28) As a young college graduate, your biggest investment ally is

A) leverage.

B) a windfall.

C) tax-free investments.

D) time.

E) derivatives.

Answer: DDiff: 2Topic: Financial PlanningAACSB: Reflective Thinking

29) You can make investments on a ________ basis, which means that not only does your

investment grow free of taxes, but the money you invest isnʹt taxed until you liquidate your

investment.

A) tax-eliminated B) progressive tax

C) tax-deferred D) asset management

Answer: CDiff: 1Topic: Financial PlanningAACSB: Diverse and Multicultural Work Environments

30) Long term capital gains are taxed at ________ percent.

A) 8 B) 10 C) 15 D) 25 E) 40

Answer: CDiff: 1Topic: LeverageAACSB: Analytical Thinking

31) Petrina was told by a successful friend to invest in stocks and income-producing real estate.

Both of these are examples of ________ investments.

A) ownership

B) lending

C) risk-free

D) short-term

E) liquid

Answer: ADiff: 2Topic: OwnershipAACSB: Diverse and Multicultural Work Environments

32) If you purchase some shares of stock

A) you may earn dividends. B) you will definitely earn dividends.

C) you may earn coupon interest. D) you will definitely earn coupon interest.

Answer: ADiff: 3Topic: Income ReturnsAACSB: Diverse and Multicultural Work Environments



33) Jennifer has money invested in stocks. She earns a return on her investment, which is a portion

of the companyʹs profits, called

A) interest.

B) a return.

C) dividends.

D) growth.

E) retained earnings.

Answer: CDiff: 2Topic: DividendsAACSB: Diverse and Multicultural Work Environments

34) What is an advantage to being a ʺpreferredʺ stock holder?

A) Preferred stock holders always get to vote for the board of directors of the company.

B) Preferred stock holders receive a better coupon interest rate.

C) Preferred stock holders receive dividend payouts before common stock holders do.

D) Preferred stock holders never pay commissions on their stock trades.

E) There are no advantages to being a preferred stock holder.

Answer: CDiff: 3Topic: LendingAACSB: Analytical Thinking

35) Hern MacTavish only invests in lending investments. If his financial advisor gave him the list

below, which might Hern invest in?

A) Saving accounts

B) Stocks

C) Income-producing real estate

D) Bonds

E) Both A and D

Answer: EDiff: 2Topic: LendingAACSB: Diverse and Multicultural Work Environments

36) Real estate investments can be income-producing investments. Which of these would be

included as an income-producing real estate investment?

A) An apartment complex

B) A shopping mall

C) Your personal home

D) All of the above

E) Only A and B above

Answer: DDiff: 1Topic: Real EstateAACSB: Analytical Thinking



37) The difference between an investment and speculation is that an investment ________ while

speculation depends solely on ________ to produce results.

A) costs less; the economic conditions

B) generates a return; supply and demand

C) costs less; generating a return

D) depends on supply and demand; economic conditions

E) depends on supply and demand; generating a return

Answer: BDiff: 2Topic: InvestmentAACSB: Diverse and Multicultural Work Environments

38) Just as valuable as the tax break on capital gains income is the fact that you donʹt have to claim it

and, therefore, you donʹt pay taxes on the asset until you

A) have an equal match in personal income.

B) sell it.

C) retire.

D) file your next yearsʹ taxes.


39) Which of the following questions is relevant to setting investment goals?

A) If I donʹt accomplish this goal, what are the consequences?

B) Am I willing to make the financial sacrifices necessary to meet this goal?

C) When do I need this money?

D) How much money do I need to accomplish this goal?

E) All of the above are relevant.

Answer: EDiff: 2Topic: Financial GoalsAACSB: Reflective Thinking

40) An option gives its owner the right to buy or sell an asset. This asset is generally

A) preferred stock.

B) mutual funds.

C) corporate bonds.

D) common stock.


Answer: DDiff: 2Topic: Financial PlanningAACSB: Diverse and Multicultural Work Environments



41) Lavon has his money invested into an asset that has averaged the following returns the last

three years: +22%, -8%, +13%. Most likely what type of asset is he invested in?

A) Corporate bonds B) Income producing real estate

C) Gold coins D) Common stock

Answer: DDiff: 2Topic: StocksAACSB: Diverse and Multicultural Work Environments

42) Latisha invested $1,000 in XYZ stock. Two years later she sold the stock for $1,200. During the

time she owned the stock, she received a total of $80 in dividends. What was her total return on

this investment?

A) 8% B) 20% C) 23.33% D) 28%


43) Tran purchased a house for a rental property for $100,000 five years ago. During the time he

owned this rental, his net rental income was a total of $4,000. He just sold the property for

$120,000. What was his average annual return on this investment?

A) 4.0% B) 4.8% C) 20% D) 24%


44) Juan purchased shares in ABC company for $5,000 three years ago. During these three years he

received $600 in dividends. He just sold the stock for $4,300. What was his total return on this

investment?

A) –14% B) –2% C) 12% D) 14%


45) Louis purchased $5,000 worth of stock three years ago and sold it today for $7,000. He received

no dividends from this investment. Inflation averaged 4% during the three years he owned the

stock. What was his annualized real rate of return on this investment?

A) 4% B) 9.33% C) 13.33% D) 36% E) 40%




46) Paula bought a stock for $200 last year and sold it today for $150. If she earned a dividend of

$100 while she held the stock her rate of return was

A) –50%. B) –25%. C) 25%. D) 33.33%. E) 50%.

Answer: CDiff: 1Topic: ReturnsAACSB: Analytical Thinking

47) If the total rate of return is multiplied by 1/N, where N is the number of years for which the

investment was held, the result is the

A) serialized rate of return. B) annualized rate of return.

C) tax-free rate of return. D) capitalized rate of return.


48) You purchased an investment for $1,000 on which you earned $120 investment last year. The

inflation rate during that time was 3%. What was your real rate of return?

A) 3%

B) 9%

C) 12%

D) 15%


Answer: BDiff: 3Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

49) You recently purchased a stock for $50. It is now worth $75, and it paid a $15 dividend during

the two years you held it. What is your annualized rate of return on this stock?

A) 80% B) 40% C) 27% D) 25%



the time you held it. Your rate of return on this stock is closest to which of the following?

A) 60% B) -20% C) 43% D) 40%

Answer: ADiff: 3Topic: ReturnsAACSB: Analytical Thinking



51) You recently purchased 100 shares of stock at $15 per share. The stock is now worth $20 per

share, and it paid a $2 dividend during the time you held it. Your rate of return on this stock is

closest to which of the following?

A) -20% B) 33% C) 35% D) 47%



the time you held it. Your rate of return on this stock is closest to which of the following?

A) 67% B) 50% C) 38% D) 33% E) 17%


53) What are the four financial questions that help focus on investing goals?

Answer: - If I do not accomplish this goal, what are the consequences?

- Am I willing to make the financial sacrifices necessary to meet this goal?

- How much money do I need to accomplish this goal?

- When do I need this money?Diff: 1Topic: Financial GoalsAACSB: Reflective Thinking

54) A prerequisite to investing is to perform a financial reality check. Explain its 3 parts.

Answer: Balance your budget. If you do not live within your means, you will never be able to save,

invest, or achieve any of your financial goals. Put a safety net in place by carrying

adequate insurance life, health, auto, homeownerʹs, liability to protect your assets

and you against catastrophes. Maintain adequate emergency funds in a safe investment

of 6 to 9 months of take-home pay.Diff: 2Topic: Financial PlanningAACSB: Reflective Thinking

55) Why is speculating in derivatives, futures contracts and options not appropriate for the typical,

long-term investor?

Answer: These are highly speculative securities that are not appropriate for the typical investor

using their important money to reach their long-term goals. These securities require

sophisticated knowledge and research not typically found in the average investor.

Because they derive their value from other assets, these securities do not generate a

return unless the underlying assets behave in a certain manner.Diff: 3Topic: DerivativesAACSB: Reflective Thinking



56) Compare and contrast lending and ownership investments.

Answer: You actually lend someone your money in a lending investment, such as a saving account

or a bond. The original investment or principal does not grow in a lending investment. It

returns interest annually and the original investment when retiring it. Note: Bonds

appreciate or depreciate in value based on changes in interest rates. Investing in bonds

can lead to capital gain (loss) much the same as equities if timed properly.

An ownership investment, such as stocks or income-producing real estate, provides an

annual return plus the potential for appreciation or growth in value of the original

principal.Diff: 2Topic: InvestmentAACSB: Analytical Thinking

57) What is the purpose of return on investment?

Answer: The return on investment communicates several pieces of important information. First the

potential return signals the risk associated with the investment. Principle 8: Risk and

Return go hand in hand tells us that the higher the potential return, the more risk

associated with the investment. Secondly, the return signals the opportunity cost of the

investment. An investment with a potential return of 6% means that you would be giving

up the opportunity to earn a higher or lower return on another investment option. You

would need to analyze the risk associated with each return to determine if one was more

appropriate than the other. Lastly, the potential return communicates how likely it will be

for you to obtain your financial goals. A low return may signal an investment that is to

conservative for you to reach your long term goals. A high return may signal that the

investment is to risky and inappropriate for your needs.Diff: 3Topic: ReturnsAACSB: Analytical Thinking

11.2 A Look at Risk-Return Trade-Offs

1) The nominal rate of interest that investors demand will increase with an increase in the expected

rate of inflation.

Answer: TRUEDiff: 2Topic: Risk PremiumsAACSB: Diverse and Multicultural Work Environments

2) The real rate of return is the nominal rate of return adjusted for inflation.


3) If you are too conservative with your investments, they may not keep up with inflation.




4) The real rate of return is the rate of return earned on an investment without any adjustment for

inflation.


5) When it comes to tax advantages, capital gains and dividend income are taxed at a lower rate

than ordinary income.

Answer: TRUEDiff: 1Topic: TaxesAACSB: Diverse and Multicultural Work Environments

6) The higher your marginal tax bracket, the less attractive tax-free investments become.


7) During times of rising inflation, investments with fixed returns like a bond or bank CD are

attractive investments to own.

Answer: FALSEDiff: 2Topic: InflationAACSB: Diverse and Multicultural Work Environments

8) The nominal rate of return is simply the real rate of return minus the inflation rate.


9) If the nominal rate is 10% and inflation is 3%, the real rate of return is 7%.


10) The real rate of return can never be a negative number.


11) Interest rates are closely tied to the rate of inflation.




12) Market risk deals with the inability to sell a security quickly at fair market value.

Answer: FALSEDiff: 1Topic: RiskAACSB: Diverse and Multicultural Work Environments

13) Historically, U.S. government securities have been considered the safest, lowest-risk investment

available.

Answer: TRUEDiff: 1Topic: RiskAACSB: Diverse and Multicultural Work Environments

14) Some types of investments expose you to multiple sources of risk.


15) Diversification eliminates all the risk from your portfolio.

Answer: FALSEDiff: 2Topic: DiversificationAACSB: Diverse and Multicultural Work Environments

16) Market risk is the risk of fluctuations in security prices due to changes in the market interest

rate.


17) One of the most important types of risk associated with real estate is the liquidity risk.


18) The risk associated with the use of debt by the firm is business risk.


19) Particularly, during election years, investors should make themselves aware of the risk resulting

from unanticipated changes in the tax or legal environment. This is classified as political and

regulatory risk.




20) Diversification lowers risk, but it also lowers the expected return.

Answer: FALSEDiff: 2Topic: DiversificationAACSB: Diverse and Multicultural Work Environments

21) For the international investor, exchange rate risk is simply another layer of risk.

Answer: TRUEDiff: 2Topic: RiderAACSB: Diverse and Multicultural Work Environments

22) Systematic risk can be effectively managed through diversification.


23) Diversification works in oneʹs portfolio because stock returns in oneʹs portfolio do not always

move in the same direction; as a result, the upswings and downturns in oneʹs portfolio eliminate

one another.

Answer: TRUEDiff: 3Topic: DiversificationAACSB: Diverse and Multicultural Work Environments

24) An investor with a low propensity for risk would avoid investments with high risk premiums.

Answer: TRUEDiff: 3Topic: Risk PremiumsAACSB: Diverse and Multicultural Work Environments

25) Unsystematic risk cannot be eliminated through diversification.

Answer: FALSEDiff: 3Topic: Risk PremiumsAACSB: Diverse and Multicultural Work Environments

26) Call risk is the risk to bondholders that a bond may be called away from them before maturity.


27) Risk capacity refers to the strength of your financial safety net.




28) Your emergency fund should always be invested in illiquid assets.

Answer: FALSEDiff: 2Topic: Emergency FundAACSB: Diverse and Multicultural Work Environments

29) Suppose that you are beginning an investment plan. You have decided that you want to retire in

30 years with $1,000,000 in your bank account at that time. How much would you need to invest

at the end each of the next 30 years if you could earn 8%?

A) $11,924,613.33

B) $83,860.16

C) $46,030.93

D) $22,045.16

E) $8,827.43


30) One should keep in mind that when it comes to tax advantages, ________ is/are better than

________.

A) ordinary income; capital gains B) capital gains; ordinary income

C) tax shelters; capital gains D) marginal rates; ordinary income

Answer: BDiff: 3Topic: Capital Gains/LossAACSB: Diverse and Multicultural Work Environments

31) The nominal rate of return minus the inflation rate is called the

A) stated rate of return.

B) standard rate of return.

C) real rate of return.

D) Fisher effect.


Answer: CDiff: 1Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

32) Historical rates of return for the last 82 years place ________ at the highest end of the spectrum

for risk and ________ at the lowest end for risk.

A) common stocks; T-Bills

B) common stocks; long-term government bonds

C) common stocks; long-term corporate bonds

D) long-term corporate bonds; long-term government bonds

Answer: ADiff: 2Topic: ReturnsAACSB: Diverse and Multicultural Work Environments



33) The ________ rate of return earned on an investment is unadjusted for lost purchasing power.

A) effective

B) annual

C) real

D) nominal


Answer: DDiff: 1Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

34) When market interest rates go up investors demand ________ returns on other types of

investments and when market interest rates go down, the return investors demand on other

types of investments ________.

A) lower; goes down B) higher; goes down

C) lower; goes up D) higher return; goes up

Answer: BDiff: 2Topic: Interest RatesAACSB: Information Technology

35) While studying the chapter on investments in Personal Finance, Becky Hargrith found out that

the ________ is equal to the real rate of return plus the rate of inflation.

A) adjusted rate B) long-term rate of return

C) nominal interest rate D) real interest rate

Answer: CDiff: 3Topic: Interest RatesAACSB: Diverse and Multicultural Work Environments

36) Alice learned that the difference between the real rate of return and the nominal or quoted rate

of return is that

A) the real rate is adjusted for inflation.

B) the real rate is not adjusted for inflation.

C) the nominal rate is adjusted for inflation.


Answer: ADiff: 2Topic: ReturnsAACSB: Diverse and Multicultural Work Environments



37) Principle #4, taxes affect personal finance decisions, tells us that several points hold true

regardless of what we invest in. Jason found a point that was included on the list in error. Which

of the following is it?

A) The marginal tax rate is the rate you pay on the next dollar of earnings.

B) Tax-free investments should be compared on a before-tax basis.

C) You should consider tax-deferred investments.

D) Capital gains are better than ordinary income when it comes to taxes.

E) The higher your marginal tax bracket, the more attractive tax-free investments become.

Answer: BDiff: 3Topic: TaxesAACSB: Reflective Thinking

38) Lawrence Wright is slow in math. He has before him the equation of (ending value minus

beginning value) and income return totalled, then divided by beginning value. This is used to

find the

A) rate of inflation.

B) capital gain.

C) capital loss

D) rate of return.

E) serialized rate of return.

Answer: DDiff: 3Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

39) That portion of a stockʹs risk or variability that can be eliminated through investor

diversification is called ________ risk.

A) unsystematic

B) systematic

C) volatility

D) inflation

E) portfolio

Answer: ADiff: 1Topic: RiskAACSB: Diverse and Multicultural Work Environments

40) That portion of a stockʹs risk or variability that cannot be eliminated through investor

diversification is called ________ risk.

A) unsystematic

B) systematic

C) unrealistic

D) inflation

E) volatility

Answer: BDiff: 1Topic: RiskAACSB: Diverse and Multicultural Work Environments



41) You have just purchased a large number of Italian bonds, and you reside in the United States.

The variability in earnings that you might experience as the relationship between the euro and

the U.S. dollar fluctuates is called

A) currency volatility risk.

B) international risk.

C) exchange rate risk.

D) fluctuation risk.


Answer: CDiff: 1Topic: RiskAACSB: Diverse and Multicultural Work Environments

42) Which of the following is not risk that can be diversified out of a portfolio of stocks?

A) unsystematic B) systematic

C) firm specific D) company-unique


43) Bruce Lee owns stocks, bonds, real estate, gold coins, T-Bills, and gemstones. He has a(n)

A) equity portfolio.

B) default-proof portfolio.

C) inflation-proof portfolio.

D) diverse portfolio.

E) risk adverse portfolio.

Answer: DDiff: 3Topic: DiversificationAACSB: Diverse and Multicultural Work Environments

44) You are considering the purchase of a corporationʹs stock. You have noted that this particular

corporation has a high use of debt, which is associated with ________ risk.

A) business

B) financial

C) corporate

D) market


Answer: BDiff: 1Topic: RiskAACSB: Analytical Thinking



45) Changes in the capital gains tax rate, or in the tax deductibility on municipal bonds are

examples of ________ risk.

A) inflation

B) political and regulatory

C) interest rate

D) exchange rate risk



46) Barney Hopkins is the financial manager for Amax Corporation. He knows that ________ risk

deals with good or bad management decisions and ________ is associated with his companyʹs

use of debt.

A) market; business

B) market; financial

C) business; interest rate

D) business; financial

E) financial; business

Answer: DDiff: 2Topic: RiskAACSB: Diverse and Multicultural Work Environments

47) Many people never consider or think of the sources of risk that affect their investments. Which

of the following is a risk associated with investing?

A) Interest rate risk

B) Inflation risk

C) Business risk

D) Financial risk

E) All of the above

Answer: EDiff: 1Topic: RiskAACSB: Diverse and Multicultural Work Environments

48) ________ risk is simply the variability in the returns of an investment that is due to events that

are unrelated to the overall market.

A) Systematic B) Unsystematic

C) Non-diversifiable D) Portfolio

Answer: BDiff: 2Topic: Risk PremiumsAACSB: Diverse and Multicultural Work Environments



49) The risk that you will not be able to find a buyer at a fair market price, and will wind up having

to sell for less than an assetʹs worth is called ________ risk.

A) inflation B) interest C) liquidity D) call


50) Alice just inherited an antique wood burning stove. While she appreciates the sentimental value

of the stove she is concerned that an investment such as this might not be able to be converted

into cash quickly at a fair market price. Alice is worried about ________ on this as an

investment.

A) liquidity risk

B) cash conversion

C) maturity risk

D) default risk


Answer: ADiff: 1Topic: Risk PremiumsAACSB: Diverse and Multicultural Work Environments

51) You own a bond issued by BMW, a German company. What kind of risk are you exposed to?

A) Inflation risk B) Interest rate risk

C) Exchange rate risk D) All of the above are correct.


52) What type of investment would have a high risk premium associated with political and

regulatory risk?

A) A drug company B) A casino company

C) A tobacco company D) All of the above are correct.

Answer: DDiff: 2Topic: Risk PremiumsAACSB: Diverse and Multicultural Work Environments

53) Which of the following would have liquidity risk associated with it?

A) A rare comic book

B) A house

C) A stamp collection






54) Albert just purchased a $1,000, 5.4%, 10-year bond when he heard about his friend Charlie who

just bought a similar bond at $1,000; 9.5%, 10-year bond. What kind of risk did Albert just

experience?

A) Interest rate B) Market C) Financial D) Business


55) Recently an oil rig in the Gulf of Texas blew up causing the value of your stock in the company

who owns the oil rig to fall. What type of risk does this represent?

A) Diversifiable risk B) Systematic risk

C) Political and regulatory risk D) Both B and C


56) As the number of stocks in your portfolio increases

A) the variability in your portfolio increases.

B) the systematic risk in your portfolio increases.

C) the unsystematic risk in your portfolio increases.



57) What are the benefits of a well-diversified portfolio?

A) It protects you from systematic risk.

B) It protects you from firm specific risk.

C) It protects you from company-unique risk.




58) Examples of political and regulatory risk include

A) changes in the tax deductibility of interest on municipal bonds.

B) changes in the capital gains tax rate.

C) changes in the exchange rates.






59) Hostess and Kodak recently filed for bankruptcy protection in an attempt to restructure their

debts. One could assume that both of these companies experienced too much ________ risk.

A) business B) interest rate C) financial D) liquidity


60) During the economic downturn that occurred between the fall of 2007 and spring of 2009, stocks

declined in price. This period is known as a(n)

A) hare market. B) tortoise market.

C) bull market. D) bear market.

Answer: DDiff: 2Topic: RiskAACSB: Reflective Thinking

61) Principle #2: the time value of money tells us that time is our greatest ally. This being so, the

most important and most difficult step is making the commitment to get started. Tell how to

find the money and get started with Principle #15: just do it.

Answer: Pay yourself first instead of last; that is, before spending for bills and lifeʹs necessities.

Making an automatic deposit directly from your paycheck or checking account makes it

less painful because you do not see this money first. Take advantage of your employerʹs

matching funds retirement plans and the governmentʹs tax reductions, such as IRAs. Use

windfalls for investing instead of spending them. If you are having trouble getting

started, pick two months per year to cut back on spending and make those your investing

months.Diff: 2Topic: Time Value of MoneyAACSB: Reflective Thinking

62) Provide an explanation of the four points of making a comparison of investing returns on an

after-tax basis.

Answer: The tax rate we should be concerned with is the marginal tax rate, because it is the rate

we pay on the next dollar of earnings. Check out tax-free investments, which become

more attractive as your marginal tax bracket increases. Investigate investments made on a

tax-deferred basis, which means the investment grows free of taxes until you liquidate

the investment.Diff: 1Topic: ReturnsAACSB: Diverse and Multicultural Work Environments



63) How do interest rates affect returns on other investments?

Answer: The expected returns on all investments are related. What you earn on one investment

determines what you demand on another. When interest rates go up, investors demand a

higher return on all other investments, and when interest rates go down, the return

investors demand on other investments goes down. In effect, all the different investments

compete for your investment dollars, and when interest rates go up, the other

investments have to match that increase.Diff: 2Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

64) The nominal return on an investment is an illusion. Explain.

Answer: An illusion is something that is different than what it appears to be. The nominal return is

an illusion because it inflates the nominal or face value of your money possibly without

actually increasing your purchasing power of your money. The real return adjusts for the

impact of inflation on your ability to purchased goods and services. The key to investing

is to increase your standard of living to allow you to maintain or increase the quantity of

goods and services that you desire. Negative real returns that do not exceed the rate of

inflation means that your purchasing power has diminished, lowering your standard of

living. Over the long term, this can seriously interfere with your retirement plans. Young

people need to be very aware of the impact of inflation and not to be too conservative

with their longer term investments.Diff: 2Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

65) Clarify the difference between systematic and unsystematic risk.

Answer: Systematic risk is that portion of a securityʹs risk or variability that cannot be eliminated

through investor diversification, in other words, that is part of the entire market system.

(This explanation might help student remember what is ʺsystematic.ʺ). This type of

variability or risk results from factors that affect all securities. Unsystematic risk is the

risk or variability that can be eliminated through investor diversification. Unsystematic

risk results from factors that are unique to a particular firm.Diff: 2Topic: RiskAACSB: Diverse and Multicultural Work Environments

66) How does the principle of diversification work?

Answer: Diversification eliminates risk by investing in different assets instead of one. It works by

allowing the extreme good and bad returns to cancel each other out. The result is that

total variability or risk is reduced without affecting expected return.Diff: 2Topic: DiversificationAACSB: Diverse and Multicultural Work Environments



67) Describe the sources of risk in the risk-return trade off.

Answer: The interest rate risk is the risk of fluctuations in security prices due to changes in the

market interest rate. Inflation risk reflects the likelihood that rising prices will eat away

the purchasing power of your money, and that changes in the anticipated level of

inflation will result in interest rate changes, which will in turn cause security price

fluctuations. The business risk deals with fluctuations in investment value that are

caused by good or bad management decisions, or how well or poorly the firmʹs products

are doing in the marketplace.

Financial risk is associated with the use of debt by the firm. How a firm raises and uses

its money affects its level of risk. Liquidity risk deals with the inability to liquidate, or

convert into cash, quickly a security at a fair market price. Market risk is risk associated

with the overall market movements - upward and downward. Political and regulatory

risk comes from laws imposed by state and national governments that affect investment

values. The exchange rate risk refers to the variability in earnings resulting from changes

in exchange rates among countries. Call risk is the risk to bondholders that a bond may be

called away from them before maturity, resulting in a loss of income or market value. All

of these types of risk make up the risk found in the risk-return trade off.Diff: 2Topic: RiskAACSB: Diverse and Multicultural Work Environments

68) Rank the historical rates of return of the common investments discussed in this chapter from

highest to lowest.

Answer: 1. Common stocks

2. Long-term corporate bonds

3. Long-term government bonds

4. Treasury billsDiff: 1Topic: ReturnsAACSB: Diverse and Multicultural Work Environments

69) What makes up the interest rate risk?

Answer: The inflation risk premium is the rate in addition to the real rate of return that investors

demand to compensate for anticipated inflation over the life of a security. Interest rate

risk also includes the default risk premium or an additional investment return to

compensate investors for taking on the risk that the issuer may not pay the interest or

principal on a security. A third factor is the maturity risk premium, which is an additional

return demanded by investors in longer-term securities to compensate for the fact that

the value of securities with longer maturities tends to fluctuate more when interest rates

change. The liquidity risk premium reflects the risk that some bonds cannot be converted

into cash quickly at a fair market price.Diff: 2Topic: RiskAACSB: Diverse and Multicultural Work Environments



70) Why do investors sometimes demand risk premiums when investing?

Answer: The typical investor is risk averse which means they donʹt like to take risks with their

important money like retirement savings. The problem is that conservative, low risk

investments typically do not provide a high enough real return to allow these risk averse

investors to reach their goals. In order to motivate these investors to assume a higher

level of risk, then there must be a higher potential return available. The various risk

premiums increase the potential nominal returns providing motivation for investors to

assume higher risks. Without these risk premiums no one would be willing to assume the

risks inherent with entrepreneurial activities severely limiting access to financial capital

needed for business investment.Diff: 3Topic: Risk PremiumsAACSB: Diverse and Multicultural Work Environments

71) Explain the concept of liquidity relating to personal financial planning.

Answer: Part of the risk-return tradeoff is the concept of liquidity. With our emergency fund, we

canʹt afford the risk of having our money tied up in an illiquid investment in case we

experience an emergency. Since we need to have quick access to our funds, we must

accept the lower returns associated with liquid assets. Unfortunately these liquid

investments offer low returns because they donʹt include the liquidity risk premium. With

our longer term monies outside of our emergency fund, we can afford to give up liquidity

for the extra returns. It may take us months or more to be able to liquidate the

investments but since we most likely donʹt need the money in a hurry, we generally have

choices. The main purpose of the emergency fund is to protect us from having to

liquidate other investments, possibly at an unfavorable price or terms.Diff: 3Topic: RiskAACSB: Diverse and Multicultural Work Environments

11.3 The Time Dimension of Investing and Asset Allocation

1) As the length of your investment horizon increases, you can assume greater risks with your

investing.

Answer: TRUEDiff: 2Topic: Time Dimension of InvestingAACSB: Diverse and Multicultural Work Environments

2) Liquidity risk is a very important part of the time dimension of investing.


3) A young investor who is averse to risk should invest their money in government bonds.

Answer: TRUEDiff: 2Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments



4) A typical young investor should have most of their retirement money allocated in common

stocks.

Answer: TRUEDiff: 2Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

5) Because Nancy is extremely risk averse she is less likely to receive a solid rate of return on her

investment portfolio than Babby who is more accepting of a risky portfolio.


6) A 60-year-old investor should not be too concerned about liquidity and market risk in their

retirement portfolio.

Answer: FALSEDiff: 2Topic: Time Dimension of InvestingAACSB: Diverse and Multicultural Work Environments

7) Typically, the closer you get to retirement, the smaller the proportion of your retirement funds

that should be invested in common stocks.


8) The concept of asset allocation has nothing to do with the time dimension of investing.

Answer: FALSEDiff: 2Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

9) A catastrophic loss is less critical to an older investor than it is to a younger investor since

younger investors typically have less money to lose.

Answer: FALSEDiff: 2Topic: Time Dimension of InvestingAACSB: Diverse and Multicultural Work Environments

10) Asset allocation and diversification are not related concepts.

Answer: FALSEDiff: 2Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments



11) Which of the following statements is not true of asset allocation?

A) Investments are spread across several different investment classes.

B) Investments reflect the investorʹs specific time horizon.

C) Allocation may be made in domestic stocks and bonds.

D) Allocation may be made in international stocks and bonds.

E) All of the above statements are true.

Answer: EDiff: 3Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

12) Asset allocation has to do with how your money should be divided among which of the

following?

A) Stocks

B) Corporate bonds

C) Government bonds

D) Real estate

E) All of the above


13) For individuals in their golden years who are approaching retirement, a mix of ________ percent

common stocks and ________ percent bonds is a relatively common recommendation from

financial planners.

A) 20, 80

B) 80, 20

C) 40, 60

D) 60, 40



14) Investing prior to age 54 is a time of ________ by investing the majority of oneʹs savings into

________.

A) wealth preservation; conservative funds

B) wealth preservation; preferred stocks

C) wealth accumulation; common stocks

D) wealth accumulation; bonds

E) wealth dispersal; common and preferred stocks

Answer: CDiff: 2Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments



15) As a young college graduate, your biggest investment ally is

A) leverage.

B) the amount of investment.

C) tax-free investments.

D) time.

E) the class of investments.

Answer: DDiff: 2Topic: InvestmentAACSB: Diverse and Multicultural Work Environments

16) Cretia Robritti discovered that the purpose of asset allocation is to ensure that the investor is

________, generally with holdings in several different ________ of investments.

A) protected; denominations

B) well diversified; amounts

C) well diversified; classes

D) evenly distributed; classes

E) evenly distributed; amounts

Answer: CDiff: 2Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

17) Principle 8, Risk and Return go hand in hand, tells us that you ________ as the length of the

investment horizon ________.

A) can afford to take on additional risk; increases

B) can afford to take on additional risk; decreases

C) cannot afford not to take on additional risk; shortens

D) cannot afford to take on additional risk; increases


18) Why should a younger investor, saving for the long term, have most of their money in common

stocks?

A) Over time, common stocks generate the largest average returns.

B) Investors with lots of time ahead of them have the opportunity to recover from a serious

investment set-back.

C) They require the least amount of knowledge, research and expense.






19) Why should investors with a short investment horizon invest less money in common stocks?

A) Because the stock market is very volatile and a catastrophic market event can happen at

any time.

B) Because the investors wonʹt have enough time available to effectively recover from a loss

of their investment principle.

C) Because the transaction costs will negatively affect their returns in the short-term.



Answer: EDiff: 3Topic: Time Dimension of InvestingAACSB: Diverse and Multicultural Work Environments

20) What does an effective asset allocation strategy provide to an investor?

A) An effective diversification strategy

B) An opportunity to maximize their returns based on appropriate risk.

C) An opportunity to minimize their losses based on appropriate risk.

D) All of the above are correct


Answer: DDiff: 3Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

21) Is it possible to both accumulate wealth and preserve wealth with the same asset allocation

strategy?

A) Yes, a well-constructed portfolio can achieve both goals effectively.

B) No, there are conflicting risks that are contrary to achieving both goals with the same asset

classes.

C) Yes, a diversified bond portfolio is appropriate for all investors.

D) No, a diversified stock portfolio is too risky for the typical young investor.

Answer: BDiff: 3Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

22) Which of the following statements regarding risk in investing is most correct?

A) Avoiding risk is the best strategy to accumulate wealth.

B) It is most important to avoid risk during the early years, up to age 54.

C) It is hard to achieve a positive real return by avoiding risk all together.

D) Trying to avoid risk is an exercise in futility.




23) Provide an explanation for the concept of asset allocation in investing and differentiate between

the 3 stages.

Answer: Asset allocation attempts to ensure that the investor is well diversified, generally with

holdings in several different classes of investments, with the objective being to increase

your return on those investments while decreasing your risk. The idea of the time

dimension of risk is taken into account by recognizing that common stocks are much less

risky over a longer time horizon.

Stage 1 is a time of wealth accumulation through age 54. Because the time horizon is long,

investments with higher returns and risks should be sought, especially common stocks, to

grow into large sums by retirement. Stage 2 consists of the golden years approaching

retirement, ages 55 to 64. Here the goal becomes preserving the level of wealth that has

already been accumulated and to allow this wealth to continue to grow. Move some of

the portfolio, up to 40%, from common stocks into bonds. Stage 3 is the retirement years

over age 65 when you are no longer saving, you are spending. Income is now of

paramount importance. Allow for some growth in savings simply to keep inflation from

devouring your accumulation.Diff: 2Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

24) How does the time dimension of investing relate to the concept of liquidity?

Answer: Liquidity concerns the ability to liquidate an asset for a fair market price in a reasonable

amount of time. The time dimension of investing means that having sufficient time

available until you need your funds allows you invest in less liquid assets that generally

have a higher return. The stock market is very volatile and it is common for there to be

severe market downturns from time to time. To someone who needs their money now,

they would not want to have to liquidate while the market value of their stocks has

plummeted, causing them a serious financial loss. Historically, the markets will recover

and investors who were not forced to liquidate at the lower market values will recover

most if not all of their capital. For a younger investor, a severe market downturn

represents a tremendous buying opportunity since many good stocks are ʹon saleʹ. To an

older investor who is not properly diversified, a severe market downturn could seriously

interrupt their retirement goals causing financial stress and anxiety.Diff: 3Topic: Asset AllocationAACSB: Diverse and Multicultural Work Environments

11.4 What You Should Know About Efficient Markets

1) It is very tough to consistently beat the market.

Answer: TRUEDiff: 2Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments



2) On average, just by chance, half of the stock marketʹs investors will outperform the market and

half will underperform the market.


3) The more efficient the market, the faster prices react to new information.


4) Under the risk aversion effect, investors who lose money are more reluctant to take risks.


5) The herd behavior effect involves the emotions of fearing regret and seeking pride, resulting in

selling winners too soon and keeping losers too long.

Answer: FALSEDiff: 3Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments

6) If you earned a negative 5% return on your investments while the overall stock market was

down 9% then you have outperformed the market.


7) An efficient market is one in which all relevant information about the stock is reflected in the

stock price.


8) In trying to ʺtime the marketʺ investors are just as likely to miss out on upswings in the market

as well as avoid down turns.




9) Because itʹs difficult to beat the market, make sure you donʹt give away too much of your return

in the way of commissions.


10) When a stock price reflects all relevant information about the stock, the market is said to be

A) efficient.

B) fractioned.

C) smooth.

D) flat.


Answer: ADiff: 1Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments

11) The disposition effect involves

A) holding onto winners too long. B) selling losers too soon.

C) both A and B. D) neither A nor B.

Answer: DDiff: 2Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments

12) Our study of efficient markets tells us all of the following about investing except

A) do not try to time the market stay with your plan.

B) long-term investing is your best bet, not systems.

C) go with the best investment advisor money can buy.

D) focus on effective asset allocation.

E) diversify and seek help if you donʹt feel comfortable.

Answer: CDiff: 3Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments

13) Anthony Hopkins wants to start investing and desires to consistently beat the market. What will

you tell him?

A) It can be done regularly by a skilled investor.

B) It is very tough to do so.

C) Half the time you should outperform the market.

D) Half the time you should underperform the market.

E) All of the above except A

Answer: EDiff: 2Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments



14) Greg spent the weekend in Las Vegas. He started out with $10,000 and won an additional $5000.

Greg was very risky with how he gambled with the $5000 he had won. Greg was exhibiting the

________ effect.

A) disposition

B) house money

C) loss then risk aversion

D) Las Vegas


Answer: BDiff: 2Topic: Efficient MarketAACSB: Ethical Understanding and Reasoning

15) Herd behavior

A) is a kind of self-fulfilling behavior.

B) involves emotions of fearing regret and seeking pride.

C) is exemplified when investors take higher risks with profits than they would normally

take.


Answer: ADiff: 2Topic: Efficient MarketAACSB: Ethical Understanding and Reasoning

16) Tell how your understanding of efficient markets helps with investing.

Answer: My understanding tells me several things worth knowing, which include:

- There is no foolproof system for beating the market; invest for the long-term.

- Do not try to time the market to take advantage; stay with your plan.

- Focus on the asset allocation process based on your age in the financial life cycle.

- Keep down the commissions that are paid to brokers and professionals.

- Diversify and seek help if you do not feel comfortable.Diff: 2Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments

17) What is an efficient market and can you beat the market?

Answer: An efficient market is a market in which all relevant information about stocks is reflected

in the stock price. The market is efficient in degrees. There are at times undervalued

securities and some people are able to take advantage of them while others lose. It is very

tough to consistently beat the market. On average, half the time you should expect to

outperform the market, and half the time underperform it. The bottom line here is that

you should keep to your plan and invest for the long term. If we try to time the market,

we are just as likely to miss an upswing as we are to avoid a downswing.Diff: 2Topic: Efficient MarketAACSB: Diverse and Multicultural Work Environments



11.5 Security Markets

1) An individual selling previously issued shares to another individual is a transaction that would

be traded in the primary market.

Answer: FALSEDiff: 1Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments

2) The Securities Act of 1934 created the SEC to enforce trading laws.

Answer: TRUEDiff: 1Topic: Regulation of Securities MarketAACSB: Diverse and Multicultural Work Environments

3) American Depository Receipts are receipts given by American banks for deposits in foreign

countries.

Answer: FALSEDiff: 3Topic: International MarketsAACSB: Information Technology

4) Stocks of most larger companies trade on the American Stock Exchange, while the stocks of

most smaller companies trade on the New York Stock Exchange.

Answer: FALSEDiff: 1Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

5) The New York Stock Exchange and the American Stock Exchange are considered regional stock

exchanges.


6) An over-the-counter market has a physical location where trading occurs.


7) An initial public offering is the first time the companyʹs stock is traded publicly.

Answer: TRUEDiff: 1Topic: Primary MarketsAACSB: Information Technology



8) Seasoned new issues are stock offerings by companies that already have common stock traded

in the marketplace.

Answer: TRUEDiff: 1Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments

9) An IPO is the sale of previously issued shares to the general public.

Answer: FALSEDiff: 1Topic: Initial Public OfferingAACSB: Diverse and Multicultural Work Environments

10) A primary market is a market in which new, as opposed to previously issued, securities are

traded.


11) A sale of a security in the primary markets is the only time the issuing company receives the

proceeds from the sale.


12) Firms raise outside financial capital through the sale of stocks in the secondary markets.


13) Stocks are initially sold in the primary markets with the help of an investment banker serving as

the underwriter.


14) A prospectus is an advertisement placed in a newspaper or magazine that provides a listing of

the underwriting syndicate involved in the new offering, in addition to basic information on the

offering.

Answer: FALSEDiff: 2Topic: Primary MarketsAACSB: Information Technology



15) An ask on offer price is one at which an individual is willing to sell a security.

Answer: TRUEDiff: 2Topic: Secondary MarketsAACSB: Information Technology

16) In the over-the-counter market, the individual investor must be physically present to purchase

the security over-the-counter.


17) Any company can have its securities listed on the NYSE.


18) The price at which an individual investor is willing to buy a security is the bid price.

Answer: TRUEDiff: 2Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

19) When an individual investor sells their shares on the OTC, the price at which they are willing to

sell is called the bid price.


20) The OTC market is a link-up of dealers, with stringent listing and membership requirements.


21) The NASDAQ is the largest electronic stock exchange.

Answer: TRUEDiff: 3Topic: Secondary MarketsAACSB: Information Technology

22) Churning occurs when a broker engages in excessive trading in a clientʹs security account to

generate more commissions for the broker.

Answer: TRUEDiff: 3Topic: Regulation of Securities MarketAACSB: Diverse and Multicultural Work Environments



23) A circuit breaker protects individual investors from losing money on their investments.

Answer: FALSEDiff: 3Topic: Regulation of Securities MarketAACSB: Information Technology

24) An individual investor should look for a stock broker who will churn their accounts for them.

Answer: FALSEDiff: 3Topic: Regulation of Securities MarketAACSB: Information Technology

25) Although some bonds are traded on the NYSE, most of the buying and selling of bonds doesnʹt

occur on organized exchanges.


26) You have just purchased shares of stock from a stockbroker. These shares were previously

traded on the NYSE. This trade took place in the

A) primary market.

B) secondary market.

C) tertiary market.

D) quaternary market.


Answer: BDiff: 1Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

27) You just concluded a stock purchase transaction via a computer hookup rather than in an

organized exchange. This trade took place in the

A) over-the-counter market.

B) NYSE.

C) AMEX.

D) primary market.


Answer: ADiff: 2Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments



28) IBM went to a(n) ________ who served as a(n) ________ to sell an IPO in the primary markets.

A) underwriter; investment broker

B) underwriter; investment banker

C) investment broker; underwriter

D) investment banker; underwriter

E) investment banker; underachiever

Answer: DDiff: 2Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments

29) A(n) ________ is a legal document that describes a securities issue and is made available to

potential investors.

A) disclosure statement

B) offering contract

C) prospectus

D) tombstone


Answer: CDiff: 1Topic: Regulation of Securities MarketAACSB: Information Technology

30) A(n) ________ advertisement provides a listing of the underwriting syndicate involved in a new

offering.

A) prospectus

B) underwriting notification

C) brokerage notification

D) tombstone


Answer: DDiff: 1Topic: Regulation of Securities MarketAACSB: Information Technology

31) IBM is considering hiring an investment banker who will purchase and subsequently resell an

issue of stock for them. This service is called

A) stock brokerage.

B) full-service brokerage.

C) underwriting.

D) churning.


Answer: CDiff: 2Topic: Initial Public OfferingAACSB: Information Technology



32) ABC Corporation is selling additional shares of common stock. Although ABC Corporation has

already sold shares of stock in the public equity markets, these are new shares of stock, and

have never been sold or traded previously. This is called a(n)

A) initial public offering.

B) seasoned new issue.

C) secondary issue.

D) blue chip issue.


Answer: BDiff: 2Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments

33) ABC Corporation is selling additional shares of common stock. These are new shares of stock,

and have never been sold or traded previously. The selling of these shares would take place in

the ________ market.

A) primary

B) secondary

C) tertiary

D) quaternary


Answer: ADiff: 2Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments

34) Securities that are less frequently traded, along with many new and high-tech stocks, are

relegated to the

A) NYSE. B) AMEX. C) ADR market. D) OTC market.

Answer: DDiff: 1Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

35) Most of the bonds that are bought and sold are not transacted on the organized exchanges. They

are bought and sold through bond dealers who do not sell many ________ bonds but do trade

many ________ bonds in the secondary market.

A) corporate; government

B) government; corporate

C) high par value; corporate

D) government; low par value

E) corporate; firm-specific bonds

Answer: ADiff: 3Topic: SecuritiesAACSB: Diverse and Multicultural Work Environments



36) You have just recently started your investment activities for retirement. You were happy to

learn from your broker that your investorʹs account balance would be insured for up to $500,000

through the ________ in the event their brokerage firm goes bankrupt.

A) FDIC B) FSLIC C) NCUA D) SIPC E) FTC

Answer: DDiff: 1Topic: Secondary MarketsAACSB: Information Technology

37) The two major organized stock exchanges in the Unites States are the ________ and the

________.

A) AMEX; Chicago

B) NYSE; AMEX

C) NYSE; Chicago

D) NYSE; Pacific

E) AMEX; Pacific

Answer: BDiff: 1Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

38) You and your spouse have decided to incorporate bonds into your newly-formed retirement

portfolio. You will most likely purchase them

A) directly from a bond dealer.

B) with your broker acting as intermediary.

C) directly from the issuing institution.

D) with an underwriter acting as intermediary.

Answer: BDiff: 2Topic: SecuritiesAACSB: Diverse and Multicultural Work Environments

39) The difference between an organized exchange and an over-the-counter market is that the

transactions that occur on an organized exchange ________ and the over-the-counter

transactions ________.

A) are initial offerings; are seasoned issues

B) are seasoned issues; are initial offerings

C) take place in a physical building; are conducted over the phone or via a computer

D) are conducted over the phone or via a computer; take place in a physical building

E) are initial offerings; are conducted over the phone

Answer: CDiff: 2Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments



40) Patti DeVry has been trading stocks in the over-the-counter market. When she wants to sell her

stocks she will specify the ________ price and when she wants to purchase stocks she will

specify the ________ price.

A) ask on offer; bid

B) bid; ask on offer

C) starting; minimum

D) ask; minimum

E) bid; minimum

Answer: ADiff: 2Topic: Bid/Ask PriceAACSB: Information Technology

41) General Electric is the only stock originally listed and still remaining on the ʺBig Board.ʺ This

means that its stock is traded on the

A) NASDAQ.

B) NYSE.

C) Regional.

D) AMEX.

E) International.

Answer: BDiff: 3Topic: Secondary MarketsAACSB: Information Technology

42) Acting upon assumed good advice, your brother buys stock in I-Link, an upcoming

communications firm. Since this is the first time I-Link is trading its stock, your brother will be

involved in a(n)

A) secondary market transaction.

B) initial public offering.

C) seasoned new issue.

D) tombstone purchase.

E) buy low transaction.

Answer: BDiff: 3Topic: Initial Public OfferingAACSB: Information Technology

43) Gracie Johnson saw the securities announcement for New York Bagel Enterprises that provided

the details of the offering and a listing of the underwriting syndicate. She saw the

A) tombstone advertisement.

B) prospectus.

C) initial post.

D) exchange advertisement.

E) underwriterʹs issue.

Answer: ADiff: 2Topic: Regulation of Securities MarketAACSB: Information Technology



44) The two types of securities offerings in the primary markets are ________ and ________.

A) seasoned new issues; long-term bonds

B) long-term bonds; government bills and notes

C) initial public offerings; seasoned new issues

D) seasoned new issues; penny stocks

E) initial public offerings; seasoned old issues

Answer: CDiff: 1Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments

45) All of the following are true about the American Stock Exchange except

A) it is the second most important of the organized exchanges.

B) it is one of the secondary markets.

C) its trading volume is a small fraction of that of the NYSE.

D) its dollar volume is larger than all the regional exchanges.

E) it ranks as number two in terms of the number of companies it lists.


46) Jeffery is an underwriter and sells shares on the ________ market for his job. However, in his

personal investment life, he will purchase his stocks through the ________ market.

A) primary, secondary

B) secondary, primary

C) primary, bond

D) open, closed


Answer: ADiff: 2Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

47) Jordan has a few thousand dollars to invest. He wants to find newly issued stock of a fast -

growing new company. He will contact an underwriter and attempt to purchase the shares in

the ________ market.

A) secondary

B) New York Stock Exchange

C) primary

D) NASDAQ

E) commodity

Answer: CDiff: 2Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments



48) Securities are generally sold in the primary markets with the help of a(n) ________ serving as

a(n) ________.

A) individual investor; underwriter

B) corporation; investment banker

C) regulatory commission; individual investor

D) underwriter; regulatory commission

E) investment banker; underwriter

Answer: EDiff: 2Topic: SecuritiesAACSB: Diverse and Multicultural Work Environments

49) Securities include both ________ and ________.

A) stocks; mutual funds

B) bonds; mutual funds

C) real estate; stocks

D) stocks; bonds

E) bonds; money market funds

Answer: DDiff: 1Topic: SecuritiesAACSB: Diverse and Multicultural Work Environments

50) Much of the day-to-day regulation of the market is left to the securities industry and is

performed by the exchanges and the

A) SRC. B) FDIC. C) OTC. D) SIPC. E) FINRA.

Answer: EDiff: 2Topic: Regulation of Securities MarketAACSB: Diverse and Multicultural Work Environments

51) A(n) ________ is a marketable document (a receipt) that certifies a bank holds shares of a foreign

firmʹs stock that backs the receipt.

A) FINRA B) MDR C) FFS D) ADR




52) The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud

Enforcement Act of 1988 made it illegal to trade while in the possession of inside information, or

ʺmaterialʺ non-public information held by

A) officers.

B) directors.

C) major stockholders.



Answer: DDiff: 3Topic: Regulation of Securities MarketAACSB: Diverse and Multicultural Work Environments

53) What is the purpose of a circuit breaker for the market?

A) It prevents the market from declining in value.

B) It prevents investors from losing money in the market.

C) It temporarily stops computerized trading to allow investors to analyze the extraordinary

market swings.



Answer: CDiff: 3Topic: Regulation of Securities MarketAACSB: Diverse and Multicultural Work Environments

54) Differentiate between primary and secondary security markets.

Answer: A primary market is one in which newly issued, as opposed to previously issued,

securities are sold (or offered). They come in one of two types: initial public offerings and

seasoned new issues.

IPO means it is the first time the company has offered its stock to the public for sale.

Seasoned new offerings are made by companies that already have common stock being

traded.Diff: 1Topic: Primary MarketsAACSB: Diverse and Multicultural Work Environments

55) Name the major organizations regulating the stock market and tell why they came about.

Answer: A federal agency, called The Securities and Exchange Commission, provides general

regulation of the markets. The National Association of Security Dealers regulates the OTC

market. The exchanges themselves are engaged in much self-regulation. Regulation came

about because of the great stock market crash of 1929 and because of fraudulent

information. The Securities Exchange Act of 1934 is the cornerstone of the major acts to

regulate hinge on disclosing adequate relevant information relating to the offering of

securities to make intelligent choices. Acts to regulate insider trading and market abuses

have been enacted more recently.Diff: 2Topic: Regulation of Securities MarketAACSB: Diverse and Multicultural Work Environments



56) Which organization would handle frequently traded OTC stock, bonds, and foreign stock?

Answer: The over the counter market handles frequently traded stock in secondary markets.

Bonds, in the secondary market, are traded by bond dealers who buy and sell bonds out

of their own holdings. Over 300 foreign companiesʹ stock is sold on the NYSE, AMEX,

and NASDAQ. Many others can be traded (purchased and sold) through American

Depository Receipts. [Of course, ADRs are traded on NYSE, Amex, Nasdaq.]Diff: 2Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

57) Compare and contrast organized exchanges and OTC markets. List the nine major U.S. stock

exchanges in the secondary market.

Answer: An organized exchange occupies a physical location (building) where trading occurs.

Over-the-counter transactions do not require you to go to a physical site. They are

handled over the phone or via a computer hookup.

The nine major organized exchanges are:

1. NYSE

2. AMEX

3. Pacific

4. Chicago

5. Philadelphia

6. Cincinnati

7. Intermountain

8. Spokane

9. BostonDiff: 2Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments

58) Explain the bid and ask price system when trading in stocks.

Answer: The OTC market is a network of broker dealers who actually buy and sell various

securities themselves. Since it is not an ʹauctionʹ like the organized markets are where

supply and demand determine the market price, the dealers need to communicate to

investors what price they are willing to trade the securities at.

The bid price is what the Dealer is willing to bid to purchase a share of stock from an

investor wishing to sell their stock. They publish the bid price so that someone wishing to

sell their stock can determine if they are willing to sell to the Dealer at the bid price.

The asking price is the price that the Dealer is asking for the shares that they own. They

publish this price so that potential purchasers know what price they will have to pay in

order to purchase the stock from the Dealerʹs inventory.Diff: 2Topic: Secondary MarketsAACSB: Diverse and Multicultural Work Environments



11.6 How Securities Are Traded

1) Specialists maintain a fair and orderly market by buying and selling stock from their inventory

to keep the market from fluctuating more than it would otherwise.

Answer: TRUEDiff: 1Topic: SpecialistsAACSB: Diverse and Multicultural Work Environments

2) A discount broker executes trades but does not provide much advice.

Answer: TRUEDiff: 1Topic: Stock BrokersAACSB: Diverse and Multicultural Work Environments

3) Reggie believed that the price of his stock was going to drop in the near future his strategy was

to short sell that stock to make a profit.

Answer: TRUEDiff: 1Topic: Short SellingAACSB: Diverse and Multicultural Work Environments

4) A market order is an order to buy or sell a set number of securities immediately at the best price

available.

Answer: TRUEDiff: 1Topic: Purchasing StocksAACSB: Information Technology

5) Placing a market order exposes the buyer to more risk than placing a limit order.

Answer: TRUEDiff: 3Topic: Purchasing StocksAACSB: Diverse and Multicultural Work Environments

6) Reesa is purchasing stock through the NYSE and the AMEX, as a result she will need to have a

different broker to purchase stocks listed on each of these different exchanges.

Answer: FALSEDiff: 3Topic: Stock BrokersAACSB: Diverse and Multicultural Work Environments

7) Stock can only be purchased in round lots.

Answer: FALSEDiff: 2Topic: Purchasing StocksAACSB: Information Technology



8) The share price is always less with a round lot than with an odd lot purchase.

Answer: FALSEDiff: 2Topic: Purchasing StocksAACSB: Information Technology

9) A limit order specifies a securities trade is to be made only at a certain price or better.

Answer: TRUEDiff: 3Topic: Types of OrdersAACSB: Information Technology

10) When placing a market order to purchase shares of stock, you will be required to make the

order good-till-canceled.

Answer: FALSEDiff: 3Topic: Types of OrdersAACSB: Information Technology

11) A GTC order remains effective until filled or cancelled.

Answer: TRUEDiff: 3Topic: Types of OrdersAACSB: Information Technology

12) When purchasing stock short, you must put up some collateral.


13) The collateral an investor must put up when conducting a short sale is known as a margin

requirement.


14) With short selling you are hoping for the stock price to fall.


15) Full service brokers are legally obligated to analyze the recommendations they receive from

analysts.




16) Merrill Lynch, Edward Jones and Morgan Stanley Smith Barney are all full service brokers.

Answer: TRUEDiff: 3Topic: Stock BrokersAACSB: Diverse and Multicultural Work Environments

17) A full service broker will always get you a lower share price on your purchases of stock.


18) Discount brokers are so named because they are able to get you discounts on the market price of

stocks.


19) A margin call requires you to replenish the margin account by adding additional cash or

securities to bring the account back up to the minimum.

Answer: TRUEDiff: 3Topic: Securities Trading AccountsAACSB: Diverse and Multicultural Work Environments

20) If you purchases securities jointly with another person, how the account is registered is not very

important.

Answer: FALSEDiff: 3Topic: Joint AccountsAACSB: Diverse and Multicultural Work Environments

21) For most typical married couples, joint tenancy with the right of survivorship is not an

appropriate form of account ownership.

Answer: FALSEDiff: 3Topic: Joint AccountsAACSB: Diverse and Multicultural Work Environments

22) A day trader is an individual who trades with a very long-term investment horizon.

Answer: FALSEDiff: 3Topic: Day TradersAACSB: Diverse and Multicultural Work Environments



23) A day trader typically sits at a computer and looks for stocks that are moving up or down in

value.

Answer: TRUEDiff: 3Topic: Day TradersAACSB: Diverse and Multicultural Work Environments

24) When trading there are ʺround tripʺ costs in that you will pay costs when you buy securities and

when you sell securities.

Answer: TRUEDiff: 3Topic: Day TradersAACSB: Diverse and Multicultural Work Environments

25) Day trading is considered to be a safe, conservative investment practice.

Answer: FALSEDiff: 3Topic: Day TradersAACSB: Diverse and Multicultural Work Environments

26) Day trading has been called

A) ʺa trading method for transferring wealth from unsophisticated investors to sophisticated

investors.ʺ

B) ʺa trading method for transferring wealth from sophisticated investors to unsophisticated

investors.ʺ

C) ʺthe safest, most conservative trading method.ʺ

D) ʺthe long-term investorsʹ preferred trading method.ʺ

Answer: ADiff: 3Topic: Day TradersAACSB: Diverse and Multicultural Work Environments

27) You have decided to give your stockbroker the power to make trades in the market on your

behalf, without notifying you of the trades prior to execution. This is an example of

A) a power agreement. B) a discretionary account.

C) an independent account. D) none of the above.

Answer: BDiff: 2Topic: Securities Trading AccountsAACSB: Diverse and Multicultural Work Environments

28) You believe that the stock of MoabBikes will soon fall from its current price of $25 per share.

You short 1,000 shares with your broker who has a 50% margin requirement. The price falls to

$15 per share, but not before it pays a $5 dividend per share. Your commissions and other

charges totaled $50. What was your total profit?

A) $5 B) $2,450 C) $2,500 D) $4,950 E) $9,950

Answer: DDiff: 3Topic: Short SellingAACSB: Analytical Thinking



29) Should the average investor consider using short selling techniques? Why or why not?

Answer: Given the fact that the long-term trend of the stock market is upward, selling short is

very risky and is not something you should become involved in. You can lose a bundle

because you may get caught selling low and later buying high.Diff: 2Topic: Short SellingAACSB: Analytical Thinking

30) In addition to your own investment, you borrowed money from your broker to purchase shares

of a stock. Your broker called to tell you that the price of your stock has fallen and you now

need to contribute more of your own money to keep the account at the minimum level. This is

termed a(n)

A) account validation.

B) margin call.

C) minimum validation.

D) stop-loss order.


Answer: BDiff: 2Topic: Securities Trading AccountsAACSB: Diverse and Multicultural Work Environments

31) Investors who trade with a very short time horizon, generally holding onto stocks for only a few

hours, are called

A) day traders.

B) movement traders.

C) hedge traders.

D) deep discount traders.


Answer: ADiff: 1Topic: Day TradersAACSB: Analytical Thinking

32) You have decided to borrow stock from your broker, sell it in the market, and then (you hope)

replace the borrowed shares when the price drops in the future. This is an example of

A) borrowed selling.

B) selling short.

C) reverse hedging.

D) IOU trading.


Answer: BDiff: 3Topic: Short SellingAACSB: Diverse and Multicultural Work Environments



33) A ________ is an order to sell a security if the price drops below a specified level or to buy if the

price climbs above a specified level.

A) GTC order

B) market order

C) fill-or-kill order

D) stop-loss order


Answer: DDiff: 2Topic: Types of OrdersAACSB: Diverse and Multicultural Work Environments

34) A ________ is an order that specifies a securities trade is to be made only at a certain price or

better.

A) day order

B) market order

C) limit order

D) GTC order


Answer: CDiff: 1Topic: Types of OrdersAACSB: Diverse and Multicultural Work Environments

35) A ________ is an order to buy or sell a set number of securities immediately at the best price

available.

A) day order

B) market order

C) limit order

D) prompt order


Answer: BDiff: 1Topic: Types of OrdersAACSB: Diverse and Multicultural Work Environments

36) A ________ is a trading order that expires at the end of the trading day during which it was

made.

A) day order

B) market order

C) limit order

D) GTC order

E) fill-or-kill order

Answer: ADiff: 1Topic: Types of OrdersAACSB: Diverse and Multicultural Work Environments



37) A group of 100 shares of common stock is referred to as a(n)

A) odd lot.

B) round lot.

C) even lot.

D) square lot.



38) A(n) ________ order is an order to sell if the price drops below a specified level or buy if the

price climbs above a specified level.

A) good-till-cancelled

B) stop

C) limit

D) market

E) open


39) A ________ is a member of an exchange who oversees the trading in one or more stocks and is

generally responsible for maintaining a ʺfair and orderlyʺ market in those stocks by purchasing

or releasing stocks into the market.

A) floor trader

B) day trader

C) specialist

D) monitor


Answer: CDiff: 1Topic: SpecialistsAACSB: Diverse and Multicultural Work Environments

40) Your next-door neighbor, a kind, elderly lady, just discovered that her stock account had been

excessively traded in an inappropriate manner, mainly to generate excess commissions. This is

an example of

A) account theft.

B) black market trading.

C) high turnover trading.

D) churning.


Answer: DDiff: 2Topic: Market AbusesAACSB: Diverse and Multicultural Work Environments



41) The price at which an individual is willing to sell a security is called the

A) set price.

B) bid price.

C) ask on offer price.

D) take price.


Answer: CDiff: 1Topic: Bid/Ask PriceAACSB: Diverse and Multicultural Work Environments

42) Investors with ________ accounts pay in full for their security purchases.

A) margin B) cash

C) initial margin D) maintenance margin

Answer: BDiff: 2Topic: Investment InformationAACSB: Diverse and Multicultural Work Environments

43) Amy and Bob have decided to borrow a portion of the purchase price of stocks from their

broker. They will then have a ________ account.

A) cash

B) round lot

C) margin

D) debtor

E) combination

Answer: CDiff: 2Topic: Securities Trading AccountsAACSB: Information Technology

44) Barney Q. Hopkins borrows stock from his broker (short selling) with the goal of ________ and

________.

A) buying low; selling later

B) buying low; selling low

C) buying high; selling low

D) selling high; later buying low

E) borrowing money; buying low

Answer: DDiff: 2Topic: Short SellingAACSB: Diverse and Multicultural Work Environments



45) A(n) ________ account represents the money over which you give a broker power to trade for

you.

A) discretionary

B) discount

C) stock purchasing

D) securities

E) indemnity

Answer: ADiff: 1Topic: Securities Trading AccountsAACSB: Information Technology

46) You specify that your trade is to be made only at a certain price or better. You are placing a(n)

A) stop order.

B) limit order.

C) market order.

D) open order.

E) closed order.


47) A(n) ________ account represents the money or investments you have at a brokerage firm.

A) discretionary B) brokerage

C) stock purchasing D) indemnity

Answer: BDiff: 1Topic: Stock BrokersAACSB: Diverse and Multicultural Work Environments

48) Sally is attempting to purchase 88 shares of Googleʹs stock. Sally is purchasing a(n) ________ lot

of stocks.

A) square

B) round

C) odd

D) margin

E) cannot determine from the information provided

Answer: CDiff: 3Topic: Purchasing StocksAACSB: Information Technology



49) You want to buy stock in a dynamic electronics firm. You place an order that cannot be

completely filled the first day, so you ask for a(n)

A) second chance.

B) market order.

C) open order.

D) day order.

E) extended order.

Answer: CDiff: 3Topic: Types of OrdersAACSB: Information Technology

50) Barbara Ann ordered 50 shares of stock, which is called a(n) ________ lot on the NYSE.

A) discretionary

B) square

C) odd

D) round

E) even

Answer: CDiff: 2Topic: Types of OrdersAACSB: Information Technology

51) Assume you have a margin account with a 50% initial margin. You purchase 100 shares of

Microsoft at $150 per share. The price increases to $175 per share. What is the net value of your

investment (margin) now?

A) $17,500

B) $15,000

C) $ 7,500

D) $ 3,750


Answer: EDiff: 3Topic: Securities Trading AccountsAACSB: Analytical Thinking

52) Insider trading is both unfair and illegal. It occurs when officers, directors, major stockholders,

or others trade securities while

A) intoxicated.

B) in prison.

C) in possession of illegal drugs.

D) in possession of ʺmaterialʺ nonpublic security information.

E) having relatives working at the firm whose stock they are trading.

Answer: DDiff: 2Topic: Market AbusesAACSB: Information Technology



53) All of the following are ordering alternatives that specify the timeframe within which you want

your order filled except

A) GTC order. B) fill-or-kill order.

C) open order. D) limit order.

Answer: DDiff: 2Topic: Purchasing StocksAACSB: Information Technology

54) Which of the following purchase orders indicates that you want to buy or sell immediately?

A) Limit order B) Market order C) Day order D) Open order


55) You have been watching a stock that has dramatically increased in price for the last several

days. Today it closed at $50 per share. You want to purchase this stock in the morning using

your online brokerage account. You are willing to pay up to $53 a share but no higher. What

type of purchase order should you use?

A) A stop-loss order B) A good-til-cancel order

C) A market order D) A limit order

Answer: DDiff: 3Topic: Types of OrdersAACSB: Diverse and Multicultural Work Environments

56) You purchased some stock last month for $50 per share. Today the stock closed at $80 per share.

You would like to protect the profit that you have made on this stock but you really donʹt want

to sell it in case it continues to rise in price. What should you do?

A) Place a market order on this stock B) Place a stop-loss order on this stock

C) Place a protect order on this stock D) None of the above


57) Assume you have a margin account with a 50% initial margin. You purchase 100 shares of stock

at $80 per share. The price increases to $100 per share. What is the net value of your investment

(margin) now?

A) $10,000 B) $8,000 C) $6,000 D) $5,000 E) $2,000

Answer: CDiff: 3Topic: Short SellingAACSB: Analytical Thinking



58) What is the purpose of a margin account and using margin to purchase stocks?

A) A margin account allows you to purchase stocks without using any of your own money.

B) A margin account allows you to purchase more shares than you could afford to purchase

using only your own money.

C) Using margin to purchase more shares gives you the potential to earn a higher return on

your investment.


E) Only B and C are correct.

Answer: EDiff: 3Topic: Short SellingAACSB: Information Technology

59) Why does it cost so much to trade with a full service broker?

A) Full service brokers offer stock research and investment advice.

B) Full service brokers offer many different customer services.

C) Full service brokers provide a one-on-one personal relationship with the customer.


Answer: DDiff: 1Topic: Stock BrokersAACSB: Information Technology

60) What type of broker can protect your investments from systematic risk?

A) Online broker B) Discount broker

C) Full service broker D) None of the above.

Answer: DDiff: 3Topic: Stock BrokersAACSB: Information Technology

61) Describe the typical order characteristics you will encounter.

Answer: You will want to order in either round or odd lots. A round lot is a group of 100 shares of

common stocks. Round lot trading occurs on the NYSE. An odd lot is an order of less

than 100 shares of stock. If you want your order to be filled only on the day it was given,

be sure to use a day order. If you want the order to remain effective until it is filled, use

an open or good-till-canceled order.

Use a market order to buy or sell securities immediately at the best price available. You

use a limit order when you specify that the trade is to be only at a certain price or better.

Use a stop or stop-loss order to sell if the price drops below a specified level or to buy if

the price climbs above a specified level. They are used to protect your profits.Diff: 1Topic: Types of OrdersAACSB: Diverse and Multicultural Work Environments



62) What personal characteristics should you look for in a full-service broker and why are they

important?

Answer: 1. a reputation for integrity, intelligence, and efficiency

2. experience in both up and down markets

3. one who understands your investment philosophy

4. one who allows you to say ʺnoʺ without undue pressure

5. one who is upfront with total costs

All of these qualities are important in representing my best interests and not the interests

of the broker or brokerage firm. It is crucial for a broker to know the markets over the long

term as well as the short term. He or she must understand what my goals are, not just his

or hers. A broker must be an efficient and cost-saving person to allow me to continue to

trade. All of these qualities point to an ethical person who will be around for a long time

to assist me and many others.Diff: 2Topic: Stock BrokersAACSB: Reflective Thinking

63) Explain the purpose of a brokerage account and the 3 types of brokers.

Answer: A brokerage account represents the money (cash) or investments (securities) you have at

a brokerage firm. This is an account to use in the buying and selling of securities on a

regular or semi-regular basis.

A full-service broker gives advice and direction to the client. This broker is paid a

commission based upon the sales volume generated. Discount brokers execute trades

without giving advice and charge 50% to 70% less than a full-service broker. A

deep-discount broker undercuts the dominant discount brokers and will execute some

trades for up to 90% off the price of a full-service broker.Diff: 1Topic: Stock BrokersAACSB: Reflective Thinking

64) Generally, day trading should be avoided. If you decide to participate in day trading, what

should you keep in mind?

Answer: Be prepared to suffer severe financial losses.

Donʹt confuse day trading with investing–they arenʹt the same. Day traders arenʹt

interested in value, but in how the stock might perform in the next few hours or day.

Donʹt believe claims of easy profits. Investors have a tendency to talk more about when

they make money, but not about when they lose it. In fact, day trading has been called ʺa

trading method for transferring wealth from unsophisticated investors to sophisticated

investors.ʺ

Watch out for ʺhot tipsʺ and ʺexpert adviceʺ from newsletters and websites catering to

day traders. Thereʹs no question that someone makes money from day trading;

unfortunately, in the vast majority of cases, it isnʹt the investorDiff: 2Topic: Day TradersAACSB: Analytical Thinking



11.7 Sources of Investment Information

1) Investment advice is very difficult to find and expensive to purchase.

Answer: FALSEDiff: 1Topic: Investment InformationAACSB: Information Technology

2) If youʹre going to make informed investment decisions, you have to seek investment

information, read it, and interpret it.

Answer: TRUEDiff: 1Topic: Investment InformationAACSB: Information Technology

3) It is a good idea for every investor to read the Wall Street Journal.


4) According to your text, ʺfalling in loveʺ with your stock is a good idea.

Answer: FALSEDiff: 1Topic: Investment InformationAACSB: Analytical Thinking

5) The Internet is full of investment information, and all of it is stringently regulated so you can be

sure of its reliability.

Answer: FALSEDiff: 1Topic: Investment InformationAACSB: Information Technology

6) A good source of investment advice is a neutral party that doesnʹt charge a fee or earn a

commission from you.


7) An investor should always consider the source when receiving stock tips from other people.




8) The primary sources of information about the stock market and individual stocks are Moodyʹs

Investors Service, Standard & Poorʹs Stock Reports, Morningstar Investment Reports, and the

Value Line Investment Survey.

Answer: TRUEDiff: 2Topic: Investment InformationAACSB: Analytical Thinking

9) According to the Keown book, overconfidence afflicts women more often than men, and it also

leads women to trade too often.


10) The reluctance effect plays on the fear of regret and the seeking of pride, resulting in selling

winning stocks too soon and keeping losing stocks too long.


11) Brokerage firm reports

A) are provided by all discount brokers.

B) provide access to research reports prepared by the firmʹs securities analysts.

C) analyze individual companies but not the direction of the economy as a whole.

D) are only valuable if you buy the recommended stocks.

E) all of the above

Answer: BDiff: 1Topic: Investment InformationAACSB: Information Technology

12) According to the Keown book, which of the following is not a primary source of information

about the stock market and individual stocks?

A) Fitch Investment Survey B) Moodyʹs Investors Service

C) Standard & Poorʹs Stock Reports D) Morningstar Investment Reports 2

Answer: ADiff: 2Topic: Investment InformationAACSB: Analytical Thinking



13) Investors have access to an incredible amount of corporate information on the Internet,

including news sites, free software, and discussion groups. According to the Keown book,

which websites reflect the greatest online sources of investment information?

I. Yahoo! Finance

II. CNNMoney.com

III. The Motley Fool

IV. EDGAR

A) I only B) I and II C) I, II, and III D) I, II, III, and IV

Answer: DDiff: 2Topic: Investment InformationAACSB: Analytical Thinking

14) Which statement is true regarding overconfidence?

A) Overconfidence leads to trading too often.

B) Overconfidence afflicts women more often than men, and it also leads women to trade too

often.

C) Overconfident investors think they can beat the market.

D) Both A and C

Answer: DDiff: 2Topic: Investment InformationAACSB: Analytical Thinking

15) The ________ plays on the fear of regret and the seeking of pride, resulting in selling winning

stocks too soon and keeping losing stocks too long.

A) disposition effect B) reluctance effect

C) house money effect D) overconfidence effect

Answer: ADiff: 2Topic: Investment InformationAACSB: Analytical Thinking

16) There are several sources of information available to help you make intelligent choices about

buying and selling stock? If you choose a corporationʹs annual report to base your decisions on,

what should you look for?

Answer: Remember that an annual report is written to give real attention to public relations; that

is, it puts the firm in as favorable a light as possible. Concern yourself with the trends in

sales, profits, and dividends. Notice how well the company performed last year by

comparing its financial ratios to the industry norm. What does the management project

for the future? Is it positive or negative?Diff: 1Topic: Investment InformationAACSB: Information Technology



17) How does overconfidence affect investors?

Answer: Investors tend to be overconfident. Simply put, people think they know more than they

do. This overconfidence applies to their abilities, their knowledge, and the future. In

effect, most investors think they can beat the market. Overconfidence also leads to

trading too often. Of course, there is the chance that those who trade more frequently

earn higher returns. Overconfidence afflicts men more often than women, and it also

leads men to trade too often.Diff: 2Topic: Investment InformationAACSB: Reflective Thinking

18) List some helpful investment tips.

Answer: Systems donʹt beat the market. Itʹs long-term investing that works.

Stick to your investment plan and donʹt try to time the market.

Focus on the asset allocation process. You should spend your energy on the appropriate

asset allocation, taking into consideration your goals, your plan, and where you are in

your financial life cycle.

Recognize the time dimension of investing. Your asset allocation strategy should reflect

your investment horizon.

Keep the commissions down. Because itʹs difficult to beat the market, make sure you

donʹt give away too much of your return.

Diversify, diversify, diversify! The benefits of diversification have yet to be challenged.

If you donʹt feel comfortable, seek the help of a qualified financial advisor. Donʹt let the

fear of investing keep you out of the game.Diff: 2Topic: Investment InformationAACSB: Reflective Thinking


Chapter 12Investing in Stocks

12.1 Why Consider Stocks?

1) Limited liability associated with stock ownership means that shareholders can only lose the

amount of money they have invested in the company.

Answer: TRUEDiff: 1Topic: Limited LiabilityAACSB: Diverse and Multicultural Work Environments

2) A companyʹs dividend distribution can be in the form of cash or additional stock.

Answer: TRUEDiff: 1Topic: DividendsAACSB: Information Technology

3) The market price of the stock is a reflection of the potential earnings per share of the firm.

Answer: TRUEDiff: 2Topic: Earnings per ShareAACSB: Diverse and Multicultural Work Environments

4) Some firms have negative earnings per share numbers.


5) Some companies distribute earnings per share in the form of dividends and some retain these

earnings for future investment in the firm.


6) The dividend yield is calculated by dividing the earnings per share by the market price of the

stock.

Answer: FALSEDiff: 2Topic: DividendsAACSB: Information Technology

7) The dividend yield tells investors how much in the way of a return they would receive if the

stock price and the dividend level remain constant.

Answer: TRUEDiff: 2Topic: DividendsAACSB: Diverse and Multicultural Work Environments


Chapter 12 Investing in Stocks 369

8) In the event of a corporate bankruptcy, bondholderʹs claims are paid before shareholdersʹ claims

are paid.

Answer: TRUEDiff: 2Topic: Claims on AssetsAACSB: Diverse and Multicultural Work Environments

9) Common stockholders not only have the right to elect the board but also must approve

day-to-day decisions of the chief executive officer.

Answer: FALSEDiff: 2Topic: Voting RightsAACSB: Diverse and Multicultural Work Environments

10) Stock splits increase the number of the shares you own, but decrease the value of your total

holdings with the company.

Answer: FALSEDiff: 1Topic: Stock SplitAACSB: Analytical Thinking

11) Publicly traded stocks listed on a major exchange are not very liquid investments.

Answer: FALSEDiff: 1Topic: LiquidityAACSB: Diverse and Multicultural Work Environments

12) Every company must pay dividends as a portion of the companyʹs profits to its stockholders.

Answer: FALSEDiff: 1Topic: DividendsAACSB: Diverse and Multicultural Work Environments

13) According to your text, over time, investing in stocks generally outperforms most other

investments.

Answer: TRUEDiff: 2Topic: StocksAACSB: Diverse and Multicultural Work Environments

14) Holding several types of stock can greatly reduce the risk in your portfolio.

Answer: TRUEDiff: 2Topic: RiskAACSB: Analytical Thinking



15) Common stockholders have a superior claim on a companyʹs assets over creditors and

bondholders.

Answer: FALSEDiff: 2Topic: Claims on AssetsAACSB: Diverse and Multicultural Work Environments

16) A stock split is a tactic by a corporation to manipulate the market price of its stock.

Answer: TRUEDiff: 2Topic: Stock SplitAACSB: Diverse and Multicultural Work Environments

17) A proxy is a legal agreement a stockholder signs to allow someone else to vote for him or her at

the corporationʹs annual meeting.

Answer: TRUEDiff: 2Topic: Voting RightsAACSB: Information Technology

18) When a corporation engages in a stock repurchase, each remaining shareholder owns a smaller

proportion of the firm.

Answer: FALSEDiff: 2Topic: Stock RepurchaseAACSB: Diverse and Multicultural Work Environments

19) A firm may decide that the price per share for its stock is getting too high for the smaller

investor so the company ʺsplits the stock.ʺ

Answer: TRUEDiff: 2Topic: Stock SplitAACSB: Diverse and Multicultural Work Environments

20) When a corporation repurchases its own stock, it does so in the secondary markets.

Answer: TRUEDiff: 3Topic: Stock RepurchaseAACSB: Diverse and Multicultural Work Environments

21) Returns on stocks can come in the form of capital appreciation.


22) Capital appreciation refers to an increase in the selling price of your shares of stock.

Answer: TRUEDiff: 3Topic: Stock Investment StrategiesAACSB: Information Technology



23) You cannot benefit from capital appreciation until you actually sell your stock.

Answer: TRUEDiff: 2Topic: Stock Investment StrategiesAACSB: Diverse and Multicultural Work Environments

24) Both capital gains and dividends are guaranteed with common stock.


25) Dividends are paid regardless if the company makes a profit.


26) While you canʹt be assured of what you will get when you sell your stock, you will most likely

not have difficulty selling it.


27) Income stocks are stocks that have a very high capital appreciation potential.

Answer: FALSEDiff: 1Topic: Classification of Common StockAACSB: Information Technology

28) Growth stocks are issued by companies that have exhibited sales and earnings growth well

above their industry average.

Answer: TRUEDiff: 1Topic: Classification of Common StockAACSB: Information Technology

29) Most of the stocks listed in the Dow Jones Industrials have high P/E ratios and are classified as

speculative stocks.

Answer: FALSEDiff: 1Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

30) A growth stock is known for its high dividend yields.




31) When the economy slumps, the earnings of cyclical stocks drop; when the economy recovers, so

do their earnings.

Answer: TRUEDiff: 2Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

32) Microsoft is an example of a company whose common stock is considered to be a growth stock.


33) Income stocks pay relatively low dividends, and offer a high potential for capital appreciation.

Answer: FALSEDiff: 2Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

34) Speculative stocks are often traded through the OTC Bulletin Board.


35) Proctor and Gamble is an example of a blue-chip stock.


36) Defensive stocks frequently perform better during economic downturns.


37) Stocks reduce risk by portfolio rebalancing.


38) Berkshire Hathawayʹs ʺAʺ stock has never split. As a result, in mid-2014 one share of the stock

was selling at a price of more than $190,000 per share.

Answer: TRUEDiff: 2Topic: StocksAACSB: Reflective Thinking



39) Coca-Cola is an example of a red-chip stock.


40) You have just purchased 10 shares of a stock selling at $50 per share. Since that time, the

company was found to be in violation of several environmental laws and has several major

lawsuits outstanding. Which of the following statements is most correct?

A) You could lose up to your $500 investment.

B) You could lose more than your $500 investment.

C) You cannot lose your investment based on the actions of the company.

D) By owning stock in the company, you have also technically violated the law.


Answer: ADiff: 2Topic: Limited LiabilityAACSB: Diverse and Multicultural Work Environments

41) Which of the following statements is most correct regarding the general relationship between

stocks and interest rates?

A) There is no relationship between interest rates and stock prices.

B) As interest rates increase, stock prices should also increase.

C) As interest rates increase, stock prices should decrease.

D) Stock prices are negatively exponentially related to interest rate increases.


Answer: CDiff: 1Topic: Stock ValuationAACSB: Diverse and Multicultural Work Environments

42) ________ are a companyʹs distribution of its profits in the form of cash or stock to its owners.

A) Dividends

B) Coupon interest payments

C) Equity payments

D) Shareholder divestments


Answer: ADiff: 1Topic: DividendsAACSB: Diverse and Multicultural Work Environments



43) When a company buys back its own common stock it is engaging in a

A) stock split.

B) stock reissue.

C) stock repurchase.

D) stock repo.


Answer: CDiff: 1Topic: Stock RepurchaseAACSB: Diverse and Multicultural Work Environments

44) A ________ increases the number of stock shares outstanding by replacing each existing share of

stock with a stated number of new shares.

A) dividend reinvestment

B) stock split

C) stock repurchase

D) stock reissue


Answer: BDiff: 1Topic: Stock SplitAACSB: Diverse and Multicultural Work Environments

45) The net income of the firm is $4 million dollars. The firm will pay $500,000 in dividends to the

preferred shareholders. There are currently 1 million shares of common stock outstanding. What

are the earnings per share for this firm?

A) $4.00 B) $3.50 C) $4.50 D) $3.00

Answer: BDiff: 1Topic: Earnings per ShareAACSB: Analytical Thinking

46) The firm will pay an annual dividend this year of $2 per share. The current market price of the

stock is $40.00 per share. The book value of this stock is $24.00 per share. The earnings per share

for this firm is $5.75. What is the current dividend yield of this stock?

A) 14.38% B) 8.33% C) 23.9% D) 5%

Answer: DDiff: 1Topic: Earnings per ShareAACSB: Analytical Thinking

47) Your investment goal is to receive a stream of income from your investment. Which of the

following would be important information to determine whether a particular stock purchase

would suit your plan?

A) The earnings per share B) The market-to-book ratio

C) The book value D) The dividend yield

Answer: DDiff: 3Topic: DividendsAACSB: Diverse and Multicultural Work Environments



48) A(n) ________ is a legal agreement signed by a stockholder allowing someone else to vote on his

or her behalf at the corporationʹs annual meeting.

A) voting contract

B) agency contact

C) contingency contract

D) proxy


Answer: DDiff: 1Topic: Voting RightsAACSB: Information Technology

49) The ________ date is the date the stock begins trading without dividend, meaning that if you

buy it after this date you will not get the dividend for that year.

A) payment date

B) declaration date

C) ex-dividend date

D) reinvestment date

E) maturity date

Answer: CDiff: 1Topic: DividendsAACSB: Diverse and Multicultural Work Environments

50) The ________ is the date on which the board of directors announces the amount of the dividend.

A) announcement date

B) declaration date

C) dividend date

D) ex-dividend date

E) maturity date

Answer: BDiff: 1Topic: DividendsAACSB: Diverse and Multicultural Work Environments

51) You purchased 100 shares of Quantex at $150 per share for a total investment of $15,000. After

your purchase the stock had a 3 for 1 split. How many shares do you now own and how much

is your original investment now worth?

A) 100 shares and $150 dollars B) 300 shares and $15,000 dollars

C) 100 shares and $45,000 dollars D) 300 shares and $45,000 dollars

Answer: BDiff: 3Topic: Stock SplitAACSB: Analytical Thinking



52) Nathan noticed that a company that has great potential just declared a ________ because its

stock price was getting too high for the small investor to buy the stock. The company will

substitute more shares for the existing shares of stock without increasing the market value of the

firm.

A) dividend yield

B) stock repurchase

C) claim on income

D) stock split

E) stock splice

Answer: DDiff: 2Topic: Stock SplitAACSB: Diverse and Multicultural Work Environments

53) You are really keen on stocks. However, you do not like stocks with regard to ________. This

means that if a company you have invested in goes bankrupt, the creditors are paid first and

you will be out of luck.

A) claim on income

B) limited liability

C) claims on assets

D) voting rights

E) claims on dividends

Answer: CDiff: 2Topic: Claims on AssetsAACSB: Diverse and Multicultural Work Environments

54) Common stockholders are entitled to elect the companyʹs board of directors. Usually one share

of stock is equal to ________ vote(s).

A) one B) two C) 100 D) 1,000

Answer: ADiff: 2Topic: StocksAACSB: Information Technology

55) What are proxy fights?

A) Proxy fights are when two rival companies want the same voters.

B) Proxy fights are battles for proxy votes between rival groups of share holders in separate

companies.

C) Proxy fights are battles for proxy votes between rival groups of share holders in the same

company.

D) Proxy fights are when shareholders fight over who will cast their votes.

E) There is no such thing as a proxy fight.

Answer: CDiff: 3Topic: Stock Investment StrategiesAACSB: Analytical Thinking



56) The dividend yield on a share of common stock is

A) available at most large companies.

B) the amount of annual dividends divided by the market price of the stock.

C) the taxes you pay on the reinvested dividends.


E) only A and B.


57) The book value of a company is calculated by

A) adding the price per share to the dividends paid.

B) subtracting its price per share from the dividends paid.

C) subtracting the value of all the firmʹs assets from the value of its liabilities.

D) subtracting the value of all the firmʹs liabilities from the value of its assets.

Answer: DDiff: 2Topic: Investment InformationAACSB: Information Technology

58) A proxy vote means

A) filling out a voting form and having a representative turn it in for you.

B) requesting that your vote be deferred until a later date.

C) giving a representative the right to vote in your place.


Answer: CDiff: 2Topic: Voting RightsAACSB: Information Technology

59) What point marks the purchase of common stock without a right to a declared dividend?

A) Dividend payout date

B) Declaration date

C) Ex-dividend date

D) Cut-off point

E) End of fiscal year

Answer: CDiff: 1Topic: DividendsAACSB: Information Technology



60) As a shareholder in Titanic Shipping, Inc., James Blue is one of the many actual owners. In case

of the bankruptcy of the corporation, his liability would be limited to

A) his ownership percentage of the actual loss.

B) the amount of his investment.

C) nothing at all.

D) what is left after selling the stock and subtracting the debt.

Answer: BDiff: 2Topic: Limited LiabilityAACSB: Diverse and Multicultural Work Environments

61) Which feature of common stock ownership allows a stockholder to share in the companyʹs

earnings after the creditors are paid?

A) Limited liability B) Claim on income

C) Claims on assets D) Voting rights

Answer: BDiff: 2Topic: Claims on AssetsAACSB: Diverse and Multicultural Work Environments

62) Returns from shares of stock come in the form of

A) stock splits.

B) capital appreciation.

C) dividends.



Answer: EDiff: 2Topic: StocksAACSB: Diverse and Multicultural Work Environments

63) Dividends

A) are always paid, regardless of the companyʹs profitability.

B) are always paid when the company makes a profit.

C) are never paid to common stockholders; only preferred stockholders receive them.

D) None of the above is true.


64) Abby previously owned 200 shares of NEWAGE stock at $25 per share. Today the company

split the stock in a 3:1 split. Now what is the value of Abbyʹs stock?

A) $5,000 B) $6,000 C) $2,500 D) $200

Answer: ADiff: 2Topic: StocksAACSB: Analytical Thinking



65) Which of the following investment options is not affected by a change in the market rates of

interest?

A) Common stocks

B) Corporate bonds

C) Government bonds

D) None of the above is correct; all are affected.

Answer: DDiff: 3Topic: StocksAACSB: Analytical Thinking

66) Figure 13.1 in your textbook compares the returns on various investments over the period

1951-2010. Which of the following is shown to exceed the inflation rate by the widest margin?

A) Common stocks B) Government bonds

C) Treasury bills D) Mutual funds


67) Which of the following makes common stocks more risky than corporate bonds when both are

issued by the same company?

A) Claims on income

B) Unlimited liability

C) Claims on assets



Answer: EDiff: 1Topic: StocksAACSB: Diverse and Multicultural Work Environments

68) Suppose that a company feels that the price of its stock is more than the average small investor

can afford. To lower the price the company could engage in a

A) stock split. B) stock repurchase.

C) proxy vote. D) All of the above are correct.

Answer: ADiff: 2Topic: StocksAACSB: Diverse and Multicultural Work Environments



69) The dividend yield tells investors which of the following?

A) What their portfolio is worth on the open market

B) How much in the way of a return they would receive if the stock price and the dividend

level remain constant

C) When the company will be releasing dividends

D) How much in total the company has available to pay out in dividends



70) Greg Jewell read about several companies that were performing relatively well despite the

current recession. Stocks like these, that in some cases actually perform better during downturns

in the economy, are called ________ stocks.

A) cyclical

B) speculative

C) defensive

D) growth

E) seasonal

Answer: CDiff: 2Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

71) If you purchase stock of big companies like Proctor & Gamble, General Electric, and Texaco you

would be buying shares of ________ stocks.

A) blue-chip B) true-blue C) mini-caps D) speculative

Answer: ADiff: 2Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

72) Deborah recently purchased a stock that is considerably more risky than a typical stock. It has

exhibited a high degree of earnings variability. This is an example of a(n) ________ stock.

A) speculative B) blue-chip C) income D) mid-cap




73) If you were to purchase common stocks issued by large, nationally known companies with

sound financial histories with solid dividend and growth records you would own what are

called

A) best-bet stocks.

B) blue-chip stocks.

C) performance stocks.

D) long-run performance stocks.


Answer: BDiff: 1Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

74) Because of her childrenʹs immediate financial needs, your aunt Marsha has decided to switch

some of her money to high-grade utility company stocks. Her reasoning is that these ________

stocks generally pay relatively high dividends that she will be able to give to her children as

they need assistance.

A) growth B) blue-chip C) income D) cyclical E) safe

Answer: CDiff: 2Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

75) As compared to growth stocks, income stocks pay ________ dividends with ________ growth in

earnings.

A) relatively high; relatively high

B) the same; relatively high

C) relatively high; relatively little

D) relatively high; moderate

E) relatively high; the same

Answer: CDiff: 3Topic: Classification of Common StockAACSB: Analytical Thinking

76) For an investor who is retired, which category of stocks would be more appropriate for a

portion of their portfolio?

A) Blue-chip stocks

B) Income stocks

C) Growth stocks



Answer: EDiff: 3Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments



77) Brenda is a 25 year old investor who recently graduated from college and has a successful

career, which type of stock should represent a good portion of her portfolio?

A) Growth stocks B) Defensive stocks

C) Income stocks D) Risk-free stocks


78) Large-caps, mid-caps, and small-caps refer to the size of the firm issuing the stock, more

specifically, to its

A) book value. B) market value.

C) dividend. D) capacity for growth.

Answer: BDiff: 3Topic: Classification of Common StockAACSB: Information Technology

79) Which stock index will have the largest representation of small-, mid- and large -cap stocks?

A) DJIA B) S&P 500

C) Wilshire 5000 D) None of the above

Answer: CDiff: 3Topic: Stock IndexAACSB: Information Technology

80) Berkshire Hathawayʹs ʺAʺ stock has never split. As a result, in mid-2014 one share of its stock

was selling at a price of more than ________ per share.

A) $190 B) $1,900 C) $19,000 D) $190,000

Answer: DDiff: 2Topic: StocksAACSB: Reflective Thinking



81) Explain the common stock features and rights as though you are speaking to a novice.

Answer: Common stocks have limited liability; that is, if the company goes bankrupt your liability

is limited to the amount of your investment. The claim on income is not certain because

the corporation is not obligated to pay any dividends. Dividends are paid only after all

debt and other obligations have been paid, such as reinvesting the leftover earnings back

into the company. On the other hand, if the company has a booming year the

stockholders will make a bundle.

Should a company go bankrupt, the creditors have claim on its assets before the

stockholders do, and therefore the stockholders may be out of luck. Stockholders are

entitled to elect the companyʹs officers and sometimes vote on policy. The number of

votes depends upon the number of shares owned. When a firm thinks its stock price is

too high for the smaller investor, the officers will ʺsplitʺ it into more shares. Sometimes a

firm will repurchase shares so that each stockholder will own a larger proportion of the

firm.

Common stock has book value, a return (dividend yield), earnings per share, and a

market-to-book ratio.Diff: 2Topic: StocksAACSB: Diverse and Multicultural Work Environments

82) Explain the purpose and value of the dividend yield ratio.

Answer: The dividend yield ratio is a tool that allows investors to compare the potential income

return on various investment opportunities. For example, a share with a dividend yield

of 3% would produce the same amount of income as a CD with a 3% yield. Investors with

an income investment goal would value the dividend yield a lot.Diff: 2Topic: DividendsAACSB: Diverse and Multicultural Work Environments

83) What factors can effect the market price of a stock?

Answer: There are many factors that can effect the market value of a firmʹs stock price. The price of

the stock reflects the firmʹs potential to earn profits. Anything that increases the chances

of the firm making higher profits is most likely to cause the market price of the stock to

rise. Examples such as lower market rates of interest, lower production costs, successful

price increases, new and innovative products, increase in market share, favorable tax

breaks or government regulations. Anything that reduces or hinders the firmʹs ability to

make profits will negatively effect the market price of the stock. Examples include rising

market rates of interests, rising energy costs, rising costs of production, fading popularity

or obsolete products, bad publicly, losing market share to competition, unfavorable taxes

or newer, tougher government regulations.Diff: 3Topic: StocksAACSB: Diverse and Multicultural Work Environments



84) Is a positive stock split good for the current share holders?

Answer: Yes, for the most part a positive stock split is a bullish signal to the market about the

success and growth of the profit potential for the firm. When a firmʹs profits are rising,

the demand for their stock increases causing the market price of the stock to increase.

When the share price gets to high then the company can effectively lower the share price

by doing a stock split. Since a stock split increases the number of shares shareholders

own, then they will eventually end up with more dividends and capital gains if the

company continues to prosper. The market price of the stock effects the liquidity of the

stock also. It is much easier to sell stock at $40 per share than $120 per share since more

people can afford the lower price.Diff: 3Topic: Stock SplitAACSB: Analytical Thinking

85) Differentiate between the general classifications of common stock.

Answer: Blue-chip stocks are issued by large, nationally known companies with sound financial

histories and solid dividend and growth records, such as IBM. Growth stocks have

shown sales and earnings growth well above their industry average. Income stocks are

usually issued by more mature firms that pay relatively high dividends with little

increase in earnings.

Speculative stocks have much more variability and risk than do typical stocks. It is

difficult to forecast their direction for investment purposes. Cyclical stocks move with the

economy, up with recoveries and down with slumps. Defensive stocks are not as affected

by swings in the economy and they are not hurt as much in slumps.Diff: 2Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments

86) Discuss the relationship between growth stocks and income stocks and their P/E ratios.

Answer: A growth stock is a company that is actively growing and expanding. This growth

requires a lot of capital so they seldom pay much in dividends, if any. Instead they plow

their earnings back into the growth of the company. A fast growing company leads to the

potential for fast growing earnings per share. When the market thinks this growth

company has good earnings growth, they bid the share price up accordingly representing

higher P/E ratios.

Most income stocks are from companies who are relatively large and mature in their

industries. Since they are not in an active growth mode, then they donʹt need to retain

earnings and can instead pay them out to the shareholders in the form of high dividends.

Because they are not expected to have a lot of growth in earnings, then the market does

not bid up their market price resulting in relatively low P/E ratios.Diff: 3Topic: Classification of Common StockAACSB: Diverse and Multicultural Work Environments



87) Discuss four reasons to invest in stocks.

Answer: Over time, common stocks outperform all other investments. Although stocks arenʹt

guaranteed to give you any return, they usually give you a worthwhile return.

Stocks reduce risk through diversification. When you include in your portfolio different

types of investments that donʹt move (that is, the rate of return doesnʹt fluctuate) perfectly

together over time, youʹre able to reduce the risk in your portfolio. Stocks donʹt move in

the same manner as other investments such as bonds, and each stock moves in its own

way. Holding stock from multiple industries can greatly reduce your risk.

Stocks are liquid. You canʹt be assured of the price youʹll get when you want to sell your

stock, but you wonʹt have difficulty selling it. The secondary markets for common stock

are extremely well developed, and as such, you will be able to sell your stock– with

minimum transaction costs–whenever you want.

The growth in your investment is determined by more than just interest rates.With

some investments, the potential for price appreciation is largely a function of interest

rates going down. But with common stock, the value isnʹt a slave to interest rates.

Diff: 3Topic: StocksAACSB: Analytical Thinking

12.2 Stock Indexes and Quotes

1) A stock market index is a measure of the performance of a group of stocks that represent the

market or a sector of the market.


2) The Dow Jones Industrial Average is based on the movement of 500 stocks, primarily from the

NYSE.

Answer: FALSEDiff: 1Topic: Stock IndexAACSB: Diverse and Multicultural Work Environments

3) When investors talk about movements in the market, they generally refer to the Russell 1000.

Answer: FALSEDiff: 1Topic: Stock IndexAACSB: Diverse and Multicultural Work Environments

4) During a ʺbear marketʺ stocks prices typically fall.

Answer: TRUEDiff: 1Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments



5) The only time to buy stocks is in a bull market and the only times to sell stocks is during a bear

market.

Answer: FALSEDiff: 1Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments

6) The S&P 500 is a much broader index than the Dow.

Answer: TRUEDiff: 3Topic: Stock ValuationAACSB: Diverse and Multicultural Work Environments

7) The stocks tracked by the Dow represent over 50% of the market value of the NYSE.

Answer: FALSEDiff: 3Topic: Stock ListingAACSB: Diverse and Multicultural Work Environments

8) Movement in the stock market indexes determines whether it is a bear or bull market.

Answer: TRUEDiff: 2Topic: Stock IndexAACSB: Diverse and Multicultural Work Environments

9) Because the Dow Jones Index Average is based on the movement of 500 large, well-established

stocks, many investors believe it reflects price movements for large firms rather than for the

general market.

Answer: FALSEDiff: 2Topic: Stock IndexAACSB: Analytical Thinking

10) The term ʺbearʺ stems from the fact that bears raise their paws upward when they attack.

Answer: FALSEDiff: 1Topic: Market MovementsAACSB: Analytical Thinking

11) The Dow Jones Industrial Average has been an index since what year?

A) 1796 B) 1896 C) 1996 D) 2006

Answer: BDiff: 2Topic: Stock IndexAACSB: Information Technology



12) A stock market characterized by increasing prices is termed a(n) ________ market.

A) bull B) bear

C) animal D) none of the above

Answer: ADiff: 1Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments

13) A ________ is a measure of the performance of a group of stocks that represent the market or a

sector of the market.

A) stock market index

B) stock grouping

C) market composite

D) portfolio return


Answer: ADiff: 1Topic: Stock IndexAACSB: Information Technology

14) A stock market characterized by ________ prices is termed a bear market.

A) falling B) rising

C) steady D) none of the above

Answer: ADiff: 1Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments

15) If you are very optimistic about the ability of firms to earn profits today and in the immediate

future, what type of investor philosophy do you exhibit?

A) Animalistic B) Bullish C) Bearish D) Psychic

Answer: BDiff: 2Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments

16) The S&P 500

A) is the oldest and most widely quoted of the stock indexes.

B) is a narrower index than the DOW.

C) includes some stocks from the OTC market.

D) all of the above




17) The ________ is a common stock indicator, consisting of 30 large industrial firms, and is used to

indicate how well stocks have done.

A) DAIA

B) CMIA

C) DJIA

D) SPFA



18) Jessica wanted to gauge stock performance in general. She found a useful tool that measured the

stock prices of 30 large industrial firms, called the

A) Dow Jones Industrial Average.

B) Standard & Poorʹs Index.

C) Value Line Survey.

D) Moodyʹs Index.


Answer: ADiff: 1Topic: Stock IndexAACSB: Information Technology

19) If you wanted information about how the entire stock market is performing, which index would

provide you with information on virtually all types and sizes of companies?

A) Dow Jones Industrials B) S&P 500

C) NASDAQ 100 D) Wilshire 5000

Answer: DDiff: 1Topic: Stock IndexAACSB: Information Technology

20) When you got home after work, you saw on the news that the S&P was down by 20 points.

Which of the following is true?

A) All of your stocksʹ market prices must have declined by 20 points.

B) Some of your stocksʹ market prices may have increased.

C) Some of your stocksʹ market prices may have decreased.


Answer: DDiff: 1Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments



21) You are looking at the stock quotes in your newspaper and you see that your stock closed up 5%

yesterday. Where would you look to see how it has been doing over the last year?

A) Prior dayʹs close B) P/E ratio

C) 52-week high and low D) Market cap

Answer: CDiff: 1Topic: Stock ListingAACSB: Information Technology

22) All of the following are stock market indexes except

A) the Dow Jones Industrial Average. B) the Standard & Poorʹs 500.

C) the Russell 100. D) the Wilshire 5000.

Answer: CDiff: 3Topic: Earnings per ShareAACSB: Information Technology

23) The DJIA weights stocks based on

A) the size of the company. B) their place alphabetically.

C) their relative prices. D) none of the above.

Answer: CDiff: 3Topic: Stock IndexAACSB: Diverse and Multicultural Work Environments

24) Because the DJIA weights stocks based on their relative prices, when a high priced stock moves

a small amount on the DJIA, it has a(n) ________ impact on the index.

A) limited B) inordinately large

C) insignificant D) minute

Answer: BDiff: 3Topic: Stock IndexAACSB: Diverse and Multicultural Work Environments

25) Because the Dow Jones Index Average is based on the movement of only ________ large,

well-established stocks, many investors believe it reflects price movements for large firms rather

than for the general market.

A) 30 B) 50 C) 100 D) 500

Answer: ADiff: 2Topic: Stock IndexAACSB: Analytical Thinking

26) The letters or characters that represent a stock is known as the stockʹs

A) ticker. B) code. C) acronym. D) share.

Answer: ADiff: 3Topic: StocksAACSB: Information Technology



27) Compare and contrast the Dow Jones Industrial Average and Standard & Poorʹs 500-Stock

Index.

Answer: The Dow attempts to gauge the well-being of the stock market based on the performance

of 30 large industrial firms. Many investors think it reflects price movements for large

firms rather than for the general market. It weights stocks based upon their relative

prices, neglecting other factors that would be indicative. Nonetheless, it does a relatively

good job of reflecting market movements.

The S & P 500 is a much broader index because it is based on the movements of 500

stocks. It is probably a better representative of movements in the overall market.Diff: 2Topic: Stock IndexAACSB: Diverse and Multicultural Work Environments

28) What is the importance of the P/E Ratio to investors?

Answer: The P/E ratio is a measure of risk and the growth potential of the EPS of the firm. A low

P/E ratio signifies that the company is fairly mature or weak and the market is not pricing

in very much earnings growth potential into this stock. An average P/E ratio signals that

this firm is a healthy firm in a healthy industry and this firm has the potential for average

or normal earnings growth. A P/E ratio above the average P/E ratio signals that the

market is very optimistic about above average EPS growth potential and that this stock

could provide healthy capital gains. Possibly it is a new firm with a new innovative

product and its EPS are fairly small right now but this firm has the potential to explode in

sales and profits causing the market value of the stock to explode also. However, many

times a company with a high P/E ratio doesnʹt work out so well and the stock crashes

much faster than it rose in value. High P/E stocks are very speculative and risky and not

appropriate for important investing goals such as retirement.Diff: 2Topic: Earnings per ShareAACSB: Diverse and Multicultural Work Environments

12.3 Valuation of Common Stock

1) The price/earnings ratio is an indication of how much investors are willing to pay for a dollar of

the companyʹs earnings.

Answer: TRUEDiff: 1Topic: Stock ValuationAACSB: Information Technology

2) The discounted dividends valuation model states that the value of a share of stock is the present

value of its future dividends.




3) Technical analysis is a stock valuation technique that incorporates expected future earnings of

the company, the riskiness of the companies cash flows, and interest rates in the markets in

determining the current value of the stock.

Answer: FALSEDiff: 1Topic: Stock ValuationAACSB: Information Technology

4) Earnings per share is a ratio that describes the amount of net income less preferred stock

dividends available to the common shareholders.

Answer: TRUEDiff: 1Topic: Earnings per ShareAACSB: Information Technology

5) Technical analysis focuses on supply and demand, using charts and computer programs to

project stock trends.

Answer: TRUEDiff: 3Topic: StocksAACSB: Information Technology

6) According to your text, there is very little validation in using technical analysis as an investing

tool.


7) The P/E ratio approach is a type of fundamental analysis.

Answer: TRUEDiff: 3Topic: Earnings per ShareAACSB: Information Technology

8) When the market becomes too bullish, the average P/E ratio will fall.

Answer: FALSEDiff: 3Topic: Stock ValuationAACSB: Analytical Thinking

9) A technical analysis is the framework for analyzing a security in which you look at a firmʹs

internal strengths and weaknesses and external opportunities and threats in order to gain an

understanding of what the future holds for that firm and its stock.

Answer: FALSEDiff: 3Topic: Stock ValuationAACSB: Analytical Thinking



10) A stock currently selling for $105 with estimated earnings per share of $5.25 would have a P/E

ratio of

A) 10. B) 12. C) 20. D) 28. E) 30.


11) The P/E ratio of a stock is 20, and its earnings per share is $5.25. What is the current selling price

of the stock?

A) $20 B) $75 C) $100 D) $105


12) Your friend has recommended that you purchase stock in company XYZ. It is expected to pay a

$4 dividend, and has historically grown at 5%. If the required rate of return is 12%, what is the

estimated value of a share of XYZ stock?

A) $23.53 B) $33.34 C) $57.14 D) $80.00

Answer: CDiff: 3Topic: Stock ValuationAACSB: Analytical Thinking

13) You are considering purchasing one of two stocks. Stock A is expected to pay a $2.50 dividend,

and has historically grown at 6%. Stock B is expected to pay a $3.00 dividend and has

historically grown at 4%. Both are the same risk, and you desire to earn a 16% return. Which of

the following is true?

A) You should buy Stock A, since its estimated price is higher than Stock B.

B) You should buy Stock B, since its estimated price is higher than Stock A.

C) You should buy Stock A, since its estimated price is lower than Stock B.

D) You should buy Stock B, since its estimated price is lower than Stock A.

E) You should buy either Stock A or B, since the estimated prices are the same.

Answer: EDiff: 3Topic: Stock ValuationAACSB: Analytical Thinking



14) You are considering the purchase of a stock with a current market price of $50.25 per share. It is

expected to pay a dividend of $5.25 next year. Historically the stock has grown at 5%, and based

on its risk, you desire to earn a 15% return. Which of the following is true?

A) Buy the stock, since your estimated price is higher than the market price.

B) Buy the stock, since your estimated price is lower than the market price.

C) Do not buy the stock, since your estimated price is lower than the market price.

D) Do not buy the stock, since your estimated price is higher than the market price.

E) None of the above are true statements

Answer: ADiff: 3Topic: Stock ValuationAACSB: Analytical Thinking

15) ComChip is a computer chip manufacturer whose stock is selling at $50 per share. Next yearʹs

net earnings, minus the preferred stock dividends, is estimated to be $200,000. The company

currently has 100,000 shares of common stock outstanding. What is the firmʹs P/E ratio?

A) 50.00 B) 45.80 C) 25.00 D) 27.78


16) ComChip is a computer chip manufacturer. Its stock is selling at $50 per share and earnings are

$2 per share. What is the stockʹs P/E ratio?

A) 50.00 B) 45.80 C) 25.00 D) 27.78 E) 22.50


17) A stock currently sells for $100 per share, and has earnings of $2.00 per share. What is the stockʹs

P/E ratio?

A) 50.00 B) 25.00 C) 5.00 D) 1.00

Answer: ADiff: 3Topic: Stock ValuationAACSB: Analytical Thinking

18) The ratio of the annual dividend to the market price of the stock is called the

A) retention ratio.

B) plowback ratio.

C) current ratio.

D) dividend yield.


Answer: DDiff: 1Topic: DividendsAACSB: Information Technology



19) Using the stock valuation formula calculate the value of a share of stock if it is expected to pay

$5 in dividends, in addition the dividends are expected to grow at a rate of 4 percent forever,

and the investorʹs required rate of return is 12 percent.

A) $18.75 B) $39.75 C) $62.50 D) $68.50


20) Using the stock valuation formula calculate the value of a share of stock if it is expected to pay

$15 in dividends, in addition the dividends are expected to grow at a rate of 8 percent forever,

and the investorʹs required rate of return is 10 percent.

A) $6.50 B) $7.50 C) $12.00 D) $14.50

Answer: BDiff: 1Topic: Stock ValuationAACSB: Analytical Thinking

21) Your dad said that he was curious to know why there is so much fluctuation in the value of

common stocks. In 1997 the prospects for Sun Industries became more uncertain and investors

began to view it as a more risky investment than they had previously. To compensate for this

added risk, investors increased their required rate of return on Sun Industries stock, resulting in

a decline in its market value. This explains the factor of

A) earnings growth and stock valuation.

B) interest rates and stock valuation.

C) risk and stock valuation.

D) supply and demand.

E) dividend strength and stock valuation.

Answer: CDiff: 3Topic: Stock ValuationAACSB: Diverse and Multicultural Work Environments

22) A SWOT analysis

A) is a good way of breaking down a firmʹs capabilities and gaining a better understanding of

what the future may hold for the firm.

B) focuses on strengths, weaknesses, opportunities, and threats.

C) is designed to better understand a firmʹs strategies and whether or not the strategies are

sustainable.

D) both A and C.

Answer: DDiff: 2Topic: Stock Investment StrategiesAACSB: Analytical Thinking



23) For several years you have been using charts and computer programs to project trends in the

stock market. You are engaging in what type of analysis?

A) Dollar cost averaging

B) Technical

C) Fundamental

D) Price/Earnings


Answer: BDiff: 1Topic: Stock Investment StrategiesAACSB: Analytical Thinking

24) Your father-in-lawʹs stockbroker examines future earnings and dividends, the expected level of

interest rates, and the firmʹs risk to provide a basis for buy-sell recommendations. This

stockbroker uses the ________ approach to stock valuation.

A) financial statement analysis

B) earnings analysis

C) expectations method

D) fundamental analysis


Answer: DDiff: 1Topic: Stock ValuationAACSB: Information Technology

25) Louise Rogers knows that several factors affect the price of a share of common stock. The one

that says there is an inverse relationship between interest rates and the value of a share of

common stock is the ________ factor.

A) risk and stock valuation

B) interest rates and stock valuation

C) earnings growth and stock valuation

D) interest rates and risk valuation

E) interest rates and earnings growth valuation

Answer: BDiff: 2Topic: Stock ValuationAACSB: Diverse and Multicultural Work Environments

26) Your mother-in-lawʹs stockbroker focuses on supply and demand, and uses charts and

computer programs to identify and make buy-sell recommendations. She is using the ________

method.

A) descriptive analysis

B) visual hedging

C) technical analysis

D) push and shove





27) Fundamental analysis looks at which of the following?

A) Future earnings

B) Dividends

C) Expected levels of interest rates

D) The firmʹs risk

E) All of the above

Answer: EDiff: 2Topic: DividendsAACSB: Analytical Thinking

28) The discounted dividends valuation model of common stock assumes that dividends will grow

at a constant rate forever. This method tells us that the (dividend next year) divided by the

(required rate of return - growth rate) yields the

A) discounted dividend.

B) dividend growth rate.

C) value of the common stock.

D) value of the earnings.

E) value of the P/E ratio.


29) Marian read in a financial magazine that the discounted dividends valuation model of common

stock defines the value of a share of common stock as the ________ value of the infinite stream

of future ________.

A) future; growth

B) future; earnings

C) dividend; earnings

D) present; dividends

E) present; earnings

Answer: DDiff: 3Topic: Stock ValuationAACSB: Analytical Thinking

30) This equation, dividends next year/required rate of return minus growth rate tells us the stockʹs

A) dividend yield.

B) earnings per share.

C) value.

D) growth potential.

E) book-to-price ratio.




31) The ________ the firmʹs earnings growth rate, the ________ the firmʹs P/E ratio and the ________

the investorʹs required rate of return, the ________ the P/E ratio.

A) higher; higher; higher; higher

B) higher; higher; higher; lower

C) higher; higher; lower; lower

D) higher; lower; lower; lower

E) lower; lower; lower; lower

Answer: BDiff: 3Topic: Stock ValuationAACSB: Analytical Thinking

32) This approach is used regularly by security analysts to measure a stockʹs relative value, or how

much investors are willing to pay for a dollar of the companyʹs earnings. It is found by dividing

the price per share by the earnings per share and is called the

A) P/E ratio.

B) technical industry analysis.

C) fundamental analysis.

D) discounted dividends valuation.

E) market-to-price ratio.

Answer: ADiff: 3Topic: Stock ValuationAACSB: Diverse and Multicultural Work Environments

33) The following equation, (net income - preferred stock dividends)/number of shares of common

stock outstanding, allows us to calculate the ________ and this information is necessary to

calculate the ________ ratio.

A) dividend yield; dividend

B) earnings per share; P/E

C) market-to-book ratio; book-to-market

D) stock growth: P/E

E) price-to-book ratio; market-to-book

Answer: BDiff: 3Topic: Earnings per ShareAACSB: Analytical Thinking

34) Which one of the popular common stock valuation methods focuses on supply and demand and

uses a computer and charts to identify and project price trends for a stock or for the market as a

whole?

A) Fundamental analysis approach

B) Technical analysis approach

C) Price/earnings ratio approach

D) Market analysis approach

E) Industry analysis approach

Answer: BDiff: 2Topic: Stock ValuationAACSB: Information Technology



35) What are the three factors that explain why stock values fluctuate?

Answer: As interest rates rise, the value of the stock decreases. As the stockʹs risk increases, so

does the investorʹs required rate of return. As earnings grow, so does the companyʹs

capacity to pay dividends. This earnings growth is viewed as a cause of dividend

increases and stock prices.Diff: 1Topic: Stock ValuationAACSB: Diverse and Multicultural Work Environments

36) Distinguish between the technical analysis and fundamental approaches of valuation of

common stock.

Answer: Technical analysis takes a number of forms, including the interpretation of computer

programs, charts, graphs, and mathematical calculations of tracking patterns, all aimed at

spotting some trend or direction for stocks. This is no longer a useful approach because it

encourages moving in and out of the market rather than buying and holding stocks.

A fundamental analysis determines the value of a share of stock by focusing on such

factors as future earnings and dividends, expected levels of interest rates, and the firmʹs

risk. An example is the Price/Earnings Ratio which is a measure of a stockʹs relative value,

found by dividing the price per share by the earnings per share. The higher the ratio the

better.Diff: 2Topic: Stock ValuationAACSB: Analytical Thinking

37) Why is using the P/E ratio a very popular valuation tool?

Answer: Many investors use the P/E ratio because it helps to compare the stockʹs growth potential

relative to other firms. When you purchase a stock, you are not really buying the

company as it stands today. You are actually buying the earnings potential in the future.

A healthy, well run company will have innovative products and growing market share

leading to growing EPS. It is the EPS in the future that you are actually buying today. The

P/E ratio communicates how the market feels about the future prospects of the firm.

The P/E ratio also communicates a level of risk. When a stock is ʹpriced to perfectionʹ with

a high P/E ratio, then the firm had better live up to these lofty expectations for future

growth. Any bad news such as disappointing earnings growth or slowing sales growth or

competitive or regulatory pressures can cause these stocks to plummet in value to match

the new, reduced expectations for earnings growth.Diff: 3Topic: Stock ValuationAACSB: Information Technology

12.4 Stock Investment Strategies

1) A buy-and-hold investment strategy means that an investorʹs gains will be taxed as short-term

capital gains.

Answer: FALSEDiff: 1Topic: Stock Investment StrategiesAACSB: Analytical Thinking



2) The acronym DRIP stands for

A) Dividends, Returns, Interest, and Profits.

B) Dividend Rates and Income Potential.

C) Dividend Reinvestment Plan.

D) Dividend Risk and Income Potential.

Answer: CDiff: 2Topic: DividendsAACSB: Analytical Thinking

3) You have just discovered one reason not to invest in stocks. What do you think it is?

A) Stocks reduce risk through diversification.

B) Your tolerance of risk is low.

C) Over time, common stocks outperform all other investments.

D) Stocks are liquid.

E) Growth is determined by more than just interest rates.

Answer: BDiff: 2Topic: RiskAACSB: Reflective Thinking

4) The experts say that a person under the age of 40 should have a majority of their retirement

money invested in the stock markets. What is the reason for this?

A) On average, common stocks provide a higher return on investment than other investment

options.

B) Younger people have enough time ahead of them to ride out any dramatic market

movements.

C) Younger people generally donʹt have enough money to invest in other options.



Answer: EDiff: 3Topic: Risk and Return Go Hand in HandAACSB: Reflective Thinking

5) A buy-and-hold investment strategy

A) avoids timing the market.

B) minimizes transaction costs.

C) postpones capital gains taxes.

D) means your gains will be taxed as long-term capital gains.


Answer: EDiff: 3Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments



6) Which of the following questions should potential investors answer before investing?

A) Is this a good price for the stock?

B) Is this firm in a position that will allow profitability in the future?

C) Are this firmʹs strengths and weaknesses likely to get better or worse?

D) Are this firmʹs threats and opportunities likely to get better or worse?

E) All of the above

Answer: EDiff: 2Topic: Stock Investment StrategiesAACSB: Analytical Thinking

7) Discuss three reasons why dollar-cost averaging is an important concept to investors.

Answer: If you buy stock over an extended period, itʹs less likely that all your money will be

invested right before a market crash.

Dollar-cost averaging keeps you from trying to ʺtime the marketʺ in an attempt to wait

for the lowest possible price before buying. Identifying the lowest price is virtually

impossible to do, although admittedly, it is awfully tempting to try.

Most importantly, dollar-cost averaging forces disciplined investing. If you are regularly

investing in stocks, the practice becomes part of your budgeting and planning process.Diff: 2Topic: Stock Investment StrategiesAACSB: Analytical Thinking

8) What are the four basic investment questions a potential investor should answer before

investing?

Answer: Value: Is this a good price for the stock?

Quality: Is this firm in a position that will allow profitability in the future?

Strengths and Weaknesses: Are this firmʹs strengths and weaknesses likely to get better or

worse?

Threats and Opportunities: Are this firmʹs threats and opportunities likely to get better or

worse?Diff: 2Topic: Stock Investment StrategiesAACSB: Reflective Thinking

9) How do the three common investment strategies differ? Which is good if you want to avoid

being killed rather than make a killing in the market?

Answer: Dollar cost averaging occurs when you buy a fixed dollar amount of stock at specified

intervals to level out the ups and downs of prices. It is the best strategy for avoiding

being killed rather than to make a killing. The buy-and-hold idea aims at avoiding

timing the market, minimizes brokerage fees and costs, postpones capital gains taxes,

and is simple to carry out.

A dividend reinvestment plan allows you to accumulate wealth by automatically

reinvesting dividends (rather than spend them) without any brokerage fees. Without

reinvesting the dividends, your wealth will be limited to the stockʹs capital gains.Diff: 2Topic: Stock Investment StrategiesAACSB: Analytical Thinking



10) Briefly describe the SWOT analysis.

Answer: The SWOT analysis is a framework for analyzing a firm or its common stock. The

analysis forces you to consider a firmʹs internal strengths and weaknesses and external

opportunities and threats. A benefit of the analysis is that it allows you to better

anticipate changes that might occur in the company.Diff: 2Topic: Stock Investment StrategiesAACSB: Analytical Thinking

12.5 Risks Associated with Common Stocks

1) When all stocks move in the same direction, diversification among stocks works just as well as

ever.

Answer: FALSEDiff: 2Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments

2) For investors with a long time in front of them, market volatility is not of great concern today.

Answer: TRUEDiff: 2Topic: Market MovementsAACSB: Reflective Thinking

3) In the short run, market variability or volatility creates potential risk.

Answer: TRUEDiff: 2Topic: Market MovementsAACSB: Diverse and Multicultural Work Environments

4) By using the risk evaluation tool called beta, you can measure the movement of your individual

stock compared to the S&P 500.


5) If your stockʹs beta was greater than 1.0 that indicates that your stock is more susceptible to

movements in the market.

Answer: TRUEDiff: 2Topic: Stock ValuationAACSB: Diverse and Multicultural Work Environments

6) If your portfolio is very diversified then the beta is of no use to you.

Answer: FALSEDiff: 2Topic: RiskAACSB: Information Technology



7) Beta is the measure of how responsive a stock is to changes in the market portfolios, like the

S&P 500.

Answer: TRUEDiff: 2Topic: DiversificationAACSB: Information Technology

8) According to the risk-return relationship, commercial paper usually has a higher risk and

return than long-term corporate bonds.

Answer: FALSEDiff: 2Topic: Principle 8: Risk and return go hand in handAACSB: Analytical Thinking

9) You and a group of your friends have been discussing your portfolios at the company water

cooler. Your discussion has centered on how your stocks are moving up or down in price

relative to the market as a whole. Each stockʹs ________ is likely the best measure of the

relationship.

A) relative index

B) beta

C) alpha

D) delta


Answer: BDiff: 1Topic: RiskAACSB: Information Technology

10) Because every company is almost certain to experience a bad year or two, holding on to stock

for only one year

A) is not a very sound investment decision.

B) is a very sound investment decision.

C) is a good idea for those who may need to liquidate their investment quickly.

D) diversifies oneʹs portfolio risk.


11) Compared to other investment options, we can safely say that investing in stocks

A) has equal risk. B) has greater risk.

C) has less risk. D) is not worth the risk.




12) In October 2008, most of the major stock indices around the world plummeted in value. The

most likely cause for these dramatic events were

A) non-systematic risk. B) variable betas.

C) systematic risk. D) None of the above are correct.


13) What would you expect to be associated with a company whose stock has a high beta?

A) A high potential return

B) A high dividend yield

C) A large market capitalization


E) All but C are correct.

Answer: ADiff: 3Topic: RiskAACSB: Analytical Thinking

14) The phrase ________ is sadly appropriate for the actions of some people, as they perceive that

investment success rests in making frequent transactions.

A) ʺplaying the marketʺ B) ʺtiming the marketʺ

C) ʺgo big or lose your homeʺ D) ʺbuy low, sell highʺ

Answer: ADiff: 2Topic: Investment InformationAACSB: Reflective Thinking

15) Discuss the concept of using beta for investing in stocks.

Answer: Beta is a mathematical process to quantify or identify an individual stockʹs risk relative to

the overall stock market risk. It is a coefficient that amplifies or magnifies the individual

stockʹs potential price movements relative to the overall marketʹs price movements. If a

stock has a beta of 1.5, then this tells us that if the average or typical stock increased by

10% then this stock should average a 15% increase in its market price. Beta is a function of

risk. For investors with a low propensity for risk they should avoid stocks with high beta

coefficients. Investors with a willingness to speculate should look for high beta stocks to

invest in, realizing that they may lose all or most of their investment.Diff: 3Topic: RiskAACSB: Diverse and Multicultural Work Environments

16) Can you explain the risk-return trade-off with common stocks?

Answer: Stocks have more risk than other investments, but at the same time have more potential

return associated with them. By diversifying your portfolio, you reduce the risk of downs

ruining your ups. By diversifying you can diversify away some risk and by holding for

the long term they can become even less risky.Diff: 2Topic: Risk and Return Go Hand in HandAACSB: Diverse and Multicultural Work Environments


Chapter 13Investing in Bonds and Other Alternatives

13.1 Why Consider Bonds?

1) Bonds reduce risk through diversification.


2) The par value of the bond is the rate at which payments will be made to the bondholder

annually, in the form of interest.

Answer: FALSEDiff: 1Topic: BondsAACSB: Information Technology

3) The issuer of the bond is effectively loaning money to the bondholder when the bond is

purchased.


4) If you are already retired and seek additional income, then bonds as an investment choice

would be wise.


5) Bonds which are very low rated, yet high yielding bonds are known as junk bonds.


6) The face value of a bond, or the amount that is returned to the bondholder at maturity is also

known as the bondʹs denomination.


7) Bonds that do not pay interest are known as no-load bonds.



Chapter 13 Investing in Bonds and Other Alternatives 405

8) Why might you consider investing in bonds?

A) Bonds reduce risk through diversification.

B) Bonds produce steady income.

C) Bonds can be safe investment if held to maturity.

D) All of the above

Answer: DDiff: 2Topic: BondsAACSB: Diverse and Multicultural Work Environments

9) Bond issuers may do something very important for the bondholder that increases the

probability the debt will be successfully paid off at maturity. The issuer

A) establishes a sinking fund. B) sets a fixed interest rate.

C) has the bond indentured. D) has the bond deferred.

Answer: ADiff: 2Topic: Sinking FundsAACSB: Diverse and Multicultural Work Environments

10) Any bond that is backed by the pledge of collateral is known as what type of bond?

A) Collateralized

B) Secured

C) Recalled

D) Sinking

E) Agency

Answer: BDiff: 1Topic: BondsAACSB: Diverse and Multicultural Work Environments

11) Bonds enjoy all but one of the following advantages. Which is it?

A) When interest rates drop, bond prices rise.

B) Bonds may be called when interest rates drop.

C) They reduce risk through diversification.

D) Bonds produce steady income.

E) They can be a safe investment if held to maturity.

Answer: BDiff: 2Topic: BondsAACSB: Diverse and Multicultural Work Environments



12) You hold in your hands a legal document that provides the specific terms of the loan agreement,

including a description of the bond, as well as the rights of the bondholder. You have a(n)

A) agency contract.

B) bond signatory.

C) signatory contract.

D) indenture.

E) debenture.

Answer: DDiff: 1Topic: IndentureAACSB: Information Technology

13) State or municipal bonds that have interest and par value paid for with funds from a designated

project or specific tax are known as ________ bonds.

A) Series EE

B) life cycle

C) revenue

D) general obligation


Answer: CDiff: 1Topic: MaturityAACSB: Information Technology

14) The ________ is the face value of a bond, and the amount that is returned to the bondholder at

maturity.

A) return price

B) par value

C) dead price

D) market price


Answer: BDiff: 1Topic: Par ValueAACSB: Diverse and Multicultural Work Environments

15) Herman Melville never thought of a bond as being a ________ and that he would be a ________

when securing one until he read about it in his personal finance text.

A) lien; borrower

B) loan; borrower

C) loan; lender

D) lien; debenture

E) lien; lender

Answer: CDiff: 2Topic: BondsAACSB: Diverse and Multicultural Work Environments



16) An unsecured long-term bond is known as a(n)

A) bondenture. B) indenture. C) debenture. D) abdenture.


17) What could happen if you sell a bond before its maturity date?

A) You could have a capital gain.

B) You could have a capital loss.

C) You could break even with the price you paid for the bond.




18) Which of the following determines what the annual interest payment on a bond will be?

A) The par value of the bond

B) The maturity date of the bond

C) The coupon rate of the bond



Answer: EDiff: 2Topic: Coupon Interest RateAACSB: Diverse and Multicultural Work Environments

19) XYZ company issued bonds three years ago with a 7% coupon rate. Today, the market rate of

interest was lowered to 4%. What most likely will happen next?

A) XYZ company will lower the par value of their bonds.

B) XYZ company will raise the coupon rate of their bonds.

C) XYZ company will call their bonds in.


Answer: CDiff: 2Topic: CallsAACSB: Diverse and Multicultural Work Environments

20) What is the purpose of the sinking fund?

A) To force the issuing company to save money to retire the bonds at maturity

B) To raise outside capital to sink back into the company

C) To cause the coupon rate to increase


Answer: ADiff: 2Topic: Sinking FundsAACSB: Diverse and Multicultural Work Environments



21) Your friend wants you to seriously consider investing in bonds like she did. Why?

Answer: When interest rates decline, the price of bonds rises. Bonds reduce risk through

diversification. Bonds also produce steady current income. They can be a safe investment

when held for the long term to maturity.Diff: 1Topic: BondsAACSB: Analytical Thinking

22) Provide an explanation of the basic bond terminology and features.

Answer: A bond has a par value, or face value, which is the amount that will be returned to the

bondholder at maturity. Bonds pay a percentage of their par value annually in the form

of coupon interest rates. A legal agreement, called an indenture, is created between the

issuing firm and the bond trustee who represents the bondholders. Bonds have a call

provision to recall bonds when the interest rates drop so the issuer can make more

money. To protect the issuer and the investor, a sinking fund may be established by the

issuer to set aside money to pay off bonds at maturity.Diff: 1Topic: BondsAACSB: Analytical Thinking

23) What is the purpose of the call provision on some bonds?

Answer: Many times the issuing company needs to raise outside financial capital when the market

rates of interest are high, forcing the company to offer a high coupon rate to make the

bonds attractive. The high coupon rates mean than the company must pay out a large

amount of money to the bondholders. The call provision allows the company to refinance

their debt at a lower coupon rate meaning they will save money on the coupon payments.

When the market rates of interest fall, they can sell new bonds with a lower coupon rate

and use the proceeds from the new bond issue to call the older, more expensive bonds.Diff: 2Topic: CallsAACSB: Analytical Thinking

13.2 Basic Bond Terminology and Features

1) Interest payments on municipal bonds are exempt from federal taxes and state taxes as long as

you live in the state in which the bonds were issued.

Answer: TRUEDiff: 2Topic: Municipal BondsAACSB: Diverse and Multicultural Work Environments

2) An I bond is an accrual-type bond, meaning that interest is added to the value of the bond and

paid when the bond is cashed in.

Answer: TRUEDiff: 1Topic: Treasury SecuritiesAACSB: Diverse and Multicultural Work Environments



3) The biggest single payer in the bond market is the U.S. Government.


4) An indenture is an unsecured long-term bond.

Answer: FALSEDiff: 1Topic: IndentureAACSB: Diverse and Multicultural Work Environments

5) A secured bond is one that is backed by collateral.


6) A debenture is a long-term bond secured by collateral.

Answer: FALSEDiff: 2Topic: Treasury SecuritiesAACSB: Diverse and Multicultural Work Environments

7) TIPS are treasury bonds for which the par value changes with the consumer price index.


8) Governments issue savings bonds such as the Series EE bonds in an attempt to meet the

investing needs of the small investor.


9) If the school district wants to build a new high school, they can sell municipal bonds.

Answer: TRUEDiff: 2Topic: Municipal BondsAACSB: Diverse and Multicultural Work Environments

10) Most corporate bonds are tax-free bonds in the state the corporation is based in.

Answer: FALSEDiff: 2Topic: BondsAACSB: Information Technology



11) The largest single player and payer in the bond market

A) is corporate America.

B) are municipal bond issuers.

C) is the U.S. government.

D) are foreign firms.

E) are schools and county governments.

Answer: CDiff: 1Topic: Treasury SecuritiesAACSB: Diverse and Multicultural Work Environments

12) The long-term bond you own was issued by IBM Corporation and used no collateral. This is an

example of a(n)

A) unsecured mortgage.

B) credit.

C) debenture.

D) nomenclature.



13) You own a(n) ________ certificate, which is a certificate that represents a portion of ownership

in a pool of federally insured mortgages.

A) interest

B) mortgage bond

C) collateral

D) pass-through


Answer: DDiff: 1Topic: Predatory LendingAACSB: Diverse and Multicultural Work Environments

14) The bond that you own does not pay any interest. Instead, it is sold at a ʺdiscountʺ from its

maturity value. This is a ________ bond.

A) no interest

B) face discount

C) growth

D) zero coupon





15) If you were considering the purchase of a bond issued by a state, county, or city you would be

considering the purchase of a ________ bond.

A) state

B) municipal

C) government hedge

D) corporate


Answer: BDiff: 1Topic: Municipal BondsAACSB: Diverse and Multicultural Work Environments

16) Peter must read the ________, or legal agreement between the firm issuing the bond and the

bond trustee who represents the bondholders.

A) contract

B) indenture

C) provisions

D) debenture

E) prospectus

Answer: BDiff: 1Topic: IndentureAACSB: Information Technology

17) Randall has $25,000 and is considering investing in bonds. With this amount of start up money

he should look into which of the following bonds?

A) Agency bonds

B) Corporate bonds

C) Pass-through certificates

D) All of the above would be good choices.


18) The city of Houston passed a bond issue to build a bridge over the bay. The bond was to have

the interest paid by the income generated by charging drivers a toll to cross the bridge. This is

an example of a ________ bond.

A) collateralized

B) cash

C) revenue

D) general obligation


Answer: CDiff: 1Topic: Municipal BondsAACSB: Diverse and Multicultural Work Environments



19) The interest rate carried on agency bonds, such as FNMA and FHLB, is ________ the interest

rate on Treasury bonds.

A) higher than

B) lower than

C) usually the same as

D) at most half that of


Answer: ADiff: 2Topic: Predatory LendingAACSB: Diverse and Multicultural Work Environments

20) The advantages of Treasury bonds include

A) there is no default.

B) they canʹt be called in.

C) most interest is free of state and local taxes.


E) only A and C.

Answer: DDiff: 3Topic: Treasury SecuritiesAACSB: Diverse and Multicultural Work Environments

21) Treasury bonds are generally viewed as being risk-free, given the governmentʹs ability to

________ and ________.

A) tax people; do volume business

B) tax corporations; do volume business

C) tax; print more money

D) print money; do volume business


Answer: CDiff: 3Topic: Treasury SecuritiesAACSB: Diverse and Multicultural Work Environments

22) The corporate bond that you own is backed by the corporationʹs Houston, Texas real estate

holdings. If the company defaults, these holdings could be liquidated to repay the debt. This is

an example of a ________ bond.

A) mortgage

B) debenture

C) liquidation

D) credit


Answer: ADiff: 1Topic: BondsAACSB: Diverse and Multicultural Work Environments



23) Because there is no default or call risk associated with government bonds, they generally pay

________ rate of interest than other bonds.

A) a higher B) a lower

C) the same D) none of the above

Answer: BDiff: 2Topic: Municipal BondsAACSB: Diverse and Multicultural Work Environments

24) When there are changes in the consumer price index, there is a corresponding change in the par

value of

A) TIPS. B) Series EE bonds.

C) I Bonds. D) Munis.

Answer: ADiff: 2Topic: Treasury SecuritiesAACSB: Diverse and Multicultural Work Environments

25) Brittany has learned in her research that ________ are issued by the FNMA and the FHLB.

A) pass-through certificates B) agency bonds

C) treasury bonds D) treasury inflation-indexed bonds

Answer: BDiff: 2Topic: Predatory LendingAACSB: Diverse and Multicultural Work Environments

26) Because junk bonds carry a much higher risk of default, they also carry an interest rate ________

percent above the AAA grade long-term bonds.

A) 1 - 2 B) 3 - 6 C) 7 - 9 D) 10 - 12 E) 20 - 25

Answer: BDiff: 1Topic: BondsAACSB: Analytical Thinking

27) ________ bonds are sold electronically, and they are now sold at face value; that is, you pay $50

for a $50 bond.

A) Electronic Series EE B) I

C) Paper Series EE D) Only A and B

Answer: ADiff: 1Topic: Treasury SecuritiesAACSB: Information Technology

28) Which of the following starts off with the highest risk bond and ends with the lowest risk bond?

A) Municipal, Corporate, Treasury, Junk B) Corporate, Junk, Treasury, Municipal

C) Junk, Corporate, Municipal, Treasury D) Corporate, Junk, Municipal, Treasury




29) Which of the following bonds would be appropriate for a retired person seeking a stream of

income during retirement?

A) U.S. Treasury B) Investment grade corporate bond

C) Municipal bond D) All of the above are correct.


30) One of the problems with most bonds is that their coupon payment is fixed and rising inflation

weakens the purchasing power of their coupon payments. Which of the following bonds is the

best option during times of high inflation?

A) FNMA Agency bonds B) TIPS

C) High grade corporate bonds D) High yield speculative bonds

Answer: BDiff: 2Topic: Treasury SecuritiesAACSB: Diverse and Multicultural Work Environments

31) In the event that a corporation files for bankruptcy, bond trustees have the power to

A) issue new bonds.

B) recall outstanding bonds.

C) sell the corporations secured assets and use the proceeds to pay the bondholders.

D) change the interest rate on outstanding bonds.


32) Outline, with a brief description, the different types of bonds.

Answer: 1. Corporate bonds issued by corporations as either secured or unsecured

2. Treasury bonds risk-free bonds issued by the federal government

3. Agency bonds issued by federal agencies, such as the FNMA and the FHLB

4. Pass-through certificates a Ginnie Mae is a federally insured mortgage

5. Treasury inflation-indexed bonds

6. U.S. series EE bonds savings bonds with variable interest and low denominations

7. Municipal bonds city, county, and state bonds funded by projects and taxes

8. Zero coupon bonds bonds with no interest sold at a deep discount from par value

9. Junk bonds low-rated, high-yield bonds rated BB or lower, mostly from new firmsDiff: 2Topic: BondsAACSB: Reflective Thinking



33) Why are the tax implications of investing in bonds more involved than the tax implications of

investing in common stock?

Answer: Common stock is pretty straight forward when it comes to paying taxes on their returns.

With stock, you either have a capital gain or loss and possibly dividend income, both of

which are obviously taxable sources of income. With the many different types of bonds,

some are taxable bonds and, similar to stocks, you either have a capital gain or loss and

interest income, all of which are obviously taxable. However, with U.S. Treasuries, their

may be tax liabilities on certain sources of income, either capital gains or rate adjustments

with TIPS. Municipal bonds are similar except it also depends on where you live and

what State issued the bonds. There may not be a Federal tax liability but there may be

different State tax liabilities.Diff: 3Topic: BondsAACSB: Reflective Thinking

13.3 Evaluating Bonds

1) Investors require a higher rate of return on bonds with higher bond ratings.

Answer: FALSEDiff: 1Topic: Bond RatingsAACSB: Diverse and Multicultural Work Environments

2) The yield to maturity for a bond with eight years to maturity, with a face value of $1,000, pays

10 percent annual coupon and currently sells for $1,950, is 5 percent.

Answer: FALSEDiff: 3Topic: YieldAACSB: Analytical Thinking

3) The current yield, the coupon rate, and the yield to maturity are equal if the bond sells at par

value.

Answer: TRUEDiff: 2Topic: YieldAACSB: Analytical Thinking

4) A bondʹs yield is always exactly the same as its coupon interest rate.

Answer: FALSEDiff: 2Topic: YieldAACSB: Information Technology

5) In comparing municipal bonds to other taxable bonds, the comparison must be between

equivalent taxable yields.

Answer: TRUEDiff: 2Topic: Taxable YieldAACSB: Diverse and Multicultural Work Environments



6) A bondʹs coupon interest rate is a factor if its market price.

Answer: FALSEDiff: 2Topic: YieldAACSB: Information Technology

7) Coupon interest is usually paid in quarterly installments.

Answer: FALSEDiff: 2Topic: Coupon Interest RateAACSB: Diverse and Multicultural Work Environments

8) There is an inverse relationship between interest rates and bond values.

Answer: TRUEDiff: 2Topic: Bond PriceAACSB: Diverse and Multicultural Work Environments

9) When a bond is bought at a premium price above its par value, the current yield will be lower

than the coupon rate.

Answer: TRUEDiff: 2Topic: YieldAACSB: Diverse and Multicultural Work Environments

10) When a bond is bought at a discount price below its par value, the current yield will be higher

than the coupon rate.


11) For a long-term investor, the yield to maturity is the most important yield to determine.


12) Michael Milkman has suggested that you consider the purchase of some bonds that are rated BB

or below. He is asking you to purchase ________ bonds.

A) junk

B) very risky

C) high-yield

D) All of the above

E) Only A and B.

Answer: DDiff: 1Topic: BondsAACSB: Information Technology



13) Karyn wants to evaluate some bonds she is contemplating buying. In order to adequately

evaluate them, she should check the bond yields, read the bond quotes in a paper, and check the

A) par values. B) bond ratings.

C) company rating. D) companyʹs performance.

Answer: BDiff: 1Topic: Bond RatingsAACSB: Information Technology

14) A bond rating is really a measure of a bondʹs

A) performance.

B) yield.

C) market value.

D) riskiness.

E) yield to maturity.

Answer: DDiff: 1Topic: Bond RatingsAACSB: Information Technology

15) Gail used her financial calculator to calculate her bondʹs yield to maturity. Given the following

information what was her yield? N = 10; PV = -880.00; PMT = 100; FV = 1000.

A) 10.0%

B) 8.80%

C) 10.18%

D) 12.14%


Answer: DDiff: 2Topic: Bond PriceAACSB: Analytical Thinking

16) What is the value of a $1,000 par value bond with a 12% annual coupon that will mature in 5

years if the bond is currently priced to yield 10%?

A) $955.76 B) $1,000.00 C) $1,075.82 D) $1,158.52

Answer: CDiff: 3Topic: Bond PriceAACSB: Analytical Thinking

17) Using a financial calculator calculate the value of a bond that matures in 20 years with a coupon

interest rate of 10%, which is the required rate of return, and a par value of $1,000.

A) $100 B) $1,000 C) $1,100 D) $10,000

Answer: BDiff: 2Topic: Bond QuotesAACSB: Analytical Thinking



18) You have a corporate bond that pays interest every six months. Its par value is $1,000 and it

carries a coupon rate of 10%. What is your accrued interest on the bond if it has been four

months since interest was last paid?

A) $33.33

B) $50.00

C) $66.66

D) $100.00


Answer: ADiff: 3Topic: YieldAACSB: Analytical Thinking

19) You are considering the purchase of one of two different bonds, a muni, which currently yields

6%, and a corporate, which currently yields 10%. If you are trying to maximize your return and

you are in a 38% tax bracket, which of the following is true?

A) The muni bond has a better yield for you.

B) The corporate bond has a better yield for you.

C) The bonds have identical yields for you.

D) There is not enough information to determine which is a better yield for you.

Answer: BDiff: 3Topic: Taxable YieldAACSB: Analytical Thinking

20) Sherman has three bonds with a $1,000 par value that pay a 9% coupon interest rate. How much

will he earn every six months?

A) $27 B) $90 C) $135 D) $202.50 E) $270

Answer: CDiff: 3Topic: Coupon Interest RateAACSB: Analytical Thinking

21) Suppose that you have a bond that has a par value of $1,000 and a coupon interest rate of 9%. Its

current price is $950 and it will mature in 7 years. What is the yield to maturity?

A) 8.45% B) 9.00% C) 10.03% D) 10.23%

Answer: CDiff: 3Topic: YieldAACSB: Analytical Thinking

22) A bond has a par value of $1,000, a market price of $300, and a 9% coupon rate. It will mature in

5 years. What is the current yield of the bond?

A) 18.89% B) 19.00% C) 21.75% D) 48.27% E) 44.96%

Answer: DDiff: 2Topic: YieldAACSB: Analytical Thinking



23) Suppose that you just purchased a $1,000 Treasury Inflation-Indexed Bond which carried an

original interest rate of 3.375%. The consumer price index just increased by 5% increasing the

par value of the bond to $1,050. What is your interest payment considering this change?

A) $31.75 B) $33.75 C) $35.44 D) $50.00 E) $52.50

Answer: CDiff: 3Topic: PaymentsAACSB: Analytical Thinking

24) Suppose you just purchased a corporate bond with a par value of $1,000 for $951.25. It carries a

7% coupon rate and will mature in 5 years. What is the yield to maturity?

A) 6.14% B) 7% C) 8.23% D) 12%

Answer: CDiff: 3Topic: YieldAACSB: Analytical Thinking

25) The invoice price of a bond

A) is the price you pay if you buy the bond in the secondary market.

B) is the quoted price of the bond.

C) is the stated price of the bond plus the bondʹs accrued interest.


E) only A and C.

Answer: EDiff: 3Topic: Treasury SecuritiesAACSB: Information Technology

26) Pedro is trying to take advantage of the bond valuation relationships. He has figured out that

when you expect interest rates to go up, buy ________ bonds and when you expect interest rates

to go down, buy ________.

A) government bonds; short-term bonds

B) interest-indexed bonds; long-term bonds

C) very long-term; bonds with very short-term maturities that are not callable

D) very short-term; bonds with very long-term maturities that are not callable

E) interest-proof; long-term bonds

Answer: DDiff: 3Topic: YieldAACSB: Diverse and Multicultural Work Environments



27) It is a fact that there is a(n) ________ relationship between interest rates and bond values in the

secondary market. When interest rates ________, bond prices ________, and when interest rates

________, bond prices ________.

A) direct; rise; rise; drop; drop

B) direct; rise; drop; drop; rise

C) inverse; rise; drop; drop; rise

D) inverse; rise; rise; drop; drop

E) direct; drop; rise; rise; drop

Answer: CDiff: 3Topic: Bond PriceAACSB: Diverse and Multicultural Work Environments

28) What is the par value of a corporate bond that was issued with an 9% annual coupon, pays $45

in semiannual interest, and is due in 15 years?

A) $1,000.00 B) $1,070.23 C) $1,080.00 D) $1,167.33

Answer: ADiff: 2Topic: Par ValueAACSB: Analytical Thinking

29) What is the value of the current yield?

A) It allows the investor to determine the coupon payment for the bond.

B) It measures the return and changes with the maturity date.

C) It allows the investor to compare the bond with alternative investment opportunities.



Answer: CDiff: 2Topic: YieldAACSB: Diverse and Multicultural Work Environments

30) When a bond is described as AA, what does this refer to?

A) A bond that has above average coupon payments

B) A bond that has above average yield to maturity

C) A bond rating of ʺvery strongʺ capacity to pay interest and principle repayment



Answer: CDiff: 2Topic: Bond RatingsAACSB: Information Technology



31) A bond with a speculative rating will have which of the following characteristics?

A) A high coupon yield

B) A high yield to maturity

C) Double BB or lower rating



Answer: DDiff: 3Topic: Bond RatingsAACSB: Information Technology

32) Which of the following is true regarding fluctuations in the prices of bonds?

A) When interest rates go up, bond prices go up.

B) When interest rates go down, you want to purchase very short-term bonds.

C) As interest rates rise, investors demand a higher return on bonds.

D) all of the above

E) only A and B

Answer: CDiff: 3Topic: Bond PriceAACSB: Analytical Thinking

33) If a bond has a fixed coupon interest rate, the only way for the bond to increase its return to

investors is to

A) drop in value and sell for less. B) increase in value and sell for more.

C) change its coupon interest rate. D) All of the above are correct.

Answer: ADiff: 3Topic: Bond PriceAACSB: Diverse and Multicultural Work Environments

34) A corporate bond with a face value of $1,000 is currently selling at par, and pays an 8% yield to

maturity. Which of the following statements concerning this bond is true?

A) Its current market price is $1,000.

B) Its current semi-annual coupon payment is $40.

C) Its current yield is 8%.



Answer: DDiff: 3Topic: Bond PriceAACSB: Diverse and Multicultural Work Environments



35) Make a list and check it twice to tell how to select a good bond.

Answer: 1. Think how taxes will affect the investment.

2. Keep the inverse relationship in mind.

3. Avoid losers and do not worry about picking winners.

4. Consider only high-quality bonds.

5. Buy when first issued, not in the secondary market.

6. Avoid bonds that are more likely to be called.

7. Match the bondʹs maturity to your investment time horizon.

8. Stick to large issues.

9. Go with Treasury bonds when in doubt.Diff: 2Topic: BondsAACSB: Analytical Thinking

36) There are dangers present in bond investing. Tell everyone what they all are.

Answer: If interest rates rise, bond prices will fall. When the issuer experiences financial problems,

the bondholder may be paid or may lose out. If interest rates fall, rather than experience

price appreciation, the bond may be called. If you need to sell your bonds early, you may

have a problem selling them at a reasonable price, particularly if they are bonds issued by

a small corporation. Finding a good investment outlet for the interest you receive may be

difficult and your accumulation will be limited to the bondʹs par value. (You will lose

compounding and the time value of money.)Diff: 2Topic: BondsAACSB: Analytical Thinking

37) When interest rates rise, bond values drop, and when interest rates drop, bond values rise.

Using this inverse relationship, develop a two-part strategy for the bond investor.

Answer: When an investor expects interest rates to rise, put money in very short-term bonds.

When the investor expects interest rates to decline, purchase very long-term maturities

that are not callable.Diff: 2Topic: Bond PriceAACSB: Analytical Thinking

38) How do you determine a bondʹs valuation?

Answer: The simplest way is to use a financial calculator. It will add the present value of the

interest payments to the present value of repayment of par at maturity.Diff: 1Topic: Bond PriceAACSB: Analytical Thinking

39) Tell what you will find in a bond listing in the Wall Street Journal.

Answer: The name of the bond will be listed in the first column in alphabetical order. Next, you

will see the current yield, followed by the volume of trading during the previous day. The

fourth and fifth columns list the closing price that day and the net change in the closing

price from the day before that, respectively.Diff: 1Topic: Bond QuotesAACSB: Information Technology



40) How would you go about rating bonds as a possible investment?

Answer: Practically speaking, the first thing to consider is the bond rating and how that fits with

the investorʹs risk tolerance profile. Second, compare the bond yield, consisting of two

parts. Look at the ratio of the annual interest payment to the bondʹs market price, known

as the current yield. Also look at the yield to maturity, which is the true yield. If these suit

you, next consider the bond rating, which is a reflection of the bondʹs risk and the

companyʹs performance. Last, read the quote listings in the Wall Street Journal to see the

daily movements.Diff: 2Topic: BondsAACSB: Reflective Thinking

13.4 Preferred Stock - An Alternative to Bonds

1) Preferred stock is similar to bonds in that its dividends are of a fixed size and are paid before

common stock dividends are paid.

Answer: TRUEDiff: 1Topic: Preferred StockAACSB: Information Technology

2) If you are the owners of a share of preferred stock then you have voting rights.

Answer: FALSEDiff: 1Topic: Preferred StockAACSB: Information Technology

3) For an investor looking for capital gains, preferred stock is preferred over common stock.

Answer: FALSEDiff: 2Topic: Preferred StockAACSB: Information Technology

4) A corporation that issues preferred stock will mostly likely call the stock when the market rates

of interest increase.

Answer: FALSEDiff: 2Topic: Preferred StockAACSB: Diverse and Multicultural Work Environments

5) A firm can only have one issue of preferred stock available at any one point in time.

Answer: FALSEDiff: 3Topic: Preferred StockAACSB: Diverse and Multicultural Work Environments

6) The market price of preferred stock is inversely related to the market rates of interest.

Answer: TRUEDiff: 3Topic: Preferred StockAACSB: Analytical Thinking



7) Corporations receive a tax break on the dividend income from preferred stock.

Answer: TRUEDiff: 3Topic: Preferred StockAACSB: Diverse and Multicultural Work Environments

8) When a preferred stock requires that all past unpaid preferred stock dividends must be paid

before any common stock dividends can be declared, this preferred stock has a ________

feature.

A) non-payment

B) cumulative

C) dividend protection

D) risk-minimization


Answer: BDiff: 1Topic: Preferred StockAACSB: Information Technology

9) When you are holding preferred stock that you can exchange for a predetermined number of

shares of common stock, you are holding ________ stock.

A) reissued preferred

B) migratory preferred

C) convertible preferred

D) class B common


Answer: CDiff: 1Topic: Preferred StockAACSB: Information Technology

10) If you were to own a stock that offers voting rights and may pay dividends, you would most

likely own ________ stock.

A) preferred

B) common

C) mutual fund

D) bond-value





11) Jacqueline is attempting to determine the value of her preferred stock. She needs to form a

fraction with the annual preferred stock dividend on the top and ________ on the bottom.

A) market price

B) book value

C) closing price

D) required rate of return

E) historical rate of return

Answer: DDiff: 3Topic: Preferred StockAACSB: Analytical Thinking

12) Kathy Faust was paid all of her past dividends before any common stock dividends were

declared. Obviously, she profited from preferred stockʹs ________ feature.

A) adjustable rate

B) cumulative

C) convertible

D) multiple issue

E) callability


13) Which of the following best describes preferred stock?

A) Like an indenture, it represents a legal obligation to the firm to pay dividends.

B) Like common stock, it represents an equity claim on the assets and earnings of the firm.

C) Like a bond, it pays out a fixed stream of income ahead of any common stock dividends.



Answer: EDiff: 3Topic: Preferred StockAACSB: Diverse and Multicultural Work Environments

14) Your required rate of return on company XYZʹs preferred stock is 12%. Their preferred stock

pays a fixed annual dividend of $4. A share of XYZ preferred is valued at

A) $4.80. B) $33.34. C) $48.00. D) $54.44.

Answer: BDiff: 3Topic: Preferred StockAACSB: Analytical Thinking



15) What are the major differences between preferred stock and common stock?

A) Preferred stock dividends are paid out before dividends on common stock can be issued.

B) Common stock has voting rights and preferred stock does not.

C) Common stock has potentially higher capital gains than preferred stock.



Answer: DDiff: 2Topic: Preferred StockAACSB: Analytical Thinking

16) What risks are you assuming with preferred stock that you would not have with common stock

and bonds? Be specific.

Answer: When interest rates rise, the value of the preferred stock drops. When interest rates drop,

the value of the preferred stock rises and the preferred stock is called away from the

investor. The investor does not participate in the capital gains that common stockholders

receive. This investment does not have the safety of bond interest payments, because

preferred stock dividends can be passed without the risk of bankruptcy.Diff: 2Topic: Preferred StockAACSB: Analytical Thinking

17) Describe the features and characteristics of preferred stock as discussed in your textbook.

Answer: I know that a firm can issue multiple classes of preferred stock, each with a different set

dividend. The cumulative feature, which gets all of my unpaid dividends in arrears

caught up, protects me from omitted dividends. The adjustable rate allows the value of

my stock to remain relatively constant. I know that not all stock is cumulative or has an

adjustable rate. I can purchase convertible stock that can be exchanged for common stock.

I can purchase callable preferred stock, but it may be called in when interest rates drop.Diff: 1Topic: Preferred StockAACSB: Reflective Thinking

18) Compare and contrast preferred stock with bonds and common stock.

Answer: Preferred stock is often called a hybrid or combination security, leaning more closely

toward bonds. It is similar to common stock because it has no fixed maturity date and not

paying dividends will not bring on bankruptcy. It is similar to bonds in that its dividends

are of a fixed size and are paid before common stock dividends are paid. It also carries no

voting rights. Preferred stockholders do not share in any profit growth of the firm, but are

limited to their stated annual dividends. This means, just as with a bond, if the firm has a

great year and earns a lot of money, your stock dividend does not change.Diff: 2Topic: Preferred StockAACSB: Reflective Thinking



19) Why does preferred stock not have the potential for capital gains like common stock does?

Answer: Capital gains represent the earnings growth of a company reflected in the market price of

its stock. Preferred shareholders receive preferential treatment in the payment of

dividends but these dividends are normally fixed. As the companyʹs profits grow, the

preferred dividends do not grow accordingly. The market price of preferred stock is

determined by these fixed dividends. The growth in earnings is then passed on to the

common stockholders in the form of increased dividends or retained earnings for more

growth. Growing earnings leads to increased market demand for the common stock

which leads to bigger capital gains potential.Diff: 3Topic: Preferred StockAACSB: Reflective Thinking

13.5 Investing in Real Estate

1) The novice investor can easily make big returns investing in real estate.

Answer: FALSEDiff: 1Topic: Real EstateAACSB: Diverse and Multicultural Work Environments

2) Vacation homes are the most popular of all the direct real estate investments.

Answer: TRUEDiff: 1Topic: Real EstateAACSB: Diverse and Multicultural Work Environments

3) Approximately two-thirds of Americans own their own homes.

Answer: TRUEDiff: 1Topic: Real EstateAACSB: Information Technology

4) The main advantage to investing in real estate is liquidity.

Answer: FALSEDiff: 1Topic: Real EstateAACSB: Diverse and Multicultural Work Environments

5) According to the Morgan Stanley REIT Index, REITs fell by about 15 percent between March

2007 and March 2009.

Answer: FALSEDiff: 2Topic: REITAACSB: Diverse and Multicultural Work Environments



6) According to the Morgan Stanley REIT Index, REITs fell by about ________ between March 2007

and March 2009. Then between March 2009 and March 2014, the Morgan Stanley REIT Index

rose by more than two and a half times, but REITs were still down ________ from their 2007

high.

A) 15 percent; 45 percent B) 50 percent; 50 percent

C) 75 percent; 30 percent D) 95 percent; 5 percent

Answer: CDiff: 3Topic: REITAACSB: Diverse and Multicultural Work Environments

7) A real estate investment that is most similar to a mutual fund specializing in real estate

investment is called a

A) real estate agency bond.

B) pass-through property bond.

C) property trust.

D) real estate investment trust.


Answer: DDiff: 1Topic: Real EstateAACSB: Information Technology

8) What are the disadvantages associated with investing directly in real estate?

A) Increasing property taxes and insurance costs

B) Large investment of time and energy required

C) Illiquidity



Answer: DDiff: 1Topic: Real EstateAACSB: Diverse and Multicultural Work Environments

9) Provide a list of direct and indirect real estate investments. Which one is best for the average

investor?

Answer: Direct vacation home, commercial property, apartment, duplex, developed or

undeveloped land, speculative building

Indirect partnerships that buy and manage property (syndicates) and investment

companies that pool the money of many investors and invest in real estate (REIT)

The most attractive real estate alternative for the novice is the real estate investment trust

or REIT.Diff: 2Topic: Real EstateAACSB: Diverse and Multicultural Work Environments



13.6 Investing - Speculating - in Gold, Silver, Gems, and Collectibles

1) It is possible to make fortunes dealing in collectibles.

Answer: TRUEDiff: 3Topic: Speculative InvestmentAACSB: Diverse and Multicultural Work Environments

2) Gold and precious gems should hold a place in any diversified retirement portfolio.

Answer: FALSEDiff: 3Topic: Speculative InvestmentAACSB: Diverse and Multicultural Work Environments

3) If an asset doesnʹt earn a return, its value is determined by supply and demand.


4) Gold, precious gems, and other collectibles always earn handsome returns.

Answer: FALSEDiff: 3Topic: Speculative InvestmentAACSB: Diverse and Multicultural Work Environments

5) Collectibles such as baseball cards and beanie babies can be fun, but one should not expect them

to provide for your financial future.


6) What is the best strategy recommended in your textbook for collectibles?

A) Buy and hold.

B) Buy low, sell high.

C) Avoid them as an investment.

D) Buy high, sell higher.


Answer: CDiff: 1Topic: Speculative InvestmentAACSB: Diverse and Multicultural Work Environments

7) Since 1980 the price of gold

A) has been fairly constant. B) has steadily risen.

C) has steadily fallen. D) has bounced up and down.

Answer: DDiff: 2Topic: Speculative InvestmentAACSB: Diverse and Multicultural Work Environments



8) According to your textbook, when you are investing in gold, silver, gems, and collectibles you

are actually

A) discreetly investing.

B) diversifying your investment portfolio.

C) hedging.

D) speculating.



9) Which of the following is not an example of speculative investing as outlined in the text?

A) Gold

B) Silver

C) Stocks

D) Precious stones

E) Collectibles

Answer: CDiff: 1Topic: Real EstateAACSB: Diverse and Multicultural Work Environments

10) Alice recently bought dozens of collectable Barbie dolls. What ultimately will determine the

investment value of Aliceʹs Barbies when she goes to resell them?

A) Its return

B) Its cost

C) Book value

D) Supply and demand



11) What, if any, are the pros and cons of speculating in precious metals, precious gems, and

collectibles?

Answer: When timed correctly, these speculations can provide a nice return and you can escape

the cons of other types of investments. The major problem here is that their value is based

upon supply and demand and does not generate a return. Sometimes we may be tempted

to sink money into these areas because of emotion or greed. It is anybodyʹs guess what

might happen to them in the future.Diff: 2Topic: Speculative InvestmentAACSB: Diverse and Multicultural Work Environments



12) When is it OK to speculate?

Answer: It is OK to speculate when you have some extra money to lose. It is not OK to speculate

with money that you canʹt afford to lose because it will interfere with your standard of

living or achieving you long term savings and investment goals. Speculating is just liking

gambling at a Casino. It can be very exciting and pleasurable when done responsibly with

a few extra dollars that you can afford to lose. Sometimes you win but most times you

lose most or all of your money. Speculating is just too risky for your important money.

Donʹt risk your long term financial security by gambling.Diff: 2Topic: Speculative InvestmentAACSB: Diverse and Multicultural Work Environments

13) How can you improve your chances when investing in bonds?

Answer: As with investing in common stock, investing in bonds should be preceded by

establishing goals. This will determine your asset allocation and how much of your

savings should go into bonds.

For the sake of diversification, donʹt discount the value of holding some bonds. Their

lower interest rates may seem boring when the stock market is riding high, but youʹll

appreciate them when they slow the downward spiral of your portfolio during a market

downturn.

Understand taxes and bonds. While the tax-free nature of municipal bonds is great,

bonds arenʹt of value to everyone. Compute the equivalent taxable yield for your tax

bracket before you choose them. If you are in a low bracket, you may find that you can

earn enough interest with taxable alternatives to pay the taxes and still come out ahead. If

you are attempting to avoid state income tax, buy municipals issued by your state of

residence.

Be aware of the potential downside of bonds. Consider how you would react if interest

rates rose and the value of your bonds dropped, and also keep in mind the fact that

shorter-term bonds drop less in price when interest rates climb. Letʹs face it: Interest rates

are at historical lows, as of 2015, but someday theyʹre going to rise.Diff: 3Topic: BondsAACSB: Reflective Thinking


Chapter 14Mutual Funds: An Easy Way to Diversify

14.1 Why Invest in Mutual Funds?

1) Mutual funds provide an inexpensive way for investors to diversify and gain access to

professional management.

Answer: TRUEDiff: 1Topic: Mutual FundAACSB: Diverse and Multicultural Work Environments

2) Mutual fund shareholders directly own the fundʹs securities.

Answer: FALSEDiff: 2Topic: Mutual FundAACSB: Diverse and Multicultural Work Environments

3) Mutual funds eliminate the systematic risk through diversification.


4) The trade-off for mutual fund diversification is lower-than-market performance.


5) Most small investors donʹt have the time, expertise, or desire to do the research necessary to

invest in individual stocks therefore mutual funds are a good solution.


6) Mutual funds give smaller investors the same ability to diversify and reduce risk as big

investors with a great deal of money have.


7) One disadvantage of mutual fund investments is that they are illiquid.



Chapter 14 Mutual Funds: An Easy Way to Diversify 433

8) The potential lower returns on mutual funds versus the potential returns on individual stocks is

due to poor performance by the fund managers.

Answer: FALSEDiff: 3Topic: Mutual FundAACSB: Information Technology

9) By law, all mutual funds must be broadly diversified.


10) All mutual funds carry the same level of diversification and exposure to risk.


11) Because mutual funds trade in such large quantities, they pay far more in terms of commissions.


12) Which of the following is a disadvantage to mutual fund investing?

A) On average they underperform the market returns.

B) Costs may be high and vary dramatically from fund to fund.

C) Not all mutual funds are truly safe.

D) You cannot diversify away systematic risk.

E) All of the above

Answer: EDiff: 3Topic: Mutual FundAACSB: Diverse and Multicultural Work Environments

13) When you own shares in a mutual fund you make money in which of the following ways?

A) As the value of all of the securities held by the mutual fund increase, the value of each

mutual fund share also increases.

B) If a fund receives interest or dividends from its holdings this income is passed on to share

holders.

C) If the fund sells a security for more than it originally paid for it, the shareholders receive

this in the form of capital gains.

D) You receive a portion of the commissions that the fund manager charges for trades.

E) Only A, B and C are correct.




14) Principle 8 tells us that diversification reduces

A) risk.

B) costs.

C) profitability.

D) earnings.



15) For your investment program, you have occasionally been holding a few stocks that you

purchased from various brokers. Based on this, which advantages of mutual funds would be

appealing to you?

A) Diversification

B) Professional management

C) Avoidance of bad brokers

D) only A and C

E) A, B, and C


16) Each individual mutual fund hires an investment advisor, generally from the management

company, who oversee the particular fund. How is this advisor paid?

A) Hourly

B) Based on a percentage of the commissions charged on an annual basis

C) Based on a percentage of the total value of the fund on an annual basis

D) Annually based on the capital gains realized by the fund


Answer: CDiff: 2Topic: Mutual FundAACSB: Information Technology

17) Which of the following is a benefit to investing in a mutual fund?

A) Most small investors donʹt have the time, knowledge or desire to do the research necessary

to purchase individual stocks.

B) Mutual fund transaction fees are considerably lower than the brokerage fees most small

investors incur buying and selling individual stocks.

C) Most small investors want to be able to invest relatively small amounts of money on a

regular basis.



Answer: DDiff: 2Topic: Mutual FundAACSB: Information Technology



18) The investor services that most mutual funds offer include

A) bookkeeping services.

B) checking accounts.

C) automatic systems to add to or withdraw from your account.


E) All but B are correct

Answer: DDiff: 1Topic: Mutual FundAACSB: Information Technology

19) Which type of risk can an investor effectively manage by investing in broadly diversified

mutual funds?

A) Serial risk B) Systematic risk

C) Unsystematic risk D) None of the above is correct.


20) Why would someone want to give serious attention to investing in mutual funds? At the same

time, why would you not invest in them?

Answer: Mutual funds on the whole serve to level the investment playing field between large and

small investors. They offer an inexpensive way to instant diversification, professional

management guidance, minimal transaction costs, liquidity, flexibility, many services,

avoidance of bad brokers.

Mutual funds perform lower than the market does. Sales and annual expense fees can be

very costly be selective. Not all mutual funds are truly safe. Systematic risk is still

present and taxes are not deferred.Diff: 2Topic: Mutual FundAACSB: Reflective Thinking

21) What are the two broad types of risks that are associated with investing? Can you avoid them

by investing in Mutual Funds?

Answer: The two broad types of risks associated with investing are systemic and unsystemic risks.

A broadly diversified Mutual Fund can protect you from unsystemic risk associated with

an individual company, industry or country. These funds invest in a broad spectrum of

firms, industries and possibly countries to minimize the impact of specific unsystemic

risks.

A narrowly focused sector fund invests in many firms in the same industry or country.

While the risk of a few firms failing is diversified away, the risk of a systemic event

effecting the entire industry or country is not diversified away. A new technology,

political change, natural disaster or some other broad impact will effect all the

investments in the fund.Diff: 3Topic: RiskAACSB: Reflective Thinking



22) Do the advantages of investing in a Mutual Fund outweigh the disadvantages for the average

small investor?

Answer: A case can be made that the advantages to the small investor far outweigh the

disadvantages of investing in mutual funds. The average investor does not have the time,

expertise or desire to do the research necessary to invest in individual stocks. They

typically donʹt have the money to adequately diversify at realistic costs. They are fairly

naive when it comes to market trends, predatory Brokers, and economic impacts on the

markets. Mutual Fund Managers are much better suited to succeed in the markets than an

individual investor. The services funds provide are invaluable with record keeping and

paying taxes. The trick is to find a good Mutual Fund company that provides the

selection and services that you need and dollar cost average your investments.Diff: 3Topic: Mutual FundAACSB: Diverse and Multicultural Work Environments

23) Briefly explain the three ways to make money when you own shares in a mutual fund.

Answer: First, as the value of all the securities held by the mutual fund increases, the value of each

mutual fund share also goes up.

Second, if a fund receives interest or dividends from its holdings, this revenue is passed

on to shareholders in the form of dividends.

Third, if the fund sells a security for more than it originally paid for the security, the

shareholders receive this gain in the form of a capital gains distribution, generally paid

annually.Diff: 3Topic: Mutual FundAACSB: Reflective Thinking

14.2 Investment Companies

1) At the beginning of 2014, bond funds–including both municipal and taxable bond funds–made

up the largest segment of the $279 billion closed-end fund market.

Answer: TRUEDiff: 3Topic: Bond FundAACSB: Analytical Thinking

2) An equity REIT investment is limited to mortgages on income producing properties.

Answer: FALSEDiff: 3Topic: REITAACSB: Information Technology

3) A unit investment trust is a fixed pool of securities, generally municipal bonds, with each unit

representing a proportionate ownership in that pool.

Answer: TRUEDiff: 2Topic: Unit Investment TrustAACSB: Information Technology



4) Shares in open-end mutual funds are actively traded in secondary markets.


5) An open-end mutual fund has a fixed number of shares which are sold by the mutual fund at

its inception.


6) When you own shares in a mutual fund, you directly own shares of the companies that make up

the fund.


7) The most common and popular form of mutual fund is an open-end mutual fund.

Answer: TRUEDiff: 2Topic: Mutual FundAACSB: Information Technology

8) The term ʺopen endʺ mutual fund means that this type of investment company can issue an

unlimited number of ownership shares.

Answer: TRUEDiff: 2Topic: Mutual Fund ClassificationsAACSB: Information Technology

9) A closed-end fund trades more like common stock than a mutual fund.

Answer: TRUEDiff: 3Topic: Mutual FundAACSB: Information Technology

10) A unit investment trust usually invests in ________ and an REIT always invests in ________.

A) real estate; agency bonds

B) real estate; municipal bonds

C) real estate; load mutual funds

D) municipal bonds; real estate

E) municipal bonds; real estate bonds

Answer: DDiff: 2Topic: Unit Investment TrustAACSB: Information Technology



11) A(n) ________ is a fixed pool of securities, generally municipal bonds, with each unit

representing a proportionate ownership in that pool.

A) open-end investment company B) closed-end mutual fund

C) unit investment trust D) real estate investment trust


12) A(n) ________ is a mutual fund company that has the ability to issue as many shares as

investors are willing to purchase.

A) closed-end mutual fund

B) share repurchase fund

C) open-end mutual fund

D) variable share mutual fund



13) An ________ is a fixed pool of securities, generally municipal bonds.

A) earning trust

B) unit investment trust

C) equity corporation

D) asset diversification company


Answer: BDiff: 1Topic: Mutual FundAACSB: Information Technology

14) Roberta Cartwright puts money each month into a mutual fund that has very few controls; in

that, the managers can invest in whatever they want because this type of fund is not regulated

by the SEC. Roberta has a(n) ________ fund.

A) open-end

B) closed-end

C) hedge

D) no-load

E) back-end load

Answer: CDiff: 1Topic: Mutual FundAACSB: Diverse and Multicultural Work Environments



15) Hedge fund managers charge very high fees, generally taking ________ of the assets under

management (even when the fund loses money) along with ________ of the profits–and some

take even more.



Answer: BDiff: 3Topic: Mutual FundAACSB: Reflective Thinking

16) Former hedge fund manager Bernie Madoff ran a Ponzi scheme, in which he took money from

new investors and used that money to pay earlier investors, all the while pocketing most of the

money for himself. In the end, Madoff lost around ________ of his investorsʹ money and ended

up behind bars.ʺ

A) $100 million B) $5 billion C) $25 billion D) $50 billion

Answer: DDiff: 3Topic: Mutual FundAACSB: Reflective Thinking

17) Which of the following funds would be the most appropriate investment for the average small

investor?

A) No-load open-end fund B) No-load closed-end fund

C) Front-end load fund D) Back-end load fund

Answer: ADiff: 2Topic: Mutual FundAACSB: Diverse and Multicultural Work Environments

18) Compare and contrast open-end and closed-end mutual funds.

Answer: Open-end funds can literally issue as many shares as investors want. The fund grows

and shrinks as shares are bought by investors and sold by the same. The value of all the

investments determines how much each share in the fund is worth. On the other hand, a

closed-end fund only sells shares once. After that, investors must conduct trading among

themselves. This fund determines the value of each share by the value of the investments

that the fund holds and investorsʹ demand for the shares in the fund.Diff: 1Topic: Mutual FundAACSB: Analytical Thinking

19) In what ways do unit investment trusts and real estate investment trusts resemble mutual

funds?

Answer: UITs are a pool of investments, generally municipal bonds, and REITs are also a pool of

investments, in this case made up of a diversity of real estate holdings. Investors buy

shares just as they do in mutual funds. Like mutual funds, these two investments are not

limited only to the wealthy.Diff: 2Topic: Unit Investment TrustAACSB: Analytical Thinking



14.3 Calculating Mutual Fund Costs and Returns

1) 12b-1 fees are marketing expenses for the mutual fund that are passed on to the fund

shareholders.

Answer: TRUEDiff: 1Topic: Mutual Fund Cost and FeesAACSB: Information Technology

2) A mutual fund that does not charge a commission on your ownership shares is referred to as a

load fund.

Answer: FALSEDiff: 1Topic: Mutual Fund Cost and FeesAACSB: Information Technology

3) ʺClassesʺ of mutual funds have different fee arrangements attached to them.


4) Sometimes, when you purchase shares directly from the mutual fund company itself, there will

not be a sales load.


5) Mutual funds charge high sales loads because their potential returns are much higher than the

returns for individual stocks.

Answer: FALSEDiff: 3Topic: Mutual Fund Cost and FeesAACSB: Information Technology

6) Back-end load mutual funds charge a commission when the investor sells the mutual fund.


7) Mutual fund fees and expenses will negatively affect the return you receive on your investment.




8) A mutual fundʹs expense ratio compares the fundʹs expenses to its total assets.


9) Net asset value is determined by taking the total market value of all the securities held by the

mutual fund, subtracting out any liabilities, and dividing the result by the number of shares

outstanding.

Answer: TRUEDiff: 1Topic: Net Asset ValueAACSB: Analytical Thinking

10) All distributions from a mutual fund, whether paid out or reinvested, are taxable in the year in

which they occur.

Answer: TRUEDiff: 1Topic: Mutual Fund ReturnsAACSB: Diverse and Multicultural Work Environments

11) When you own shares of a mutual fund, you can choose to have the dividend and capital gains

distributions paid directly to you in the form of cash or you can choose to have them reinvested

into additional shares of the fund itself.

Answer: TRUEDiff: 1Topic: Mutual Fund ReturnsAACSB: Information Technology

12) Which of the following statements is true regarding mutual fund load charges?

A) Load funds perform better than no-load funds.

B) Back-end load funds perform better than no-load funds.

C) Load funds perform more poorly than back-end load funds.

D) No-load funds perform just as well as load funds.


Answer: DDiff: 3Topic: Mutual Fund Cost and FeesAACSB: Analytical Thinking



13) Tabitha is just beginning to develop her financial portfolio. She does not want to pay

commissions to purchase shares in mutual funds, as her friend you would advise her to invest

her dollars in ________ funds.

A) load

B) front-load

C) back-load

D) no-load

E) side-load

Answer: DDiff: 1Topic: Mutual Fund Cost and FeesAACSB: Information Technology

14) A mutual fund that does not charge a commission to own its shares is called a

A) free issue fund.

B) market fund.

C) no-load fund.

D) no-charge fund.

E) free-load fund.

Answer: CDiff: 1Topic: Mutual Fund Cost and FeesAACSB: Information Technology

15) When comparing which mutual fund to invest in, which of the following would be important to

consider?

A) Load

B) Net asset value

C) Expense ratio




16) Which of the following are passed on to fund share holders through 12b-1 fees?

A) Commissions

B) Advertising expenses

C) Promotional fees

D) Only B and C

E) All of the above




17) Which of the following will affect your capital gains liability?

A) Turnover ratio

B) Changes in net asset value

C) Expense ratio



Answer: EDiff: 3Topic: Mutual Fund Cost and FeesAACSB: Diverse and Multicultural Work Environments

18) The ________ is the value of the mutual fundʹs holdings, minus any debt, divided by the

number of shares outstanding.

A) net worth

B) market value

C) tangible value

D) net asset value


Answer: DDiff: 1Topic: Net Asset ValueAACSB: Analytical Thinking

19) Total returns on mutual funds can be calculated by adding dividends distributed, capital gains

distributed, and ________ and dividing this sum by the beginning NAV.

A) beginning NAV - ending NAV

B) ending NAV - beginning NAV

C) dividends undistributed + capital gains undistributed

D) beginning NAV + ending NAV

E) ending NAV + beginning NAV

Answer: BDiff: 3Topic: Mutual Fund ReturnsAACSB: Analytical Thinking

20) What is the total return for a mutual fund with the following characteristics?

beginning NAV = $55.82

ending NAV = $70.52

dividends distributed = $2.25

capital gains distributed = $3.50

A) 29.71% B) 30.82% C) 32.26% D) 36.64%

Answer: DDiff: 3Topic: Mutual Fund ReturnsAACSB: Analytical Thinking



21) Zippo Mutual Fund is one of your best performers. It just announced a year-end distribution of

$2.50 per share in capital gains and $4.25 in dividends. Assuming the NAV increased from

$31.50 to $43.75, calculate your total annual return.

A) 60.32% B) 46.87% C) 26.95% D) 24.53%

Answer: ADiff: 3Topic: Mutual Fund ReturnsAACSB: Analytical Thinking

22) You purchased 100 shares of Gibraltar Strength Fund for $20.50 per share. As a result of

distribution reinvestment you currently own 120 shares with a NAV of $22.75 per share. What is

your total return?

A) 16.67% B) 20.00% C) 24.91% D) 33.17%


23) Suppose that the current value of all of a mutual fundʹs holdings is determined to be $750

million. The fundʹs liabilities are $125 million and it grew at 20% from last year. It currently has

45 million shares outstanding. What is the fundʹs NAV?

A) $12.00 per share B) $13.89 per share

C) $14.40 per share D) $16.80 per share

Answer: BDiff: 3Topic: Net Asset ValueAACSB: Analytical Thinking

24) You purchased 100 shares of a fund for $15.50 per share. Its current NAV is 20.75 per share.

There were no distributions. What is your total return?

A) 33.87% B) 22.33% C) 79.67% D) 25.51%

Answer: ADiff: 3Topic: Mutual Fund ReturnsAACSB: Analytical Thinking

25) You purchased 100 shares of Gibraltar Strength Fund for $12.75 per share. Its current NAV is

18.75 per share. There was a total of $0.25 in dividends and $0.75 in capital gains distributed.

What is your total return?

A) 32.00% B) 37.33% C) 47.06% D) 54.90%




26) What does the following mathematical expression yield? (total market value of all securities -

liabilities) divided by (total shares outstanding) =

A) asset value.

B) net value.

C) net asset value.

D) net return value.

E) asset return value.

Answer: CDiff: 2Topic: Net Asset ValueAACSB: Analytical Thinking

27) You purchased 1,000 shares of fund ABC for $35.00 NAV per share. You elected the dividend

reinvestment plan and had all dividend and capital gains distributions reinvested in additional

shares. You just closed your account and sold 1,100 shares for $30 NAV. What was your total

return on this investment?

A) -6.06% B) -5.71% C) 5.71% D) 6.06%

Answer: BDiff: 2Topic: Mutual Fund ReturnsAACSB: Analytical Thinking

28) You purchased 500 shares in a mutual fund for $32 NAV. You elected the dividend

reinvestment plan and had all dividend and capital gains distributions reinvested in additional

shares. You just closed your account and sold 550 shares for $48 NAV. What was your total

return on this investment?

A) 24.03% B) 34.29% C) 50.86% D) 65.00%


29) Explain what the three ʹclassesʹ of a mutual fund shares are all about.

Answer: There is actually only one mutual fund but you can purchase shares in this fund several

different ways. Depending on how you purchase the share, there may be different loads

or sales commissions associated with the purchase or redemption of the share. Class A

shares can be purchased directly from the Fund itself or through an Agent like a Financial

planner. Class A shares have a front-end load or commission that comes right off the top

of your purchase. Class B shares are typically sold by a Stock Broker. They do not have a

front-end load so your entire investment is placed into your account. If you withdraw

money before a certain date, then there is a back-end load applied to your withdrawal.

Class C funds are the least attractive since they have both a front-end and back-end load

plus higher fees.Diff: 2Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments



30) Explain how sales loads and fund expenses can negatively impact your return on investment in

a mutual fund.

Answer: The sales load and fund expenses are subtracted out of your account which means you

have less of your money available or fewer shares available to grow and earn a return.

For example, if you invest $1,000 into a 5% front-end load fund, $50 is subtracted off the

top leaving only $950 in the account. If your account grows to $1,500 by the end of the

year, and the fund expenses are 2%, then they will remove another $30 from your account

balance. With this example, if the total gross return on your money was 12%, after the

load and expenses your net return would be much less.Diff: 3Topic: Mutual Fund Cost and FeesAACSB: Diverse and Multicultural Work Environments

31) Briefly describe the cost involved in mutual funds.

Answer: A mutual fund has either a sales commission or no sales commission involved. Funds are

either a no-load fund, a load fund, or a back-end load, the load being the commission. A

mutual fund can also charge management, marketing, and trading fees.Diff: 1Topic: FeesAACSB: Information Technology

32) Explain how a dividend reinvestment plan is similar to compounding and the time value of

money.

Answer: With compounding, the interest you earned from previous periods earns interest in the

current period. As time progresses, the interest earning interest becomes a substantial

part of your future value. By reinvesting all dividend and capital gains distributions into

additional shares of the fund, you are basically compounding these new shares which

will earn more distributions, additional new shares, and this reinvesting will make up a

substantial portion of the future value of your total investment.Diff: 2Topic: Mutual Fund ReturnsAACSB: Reflective Thinking

33) What are the tax liabilities concerning investing in a mutual fund?

Answer: There may be a tax liability due on the current dividend and capital gains distributions

made during the current tax year. Taxes on these distributions are due regardless if you

received the distributions in cash or reinvested them in additional shares. In addition to

taxes on distributions, there is also a potential capital gains tax on the increase in NAV

from the purchase to the sale. One of the great benefits of investing in most large Mutual

Fund Companies is they provide shareholders with an end of the year 1099 tax statement

that shows all distributions and capital gains for the previous tax year.Diff: 3Topic: Mutual Fund ReturnsAACSB: Diverse and Multicultural Work Environments



14.4 Types and Objectives of Mutual Funds

1) Exchange traded funds are mutual funds that trade on an exchange just like individual

securities and can be bought or sold throughout the trading day.

Answer: TRUEDiff: 1Topic: Exchange Traded FundAACSB: Diverse and Multicultural Work Environments

2) A sector fund is a mutual fund that tries to maximize the degree of diversification.

Answer: FALSEDiff: 3Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments

3) Tax-exempt money market mutual funds invest in only very short-term municipal debt.

Answer: TRUEDiff: 1Topic: Money Market Mutual FundAACSB: Diverse and Multicultural Work Environments

4) Money market mutual funds invest primarily in the stocks of publicly traded companies.

Answer: FALSEDiff: 2Topic: Money Market Mutual FundAACSB: Diverse and Multicultural Work Environments

5) Sixty-five percent of Sallyʹs mutual funds are invested in environmentally friendly companies.

We can assume Sally has invested in sector funds.

Answer: TRUEDiff: 2Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments

6) Stock market mutual funds are not very popular and consumers tend to invest in them the least.


7) A bond mutual fund is an appropriate choice for an investor with an income goal.


8) An aggressive growth fund is an appropriate choice for an investor looking for capital gains.




9) Brian and Kallie are looking for investments that provide steady income to live on, moderate

growth in capital, and moderate stability in their investments. They should look into balanced

mutual funds.


10) An index fund is a great choice for those who want to ʺbeat the market.ʺ


11) For an investor with little time or desire to follow the markets, a life cycle fund would be an

appropriate choice for their retirement savings.


12) By law, a bond fund may not invest in international securities.


13) An ETF provides better diversification than investing in individual company stocks.

Answer: TRUEDiff: 2Topic: Exchange Traded FundAACSB: Diverse and Multicultural Work Environments

14) With target retirement funds the only decision you have to make is when you plan to retire.

Answer: TRUEDiff: 3Topic: Mutual FundsAACSB: Diverse and Multicultural Work Environments

15) An ETF provides similar services to an investor to those that a mutual fund investment

provides.

Answer: FALSEDiff: 3Topic: Exchange Traded FundAACSB: Diverse and Multicultural Work Environments



16) One of the most valuable mutual fund services available is automatic reinvestment of cash

flows.

Answer: TRUEDiff: 3Topic: Mutual Fund ServicesAACSB: Information Technology

17) Once you open a mutual fund account, you can use EFT to have money directly withdrawn

from your bank account to pay yourself first.


18) Money market mutual funds have check writing privileges.


19) According to the Keown book, ________ are by far the most popular funds, accounting for more

than half of all mutual funds.

A) equity funds B) bond funds

C) hybrid funds D) money market funds

Answer: ADiff: 2Topic: Mutual Fund ClassificationsAACSB: Reflective Thinking

20) One type of mutual fund does not endeavor to achieve the goals of a balance of bonds and stock

or growth, income, and stability. Instead, it focuses on personal characteristics, such as age and

risk tolerance, and your position in the financial life cycle. This is the

A) index fund.

B) sector fund.

C) growth and income fund.

D) balanced fund.

E) life cycle fund.

Answer: EDiff: 2Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments



21) Money market mutual funds

A) are very risky investments.

B) require significant investments, so are out of reach of the common investor.

C) carry no loads.

D) None of the above.

E) Both A and B are correct.

Answer: CDiff: 2Topic: Money Market Mutual FundAACSB: Analytical Thinking

22) Bonnie and James are retired. They wish to continue to invest in their portfolio and are seeking

income instead of growth. Which should they invest in?

A) Growth funds

B) Bond funds

C) Sector funds



Answer: BDiff: 2Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments

23) Of the different types of mutual funds, ________ are by far the most popular, and now account

for half of all mutual funds.

A) money market mutual funds

B) stock mutual funds

C) balanced mutual funds

D) asset allocation funds

E) bond funds


24) If you want to invest only in the telecommunications industry, which fund would be

appropriate for you?

A) S&P 500 Index fund

B) Telecommunications sector fund

C) Telecommunications ETF

D) Telecommunications money market fund

E) Both B and C are correct.

Answer: EDiff: 2Topic: Mutual Fund ClassificationsAACSB: Information Technology



25) Life cycle funds

A) are designed for people with at least 20 years until retirement.

B) require you to decide how to allocate your investment among stocks, bonds, and money

market instruments.

C) grow less conservative as your retirement date nears.

D) try to tailor their holding to the investorʹs individual age, and risk tolerance.

Answer: DDiff: 3Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments

26) A balanced mutual fund is aimed at investors who want

A) steady income to live on.

B) moderate growth in capital.

C) moderate stability in their investments.




27) Which of the following funds protect you from systematic risk?

A) S&P 500 Index fund

B) Growth fund

C) Balanced fund

D) All of the above



28) What are the differences between an ETF and a mutual fund?

A) An ETF can be traded like a share of common stock.

B) An ETF can be purchased on margin or sold short like a share of common stock.

C) An ETF is more tax-efficient than most mutual funds.



Answer: DDiff: 3Topic: Exchange Traded FundAACSB: Analytical Thinking



29) Which of the following services do ETFs offer?

A) Automatic reinvestment of dividends, interest, and capital gains

B) Bookkeeping and tax help

C) Phone and Internet switching

D) All of the above


Answer: EDiff: 3Topic: Exchange Traded FundAACSB: Diverse and Multicultural Work Environments

30) One of the advantages of municipal bond funds is that

A) they may be exempt from state taxes.

B) the interest is generally exempt from federal taxes.

C) they are all no-load funds.

D) both A and B are correct.

Answer: DDiff: 3Topic: Mutual FundAACSB: Diverse and Multicultural Work Environments

31) For an investor with some speculative money to invest, which fund would be an appropriate

choice for potentially large returns?

A) Junk bond fund

B) Aggressive growth fund

C) High technology sector fund




32) Bond funds differ from individual bond purchases in that

A) bond funds offer less liquidity than individual bonds.

B) with a bond fund, you donʹt get professional management.

C) the bond fund doesnʹt mature as individual bonds do.


Answer: CDiff: 2Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments



33) Donel is investing in a mutual fund that really is not as diversified as other funds. It may enjoy

good capital gains but is also much riskier when it comes to unsystematic risk. This fund is

called a(n) ________ fund.

A) growth-and-income

B) sector

C) life cycle

D) asset allocation

E) bond


34) The mutual fund that invests in Treasury bills and very short-term notes and is considered

practically risk free is the

A) stock fund.

B) bond fund.

C) balanced fund.

D) life cycle fund.

E) money market fund.

Answer: EDiff: 1Topic: Money Market Mutual FundAACSB: Diverse and Multicultural Work Environments

35) Which of the following mutual fund services is similar in concept to compounding and the time

value of money?

A) Dollar cost averaging B) Automatic reinvestment

C) Funds express options D) Internet switching

Answer: BDiff: 2Topic: Mutual Fund ServicesAACSB: Analytical Thinking



36) Why are stock mutual funds so popular? Briefly outline the highlights of each type of fund.

Answer: There is a stock mutual fund for almost every need about 6,000 in all. They serve many

purposes as follows:

1. Aggressive growth funds try to maximize capital appreciation while ignoring

income; they are risky with wide price swings.

2. Small-company growth funds are aggressive funds in undiscovered companies with

potentially unlimited future growth.

3. Growth funds are similar to aggressive funds but pay more attention to strong firms

that pay dividends.

4. Growth-and-income funds attempt to provide a steady stream of income and have

some potential for increasing value.

5. Sector funds try to capture the advantage of a single industry; they are risky and lose

the diversity advantage.

6. Index funds buy stocks that make up the S&P 500, which is good for those who want

to mimic the market rather than beat it at low cost.

7. International funds seek to diversify and grow by focusing on general world regions

or foreign companies with abnormal growth potential regardless of location.Diff: 2Topic: Mutual Fund ClassificationsAACSB: Reflective Thinking

37) There are dissimilarities between U.S. government, GNMA, municipal, and corporate bond

funds. Please point them out.

Answer: The major difference stems from the bond vehicle. U.S. government bonds invest in

securities issued by the federal government. GNMA bonds specialize in pools of

residential mortgages. Municipal funds are generally exempt from some form of taxes

and invest in municipalities, such as cities, counties, and states. Corporate funds invest in

various for-profit corporations and have the potential for defaulting.Diff: 2Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments

38) Compare the investment vehicles and tax treatment of tax-exempt and government securities

money market mutual funds.

Answer: The tax-exempt fund invests only in very short-term municipal debt, while the

government securities fund invests solely in U.S. government securities. The former is

exempt from federal income taxes, while the latter is not.Diff: 2Topic: Money Market Mutual FundAACSB: Diverse and Multicultural Work Environments

39) How is an asset allocation fund different from a balanced mutual fund?

Answer: Asset allocation funds seek to time the market by moving money between stocks and

bonds. These attempts may cost more and therefore diminish returns.Diff: 2Topic: Mutual Fund ClassificationsAACSB: Diverse and Multicultural Work Environments



40) Prepare a case for investing in a bond fund versus individual bonds.

Answer: A bond mutual fund suits the small investor as well as the large investor. You can begin

with as little as $1,000 and add more later in smaller amounts. The funds offer more

liquidity than individual bonds, and on top of that you get professional management.

Rather than receiving a semiannual check as with bonds, you can choose a monthly check

or reinvest back into the fund. The bond fund does not mature; it is virtually perpetual

and carefree.Diff: 2Topic: Mutual Fund ClassificationsAACSB: Information Technology

41) What is the purpose of a Target Retirement fund and who would benefit from it?

Answer: A target retirement fund is designed to make sure that an individual is properly

diversified based on how much longer they have until retirement. A younger personʹs

fund would have a greater percentage of common stocks verses bonds because they have

enough time remaining to be exposed to more risk. As a person nears retirement age, the

fundʹs managers automatically change the make-up of the investments in the fund to

more conservative, less volatile investments more appropriate for someone needing their

money fairly soon.

These types of funds are ideal for the average person who does not have the time,

expertise or desire to put in the effort necessary to manage their own monies. With these

funds, a person just states what year they plan on retiring and then set up automatic

payments and everything else is decided by professional investment managers.Diff: 2Topic: Mutual Fund ClassificationsAACSB: Analytical Thinking

42) What are the advantages of index funds?

Answer: Index funds are set up to mimic or duplicate the stocks found in a market index like the

S&P 500 or or Dow Jones Industrials. They are called passively managed funds because it

does not take any expertise to select the stocks from the index, these funds do not require

high paid managers or have a lot of trading costs or other expenses associated with a

actively traded fund. Because of the low costs, most index funds are no-load funds with

very low expense fees.

Because of the efficient markets, it is very difficult for an actively traded fund to

consistently beat the market indexes over time. For a typical, dollar cost averaging, buy

and hold investor, the index funds are a very good choice for their important savings.Diff: 2Topic: Mutual Fund ClassificationsAACSB: Analytical Thinking



43) What are ETFs and what are their advantages?

Answer: An ETF is a hybrid type investment that mimics the diversification of a mutual fund but

enjoys the flexibility of an actively traded share of common stock. Most ETFs follow an

underlying index, similar to an index fund. The main advantages of an ETF is that you

donʹt need to open up a special account or have a minimum deposit for an account. If you

already have a trading account you can purchase shares of an ETF just like shares of any

common stock. You can actively trade the ETF anytime of the day taking advantages of

market movements. You can trade ETFs using margin and short selling. Because of their

nature, the tax liability for capital gains comes upon the trade only and is much less

complex than the potential tax liability of mutual funds.Diff: 2Topic: Exchange Traded FundAACSB: Analytical Thinking

14.5 Buying a Mutual Fund

1) The process of buying a mutual fund involves determining your investment goals, identifying

funds that meet your objectives, and evaluating those funds.

Answer: TRUEDiff: 1Topic: Financial GoalsAACSB: Reflective Thinking

2) To obtain information about mutual funds you must always pay a fee.

Answer: FALSEDiff: 1Topic: Sources of InformationAACSB: Information Technology

3) Mutual funds sold by a bank are insured by the federal government.


4) When screening mutual funds,two of the best websites are: Morningstar and Yahoo!Finance.

Answer: TRUEDiff: 3Topic: Sources of InformationAACSB: Information Technology

5) A source of third-party information like Morningstar or Yahoo! Finance is typically biased

towards certain mutual fund companies.

Answer: FALSEDiff: 3Topic: Sources of InformationAACSB: Information Technology



6) When selecting a mutual fund, since past performance doesnʹt necessarily predict future results,

you donʹt need to look at the fundʹs past performance.

Answer: FALSEDiff: 3Topic: Sources of InformationAACSB: Analytical Thinking

7) You may be charged a small transaction fee when you buy no load funds through a ʺmutual

fund supermarket.ʺ

Answer: TRUEDiff: 2Topic: Sources of InformationAACSB: Information Technology

8) The No. 1 predictor of mutual fund performance is ʺlooking at the mutual fundʹs costsʺ; the

lower they are, the better the predicted performance.

Answer: TRUEDiff: 2Topic: Mutual Fund Cost and FeesAACSB: Analytical Thinking

9) Bernie has followed the three steps to begin mutual fund investing and is ready to make the

purchase. What are his choices in buying?

A) Use a broker.

B) Use a financial advisor.

C) Buy direct.

D) Buy through a mutual fund supermarket.

E) All of the above

Answer: EDiff: 2Topic: Sources of InformationAACSB: Information Technology

10) Why is it important to determine what investment goals you are trying to achieve before you

invest in a mutual fund?

A) The mutual fund company may attempt to change your goals to meet their fund offerings.

B) You must provide the mutual fund company with your defined goals before they allow

you to purchase shares.

C) You must look for a mutual fund with the same or similar investment goals that you have

in order to find an appropriate fund.



Answer: CDiff: 2Topic: Financial GoalsAACSB: Reflective Thinking



11) What sources of information does Art Keown, your textbook author, recommend when

researching mutual fund investing?

A) Yahoo! Finance

B) The Wall Street Journal

C) MoneyCentral

D) Morningstar Mutual Funds

E) All of the above

Answer: EDiff: 3Topic: Sources of InformationAACSB: Reflective Thinking

12) A mutual fund ________ provides a description of the mutual fund including the fundʹs

objectives and risk, its historical performance, its expenses, managerʹs history and other

information.

A) prospectus B) prospector C) debenture D) indenture

Answer: ADiff: 2Topic: Sources of InformationAACSB: Information Technology

13) What information can an investor find in the prospectus of a mutual fund?

A) The fundʹs goal and investment strategy

B) The fund managerʹs past experience

C) The fundʹs 12b-1 fees



Answer: DDiff: 3Topic: Sources of InformationAACSB: Information Technology

14) Investment companies are required by law to offer a prospectus to prospective investors. Let

your instructor know which 5 parts you think are the most important and why.

Answer: The fundʹs goal and investment strategy is important because I want it to align with my

own personal goal and strategy. The fundʹs manager must have a good track record of

successful performance or I will not invest. I must know what the distribution options are

to see if they will meet my needs. I want to take advantage of all of the services offered to

get the most out of my mutual fund. Last, I want to know the fundʹs performance since

inception. Letʹs face it, if it hasnʹt done well I donʹt need it.Diff: 2Topic: ProspectusAACSB: Analytical Thinking



15) What are the four choices for purchasing a mutual fund?

Answer: 1. broker

2. financial advisor

3. buy direct

4. mutual fund supermarketDiff: 1Topic: Sources of InformationAACSB: Analytical Thinking

16) Provide a list of sources of information to evaluate mutual funds.

Answer: 1. Morningstar Mutual Funds

2. The Wall Street Journal

3. Yahoo! Finance

4. MoneyCentral

5. The Mutual Fund ProspectusDiff: 1Topic: Sources of InformationAACSB: Information Technology

17) What steps would you advise someone to go through when buying a mutual fund?

Answer: First, determine your investment goals. Second, identify funds that meet your objectives.

Third, evaluate the fund.Diff: 2Topic: Mutual FundAACSB: Analytical Thinking

18) According to the Keown book, mutual funds are a great way to invest. Once you have the

minimum amount saved–about $3,000 for most Vanguard mutual funds–itʹs time to start

investing. What are a few factors to keep in mind?

Answer: Goals. Set up your investment plan to meet your goals.

Put your plan on autopilot. The easiest way to save is to never see the money in the first

place. Just about every mutual fund allows you to have money automatically pulled from

your checking account each month and invested in the mutual fund of your choice.

Paying yourself first, as itʹs called, always makes sense.

Taxes. As you invest, keep your tax situation in mind, because mutual funds pass along

taxable income from their investments in the form of dividends and capital gains–and

even if your money remains invested in the mutual funds, there might be taxes to pay.

Taxes when you move money. When you move money from one fund to another, even

within the same fund family, the IRS looks at the movement as a sale and a purchase and

assesses taxes on any gain from the sale.

The losers. While itʹs hard to pick winners, itʹs much easier to pick losers. If a fund has

done poorly in the past, chances are it will do poorly in the future. Take the time to check

out the past performance of a fund you are interested in.

Costs, costs, costs. Keep your costs down, as lower-cost mutual funds tend to do better

than higher-cost funds. Read the fine print. Watch for commissions, maintenance, and

other fees that eat away at your money!Diff: 3Topic: Mutual FundsAACSB: Analytical Thinking


Chapter 15Retirement Planning

15.1 Social Security and Employer-Funded Pensions

1) The size of your Social Security benefits are determined by your number of years of earnings,

your average level of earnings, and an adjustment for inflation.

Answer: TRUEDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

2) An employeeʹs Social Security contributions are invested in a general fund account and will be

made available for the employee at retirement.


3) Social Security is a plan where current workersʹ contributions pay for current retireeʹs benefits.


4) The Federal Insurance Contributions Act isnʹt an investment, but rather a mandatory insurance

plan that one pays into through salary deductions.


5) Social Security is a health care, retirement, disability income, and life insurance plan.


6) Robin was born after 1960, therefore, the retirement age for her to receive full Social Security

benefits is 65.

Answer: FALSEDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments


Chapter 15 Retirement Planning 461

7) For most people, there is really no reason to save for retirement since Social Security will

provide retirement benefits until you die.

Answer: FALSEDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

8) Most employees in the United States today are covered by an employer funded defined -benefit

plan.

Answer: FALSEDiff: 1Topic: Defined Benefit Retirement PlanAACSB: Information Technology

9) Under a funded pension plan, the employer makes regular contributions to a trustee who

collects and invests the retirement funds.

Answer: TRUEDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

10) One of the drawbacks to defined-benefit plans are their lack of portability, meaning that if you

leave the company the value of the pension is not likely to go with you.

Answer: TRUEDiff: 1Topic: Defined Benefit Retirement PlanAACSB: Information Technology

11) Today, the typical American worker will receive a defined-benefit retirement plan from their

employer.

Answer: FALSEDiff: 2Topic: Defined Benefit Retirement PlanAACSB: Information Technology

12) Under a defined benefit plan you receive a promised or ʺdefinedʺ benefit payout at retirement.

Answer: TRUEDiff: 2Topic: ProvisionsAACSB: Information Technology

13) Which of the following benefits is not provided by Social Security?

A) Death

B) Disability

C) Education

D) Health

E) Retirement

Answer: CDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments



14) Which of the following statements is true regarding Social Security retirement benefits?

A) It attempts to replace 42% of your average earnings.

B) Not all occupations are covered.

C) Some peopleʹs benefits may be taxed.

D) You may retire beginning at age 62 with reduced benefits.

E) All of the above

Answer: EDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

15) Social Security is a mandatory insurance program that provides a base level of protection for all

of the following occurrences except one. Choose that one.

A) Death

B) Disability

C) Health problems

D) Retirement

E) Job loss


16) Social Security is a system where current workersʹ pay taxes that are used to pay current

retireesʹ benefits. How is Social Security funded?

A) Income taxes by all Americans

B) Payroll taxes on employees up to a salary cap

C) Payroll taxes on employers up to a salary cap




17) To be eligible for Social Security benefits, you receive one credit for every $1,200 in wages that

you earn, up to 4 credits per year. How many total credits do you need to qualify for benefits?

A) 4 B) 20 C) 30 D) 40

Answer: DDiff: 1Topic: Social SecurityAACSB: Analytical Thinking



18) The system of Social Security is based on young working people paying taxes to support older

retired people. The dependency ratio is the number of workers to retirees. Forty years ago it was

16 workers for every one retiree. What will happen to this ratio by the year 2048?

A) It will reverse so that there will be more retirees than workers.

B) It will increase, because there will be more young workers than retirees.

C) It will decline to 2 workers for every 1 retiree.

D) Nothing, since the ratio of young people to old people does not change.

Answer: CDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

19) How is the size of a personʹs Social Security retirement benefits determined?

A) It depends on the number of credits earned in a personʹs lifetime.

B) It depends on the average level of earning over a personʹs lifetime.

C) It depends on the number of years a person has paid Social Security taxes.



Answer: DDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

20) Many older companies have changed from a defined-benefit plan to a(n) ________, which is a

retirement plan where workers are credited with a percentage of their pay each year, plus a

predetermined rate of interest.

A) funded pension plan

B) cash balance plan

C) unfunded pension plan

D) percentage plus inflation plan


Answer: BDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

21) Your company pays retirement benefits to current retirees out of current earnings, on a

pay-as-you-go basis. This is an example of a(n)

A) unfunded pension plan. B) funded pension plan.

C) cash balance plan. D) none of the above.

Answer: ADiff: 2Topic: Employer Sponsored Retirement PlanAACSB: Information Technology



22) When an employer makes pension fund contributions directly to a trustee who holds and

invests those funds, the plan is said to be a(n)

A) defined-contribution plan.

B) funded pension plan.

C) unfunded pension plan.

D) cash balance plan.



23) Frank is considering a new job. However he is concerned about his pension fund. He knows that

________ which is the requirement that he must work for his firm for a specified period of time

prior to gaining ownership of the retirement contributions made by his employer has to be met

first.

A) tenuring

B) certifying

C) vesting

D) validating


Answer: CDiff: 1Topic: ProvisionsAACSB: Information Technology

24) If your pension fund contained a provision that allowed employees who were leaving the

company to retain and transfer any pension benefits earned to another pension plan, it would be

said to have

A) transference.

B) releasability.

C) transportance.

D) portability.


Answer: DDiff: 1Topic: ProvisionsAACSB: Information Technology

25) With a ________, you, and usually your employer, pay funds into your retirement plan.

A) deducted-benefit plan B) noncontributory retirement plan

C) contributory retirement plan D) none of the above

Answer: CDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology



26) A ________ is defined by the fact that your employer provides all the funds for the retirement

plan, without any contribution from you.

A) defined-benefit plan

B) noncontributory retirement plan

C) contributory retirement plan

D) portable



27) Which of the following is a problem associated with many defined-benefits programs?

A) Lack of portability

B) Failure to adjust for inflation once payments begin

C) Many are unfunded.

D) All of the above

E) A and C only

Answer: DDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Analytical Thinking

28) Defined-benefit pension plans are generally ________ and they lack ________.

A) contributory; divesting

B) noncontributory; divesting

C) contributory; portability

D) noncontributory; portability

E) vested; portability

Answer: DDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

29) Why have many companies switched from traditional defined-benefits plans to cash-balance

plans?

A) They want to shower their employees with money

B) Regulatory reform made it necessary.

C) They save money with them as a result of reduced future benefits for older workers.



Answer: CDiff: 3Topic: Defined Benefit Retirement PlanAACSB: Information Technology



30) How will you access in an accurate manner the amount of your retirement income?

Answer: Call Social Security at 800-772-1213 for a Personal Earnings and Benefits Estimate

Statement to see what your monthly check will be. Go to your employerʹs benefits office

and request a similar statement relative to your retirement. Use a financial calculator or a

computer program to calculate all of your investments and savings. Go to the Social

Security Administrationʹs on-line website to access additional information.Diff: 1Topic: Social SecurityAACSB: Information Technology

31) How does Uncle Sam determine our Social Security monthly retirement check for all practical

purposes?

Answer: Our number of years of earnings, average level of earnings, and an adjustment for

inflation all go into the calculation of our retirement benefit. SS attempts to replace 42% of

our average earnings over the working years.Diff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

32) Explain why we do not invest in Social Security. What are the four basic benefits for those who

are qualified?

Answer: We actually purchase mandatory insurance, rather than invest, in Social Security. It can

provide benefits for death, disability, health problems, and retirement.Diff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

33) Social Security benefits are very nice to get and help many current retirees live above the

poverty line. Why should someone who is 25 years old today not count on receiving the same

type of Social Security benefits when they retire in 45 years from now?

Answer: The demographics of American society have changed dramatically since when Social

Security was created in 1933. The two main problems is the dependency ratio of young

workers for every one retiree and the fact that the average life expectancy of retirees is

increasing quickly. In 1933 the average life expectancy was 65 years old. The idea that 40

young working families would pay a small amount of taxes to support one retiree for a

relatively short period of time. The current life expectancy is increasing meaning current

retirees are drawing benefits much longer than expected. This is due to tremendous

improvements in lifestyles, diets, health care, medicine and technology. If this trend

continues then life expectancies will keep increasing causing serious financial strains on

the system as it is now. Plus families are having fewer children causing the dependency

ratio of workers to retirees to keep shrinking and is projected to be 2 to 1 in forty years.

Some economists believe that the retirement age needs to raised up well past 70 rather

than future benefits be reduced.Diff: 3Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments



34) Relate the pros and cons of defined-benefit plans.

Answer: Under a defined-benefit plan you receive a promised pension payout at retirement. Some

employers pay for it 100%. The money grows tax-deferred. The employer bears the risk

and you are promised the same amount regardless of the market. You may become

vested in these plans, which is what you want in the first place.

In general, the most that any employee gets is 40% to 45% of his or her before-retirement

income. Companies can change their position or policy with little notice. The plans lack

portability, that is, the ability to move with you to your new job. Very few of them adjust

for inflation and some are not funded.Diff: 2Topic: Employer Sponsored Retirement PlanAACSB: Reflective Thinking

15.2 Plan Now, Retire Later

1) Because inflation makes goods and services cost more over time, one would be wise to always

plan for inflation when planning oneʹs retirement.

Answer: TRUEDiff: 1Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

2) One of the first steps in planning for your retirement is figuring out just what you want to do

when you retire.

Answer: TRUEDiff: 1Topic: Planning for RetirementAACSB: Reflective Thinking

3) One of the best things about retirement is that retirees donʹt have to pay income taxes once they

retire.

Answer: FALSEDiff: 1Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

4) Since the 2000s, the average personal savings rate in the U.S. has decreased.

Answer: FALSEDiff: 2Topic: SavingAACSB: Reflective Thinking

5) According to the Employee Benefit Research Institute, one-third of U.S. households between the

ages of 30 and 59 wonʹt have enough money for retirement, even if they work until theyʹre 70.




6) As of 2014, the average monthly Social Security benefit for retired workers was

A) $959. B) $1,150. C) $1,294. D) $1,677.

Answer: CDiff: 2Topic: Social SecurityAACSB: Reflective Thinking

7) Suppose that you have estimated that, to provide for your retirement income, you will need

$2,250,000 on deposit in your retirement account when you retire. You believe that you will earn

an average of 11% on your retirement investments until you retire in 35 years. What must your

annual deposits be to accumulate this total?

A) $21,991.14

B) $6,586.85

C) $5,904.84

D) $6,878.77


Answer: BDiff: 3Topic: Planning for RetirementAACSB: Analytical Thinking

8) Like many Americans you know that you must plan your retirement funds carefully because

there may be a discrepancy between the funds that you will need to survive on during

retirement and the income that you will have available during retirement. What will likely be

the relationship between fund needs and income available during retirement for MOST

Americans?

A) They will match.

B) They will be close.

C) They will not be close income will be greater than needs.

D) They will not be close needs will be greater than income.

Answer: DDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

9) You have determined that you will need to accumulate $1,000,000 in your retirement account in

order to cover your inflation-adjusted shortfall. Which of the following is closest to the amount

of money you would need to put into a tax-deferred retirement account every year if you plan

on retiring in 40 years? Assume an 8% average return on this account, and that it is empty

today.

A) $1,458 B) $3,860 C) $5,957 D) $8,444

Answer: BDiff: 3Topic: Planning for RetirementAACSB: Analytical Thinking



10) ________ of workers feel confident they will have enough money to live comfortably in

retirement, only ________ have actually tried to calculate how much they will need when in

retirement.



Answer: BDiff: 3Topic: Planning for RetirementAACSB: Reflective Thinking

11) What investment goals should a person have when determining where to put their 401k monies

in their account?

Answer: For the younger workers under the age of 55, their goal should be the accumulation of

wealth through capital gains. A good diversified portfolio of Index funds, Growth funds

and Balance funds would be appropriate choices. Between ages 55 and 65, their goals

should change to wealth preservation so they should gradually reallocate their portfolio

away from capital gains to less volatile funds like bond funds so that by the time they

near retirement they have 70% into Bond funds and 30% into Balanced funds. Once

retired, wealth preservation and income are the main goals so they should have a

majority of their portfolio in Bond funds and Government Security funds for safety and

income.Diff: 3Topic: Defined Contribution Retirement PlanAACSB: Reflective Thinking

12) Relate the 7 steps to funding your retirement needs. What is the hardest part?

Answer: 1. Set realistic and well thought out goals.

2. Estimate how much you will need to meet your goals.

3. Estimate your income available at retirement.

4. Calculate the annual inflation-adjusted shortfall.

5. Calculate funds needed at retirement to cover this shortfall over your entire

retirement.

6. Determine how much you must save annually between now and retirement.

7. Put the plan in play and save.

The hardest part always seems to be getting started.Diff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

13) Discuss the basic considerations when facing retirement.

Answer: Make sure you meet the qualifications to begin receiving payments. Decide on the type of

payout you want and its tax consequences. Look at all payout options because you may

want a combination payout. Once you receive these funds, make sure you understand

investing, diversification, the time dimension of risk, and what you want to do with

them.Diff: 1Topic: Planning for RetirementAACSB: Reflective Thinking



15.3 Retirement Plans

1) The only difference between a defined-benefit plan and a defined-contribution retirement plan

is the tax deduction for the defined-contribution plan.

Answer: FALSEDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Information Technology

2) Under a defined-contribution plan, your employer alone or you and your employer together

contribute directly to an individual account set aside specifically for you.

Answer: TRUEDiff: 1Topic: Defined Contribution Retirement PlanAACSB: Information Technology

3) A 401(k) plan is a tax-deferred retirement savings plan in which employees of private

corporations may contribute a portion of their wages up to a maximum amount set by law.


4) The big disadvantage with a defined-contribution plan is that you donʹt know in advance

exactly how much money you can plan on for retirement income.


5) By law, everyone must contribute the maximum amount into their 401(k) plans at work.

Answer: FALSEDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments

6) You should take advantage of any matching your company is willing to do for your 401(k).

Answer: TRUEDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking

7) According to the author, 401(k) plans are actually do it yourself variation of a

profit-sharing/thrift plan.




8) The Keogh plan is a retirement plan for individuals who work for large multinational

corporations.

Answer: FALSEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

9) It is a good idea to start saving for retirement as early as possible to take advantage of

compounding returns on your savings.


10) Individual retirement arrangements (IRAs) are personal savings accounts that give you tax

advantages for saving for retirement.

Answer: TRUEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

11) Anyone can open up an IRA account but not everyone may get tax-advantages from it because

there are income limitations.


12) Contributions to a traditional IRA are always tax deductible.


13) If all contributions to your IRA are tax deductible, then all withdrawals from your IRA will be

taxed, unless youʹre just moving your money into another IRA.


14) A person may have more than one qualified retirement plan open at the same time.




15) A ʹself-directedʹ retirement plan is one in which a plan administrator determines how much

your contributions will be and what investment options you will have available.

Answer: FALSEDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

16) With a traditional IRA and a Roth IRA, you can make withdrawals at any time with no

penalties.

Answer: FALSEDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Information Technology

17) With a Roth IRA, after five years you can make withdrawals before age 59 1/2 without a penalty

but you must pay taxes on the withdrawals.


18) The Savers Tax Credit is designed to encourage low to moderate income workers contribute to

their retirement accounts.


19) A Coverdell Education Savings Account works just like the Roth IRA for qualified education

expenses, except with respect to contributions.

Answer: TRUEDiff: 2Topic: Savings for CollegeAACSB: Information Technology

20) With an IRA your investment choices include stocks, bonds, mutual funds, CDs and real estate.

Answer: TRUEDiff: 2Topic: Planning for RetirementAACSB: Information Technology

21) If you have a defined-benefit retirement plan, youʹre considered an ʺinactive participant.ʺ




22) For someone wanting to minimize the taxes they are paying now, a Roth IRA would be

preferable to a traditional IRA.


23) Contributions to Roth IRAs are tax deductible.


24) The Roth IRA does not require that distributions begin by age 70 1/2.

Answer: TRUEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

25) One of the advantages to a traditional IRA is that it allows you to make a penalty -free

withdrawal to purchase your first home.

Answer: TRUEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

26) The main advantage of the Roth IRA over the traditional IRA is the employer matching funds.


27) A(n) ________ is a tax-deferred retirement plan that is essentially the same as a 401(k) plan,

except that it is aimed at employees of schools and charitable organizations.

A) 404(a)

B) 402(b)

C) 403(b)

D) 007(a)


Answer: CDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Information Technology



28) A(n) ________ is a pension plan in which you and your employer or your employer alone

contribute funds directly to a retirement account set aside specifically for you.

A) defined-benefit plan

B) cash balance plan

C) defined-contribution plan

D) percentage plus inflation plan


Answer: CDiff: 1Topic: Defined Contribution Retirement PlanAACSB: Information Technology

29) Brian works for Walmart. Walmart contributes company stock into his retirement account

instead of cash. This is called a(n)

A) ESOP.

B) thrift.

C) EFLP.

D) stock-contribution plan.


Answer: ADiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

30) You are participating in a pension plan where the companyʹs contributions vary from year to

year, depending on the firmʹs performance. This is an example of a(n)

A) variable contribution plan.

B) earnings establishment plan.

C) performance retirement plan.

D) profit-sharing plan.


Answer: DDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

31) Burt Reynolds has changed jobs. His last retirement planʹs contributions depended on how well

the company performed and he shared in the earnings. His present employer allows him

ownership in the firm, although this is the riskiest plan. Burtʹs former plan was a(n) ________

and his current plan is a(n) ________.

A) ESOP; money purchase plan

B) profit-sharing plan; ESOP

C) ESOP; 401(k)

D) profit-sharing plan; thrift and savings plan

E) ESOP; profit sharing plan




32) Why does a tax-deferred retirement account accumulate more money than a taxable account,

assuming the same amount is contributed every year and the accounts earn the same return

every year?

A) There are different investment options available for tax-deferred accounts.

B) You can take bigger risks with assets that generate higher returns in a tax-deferred

account.

C) With tax-deferred accounts, there are no income or capital gains tax liabilities on account

activity.

D) All of the above are correct


Answer: CDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

33) Why have employers switched to defined-contribution plans instead of defined-benefits plans

for most companies?

A) They remove the financial risk for future pension costs away from the company and pass it

on to the employee.

B) The employer doesnʹt want to do any bookkeeping for the retirement plan.

C) Employers care deeply about what employees eventually receive from their plan.



Answer: ADiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments

34) Tran is employed at a company that annually contributes anywhere from 2% up to 12% of his

salary into his retirement plan, depending on how good the companyʹs financials were that

year. This type of contribution plan is a(n) ________ plan.

A) 401(k) B) ESOP C) profit-sharing D) performance

Answer: CDiff: 2Topic: Employer Sponsored Retirement PlanAACSB: Diverse and Multicultural Work Environments

35) A(n) ________ retirement plan is one in which the company will contribute shares of company

stock into the employeeʹs account in place of a cash contribution. The employee does well if the

company stock appreciates in value, but can suffer dramatically if the stock depreciates in value.

A) 401(k) stock account B) 403(b) stock account

C) ESOP D) stock repurchase plan

Answer: CDiff: 2Topic: Employer Sponsored Retirement PlanAACSB: Diverse and Multicultural Work Environments



36) 401(k) and 403(b) plans are the most common retirement plans these days. What are the big

advantages to employees with these plans?

A) You donʹt pay taxes on money contributed to 401(k) plans.

B) Earnings on your retirement account are tax deferred.

C) Many firms contribute an employer match, which represents a 100% risk-free return to the

employee.



Answer: DDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments

37) The difference between a Money Purchase Plan and a Profit Sharing plan is that

A) with the Profit Sharing Plan the employee is guaranteed to see profits in their retirement

funds.

B) with the Money Purchase Plan the contributions are required regardless of how the firm

performs.

C) Profit Sharing Plans constantly outperform Money Purchase Plans.

D) all of the above are correct.

E) both A and C are correct.

Answer: BDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments

38) Jahwana works for a large corporation with a 401(k) retirement plan. The company matches

dollar for dollar the first 5% of the employeeʹs salary contributed to the 401(k). Jahwana

currently earns $40,000 in gross salary and she currently contributes 15% of her salary into her

401(k). How much money in dollars is the total contribution to her account every year?

A) $2,000 B) $4,000 C) $6,000 D) $8,000

Answer: DDiff: 3Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking

39) Alex works for a company with a 401(k) plan. He currently earns $80,000 in gross salary and

contributes 8% of his gross salary into his 401(k) account. If his marginal tax rate is 33%, how

much income tax liability is he saving by participating in his 401(k)?

A) $6,400 B) $2,112 C) $6,000 D) $16,800

Answer: BDiff: 3Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking



40) Erica works for a company with a 401(k) plan. The company matches at $0.50 on the dollar the

first 6% of the employeeʹs salary contributed to the 401(k). If Erica earns $90,000 and contributes

12% of her salary, how much will the employer match be in dollars for the year?

A) $1,400 B) $2,700 C) $3,500 D) $6,200

Answer: BDiff: 3Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking

41) What are the disadvantages of an ESOP retirement plan?

A) Your retirement account is not diversified.

B) The return on your account is subject to the success of the company.

C) If the company files for bankruptcy, the stock in your account could become worthless.



Answer: DDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Reflective Thinking

42) Valerie works as a free-lance artist. Her financial advisor suggested she establish a Keogh plan

for her retirement. Is this an appropriate suggestion for her?

A) Yes B) No

Answer: ADiff: 2Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

43) Of the tax-favored retirement plans for the self-employed and small business employee, one is

limited to $52,000 of annual contributions per person. It is the ________ plan.

A) Keogh B) SEP-IRA C) SIMPLE D) 401(k) E) thrift

Answer: BDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

44) If you are self-employed or work for a small business which of the following retirement plans

would you be most likely to have?

A) 403(b)

B) 401(k)

C) Thrift and savings plan

D) Keogh plan


Answer: DDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Information Technology



45) Which of the following retirement plans is designed for small businesses?

A) SIMPLE plans

B) SEP-IRA plans

C) ESOP

D) All of the above

E) Only A and B

Answer: EDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Information Technology

46) What are the advantages to a SIMPLE plan for retirement for the small business owners?

A) The plan is very easy to set up.

B) The plan works well for small business owners with 100 employees or less.

C) The small business owner has some flexibility in determining how much to contribute to

the plan.



Answer: DDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

47) Rihab just got a new job and wants to roll over her retirement account from her previous job at a

large corporation into an IRA. Which of the following is true?

A) Doing this avoids the 10% early distribution penalty.

B) Rihab should speak to a financial planner to learn make sure she follows the rollover rules

to avoid taxes.

C) Both A and B

D) Neither A nor B


48) What advantage does the Roth IRA have over the traditional IRA?

A) Early withdrawals from a Roth are subject to penalities, so you wonʹt be tempted to dip

into your investment.

B) Unlike the traditional IRA, with a Roth you donʹt pay taxes while your money is in the

IRA.

C) With a Roth you take care of taxes ahead of time and end up with more money to spend at

retirement.

D) Contributions to a Roth IRA are tax deductible.




49) You want to start an Coverdell Education Savings Account for your child. Suppose that you

contribute $500 each year to this account for 18 years, starting when he or she is born. If you can

earn 8% on the deposits, how much will be on deposit at the end of the 18th year?

A) $4,306.38

B) $17,581.05

C) $18,725.12

D) $3,682.89


Answer: CDiff: 3Topic: Savings for CollegeAACSB: Analytical Thinking

50) Reggie has two children. He is wanting to put money away for their college education. What

type of plan can only be used for college and graduate school, and allows contributions of up to

$250,000?

A) 403(b) B) ESOP C) 529 D) 12b-4

Answer: CDiff: 1Topic: Savings for CollegeAACSB: Diverse and Multicultural Work Environments

51) What is a disadvantage of the ʺPrepaid College Tuition Planʺ version of the 529 plan?

A) Distributions before age 59 1/2 incur a 10% tax penalty.

B) They generally guarantee that your child will be covered only if he or she attends a public

in-state university or college.

C) They allow greater flexibility than the College Savings Plans.

D) All of the above.

E) None of the above.

Answer: BDiff: 2Topic: Retirement PlanAACSB: Information Technology

52) Frances McClurg favors the Roth IRA over the traditional IRA. What advantage does the Roth

provide over the traditional IRA?

A) She can avoid income taxes when she withdraws.

B) The earnings are tax deferred, unlike a traditional IRA.

C) Contributions are tax deductible.

D) It saves tax money for education.

Answer: ADiff: 1Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking



53) Lori Watts favors the traditional IRA over the Roth IRA. What advantage does the traditional

IRA have over the Roth?

A) The earnings are tax-exempt, unlike a Roth IRA.

B) Contributions are likely to be fully or partially tax deductible.

C) It saves tax money for education.

D) There are no penalties for early withdrawals.

Answer: BDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

54) Which of the following statements about saving for college is not true?

A) The Coverdell Education Savings Account works just like the Roth IRA, except with

respect to contributions.

B) If the money in a Coverdell Education Savings Account isnʹt used for college, taxes and

penalties may apply.

C) Some 529 plans are prepaid college tuition plans.

D) You must open a 529 plan sponsored by the state in which you reside.

E) 529 college savings plans offer more flexibility than prepaid college tuition plans.

Answer: DDiff: 2Topic: Savings for CollegeAACSB: Information Technology

55) Jose does not have a retirement plan at work. He currently earns $30,000 in salary and is in the

15% marginal tax bracket. If he contributes the maximum contribution of $5,500 to his

traditional IRA, how much money will he save on his income tax liability?

A) He wonʹt save any money, since only the Roth IRA has tax deductions on contributions.

B) He wonʹt save any money, since his income does not qualify for tax deductions for a

qualified plan.

C) $825

D) $5000

Answer: CDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

56) Alicia works two jobs and still makes very little income. Why is the Saverʹs Tax Credit a good

idea for her?

A) Because it will possibly increase her tax refund

B) Because it will possibly reduce the amount of income tax that she owes

C) It allows her to offset part of the first $2,000 that she can contribute to an IRA or a 401(k)

plan.






57) June and Ward Cleaver are married. June works as an accountant and contributes to a 401(k)

plan at work. Ward is a web page designer and works for himself from their home. What type

of retirement plan would be an option for Ward?

A) Keogh plan

B) SEP-IRA plan

C) Individual IRA




58) If you have a defined-benefit retirement plan through your place of employment, you are

considered a(n) ________; and as such, there is an income limit after which your IRA

contributions are no longer tax deductible.

A) restricted participant

B) deactivated participant

C) active participant



Answer: CDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

59) Fred and Carlie want to save some money for a down payment on a house. They figure it will

take at least 10 years to save up enough money. Which of the following would be the best way

for them to save this money?

A) Traditional IRA B) Roth IRA

C) 529 Savings Plan D) Keogh Plan

Answer: BDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology



60) What are the advantages and disadvantages of a defined-contribution plan like a 401k?

Answer: The big advantages are the tax-deductibility of your contributions, the tax-deferred

treatment during your working years, and the employer match if any. With wise

investment decisions and consistent contributions an employee can accumulate a

substantial amount of retirement funds over the long haul. Portability and vesting are

also very important benefits since most younger workers will switch jobs throughout

their working lives.

The big disadvantages are not knowing what your retirement income will be upon

retirement, poor investment decisions and market swings close to retirement. Many

people are not very sophisticated with investing and they choose investment options that

are either to risky or to conservative for their life cycle stage. Many people donʹt

contribute the maximum allowed to get the full benefits of the employer match or the

maximum accumulation over time.Diff: 2Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking

61) Compare and contrast the defined-contribution plans.

Answer: Under profit-sharing plans your employer contributes a portion of the companyʹs profits

to your individual plan. Things are great when there is a profit and not so great when

there is none. Money purchase plans have a guaranteed contribution by the employer of a

set percentage of each employeeʹs salary. Employers match a percentage of employeeʹs

contributions in a thrift-and-savings plan. An ESOP is the riskiest plan. Here, your

company contribution consists of the companyʹs stock. If the firm goes broke you lose

everything. A 401(k) plan is a tax-deferred retirement plan in which both the employeeʹs

contributions and earnings are tax-deductible.Diff: 1Topic: Employer Sponsored Retirement PlanAACSB: Analytical Thinking

62) Are retirement plans different for the self-employed and employees of small businesses? Do

you have to work full-time to qualify for one?

Answer: Both part-time and full-time small business owners and employees can qualify for one of

three tax-favored retirement plans. A Keogh plan allows large tax-deductible

contributions to either a defined-contribution or a defined-benefit or a combination of

both plans. Under a defined-benefit Keogh you are allowed to contribute whatever

amount you deem necessary to meet your needs. A SEP-IRA is similar to a Keogh and is

easier to set up, but contributions are more limited. A SIMPLE plan provides some

employer matching funds, is for businesses with less than 100 employees, and is very

simple to set up and use.Diff: 3Topic: IRS Qualified Retirement PlansAACSB: Reflective Thinking



63) What does the term ʹself directedʹ mean concerning retirement accounts?

Answer: The term self directed means that the individual account holder will make the investment

decisions for their retirement monies. For employer sponsored plans, the employer will

select a Financial Institution like a Mutual Fund company to be the plan Administrator.

Typically there will be a selection of various mutual fund categories available to meet the

requirements of a diverse group of employees. It is the employee who chooses which

fund or funds they feel are best suited to their individual needs, hence they are ʹself

directingʹ their retirement account.

With an individual retirement account, the individual makes all of the choices

themselves. They choose a Financial Institution to act as the Plan Administrator and the

individual chooses whatever investments they want for their account.Diff: 3Topic: Planning for RetirementAACSB: Reflective Thinking

64) What are the major differences between the new IRAs and the traditional IRA?

Answer: All three of them are on a tax-deferred basis for individuals. They are separate from any

employer plan. The traditional IRA can be fully tax-deductible, partially tax-deductible,

or not tax-deductible, depending on the amount of your earnings and whether your

spouse or you yourself have a company retirement plan. The Roth IRA does not have

tax-deductible contributions, but rather has tax-free withdrawals upon retirement. The

Coverdell Education Savings Account (Education IRA) is just like the Roth IRA except

that contributions are limited to $2000 annually per child for each child younger than 18.Diff: 1Topic: IRS Qualified Retirement PlansAACSB: Reflective Thinking

65) Why is it a wise idea to have 3 retirement plans in place?

Answer: The three-retirement-plan idea is worthy of consideration for several reasons. We may

misjudge our retirement needs and it never hurts to have a little extra. It is far better to

have too much than too little. The Social Security system may be under such a strain that

benefits may be scaled back, thus making an additional source of income necessary. Our

employerʹs plan or plans may not hold up for several reasons. All of this will prevent us

from working part or full-time in later years, but we may not be able to work during our

retirement years.Diff: 3Topic: Planning for RetirementAACSB: Analytical Thinking



66) What is the purpose of a rollover when it comes to retirement plans?

Answer: With the popularity of defined-contribution plans these days, employees need some way

to make their retirement plans portable so they can take their retirement money with

them when they leave the company before retirement. Since qualified retirement plans

have tax liabilities and penalties for early withdrawals, the IRS had to come up with a

process for the employee to maintain their retirement monies without being penalized.

Now the employee can rollover their money into another qualified plan without any

taxes or penalties. There are strict rules governing rollovers so it pays to get professional

advice to avoid any tax consequences.Diff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

67) How does one set up a qualified individual retirement account?

Answer: Because of the IRS regulations concerning tax-advantaged retirement accounts, you must

set up an account with a Plan Administrator such as a Bank, Mutual Fund or other

Financial Institution. The Plan Administrator ensures that all IRS regulations are followed

and provides the IRS and account holder with the appropriate tax documents. Typically

there is a nominal fee or minimum starting deposit to open up an individual retirement

account.Diff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

15.4 Facing Retirement - The Payout

1) Under a single life annuity, you receive a set monthly payment for the rest of your life.

Answer: TRUEDiff: 1Topic: AnnuityAACSB: Information Technology

2) Through the single life annuity, once you reach the age of 100 the annuity payments cease.

Answer: FALSEDiff: 1Topic: AnnuityAACSB: Information Technology

3) The good thing about retirement is you no longer have to pay income taxes.

Answer: FALSEDiff: 1Topic: PayoutAACSB: Diverse and Multicultural Work Environments

4) Under the annuity for life policy your payments will continue to your beneficiaries upon your

passing up until a specified time.

Answer: TRUEDiff: 1Topic: PayoutAACSB: Diverse and Multicultural Work Environments



5) Your decision on what type of annuity to purchase will have a dramatic impact on the monthly

payments you will receive upon retirement.

Answer: TRUEDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

6) With a lump-sum distribution of your retirement benefits, you must pay all of the income taxes

on the entire amount up front.


7) Annuity payments will adjust for inflation over the years of retirement.

Answer: FALSEDiff: 2Topic: AnnuityAACSB: Information Technology

8) A joint and survivor annuity provides payments for both you and your spouse.


9) To avoid paying income taxes on your lump-sum distribution, you could roll it over into a

qualified IRA.


10) A disadvantage of the annuity for life plan is that the payments stop when you die, so you canʹt

pass the money on to your heirs.

Answer: FALSEDiff: 3Topic: PayoutAACSB: Information Technology

11) Relative to insurance, when a payout arrangement is made in which one receives all benefits in

a single payment, this is called a

A) cash payout.

B) lump-sum option.

C) single distribution plan.

D) point plan.


Answer: BDiff: 1Topic: PayoutAACSB: Diverse and Multicultural Work Environments



12) Once May Lou starts receiving her $1,200 monthly annuity payments she will pay income tax as

if the annuity were

A) tax-deferred.

B) tax-sheltered.

C) tax-exempt.

D) tax-free income.

E) normal income.

Answer: EDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

13) Richard Harris wants to elect the single life annuity option for retirement. His mother lived to

age 92 and his dad lived to be 89. This annuity will pay Richard a set monthly payment for as

long as he lives. What possible disadvantage might he face?

A) There will be no inflation protection.

B) There will be no flexibility for withdrawals in case of emergencies.

C) The balance of the money left over upon death will not be passed on to his heirs.



Answer: DDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

14) Why might one want to select the lump-sum payment option for oneʹs retirement funds?

A) Taking the lump-sum can be a hedge against inflation.

B) The lump-sum option provides greater flexibility than other options.

C) You can invest the funds and perhaps earn a higher return.

D) Having access to the funds provides money for emergencies.

E) All of the above

Answer: EDiff: 3Topic: PayoutAACSB: Reflective Thinking

15) A ________ option provides payments over the life of both you and your spouse no matter how

long you live.

A) single life annuity

B) lump sum annuity

C) joint and survivor annuity

D) annuity for life

E) combination annuity

Answer: CDiff: 1Topic: AnnuityAACSB: Information Technology



16) When planning the retirement payout, there are several options from which to choose. With the

________ option the annuity provides payments over the life of both you and your spouse.

A) single life annuity

B) lump sum annuity

C) joint and survivor annuity

D) annuity for life

E) combination annuity

Answer: CDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

17) You and your spouse both have good retirement plans through work and you both receive good

Social Security checks based on your own incomes. If your goal is to maximize the size of your

annuity check every month, which option should you choose?

A) Single Life Annuity

B) Annuity for Life or Certain Period

C) Joint and Survivor Annuity

D) All annuities have equal payment amounts, so it doesnʹt matter which you choose.

Answer: ADiff: 2Topic: AnnuityAACSB: Reflective Thinking

18) When is rolling your lump-sum retirement benefits into an IRA a good financial decision?

A) If you have taken a new job

B) If you have retired early

C) If you donʹt need the funds immediately



Answer: DDiff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments

19) Congratulations! You have just retired with $1.4 million dollars in your 401(k) plan. You will be

receiving a fairly large Social Security check and you have adequate personal savings outside of

your 401(k) to live on for several years. You donʹt want to lock up your retirement money into

an annuity because you want to be flexible for the future. What would be your best option?

A) Purchase an early withdrawal annuity.

B) Roll over the balance into a qualified IRA account.

C) Hire a Certified Financial Planner for investing advice.



Answer: EDiff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments



20) Elaborate on the basics of annuities and payouts.

Answer: A single life annuity allows you to receive a set monthly payment for life. An annuity for

life (with ʺcertain periodʺ provision) also pays for life. In addition, if you die within the

set period (usually 10 or 20 years), your beneficiary will get the payments until the end of

the period. This option provides a smaller payment. A joint and survivor annuity

provides payments over the life of both you and your spouse. None of these options

allow for any inflation protection or flexibility in payouts.

A lump-sum option gives you your benefits in one single payment. It is great for

inflation protection, emergency funds, access to large sums of money, and investing in

other endeavors. You can roll over the lump sum into an IRA or qualified plan. The

dangers are a high tax bill and spending too much of it.Diff: 2Topic: AnnuityAACSB: Reflective Thinking

21) How are distributions/payouts/settlements taxed?

Answer: Annuity payouts are taxed as normal income. Lump-sum distributions can be taxed

using a 5 or 10 year averaging technique. This eases your tax burden, but you still have to

pay them all at once.Diff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments

22) Why would it be a good idea to hire a Certified Financial Planner before you retire?

Answer: Many people will retire with a substantial amount of money in their retirement account.

Most people would benefit from expert advice before they retire since there are many

complicated and important decisions to be made. Annuities may be very good choices for

some people but there is not much flexibility after the decision is made. People with

spouses and dependents want to make sure they make the right choice before they

purchase the annuity. There may be serious tax liability depending on which choice you

make, especially with a lump sum option.

For those that roll over their accounts into a qualified IRA account, they will benefit with

investment advice to make appropriate investment decisions to protect them from market

swings and inflation.Diff: 3Topic: Financial PlanningAACSB: Reflective Thinking

15.5 Putting a Plan Together and Monitoring It

1) Vanguard and Fidelity are two low-cost mutual fund families that offer Roth IRAs. Stick to

them or another mutual fund family that features low costs and expenses.




2) Today, there are roughly 18,000 publicly traded stock and bond funds, and for many workers,

the prospect of choosing among them is paralyzing.

Answer: FALSEDiff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

3) For low income senior households Social Security is a very important financial asset.


4) As a young consumer you would be wise to be very cautious with your investing and avoid

investing in stocks.

Answer: FALSEDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

5) Consistently saving a little money for retirement when you are in your twenties is much better

than saving a lot more money when you are in your fifties.


6) Two of the most important considerations when saving for retirement is the time you have to

save and the return you earn on your savings.


7) Retirement income comes from which of the following sources?

A) Social Security

B) Pensions

C) Asset income

D) Earnings

E) All of the above

Answer: EDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments



8) Today, there are roughly ________ publicly traded stock and bond funds, and for many

workers, the prospect of choosing among them is paralyzing.

A) 5,000 B) 8,000 C) 18,000 D) 23,000

Answer: BDiff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

9) Lucius starts saving $100 per month at age 25 and averages 6% per year compounded monthly.

Hector starts saving $1,215.22 per month at age 55 and averages 6% per year compounded

monthly. Who will be better off at age 65 assuming neither had in money in their account when

they started?

A) Lucius will have $15,476.20 and Hector will have $16,017.57 at age 65.

B) Lucius will have $199,149.07 and Hector will have $163,879.34 at age 65.

C) They both will have the same amount of money in their accounts at age 65.

D) Not enough information available.

Answer: CDiff: 3Topic: Planning for RetirementAACSB: Analytical Thinking

10) What are some very important things to monitor concerning your retirement plan, both before

and after retirement?

Answer: Inflation and tax policy will have an enormous impact on whether or not you will reach

your retirement goals and be able to enjoy the standard of living you planned for during

retirement. Inflation changes which effects the real return on your savings. Tax policy

changes which also impacts your after-tax return. Social Security reform and Medicare

reform could have a dramatic impact on retirement goals. Economic conditions such as

interest rates and recession can impact your investments but also the company you

worked for who may be paying out your benefits or is a major holding in your ESOP

plan. Maintaining a budget and not withdrawing too much money too soon could hurt

your chances of not outliving your savings. Possibly delaying retirement, delaying Social

Security benefits, or working part time during retirement may be necessary and

identified through good planning and monitoring.Diff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

11) If your employer offers a 401(k) or 403(b) plan, why should you participate?

Answer: Not only are the plans convenient, many include a company match. Thatʹs free money,

and youʹve got to take advantage of it.Diff: 2Topic: Planning for RetirementAACSB: Analytical Thinking


Chapter 16Estate Planning: Saving Your Heirs Money and Headaches

16.1 The Estate Planning Process

1) The final step in estate planning is determining which estate planning techniques are most

appropriate to achieve your goals.


2) The first step in estate planning is to determine the value of your estate.


3) Estate planning is important because it protects your family against major catastrophes and

helps keep taxes to a minimum.

Answer: TRUEDiff: 1Topic: Estate PlanningAACSB: Reflective Thinking

4) The correct equation to determine your estateʹs net worth is: value of your estate - level of

estateʹs liabilities.


5) The law allows you to give $25,000 per year tax free in 2015 to as many people as youʹd like.

Answer: FALSEDiff: 1Topic: TaxesAACSB: Information Technology

6) There is no limit to the size of transfers that can be made between spouses on a tax -free basis.

Answer: TRUEDiff: 1Topic: TaxesAACSB: Information Technology

7) The unified tax credit effectively nullifies the taxes on the first $5.34 million of oneʹs estate.




8) Gifts reduce the taxable value of your estate and allow you to help out your heirs while youʹre

still alive.


9) If you give $14,000 as a gift to someone who is not a blood relative, you will pay taxes on these

funds and so will the recipient.


10) The federal estate tax exemption is $5.34 million per person. Recently, lawmakers ruled that the

exempted amount held by the first to die would be transferable to the surviving spouse.

Therefore, a married couple can now avoid federal estate taxes with combined assets of up to

$10.68 million even without good estate planning.


11) You are engaging in ________ when you plan for what happens to your accumulated wealth

and your dependents after you die, as well as determining decision-making authority should

you be physically or mentally impaired.

A) estate planning

B) retirement planning

C) unified planning

D) death establishment

E) None of the above is correct.

Answer: ADiff: 1Topic: Estate PlanningAACSB: Reflective Thinking

12) Which of the following is/are a typical cash need(s) of oneʹs estate?

A) Funeral expenses

B) Legal fees

C) Outstanding debt

D) Estate and inheritance taxes

E) All of the above

Answer: EDiff: 2Topic: Estate PlanningAACSB: Analytical Thinking


Chapter 16 Estate Planning: Saving Your Heirs Money and Headaches 493

13) All of the following are commonly used estate planning tools except

A) a will.

B) durable power of attorney and joint ownership of assets.

C) life insurance.

D) gifts and trusts.

E) All of the above are commonly used estate planning tools.


14) Herbert Dix picked up a booklet at his attorneyʹs office that described estate planning. All of the

following were included as primary objectives of estate planning except

A) distribute property according to your wishes and provide for your dependents.

B) develop a plan that will minimize estate and inheritance taxes.

C) develop a plan that minimizes settlement costs, including legal and accounting fees.

D) utilize a living will to describe your choices in a terminal situation and a health care proxy

to identify those to whom you relinquish health care decision-making authority in the

event of physical or mental impairment.

E) estate planning involves all of the above objectives.

Answer: EDiff: 3Topic: Estate PlanningAACSB: Reflective Thinking

15) Which of the following does not have to be paid out of your estate before distribution to your

heirs?

A) Legal fees

B) Funeral expenses

C) Outstanding debt

D) Estate and inheritance taxes

E) All of the above must be paid prior to the distribution of assets.


16) To determine your estateʹs net worth, you would

A) add the amount of your estateʹs assets to the amount of your estateʹs liabilities.

B) add the amount of your estateʹs accounts receivable to the amount of your estateʹs assets.

C) subtract the amount of your estateʹs assets from the amount of your estateʹs liabilities.

D) subtract the amount of your estateʹs liabilities from the amount of your estateʹs assets.

E) ask your lawyer the amount of your estateʹs worth and deduct it from the amount of your

estateʹs market value.

Answer: DDiff: 2Topic: Estate PlanningAACSB: Analytical Thinking



17) The process of determining what your heirs will receive from your estate occurs in which step of

the estate planning process?

A) Step 1 B) Step 2 C) Step 3 D) Step 4 E) Step 5

Answer: BDiff: 1Topic: Estate PlanningAACSB: Analytical Thinking

18) You and your spouse wish to give each of your three grandchildren a yearly tax-free gift from

your estate. If you give each of your three grandchildren the maximum amount allowed by law,

what is the total amount that you as a couple would pay out in gifts in 2014?

A) $14,000 per year B) $42,000 per year

C) $54,000 per year D) $84,000 per year


19) The U.S. tax code allows ________ to transfer the entire estate to the survivor tax -free, assuming

the recipient is a U.S. citizen.

A) a generation-skipping clause

B) gift taxes

C) a common disaster clause

D) tenancy in common

E) an unlimited marital deduction

Answer: EDiff: 2Topic: TaxesAACSB: Diverse and Multicultural Work Environments

20) What does the generation skipping tax do?

A) It imposed additional tax on gifts and bequests that are made from grandparent to

grandchild.

B) It allows grandparents to skip paying taxes on funds gifted to grandchildren.

C) It encourages parents to skip leaving funds to their own children and to plan on leaving

their estate to their grandchildren.

D) All of the above





21) Your estate tax burden can be reduced by giving gifts to your heirs prior to your death. This has

the effect of reducing the value of your estate and thus lowering your tax obligation. As of 2011,

each spouse can give up to $________ each year to ________.

A) 7,000; 2 people

B) 8,000; 3 people

C) 9,000; 4 people

D) 10,000; 5 people

E) 14,000; as many people as you like

Answer: EDiff: 2Topic: TaxesAACSB: Analytical Thinking

22) A married couple with 2 children and 5 grandchildren has an estate valued at $4 million. They

decide to use gifts as a means to transfer some of their wealth to their family now and lower the

value of their estate. If for a five-year period the couple give the maximum tax-free gift to each

of their children and grandchildren, the value of their estate would be reduced to

A) $84,000. B) $420,000. C) $3,090,000. D) $3,916,000.


23) The unified tax credit

A) Allows individuals to give $14,000 tax-free each year to as many people as they like.

B) Ensures that almost half of any amount that you pass on beyond the first $3.5 million of an

estate will be lost in taxes.

C) Lets money be passed down from a grandparent to a grandchild tax-free.

D) Essentially nullifies the taxes on the first $5.34 million of an estate.


24) Provide some common sense approaches to estate planning.

Answer: Begin today by writing a will. Value your estate and determine if any of your children

have special needs. Approach a professional for assistance do not make out your own

will or plan your own estate. Make sure your family knows where your estate planning

documents are.Diff: 2Topic: Estate PlanningAACSB: Reflective Thinking



25) What steps would you take in the estate planning process?

Answer: 1. Determine what your estate is worth.

2. Choose your heirs, determine their needs, and decide what they receive.

3. Determine the cash needs of the estate.

4. Select and implement your estate planning techniques.Diff: 1Topic: Estate PlanningAACSB: Reflective Thinking

26) Describe the typical funeral and administrative expenses.

Answer: Typical funeral expenses include burial costs, a burial plot, and any cost of future care of

the burial plot. Typical estate administrative expenses consist of court costs, executorʹs

fees, attorneyʹs fees, accountantʹs fees, and appraiserʹs fees.Diff: 1Topic: Estate PlanningAACSB: Analytical Thinking

27) How can you use the unlimited marital deduction to your advantage?

Answer: There is no limit to the size of transfers between spouses that can be made on a tax -free

basis. Also, there is no limit on the value of an estate that can be transferred to a spouse.

As a result, all federal taxes can be avoided. But, if the estate is large, lots of planning

needs to be done to prepare for when the second spouse dies to avoid or reduce the taxes.

In fact, using the unlimited marital deduction may incur more estate taxes, as opposed to

sheltering part of the estate from taxation upon the death of the first spouse.

The unlimited marital deduction does not apply to non-citizen spouses. Transfers to

non-citizen spouses are limited to the estate and tax-free transfer exemption for the year

($5.34 million in 2014) With specialized estate planning, a trust can be used to reduce or

avoid taxation on marital estate transfers to non-citizen spouses.Diff: 3Topic: TaxesAACSB: Reflective Thinking

28) Outline the steps in calculating estate taxes.

Answer: 1. Calculate the value of the gross estate.

2. Calculate the taxable estate.

3. Calculate the gift-adjusted taxable estate.

4. Calculate the estate taxes.Diff: 1Topic: TaxesAACSB: Information Technology

16.2 Wills

1) A living will allows you to state your wishes regarding medical treatment in the event of an

illness or injury that renders you unable to make decisions regarding your health care.

Answer: TRUEDiff: 1Topic: WillAACSB: Information Technology



2) An attestation and witness clause is an attachment to a will that alters or amends a portion of

the will signed in front of two witnesses.

Answer: FALSEDiff: 1Topic: WillAACSB: Information Technology

3) The introductory statement of a will identifies whose will it is and revokes any prior wills.


4) A will is a legal document that describes how you want your property to be transferred to

others.


5) The executor is the individual who is responsible for carrying out the provisions of your will.

Answer: TRUEDiff: 1Topic: ExecutorAACSB: Information Technology

6) Probate is the legal process of distributing an estateʹs assets.

Answer: TRUEDiff: 1Topic: ProbateAACSB: Information Technology

7) Individuals to whom you have willed your property are known as executors.

Answer: FALSEDiff: 3Topic: WillAACSB: Information Technology

8) The main purpose of probate is to make sure the beneficiaries are treated equally.

Answer: FALSEDiff: 3Topic: ProbateAACSB: Reflective Thinking

9) A will created by an attorney cannot be contested.

Answer: FALSEDiff: 3Topic: WillAACSB: Analytical Thinking



10) A will can be amended by a codicil for relatively minor changes.


11) A durable power of attorney means that the attorney who wrote the will for you is your legal

guardian in case you become incapacitated and canʹt make decisions yourself.

Answer: FALSEDiff: 3Topic: Power of AttorneyAACSB: Information Technology

12) A living will is a directive to a physician that allows you to state your wishes regarding medical

treatment in the event you are unable to make decisions for yourself.


13) We may prepare a ________ to appoint someone to legally act on our behalf in the event we

become mentally incapacitated and a ________ to state our wishes in the event of a terminal

illness or injury.

A) living will; common disaster clause

B) durable power of attorney; living will

C) last letter of instruction; living will

D) living will; durable power of attorney

E) durable power of attorney; last letter of instruction

Answer: BDiff: 2Topic: Power of AttorneyAACSB: Information Technology

14) The individual you name who will care for your minor aged children is known as their

A) executor.

B) beneficiary.

C) guardian.

D) personal representative.


Answer: CDiff: 3Topic: WillAACSB: Analytical Thinking



15) Ingrid is single with no dependents. She has been in the hospital with a coma for the last 2

weeks. Her bills are piling up and her rent on her apartment is due. Who is legally empowered

to take care of her banking and bill paying while she is incapacitated?

A) Whoever is named as her executor

B) Whoever is named in her living will

C) Whoever is named in her durable power of attorney

D) Whoever is named in her durable health care power of attorney

Answer: CDiff: 3Topic: Power of AttorneyAACSB: Reflective Thinking

16) Because Toby and Jennyʹs children are under the age of 18 they should name a ________ to care

for them and manage their property should Toby and Jenny pass away.

A) juvenile attorney

B) guardian

C) proxy

D) godparent


Answer: BDiff: 1Topic: GuardianAACSB: Reflective Thinking

17) An attachment to a will that alters or amends a portion of the will is called a

A) proxy.

B) codicil.

C) letter of last instructions.

D) revocation.


Answer: BDiff: 1Topic: WillAACSB: Information Technology

18) Someone who receives assets or money from a person after death is called the deceasedʹs

A) receptor.

B) receptee.

C) obtainee.

D) beneficiary.


Answer: DDiff: 1Topic: BeneficiaryAACSB: Information Technology



19) An individual who is responsible for carrying out the provisions of your will and managing

your property until the estate is passed on to your heirs is called the

A) attorney.

B) lease.

C) executor.

D) receptor.


Answer: CDiff: 1Topic: ExecutorAACSB: Information Technology

20) What is/are advantage(s) to establishing a trust?

A) Trusts bypass probate.

B) Trusts can ensure that children from a previous marriage will receive some inheritance.

C) Trusts can be used to shelter assets from estate taxes.

D) A trust does not become a matter of public record, so it offers confidentiality.

E) All of the above are advantages to using a trust.

Answer: EDiff: 3Topic: TrustAACSB: Analytical Thinking

21) A trust that gives the individual establishing the trust the ability to direct income from the trust

to his or her spouse over the spouseʹs life, and then, at the spouseʹs death, to choose to whom

the assets go is called a

A) sprinkling trust.

B) Q-TIP.

C) A-B trust.

D) credit-shelter trust.

E) unified credit trust.

Answer: BDiff: 3Topic: TrustAACSB: Analytical Thinking

22) Alfred has appointed an executor in his will. This person will be responsible for

A) carrying out Alfredʹs wishes.

B) acting under the durable power of attorney.

C) managing Alfredʹs property until the estate is passed on to the heirs.

D) acting under the durable health care power of attorney.

E) both A and C.

Answer: EDiff: 3Topic: ExecutorAACSB: Analytical Thinking



23) John Kennedy Jr. and his wife Caroline both perished in the same plane crash. Which of the

following clauses would identify who is assumed to have perished first?

A) Appointment clause

B) Common disaster clause

C) Attestation clause

D) Witness clause

E) Bimodal death clause

Answer: BDiff: 1Topic: WillAACSB: Information Technology

24) Herbertʹs will is missing the section revoking any earlier wills. A young lawyer prepared the

will and made this oversight. What dangers are present because of this omission?

A) There may be a prior conflicting will.

B) Multiple wills make a mess out of the probate process.

C) The probate process will slow down tremendously.

D) It could be many years before the heirs receive their inheritance.

E) All of the above

Answer: EDiff: 3Topic: WillAACSB: Analytical Thinking

25) Which of the following is a requirement of a valid will?

A) You must be mentally competent when the will is written.

B) You canʹt be under undue influence of another person.

C) Your will must conform to the laws of the state.

D) All of the above

E) Only A and B

Answer: DDiff: 3Topic: WillAACSB: Analytical Thinking

26) The ________ allows for the distribution of money and property in a will.

A) attestation and witness clause

B) payment of debt and taxes clause

C) common disaster clause

D) disposition of property clause

E) introductory statement

Answer: DDiff: 2Topic: WillAACSB: Information Technology



27) You were almost killed in a recent mountain bike accident and have decided to write a will. You

also plan to construct a(n) ________, which will give information and directions with respect to

the execution of your will.

A) codicil

B) letter of last instructions

C) living trust

D) appointment clause

E) attestation and witness clause

Answer: BDiff: 2Topic: WillAACSB: Analytical Thinking

28) Carey is a widow with two teenagers, Brenda age 13 and Terry age 15. Her health has declined

and she knows that a will should be drafted. Which of the following statements is not an

important reason to have a will?

A) Without a will the court will choose Brendaʹs and Terryʹs guardian(s).

B) Without a will the court will appoint an administrator for the estate.

C) The childrenʹs best interests may not be served without a will.

D) Without a will, the estate administration fees may cost more, thus leaving less to heirs.

E) All of the above are reasons Carey should have a will.

Answer: EDiff: 3Topic: WillAACSB: Reflective Thinking

29) All of the following features are common to a basic will except

A) introductory statement.

B) payment of debt and taxes clause.

C) disposition of property clause.

D) establishment of a trust.

E) appointment clause.

Answer: DDiff: 3Topic: WillAACSB: Analytical Thinking

30) Within Herbertʹs will he designates ________ who are willed his property, an ________ who will

be responsible for carrying out the provisions of the will, and a(n) ________ who will care for

any of his children under age ________.

A) trustees; attorney; executor; 18

B) heirs; executor; nanny; 16

C) beneficiaries; executor; guardian; 18

D) heirs; attorney; guardian; 16

E) heirs; attorney; guardian; 21

Answer: CDiff: 3Topic: BeneficiaryAACSB: Analytical Thinking



31) What should you do once your will has been drawn up?

Answer: Signing the will in the presence of witnesses should follow drawing up a will. Keep it

stored in a safe place. Periodically review and update it.Diff: 1Topic: WillAACSB: Reflective Thinking

32) Provide a description of the basic features and clauses found in a will. What might invalidate

your will?

Answer: The introductory statement identifies that it is your will and revokes all prior wills. You

want to direct the payment of any debts, dying and funeral expenses, and taxes. Allow

for the disposition of money and property to those who should get it and in what

amount. Appoint the executor of the estate and the guardian of any children under age

18. Identify which spouse is assumed to have died first in the event of a common disaster.

Date and validate the will by signing in the presence of two or more witnesses; that is,

incorporate an attestation and witness clause.

A will could be invalidated under the following circumstances:

· evidence suggesting lack of mental competence when the will was written

· evidence of undue influence, or pressure, on the individual to write the will with

certain provisions

· provisions in the will that do not comply with state lawDiff: 3Topic: WillAACSB: Reflective Thinking

33) Give five good reasons to have a will.

Answer: 1. to have control over the guardianship of your children and their property

2. to take care of any children with special needs

3. to transfer property that is not co-owned or in trusts according to your wishes

4. to make special gifts and bequests and arrangements for pets

5. to select an administrator of your choice who will execute the will according to your

wishesDiff: 1Topic: WillAACSB: Analytical Thinking

16.3 Avoiding Probate

1) A qualified terminable interest property trust gives the individual establishing the trust the

ability to direct income from the trust to his or her spouse over the spouseʹs life, and then, at the

spouseʹs death, to choose to whom the assets go.

Answer: TRUEDiff: 1Topic: TrustAACSB: Analytical Thinking



2) A trust is created when a grantor transfers property to a trustee for the benefit of one or more

people.


3) Under joint tenancy with the right of survivorship, two or more individuals share ownership of

the assets; when one of the owners dies that ownerʹs share of the assets becomes part of the

deceasedʹs estate and is distributed according to the deceasedʹs will.

Answer: FALSEDiff: 2Topic: OwnershipAACSB: Analytical Thinking

4) Through joint tenancy in common, George was able to transfer his share of his assets in a

company he owns with his best friend to his son instead of to his best friend.

Answer: TRUEDiff: 3Topic: OwnershipAACSB: Analytical Thinking

5) For most married couples, tenancy by the entirety is the best way to establish ownership.

Answer: TRUEDiff: 3Topic: OwnershipAACSB: Analytical Thinking

6) If you have children from a previous marriage and you get remarried and own property jointly

with your new spouse, then tenancy by the entirety should be sufficient for you if you wish

your children to inherit your property.


7) In most states, community property is recognized and trumps any allocations in your will.


8) Giving assets away as a gift reduces the value of your estate and allows you to help your heirs

while youʹre still alive.




9) Trusts are much more difficult to challenge in court than are wills which is what makes them

more attractive.


10) If a family has young children, or there are children from a previous marriage, then a trust is

probably the best way to go for estate planning.


11) A durable health care power of attorney allows you to designate another person to make life

support decisions if you are unable to.


12) If you die without one, your state will ʺwrite one for youʺ based on intestacy laws.

Answer: TRUEDiff: 2Topic: WillAACSB: Analytical Thinking

13) One in 10 American adults who do not have any elements of an estate plan in place say that

they havenʹt created a plan because they donʹt want to think about dying or becoming

incapacitated.

Answer: FALSEDiff: 3Topic: Estate PlanningAACSB: Analytical Thinking

14) The purpose of a ________ trust is to reduce estate tax liability when one spouse predeceases the

other.

A) sprinkling B) family C) Q-TIP D) revocable

Answer: BDiff: 1Topic: TrustAACSB: Information Technology



15) During the lifetime of Jack and his wife, they acquired assets individually and as members of

former marriages. During their marriage, they acquired more joint property, but his wife left all

of her estate to her children. Upon his wifeʹs death, Jack would have received the other half of

their

A) property owned as joint tenants with right of survivorship.

B) community property, if residents of a community property state.

C) property owned as tenants by the entirety.


E) only A and C.

Answer: EDiff: 3Topic: OwnershipAACSB: Analytical Thinking

16) The difference between a testamentary trust and a living trust is that a testamentary trust

A) is written by an attorney.

B) is created by a will.

C) exists only after probate.

D) is controlled by the heirs.

E) both B and C.


17) A ________ provides a directive to a physician that allows you to state your wishes regarding

medical treatment in the event of a terminal illness or injury that renders you unable to make

decisions regarding life support or other medical treatments.

A) letter of last instructions

B) revocable will

C) living will

D) termination letter


Answer: CDiff: 1Topic: WillAACSB: Information Technology

18) Madonna is a famous singer; as such, she may select to settle her estate through a trust because

of which reason(s)?

A) Trusts are harder to challenge.

B) Trusts reduce estate taxes.

C) Trusts provide confidentiality.

D) Trusts allow for professional management.

E) All of the above




19) In which kind of trust can you place your assets while still alive?

A) A revocable living trust

B) Sprinkling trust

C) An irrevocable living trust


E) Both A and C above


20) What is the name for a document that provides for someone to act in your place for legal and

financial matters in the event that you become mentally incapacitated?

A) Specific power of attorney

B) Revocable power of attorney

C) Incapacitated power of attorney

D) Durable power of attorney


Answer: DDiff: 1Topic: Power of AttorneyAACSB: Analytical Thinking

21) What methods exist to avoid probate, or to establish non-probate property?

A) Gifts

B) Trusts

C) Contracts like life insurance and retirement plans

D) Joint ownership

E) All of the above

Answer: EDiff: 2Topic: ProbateAACSB: Analytical Thinking

22) You know that the advantages of having a will likely outweigh the disadvantages associated

with probate. Which is not a disadvantage of probate?

A) Legal fees and court costs must be paid.

B) The will is validated.

C) There are typically executor fees for settling the estate (unless the executor is a family

member who chooses only to be reimbursed for expenses).

D) Costs of probate can equal 1 to 8 percent of the value of the estate.

E) The process may be slow, particularly if someone challenges the will.

Answer: BDiff: 2Topic: ProbateAACSB: Analytical Thinking



23) A ________ is a trust that distributes income according to need, as determined by the discretion

of the trustee rather than according to some preset formula.

A) family trust

B) sprinkling trust

C) needs distribution trust

D) compassion trust


Answer: BDiff: 1Topic: TrustAACSB: Information Technology

24) A(n) ________ is a trust established to transfer assets to your children, while allowing the

surviving spouse access to funds in the trust, if necessary. Trust assets are distributed to the

children tax free upon the death of the surviving spouse.

A) family trust B) revocable living trust

C) irrevocable living trust D) pre-probate trust

Answer: ADiff: 1Topic: TrustAACSB: Information Technology

25) If you were to create a trust by your will, which becomes active only after you die, then you

have created a(n) ________.

A) terminal trust B) revocable living trust

C) irrevocable living trust D) testamentary trust

Answer: DDiff: 1Topic: TrustAACSB: Analytical Thinking

26) A trust in which you relinquish title and control of the assets when they are placed in the trust,

which becomes a separate legal entity, is called a(n)

A) family trust. B) revocable living trust.

C) irrevocable living trust. D) testamentary trust.

Answer: CDiff: 1Topic: TrustAACSB: Analytical Thinking

27) A legal entity in which you control the assets and can receive income, but also have the option

to leave or remove assets, is called a(n)

A) family trust. B) revocable living trust.

C) irrevocable living trust. D) testamentary trust.

Answer: BDiff: 1Topic: TrustAACSB: Analytical Thinking



28) For someone who dies intestate, or without a valid will, ________ and the applicable state laws

allow for the orderly distribution of the estate.

A) durable power of attorney

B) letter of last instructions

C) probate

D) testamentary trust

E) all of the above

Answer: CDiff: 2Topic: ProbateAACSB: Analytical Thinking

29) Which feature makes it possible for a married couple to transfer up to $10.68 million and avoid

federal estate tax, all without having to use a family trust?

A) Propaganda B) Portability C) Sustainability D) Revocable

Answer: BDiff: 2Topic: EscrowAACSB: Analytical Thinking

30) Only about ________ Americans have created a trust as part of an estate plan.

A) one out of three B) one out of five

C) five out of 10 D) eight out of 10

Answer: BDiff: 2Topic: Estate PlanningAACSB: Reflective Thinking

31) A ________ gives the individual establishing the trust the ability to direct income from the trust

to his or her spouse over the spouseʹs life, and then to whomever else the individual wants the

funds to go.

A) Q-TIP trust B) sprinkling trust

C) family trust D) living trust

Answer: ADiff: 1Topic: TrustAACSB: Analytical Thinking

32) The legal procedure that establishes the validity of a will, and then distributes the assets of the

estate including the payment of any taxes, is called

A) probate. B) verification.

C) certification hearing. D) establishment hearing.

Answer: ADiff: 1Topic: ProbateAACSB: Analytical Thinking



33) In some states, property that is acquired during a marriage is referred to as ________ and upon

the death of either spouse, his/her half is distributed according to the will, or if intestate,

according to state law.

A) ownership property

B) community property

C) marriage assets

D) common assets


Answer: BDiff: 1Topic: OwnershipAACSB: Analytical Thinking

34) Through the portable estate exemption a surviving spouseʹs exemption amount will do which of

the following?

A) Increase B) Decrease

C) Remain the same D) None of the above

Answer: ADiff: 2Topic: ProbateAACSB: Analytical Thinking

35) ________ is a type of ownership where two or more individuals share asset ownership, but the

asset is passed to the deceased ownerʹs estate and is distributed according to his or her will.

A) Survivorship tenancy

B) Ownership tenancy

C) Tenancy in common

D) Tenancy without distribution

E) Joint tenancy with the right of survivorship

Answer: CDiff: 1Topic: OwnershipAACSB: Analytical Thinking

36) The unlimited gift tax exclusion for medical or education expenses can only be gifted to which

of the following?

A) Blood relatives

B) Siblings

C) Your biological children

D) Anyone regardless to how they are related to you


Answer: DDiff: 1Topic: OwnershipAACSB: Analytical Thinking



37) ________ is a type of ownership that exists only between married couples.

A) Survivorship tenancy

B) Tenancy by the entirety

C) Common tenancy

D) Marriage tenancy

E) Conjugal tenancy


38) Under ________, ownership passes directly on to the surviving owner or owners, bypassing the

will. With ________, when one spouse dies assets become part of the deceasedʹs estate and are

distributed through the will.

A) tenancy in common, community property

B) tenancy in common, tenancy by the entirety

C) joint tenancy with the right of survivorship, tenancy in common

D) joint tenancy, the right of survivorship

E) tenancy in the entirety, uncommon tenancy

Answer: CDiff: 3Topic: OwnershipAACSB: Analytical Thinking

39) Which of the following is a disadvantage of joint ownership?

A) Jointly owned assets avoid probate.

B) It makes it legal for one party to ʺtake the money and run.ʺ

C) It discourages compromise in the case of a divorce.

D) None of the above is a disadvantage of joint ownership.

Answer: DDiff: 3Topic: OwnershipAACSB: Analytical Thinking

40) You and your roommate have decided to purchase a house together. If you want your share of

the asset to pass on to your relatives named in your will, what type of ownership should you

establish for the house?

A) Tenancy in common

B) Community property

C) Joint tenancy with the right of survivorship

D) Tenancy by the entirety

Answer: ADiff: 3Topic: OwnershipAACSB: Analytical Thinking



41) You and your brother have decided to invest in the stock market together. You will put in $5,000

each and open a single account at a brokerage. How should the ownership of this account be

established if both of you wish the other to keep all the money in the event that the other should

die?

A) Tenancy by the entirety

B) Joint tenancy with the right of survivorship

C) Tenancy in common

D) Community property


42) Identify three advantages and three disadvantages of irrevocable living trusts.

Answer: Advantages of irrevocable living trusts include:

· Assets avoid probate.

· No estate taxes are imposed on appreciation of assets when you die.

· Income earned on assets can be directed to the beneficiary, which can result in tax

savings if the beneficiary is in a lower tax bracket.

Disadvantages of irrevocable living trusts include:

· There is no control over assets in the trust

· Assets cannot be used for loan collateral.

· The cost of setting up the irrevocable trust may be more than the probate costs you are

trying to avoid.Diff: 2Topic: TrustAACSB: Analytical Thinking

43) Identify three advantages and three disadvantages of revocable living trusts.

Answer: Advantages of revocable living trusts include:

· Assets avoid probate.

· The grantor can alter the trust while living.

· Assets will be professionally managed by the trustee should you become incompetent.

Disadvantages of revocable living trusts include:

· There are no estate tax advantages.

· Assets in the trust are part of your, the grantorʹs, estate for tax purposes,.

· Assets cannot be used as collateral for a loan.Diff: 2Topic: TrustAACSB: Analytical Thinking



44) Make a list of ways to avoid probate.

Answer: 1. Establish joint ownership.

2. Give gifts.

3. Name beneficiaries in contracts.

4. Establish a trust.Diff: 1Topic: ProbateAACSB: Analytical Thinking

45) List some common reasons people use trusts.

Answer: Trusts avoid probate.

Compared to wills, trusts are much more difficult to challenge in court.

Trusts can reduce estate taxes.

Trusts allow for professional management.

Trusts provide for confidentiality.

Trusts can be used to provide for a child with special needs.

Trusts can be used to hold money until a child reaches maturity.

Trusts can ensure that children from a previous marriage will receive some inheritance.Diff: 2Topic: TrustAACSB: Analytical Thinking


Chapter 17Financial Life EventsFitting the Pieces Together

17.1 The Ingredients of Success

1) The earlier you start saving for your retirement, the easier it will be to reach your financial goals.


2) Financial goals must be reexamined periodically and adjusted to accommodate changes in your

life.


3) College graduates should be prepared to make many financial decisions during their first

decade after graduation.

Answer: TRUEDiff: 1Topic: Financial PlanningAACSB: Reflective Thinking

4) If you have good financial goals then you really donʹt need a financial plan.

Answer: FALSEDiff: 2Topic: Financial PlanningAACSB: Reflective Thinking

5) Women are more likely to have a pension than men.

Answer: FALSEDiff: 1Topic: Women and Personal FinanceAACSB: Diverse and Multicultural Work Environments

6) As a percentage, there are more elderly men living below the poverty line today than there are

elderly women living below the poverty line.

Answer: FALSEDiff: 1Topic: Women and Personal FinanceAACSB: Diverse and Multicultural Work Environments

7) Women live, on average, 7 years longer than men.

Answer: TRUEDiff: 3Topic: Women and Personal FinanceAACSB: Diverse and Multicultural Work Environments


Chapter 17 Financial Life EventsFitting the Pieces Together 515

8) It is never a good idea for both spouses to be actively involved in and aware of the familyʹs

finances. This can lead to arguments.

Answer: FALSEDiff: 1Topic: Women and Personal FinanceAACSB: Reflective Thinking

9) Roxanne began saving for retirement at age 23 when she graduated college. She wants to have

$2.3 million dollars in her retirement account when she reaches age 55. If she deposits $9,000

each year in an account earning an 11% Annual Rate of Return, will she achieve her goal in

time?

A) Yes, she will have over $2.3 million dollars in the account.

B) No, she will have less than $2.3 million dollars in the account.

Answer: BDiff: 2Topic: Time Dimension of InvestingAACSB: Analytical Thinking

10) Suppose that immediately after graduation you invested $3,000 each year for 15 years and

nothing thereafter. You earn 10% on this money. Which of the following is closest to the amount

of money you would you have on deposit when you retired in 40 years (25 years after the

deposits stopped)?

A) $47,812 B) $523,482 C) $834,295 D) $1,032,736


11) What is the importance of understanding the financial life cycle?

A) It allows you to be proactive in financial planning to prepare for your changing needs.

B) It allows you to take advantage of the time-value-of-money.

C) It helps you in achieving your long-term financial goals.



Answer: DDiff: 1Topic: Financial Life EventsAACSB: Reflective Thinking

12) At the end of each year for 25 years you deposit $365 in an account that earns 12% interest. If

instead you had begun saving earlier, and had deposited $365 in the account each year for 50

years, how much more money would you have on deposit?

A) $13,607.10 B) $157,557.18 C) $718,449.48 D) $827,339.80




13) What is a smart thing for married women to do regarding their personal financial situation?

A) Make sure their plan recognizes that women live longer than men and that half of all

marriages end in divorce.

B) Be involved in decisions regarding their husbandʹs employee benefits and retirement

plans.

C) See a financial planner about any specific concerns.



Answer: DDiff: 2Topic: Women and Personal FinanceAACSB: Reflective Thinking

14) Which of the following statistics concerning women are not true?

A) About 75% of the elderly people living in poverty are women.

B) Eighty percent of all widows who are now living in poverty were not living in poverty

while their husbands were still alive.

C) Almost half of all single elderly women get most of their income from Social Security.

D) Only 22% of women 65 and older received pension benefits, versus 29% of men, and the

median amount of the womenʹs pension income was over twice that of men.

Answer: DDiff: 3Topic: Women and Personal FinanceAACSB: Diverse and Multicultural Work Environments

15) Why is it more difficult for women to plan for their retirement than it is for men?

A) On average, men die younger than women.

B) Women generally earn less income and pay less into Social Security than men do.

C) Women rely on defined-benefit plans more than men do.



Answer: EDiff: 3Topic: Women and Personal FinanceAACSB: Information Technology



16) List the 10 ʹingredientsʹ in order to succeed financially.

Answer: - Evaluate your financial health.

- Plan and budget.

- Manage your cash and credit.

- Control your debt.

- Make knowledgeable consumer decisions.

- Have adequate health, life, property, and liability insurance.

- Understand investing principles.

- Make investment decisions that reflect your goals.

- Plan for retirement.

- Plan for what happens to your accumulated wealth and your dependents after

you die.Diff: 2Topic: Financial PlanningAACSB: Reflective Thinking

17) According to ʺStep 1: Manage Your Life,ʺ what are the two things that, if not eliminated, might

jeopardize your future?

Answer: Delete Any Eyebrow-Raising Photos from Facebook and Other Social Media. Because

potential employers will look at Twitter, Instagram, Facebook, and other social media,

photos of you drinking or having fun on spring break must go.

Eliminate FEAR! Donʹt Be Afraid to Invest in Yourself. In a way, your largest financial

asset is your ʺhuman capital.ʺ Youʹll most likely hold several jobs over your lifetime, so

make sure your skill set grows over time.Diff: 2Topic: Financial ChallengesAACSB: Reflective Thinking

18) Why is it important for someone twenty five years old to start planning for retirement?

Answer: When you are young your best friend is time. With the time-value-of-money working

for you, you can start saving a relatively small amount of money when you are young

and accumulate a fairly large amount of money by the time you retire. If you wait until

later in life to start saving for retirement, you would need to save a dramatically larger

amount to even come close to the younger saver. This represents an opportunity cost of a

lower standard of living for the older saver. Starting early, consistently investing in the

stock market, and taking advantage of the tax deferred retirement accounts is the

smartest thing a young person can do.Diff: 2Topic: Time Value of MoneyAACSB: Reflective Thinking



19) Why is it more challenging for women to become financially security?

Answer: Because the woman stereotypically has responsibility to raise the children, this may

interfere with their careers meaning they may earn less money and contribute less money

to their own retirement accounts, especially when they are younger. Statistically, women

live longer than men so they are most likely to end up alone. Because they live longer

they run out of retirement monies and rely on Social Security only. Many times they

relied on their husbands to handle the family finances and they are naive as to what to do

financially.Diff: 3Topic: Women and Personal FinanceAACSB: Reflective Thinking

17.2 Financial Life Events

1) When you get married it is a good time to evaluate your and your spouseʹs financial goals and

come up with a set of joint financial goals.


2) Given the current divorce rate in the country if one spouse has good credit established, then it is

equally important for the other spouse to establish credit in his or her own name.

Answer: TRUEDiff: 2Topic: Financial Life EventsAACSB: Analytical Thinking

3) For a married couple with opposite spending habits, one checking account for the family is the

ideal strategy.

Answer: FALSEDiff: 2Topic: Financial Life EventsAACSB: Reflective Thinking

4) In spite of the fact that many younger couples have high living expenses at first, itʹs is still

vitally important to start a savings plan.


5) Tracking your spending for a month or so will help you plan savings.

Answer: TRUEDiff: 2Topic: Pay Yourself FirstAACSB: Analytical Thinking



6) Couples should have many conversations about their views on family finances prior to

becoming engaged or married.


7) When you get married, by law you must have joint credit card accounts instead of individual

accounts.

Answer: FALSEDiff: 2Topic: Financial Life EventsAACSB: Analytical Thinking

8) One of the first things a newly married couple should do is update their financial records and

consider making each other the beneficiary on their financial accounts.


9) Your spouseʹs credit score may have a positive or negative impact on your ability to acquire a

mortgage together.


10) Insurance planning becomes much more important when a person gets married.

Answer: TRUEDiff: 2Topic: Financial Life EventsAACSB: Diverse and Multicultural Work Environments

11) Estate planning is much less important for married people than for single people.

Answer: FALSEDiff: 2Topic: Financial Life EventsAACSB: Diverse and Multicultural Work Environments

12) Your tax status and the tax-advantaged benefits and opportunities afforded you by your

employer may change as a result of your marriage.

Answer: TRUEDiff: 3Topic: Financial Life EventsAACSB: Diverse and Multicultural Work Environments



13) If you and your spouse have different money management styles, it may be wise to maintain

separate checking accounts.


14) According to U.S. News and World Reports, the required investment for a medium income family

to raise and support a child for 22 years is approximately

A) $52,000

B) $197,704

C) $1,000,000

D) $1,450,000

E) $3,000,000

Answer: DDiff: 1Topic: Financial Life EventsAACSB: Analytical Thinking

15) What is a reason that your textbook suggests as to why a newly married couple would want to

establish separate checking accounts?

A) It makes record keeping much easier.

B) It is preferable if the couple has incompatible money management styles.

C) One always gets a better deal from the bank on two accounts versus one account.

D) All of the above


Answer: BDiff: 1Topic: Financial Life EventsAACSB: Reflective Thinking

16) According to your textbook, which is a typical financial event that recent graduates may face

during their first decade out of college?

A) Buying a car

B) Establishing credit

C) Paying taxes

D) Repaying student loans

E) All of the above

Answer: EDiff: 1Topic: Financial Life EventsAACSB: Diverse and Multicultural Work Environments



17) Part of life event number 1, getting started, is laying the groundwork for your financial goals.

Which of the following is part of laying the groundwork?

A) Establishing a budget

B) Checking your credit score

C) Establishing an emergency fund




18) Part of the getting started stage is to begin saving for your goals. What are the critical steps to

doing so?

A) Make savings automatic.

B) Live within your means.

C) Catch your matches.




19) What challenges to personal financial planning does marriage present?

A) Setting common goals

B) Establishing a common household budget

C) Asset ownership and estate planning




20) List the main ʺlife eventsʺ as discussed in your textbook.

Answer: 1. Getting started

2. Marriage

3. Buying a home

4. Having children

5. Inheritance, bonuses, or unexpected money

6. A major illness

7. Caring for an elderly parent

8. Retiring

9. Death of a spouse

10. DivorceDiff: 1Topic: Financial Life EventsAACSB: Reflective Thinking



21) Discuss what is involved in Life Event 1: Getting started.

Answer: Before you can begin your lifeʹs journey, you need to figure out where you are now.

Creating an income statement and balance sheet is essential in determining your financial

health and establishing a realistic budget. You must establish an emergency fund and

have adequate insurance in place to protect your long term savings and investments

incase of an unplanned event. Establishing and maintaining strong credit is essential to

having access to affordable credit. Establishing realistic goals and creating a plan to

achieve them are next. Without a plan in place, the odds of achieving your goals are low.Diff: 3Topic: Financial Life EventsAACSB: Reflective Thinking

22) Why is discussing personal finances with your significant other so important prior to getting

married?

Answer: Personal finances become more challenging when their are two people involved.

Financial stress can lead to an unhappy marriage and divorce. Understanding each

otherʹs perspectives and habits before you get into the marriage may help to prevent any

future problems before they arise.

Their income, debt, saving and spending habits need to be known so that you can work

together to establish common financial goals, budgets and priorities in life. If you cant

effectively communicate with each other over these issues before you get married then

heaven help you afterwards!Diff: 3Topic: Financial Life EventsAACSB: Reflective Thinking

23) Buying a home is one of the smartest investments you can make. What are the proper steps

necessary to make sure you do it right?

Answer: Part of financial planning is looking into the future for threats or opportunities that may

arise. Saving up the largest downpayment you can afford may take several years of

planning and budgeting. Establishing or repairing good, strong credit may also take

several years to allow you to get approved for affordable financing. Using the 28/36 rule

to help you understand the impact of other debt payments like car and student loans will

help you to properly manage and or eliminate some non-mortgage debt before you

purchase the home. Becoming aware of the tax implications associated with owning a

home in your State is also beneficial.Diff: 3Topic: Financial Life EventsAACSB: Analytical Thinking



24) How should a family plan for having children from a personal financial perspective?

Answer: By being proactive, a family can plan for children financially making less of a financial

impact and stress upon the birth of the children. For a typical newlywed younger couple,

they may have car loans, student loans and credit card debt from being single. A good

goal would be to pay off as much of this debt prior to having a family. If they also plan on

buying a home, possibly the increased expenses from owning a home and having

children might be more than they can handle. Delaying one of these major decisions until

they have paid off debt, increased their savings or both might be a good idea. Being

properly insured is a must before the pregnancy and making sure their health coverage

includes pregnancy expenses is key.Diff: 3Topic: Financial Life EventsAACSB: Reflective Thinking

25) How can someone plan for a major illness?

Answer: Part of financial planning is being prepared for the unplanned events that occur to most

of us sooner or later. Sound budgeting to make sure we have enough in an emergency

fund to meet the liquidity ratios from chapter two is essential. Keeping our debt ratios

under 15% gives us options and flexibility in case something bad happens and we lose

some income. Being properly insured before we develop a pre-existing condition is

vitally important. You canʹt avoid a catastrophe but you can be proactive in managing

and lessening itʹs financial impact.Diff: 3Topic: Financial Life EventsAACSB: Reflective Thinking

26) How can someone plan for a divorce?

Answer: Hopefully you will only marry once and forever but the odds are not in your favor,

unfortunately. It is critically important for both spouses to be actively involved in and

aware of the financial decisions for the family. Maintaining your own personal credit

during your marriage is essential. Making sure that the joint assets are titled properly also

protects you from possible harm in case of divorce. Maintain your own checking and

savings accounts and use a joint account for joint expenses makes sense and protects you

from the other spouse having access without your knowledge. Use joint credit sparingly

and limit your debt limits accordingly. Try to maintain communications and civility

during the divorce to limit attorney fees. Make sure insurance needs are met and change

beneficiary designations accordingly. If you are awarded alimony or child support

payments, make sure the judge requires the payor to have adequate life insurance

coverage where you are the policy owner and beneficiary.Diff: 3Topic: Financial Life EventsAACSB: Reflective Thinking

17.3 The Keys to Success: A Dozen Decisions

1) Medical insurance can keep medical expenses from becoming a catastrophic financial event.

Answer: TRUEDiff: 1Topic: 12 Keys to SuccessAACSB: Diverse and Multicultural Work Environments



2) Opening a 529 plan for yourself near the end of your career is a good means to save for your

retirement.

Answer: FALSEDiff: 1Topic: 12 Keys to SuccessAACSB: Diverse and Multicultural Work Environments

3) It is a good idea to pay all your bills first and then determine how much to save with what is left

over.

Answer: FALSEDiff: 1Topic: 12 Keys to SuccessAACSB: Analytical Thinking

4) Understanding key personal finance topics can prevent you from being a victim to fraud and

self-interested behaviors of sales people and financial advisors.


5) Procrastination is the enemy of the power of compounding.

Answer: TRUEDiff: 1Topic: 12 Keys to SuccessAACSB: Reflective Thinking

6) Living below your means leads to a harsh, barren lifestyle with little or no pleasure in life.

Answer: FALSEDiff: 1Topic: 12 Keys to SuccessAACSB: Reflective Thinking

7) Living below your means deals with buying what you need versus buying what you want.

Answer: TRUEDiff: 2Topic: 12 Keys to SuccessAACSB: Analytical Thinking

8) A budget is essential for a recent college graduate with no dependents.


9) The key to keeping the cost of home and auto insurance down is to keep your deductibles as

high as you can afford.




10) Carrying debt today is limiting your financial options in the future.


11) The best investment advice for younger people is to be conservative and avoid risk.


12) Only people 40 years or older should max out their retirement contributions at work.


13) Your potential income sources should be evaluated prior to having children.


14) On average, married men earn 26% more money than unmarried men.


15) Which of the following statements is correct?

A) You should spend less than you earn and budget your money.

B) You should know the costs of borrowing.

C) You should understand the difference between good and bad debt.

D) You should make sure that you can repay what you borrow.

E) All of the above statements are correct.

Answer: EDiff: 1Topic: 12 Keys to SuccessAACSB: Reflective Thinking

16) According to your text, which of the following is true regarding employment in todayʹs world?

A) Your history with the company is all that matters.

B) Working at a company for many years ensures that you will keep your job.

C) Reinventing and upgrading your skills is a necessity in todayʹs business world.

D) None of the above.

Answer: CDiff: 1Topic: Financial Life EventsAACSB: Diverse and Multicultural Work Environments



17) According to your text, is it recommended that couples have a joint credit card or not?

A) No, it is best for couples to have their own credit cards.

B) Yes, it is important for couples to have joint credit cards.

Answer: ADiff: 1Topic: 12 Keys to SuccessAACSB: Reflective Thinking

18) Which of the following is not true regarding investing in stocks?

A) They are risky, but not as risky as not investing in them.

B) Mutual funds are an easy way to invest in stocks and diversify.

C) You should let asset allocation decisions be guided by your time horizon.

D) You should review the time dimension of investing.

E) All of the above are true statements.

Answer: EDiff: 1Topic: 12 Keys to SuccessAACSB: Analytical Thinking

19) Which of the following does a budget help you accomplish?

A) It allows you to not think about what you spend money on.

B) It allows you to live above your means.

C) It forces you to use restraint.

D) All of the above


Answer: CDiff: 1Topic: 12 Keys to SuccessAACSB: Analytical Thinking

20) Which of the following is one of the ʺkeys to financial successʺ as outlined in Chapter 17 of your

textbook?

A) Live Below Your Means B) Hide Your Plastic

C) Realize You Arenʹt Indestructible D) All of the above

Answer: DDiff: 1Topic: 12 Keys to SuccessAACSB: Information Technology

21) Why are stocks risky, but not as risky as not investing in them?

Answer: Stocks are risky due to the ups and downs experienced both in the individual stock as

well as in the stock market in general. They are indeed risky.

They are not as risky as not investing in them for the following reasons:

1. Diversification will reduce the risk of owning individual stocks.

2. The time dimension of planning will reduce the general market risks (fluctuations).

3. You will be better able to keep ahead of inflation and taxes.Diff: 2Topic: SavingAACSB: Diverse and Multicultural Work Environments



22) Discuss why budgeting is so critical to financial success and what it forces you to do.

Answer: Budgeting is critical in allowing you to save more than you spend.

It forces you to do the following:

1. Use restraint when purchasing items or obtaining/using credit.

2. More carefully consider what you spend your money on.

3. Live below your means.

4. Be frugal.Diff: 1Topic: BudgetAACSB: Reflective Thinking

23) What does the phrase ʺliving below your meansʺ really mean and how is it related to wealth

building?

Answer: Living below your means is simply saving money by spending less than you earn.

This is related to wealth building in that, by practicing this method of living, you are

getting out of the trap or tendency that many people have of spending to their level of

earning (or beyond). It allows you to be realistic with respect to what you can really

afford.Diff: 2Topic: SavingAACSB: Reflective Thinking

17.4 Tying Things Together: Debt and the Real World

1) There are always positive things you can do to change your credit score so it is worth the time to

try and manage it.


2) The interest on your mortgage is generally tax deductible and this tax benefit should be

considered when determining which type of debt you should use.


3) According to the Keown book, in 2014, the average interest rate on a credit card was around 15.6

percent–expensive borrowing, to be sure.

Answer: TRUEDiff: 2Topic: DebtAACSB: Reflective Thinking



4) At the beginning of 2014, according to CreditCards.com and Cardweb.com, the average credit

card debt per household with at least one credit card was $15,279, up from $2,985 in 1990.

Answer: TRUEDiff: 3Topic: DebtAACSB: Information Technology

5) Studies show that there is an inverse relationship between education and playing the lottery,

with 54 percent of lottery players earning less than $40,000.

Answer: TRUEDiff: 2Topic: Financial ChallengesAACSB: Reflective Thinking

6) Which of the following is considered to be a key element to effective debt management?

A) Know and understand the costs of debt.

B) Complete a budget: always spend more than you earn.

C) Take the largest possible loan you can obtain.

D) Accept credit whenever it is offered.


Answer: ADiff: 1Topic: DebtAACSB: Diverse and Multicultural Work Environments

7) The debt limit ratio is

A) total monthly take-home pay divided by total monthly nonmortgage payments.

B) total monthly nonmortgage payments divided by total monthly take-home pay.

C) total monthly gross pay divided by total monthly mortgage payments.

D) total monthly mortgage payments divided by total monthly gross pay.

Answer: BDiff: 1Topic: DebtAACSB: Analytical Thinking

8) Suppose that you want to purchase a home. Your lender has told you that the standard limit for

your total debt limit ratio is ________ including your mortgage debt.

A) 24%

B) 36%

C) 38%

D) 40%


Answer: BDiff: 1Topic: DebtAACSB: Analytical Thinking



9) Debt is being marketed to adults as much as toys are to children. What are some of the results of

this?

A) People are encouraged to borrow more than they should.

B) Almost 60% of those aged 30 and under do not pay off their credit card bills every month.

C) Students are limited in their capacity to obtain debt.

D) All of the above

E) Only A and B


10) According to the Keown book, the average student debt is more than ________. In addition,

according to a recent Fidelity survey, total student debt–including credit card debt and personal

and family loans–tops ________.

A) $9,000; $15,000 B) $19,000; $25,000

C) $29,000; $35,000 D) $39,000; $45,000

Answer: CDiff: 3Topic: Student LoanAACSB: Reflective Thinking

11) Discuss the results of having debt marketed to adults the same way toys are marketed to

children.

Answer: 1. Students and those with little capacity to repay are being given the opportunity to

increase debts at will. Many students only need a college ID to obtain a credit card. These

cards typically come with all types of free goodies to entice application.

2. People are encouraged to borrow more than they should. Borrowing is becoming part

of our culture. In a recent survey of those aged 30 and under, almost 60 percent do not

pay off their credit card bills every month. For those over 60, it falls to less than 15

percent.

3. Bankruptcies have reached an all-time high. Debt as a percent of disposable income

has nearly doubled over the last 40 years. In 1997 was the first year where over 1 million

Americans filed for bankruptcy.Diff: 2Topic: DebtAACSB: Diverse and Multicultural Work Environments

12) Discuss why it is important to keep a clean credit record.

Answer: 1. It provides a source of funds that might not otherwise be available in the case of an

emergency or crisis. You might lose your job or become ill.

2. It can significantly hurt you in getting a car loan, an apartment, and even a job.

3. It significantly affects the rate that you pay when you borrow money. Rates can be up

to six percent higher on mortgage rates for those with poor credit.Diff: 2Topic: DebtAACSB: Reflective Thinking



13) List the six keys to successful debt management.

Answer: 1. Budget and spend less than you earn.

2. Know the costs.

3. Understand the difference between good and bad debt.

4. Make sure you can repay what you borrow; set your own standards.

5. Keep a clean credit record; it is a source of emergency money.

6. Do not live with bad (and expensive) debt.Diff: 1Topic: DebtAACSB: Information Technology


Test Bank to Accompany Personal Finance: Turning Money into Wealth, 7e

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