Personal Finance, 2nd Edition Test Bank by Ace Test Banks

Personal Finance, 2nd Edition

Vickie L. Bajtelsmit

Chapter 1 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 47 questions. 46 Multiple Choice | 1 Multiple Select LO 1.1

17%

LO 1.2

30%

LO 1.3

11%

LO 1.4

17%

LO 1.5

26%

Easy

13%

Medium

85%

Hard

Knowledge

13%

Comprehensive

38%

Application

36%

Analysis

13%

Calculations Percentage Change Calculation

#14

Percentage Change Calculation (with distractor)

#15

Percentage Change Calculation (multiple yrs.)

#16

Annual Percentage Change Calculation

#17

Fee Calculation

#34

Opportunity Cost Calculation

#40

1. Personal finance is a specialized area of study that focuses A) exclusively on investments and retirement planning. B) on financial management, household budgets, and investments. C) exclusively on investment management and household budgets. D) on individual and household financial decisions, such as budgeting, saving, spending, tax planning, insurance, and investments. Answer: D Solution: Personal finance is a specialized area of study that focuses on individual and household financial decisions, such as budgeting, saving, spending, tax-planning, insurance, and investments. Format: Multiple Choice Title: Test Bank 1.1 Personal Financial Planning Section: Why Study Personal Financial Planning? Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 2. Critical to the success of building a comprehensive financial plan is that you approach its creation in a logical order. The steps to success, in the correct order, are as follows: A) Secure basic needs, build and protect wealth, and establish a firm foundation. B) Secure basic needs, establish a firm foundation, and build and protect wealth. C) Build and protect wealth, establish a firm foundation, and secure basic needs. D) Establish a firm foundation, secure basic needs, and build and protect wealth. Answer: D Solution: Critical to the success of building a comprehensive financial plan is that you approach its creation in a logical order. The steps to success are: establish a firm foundation, secure basic needs, and build and protect wealth. Format: Multiple Choice Title: Test Bank 1.1 Steps to a Comprehensive Financial Plan Section: Elements of a Comprehensive Financial Plan Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 2 minutes 3. The financial planning process includes five steps. Four of the steps are listed next: • Analyze your current financial status. • Implement your financial plan. • Monitor your progress and revise your plan as needed. • Organize your financial information and set short-term and long-term goals.

What is the missing step? A) Identify and evaluate alternative strategies for meeting your goals. B) Understand the personal financial planning process. C) Acquire the necessary decision-making skills and tools. D) Build wealth and protection against emergencies. Answer: A Solution: The five steps in the financial planning process are as follows: 1. Organize your financial information and set short-term and long-term goals. 2. Analyze your current financial status. 3. Identify and evaluate alternative strategies for achieving your goals. 4. Implement your financial plan. 5. Monitor your progress and revise your plan as needed. Format: Multiple Choice Title: Test Bank 1.1 The Five Steps in the Financial Planning Process Section: The Personal Financial Planning Process Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 2 minutes 4. An effective financial plan must be adaptable to changing circumstances. Which would not be a reason to take you back to Step 1 of the financial planning process? A) Changes in economic conditions B) Birth of a child C) Purchase of life insurance D) Marriage Answer: C Solution: Many changes will occur over the course of your life. Not only will changes in your personal circumstances (a new job, marriage, and children) affect your financial planning objectives and strategies but also may changes in economic conditions necessitate a revision of your comprehensive financial plan. Thus, revising your plan takes you continually back to the beginning of the process again. Life insurance is a result of changing a financial plan. Format: Multiple Choice Title: Test Bank 1.1 Section: The Personal Financial Planning Process Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking

Expected Time to Complete: 1 minute

5. Personal financial planning does not include which of the following? A) Buying insurance B) Deciding which make and model of car to buy C) Budgeting D) Assessing attitude toward risk Answer: B Solution: Personal financial planning includes budgeting, savings, buying insurance, and assessing attitudes toward risk. While determining the cheapest form of financing and the opportunity cost associated with purchasing a car is part of financial planning, the qualitative factors involved in the make and model of a vehicle is not. Format: Multiple Choice Title: Test Bank 1.1 Personal Financial Planning Section: Why Study Personal Financial Planning? Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 6. Which is not a necessary activity in securing your basic needs? A) Making purchase and credit decisions B) Managing cash for liquidity and emergencies C) Selecting financial institutions for checking and savings accounts D) Investing to achieve long-term goals Answer: D Solution: Securing your basic needs is the second element of a comprehensive financial plan. Making purchase and credit decisions, managing cash for liquidity and emergencies, and selecting financial institutions for checking and savings accounts are all activities necessary to completing this part of your plan, not longterm investments. Format: Multiple Choice Title: Test Bank 1.1 Secure Your Basic Needs Section: Elements of a Comprehensive Financial Plan Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 7. Which is not a necessary activity in establishing a firm foundation?

A) Protecting income and wealth from losses B) Acquiring necessary decision-making skills and tools C) Understanding the personal financial planning process D) Setting short-term and long-term goals Answer: A Solution: Establishing a firm foundation is the first element of a comprehensive financial plan. Acquiring necessary decision-making skills and tools, understanding the personal financial planning process, and setting short-term and long-term goals are all activities necessary to completing this part of your plan, not insurance protection. Format: Multiple Choice Title: Test Bank 1.1 Establishing a Firm Foundation Section: Elements of a Comprehensive Financial Plan Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 8. Which is not a necessary activity in building and protecting wealth? A) Writing a will B) Investing to achieve long-term goals C) Buying property and liability insurance D) Managing cash for liquidity and emergencies Answer: D Solution: Writing a will, investing to achieve long-term goals, protecting income and wealth from losses, and buying property and liability insurance are all activities necessary to completing this part of your plan, not cash/liquidity management. Format: Multiple Choice Title: Test Bank 1.1 Build and Protect Wealth Section: Elements of a Comprehensive Financial Plan Learning Objective: 1.1 Describe the personal financial planning process, and explain how the elements of a comprehensive financial plan fit together. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 9. As you build your financial plan, you’ll need to consider the unique characteristics of your household that may influence spending and saving. Which of these factors is not unique to your household? A) Life cycle stage B) Family makeup C) Inflation and interest rates D) Values and attitudes

Answer: C Solution: Factors unique to your household are your life cycle stage, family makeup, and values and attitudes. While economic factors, such as inflation and interest rates, are important considerations for everyone who is developing and implementing financial plans. Format: Multiple Choice Title: Test Bank 1.2 Factors That Influence Financial Planning Decisions Section: Factors That Influence Financial Planning Decisions Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 10. If your ____ are larger than your _____, your wealth is negative. A) expenses; debts B) debts; assets C) assets; debts D) assets; income Answer: B Solution: If your debts are larger than your assets, your wealth is negative. Format: Multiple Choice Title: Test Bank 1.2 Life Cycle Factors Section: Individual Characteristics and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 11. A person’s fundamental beliefs concerning what is important in life are referred to as A) judgments. B) values. C) attitudes. D) opinions. Answer: B Solution: Values are fundamental beliefs about what is important in life. Format: Multiple Choice Title: Test Bank 1.2 Fundamental Beliefs Section: Individual Characteristics and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Easy

Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 12. When the consumer price index (CPI) increases, A) you can buy goods and services cheaper. B) the prices of goods and services are more expensive. C) the value of the dollar is high. D) you will earn less on your investments. Answer: B Solution: In the United States, inflation is typically measured by the change in the CPI, which is a representative basket of more than 400 goods and services used by urban households, including food, housing, consumer goods, gasoline, and clothing. When the consumer price index (CPI) increases, the prices of goods and services become more expensive. Format: Multiple Choice Title: Test Bank 1.2 CPI Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 13. As inflation _______, the spending power of money______. A) increases; increases B) decreases; decreases C) increases; decreases D) decreases; remains the same Answer: C Solution: Inflation refers to an increase in prices. As prices of goods and services go up, the spending power of your money goes down; thus, a dollar will not purchase as much as it previously did. Format: Multiple Choice Title: Test Bank 1.2 Inflation Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 14. Your salary was $32,000 in 2019. It increased to $35,000 in 2020. What was the percentage increase in your salary from 2019 to 2020?

A) 8.57% B) 9.14% C) 9.38% D) 33.5% Answer: C New value−Old value Solution: Percentage change = Old value Percentage change =

$35,000 − $32,000 = 0.0938, or 9.38% $32,000

Format: Multiple Choice Title: Test Bank 1.2 Percentage Change Calculation Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 15. Your salary was $28,000 in 2018 and $30,000 in 2019. In 2020, your salary was $34,000. What was the percentage increase in your salary from 2018 to 2020? A) 7.14% B) 11.76% C) 14.29% D) 21.43% Answer: D New value−Old value Solution: Percentage change = Old value Percentage change =

$34,000 − $28,000 = 0.2143, or 21.43% $28,000

16. Your salary increased from $20,000 to $30,000 in five years. What is the percentage increase? A) 33% B) 50% C) 100% D) 150% Answer: B New value−Old value Solution: Percentage change = Old value Percentage change =

$30,000 − $20,000 = 0.50, or 50% $20,000

Format: Multiple Choice Title: Test Bank 1.2 Percentage Change Calculation Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 17. Your salary has increased 50% in 5 years. What is the annual percentage increase? A) 8.5% B) 8.7% C) 10% D) 11.2% Answer: A 1

Solution: Annual percentage change = (1 + Percentage change)𝑁 – 1, where N = number of years. 1

Annual percentage change = (1 + 0.50)5 – 1 = 0.085, or 8.5% Format: Multiple Choice Title: Test Bank 1.2 Annual Percentage Change Calculation Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 18. The Federal Reserve often __________ the __________ rate to stimulate the economy.

A) lowers; prime B) lowers; federal funds C) raises; federal funds D) raises; prime Answer: B Solution: The Federal Reserve (commonly called the Fed) controls the money supply in the economy in order to manipulate the rate of interest. The Fed lowers the federal funds rate to stimulate the economy and raises the federal funds rate to slow down the economy. Format: Multiple Choice Title: Test Bank 1.2 Federal Funds Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 19. Why do interest rates on different types of borrowing, such as federal funds and mortgages, tend to track each other and the inflation rate? A) They are all long-term maturities. B) They are all short-term maturities. C) They are all affected similarly by economic conditions. D) They all have the same risks. Answer: C Solution: The interest rates on different types of borrowing, such as Federal Funds and mortgages, tend to track each other, and the inflation rate, because they are all affected similarly by economic conditions. Format: Multiple Choice Title: Test Bank 1.2 Interest Rates Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 20. The federal funds rate is the rate that A) banks charge customers for short-term loans. B) the Federal Reserve charges banks for short-term loans. C) banks charge each other for short-term loans. D) credit card issuers use as the teaser rate. Answer: C

Solution: The federal funds rate is the interest rate that banks charge each other for short-term loans. Format: Multiple Choice Title: Test Bank 1.2 Federal Funds Rate Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 21. An expansion is a phase in the economic cycle that is characterized by _____ business investment and ______ employment opportunities. A) decreasing; decreasing B) increasing; increasing C) decreasing; increasing D) increasing; decreasing Answer: B Solution: An expansion is the growth phase in the economic cycle that is characterized by increasing business investment and increasing employment opportunities. In times of growth and low unemployment, salaries tend to rise more quickly, and there are better opportunities for advancement. Section: The Economy and the Job Market Format: Multiple Choice Title: Test Bank 1.2 Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 22. Which of the following are parts of the economic cycle? (Select any two) A) Expansion B) Extension C) Decline D) Inflation E) Recession F) Unemployment Answer: A and E Solution: The economy experiences a pattern of ups and downs, commonly referred to as the economic cycle, or business cycle. A low point in the cycle is called a recession (or, in the extreme, a depression) and the high point is called an expansion.

Format: Multiple Select Title: Test Bank 1.2 Economic Cycles Section: Economic Factors and Your Financial Plan Learning Objective: 1.2 Describe how individual characteristics and economic factors influence personal financial planning. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 23. Which of the following is not one of the recommended SMART guidelines for personal financial goals? A) Realistic B) Attainable C) Manageable D) Specific Answer: C Solution: The key to setting effective financial goals is to make them SMART: specific, measurable, attainable, realistic, and time-specific. Format: Multiple Choice Title: Test Bank 1.3 SMART Goals Section: The Goal-Setting Process Learning Objective: 1.3 Create a prioritized list of short-term and long-term personal financial goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 24. Rosa graduated at the top of her high school class, and has set the following goal as part of her financial plan: “graduate from college with a B.S. in Business Management.” Which aspect of the SMART goal model is missing from her goal? A) The goal is not specific. B) The goal is not measurable. C) The goal is not attainable. D) The goal is not time-specific. Answer: D Solution: When you set SMART goals, it must be with specific due dates, as they are much more effective. Our natural inclination is to put off difficult tasks, so we need to set near-term and long-term targets to be sure we stay on track. Format: Multiple Choice Title: Test Bank 1.3 SMART Goal Guidelines Section: The Goal-Setting Process Learning Objective: 1.3 Create a prioritized list of short-term and long-term personal financial goals.

Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 25. Andre graduated from college this year and obtained a well-paid job with a large accounting firm. Andre has developed the following goal: “save for retirement.” This goal meets which criteria of the SMART goal model? A) Specific B) Measurable C) Time-Specific D) None Answer: D Solution: “Save for retirement” does not meet any of the criteria listed as a SMART goal. A specific goal must clearly identify what you want to achieve: how much and at what interval will you save, such as “save $400 per month until 65 years.” A measurable goal must be accounted to show progress, such as “having your monthly saving automatically deposited to a retirement saving account.” A time-specific goal must be set with specific due dates, to be effective, such as “direct-depositing $400 from your biweekly paycheck into your IRA until you reach 65 years old.” Format: Multiple Choice Title: Test Bank 1.3 Smart Goal Guidelines Section: The Goal-Setting Process Learning Objective: 1.3 Create a prioritized list of short-term and long-term personal financial goals. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 26. Your goals will differ depending on your stage in the life cycle and your family makeup. Which is not an appropriate short-term savings goal? A) Spring break vacation B) Emergency fund C) Down payment on a home D) Life insurance Answer: C Solution: Short-term goals should be reasonably accomplished within the next year, such as buying life insurance, taking a vacation, or setting aside an emergency fund. Estimating the costs of attaining the financial objectives is necessary in establishing a reasonable time frame for the respective goals. Format: Multiple Choice Title: Test Bank 1.3 Smart Goal Guidelines Section: The Goal-Setting Process Learning Objective: 1.3 Create a prioritized list of short-term and long-term personal financial goals.

Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 27. For many households, repayment of high-interest debt is an important financial goal. Using the following table, estimate the payments necessary to pay off $2,500 in credit card debt in two years at 15% APR.

A) $113 B) $121 C) $226 D) $242 Answer: B Solution:

Format: Multiple Choice Title: Test Bank 1.3 Monthly Payments Necessary to Pay Off Debt Section: The Goal-Setting Process Learning Objective: 1.3 Create a prioritized list of short-term and long-term personal financial goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 28. Financial planners must have a

A) college degree with an emphasis or major in business. B) college degree and two years of experience in finance. C) securities license from the state of federal government. D) willingness to provide financial advice. Answer: D Solution: Because virtually anyone can claim to be a financial planner, you’ll need to carefully evaluate the educational credentials and certifications of any professional you are considering hiring. Format: Multiple Choice Title: Test Bank 1.4 Financial Planners Section: Selecting Qualified Financial Planning Professionals Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 29. Which of the following should not be a major factor when choosing a personal financial planner? A) Affiliation B) Certification C) Education D) Reputation Answer: A Solution: In choosing a professional to help you with your personal finances, you should consider education, certification, experience, reputation, and fees. Format: Multiple Choice Title: Test Bank 1.4 Factors to Consider in Choosing a Planner Section: Factors to Consider in Choosing a Planner Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 30. Which of the following has passed a comprehensive examination covering all the topic areas considered necessary in the practice of consumer financial planning and has at least three years of work experience in the field? A) Accredited Financial Planner (AFC) B) Certified Public Accountant (CPA) C) Certified Financial Planner (CFP) D) Chartered Financial Consultant (ChFC)

Answer: C Solution: Planners who are Certified Financial Planners (CFP®) have passed a comprehensive examination covering all the topics considered necessary in the practice of financial planning, and they have at least three years’ work experience in the field. Format: Multiple Choice Title: Test Bank 1.4 Qualifications of Financial Planners with Certifications Section: Factors to Consider in Choosing a Planner Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 31. Integrity of the profession is essential to its long-term success. Which professional is not required to pass a comprehensive exam and adhere to a rigorous code of ethics? A) Certified Public Accountants (CPAs) B) Attorneys C) Certified Financial Planner (CFP®) D) All these professionals are required. Answer: D Solution: Because the integrity of the profession is essential to its long-term success, the Certified Financial Planner Board of Standards adheres to a stringent code of ethics to promote the highest principles and standards for certified financial planners. Similar standards are required of Certified Public Accountants (CPAs) and attorneys. Format: Multiple Choice Title: Test Bank 1.4 Professional Requirements Section: Factors to Consider in Choosing a Planner Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 32. In a __________ arrangement, the planner is compensated for every financial product sold but does not receive any payment for developing a personal financial plan. A) Fee-only B) Commission-only C) fee plus commission D) fee offset by commission Answer: B

Solution: In a commission-only arrangement, the planner receives no payment for helping you develop your financial plan or managing your portfolio but receives a commission when you buy or sell a financial product, such as mutual fund shares or an insurance policy. Format: Multiple Choice Title: Test Bank 1.4 How Are Planners Paid Section: How Are Planners Paid? Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 33. In a fee-only arrangement, the planner is typically compensated with an annual fee that is based on the A) number of financial products purchased. B) value of financial products purchased. C) number of meetings with the client. D) value of the client’s assets being managed. Answer: D Solution: In a fee-only arrangement, the planner is typically compensated with an annual fee that is based on the value of the client’s assets being managed, such as one percent per year of your investment portfolio or an hourly free for services. Format: Multiple Choice Title: Test Bank 1.4 Fee-Only Compensation Arrangement Section: How Are Planners Paid? Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 34. Dolores’s purchased 1,000 shares of the S&P 500 index (SPY) at $300 per share, inside her $1.1 million fee-only account this year. The planner’s firm charges commissions of $0.27 per share and 1% on fee-based accounts. How much does her planner charge this year? A) $270 B) $3,000 C) $11,000 D) $11,270 Answer: C Solution: Although the firm can charge both commissions and fees in a fee-based account, Dolores’ account is a fee-only account. The planner charges a

percentage fee of the assets in the respective account (1%per year of your investment portfolio). Hence, $1,100,000 × 0.01 = $11,000. Format: Multiple Choice Title: Test Bank 1.4 Fee Calculation Section: How Are Planners Paid? Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 35. Henry pays his financial planner a one percent fee based on the value of the assets in his investment account. He noticed on his year-end statement that the firm rebated a $1,200 credit to his account. His planner said that was because the firm made $1,200 in dealer concessions from an IPO that he purchased. What type of fee arrangement is this? A) Fee-based B) Fee-only C) Fee plus commission D) Fee offset by commission Answer: D Solution: In a fee offset by commission arrangement, the planner charges a fee for services, as in a fee-only arrangement, but reduces the fee if commissions are later earned on products purchased by the client. This reduces the conflict of interest inherent in the commission-only arrangement, because the planner does not make extra money by selling you the financial products. In a fee-only arrangement, the planner would be prohibited from selling any investment that includes additional compensation. Format: Multiple Select Title: Test Bank 1.4 Planner Fee Arrangements Section: How Are Planners Paid? Learning Objective: 1.4 Know when and how to find qualified financial planning professionals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 36. One of the biggest mistakes people make in their finances is that they are too _____ in their assumptions. A) specific B) optimistic C) pessimistic D) conservative Answer: B

Solution: One of the biggest mistakes people make in their finances is that they are too optimistic in their assumptions. Being able to make reasonable assumptions is a critical component of successful decision making. Format: Multiple Choice Title: Test Bank 1.5 Assumptions Used in Financial Planning Section: Make Reasonable Assumptions Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 37. If you are considering working part-time at a second job in addition to your regular one, you should only consider A) total costs and benefits of both jobs. B) total costs and benefits of each job. C) marginal costs and marginal benefits. D) marginal costs of each job and total benefits. Answer: C Solution: If you are considering working part-time at a second job in addition to your regular one, you should only consider marginal costs and marginal benefits and not the total costs and benefits of both jobs. The term “marginal” refers to the change in outcome, or the additional benefit or cost, that will result from the decision you make. In choosing between two possible jobs, you’ll consider how much extra benefit you would get from the additional job and balance that against the extra financial and human cost. Format: Multiple Choice Title: Test Bank 1.5 Apply Reasoning Section: Make Reasonable Assumptions Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Hard Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 38. You are considering adding a wood shop to your home. You enjoy woodworking and could make some items for sale. In considering this addition, you only look at the extra cost of the shop and the potential benefits of having the shop. This is an example of A) opportunity cost consideration. B) sensitivity analysis. C) marginal reasoning. D) reasonable assumptions. Answer: C

Solution: The term “marginal” refers to the change in outcome, or the additional benefit or cost, that will result from the decision you make. In applying marginal reasoning, you will consider only the additional benefits that the shop brings and not the general benefits of having the addition in the first place. In choosing the addition, you’ll consider how much extra benefit you would get from the shop and balance that against the extra financial cost and burden. Format: Multiple Choice Title: Test Bank 1.5 Apply Reasoning Section: Make Reasonable Assumptions Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 39. In deciding whether to attend graduate school full-time, estimating your lost earnings while you are in school is an example of A) marginal reasoning. B) sensitivity analysis. C) future value. D) opportunity cost. Answer: D Solution: Every financial decision you make has an opportunity cost, a measure of what you have to give up in order to take a particular action. You must decide whether the costs of attending graduate school and giving up the earnings from your job will be worth the net increase in earnings after graduation. Format: Multiple Choice Title: Test Bank 1.5 Apply Reasoning Section: Make Reasonable Assumptions Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 40. Desiree currently works as a manager of an electronics store earning an annual salary of $50,000. She noticed an internal job opening for a regional manager that pays $100,000 salary, but an MBA is required for consideration. The cost for a fulltime MBA program in two years is $60,000. What is her opportunity cost for attending graduate school, without consideration for time value of money? A) $100,000 B) $120,000 C) $160,000 D) $220,000

Answer: C Solution: $60,000 cost of MBA program + $100,000 two years of missed earnings = $160,000 Format: Multiple Choice Title: Test Bank 1.5 Opportunity Cost Calculation Section: Consider Opportunity Costs Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 41. Which type of decision maker is spontaneous and often makes “gut” decisions? A) Rational decision maker B) External decision maker C) Internal decision maker D) Intuitive decision maker Answer: D Solution: An intuitive decision maker is spontaneous and often makes “gut” decisions. Format: Multiple Choice Title: Test Bank 1.5 Decision-Making Styles Section: Decision-Making Styles Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 42. Holly is uncomfortable with change. She spends a lot of time thinking over alternatives, even for relatively inconsequential decisions. She is a typical A) agonizer. B) antagonizer. C) intuitive decision maker. D) analytical decision maker. Answer: A Solution: An agonizer puts off making decisions as long as possible, spends a lot of time thinking over alternatives, even for relatively inconsequential decisions, and is uncomfortable with change. Format: Multiple Choice Title: Test Bank 1.5 Type of Decision-Making Section: Decision-Making Styles Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions.

Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 43. You are calculating your potential return on your stock investments. If you calculate different possible returns based on assuming a variety of interest rates and stock market conditions, this is an example of A) reasonable assumptions. B) sensitivity analysis. C) marginal analysis. D) opportunity cost. Answer: B Solution: Sensitivity analysis asks the question, “What effect would it have on my personal finances if my assumptions turn out to be wrong?” By considering the outcomes under different assumptions, you can reduce the risk that your plan will have an unexpected impact on your finances. Format: Multiple Choice Title: Test Bank 1.5 Reasoning Application Section: Make Reasonable Assumptions Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 44. You have estimated that, if your investments earn 10 percent per year, you can retire at age 65. If you reestimate your retirement date assuming a lower investment return, you are using A) average reasoning. B) sensitivity analysis. C) marginal reasoning. D) opportunity cost. Answer: B Solution: Sensitivity analysis asks the question, “What effect would it have on my personal finances if my assumptions turn out to be wrong?” By reconsidering the expected investment returns, you are reducing the risk that your plan will not reach your goal. Format: Multiple Choice Title: Test Bank 1.5 Reasoning Application Section: Make Reasonable Assumptions Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium

Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 45. If you must seek advice from a number of people before making a decision, you would be considered a (an) A) rational decision maker. B) intuitive decision maker. C) external decision maker. D) internal decision maker. Answer: C Solution: External decision makers must obtain opinions and confirmation from others before making decisions, because they have trouble making decisions independently. Format: Multiple Choice Title: Test Bank 1.5 Type of Decision-Making Section: Decision-Making Styles Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 46. Which of the following is a possible negative consequence for overly rational decision makers? A) Reduced investment returns B) Difficulty staying on a budget C) Too much debt D) Avoiding professional help Answer: A Solution: If you’re an overly “rational” decision maker, you may suffer negative consequences, such as taking too long to make a decision, which can result in reduced or missed investment returns. Format: Multiple Choice Title: Test Bank 1.5 Type of Decision-Making Section: Decision-Making Styles Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes

47. Which type of decision maker is most likely to have trouble sticking to a budget and, as a result, may fall into debt? A) Rational decision maker B) External decision maker C) Intuitive decision maker D) Internal decision maker Answer: C Solution: If you’re overly spontaneous in making financial decisions, you may have trouble sticking to a budget, have too much debt, pay too much for major purchases, or incur personal costs from taking too many wrong turns in life. Format: Multiple Choice Title: Test Bank 1.5 Type of Decision-Making Section: Decision-Making Styles Learning Objective: 1.5 Consider opportunity costs and marginal effects in making personal finance decisions. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute

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Chapter 2 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 67 questions: 64 Multiple Choice | 3 Multiple Select LO 2.1 LO 2.2 LO 2.3 LO 2.4

19 22 15 11 67

28% 33% 22% 16%

Easy Medium Hard

Knowledge Comprehensive Application Analysis Evaluation Synthesis

9 24 11 19 2 2 67

13% 36% 16% 28% 3% 3%

Calculations Net Worth Calculation Net Worth (with distractors) Calculation Balance Sheet Calculation Net Cash Flow (with distractors) Calculation Liquidity ratio Calculation Liquidity ratio (multiple distractors) Calculation Debt Payment Ratio (with distractors) Calculation Savings Ratio (with distractors) Calculation Debt Ratio (with distractors) Calculation Mortgage Debt Service Ratio (with distractor) Calculation Savings Ratio (with distractor) Calculation FV Lump-sum Calculation FV Lump-sum Calculation FVA Calculation FVA Calculation FVA-due Calculation Present Value of a Lump Sum PVA Calculation PMT Calculation PVA Calculation (Evaluation of 2 scenarios) Net Worth (itemized sub-category) Calculation FVA Calculation (convert to periodic rate)

10 53 4 67

15% 79% 6%

22 15 16 17 27 30 31 32 33 35 39 41 46 47 54 55 56 58 63 65 62 18 53

1. It is recommended that tax records be kept A) 3 years, because most IRS audits occur within three years of filing a return. B) 5 years, because most IRS audits occur within five years of filing a return. C) 7 years, because most IRS audits occur within three years of filing a return. D) 7 years, because most IRS audits occur within five years of filing a return. Answer: C Solution: Any documents that support tax deductions should be filed with your tax records. Although most Internal Revenue Service (IRS) audits occur within three years of filing a return; they can also occur later, so it’s generally recommended that you keep tax records for seven years to be safe. Format: Multiple Choice Title: Test Bank 2.1 How Long Should You Keep Records Section: What Financial Records Do You Need to Keep? Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 2. Bills for utilities, telephone, car expenses, and other irregular expenses that are not tax deductible should be kept for A) one month. B) one year. C) five years. D) seven years. Answer: B Solution: Bills for utilities, telephone, car expenses, and other irregular expenses that are not tax-deductible should be kept for a full year so that you can accurately report the costs in your budget and personal cash flow statements. Format: Multiple Choice Title: Test Bank 2.1 How Long Should You Keep Records Section: What Financial Records Do You Need to Keep? Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Format: Multiple choice Section: 2.1 Learning Objective: 2.1 Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension

Expected Time to Complete: 1 minute

3. A ______ is considered more secure than a _______ because it is a locked box at a remote location, which means thieves cannot access it during a home robbery. A) safe deposit box; lockbox B) lockbox; safe deposit box C) lockbox; dropbox D) dropbox; safe deposit box Answer: A Solution: A safe deposit box is considered more secure than a lockbox in your home because it is a locked box at a remote location, such as a bank, which means thieves cannot access it during a home robbery. Format: Multiple Choice Title: Test Bank 2.1 Where Should You Keep Important Documents Section: What Financial Records Do You Need to Keep? Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Expected Time to Complete: 1 minute 4. Which of the following is an asset? A) Student loans B) Home mortgage C) Automobile D) Credit card balance Answer: C Solution: An automobile is an asset. Loans are liabilities (debt). Format: Multiple Choice Title: Test Bank 2.1 Assets Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Easy Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute

5. Which of the following information is included on a household’s personal balance sheet? (Select any two.) A) The total annual earnings B) The value of everything that the household owns C) The total annual debt payments D) The amount of all debts owed to others E) Household income F) Household expenses G) Household budget Answer: B and D Solution: A personal balance sheet is a financial statement that details the value of everything you own and subtracts what you owe to others. Format: Multiple Select Title: Test Bank 2.1 Balance Sheet Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 6. Liquid assets are A) cash or near-cash assets that can be easily converted to cash without loss of value. B) assets you can easily sell. C) assets related to water and mineral rights. D) assets that are used for investment purposes. Answer: A Solution: Liquid assets are cash and near-cash assets that can easily be converted to cash without loss of value. Checking and savings accounts are examples of liquid assets. Format: Multiple Choice Title: Test Bank 2.1 Liquid Assets Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute

7. Which of the following best defines market value? A) The price that was paid for the asset B) The price that an asset could be sold for today C) The purchase price of an asset minus depreciation D) The purchase price of an asset plus depreciation Answer: B Solution: The market value is the price you could sell an asset for today. This is usually not the same as what you paid for the asset. Format: Multiple Choice Title: Test Bank 2.1 Valuing Your Assets and Debts Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping and prepare a personal balance sheet. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute

8. If you borrow to buy a new car with a note, which of the following items on the balance sheet will be affected? A) Assets Only B) Debts Only C) Assets and Debts D) Unable to Determine Answer: C Solution: For some assets, such as your car, there may be corresponding debt that was used to purchase it. In this case, a loan was used to purchase the care. Hence, the market value in the car will be included in the asset section of your balance sheet and the loan balance in the debt section. Format: Multiple Choice Title: Test Bank 2.1 Valuing Your Assets and Debts Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 9. If you lease a new car, which of the following items on the balance sheet will be affected?

A) Assets only B) Debts only C) Assets and debts D) Unable to determine Answer: B Solution: If you lease a car, your payment obligations are a debt; but you don’t own the car, so you shouldn’t include it as an asset. Format: Multiple Choice Title: Test Bank 2.1 Valuing Your Assets and Debts Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 10. If you have an insurance policy that has a cash surrender value, A) this represents an asset for you. B) this represents a liability for you. C) no value is entered on the balance sheet unless the policy is surrendered. D) the premiums still due are subtracted from the surrender value to arrive at market value. Answer: A Solution: An insurance policy is counted as an asset only if it’s a policy that accumulates cash value over time. If you cancel an insurance policy that has a cash surrender value, the insurer will return that amount of money to you. Because this is an available source of cash to you, you should count it as an asset. Format: Multiple Choice Title: Test Bank 2.1 Valuing Your Assets and Debts Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Application AACSB: Reflective Expected Time to Complete: 1 minute 11. A _______ shows only a single point in time, whereas a ________ reflects transactions that occur over a period of time. A) personal cash flow statement; personal balance sheet

B) personal balance sheet; personal cash flow statement C) personal cash flow statement; net worth D) personal balance sheet; net worth Answer: B Solution: A personal balance sheet shows only a single point in time, whereas a personal cash flow statement reflects transactions that occur over a period of time. Format: Multiple Choice Title: Test Bank 2.1 Your Financial Condition Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Expected Time to Complete: 1 minute 12. Which assets are considered liquid assets? (Select any two.) A) Money market accounts B) Market value of automobile(s) C) Home furnishings D) Cash value of life insurance E) Individual retirement account(s) Answer: A and D Solution: Liquid assets are cash and near-cash assets that can easily be converted to cash without loss of value. Money market accounts and life insurance with cash value are examples of liquid assets. Format: Multiple Select Title: Test Bank 2.1 Liquid Assets Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

13. You purchased a car at the beginning of the year for $35,000 and you noticed a similar used car just sold for $28,000. You financed the purchased with a $30,000 auto loan and paid $5,000 from your savings. If your loan balance is currently $23,635, what is the current market value? A) $28,000 B) $28,635

C) $35,000 D) $21,635 Answer: A Solution: The market value is the price you could sell the asset for today. Since a similar used car was sold for $28,000, it represents the closest value that your car can be sold. Format: Multiple Choice Title: Test Bank 2.1 Market Value Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 14. Which of the following formulas is used to calculate personal net worth? A) Total assets + Total debts B) Total assets - Total debts C) Total debts - Total assets D) Liabilities - Unpaid bills Answer: B Solution: A personal balance sheet is a financial statement that details the value of everything you own (assets) and subtracts what you owe to others (debts) to arrive at your net worth. Format: Multiple Choice Title: Test Bank 2.1 How Much Are You Worth Today Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 15. Your assets total $100,000. Your total debts are $80,000. Your net worth is A) $20,000. B) $180,000. C) 0.8%. D) 1.2%. Answer: A

Solution: Net worth = Total assets - Total debts Net worth = $100,000 in assets - $80,000 in debts = $20,000 Format: Multiple Choice Title: Test Bank 2.1 Net Worth Calculation Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 16. What is Veronica’s net worth if her assets total $15,000, her gross income is $40,000, her student loan debt is $20,000 (she has no other debts), and her annual expenses (including taxes) total $38,000? A) $2,000 B) $5,000 C) -$5,000 D) -$18,000 Answer: C Solution: Net worth = Total assets - Total debts Net worth = $15,000 in assets - $20,000 in debts = -$5,000 Format: Multiple Choice Title: Test Bank 2.1 Net Worth Calculation Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 17. Carlos has a net worth of $450,000 and debts worth $300,000. What amount of assets does Carlos have? A) $750,000 B) $300,000 C) $150,000 D) No debt Answer: A Solution: Net worth = Total assets - Total debts $450,000 = assets - $300,000 in debts = $750,000 Format: Multiple Choice

Title: Test Bank 2.1 Balance Sheet Calculation Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 18. Jane has liquid financial assets of $25,000, real estate assets of $125,000, credit card debt of $1,000, and an $89,000 mortgage. Calculate her net worth. A) $240,000 B) $150,000 C) $90,000 D) $60,000 Answer: D Solution: Net worth = Total assets - Total debts Total Assets = $25,000 financial assets + $125,000 real estate = $150,000 Total Debts = $1,000 credit card + $89,000 mortgage = $90,000 Net worth = $150,000 in assets - $90,000 in debts = $60,000 Format: Multiple Choice Title: Test Bank 2.1 Net Worth Calculation Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 19. Insolvency occurs when a person A) has a positive net worth but is unable to pay his or her debt obligations with current income. B) has positive net worth but must sell existing assets to pay his or her debt obligations. C) is unable to pay his or her debt obligations as they come due. D) has spending exceeding income. Answer: C Solution: Insolvency is the inability to pay your debts as they come due, because your total debts exceed your total assets. Format: Multiple Choice Title: Test Bank 2.1 Insolvency

Section: Summarizing Your Financial Condition Learning Objective: 2.1 Develop a system for financial record keeping, and prepare a personal balance sheet. Difficulty: Medium Bloomcode: Comprehension AACSB: Expected Time to Complete: 1 minute 20. A financial statement used to evaluate the relationship between your income and expenditures is known as a A) personal balance sheet. B) personal cash flow statement. C) cost-benefit statement. D) liquidity statement. Answer: B Solution: A personal cash flow statement is a financial statement used to evaluate the relationship between your income and your spending. Format: Multiple Choice Title: Test Bank 2.2 Income and Expenditures Section: Evaluating Your Personal Financial Situation Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 21. A personal cash flow statement A) shows income and expenditures at one specific point in time. B) uses the same information needed for the personal balance sheet. C) shows income and expenditures over a period of time. D) is necessary for calculating one’s net worth. Answer: C Solution: Where your personal balance sheet is a snapshot of your financial condition at a certain point in time, your personal cash flow statement shows inflows and outflows of cash over a period of time, often one month or one year. Format: Multiple Choice Title: Test Bank 2.2 Personal Cash Flow Statement Section: The Personal Cash Flow Statement Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Easy

Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 22. When recording inflows and outflows of cash for the cash flow statement, it is important to A) monitor your spending for at least two years to get an accurate picture. B) continue your normal spending behavior. C) record assets at their market value. D) track inflows more than outflows. Answer: B Solution: It is important not to alter your normal spending behavior, even temporarily, because what you record is the basis of future budgeting. You need to incorporate expenses accurately in your log, so that you can more realistically evaluate your current finances. Format: Multiple Choice Title: Test Bank 2.2 Recording Cash Outflows Section: The Personal Cash Flow Statement Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Expected Time to Complete: 1 minute 23. Which of the following information is included on a household’s personal cash flow statement? (Select any two.) A) The value of all household assets B) The amount of all debts owed to others C) Household income D) Household expenses E) Value of your car F) Mortgage balance Answer: C and D Solution: A personal cash flow statement is a financial statement used to evaluate the relationship between your household income and your household spending (expenses). Format: Multiple Select Title: Test Bank 2.2 Personal Cash Flow Statement Section: The Personal Cash Flow Statement Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 24. Which is not a source of income in a personal cash flow statement? A) Scholarships B) Cash allowances or gifts from your parents or others C) Tax refund D) Alimony received Answer: C Solution: Scholarships, cash allowances or gifts from your parents or others, and alimony received are sources of income. A tax refund is a return of a payment (expense), not income. Format: Multiple Choice Title: Test Bank 2.2 Cash Inflows Section: The Personal Cash Flow Statement Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Expected Time to Complete: 1 minute 25. Fixed expenses are A) different dollar amounts each month. B) the same percentage of a person’s income each month. C) the same dollar amount in each payment period. D) more common than variable expenses. Answer: C Solution: Fixed expenses are expenditures that easy to identify and track because they are the same from month to month, such as rent and car loan payments. Format: Multiple Choice Title: Test Bank 2.2 Fixed Expenses Section: The Personal Cash Flow Statement Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

26. To get a realistic picture of actual expenditures, it is recommended that you keep a _____ spending log for at least a _____. A) daily; week B) daily; month C) weekly; month D) monthly; year Answer: B Solution: To get a realistic picture of actual expenditures, it is recommended that you keep a daily spending log to track your expenditures for at least a month to be sure that you’ve included even irregular cash outflows. At the end of the time period you have chosen, you can total the amounts entered in your spending log to put into your personal cash flow statement. Format: Multiple Choice Title: Test Bank 2.2 Spending Log Section: The Personal Cash Flow Statement Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 27. What is Veronica’s net cash flow if her assets total $15,000, her gross income is $40,000, her student loan debt is $20,000 (she has no other debts), and her annual expenses (including taxes) total $38,000? A) $2,000 B) $5,000 C) -$5,000 D) -$18,000 Answer: A Solution: Net cash flow = Total cash inflows − Total cash outflows Net cash flow = $40,000 cash inflows − $38,000 cash outflows = $2,000 Format: Multiple Choice Title: Test Bank 2.2 Net Cash Flow Calculation Section: Net Cash Flow Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 28. The savings ratio will be negative if

A) cash inflows exceed cash outflows. B) cash outflows exceed cash inflows. C) assets exceed debts. D) debts exceed assets. Answer: B Solution: The savings ratio will be negative if cash outflows exceed cash inflows. A negative savings ratio means that, rather than saving, you are accumulating more debt. Format: Multiple Choice Title: Test Bank 2.2 Negative Savings Ratio Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 29. The liquidity ratio measures A) how many years you could pay your monthly expenses from your assets. B) how many months you could pay your monthly expenses from your liquid assets. C) the number of times that your liquid assets exceed your water bill. D) the number of times that your assets exceed your debts. Answer: B Solution: The liquidity ratio measures how many months you could pay your monthly expenses from your liquid assets. Format: Multiple Choice Title: Test Bank 2.2 Liquidity Ratio Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 30. Don has assets of $5,000, of which $1,800 are in checking and savings accounts. His annual expenses are $15,000. Don’s liquidity ratio would be A) 0.120. B) 0.333. C) 1.440. D) 4.000.

Answer: C Liquid assets Solution: Liquidity ratio = Monthly expenses $1,800 = 1.44 ($15,000/12 months) Format: Multiple Choice Title: Test Bank 2.2 Liquidity ratio Calculation Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes Liquidity ratio =

31. You have the following financial information on the Haring family: Total assets (including a house) Checking and savings account Monthly after-tax income Total monthly expenses Monthly savings Monthly debt payments Total debt (including mortgage)

$300,000 $10,000 $5,500 $5,000 $300 $2,000 $280,000

What is the Haring family’s liquidity ratio? A) 1.5 B) 2.0 C) 2.5 D) 3.0 Answer: B Liquid assets Solution: Liquidity ratio = Monthly expenses Liquidity ratio =

$10,000 = 2.0 $5,000

Format: Multiple Choice Title: Test Bank 2.2 Liquidity Ratio Calculation Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium

Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 32. You have the following financial information on the Haring family: Total assets (including a house) Checking and savings account Monthly after-tax income Total monthly expenses Monthly savings Monthly debt payments Total debt (including mortgage)

$300,000 $10,000 $5,500 $5,000 $300 $2,000 $280,000

What is the Haring family’s debt payment ratio? A) 25% B) 28% C) 30% D) 36% Answer: D Total monthly debt payments Solution: Debt payment ratio = After–tax monthly income $2,000 = 0.3636 or 36% $5,500 Format: Multiple Choice Title: Test Bank 2.2 Debt Payment Ratio Calculation Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes Debt payment ratio =

33. You have the following financial information on the Haring family: Total assets (including a house) Checking and savings account Monthly after-tax income Total monthly expenses Monthly savings Monthly debt payments Total debt (including mortgage)

$300,000 $10,000 $5,500 $5,000 $300 $2,000 $280,000

What is the Haring family’s savings ratio? A) 4% B) 5% C) 10% D) 18% Answer: B Monthly savings Solution: Savings ratio = After–tax monthly income Savings ratio =

$300 = 0.0545 or 5% $5,500

Format: Multiple Choice Title: Test Bank 2.2 Savings Ratio Calculation Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 34. Which personal financial ratio measures the percent of your total assets that you’ve financed with debt? A) Debt ratio B) Debt payment ratio C) Mortgage debt service ratio D) Liquidity ratio Answer: A Solution: The debt ratio measures the percent of your total assets that you’ve financed with debt. The debt payment ratio and the mortgage debt service ratio measure your ability to pay your financial obligations. The liquidity ratio tells you how many months you could pay your monthly expenses from your liquid assets. Format: Multiple Choice Title: Test Bank 2.2 Debt Ratios Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

35. Gross monthly income = $3,500 After-tax monthly income = $2,970 Total debt = $86,000 Total monthly debt payments = $402 Total assets = $113,000 Based on the information given, what is the debt ratio? A) 3% B) 47% C) 76% D) 131% Answer: C Total debts Solution: Debt ratio = Total assets Debt ratio =

$86,000 = 0.76 or 76% $113,000

Format: Multiple Choice Title: Test Bank 2.2 Debt Ratio Calculation Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 36. The debt payment ratio estimates the percentage of __________ that is used to cover required monthly ________ on all debts. A) after-tax income; minimum payments B) total income; minimum payments C) after-tax income; average payments D) total income; average payments Answer: A Solution: The debt payment ratio estimates the percentage of after-tax income that is used to cover required monthly minimum debt payments of all debts. Format: Multiple Choice Title: Test Bank 2.2 Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios.

Difficulty: Medium Bloomcode: Comprehensive AACSB: Analytic Expected Time to Complete: 1 minute 37. The mortgage debt service ratio measures the percentage of your gross income that you pay in A) mortgage payments. B) mortgage payments and property taxes. C) mortgage payments and homeowner’s insurance. D) mortgage payments, property taxes, and homeowner’s insurance. Answer: D Solution: The mortgage debt service ratio measures the percentage of your gross income that you pay in mortgage payments, property taxes, and homeowners’ insurance. Format: Multiple Choice Title: Test Bank 2.2 Mortgage Debt Service Ratio Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. If interest rates increase significantly in the future, in what ways will your borrowing decisions and financial ratios be impacted? A) Higher rates will increase the amount of loan you can obtain because your debt payment ratios will increase. B) Higher rates will increase the amount of loan you can obtain because your debt payment ratios will decrease. C) Higher rates will reduce the amount of loan you can obtain because your debt payment ratios will increase. D) Higher rates will reduce the amount of loan you can obtain because your debt payment ratios will decrease. Answer: C Solution: Higher rates will reduce the amount of loan you can obtain because your debt payment ratios will increase. Monthly debt payment will increase by the higher rate, while your income remains the same. Format: Multiple Choice Title: Test Bank 2.2 Measuring Debt Usage Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios.

Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 39. You estimate your monthly mortgage principal and interest will be $1,000, property taxes will be $160 per month, and homeowner’s insurance will be $50 per month. If your gross monthly income is $4,000 per month and your tax rate is 20 percent, what is your mortgage debt service ratio? A) 30.25% B) 37.80% C) 60.50% D) 65.20% Answer: A Principal + Interest + Property taxes + Insurance Solution: Mortgage debt service ratio = Gross monthly income Mortgage debt service ratio =

$1,000 + $160 + $50 = 0.3025 or 30.25% $4,000

Format: Multiple Choice Title: Test Bank 2.2 Mortgage Debt Service Ratio Calculation Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 40. Borrowing at _________ is a major reason for the ______ standard of living in the United States. A) low interest rates; declining B) high interest rates; declining C) low interest rates; rising D) high interest rates; rising Answer: C Solution: Access to low interest credit has been a major reason for the rising standard of living in the United States. Purchasing large assets like homes and autos over a manageable period of time raises the standard of living. Format: Multiple Choice Title: Test Bank 2.2 Measuring Debt Usage Section: Using Financial Ratios

Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 41. Tyler’s monthly gross income is $4,200 and his monthly after-tax income is $3,400. He saves approximately $300 a month. What is his savings ratio? A) 7.14% B) 8.80% C) 18.00% D) 38.00% Answer: B Monthly savings Solution: : Savings ratio = After–tax monthly income Savings ratio =

$300 = 0.088 or 8.8% $3,400

Format: Multiple Choice Title: Test Bank 2.2 Savings Ratio Calculation Section: Using Financial Ratios Learning Objective: 2.2 Prepare a personal cash flow statement, and evaluate your financial situation using financial ratios. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 42. The basic idea of time value of money is that $1 to be received in the ________ is worth ______$1 received today because of the value of the compound interest. A) past; less than B) future; less than C) future; more than D) past; the same as Answer: B Solution: The basic idea of the time value of money is this: Money received today is worth more than the same dollar amount to be received in the future. This is true; because, if you get an amount of money today, you can invest it to earn compound interest so that it will grow over time. Format: Multiple Choice

Title: Test Bank 2.3 Time Value of Money Section: The Power of Compound Interest Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 2 minutes 43. ________ occurs when you earn interest on your investment balance and then leave the interest in the account so that you earn future interest on the__. A) Compounding; original balance B) Discounting; original balance C) Compounding; original balance plus the accumulated interest earnings D) Discounting; original balance plus the accumulated interest earnings Answer: C Solution: Compounding occurs when you earn interest on your investment balance and then leave the interest in the account so that you earn future interest on the original balance plus the accumulated interest earnings. Format: Multiple Choice Title: Test Bank 2.3 Compounding Section: The Power of Compound Interest Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 44. The time value of money is a good argument against saving money in a piggy bank at home, because the money will A) gain purchasing power over time due to inflation. B) lose purchasing power over time due to inflation. C) maintain purchasing power over time despite inflation. D) maintain purchasing power over time due to inflation. Answer: B Solution: The time value of money is a good argument against saving money in a piggy bank at home, because the money will lose purchasing power over time due to the eroding effects of inflation. Format: Multiple Choice Title: Test Bank 2.3 Inflation Section: The Power of Compound Interest Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 2 minutes 45. You want to know how much $10,000 invested today is going to be worth 10 years from now. Which type of time value of money calculation should be used to solve this problem? A) Present value of a lump sum B) Future value of a lump sum C) Present value of an annuity D) Future value of an annuity Answer: B Solution: You are solving for the future value of a $10,000 lump sum. Format: Multiple Choice Title: Test Bank 2.3 TVM Method Section: Time Value of Money Calculation Methods Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 46. You invest $1,000 today and earn 10% interest, compounded annually. How much will you have in five years? A) $1,475.19 B) $1,550.26 C) $1,610.51 D) $1,720.82 Answer: C Solution: Calculate the future value of a $1,000 lump sum in five years at 10% APY. Financial Calculator: Input N=5, I/Y=10, PV=-1,000, and Solve for FV = 1,610.51 Excel Function: “=FV(Rate, Nper, Pmt, PV, Type)” =FV(0.10, 5, 0, -1000, 0) => 1,610.51 TVM Equation: Future value of a lump sum (FV) = PV × (1 + i)n Future value of a lump sum (FV) = $1,000 × (1 + 0.10)5 = $1,610.51 Format: Multiple Choice Title: Test Bank 2.3 FV Lump-Sum Calculation Section: Future Value: How Much Will My Money Grow?

Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 47. You deposit $200 today into a bank account. If the account earns 8% annually, how much will you have at the end of 10 years. A) $93 B) $432 C) $2,897 D) $3,329 Answer: B Solution: Calculate the future value of a $200 lump sum in 10 years at 8% APY. Financial Calculator: Input N=10, I/Y=8, PV=-200, and Solve for FV = 431.78 or 432 Excel Function: “=FV(Rate, Nper, Pmt, PV, Type)” =FV(0.08, 10, 0, -200, 0) => 431.78 or 432 TVM Equation: Future value of a lump sum (FV) = PV × (1 + i)n Future value of a lump sum (FV) = $200 × (1 + 0.08)10 = $431.78 or $432 Format: Multiple Choice Title: Test Bank 2.3 FV lump-sum Calculation Section: Future Value of a Lump Sum Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 48. If you receive a series of equal end-of-year payments over several years, this is an example of A) a perpetuity. B) an ordinary annuity. C) an annuity due. D) compounding. Answer: B

Solution: An annuity is a series of payments of equal dollar amounts made at regular intervals for a period of time. An ordinary annuity is one in which each payment occurs at the end of the period. Format: Multiple Choice Title: Test Bank 2.3 Equal Series of Payments Section: Future Value: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

49. An annuity is a series of _____ payments made at ________, for a period of time. A) equal; monthly intervals B) equal; regular intervals C) increasing; regular intervals D) decreasing; regular intervals Answer: B Solution: An annuity is a series of equal payments made at regular intervals, for a period of time. Intervals doesn’t have to be monthly. Format: Multiple Choice Title: Test Bank 2.3 Annuity Section: Future Value: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 50. An annuity due is a type of annuity in which each payment is made or received at A) the end of a period B) the beginning of a period C) predetermined intervals within a period D) any time Answer: B Solution: An annuity is a series of payments of equal dollar amounts made at regular intervals for a period of time. An annuity due is one in which each payment occurs at the beginning of the period. Format: Multiple Choice Title: Test Bank 2.3 Annuity Due Section: Future Value: How Much Will My Money Grow?

Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 51. Which of the following is true regarding future value, all else equal? A) The longer the term, the lower the future value. B) The higher the interest rate, the lower the future value. C) The shorter the term, the higher the future value. D) The lower the interest rate, the lower the future value. Answer: D Solution: Interest rates have a positive relationship to the future value. The lower the interest rate the lower the future value, and the higher the interest rate, the higher the future value. Format: Multiple Choice Title: Test Bank 2.3 Interest Rates and TVM Section: Future Value: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 52. In order to determine how much, you would need to save annually to finance your child’s college education in 10 years, you would use the A) future value of a lump sum. B) future value of an annuity. C) present value of a lump sum. D) present value of an annuity. Answer: B Solution: You would use the future value of an annuity to determine the annual savings required to fund the cost of college 10 years from now. Format: Multiple Choice Title: Test Bank 2.3 TVM Section: Future Value: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes

53. You save $250 at the end of every month from your paycheck. If you can earn 6% APY, compounded monthly, how much will you have saved in 5 years? A) $15,000 B) $16,911 C) $17,443 D) $20,406 Answer: C Solution: Calculate the future value of a $250 annuity for 60 months at a 6% APY (0.5% monthly periodic rate). The monthly periodic rate is 6% APY divided by 12 months in a year because the money compounds monthly. Financial Calculator: Input N=(5x12), I=(6/12), Pmt=-250, PV=0, and Solve for FV = 17,443 Excel Function: “=FV(Rate, Nper, Pmt, PV, Type)” =FV((0.06/12), (5x12), -250, 0, 0) => 17,443 (1+i)n −1

TVM Equation: Future value of an annuity = Pmt × i (1 + 0.005)60 − 1 Future value of an annuity = $250 × = $17,443 0.005 Format: Multiple Choice Title: Test Bank 2.3 FVA Calculation Section: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 4 minutes 54. If you are investing $2,500 a year (end-of-year payments) into a retirement account that earns 9% interest annually, how much will you have at the end of 20 years? A) $14,011 B) $127,900 C) $139,400 D) $141,911 Answer: B Solution: Calculate the future value of a $2,500 annuity for 20 years at 9% APY. Financial Calculator: Input N=20, I=9, Pmt=-2500, PV=0, and Solve for FV = 127,900

Excel Function: “=FV(Rate, Nper, Pmt, PV, Type)” =FV(0.09, 20, -2500, 0, 0) => 127,900 TVM Equation: Future value of an annuity = Pmt x Future value of an annuity = $2,500 ×

(1+i)n −1 i

(1 + 0.09)20 − 1 = $127,900 0.09

Format: Multiple Choice Title: Test Bank 2.3 FVA Calculation Section: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 55. You plan to invest $2,000 every year (end-of-year payments) from now until you retire in 30 years. If you can earn 7% annually on your invested funds, how much will you have when you retire? A) $15,225 B) $25,081 C) $188,922 D) $204,146 Answer: C Solution: Calculate the future value of a $2,000 annuity for 30 years at 7% APY. Financial Calculator: Input N=30, I=7, Pmt=-2000, PV=0, and Solve for FV = 188,922 Excel Function: “=FV(Rate, Nper, Pmt, PV, Type)” =FV(0.07, 30, -2000, 0, 0) => 188,922 (1+i)n −1

TVM Equation: Future value of an annuity = Pmt x i (1 + 0.07)30 − 1 Future value of an annuity = $2,000 × = $188,922 0.07 Format: Multiple Choice Title: Test Bank 2.3 FVA Calculation Section: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium

Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 56. You plan to invest $1,500 every year (beginning-of-year payments) for the next 10 years. If you can earn 9% on your invested funds, how much will you have in 10 years? A) $22,789 B) $24,840 C) $28,391 D) $22,406 Answer: B Solution: Calculate the future value of a $1,500 annuity due for 10 years at 9% APY. Financial Calculator: Set Annuity to BEG, Input N=10, I=9, Pmt=-1500, PV=0, and Solve for FV = 24,840 Excel Function: “=FV(Rate, Nper, Pmt, PV, Type)” =FV(0.09, 10, -1500, 0, 1) => 24,840 Format: Multiple Choice Title: Test Bank 2.3 FVA-Due Calculation Section: How Much Will My Money Grow? Learning Objective: 2.3 Explain how compound interest benefits investors. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 57. The process of calculating present value is known as A) compounding. B) discounting. C) annuitizing. D) averaging. Answer: B Solution: The process of calculating present value is known as discounting. Format: Multiple Choice Title: Test Bank 2.4 Present Value Section: Present Value: How Much Do I Need Today to Reach a Future Goal? Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future.

Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 58. One year from now, you need to have $5,000 to pay your tuition. How much do you need to invest today if you can earn 10% interest, compounded annually? A) $3,355.75 B) $3,875.25 C) $4,000.55 D) $4,545.45 Answer: D Solution: Calculate the present value of a $5,000 lump sum a year from now at 10% APY. Financial Calculator: Input N=1, I/Y=10, FV=5000, and Solve for PV = -4,545.45 Excel Function: “=PV(Rate, Nper, Pmt, FV, Type)” =PV(0.10, 1, 0, 5000, 0) => 4,545.45 1

TVM Equation: Present value of a lump sum (PV) = FV × (1+i)

1 1 ) = $4,545.45 Present value of a lump sum (PV) = $5,000 × ( 1 + 0.10

Format: Multiple Choice Title: Test Bank 2.4 PV Calculation Section: Present Value of a Lump Sum Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 59. You expect to receive a sum of money 10 years from now, and you want to know how much it is worth today. Which time value of money calculation should be used to solve this problem? A) Present value of a lump sum B) Future value of a lump sum C) Present value of an annuity D) Future value of an annuity

Answer: A Solution: Present value of a lump sum is the discounted value of the future sum, by the APR over the time frame of 10 years. Format: Multiple Choice Title: Test Bank 2.4 Present Value Section: Present Value of a Lump Sum Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 60. You can afford to make $100 monthly payments for three years, and you want to know how much you can borrow based on this payment amount. Which type of time value of money calculation should be used to solve this problem? A) Present value of a lump sum B) Future value of a lump sum C) Present value of an annuity D) Future value of an annuity Answer: C Solution: The present value of a $100 monthly amortization payment over three years at a particular APR represents the loan value. Format: Multiple Choice Title: Test Bank 2.4 Determine Which Type of TVM Section: Present Value of an Annuity Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

61. You just won a $20 million lottery. You can choose either receiving $8 million today or $800,000 per year for 25 years. Which time value of money calculation should you use to decide between these two alternatives? A) Future value of a lump sum B) Present value of a lump sum C) Future value of an annuity D) Present value of an annuity

Answer: D Solution: You need to calculate the present value of the $800,000 annuity over 25 years at your APR to determine if this option is better than $8 million. Format: Multiple Choice Title: Test Bank 2.4 Determine Which Type of TVM Section: Present Value of an Annuity Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 62. You just won a $20 million lottery. You can choose either receiving $8 million today or $800,000 per year for 25 years. Assuming you think you, can earn 8% per year on your investments, compounded annually, which of these alternatives is preferable? A) $8 million lump sum is preferable because the annuity is worth $2,920,358. B) $8 million lump sum is preferable because the annuity is worth $7,854,518. C) Annuity is preferable because it is worth $8,539,821 to you. D) Annuity is preferable because it’s worth $20 million Answer: C Solution: Calculate the present value of an $800,000 annuity over 25 years at 8% APR. Financial Calculator: Input N=25, I/Y=8, Pmt=800000, FV=0, and Solve for PV = -8,539,821 Excel Function: “=PV(Rate, Nper, Pmt, FV, Type)” =PV(0.08, 25, 800000, 0, 0) => -8,539,821 TVM Equation: Present value of an annuity (PVA) = PMT ×

Present value of an annuity (PVA) = $800,000 ×

1−(

1 n ) 1+i

25 1 1 − (1 + 0.08)

0.08

= $8,539,821

AACSB: Analytic Expected Time to Complete: 5 minutes 63. You want to receive payments of $20,000 each year (end-of-year payments) for 15 years. If you can earn 8% on your funds, how much would you have to invest today in order to reach your goal? A) $54,304 B) $63,055 C) $171,190 D) $184,885 Answer: C Solution: Calculate the present value of a $20,000 annuity over 15 years at 8% APR. Financial Calculator: Input N=15, I/Y=8, Pmt=20000, FV=0, and Solve for PV = -171,190 Excel Function: “=PV(Rate, Nper, Pmt, FV, Type)” =PV(0.08, 15, 20000, 0, 0) => -171,190 TVM Equation: Present value of an annuity (PVA) = PMT ×

Present value of an annuity (PVA) = $20,000 ×

1−(

1 n ) 1+i

15 1 1 − (1 + 0.08)

0.08

= $171,190

Format: Multiple Choice Title: Test Bank 2.4 PVA Calculation Section: Present Value of an Annuity Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 64. Loan amortization is based upon A) future value. B) future value of an annuity. C) present value. D) present value of an annuity.

Answer: D Solution: Amortization is the financial term for the process of paying interest on a declining loan balance in addition to repaying some of the face value of the loan with each payment. The payments on an amortized loan are calculated so that by the time you make your last payment, you’ve paid off the total loan balance. The process is the same as calculating the present value of an annuity. Instead of solving for the present value, though, you solve for the payment. Format: Multiple Choice Title: Test Bank 2.4 Amortization Section: Loan Payments Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 65. You borrow $10,000 from your bank at 7% APR for 4 years, what will be your monthly payment? A) $239 B) $253 C) $376 D) $421 Answer: A Solution: Calculate the monthly payment for a $10,000 loan over 4 years at 7%APR. Financial Calculator: Input N=(4x12), I=(7/12), PV=10000, FV=0, and Solve for Pmt = -239 Excel Function: “=PMT(Rate, Nper, PV, FV, Type)” =PMT((0.07/12), (4x12), 10000, 0, 0) => -239 TVM Equation: Payment on amortized loan: PMT = PVA ×

PMT = $10,000 ×

0.005833 48 1 1−( ) 1 + 0.005833

i 1−(

1 n ) 1+i

= $239

Format: Multiple Choice Title: Test Bank 2.4 PMT Calculation Section: Loan Payments Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future.

Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute

66. You are considering two amortized loans with the same number of months to repay and the same initial amount borrowed. If the interest rate on Loan A is ______ than the rate on Loan B, then the payment on Loan A will be _______ the payment on Loan B. A) higher; higher than B) higher; lower than C) lower; higher than D) lower; same as Answer: A Solution: If you are comparing two amortized loans with the same number of months to repay and the same initial amount borrowed, a higher interest rate will cause the payment amount to be higher, and vice versa. Format: Multiple Choice Title: Test Bank 2.4 How Interest Rates Affect Loan Payments Section: Loan Payments Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 67. You are considering two amortized loans with the same interest rate and the same initial amount borrowed. If the number of months to repay Loan × is _____ than the number of months to repay Loan Y, the monthly payment on Loan × will be ________ the payment on Loan Y. A) greater; higher than B) greater; lower than C) less; lower than D) less; same as Answer: B Solution: If you are comparing two amortized loans with the same interest rate and the same initial amount borrowed, the greater the term to maturity, the lower the monthly payment, because the principal is stretched further out. Format: Multiple Choice Title: Test Bank 2.4 How the Maturity Affect Loan Payments Section: Loan Payments

Learning Objective: 2.4 Calculate present value of funds to be received or paid in the future. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes

Chapter 3 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 62 questions. 58 Multiple Choice | 4 Multiple Select

LO 3.1 LO 3.2 LO 3.3 LO 3.4 LO 3.5 Total

20 9 8 19 6 62

32% 15% 13% 31% 10% 100%

Easy Medium Hard

Knowledge Comprehension Application Analysis Evaluation Synthesis

9 26 17 10 0 0 62

15% 42% 27% 16% 0% 0% 100%

10 46 6 62

Calculations Q# Test Bank Question 3.1 Inflation Adjusted Expense Calculation 11 3.2 Opportunity Cost of Lost Interest Calculation 23 3.2 Cash Reserve Calculation 26 3.2 Pay Yourself First Calculation 29 3.4 APY Calculation 40 3.4 CD Calculation 45 3.4 Rule of 72 Calculation 54 3.4 Rule of 72 Calculation 55 3.4 Rule of 72 APY Calculation 56

16% 74% 10% 100%

1. A plan for future spending and saving that will enable you to achieve your financial goals is called a ______. A. cash flow statement. B. budget. C. net worth statement. D. balance sheet. Answer: B Solution: A budget is a plan for future spending and saving that will enable you to achieve your financial goals. The budgeting process is critical to the success of your financial plan. Format: Multiple Choice Title: Test Bank 3.1 Future Spending and Saving Plan Section: Developing, Implementing, and Monitoring a Household Budget Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 2. Although an annual budget can help with the big picture, most people find it necessary to budget on a ______ basis covering the entire _____ to coincide with payment obligations. A. daily; week B. weekly; month C. monthly; quarter D. monthly; year Answer: D Solution: Although an annual budget can help with the big picture, most people find it necessary to budget on a monthly basis covering the entire year to coincide with payment obligations. Format: Multiple Choice Title: Test Bank 3.1 Budget Time Period Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 3. The steps in the budgeting process are forecasting cash flows, __________ the budget, monitoring, and reevaluating over time.

A. adjusting B. negotiating C. selecting D. implementing Answer: D Solution: The budgeting process is the process of planning for future income and expenditures and tracking your actual cash flows over time. The process includes four steps: (1) Forecasting; (2) Implementing; (3) Monitoring; (4) Reevaluating regularly. Format: Multiple Choice Title: Test Bank 3.1 The Budgeting Process Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 4. Which is a valid method to forecast future variable expenses? A. Increase variable expenses by the difference from last year. B. Increase variable expenses by the expected rate of inflation. C. Increase variable expenses by the average of the past three years. D. Increase variable expenses by the average of the past five years Answer: B Solution: Increase variable expenses by the expected rate of inflation. Prior years increases are based on prior years economic conditions, and do not predict how the economy will perform in the future. Format: Multiple Choice Title: Test Bank 3.1 Forecasting Future Expenditures Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 5. Which of the following budget categories is a fixed expense? A. Transportation B. Mortgage payment C. Entertainment

D. Utilities Answer: B Solution: Fixed expenses, such as installment loan payments, are by definition, going to remain the same. A mortgage payment is an amortization payment; a fixed payment that pays off a loan in equal installments within a set time frame. Format: Multiple Choice Title: Test Bank 3.1 Fixed Expenses Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 6. Which of the following budget categories is a variable expense? A. Mortgage payment B. Car loan payment C. Food costs D. Health club dues Answer: C Solution: Fixed expenses, such as any installment payments, are by definition, going to remain the same. Loan amortization payments and memberships payments are fixed contractual payments of equal installments within a set time frame. Variable expenses, such as food are more difficult to estimate, and are based on discretionary factors such as lifestyle. Format: Multiple Choice Title: Test Bank 3.1 Variable Expenses Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 7. Which of the following is a variable expense? (Select 2) A. Rent payment B. Property taxes C. Clothing D. Uninsured medical expenses E. Student loan payment F. Car insurance payment Answer: C and D

Solution: Variable expenses, such as clothing and uninsured medical expenses are difficult to estimate. Clothing is based on discretionary factors such as lifestyle, and illnesses and accidents are not anticipated. Fixed expenses, such as any installment payments, are by definition, going to remain the same. Loan amortization payments, lease payments, property taxes and insurance premiums are fixed contractual payments of equal installments within a set time frame. Format: Multiple Select Title: Test Bank 3.1 Variable Expenses Learning Objective: 3.1 Develop, implement, and monitor a household budget. Section: The Budgeting Process Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 8. Whether its charity, gift giving, or lavish birthday parties for your kids, it makes no sense to be generous with money you can’t afford to give. Which is not a budget solution for this mistake? A. Budget for such expenditures B. Consider ways to give your time instead of money C. Use a credit card to balance your budget D. Create an account to save for next year’s donations and gifts Answer: C Solution: Budget for discretionary expenditures, and avoid making impulse purchases or donations. Consider ways to give your time and talents instead of money. Create an account to save for next year’s donations and gifts, and spend only from that account the following year. Borrowing to make up for overspending will just increase the loan payment burden on subsequent budgets. Format: Multiple Choice Title: Test Bank 3.1 Solutions for Common Budget Mistakes Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 9. Which is not a valid budget solution to buying stuff that you don’t need? A. Stick to a budget B. Leave credit cards at home C. Find lower interest credit cards D. Stick to a “need” list Answer: C

Solution: Strictly adhere to a budget, leave credit cards at home, or stick to a “need” list, are potential solutions. Borrowing to make up for overspending, even at lower interest rates, will just increase the loan payment burden on subsequent years. Format: Multiple Choice Title: Test Bank 3.1 Solutions for Common Budget Mistakes Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 10. Which is not a common budget mistake? A. Having too little emergency cash. B. Supersizing your house C. Underusing credit cards. D. Underinsuring. Answer: C Solution: Many families live from paycheck to paycheck and require an emergency fund to avoid financial catastrophe. A layoff, a car breakdown, or an unexpected bill can lead to financial crisis. Expensive houses come with increased costs for maintenance, taxes, and insurance. Too much mortgage debt and you won’t be able to survive a break in employment. Even though health insurance can be a large monthly expense, if your employer doesn’t cover all the premiums, it’s a mistake to be uninsured. Twenty percent of bankruptcies are triggered by medical bills. Overusing credit cards (not underusing) are a common budget mistake. Your overall financial position will decline as debt increases. Format: Multiple Choice Title: Test Bank 3.1 Common Budget Mistakes Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 11. Simone spent an average of $500 each month on groceries last year for herself and her family. She is now forecasting the family budget for next year. She read that an inflation rate of 5% is expected. How much should Simone budget for the monthly grocery expense next year? A. $500 B. $525 C. $750

D. $475 Answer: B Solution: If you spent $500 on groceries last year and you anticipate 5% inflation, your monthly grocery expenditures for the coming year can be estimated as $500 × 1.05 = $525. Format: Multiple Choice Title: Test Bank 3.1 Inflation Adjusted Expense Calculation Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 12. A budget variance occurs when your actual expenses are ______ than your budgeted expenses. A. less than B. more than C. different D. all of the above Answer: D Solution: A budget variance occurs when your actual expenses are different from your budgeted expenses. Format: Multiple Choice Title: Test Bank 3.1 Budget Variance Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 13. Which of the following is (are) good reasons for tracking budget variances? A) To ensure that large, irregular cash expenses do not cause financial hardship. B) To determine the largest categories of expenditures for future reductions. C) To identify small cash leakages before a major shortfall. D) All of the choices are good reasons to track budget variances. Answer: D Solution: The reasons for tracking budget variances are: to identify small cash leakages as soon as possible so that you can change your behavior before you have a major budget shortfall, and to ensure that large irregular cash expenses

do not cause financial hardship. Income often comes in regular, predictable amounts, whereas some expenses, such as unexpected car and home repairs, tuition bills, or tax payments, may come in chunks and must be budgeted for in advance. Format: Multiple Choice Title: Test Bank 3.1 Budget Variances Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Hard Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 14. If your projected net cash flow is negative, which of the following should you do first? A. Make sure you have a large enough credit line to make up the difference. B. Take steps to reduce your discretionary spending or increase your cash inflows. C. Save more so that you can build up your emergency fund. D. Apply for another credit card with a high credit limit. Answer: B Solution: Take steps to reduce your discretionary spending or increase your cash inflows. Borrowing to make up for overspending will just increase the loan payment burden on subsequent years. Although you should build up your emergency fund, it’s not the immediate concern when you are currently in a deficit. Format: Multiple Choice Title: Test Bank 3.1 Addressing a Negative Cash Flow Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 15. Naomi is in the implementation stage of budgeting. She needs to reduce expenses by $100 so that her forecasted expenses do not exceed forecasted income. Of the following expenses, which is the easiest to reduce, assuming an individual has all of the categories in their budget? A. Student loan payment B. Entertainment C. Groceries D. Rent payment

Answer: B Solution: Variable expenses are the easiest to reduce. Groceries are an essential need; however, entertainment is a purely discretionary expense. Format: Multiple Choice Title: Test Bank 3.1 Reducing Expenses Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 16. If the reason you’re exceeding your budget is that you’re failing to control your discretionary spending in certain areas, you should A. take the time to review your financial goals B. evaluate your progress toward meeting your goals C. weigh the benefits and costs of the purchases that are interfering with your plan D. All these should be done Answer: D Solution: If the reason you’re exceeding your budget is that you’re failing to control your discretionary spending in certain areas, you should take the time to review your financial goals, evaluate your progress toward meeting them, and carefully weigh the benefits and costs of the purchases that are interfering with your plan. Format: Multiple Choice Title: Test Bank 3.1 Revising Your Budget Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 17. Even though you can’t necessarily anticipate unexpected events like layoffs and illness, you can lessen the impact by maintaining A. good credit. B. an emergency fund. C. a revised budget. D. a reconciled budget. Answer: B

Solution: Unexpected events, such as layoff and illness often lead to household financial distress. Even though you can’t necessarily anticipate these problems, you can lessen the impact by maintaining an emergency fund. Format: Multiple Choice Title: Test Bank 3.1 Unexpected Events Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 18. ______ a budget is the process of adjusting the budget for unexpected expenditures. A. Reconciling B. Revising C. Replacing D. Revoking

Answer: B Solution: After tracking your budget for several months, you might find that you have been too conservative in estimating certain expenses or that you have forgotten to make allowances for unexpected expenses, such as car repairs or medical bills. In either case, you need to go back, and revise a budget it so that, going forward, you’ll be able to meet your expenses. Format: Multiple Choice Title: Test Bank 3.1 Adjusting a Budget Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 19. The process of adjusting income, expenses, and savings so that you do not spend more than you earn in the future is known as ________ a budget. A) monitoring B) reevaluating C) reconciling D) adjusting Answer: C Solution: Reconciling a budget is the process of adjusting income and spending so that your expenses do not exceed your income.

Format: Multiple Choice Title: Test Bank 3.1 Implementing Your Budget Section: The Budgeting Process Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 20. In a committed relationship, when one partner hides purchases from the other partner, or makes a major purchase without consulting the partner, it is called A. financial disregard B. financial disrespect C. financial infidelity D. financial hardship Answer: C Solution: In a committed relationship, when one partner hides purchases from the other partner, or makes a major purchase without consulting the partner, it is called financial infidelity. Format: Multiple Choice Title: Test Bank 3.1 Household Budgeting Section: Money Attitudes and Household Budgeting Learning Objective: 3.1 Develop, implement, and monitor a household budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Ethics Expected Time to Complete: 1 minute 21. Which asset in the following list is the most liquid? A. Funds in a five-year certificate of deposit B. Funds in a checking account C. Funds in the stock market D. A real estate investment Answer: B Solution: Liquid investments are those that can easily be converted to cash without loss of value, such as funds in a checking or savings account. Format: Multiple Choice Title: Test Bank 3.2 Liquid Assets Section: The Role of Cash in Your Financial Plan Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 22. Which is not a general reason for holding cash? A. Managing transaction needs B. Preparing for cash emergencies C. Keeping up with inflation D. Making a temporary investment Answer: C Solution: Reasons for holding cash are: managing transaction needs; preparing for cash emergencies; and making a temporary investment. All these purposes are related to managing liquidity. Cash is the most susceptible for loss of purchasing power due to inflation. Format: Multiple Choice Title: Test Bank 3.2 Cash Management Section: Costs and Benefits of Holding Cash Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 23. The local credit union pays interest of 7% on amounts above $500 in a savings account. Because Gwen does not trust banks. She chooses not to have a savings account, and instead keeps $1,000 in cash in her home safe. What is Gwen’s annual opportunity cost of keeping her money at home instead of putting it in a savings account at the credit union? A. $70 B. $35 C. $3.50 D. There is no opportunity cost to Gwen. Answer: B Solution: The opportunity cost is the interest that she could have earned at the bank. $500 x .07 = $35. Format: Multiple Choice Title: Test Bank 3.2 Opportunity Cost of Lost Interest Calculation Section: Costs and Benefits of Holding Cash Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium Bloomcode: Analysis

AACSB: Analytic Expected Time to Complete: 2 minutes 24. Which is not an appropriate transaction account? A. Venmo B. Bank of America checking account C. PayPal D. Valley National 3% Certificate of Deposit Answer: D Solution: A transaction account, such as a bank checking account, or electronic wallets like Venmo or PayPal, allows you to easily deposit and withdraw funds, as well as make electronic payments in a timely fashion, and at minimal cost. Bank CDs offer attractive interest rates on deposit accounts, but the time required as a deposit, makes it inappropriate for a transaction account. Format: Multiple Choice Title: Test Bank 3.2 Transaction Accounts Section: Costs and Benefits of Holding Cash Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 25. Janice’s monthly expenses are $6,000, and she has $10,000 in checking and savings. Which of the following is true about her financial situation? A. Janice needs to try to reduce her spending. B. Janice needs to increase her emergency fund. C. Janice has too much in liquid assets. D. Janice should consider investing her $10,000 in a stock mutual fund to generate higher returns on her investment. Answer: B Solution: Janice needs to increase her emergency fund. An emergency should cover at least 3-6 months of expenses. Format: Multiple Choice Title: Test Bank 3.2 Preparing for Cash Emergencies Section: Costs and Benefits of Holding Cash Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

26. A household with average household expenses of $3,000 a month should have a cash reserve for emergencies of at least A. $4,000. B. $5,000. C. $6,000. D. $10,000. Answer: C Solution: Minor cash emergencies, such as a car repair, can be handled with a relatively modest emergency fund. In contrast, being out of work for a few months can have much more serious effects. Sufficient liquid assets to cover two months is the minimum cash reserve for emergencies. $3,000 x 2 months = $6,000. Format: Multiple Choice Title: Test Bank 3.2 Cash Reserve Calculation Section: How Much Should You Hold in Cash? Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 27. Setting up automatic bill payment whenever possible will help ensure that A. your bills are paid on time. B. you avoid late payment fees. C. your credit rating is not adversely affected. D. All of the above Answer: D Solution: Setting up automatic bill payment whenever possible will help ensure that your bills are paid on time, avoid late payment fees, and your credit rating is not adversely affected. Format: Multiple Choice Title: Test Bank 3.2 Auto Bill Payment Section: Rules of Effective Cash Management Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 28. The principle of paying yourself first means that you should

A. set aside the money necessary for achieving personal goals after you spend money on non-essentials during the month. B. set aside the money necessary for achieving personal goals before you spend money on non-essentials during the month. C. pay your bills prior to setting aside money necessary for achieving personal goals during the month. D. pay your non-essential bills prior to setting aside money necessary for achieving personal goals during the month. Answer: B Solution: The principle of paying yourself first means that you should set aside the money necessary for achieving personal goals before you spend money on non-essentials during the month. Format: Multiple Choice Title: Test Bank 3.2 Pay Yourself First Section: Rules of Effective Cash Management Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 29. You need $25,000 in four years to start your own business. If you can earn 8% on your funds, how much do you need to invest today in order to reach your goal? A) $7,548 B) $15,854 C) $18,376 D) $34,012 Answer: C Solution: Calculate the present value required to reach $25,000 in 4 years from now, if earning 8% APY. Financial Calculator: Input N=4, I/Y=8, FV=25000, and Solve for PV = -18,376 Excel Function: “=PV(Rate, Nper, Pmt, FV, Type)” =PV(0.08, 4, 0, 25000, 0) => -18,376 1

TVM Equation: Present value of a lump sum (PV) = FV x (1+i)

4 1 ) = $18,376 Present value of a lump sum (PV) = $25,000 x ( 1 + 0.08

Format: Multiple Choice Title: Test Bank 3.2 Pay Yourself First Calculation Section: Rules of Effective Cash Management Learning Objective: 3.2 Explain why cash management is an important component of your financial plan. Difficulty: Hard Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 30. A depository institution differs from a nondepository institution in that it gets its funds from _______, and its primary source of income is from __________. A. investors; investments B. customer deposits; interest earned on loans made to customers C. interest earned on loans made to customers; customer deposits D. the Fed; interest earned on loans made to customers Answer: B Solution: A depository institution differs from a nondepository institution in that it gets its funds from customer deposits, and its primary source of income is from interest earned on loans made to customers. Format: Multiple Choice Title: Test Bank 3.3 Depository Institutions Section: Depository Institutions Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 2 minutes 31. Of the following, which is not a depository institution? (Select 2) A. Commercial bank B. Mutual fund company C. Life insurance company D. Credit union E. Online bank F. Savings and loan association Answer: B and C Solution: Mutual Fund Company and Life Insurance Company are not depository institutions. Mutual funds invest capital provided by their investors, and life insurance companies invest premiums provided by its customers.

Format: Multiple Select Title: Test Bank 3.3 Nondepository Institutions Section: Nondepository Institutions Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 32. Depository institutions are considered less risky than nondepository institutions because ___________. A. they don’t make risky investments B. limited deposits are insured by the federal government C. unlimited deposits are insured by the federal government D. investments are protected by the federal government Answer: B Solution: Depository institutions are considered less risky than nondepository institutions because deposits held in these institutions are insured for up to $250,000 per depositor per account type, by the Federal Deposit Insurance Corporation (FDIC), a government-sponsored insurance agency. Format: Multiple Choice Title: Test Bank 3.3 Depository Institutions Section: Depository Institutions Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 33. Which of the following correctly describe credit unions? (Select 3) A. Owned by depositors B. Owned by investors C. Not insured by the FDIC D. Insured by the FDIC E. Depository institution F. Nondepository institution Answer: A, C, and E Solution: A credit union is a special form of mutual depository institution. It gets its funds from checking and savings deposits and makes loans to its depositors, who are also the owners of the institution. Depositors in credit unions are insured

for up to $250,000 by the National Credit Union Association, which operates the National Credit Union Share Insurance Fund (NCUSIF). Format: Multiple Select Title: Test Bank 3.3 Credit Unions Section: Depository Institutions Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 34. Credit unions are a unique type of depository institution because credit unions A. are primarily mortgage lenders. B. tend to charge higher fees than commercial banks. C. are nonprofit. D. are insured by FDIC. Answer: C Solution: An important distinction between credit unions and other depository institutions is that credit unions have nonprofit status and often make use of a partially volunteer labor force. Format: Multiple Choice Title: Test Bank 3.3 Credit Unions Section: Depository Institutions Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 35. A ________ is an investment company that sells shares to investors, and then invests the pool of funds in stocks, bonds, or other assets. A. mutual fund B. life insurance company C. brokerage firm D. credit union Answer: A Solution: 35. A mutual fund is an investment company that sells shares to investors and then invests the pool of funds in stocks, bonds, or other assets. Format: Multiple Choice Title: Test Bank 3.3 Nondepository Institutions

Section: Nondepository Institutions Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 36. The “Four Ps” to consider when choosing a financial institution include product, price, people, and A. precision. B. productivity. C. profit. D. place. Answer: D Solution: 36. The “Four Ps” to consider when choosing a financial institution include product, price, people, and place. Format: Multiple Choice Title: Test Bank 3.3 The 4 P’s Section: Evaluating Financial Institutions Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 37. Binh wants to earn interest on his savings account, and he is concerned about fees diluting his earnings. Of the four Ps, Binh is most concerned about A. products. B. price. C. people. D. place. Answer: B Solution: Price includes both the interest you earn on liquid asset accounts and the fees you pay for cash management services. Whereas many financial institutions offer similar selections of products, the pricing of these products may vary dramatically. Format: Multiple Choice Title: Test Bank 3.3 The 4 P’s Section: Evaluating Financial Institutions

Learning Objective: 3.3 Identify and evaluate the types of financial institutions that provide cash management services. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 38. For an account that compounds interest more often than once per year, the annual percentage yield will be A. greater than the stated nominal yield. B. less than the stated nominal yield. C. equal to the stated nominal yield. D. either greater than or less than the stated nominal yield, depending on the current interest rate environment. Answer: A Solution: For an account that compounds interest more often than once per year, the annual percentage yield will be greater than the stated nominal yield, because you earn additional interest on the prior period’s interest payment. Format: Multiple Choice Title: Test Bank 3.4 APY Section: Criteria for Evaluating Cash Management Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 39. Bank A offers an account with a nominal yield of 2 percent, and it compounds interest monthly. Bank B offers an account with nominal yield of 2 percent, and it compounds interest daily. Which one has the higher APY? A. Bank A has the higher APY. B. Bank B has the higher APY. C. They both have the same APY. D. This cannot be solved from the given information. Answer: B Solution: Bank B has the higher APY. The more compounding periods in a year, the higher the APY. Format: Multiple Choice Title: Test Bank 3.4 APY Section: Criteria for Evaluating Cash Management Accounts

Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 40. An account that pays a nominal rate of 3% and compounds monthly will have an APY of A. 3.00% B. 3.02% C. 3.03% D. 3.04% Answer: D

Nominal rate m

Solution: Annual Percentage Yield (APY) = (1 + ) −1 m where m = number of compounding periods in a year. 1 + 0.03 12 ) − 1 = 0.0304, or 3.04% Annual Percentage Yield (APY) = ( 12 Format: Multiple Choice Title: Test Bank 3.4 APY Calculation Section: Criteria for Evaluating Cash Management Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 41. Compared with time deposits, demand deposits A. place a greater limit on the number of checks you can write each month. B. require you to leave the funds on deposit for a longer period of time. C. allow you to withdraw money at any time. D. pay higher rates of interest. Answer: C Solution: All checking accounts are demand deposits, which means that you have the right to “demand” withdrawal of your deposited funds with little or no notice to the financial institution. Whereas, time deposits provide a higher APY based on the length of time the deposit is required to be in place. Format: Multiple Choice Title: Test Bank 3.4 Demand Deposit

Section: Checking Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 42. A time deposit account will typically pay _____ rate of interest compared to a demand account. A. a lower B. a higher C. the same D. no Answer: B Solution: A time deposit account requires that you keep the money in the account for a minimum period of time and may specify a waiting period before you can withdraw funds. The restriction of your deposit is compensated by a higher interest rate than a more liquid account, such as a demand deposit account. Format: Multiple Choice Title: Test Bank 3.4 Time Deposit Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 43. Which is a time deposit account? A. mutual fund B. checking account C. certificate of deposit. D. money market account Answer: C Solution: A certificate of deposit (CD) is the most common type of time deposit account. You agree to leave your money on deposit until the maturity date of the CD, and in return receive a commensurate interest rate. Checking and Money market accounts are demand deposits, and a mutual fund is an investment product. Format: Multiple Choice Title: Test Bank 3.4 Time Deposit Accounts

Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 44. A certificate of deposit is a type of savings account that pays A. an increasing rate of interest on funds left on deposit for a certain period of time. B. a fixed rate of interest on funds left on deposit for a certain period of time. C. a rate based on the depository bank’s credit quality. D. a rate that changes based on inflation. Answer: B Solution: A certificate of deposit (CD) is the most common type of time deposit account. You agree to leave your money on deposit until the maturity date of the CD. CDs offered by depository institutions for the same amount and duration are fairly similar, because they are federally insured. Rates are fixed, but higher for CDs of longer duration and larger deposit amounts, and vice versa. Format: Multiple Choice Title: Test Bank 3.4 Certificates of Deposit Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 45. Citibank is offering a 5-year CD at 3.2% APY. If you invest $10,000, how much will you have when the CD matures? A. $10,320.00 B. $11,600.00 C. $11,705.73 D. $11,732.61 Answer: C Solution: Calculate the future value of $10,000 in 5 years at 3.2% APY. Financial Calculator: Input N=5, I/Y=3.2, PV=-10,000, and Solve for FV = 11,705.73 Excel Function: “=FV(Rate, Nper, Pmt, PV, Type)”

=FV(0.032, 5, 0, -10000, 0) => 11,705.73 TVM Equation: Future value of a lump sum (FV) = PV × (1 + i)n Future value of a lump sum (FV) = $10,000 × (1 + 0.032)5 = $11,705.73

Format: Multiple Choice Title: Test Bank 3.4 CD Calculation Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 46. A money market mutual fund is a mutual fund that invests in A. stocks of the 500 largest companies in the United States. B. investment-quality corporate bonds. C. short-term debt securities issued by the federal government, federal agencies, and large public corporations D. long-term certificates of deposits and government bonds. Answer: C Solution: A money market mutual fund (MMMF) is a fund that invests in shortterm, low-risk financial assets, usually short-term debt securities issued by the federal government, federal agencies, and large public corporations. These types of investments are generally referred to as money market securities, and the funds are called money market mutual funds. Format: Multiple Choice Title: Test Bank 3.4 Money Market Mutual Fund Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 47. Which of the following investments is FDIC insured? A. Money Market Mutual Funds B. US Government Bond Fund C. Chase Certificate of Deposit D. US Series EE Savings Bond

Answer: C Solution: Chase Certificate of Deposit is a time deposit insured by the FDIC. Any mutual fund, regardless of what’s in the portfolio, are not insured deposits. US Series EE Savings Bonds are direct obligations of the US Government; it is not a deposit at a bank. FDIC only insures member bank deposits. Format: Multiple Choice Title: Test Bank 3.4 FDIC Insured Deposits Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Hard Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 48. Calista has saved $20,000, which she plans to use for a down payment on a home within the next year. She would like to earn interest on her savings and she is concerned about the safety of her money. She is considering the following options. Which option would you recommend for Calista? A. A five-year certificate of deposit earning 2.15% B. A money market deposit account earning 1.11% C. A money market mutual fund earning 1.7% D. A series I savings bond that pays 1.5% above inflation Answer: B Solution: A money market deposit account earning 1.11% is the most appropriate for her situation because the deposit is completely liquid and insured by the FDIC. Mutual funds, regardless of what’s in the portfolio, are not insured deposits. The five-year CD and the Series I Savings Bonds have maturities well in excess of her target goal. Format: Multiple Choice Title: Test Bank 3.4 Evaluating Cash Management Alternatives Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Hard Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 49. Which of the following types of accounts is not insured for $250,000 by the Federal Deposit Insurance Corporation (FDIC)? A. Money market deposit account offered by commercial bank B. U.S. Series I Savings Bonds purchased at a commercial bank

C. Checking account at an online bank D. Certificate of deposit purchased at a savings and loan association Answer: B Solution: U.S. Series I Savings Bonds are direct obligations of the US government; a bond, and not a deposit at the commercial bank. FDIC only insures deposits at member banks and Savings and Loans. Money market accounts (not money market mutual fund), certificate of deposits and checking accounts are all deposits at banks. Format: Multiple Choice Title: Test Bank 3.4 Comparison of Savings Account Alternatives Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Hard Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 50. Which of the following investments provides purchasing power protection? A. Series I savings bonds B. Series EE savings bonds C. Certificates of deposit D. Money market mutual funds Answer: A Solution: Series I savings bonds carry a fixed rate of interest when you purchase the bond, but the face value on which the interest is calculated adjusts semiannually for inflation, measured by the change in the CPI. Format: Multiple Choice Title: Test Bank 3.4 Inflation Protected Investment Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 51. U.S. government Series I bonds protect investors from the risk of A. changing tax rates. B. a global financial crisis. C. outliving their assets. D. inflation.

Answer: D Solution: Series I savings bonds carry a fixed rate of interest when you purchase the bond, but the face value on which the interest is calculated adjusts semiannually for inflation, measured by the change in the CPI. Format: Multiple Choice Title: Test Bank 3.4 US Series I Savings Bonds Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 52. Which of the following pays interest that is exempt from state and local taxation? A. Certificate of deposit B. NOW account C. Series EE bond D. Money market deposit account Answer: C Solution: In addition to paying no state or local income tax on the interest earned, federal income tax on the interest is not paid until you cash in the Series EE Savings Bond. For lower- and middle-income families, the interest income is exempt from federal income taxes if it is used to pay for qualified higher education expenses. Format: Multiple Choice Title: Test Bank 3.4 Tax Advantaged Savings Section: Savings Accounts Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 53. The Rule of 72 is used to A. estimate annual percentage yield of an investment. B. calculate the interest rate required to double the value of an investment. C. estimate how long an investment will take to double in value at a given rate of interest. D. calculate the amount of liquid assets to hold for emergencies.

Answer: C Solution: The “Rule of 72” will help you determine how long an investment will take to double in value at a given rate of interest. To approximate the number of years to double your money, take 72 and divide by the APY. This is not an actual time value of money calculation; only an approximation. Format: Multiple Choice Title: Test Bank 3.4 The Rule of 72 Section: The Rule of 72 Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 54. You have invested $1,000 in an account that promises a 3 percent APY. Assuming you leave the original investment and all earned interest in the account, and ignoring taxes, estimate how long will it take to double your money? A. 72 years B. 24 years C. 12 years D. 4.16 years Answer: B Solution: To approximate the number of years to double your money, take 72 and divide by the rate. For example, at 3% APY, it will take approximately 72/3 = 24 years to double your money. Format: Multiple Choice Title: Test Bank 3.4 Rule of 72 Calculation Section: The Rule of 72 Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 55. Filmore has invested $10,000 in an account to help pay for his grandson’s education. He expects the account to return 4.5% annually. Use the rule of 72 to estimate how long it will take the $10,000 to double in value. A. 10 years B. 12 years C. 16 years D. 20 years

Answer: C Solution: To approximate the number of years to double your money, take 72 and divide by the rate. For example, at 4.5% APY, it will take approximately 72/4.5 = 16 years to double your money. Format: Multiple Choice Title: Test Bank 3.4 Rule of 72 Calculation Section: : The Rule of 72 Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 56. Ryan has $5,000 to invest, and he wishes to double his money in 9 years to pay for a vacation to celebrate his 20th anniversary. Approximately what APY would he require to reach his goal? A. 6% B. 7% C. 8% D. 9% Answer: C Solution: Using the Rule of 72, you can algebraically solve for an APY estimation: 72 # Years to double estimation = APY 9 years =

72 72 => APY = = 8% APY 9 yrs

Format: Multiple Choice Title: Test Bank 3.4 Rule of 72 APY Calculation Section: : The Rule of 72 Learning Objective: 3.4 Evaluate checking and savings account choices based on liquidity, safety, and cost. Difficulty: Hard Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 57. If you write a check or use your debit card when there isn’t enough money in your account to cover the payment, this is known as a(n) A. float. B. skim. C. stop payment.

D. overdraft. Answer: D Solution: If you write a check or use your debit card when there isn’t enough money in your account to cover it, an overdraft is created, and the payment is rejected. You can end up owing penalty fees to your financial institution. Format: Multiple Choice Title: Test Bank 3.5 Cash Management Problems Section: Cash Management Problems and Solutions Learning Objective: 3.5 Select appropriate tools for dealing with cash management problems, and protect yourself from identity theft. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 58. Overdraft protection is an A. insurance program that will cover the penalty fees if you deposit a bad check. B. insurance program that will protect you from check and debit card fraud. C. automatic loan in the amount of the insufficient funds to cover an incoming check or debit. D. automatic transfer of funds from your savings account to your checking account in the amount of the insufficient funds to cover an incoming check or debit. Answer: C Solution: Overdraft protection is an automatic loan in the amount of the insufficient funds (overdraft) to cover an incoming check or debit. Format: Multiple Choice Title: Test Bank 3.5 Overdraft Protection Section: Cash Management Problems and Solutions Learning Objective: 3.5 Select appropriate tools for dealing with cash management problems, and protect yourself from identity theft. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 59. Sophie wrote a check to a contractor who did not complete the job. She would like to make sure the contractor is unable to cash her check. She should go to her financial institution and request a(n) A. overdraft protection. B. stop payment. C. wire transfer.

D. ACH transfer. Answer: B Solution: A stop payment order will keep a person or business from cashing a check that you have given them, or from accessing funds transferred to them electronically. Format: Multiple Choice Title: Test Bank 3.5 Cash Management Solutions Section: Cash Management Problems and Solutions Learning Objective: 3.5 Select appropriate tools for dealing with cash management problems, and protect yourself from identity theft. Difficulty: Medium Bloomcode: Application AACSB: Analytic 60. Which of the following are examples of ways that your identity might be stolen? (Select 3) A. Dumpster diving B. House monitoring C. Phishing D. Pretexting E. Bank robbery F. Installing fake security systems Answer: A, C, and D Solution: According to the FTC, common methods used by identity thieves to obtain your information include: dumpster diving (going through your trash for information); phishing (fraudulent email used to lure information); and pretexting (using false pretenses to obtain information). Format: Multiple Select Title: Test Bank 3.5 Common methods used by identity thieves Section: Identity Theft Learning Objective: 3.5 Select appropriate tools for dealing with cash management problems, and protect yourself from identity theft. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 61. Which is not a recommended practice to avoid identify theft? A. Check your credit card statements for accuracy before paying the bill B. Shred all financial statements before throwing them away C. Carry extra credit cards and IDs for verification D. Do not click on links in or download attachments from suspicious emails. Answer: C

Solution: Carrying extra credit cards and IDs for verification is not a sound practice, as it increases the possibility for theft or loss. Carrying just a couple of credit cards and a driver’s license is sufficient. Format: Multiple Choice Title: Test Bank 3.5 How to Avoid Identify Theft Section: Identity Theft Learning Objective: 3.5 Select appropriate tools for dealing with cash management problems, and protect yourself from identity theft. Difficulty: Easy Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 62. Ronnie received a suspicious email prompting her to enter her bank account number and password. Her financial institution has assured Ronnie that it will never request sensitive information via email. Ronnie appears to be the target of a ______ scheme. A. pretexting B. skimming C. phishing D. dumpster diving Answer: C Solution: Being prompted to reply to a fraudulent email that seems to be coming from your financial institution is phishing. For example, it may say that your bank needs you to confirm some personal information. Format: Multiple Choice Title: Test Bank 3.5 Section: Identity Theft Learning Objective: 3.5 Select appropriate tools for dealing with cash management problems, and protect yourself from identity theft. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute

Chapter 4 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 85 questions. 84 Multiple Choice | 1 Multiple Select LO 4.1 LO 4.2 LO 4.3 LO 4.4 Total

21 23 29 12 85

25% 27% 34% 14% 100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

13 37 12 11 4 8 85

15% 44% 14% 13% 5% 9% 100%

Easy Medium Hard

13 60 12 85

15% 71% 14% 100%

Calculations Q# Test Bank Question 4.1: Average Tax Rate Calculation (with distractor) 10 4.1: Average Tax Rate & Deduction Calculation (requires algebra) 11 4.1: Marginal Tax Effect Calculation (with FICA and State Tax) 12 4.1: Payroll Tax Calculation (with SS income cap) 13 4.1: Average Tax Rate Calculation (with distractor) 14 4.1: Average Tax Rate Calculation (with distractor) 19 4.1: Marginal Tax Calculation 21 4.2: Marginal Income Calculation (based on error) 42 4.2: Marginal Income Calculation 43 4.2: Income Tax Calculation 44 4.3: Taxable Income Calculation 48 4.3: W-2 Taxable Income Calculation 59 4.3: Taxable Income Calculation (from AGI) 60 4.3: Taxable Income Calculation (itemized deductions) 61 4.3: Taxable Income Percent Calculation 63 4.3: Tax Balance Due Calculation (with tax credit) 64 4.3: Income Tax Calculation (from AGI less deduction) 65 4.3: Tax on Capital Gain of Residence Calculation 66 4.4: Tax Savings on Salary Deferral Calculation 82 4.4: Pre-tax Health Care Savings Calculation 83 4.4: Tax Due/Refund Calculation (with refundable tax credit) 85

1. The U.S. income tax is considered A) progressive. B) illegal. C) regressive. D) transgressive. Answer: A Solution: The United States has always maintained a progressive tax on income by having increasing marginal tax rates. Format: Multiple Choice Title: Test Bank 4.1 Nature of the U.S. Tax System Section: The Progressive Nature of the U.S. Tax System Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 2. A progressive tax is one in which A) you pay more if you earn more. B) you pay less if you earn more. C) you pay the same regardless of earnings. D) taxes are used for progressive services. Answer: A Solution: A progressive tax on income means higher marginal tax rates are imposed on taxpayers with higher incomes. Format: Multiple Choice Title: Test Bank 4.1 Progressive Tax Section: The Progressive Nature of the U.S. Tax System Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 3. A tax that places a disproportionate burden on taxpayers with lower incomes is A) reformative. B) progressive. C) regressive. D) liberal.

Answer: C Solution: A regressive tax places a disproportionate burden on taxpayers with lower incomes. A tax is regressive if the same tax rate is applied to all taxpayers, regardless of income, as is the case for some payroll and sales taxes. Format: Multiple Choice Title: Test Bank 4.1 Nature of the U.S. Tax System Section: The Progressive Nature of the U.S. Tax System Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 4. The sales tax A) is a regressive tax. B) takes a bigger bite out of low-income families’ disposable incomes. C) places a disproportionate burden on taxpayers with lower incomes. D) All the choices reflect sales tax. Answer: D Solution: A regressive tax places a disproportionate burden on taxpayers with lower incomes. A tax is regressive if the same tax rate is applied to all taxpayers, as is the case for sales taxes. Regressive taxes take a bigger bite out of low-income families’ disposable incomes. Format: Multiple Choice Title: Test Bank 4.1 Sales Tax Section: The Progressive Nature of the U.S. Tax System Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 5. FICA is a ________tax, which is _________. A) sales; progressive B) sales; regressive C) payroll; progressive D) payroll; regressive Answer: D Solution: Federal Insurance Contributions Act (FICA) is a payroll tax, which is regressive. A total of 15.3 percent of a wage earner’s gross pay goes to this tax, with the employer and the employee each paying half. The FICA tax is regressive not only because nearly everyone pays the same 7.65 percent rate but also

because there is an income cap ($132,900 in 2019) for the Social Security portion of the tax. Format: Multiple Choice Title: Test Bank 4.1 Social Security and Medicare Tax Section: The Progressive Nature of the U.S. Tax System Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 6. What is the FICA tax used to pay for? A) Social Security B) Medicare C) Medicaid and Medicare D) Social Security and Medicare Answer: D Solution: Federal Insurance Contributions Act (FICA) is a payroll tax, which is your contribution to Social Security and Medicare. A total of 15.3 percent of a wage earner’s gross pay goes to this tax, with the employer and the employee each paying half. Format: Multiple Choice Title: Test Bank 4.1 FICA Section: The Progressive Nature of the U.S. Tax System Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 7. Marginal tax rates today are relatively ______ by historical standards. A) high B) low C) average D) equal Answer: B Solution: Marginal tax rates today are relatively low since 1913. A marginal tax rate is the rate that applies to your next dollar of taxable income. Format: Multiple Choice Title: Test Bank 4.1 Marginal Tax Rates Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system.

Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 8. In 2020, the lowest marginal tax rate is ___ percent. A) 0 B) 10 C) 12 D) 15 Answer: B Solution: The marginal tax rates in effect in 2020 ranged from 10 percent to 37 percent. Format: Multiple Choice Title: Test Bank 4.1 Marginal Tax Rates Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 9. Which of the following is the formula for calculating the average tax rate? A) Taxes paid/Taxable income B) Taxes paid/Gross income C) Taxable income/Gross income D) Taxable income/Adjusted gross income Answer: A Taxes paid Solution: Average tax rate = Taxable income Format: Multiple Choice Title: Test Bank 4.1 Average Tax Rate Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 10. If your taxable income is $86,000, your gross income is $115,000, and you paid $18,000 in taxes, what is your average tax rate? (Round to the nearest percent.) A) 17%

B) 21% C) 26% D) 48% Answer: B Taxes paid Solution: Average tax rate = Taxable income Average tax rate =

$18,000 = 0.21 or 21% $86,000

$18,945 = $76,403 0.248

$82,750 in gross income - $76,403 in taxable income = $6,347 deductions Format: Multiple Choice Title: Test Bank 4.1 Total Deductions Calculation Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Hard Bloomcode: Synthesis

AACSB: Analytic Expected Time to Complete: 4 minutes 12. Judy is self-employed and is in the 24% federal marginal tax bracket. If she works an extra 20 hours during the year, billing $175 an hour, how much will her after-tax income increase if her Social Security tax is 6.2% and her Medicare tax is 1.45%? Assume that the state income tax rate is 3.5%. (Round to the nearest whole dollar.) A) $1,967 B) $2,090 C) $2,270 D) $2,625 Answer: C Solution: Twenty hours at $175 per hour will yield $3,500 in additional gross income. Payroll tax of 7.65% + federal marginal income tax of 24% + state income tax of 3.5% = 35.15% or 0.3515. Then using the formula, Before-tax income × (1 - Tax rate), calculate the after-tax income. After-tax income = $3,500 × (1 - 0.3515) = $2,269.75 or $2,270 Format: Multiple Choice Title: Test Bank 4.1 Marginal Tax Effect Calculation Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 13. Betsy is assessed payroll taxes on $136,500 of income. If her earnings increase to $139,000, how much more will she pay in payroll tax due to the additional income, assuming the Social Security cap is set at $137,700? A) $36.25 B) $74.40 C) $110.65 D) $191.25 Answer: C Solution: Calculate each portion of the payroll tax on the $2,500 increase in income separately, because Social Security tax is capped at $137,700, but the Medicare tax is on the full amount. Social Security will only be assessed on $1,200 of the $2,500 earnings increase ($137,700 cap - $136,500 original income). Social Security tax = 0.062 × $1,200 = $74.40 Medicare tax = 0.0145 × $2,500 = $36.25 Individual payroll tax = $74.40 + $36.25 = $110.65

Format: Multiple Choice Title: Test Bank 4.1 Payroll Tax Calculation Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 14. Joe and Sally file for federal taxes as married filing jointly. They originally anticipated that they will pay a total of $28,765 in taxes on an estimated taxable income of $168,400. When they filed their taxes at the end of the year, they calculated their tax burden to be $30,193 on a taxable income of $174,351. What was Joe and Sally's actual average tax rate at the end of the year? A) 16.50% B) 17.08% C) 17.32% D) 17.93% Answer: C Taxes paid Solution: Average tax rate = Taxable income Average tax rate =

$30,193 = 0.1732 or 17.32% $174,351

Format: Multiple Choice Title: Test Bank 4.1 Average Tax rate Calculation Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 15. To which of the following does the marginal tax rate apply? A) First dollar of income B) Next dollar of income C) Last dollar of income D) Average dollar of income Answer: B

Solution: A marginal tax rate is the rate that applies to your next dollar of taxable income. Format: Multiple Choice Title: Test Bank 4.1 Marginal Tax Rate Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 16. The reduction in taxes owed as a result of a financial decision is known as the A) regressive tax effect. B) progressive tax effect. C) marginal tax effect. D) average tax effect. Answer: C Solution: The marginal tax effect is the reduction in taxes owed as a result of a financial decision, because the marginal tax rate applies to incremental earnings. Format: Multiple Choice Title: Test Bank 4.1 Tax Effects from a Financial Decision Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 17. When a tax system is progressive, with higher rates on higher levels of income, your average tax rate will always be _______ your marginal rate. A) more than B) less than C) the same as D) more than or equal to Answer: B Solution: When a tax system is progressive, with higher rates on higher levels of income, your average tax rate will always be less than your marginal tax rate. Format: Multiple Choice Title: Test Bank 4.1 Average Versus Marginal Tax Rate Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 18. Sue and Jenny both earn gross income of $40,000 per year. Jenny qualifies for a $1,000 child tax credit but Sue does not, because she does not have children. All other things being equal, who will have the higher tax rate? (Select any two.) A) Jenny has the higher average tax rate. B) Sue has the higher average tax rate. C) Jenny and Sue will have the same average tax rate. D) Jenny has the higher marginal tax rate. E) Sue has the higher marginal tax rate. F) Jenny and Sue will have the same marginal tax rate. Answer: B and F Solution: Sue will have the higher average tax because Jenny paid $1,000 less in tax ($1,000 child tax credit). However, they both have the same marginal tax rate because they share the same income and deductions. Tax credits directly affect the tax you owe; it does not affect income or deductions. Format: Multiple Select Title: Test Bank 4.1 Marginal Tax Versus Average Tax Evaluation Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 2 minutes 19. You are single with a $67,200 annual salary and a taxable income of $55,000. Your marginal tax rate is 22%, and you owe $7,959 in taxes. What is your average tax rate? A) 11.84% B) 13.03% C) 14.47% D) 22.00% Answer: C Taxes paid Solution: Average tax rate = Taxable income Average tax rate =

$7,959 = 0.1447 or 14.47% $55,000

Format: Multiple Choice Title: Test Bank 4.1 Average Tax Rate Calculation Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 20. Income levels applicable to each marginal tax bracket are adjusted each year based on A) presidential executive order B) budget deficits C) inflation D) Federal Reserve Answer: C Solution: Although federal income tax rates can only be changed by law, the levels of income that trigger each successive increase in tax rate are automatically increased each year to account for inflation. Format: Multiple Choice Title: Test Bank 4.1 Indexing of Tax Brackets Section: Marginal Tax Rates Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 21. You have taxable income of $60,000 (22% federal marginal tax bracket). If you combine your federal marginal tax with payroll tax and state income tax, your total marginal tax rate on additional earnings is 37.65%. You learn that your employer will give you a $5,000 bonus at the end of the year. How much of your bonus will you be able to spend? (Round to the nearest whole dollar.) A) $1,250 B) $1,883 C) $3,118 D) $3,750 Answer: C Solution: $5,000 in additional earnings × (1 - 0.3765 marginal tax rate) = $3,117.50 or $3,118 Format: Multiple Choice Title: Test Bank 4.1 Marginal Tax Calculation Section: Marginal Tax Rates

Learning Objective: 4.1 Understand the major features of the federal income tax system. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 22. Harold is divorced and not remarried. He lives with his children, for which he pays more than half of the support. Harold’s filing status is A) single. B) divorced filing separately. C) head of household. D) married filing separately. Answer: C Solution: Head of household is a single person who lives with and pays more than half of the support for a dependent child or relative. Format: Multiple Choice Title: Test Bank 4.2 Filing Status Section: Filing Status Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 23. Taxpayers can choose whether they want to take ________ or _______. A) the standard deduction; itemized deductions B) the standard deduction; tax credit C) itemized deductions; tax credit D) any deductions; tax credits Answer: A Solution: If your annual expenses in certain allowed categories exceed, in total, the standard deduction for your filing status, you can choose to report itemized deductions instead of the standard deduction. Tax credits are exclusive of using either the standard or itemized deduction. Format: Multiple Choice Title: Test Bank 4.2 Deductions and Tax Credits Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

24. The total of your earned income plus your unearned income less certain allowed adjustments is known as A) taxable income. B) gross income. C) net income. D) adjusted gross income. Answer: D Solution: The IRS defines your adjusted gross income (AGI) as the total of your earned income plus your unearned income less certain allowed adjustments. Format: Multiple Choice Title: Test Bank 4.2 Income and Taxable Income Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 25. The dollar amount of a standard deduction depends upon A) filing status. B) the number of members in the household. C) income level. D) the amount of itemized deductions. Answer: A Solution: The dollar amount of a standard deduction depends upon your filing status. Format: Multiple Choice Title: Test Bank 4.2 Standard Deduction Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 26. Which is not considered by the IRS to be earned income? A) Bonus B) Commissions C) Self-employment income D) Net business income Answer: D

Solution: The IRS defines your earned income to include salaries, wages, tips, bonuses, commissions, and self-employment income. Net business income is unearned income because it is primarily income derived from a business you may own but not operate. Format: Multiple Choice Title: Test Bank 4.2 Earned Income Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 27. In which scenario are you not required to file a tax return? A) Your AGI exceeds your allowed deductions. B) Your AGI does not exceed your allowed deductions. C) Your earned income exceeds your allowed deductions but not your unearned income. D) Your unearned income exceeds your allowed deductions but not your earned income. Answer: B Solution: If your AGI is no more than your standard deduction or itemized deductions, then your taxable income is zero, and you aren’t required to file a tax return. This means that single taxpayers could have earned up to $12,200 in 2019 without having to file a return. Married couples filing jointly had to file if they earned more than $24,400. Format: Multiple Choice Title: Test Bank 4.2 Exceptions to File a Tax Return Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 28. Which of the following is not used in the calculation of taxable income? A) Unearned income B) Standard deduction C) Itemized deduction D) Tax credit Answer: D

Solution: The IRS defines taxable income as the total of your earned income plus your unearned income less certain allowed adjustments and less the greater of the standard deduction or your itemized deductions. Tax credits are adjustments to your taxed owed and not to your income. Format: Multiple Choice Title: Test Bank 4.2 Taxable Income Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 29. Which is the main federal income tax form? A) W-2 B) W-4 C) Form 1040 D) Form 1099 Answer: C Solution: The main federal income tax form is Form 1040. Format: Multiple Choice Title: Test Bank 4.2 Federal Income Tax Form Section: IRS Forms Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 30. If you made a mistake on last year's tax return, you would file a A) 1040ext. B) 1040ES. C) 1040X. D) 1099X. Answer: C Solution: You need to file a 1040X Amended Return if you make a mistake on any of the previous three years’ tax forms. Format: Multiple Choice Title: Test Bank 4.2 Corrected Tax Return Section: IRS Forms Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Easy

Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 31. A member of a household who receives at least half of his or her support from the head of the household is a(n) A) allowance. B) dependent. C) child. D) kiddie. Answer: B Solution: A member of a household who receives at least half of his or her support from the head of the household is a dependent. A dependent can be an adult who has to be financially supported and lives with you. Format: Multiple Choice Title: Test Bank 4.2 Filing Status Section: Filing Status Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Expected Time to Complete: 1 minute 32. If you’re a qualifying ______, you _____ file your own tax return . A) dependent; must B) dependent; do not have to C) child; do not have to D) child; may have to Answer: D Solution: Even if you’re a qualifying dependent (either adult or child), you may have to file your own tax return, but this will depend on the types and amounts of income you receive. Format: Multiple Choice Title: Test Bank 4.2 Qualifying Dependent Section: Filing Status Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 33. Taxpayers should itemize deductions when _____ exceed(s) the standard deduction. A) the Schedule A total

B) the Schedule B total C) tax credits D) unearned income Answer: A Solution: If your total itemized deductions listed on Schedule A are greater than the applicable standard deduction, you should itemize deductions. Format: Multiple Choice Title: Test Bank 4.2 Itemized Versus Standard Deduction Section: IRS Forms Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 34. Tom is retired and lives off the rent he collects from his properties. Which form will Tom need to include rental income with his return? A) Schedule A B) Schedule B C) Schedule D D) Schedule E Answer: D Solution: If you have income and expenses from rental properties, you will be required to account for the cash flows on Schedule E - Supplemental Income and Loss. Format: Multiple Choice Title: Test Bank 4.2 Supplemental Income Form Section: Tax Forms Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 35. Mary had taxable income of $1,560 in the form of dividends and interest payments. While Mary is claimed as a dependent by her parents, she will A) be required to file a tax return. B) not be required to file a tax return. C) be required to file a tax return only if she also had earned income. D) be required to file a tax return only if she is seeking a tax refund. Answer: A

Solution: Mary will be required to file a tax return because her unearned income, such as earnings on investment accounts, was more than $1,100, triggering the kiddie tax. Format: Multiple Choice Title: Test Bank 4.2 Dependent Tax Filing Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 36. Polly and Steve are married graduate students t who earned a total income of $23,600 this year. Based on their situation, Polly and Steve are A) required to file a joint tax return. B) required to file a tax return as any qualified filing status. C) not required to file a tax return, if they each file separate tax returns. D) not required to file a tax return but should do so if they are owed a refund. Answer: D Solution: They are not required to file a tax return, because their income is less than the standard deduction ($24,400) but should do so if they are owed a refund. The standard deduction for married filing jointly is exactly twice the standard deduction of married filing separately. Format: Multiple Choice Title: Test Bank 4.2 Choosing Married Filing Status Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 37. Carla and Anthony are a married couple. Carla had earned income of $21,500 and had $2,750 withheld in federal income taxes by her employer, and Anthony was a full-time student. Based on their status and income, Carla should file a A) joint tax return seeking a refund of $2,750. B) single filer tax return seeking a refund of $1,820. C) married but filing separate tax return seeking a refund of $1,820. D) head of household tax return seeking a refund of $2,435. Answer: A

Solution: Carla would benefit the most by filing a joint tax return and taking the standard deduction of $24,400, whereby she would owe no tax. Had she filed a separate tax return, she would deduct the standard $12,200 and pay $930 in tax based on $9,300 taxable income. Format: Multiple Choice Title: Test Bank 4.2 Tax Refund Calculation Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 3 minutes 38. Ray’s accountant informed him that he qualifies for the American opportunity tax credit because he is a full-time student at the local university. Assuming Ray qualifies for a $2,500 tax credit, this means the credit will A) reduce his taxes owed by $2,500. B) reduce his taxable income by $2,500. C) increase his itemized deductions by $2,500. D) guarantee him a tax refund of $2,500. Answer: A Solution: Tax credits are subtracted directly from the taxes you owe. Deductions reduce your taxable income. A $2,500 tax credit will reduce Ray’s taxes owed by $2,500. Format: Multiple Choice Title: Test Bank 4.2 Tax Credit Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 39. Hector has been very busy with his construction work due to peak season and has not been able to collect all of the paperwork for completing his taxes on time. What should Hector do? A) He can receive an automatic six-month extension to file his taxes by filing Form 4868 by April 15. B) He can apply by April 15 to see if he can get a 6-month extension by filing Form 4868. C) He can send his tax return late within 6-months and avoid interest but pay a penalty.

D) He should call the IRS and make a case for extra time. The IRS may or may not grant him the extension upon review. Answer: A Solution: He can receive an automatic 6-month extension to file his taxes by filing Form 4868 by April 15. Format: Multiple Choice Title: Test Bank 4.2 Tax Return Extension Section: IRS Forms Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 40. Greg and Jamie are married and both work part-time while in graduate school. Greg earns $12,000, and Jaimie earns 11,000. Based on Greg and Jamie’s situation, which of the following is true? A) Greg and Jamie will only pay federal income tax. B) Greg and Jamie will pay federal income tax and payroll taxes. C) Greg and Jamie will only pay payroll taxes. D) Greg and Jamie will not pay any form of tax. Answer: C Solution: Greg and Jamie will only pay payroll taxes (Social Security and Medicare). Their combined incomes are under the standard joint deduction of $24,400 and the standard deduction of $12,200 if filing separately, so their taxable income is zero. Format: Multiple Choice Title: Test Bank 4.2 Taxable Income Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 41. Matthew is 16 years old and can be claimed as a dependent by his parents. He received $1,500 in dividends and $650 in interest and earned $4,800 from odd jobs during the year. Will Matthew need to file a separate tax return? Why? A) Yes. His earned income exceeds the maximum limit for a dependent. B) Yes. His unearned income exceeds the maximum limit for a dependent.

C) No. His gross income does not exceed the maximum limit for a dependent. D) No. His gross income is under the standard deduction. Answer: B Solution: Even if your parent claims you as a dependent, you may still need to file a tax return, depending on the amount and type of income you received during the year. Matthew needs to file a return because his unearned income of $2,150 (earnings on dividends and interest) was more than $1,100. Format: Multiple Choice Title: Test Bank 4.2 Dependent Earnings Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 42. While preparing his tax return, Emilio accidentally added his IRA retirement contribution of $2,900 to his gross income instead of subtracting it. If he is in the 24% marginal tax bracket, what will be the impact of this error on his federal taxes? A) His reported taxes will be higher by $1,392. B) His reported taxes will be lower by $1,392. C) His reported taxes will be lower by $696. D) His reported taxes will be higher by $696. Answer: B Solution: He has overstated his taxable income by $2,900 in erroneous earnings, and the IRA contribution of $2,900 will reduce his taxable income dollar for dollar as a deduction. If he had correctly reported his IRA, his taxable income would be $5,800 lower. This is worth $1,392 in reduced taxes ($5,800 × 0.24 marginal tax rate). Format: Multiple Choice Title: Test Bank 4.2 Marginal Income Calculation Section: Marginal Tax Rates Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 43. Heidi filed as a head of household and took the standard deduction this year despite her daughter moving out last year following her graduation from college. The standard deduction for single filers is $12,200, and head of

household is $18,350. Assuming a marginal tax rate of 32%, how much is this error worth? (Round to nearest whole number.) A) $1,968 B) $3,094 C) $4,182 D) $5,872 Answer: A Solution: Heidi should have used the standard deduction for single filers ($12,200) instead of the head of household ($18,350). The difference of $6,150 represents an over statement of the deduction and requires income taxes to be applied at the marginal tax rate of 32%; $6,150 × 0.32 = $1,968. Format: Multiple Choice Title: Test Bank 4.2 Marginal Income Calculation Section: Marginal Tax Rates Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 2 minutes 44. Natasha had earned income of $58,500 and will claim the standard deduction of $12,200 as a single taxpayer. If she has no other adjustment to her tax return, what will she owe in taxes? (Round to nearest whole number.)

A) $6,045 B) $8,729 C) $10,186 D) $12,870 Answer: A Solution: Natasha will have a taxable income of $58,500 - $12,200 standard deduction = $46,300.

Her tax is $4,543 + [0.22 × ($46,300 - $39,475)] = $6,044.50. Format: Multiple Choice Title: Test Bank 4.2 Income Tax Calculation Section: Adjusted Gross Income and Taxable Income Learning Objective: 4.2 Determine whether you need to file a federal income tax return and which forms you should use. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 45. The first step in calculating federal income taxes owed is to A) make adjustments to income. B) subtract tax credits. C) add up all sources of income. D) subtract taxes already paid through employer withholding. Answer: C Solution: The first step in calculating federal income taxes owed is to add up all sources of income. Format: Multiple Choice Title: Test Bank 4.3 Steps in Calculating Federal Income Taxes Owed Section: Federal Income Tax Calculation Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 46. Which of the following is not included in total income on federal income tax returns? A) Interest income B) Tips C) Life insurance proceeds D) Unemployment compensation Answer: C Solution: Life insurance proceeds are not taxable income.

Format: Multiple Choice Title: Test Bank 4.3 Reportable Income Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 47. Which of the following must be included in total income on federal income tax returns? A) Child support received B) Tips and bonuses C) Worker’s compensation benefits D) Insurance claim payments Answer: B Solution: Tips and bonuses are reportable income. Child support received, workers compensation benefits, and insurance proceeds are not taxable. Format: Multiple Choice Title: Test Bank 4.3 Reportable Income Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 48. Lee earned a salary of $25,000 from his job as a server last year. In addition, he earned $12,500 in tips, $135 in interest income, and $200 in dividend income from investments. What was Lee’s total income last year? A) $25,000 B) $25,335 C) $37,500 D) $37,835 Answer: D Solution: Lee’s salary of $25,000 + $12,500 in tips + $135 in interest income + $200 in dividend income = $37,835 Format: Multiple Choice Title: Test Bank 4.3 Taxable Income Calculation Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Easy Bloomcode: Analysis AACSB: Analytic

Expected Time to Complete: 1 minute 49. Whether your investment income qualifies for capital gains taxation instead of ordinary income taxation, it depends on A) how long you owned the investment. B) how long you owned the investment and how much you earn. C) your filing status only. D) how long you owned the investment, how much you earn, and your filing status. Answer: D Solution: Capital gains taxes depend on if you hold an investment longer than one year. If you held the investment less than a year, then your capital gain is based on your marginal tax rate. Whereas, if held longer than a year, the gain is subject to a lower capital gains tax rate: 0 percent for those in the 10 or 12 percent tax brackets; 20 percent for those with taxable income over $434,550 (single) or $488,850 (married filing jointly); and 15 percent for everyone else. Format: Multiple Choice Title: Test Bank 4.3 Tax on Capital Gains Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 50. Which of the following is an expense that is subtracted from total income to arrive at adjusted gross income? A) Individual retirement account contributions B) Long-term capital gains C) Child-care tax credit D) Lottery winnings Answer: A Solution: Individual retirement account (IRA) contributions are Schedule 1 deductions that can be subtracted from total income to arrive at adjusted gross income. Format: Multiple Choice Title: Test Bank 4.3 For AGI Deductions Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

51. Which of the following filing status categories receives the largest standard deduction? A) Single and 65 or older B) Head of household C) Married filing separately D) Married filing jointly Answer: D Solution: For tax year 2019, the allowed standard deduction amounts were as follows: single and married filing separately, $12,200; married filing jointly, $24,400; and head of household, $18,350. Format: Multiple Choice Title: Test Bank 4.3 Standard Deductions Section: Deductions Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 52. Which of the following types of taxes paid is not an allowable itemized deduction? A) State income taxes B) Personal property taxes C) Interest on personal loan D) Mortgage interest Answer: C Solution: Interest paid on credit cards, personal loans, and car loans is not deductible. The mortgage interest deduction is now limited to interest on $375,000 of home mortgages ($750,000 for married couples filing jointly) on both first and second homes. You’re allowed to deduct up to $10,000 in state and local income taxes, real estate property taxes paid on your primary residence, and personal property taxes. Format: Multiple Choice Title: Test Bank 4.3 Itemized Deductions Section: Deductions Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 53. Medical expenses that add up to more than ____ percent of adjusted gross income can be deducted.

A) 5 B) 7.5 C) 10 D) 12.5 Answer: C Solution: You can deduct out-of-pocket expenditures for health insurance premiums, medical services (doctor, dentist, optometrist, nurses, hospitals), prescription drugs, eyeglasses, hearing aids, travel for medical purposes, special schooling for disabled children, nursing homes, alternative medicine (chiropractors, acupuncture), and other medical and dental expenses to the extent that the sum of these expenses adds up to more than 10 percent of your adjusted gross income. Format: Multiple Choice Title: Test Bank 4.3 Medical and dental expenses Section: Deductions Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 54. Which is not an itemized deduction? A) Taxes you paid B) Interest you paid C) Retirement plan contributions D) Casualty and theft losses Answer: C Solution: Taxes you paid, interest you paid, and casualty and theft losses are itemized deductions you can take on Schedule A to be applied to the AGI. Retirement plan contributions are pre-AGI deductions taken on Schedule 1. Format: Multiple Choice Title: Test Bank 4.3 Itemized Deductions Section: Deductions Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 55. Which of the following occupations would be the most likely to pay estimated taxes? A) Self-employed tax preparer B) Software engineer for Microsoft C) Nurse at local hospital D) Public school teacher

Answer: A Solution: Because income tax and FICA (Social Security and Medicare) payroll taxes are not automatically withheld from self-employed income, self-employed individuals are required to make quarterly estimated tax payments throughout the year. Format: Multiple Choice Title: Test Bank 4.3 Estimated Taxes Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 56. A $1,000 tax credit for someone with a 35 percent marginal tax rate is worth A) $350. B) $650. C) $1,000. D) $1,350. Answer: C Solution: Tax credits directly reduce the taxes you owe dollar for dollar. A $1,000 tax credit is worth $1,000, because it’s applied against the tax you owe. Format: Multiple Choice Title: Test Bank 4.3 Tax Credits Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 57. If you sell shares of stock that you have owned for 15 months, any profit made on the sale would be classified as A) ordinary income. B) a short-term capital gain. C) a long-term capital gain. D) earned income. Answer: C Solution: If you sell shares of stock that you have owned for more than 12 months (one year), any profit made on the sale would be classified as a longterm capital gain. Format: Multiple Choice Title: Test Bank 4.3 Tax on Sale of Investment Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium

Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 58. Noncash contributions, such as food or clothing, given to charitable organizations are A) allowed as deductible contributions to a qualifying charity, only if itemizing deductions. B) allowed as deductible contributions to a qualifying charity even if using the standard deduction. C) not deductible contributions. D) not deductible contributions but may qualifying for a tax credit. Answer: A Solution: Non-cash contributions, such as food or clothing, given to charitable organizations are allowed as deductible contributions to a qualifying charity, if itemizing deductions. Format: Multiple Choice Title: Test Bank 4.3 Non-cash Contributions to a Charity Section: Deductions Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 59. Glenda has W-2 gross earnings of $125,000. A total of $8,500 of her income was deferred to her company’s retirement plan, and $5,800 was used to pay for her health-care premiums. What will be her W-2 taxable income? A) $110,700 B) $116,500 C) $119,200 D) $125,000 Answer: A Solution: Your taxable income, as reported on the W-2, will exclude any payments made on your behalf for tax-qualified health insurance and retirement plans; those amounts are subtracted from your income before it is reported on the W-2 and are not subject to tax. Glenda’s taxable income reported on her W-2 is $110,700; $125,000 gross - $8,500 deferred to retirement plan - $5,800 used to pay for health care premiums. Format: Multiple Choice Title: Test Bank 4.3 W-2 Taxable Income Calculation Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic

Expected Time to Complete: 3 minutes 60. Yvonne’s adjusted gross income is $54,455. She is a single parent with a qualifying dependent. Her itemized deductions total $6,800. What is her taxable income, given the following standard deductions? Standard deduction Married/joint: $24,400 Single: $12,200 Head of household: $18,350 Married/separate: $12,200 Dependent: $1,000 A) $36,105 B) $41,255 C) $47,655 D) $46,655 Answer: A Solution: Yvonne is a single parent with a qualifying dependent, so she can file as a head of household. The standard deduction is $18,350, which is greater than her itemized deductions of $6,800. Thus, her taxable income is $54,455 AGI - $18,350 = $36,105. Format: Multiple Choice Title: Test Bank 4.3 Taxable Income Calculation Section: Federal Income Tax Calculation Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 61. Jim and Judy file taxes jointly as a married couple. They have a combined adjusted gross income of $97,651. Their Schedule A itemized expenses are as follows: interest on home mortgage, $11,986; property taxes on home, $7,300; state income taxes, $3,880; and charitable contributions, $1,500. What is their taxable income, given the following standard deductions? Standard deduction Married/joint: $24,400 Single: $12,200 Head of household: $18,350 Married/separate: $12,200 Dependent: $1,000 A) $72,985 B) $73,251

C) $74,485 D) $74,971 Answer: A Solution: Jim and Judy file taxes jointly as a married couple, so their standard deduction is $24,400; however, their itemized deductions are higher. Their itemized deductions are $11,986 interest on mortgage + $7,300 property tax + $3,880 state income taxes + $1,500 charitable contributions = $24,666. Thus, their taxable income is $97,651 AGI - $24,666 itemized deductions = $72,985. Format: Multiple Choice Title: Test Bank 4.3 Taxable Income Calculation Section: Federal Income Tax Calculation Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 4 minutes 62. To calculate taxable income, which of the following must be subtracted from adjusted gross income (AGI)? A) Adjustments to total income B) Tax credits C) FICA payroll tax D) Standard or itemized deductions Answer: D Solution: To calculate taxable income, subtract the higher of the standard deduction or itemized deductions from your AGI. Format: Multiple Choice Title: Test Bank 4.3 Steps in Calculating Federal Income Taxes Owed Section: Federal Income Tax Calculation Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 63. David and Elaine have an AGI of $97,800 and file jointly as a married couple. What proportion of their gross income will not be taxed at all, assuming the couple claims a standard deduction of $24,400? (round to nearest percent.) A) 0% B) 25% C) 75% D) 100%

Answer: B Solution: $24,400 of their AGI will not be taxed. $24,400 standrd deduction = 0.25 or 25% $97,800 AGI Format: Multiple Choice Title: Test Bank 4.3 Taxable Income Percent Calculation Section: Federal Income Tax Calculation Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 64. Yulia and Mikhail had a joint taxable income of $58,700; and according to the tax tables, they owe $7,886 in federal taxes. Yulia is a full-time student earning her four-year degree at the local university. If their employers withheld $8,942 in federal taxes from their salaries and they qualify for a $2,000 education tax credit, calculate how much they owe or how much refund they can expect this year. A) $3,056 refund B) $3,056 owed C) $1,056 refund D) $1,056 owed Answer: A Solution: Their income tax due of $7,886 will be reduced by their tax credit of $2,000. $7,886 income tax due - $2,000 tax credit = $5,886 tax due. Since they already withheld $8,942, they will receive a tax refund of $3,056 ($8,942 - $5,886). Format: Multiple Choice Title: Test Bank 4.3 Tax Balance Due Calculation Section: Federal Income Tax Calculation Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 2 minutes 65. Bill and Miley had an adjusted gross income of $75,000. They file taxes jointly and the standard deduction for married filing jointly is $24,400. They listed their itemized expenses as follows: home mortgage interest, $4,750; house property tax, $5,890; state income tax, $3,000; and charitable gifts (market

value), $245. How much do they owe in federal income tax?

A) $5,684 B) $6,072 C) $6,946 D) $7,334 Answer: A Solution: Bill and Miley should use their standard deduction of $24,400, since it is larger than their itemized deductions of $13,885. Their taxable income is $75,000 AGI - $24,400 deduction = $50,600. Their taxes owed = $1,940 + [($50,600 taxable income - $19,400 bracket) × 12%]. Taxes owed = $1,940 + ($31,200 x 0.12) = $5,684.

Format: Multiple Choice Title: Test Bank 4.3 Income Tax Calculation Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 4 minutes 66. Donald sold his primary residence for $198,425 after owning it for seven years. His profit on the sale was $24,500. The long-term capital gains tax rate is 0 percent for those in the 10 or 12 percent tax brackets, 20 percent for those with taxable income over $434,550 (single), and 15 percent for everyone else. If Donald is in the 35 percent tax bracket, how much tax will he owe on the listed transactions? (Round to the nearest whole dollar.) A) $0

B) $3,675 C) $4,900 D) $8,575 Answer: A Solution: A special capital gains tax rule applies to profits made on the sale of your primary residence, defined as the place in which you lived for two of the last five years before the sale. You can exclude from your total income up to $250,000 of the gain on the sale of your home ($500,000 for married couples). In practice, this rule means that most people will never pay any tax on the profit they realize from selling their home. Format: Multiple Choice Title: Test Bank 4.3 Tax on Capital Gain of Residence Calculation Section: Reporting Income Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 67. Some of the cost of child-care expenses can be subtracted from your taxes through which of the following mechanisms? A) Deduction B) Exemption C) Credit D) Adjustment Answer: C Solution: Child- and dependent care expenses to cover the costs of child care necessary to allow you to work can be subtracted from your taxes through tax credits. Format: Multiple Choice Title: Test Bank 4.3 Child and Dependent Care Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 68. Which of the following tax credits best applies to a low-income family with two children? A) Lifetime learning credit B) Retirement savings contribution credit C) Child tax credit D) American opportunity credit

Answer: C Solution: The child tax credit reduces the tax burden on low-income working parents with children. Format: Multiple Choice Title: Test Bank 4.3 Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 69. Which of the following tax credits applies only to qualified undergraduate education expenses? A) Lifetime learning credit B) Retirement savings contribution credit C) Child tax credit D) American opportunity tax credit Answer: D Solution: The American opportunity tax credit applies only to qualified undergraduate education expenses. Format: Multiple Choice Title: Test Bank 4.3 Tax Credits Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 70. Which of the following tax credits best applies to a low-income person contributing to an IRA? A) Lifetime learning tax credit B) Retirement savings contribution credit C) Earned income tax credit D) American opportunity credit Answer: B Solution: Retirement savings contributions credit encourages retirement savings by offering 10 to 50 percent of eligible retirement contributions a maximum tax credit of $2,000 for a single filer ($4,000 married), phased out for AGI $19,251 - $32,000 single ($38,501 - $64,000 married). Format: Multiple Choice Title: Test Bank 4.3 Tax Credits Section: Calculation of Taxes Owed

Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 71. The alternative minimum tax was designed to A) make sure that high-income people don’t take advantage of too many special tax rules to avoid paying their fair share of taxes. B) reduce the tax burden on working parents by providing an alternative tax schedule. C) avoid double taxation and offset taxes paid to another country against federal income taxes owed. D) make sure that low-income people don’t take advantage of too many special tax rules to avoid paying their fair share of taxes. Answer: A Solution: The alternative minimum tax was designed to make sure high-income people don’t take advantage of too many special tax rules to avoid paying their fair share of taxes. Format: Multiple Choice Title: Test Bank 4.3 Alternative Minimum Tax Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Medium Bloomcode: Comprehensive AACSB: Reflective Thinking Expected Time to Complete: 1 minute 72. Which of the following is most likely to trigger the alternative minimum tax (AMT) for a tax filer? A) Reporting the standard deduction instead of itemized deductions B) Contributing to your company’s tax-sheltered retirement plan C) Claiming large number of deductions or credits D) Filing as head of household Answer: C Solution: The AMT requires you to recalculate your taxes under a different set of rules in which many of the current deductions and special tax breaks do not apply. Some of the triggers for AMT liability in a given year include a large number of credits, exercise of incentive stock options, long-term capital gains, and unusually large itemized deductions. Format: Multiple Choice Title: Test Bank 4.3 Alternative Minimum Tax Section: Calculation of Taxes Owed Learning Objective: 4.3 Prepare a basic tax return.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 73. When your employer takes money out of your paycheck and sends it to the government, it is called A) an itemized deduction. B) payroll withholding. C) a tax credit. D) a regressive tax. Answer: B Solution: For earned income from employment, the payment of estimated taxes is usually accomplished through payroll withholding, whereby the employer takes money out of your income and sends it to the government. Format: Multiple Choice Title: Test Bank 4.3 Tax Payment Section: Determining Taxes Due or Refund to Be Received Learning Objective: 4.3 Prepare a basic tax return. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 74. Reimbursement accounts for qualified medical and child-care expenses are known as A) option plans. B) cafeteria plans. C) deferred compensation plans. D) flexible spending accounts. Answer: D Solution: A flexible spending account is a reimbursement account for qualified medical and child-care expenses. Each pay period, the employer subtracts a certain amount from your paycheck and deposits it in your flexible spending account. You can then obtain reimbursement from the account as you incur qualified expenses. Format: Multiple Choice Title: Test Bank 4.4 Reimbursement Accounts Section: Maximize Pretax Contributions to Qualified Benefit Plans Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension

Expected Time to Complete: 1 minute 75. Which of the following retirement accounts allows tax-free withdrawals at retirement? A) Roth IRAs B) 403(b) plans C) 401(k) plans D) Traditional IRAs Answer: A Solution: A Roth IRA does not allow you to take a current tax deduction like the other choices, so you must make your contribution with after-tax dollars. However, assuming that you use the funds for retirement or other allowed purposes, you never have to pay tax on the money again, as the account, including all accumulated investment earnings, can grow tax-free, and you can take the money out during retirement without paying any taxes on the investment earnings. Format: Multiple Choice Title: Test Bank 4.4 Retirement Accounts Section: Maximize Pretax Contributions to Qualified Benefit Plans Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 76. Which of the following is not deductible from income for federal income taxes? A) Traditional IRA contribution B) Roth IRA contribution C) Medical flexible spending account contribution D) Employer retirement plan contribution Answer: B Solution: A Roth IRA does not allow you to take a current tax deduction like the other choices, so you must make your contribution with after-tax dollars. However, assuming that you use the funds for retirement or other allowed purposes, you never have to pay tax on the money again, as the account, including all accumulated investment earnings, can grow tax-free, and you can take the money out during retirement without paying any taxes on the investment earnings. Format: Multiple Choice Title: Test Bank 4.4 Retirement Accounts Section: Maximize Pretax Contributions to Qualified Benefit Plans

Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 77. Which of the following is considered tax evasion? A) Working under the table for someone who pays you in cash and does not withhold taxes B) Contributing to tax-deferred retirement plans C) Holding a stock an extra day to avoid short-term capital gain D) Tracking your expenses during the year with the goal of itemizing expenses on your taxes Answer: A Solution: Tax evasion is when you don’t report income, underreport income, or exaggerate deductions to avoid paying income taxes. Tax avoidance is using legal tax strategies to avoid taxation, such as tax-deferred retirement plans, holding out for long-term capital gains, and itemizing eligible tax deductions. Format: Multiple Choice Title: Test Bank 4.4 Tax Evasion Section: Avoid Audits and Penalties Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 78. Which action is against the law and is subject to criminal penalties? A) Tax avoidance B) Tax evasion C) Tax deferral D) Tax exemption Answer: B Solution: Tax evasion is against the law and is subject to criminal penalties. Format: Multiple Choice Title: Test Bank 4.4 Enforcement of Tax Laws Section: Avoid Audits and Penalties Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking

Expected Time to Complete: 1 minute 79. For most taxpayers, their biggest tax shelter is their A) IRA. B) flexible spending account. C) employer retirement account. D) home. Answer: D Solution: For most taxpayers, their biggest tax shelter is their home. In addition to most capital gains from the sale of your primary residence are tax-free, mortgage interest and property taxes are deductible; so, for most taxpayers, the home is their biggest tax shelter. Format: Multiple Choice Title: Test Bank 4.4 Tax Shelter Section: Reduce the Applicable Tax Rate on Certain Income Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. All tax audits by the IRS are A) in person at the IRS. B) by mail. C) in person at your home. D) All the choices are correct. Answer: D Solution: If you are audited, you may be asked to provide documentation for specific deductions through the mail. In rare cases, you may even have to appear at a local IRS office. Alternatively, an IRS agent may come to your home to investigate, most commonly to verify small business and home office deductions. Format: Multiple Choice Title: Test Bank 4.4 IRS Audits Section: Avoid Audits and Penalties Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 81. A taxpayer can reduce his or her taxes paid by taking all of the following actions except A) filing late and delaying the tax payments.

B) shifting income between years to reduce the tax rate. C) taking advantage of all deductions available under the laws. D) availing of all tax credits that he or she is eligible for. Answer: A Solution: Filing late and delaying tax payments will not reduce taxes paid and may in fact increase the amount owed if the failure to pay on time results in penalties. All of the other choices are strategies for reducing taxes. Format: Multiple Choice Title: Test Bank 4.4 Section: Reduce the Applicable Tax Rate on Certain Income Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 82. Anita contributes 5% of her salary to her employer’s qualified retirement plan. If she earns a gross salary of $60,000 and her marginal tax rate is 24%, how much federal income tax is she saving? A) $720 B) $1,440 C) $3,000 D) $14,400 Answer: A Solution: Five percent deferral of $60,000 salary is $3,000 ($60,000 × 0.05) that she will save annually. She will save her marginal tax rate of 24% on the $3,000 annual deferral: $720 ($3,000 × 0.24). Format: Multiple Choice Title: Test Bank 4.4 Tax Savings on Salary Deferral Calculation Section: Maximize Pretax Contributions to Qualified Benefit Plans Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 83. Melissa does not receive employer-funded health-care benefits. However, she is offered an opportunity to purchase a health-care plan for $400 per month paid out of pretax dollars. How much tax does Melissa save annually if her marginal tax rate is 24%? A) $96 B) $1,152 C) $3,648

D) $4,800 Answer: B Solution: She will pay $400 × 12 months ($4,800) in pre-tax premiums. She will save 24% (her marginal tax rate) on her total pre-tax premiums of $4,800. Tax savings = $4,800 × 0.24 = $1,152. Format: Multiple Choice Title: Test Bank 4.4 Pretax Health-Care Savings Calculation Section: Maximize Pretax Contributions to Qualified Benefit Plans Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 84. Barbara found a 1099-Int from her bank while spring cleaning. She knew right away that she did not give this to her accountant for her tax preparation. What can she expect from the IRS? A) A bill from the IRS for underpayment of tax plus interest and penalty B) A refund from the IRS C) A bill from the IRS for underpayment of tax but no interest or penalty charges since she made the mistake unknowingly D) A letter informing her that she submitted an incorrect tax return Answer: A Solution: The IRS employs several levels of scrutiny to investigate tax returns for errors and intentional omissions. All earned income, investment income, and interest expenses are independently reported to the government, so errors and omissions in reporting these items are usually caught within a few months of filing a return. You’ll simply get a bill for the underpayment plus any applicable penalties. Format: Multiple Choice Title: Test Bank 4.4 Enforcement of Tax Laws Section: Avoid Audits and Penalties Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 85. Amber and Trent are married filing a joint return and have $13,000 in taxable income. They qualified for $6,557 in earned income tax credits, and their marginal tax rate is 10%. If they had $1,200 in federal taxes withheld, determine their tax due or refund to be received? (Rounded to nearest dollar.) A) $0 tax owed

B) $100 tax owed C) $556 refund D) $6,457 refund Answer: D Solution: $13,000 taxable income × 10% marginal tax rate = $1,300 tax owed. $1,200 tax withheld + $6,557 tax credits - $1,300 tax owed = $6,457 refund. Format: Multiple Choice Title: Test Bank 4.4 Tax Due/Refund Calculation Section: Determining Taxes Due or Refund to Be Received Learning Objective: 4.4 Establish financial planning strategies to legally minimize the taxes you pay. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes

Note: This Test Bank file is provided for demo purposes only. It has been preliminarily revised to Reflect the 2nd edition content, but accuracy checking has yet to be completed. Accuracy checked version will be provided with full course release. Chapter 5 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 94 Multiple Choice Questions

LO5-1 LO5-2 LO5-3 LO5-4 TOTAL

Easy 5 8 5 9 27 (29%)

Knowledge: Comprehension: Application: Analysis: Synthesis Evaluation: TOTAL

Medium 13 12 12 23 60 (64%)

Hard 0 1 1 5 7 (7%)

Total 18 21 18 37 94

23 28 29 8 4 2 94

Calculation Questions (all algorithmic) 38 48 54 55 57 82 84 85 87 88 91 93 94

Credit card payment APR Finance charge (simple) Credit card finance charge Credit Card payment HELOC credit limit / LTV Total interest paid on a loan Interest-only payment Loan payment comparison Total interest paid comparison Student loan payment Mid-period amortization balance Auto purchase amount based on loan payment and down-payment

1. Which is not a type of consumer credit? A) Debit cards B) Credit cards C) Car loans D) Student loans Answer: A Solution: Debit cards do not provide credit. Debit cards electronically draw the funds from your linked checking account. Format: Multiple Choice Title: Test Bank 5.1 Types of Consumer Credit Section: What Is Consumer Credit? Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 2. Consumer finance companies offer ______ than depository institutions. A) lower rates B) higher rates C) stricter credit standards D) higher credit standards Answer: B Solution: Depository institutions, such as banks and credit unions, obtain funds from customer deposits into checking and savings accounts. They can lend at lower rates because they pay relatively low rates of return to their depositors. They also impose fairly strict standards for creditworthiness, so if you have very little experience with borrowing or have made late payments in the past, you might not qualify for a loan. Format: Multiple Choice Title: Test Bank 5.1 Consumer Finance Companies Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute

3. Which is not a source for student loans? A) Sales finance company B) The federal government C) Depository institution D) Credit card

Answer: A Solution: The federal government, banks and credit cards, are sources for school expenses. A sales finance company makes consumer loans to buyers of products offered through its parent company, usually a large retailer. For example, many automakers and large department stores have their own finance companies for this purpose. Format: Multiple Choice Title: Test Bank 5.1 Student loans Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute

4. Borrowers who might not qualify for loans at ______ are often able to obtain loans at ______. A) depository institutions; consumer finance companies B) payday lenders; depository institutions C) consumer finance companies; depository institutions D) payday lenders; consumer finance companies Answer: A Solution: Depository institutions, such as banks and credit unions, impose the strictest standards for creditworthiness because they are using depositors’ money. However, payday lenders regularly provide short-term loans to people who don’t have any conventional alternatives, at very high rates using the borrower’s check or other valuable items as collateral, until the loan can be repaid at payday. Format: Multiple Choice Title: Test Bank 5.1 Consumer Credit Standards Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

5. The interest rate for a credit purchase from a ______ is likely to be lower than a similar loan charged by a_______. A) sales finance company; consumer finance company B) consumer finance company; sales finance company C) pawnshop; sales finance company D) pawnshop; consumer finance company Answer: A

Solution: A sales finance company makes consumer loans to buyers of products offered through its parent company, usually a large retailer. The rates charged by sales finance companies are likely to be lower than those charged by consumer finance companies, particularly if the item being purchased, such as a new car, is pledged as collateral for the loan. Pawnshops regularly provide short-term loans to people who don’t have any conventional alternatives, at very high rates using any items of value as collateral, until the loan can be repaid. Format: Multiple Choice Title: Test Bank 5.1 Consumer Credit Rates Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

6. Which would not be considered an open-end credit? A) Credit card B) Department store credit account C) Home equity line of credit D) Home mortgage Answer: D Solution: Open-end credit, also called revolving credit, is generally not earmarked for a particular purchase, and, although billing periods and requirements for minimum monthly payments are specified in advance, there isn’t a maximum time period for full repayment of the debt. Instead, the lender preapproves an amount of credit, called a credit limit or credit line, in advance of any purchase. You can then use this credit as you wish until you’ve reached your credit limit. Credit cards and department store credit accounts are unsecured revolving credit. Home equity line of credit is revolving credit secured by the home. A home mortgage is a closed-end loan that is amortized over a specific period of time at a stated APR. Format: Multiple Choice Title: Test Bank 5.1 Closed-End versus Open-End Credit Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

7. A credit card issued by Home Depot is both a ______ card and ________ type of credit. A) retail; an open-end B) retail; a closed-end

C) bank; an open-end D) bank; a closed-end Answer: A Solution: Credit cards are open-end credit, which is earmarked for any particular purchase, and, although billing periods and requirements for minimum monthly payments are specified in advance, there isn’t a maximum time period for full repayment of the debt. Instead, the lender preapproves an amount of credit, called a credit limit or credit line, in advance of any purchase. You can then use this credit as you wish until you’ve reached your credit limit. Home Depot is an open-end retail credit card issuer, whereas Visa and MasterCard are bank credit card issuers. Format: Multiple Choice Title: Test Bank 5.1 Closed-End versus Open-End Credit Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

8. Which represents the largest share of household debt in the United States? A) Home mortgages B) Student loans C) Auto loans D) Credit cards Answer: A Solution: More than 70 percent of total household debt is in the form of home mortgages. The rest is consumer credit of various types, including student loans, auto loans, credit cards, and home equity lines of credit. Format: Multiple Choice Title: Test Bank 5.1 Household Consumer Credit in the United States Section: What Is Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute

9. A _______ credit card can be used, up to your credit limit,_______. A) retail; at any retailer B) retail; only at the respective retailer C) bank; only at the respective retailer D) travel and entertainment; only at the member airlines and restaurants

Answer: B Solution: Retail credit cards issued by the respective store offer a credit line for the purchase of goods and services provided only at their physical and online stores. Bank credit cards, such as Visa and MasterCard, and travel and entertainment cards, such as American Express and Diners Club, do not have any restrictions on where to use. Format: Multiple Choice Title: Test Bank 5.1 Types Credit Cards Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

10. Which of the following is a benefit of consumer credit to the U.S. economy as a whole? A) Greater household debt B) Increased homeownership C) Lower unemployment D) Lower interest rates Answer: B Solution: Being able to spread out the cost of expensive items over time, and also getting to use them right away, makes it possible to improve your standard of living. You don’t have to save up the entire purchase price of a house over 30 years or rent it to maintain a home. The benefit of making mortgage payments versus rent payments is creating longterm wealth. Format: Multiple Choice Title: Test Bank 5.1 Advantages of Consumer Credit Section: The Advantages and Disadvantages of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

11. Ford Motor Credit, which finances Ford autos for customers, is an example of a A) consumer finance company. B) sales finance company. C) retail finance company. D) wholesale finance company. Answer: B Solution: A sales finance company makes consumer loans to buyers of products offered through its parent company, usually a large retailer or manufacturer. Ford Motors is an

auto manufacturer that has its own finance company, Ford Motor Credit, to facilitate greater auto sales. Format: Multiple Choice Title: Test Bank 5.1 Sources of Consumer Credit Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute

12. Which of the following is true about the relationship between your use of credit and your insurance premiums? A) Poor credit management may result in increased insurance premiums. B) Paying insurance premiums by credit cards reduces the amount due. C) Insurance premiums will not be affected by your credit history. D) Buying insurance through credit card companies may result in lower premiums. Answer: A Solution: Many insurance companies have been using consumer credit history as a factor in pricing individual auto and homeowner’s insurance policies. Thus, if you have a lot of outstanding debt or a history of making late credit card payments, you may be paying a higher insurance premium than others with better credit. Format: Multiple Choice Title: Test Bank 5.1 Disadvantages of Consumer Credit Section: The Advantages and Disadvantages of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes

13. Which of the following statements is true regarding trends in U.S. household debt? A) Household debt has increased at a faster rate than household income. B) Home mortgage debt is less than half of total debt. C) As a proportion of total household debt, student loans have declined and home equity loans have increased. D) Credit card debt is the largest component of outstanding consumer debt. Answer: A Solution: Total household debt has more than doubled, rising much faster than income. More than 70 percent of this debt is in the form of home mortgages. The rest is consumer credit of various types, including student loans, auto loans, credit cards, and home equity lines of credit. The fastest-growing component of debt is student loan debt.

Format: Multiple Choice Title: Test Bank 5.1 Household Consumer Credit in the United States Section: What Is Consumer Credit? Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 14. Payday lenders are controversial because they A) allow people to cash their paychecks even when they do not have a bank account. B) charge very high rates of interest. C) are in competition with traditional lenders. D) make it easier for undocumented workers to stay in the job market. Answer: B Solution: Payday lenders regularly provide short-term loans to people who don’t have any conventional alternatives, at very high rates using the borrower’s check or other valuable items as collateral, until the loan can be repaid at payday. Because the time period between when you get the money and when the lender is repaid is so short, consumers end up paying egregiously high rates of interest on these loans. Format: Multiple Choice Title: Test Bank 5.1 Payday Loans Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 15. What information is typically not asked for on a consumer credit application? A) Income B) Assets C) Debt D) Dependents Answer: D Solution: Information related to your creditworthiness usually includes details about income, assets, and debts. Format: Multiple Choice Title: Test Bank 5.1 Applying for Consumer Credit Section: Applying for Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Easy Bloomcode: Knowledge

AACSB: Knowledge Expected Time to Complete: 1 minute 16. What is a function of the Consumer Financial Protection Bureau? A) Sets the maximum interest rates that can be charged on credit cards B) Establishes standard contracts for home equity loans C) Insures the money consumers have on deposit in large banks D) Protects consumers from unfair or illegal lending practices Answer: D Solution: Protecting consumers from unfair or illegal lending practices is a function of the Consumer Financial Protection Bureau. Format: Multiple Choice Title: Test Bank 5.1 Consumer Financial Protection Bureau Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 17. Which of the following is not a form of revolving credit? A) American Express card B) Overdraft protection on a Bank America checking account C) Wells Fargo home equity line of credit D) Chase Visa debit card Answer: D Solution: Credit cards, such as an American Express travel and entertainment card; overdraft protection from a depository institution, such as Bank America; and a home equity line of credit from a depository institution, such as Wells Fargo, are all types of revolving credit. A debit card is a form of electronic payment method by a payment processor, such as Visa, that draws payment directly from a checking account at a depository institution like Chase Bank. Format: Multiple Choice Title: Test Bank 5.1 Types and Sources of Consumer Credit Section: Types and Sources of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 18. All of the following are risks associated with the use of credit cards except A) increased risk of identity theft.

B) increased risk of overspending. C) potential adverse impact on credit score. D) ability to spread the cost of large purchases over time. Answer: D Solution: Increased risk of overspending and identity theft are risks associated with the use of credit cards that may also negatively impact your credit score. The ability to spread the cost of large purchases over time enhances your standard of living, thus, is a benefit of credit. Format: Multiple Choice Title: Test Bank 5.1 Disadvantages of Consumer Credit Section: The Advantages and Disadvantages of Consumer Credit Learning Objective: 5.1 Describe the role of consumer credit in your financial plan. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 19. In order to assess a prospective borrower's credit capacity, the lender will evaluate A) the economic conditions in the area. B) your total debt and assets. C) your income tax rate. D) the sources of your income and expenses Answer: D Solution: A lender’s assessment of your ability, or capacity, to repay your debts is usually based on your household cash flow. Lenders may evaluate your capacity by looking at your sources of income and your expenses. Format: Multiple Choice Title: Test Bank 5.2 Credit Capacity Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 20. Lenders will consider borrowers who have _______ to be less likely to default on a loan. A) higher levels of assets B) lower levels of assets C) higher levels of debt D) lower levels of income Answer: A Solution: Lenders are interested in your household’s net worth or capital. If total assets are greater than total debts, they will consider that you could, if necessary, liquidate other

assets to pay back the loan. In addition, lenders know that you won’t want to risk your other assets being taken to repay the debt. Format: Multiple Choice Title: Test Bank 5.2 Capital Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 21. If you don’t make payments on a secured loan as promised, a lender can A) take any pledged collateral and resell it to pay off the loan. B) take any of your assets and resell it to pay off the loan. C) take any pledged collateral until you make all the missed payments. D) attach a lien on the pledged assets. Answer: A Solution: If you don’t make payments on a secured loan as promised, a lender can take any pledged collateral and resell it to pay off the loan. Format: Multiple Choice Title: Test Bank 5.2 Collateral Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 22. It is recommended that borrowers take the ____ loan they can afford, when obtaining ____ loans. A) shortest; debt consolidation B) longest; debt consolidation C) highest; debt consolidation D) highest; any Answer: A Solution: If you decide to consolidate your debts for lower interest rates, it’s best to take the shortest loan that you can reasonably afford to pay off. If you stretch out the payment schedule, you will pay additional interest charges, and it will take you that much longer to get your finances back on track. In addition, it’s very important to limit debt to what you’re paying off. If you couldn’t afford the payments before the debt consolidation, you certainly won’t be able to make payments on the Refinanced loan and any additional debt.

Format: Multiple Choice Title: Test Bank 5.2 Debt Consolidation Loan Section: Strategies for Reducing Debt Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 23. Bankruptcy appears on your credit report ____ and may affect your ability to obtain _____. A) for 10 years; any credit B) for 7 years; a mortgage C) forever; any credit D) forever; a mortgage Answer: A Solution: Bankruptcy appears on your credit report for 10 years and may affect your ability to obtain a home mortgage or any other credit. Format: Multiple Choice Title: Test Bank 5.2 Bankruptcy on Your Credit Report Section: Bankruptcy Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 24. In assessing a person’s creditworthiness using the Five Cs of Credit, which of the following is applicable in the category of “capacity”? A. The income of the person applying for credit B. The value of the asset that will secure the loan C. The amount of other debt the applicant already owes D. The credit score of the person applying for credit Answer: A Solution: A lender’s assessment of your ability, or capacity, to repay your debts is usually based on your household cash flow. Lenders may evaluate your capacity by looking at your sources of income and your expenses. Format: Multiple Choice Title: Test Bank 5.2 Assessing Credit Capacity Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights.

Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 25. All of the following are reasons that credit counselors recommend using a debt consolidation loan to pay off existing consumer credit accounts, except A) you will pay lower annual fees. B) lenders will increase your credit card limits. C) your monthly payment will be lower. D) you will pay lower annual finance charges. Answer: B Solution: A debt consolidation loan is a loan earmarked for repayment of debt with higher total finance charges. If you decide to consolidate your debts to reduce your payments, it’s very important to stop using the cards you’re paying off. If you couldn’t afford the payments before, you certainly won’t be able to make payments on both the Refinanced loan and any new debt. Format: Multiple Choice Title: Test Bank 5.2 Debt Consolidation Loans Section: Strategies for Reducing Debt Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 26. Which of the following is not one of the Five C's of Credit? A) Conditions B) Capacity C) Credibility D) Capital Answer: C Solution: The “Five Cs of Credit” are capacity, capital, collateral, character, and conditions. Format: Multiple Choice Title: Test Bank 5.2 The Five Cs of Credit Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge

Expected Time to Complete: 1 minute 27. When lenders evaluate your sources of income and your expenses, which of the Five Cs of Credit are they considering? A) Capacity B) Capital C) Collateral D) Character Answer: A Solution: A lender’s assessment of your ability, or capacity, to repay your debts is usually based on your household cash flow. Lenders may evaluate your capacity by looking at your sources of income and your expenses. Format: Multiple Choice Title: Test Bank 5.2 Credit Capacity Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 28. When you know that you cannot meet your debt obligations, you should A) contact your creditors directly to explain the situation. B) not contact your creditors because it will adversely affect your credit report. C) declare bankruptcy as soon as possible. D) use alternative lenders such as payday lenders. Answer: A Solution: If you’ve already gotten so far behind on your payment obligations that you can’t see any way to resolve your financial problems, the most common strategy in this situation is avoidance. This is not a good approach, and it increases the risk that your creditors will take more serious steps to collect the debt. Instead, you should contact your creditors directly and seek out consumer credit counseling. As a last resort, you might consider declaring bankruptcy, but doing so has serious long-term consequences. Format: Multiple Choice Title: Test Bank 5.2 Credit Troubles Section: Bankruptcy Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes

29. A person who agrees to take responsibility for the repayment of a loan if the primary borrower defaults are known as a A) mentor. B) guarantor. C) cosigner. D) benefactor. Answer: C Solution: A cosigner is a person who agrees to take responsibility if you don’t make your payments as agreed. The lender can use the same collection methods against the cosigner as it can against the borrower, such as garnishing wages and suing in a court of law. And if the loan goes into default, the cosigner’s credit will be adversely affected. Format: Multiple Choice Title: Test Bank 5.2 Cosigner Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 30. Lenders cannot deny credit based on A) credit history. B) debt obligations. C) income. D) marital status. Answer: D Solution: Lenders are not allowed to deny you credit based on race, sex, marital status, religion, age, national origin, or receipt of public benefits. However, they can deny credit based on insufficient income or credit history. Format: Multiple Choice Title: Test Bank 5.2 Credit Rights Section: Your Consumer Credit Rights Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 31. Which of the following is not one of the factors considered in the FICO credit scoring system? A) Level of debt

B) Employment history C) Variety of debt sources D) Length of credit history Answer: B Solution: FICO credit score factors include payment history, amounts owed (level of debt), length of credit history, new credit, and types of credit used (variety of debt sources). Format: Multiple Choice Title: Test Bank 5.2 FICO Credit Score Factors Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 32. Which of the following FICO credit scoring factors carries the greatest weight? A) Payment history B) Amounts owed C) Types of credit used D) Length of credit history Answer: A Solution: FICO credit score factors include payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and types of credit used (10%). Format: Multiple Choice Title: Test Bank 5.2 Largest FICO Credit Score Factor Section: Measuring Your Credit Capacity Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 33. Negative credit information, with the exception of bankruptcies, must be removed from a credit report after ___ years. A) 3 B) 5 C) 7 D) 10 Answer: C

Solution: Negative credit information, with the exception of bankruptcies, must be removed from a credit report after 7 years. Format: Multiple Choice Title: Test Bank 5.2 Accuracy of Reported Credit Information Section: Your Consumer Credit Rights Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 34. Which of the following is not one of the recommended solutions if you are having trouble making payments on your consumer credit? A) Take a second job. B) Live with your parents or other family members. C) Transfer balances to another credit card. D) Sell some assets. Answer: C Solution: Transferring balances to another credit card is not a solution for reducing debt, but just a method of Refinancing that may provide a potentially irresistible opportunity to further increase debt. Format: Multiple Choice Title: Test Bank 5.2 Strategies for Reducing Debt Section: Strategies for Reducing Debt Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 35. A strategy that starts with budgeting the absolute necessities and debt payments and then adds expenditures until there is no more cash flow is known as a A) net sum budget. B) pro forma budget. C) line item budget. D) zero-based budget. Answer: D Solution: Zero-based budgeting is a strategy often recommended by financial planners. To construct a zero-based budget, you start with absolute necessities and debt payments and then add expenditures until you run out of cash. Thus, “fun” money for

entertainment, eating out, and clothes shopping would have lower priority than payments to reduce your debt. Format: Multiple Choice Title: Test Bank 5.2 Zero-Based Budget Section: Strategies for Reducing Debt Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 36. Which type of bankruptcy requires the liquidation of most of your assets? A) Chapter 5 B) Chapter 7 C) Chapter 11 D) Chapter 13 Answer: B Solution: A Chapter 7 bankruptcy requires the liquidation, or sale, of most of your assets. The proceeds of the sale of your assets are used to pay creditors to the extent possible, and most of your financial obligations are then cleared. Format: Multiple Choice Title: Test Bank 5.2 Bankruptcy Section: Bankruptcy Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 37. Which type of bankruptcy requires that you develop and implement a plan to repay your debts under court supervision and allows you to keep all of your assets? A) Chapter 5 B) Chapter 7 C) Chapter 11 D) Chapter 13 Answer: D Solution: In a Chapter 13 bankruptcy, you can generally keep all of your assets under protection from creditors’ claims while you develop and implement a plan to repay your debts under court supervision, usually with reduced balances and payments. Format: Multiple Choice

Title: Test Bank 5.2 Bankruptcy Section: Bankruptcy Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 38. Maria has accumulated $6,000 in credit card debt and the annual rate on the card is 12%. If she wants to be able to pay it off in four years (48 months), what monthly payment will she need to make (rounded to the nearest dollar)? A) $125 B) $158 C) $164 D) $185 Answer: B Solution: Calculate the monthly payment necessary to amortize a $6,000 loan (PV) over 48 months (N) at a 12% APR. Financial Calculator: Input PV = 6,000, FV = 0, N = 48, I = 12/12 and Solve for PMT => -158.00 Excel Function: =PMT(Rate, Nper, PV, FV, Type) =PMT((0.12/12), 48, 6000, 0, 0) => -158.00 TVM Formula: PMT = PVA ×

PMT = $6,000 ×

𝑖 𝑛 => 1 ) 1– ( (1 + 𝑖) 0.01

48 1 ) 1– ( (1 + 0.01)

= $158.00

Format: Multiple Choice Title: Test Bank 5.2 Credit Card Payment Calculation Section: Strategies for Reducing Debt Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic AACSB: Analytic

Expected Time to Complete: 2 minutes [Note to programmers: Please make this problem algorithmic. Detractor answers: A) loan value/# of months; C) Problem solved for annual payment and then divided by 12: PV=6000, N=4, I=12, solve for PMT =1975. Divide by 12 = 164; D) Add on interest: 12% × 6000 = 720. × 4years = 2880. Total (6000+2880)/48 =185] 39. Which of the following is not correct about your consumer credit rights? A) Lenders must provide you with full and truthful information about loans they are offering. B) Lenders billing statements must provide you with full information about all charges made to your account. C) Credit card interest rates cannot be increased in the first 12 months after you open an account. D) Promotional rates, such as 0 percent interest, on new credit cards must last for at least six months. Answer: C Solution: There are several important protections against unfair credit card practices related to interest rates and fees, Promotional rates must last at least 6 months; and interest rates cannot be increased in the first 12 months after you have opened a credit card unless you have been late in making your payments or the rate increase was disclosed when you first opened the card. Lenders must provide you with full and truthful information about loans they are offering, and billing statements must provide you with full information about all charges made to your account. Format: Multiple Choice Title: Test Bank 5.2 Your Consumer Credit Rights Section: Your Consumer Credit Rights Learning Objective: 5.2 Maintain your creditworthiness, and understand your consumer credit rights. Difficulty: Hard Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 40. Lenders are required to report the ____ on all types of loans they advertise so that borrowers can easily compare borrowing costs. A) annual percentage yield (APY) B) annual percentage rate (APR) C) nominal percentage rate (NPR) D) real percentage rate (RPR) Answer: B Solution: The Truth in Lending Act requires lenders to provide you with full and truthful information, written in plain language, including the true cost of consumer credit as measured by APR, which includes finance charges, fees, and penalties. This information

enables you to make better decisions when choosing between potential lenders and reduces the likelihood that you’ll be taken advantage of by unscrupulous lenders. Format: Multiple Choice Title: Test Bank 5.3 Full Information from Prospective Lender Section: Your Consumer Credit Rights Learning Objective: 5.3 Common Credit Card Contract Terms. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 41. A smart card is similar to a _____ card but _______. A) prepaid; can be used anywhere B) debit; offers a credit line C) credit; is automatically paid from your checking account D) debit; payment is delayed until the monthly due date Answer: A Solution: Unlike debit and ATM cards, smart cards actually store electronic cash and do not require a bank account. These funds have already been withdrawn from a bank account and are essentially “on deposit” in the card until used. Prepaid cards such as Walmart or Starbucks gift cards operate on the same principle but cannot be used anywhere. Format: Multiple Choice Title: Test Bank 5.3 Smart Cards Section: Types of Cards Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 42. The federally regulated minimum payment on your credit card is A) just the monthly interest due on the account for the period. B) the monthly interest due on the account for the period and one percent of the outstanding balance. C) the amortized value of the outstanding balance. D) the amount of interest and fees due on the account for the period plus one percent of the outstanding balance. Answer: D Solution: Under guidelines suggested by federal regulators and adopted by most credit card issuers, the minimum payment is equal to the amount of interest and fees due on the account for the period plus 1 percent of the balance owed. Format: Multiple Choice Title: Test Bank 5.3 Minimum Payment on a Credit Card

Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 43. You should always pay more than the minimum monthly payment owed on your credit card because A) it is only enough to pay the interest and fees and does not include any repayment of the outstanding balance. B) otherwise it can take several years to fully repay the balance. C) otherwise you will never fully repay the balance. D) it is only enough to pay the interest and does not include any repayment of the outstanding balance. Answer: B Solution: Under guidelines suggested by federal regulators and adopted by most credit card issuers, the minimum payment is equal to the amount of interest and fees due on the account for the period plus one percent of the balance owed. At this rate, it can take several years to fully repay the balance. Format: Multiple Choice Title: Test Bank 5.3 Minimum Payment on a Credit Card Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 44. Which is not a mobile payment method? A) Venmo B) Square Cash C) Apple Pay D) Smart card Answer: D Solution: Smartphone apps such as Venmo, Square Cash, and Apple Pay are mobile payment options. Smart cards are cards embedded with a computer chip that can store electronic cash. Format: Multiple Choice Title: Test Bank 5.3 Mobile Payments Section: Types of Cards Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge

Expected Time to Complete: 1 minute 45. If your credit card agreement gives you a grace period, no interest will accrue A) on new charges (other than cash advances) until the due date, even if you carried a balance from the previous month. B) during the grace period on the balance from the previous month (other than cash advances). C) if you carried a balance from the previous month (other than cash advances). D) on new charges (other than cash advances) until the due date, if you paid in full the prior statement balance. Answer: D Solution: The period of time from a transaction to the due date is called the grace period. If you pay in full each month, no interest will accrue during the grace period on new charges (other than cash advances) until the due date. Format: Multiple Choice Title: Test Bank 5.3 Transaction, Billing, and Due Dates Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 46. In calculating the annual percentage rate (APR) on a credit card account, the total annual finance charges include interest and A) all annual fees. B) late payment charges. C) over-the-limit charges. D) all fees and charges assessed on the account. Answer: A Solution: The APR includes finance charges incurred for the year and the annual fee. Format: Multiple Choice Title: Test Bank 5.3 Annual Percentage Rate (APR) Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 47. The formula to calculate the APR is the A) average loan balance divided by the total annual finance charges.

B) total annual finance charges plus annual fee divided by average loan balance. C) total annual finance charges plus annual fee divided by outstanding loan balance. D) outstanding loan balance divided by the total annual finance charges. Answer: B Total annual finance charges + Annual fee Solution: Annual percentage rate = Average loan balance Format: Multiple Choice Title: Test Bank 5.3 Annual Percentage Rate (APR) Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 48. If you borrow $10,000 and pay $1,200 in annual interest, the APR on your loan is A) 1.0% B) 1.2% C) 6.0% D) 12.0% Answer: D Total annual finance charges + Annual fee Solution: Annual percentage rate = Average loan balance Annual percentage rate =

$1,200 = 0.12 ~ 12% $10,000

Format: Multiple Choice Title: Test Bank 5.3 APR Calculation Section: Annual Percentage Rate (APR) Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes [Note to programmers: Please make this problem algorithmic by changing the loan amount and interest. Suggestions for detractor answers: correct answer/10, correct answer/2, and correct answer/12. 49. Which of the following statements regarding retailers and bank credit cards is true? A) Retailers incur a cost for accepting credit cards.

B) All retailers now accept some type of bank credit card. C) Very few financial institutions offer credit cards D) Retailers receive half of the credit card finance charges. Answer: A Solution: Nearly all financial institutions offer credit cards. Some businesses don’t accept credit cards, and others accept only certain cards. For example, a business might accept Visa and MasterCard but not American Express. This is because the retailer incurs a transaction fee for accepting credit purchases, with the highest fees charged by American Express and Discover. Retailers do not receive any portion of the finance charges that a consumer pays for an outstanding balance. Format: Multiple Choice Title: Test Bank 5.3 Bank Credit Cards Section: Types of Cards Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 50. An interest rate on credit cards that is below the market rate and is offered to new customers is known as a __________ rate. A) teaser B) cash advance C) temporary D) balance transfer Answer: A Solution: Many issuers offer a below-market promotional, or “teaser,” rate to attract new customers and to encourage current credit card holders to transfer balances from other cards. Format: Multiple Choice Title: Test Bank 5.3 Credit Card Interest Rates Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 51. Making the minimum payment on a credit card bill each month A) will not significantly reduce the overall debt. B) ensures that the balance will be repaid in the minimum time period. C) ensures that late payment penalties will not be imposed. D) will improve your credit score.

Answer: A Solution: Making the minimum payment on a credit card bill each month will not significantly reduce the overall debt. Format: Multiple Choice Title: Test Bank 5.3 Minimum Payment on Credit Card Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 52. For borrowers who carry a balance on their credit cards, which of the following methods essentially gives the consumer free credit from the date of purchase until the beginning of the next billing cycle? A) Average daily balance method with a grace period B) Average daily balance method without a grace period C) Previous balance method D) None of these Answer: D Solution: With some credit cards, if you pay in full each month, no interest will accrue on new charges (other than cash advances) until the due date; this period of time from transaction to the due date is called the grace period. If you do not pay your previous balance in full by the due date, interest will begin to accrue on new purchases immediately. Format: Multiple Choice Title: Test Bank 5.3 Transaction, Billing, and Due Dates Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 53. Which of the following is used to calculate the finance charge in a particular billing cycle? A) Periodic rate × Account balance owed B) APR × Average loan balance C) APR × Account balance owed D) Periodic rate × Average loan balance Answer: A

Solution: The finance charge is the dollar amount of interest charged by the lender in a particular billing cycle. Finance charge = Periodic rate × Account balance owed. Format: Multiple Choice Title: Test Bank 5.3 Finance Charge Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 54. The quoted annual rate on your credit card is 18%, and there is a $50 annual fee. If your account balance for the monthly billing period is $1,000, what is your finance charge? A) $15.00 B) $15.75 C) $65.00 D) $180.00 Answer: A Solution: The finance charge is the dollar amount of interest charged by the lender in a particular billing cycle. Finance charge = Periodic rate × Account balance owed. Finance charge =

Nominal rate x Account balance owed Number of billing periods per year

Finance charge =

0.18 × $1,000 = $15 12 months

Format: Multiple Choice Title: Test Bank 5.3 Finance Charge Calculation Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes [Note to programmers: Please make this problem algorithmic; Correct answer is balance × (rate%/12) = 1000 × 1.5%; Detractor answers: B) rate × (balance + annual fee); C) annual fee + (balance × (rate/12)); balance × rate] 55. At the end of your credit card billing cycle (March 31), you have a balance of $2,000. On April 10, you made a $1,000 payment on the account, and on April 15, you used your card to make a purchase of $500. What is the average daily balance that will be used to calculate your finance changes for the month (rounded to the nearest dollar)?

A) $1,500 B) $1,567 B) $1,581 C) $1,633 Answer: B Solution: Because you carried a balance from the previous billing cycle, the grace period will not apply, so you’ll need to calculate the balance owed on each day of the billing period, including new transactions, and subtract any payments received. Your daily balances are as follows: March 31to April 9 10 days $2,000 balance April 10 to April 14 5 days $1,000 balance (made $1,000 payment) April 15 to April 30 16 days $1,500 balance (made $500 purchase) These amounts result in an average daily balance of: [(10 days × $2,000) + (5 days × $1,000) + (16 days × $1,500)]/31 days = $1,580.65 Format: Multiple Choice Title: Test Bank 5.3 Credit Card Finance Charge Calculation Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 5 minutes 56. The grace period is the period of time before A) interest begins to accrue on new transactions. B) a penalty will be assessed for late payment. C) the balance is due in full. D) the lender will increase the interest rate on the credit card. Answer: A Solution: The grace period is the period of time from a new transaction in a billing cycle to the due date, when no interest will accrue. Format: Multiple Choice Title: Test Bank 5.3 Grace Period Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute

57. You have $15,000 in credit card debt, and your APR is 14%. How much will you need to pay each month if you want to pay off the debt in three years (rounded to the nearest dollar)? A) $513 B) $507 C) $338 D) $538 Answer: A Solution: Calculate the payment necessary to amortize a $15,000 loan (PV) over 36 months (N) at a 14% APR. Financial Calculator: Input PV = 15,000, FV = 0, N = 36, I = 14/12 and Solve for PMT => -512.66 Excel Function: =PMT(Rate, Nper, PV, FV, Type) =PMT((0.14/12), 36, 15000, 0,0) => -512.66 TVM Formula: PMT = PVA ×

$15,000 ×

𝑖 𝑛 1 ) 1– ( (1 + 𝑖) 0.011667

36 1 ) 1– ( (1 + 0.011667)

= $512.67

Format: Multiple Choice Title: Test Bank 5.3 Credit Card Payment Calculation Section: Common Credit Card Contract Terms Learning Objective: 5.3 Evaluate credit card choices based on terms and costs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes [Note to programmers: Please make this problem algorithmic by changing the total debt and APR. Correct calculator solution: I = 14/12, PV = 15000, N = 3 × 12 = 36, FV = 0, solve for PMT = -513. Detractor answers B) beginning of year payments: correct answer/(1+rate/12), C) swap FV and PV: I = 14/12, N = 36, PV = 0, FV = 15000, solve for PMT = -338, D) annual payment/12: I = 14, N = 3, PV = 15000, solve for PMT = 6461/12 = -538] 58. Payments on car loans are typically ____ and _____. A) fixed; amortizing B) variable; amortizing

C) fixed; revolving D) variable; revolving Answer: A Solution: Payments on car loans are typically fixed and amortizing. Format: Multiple Choice Title: Test Bank 5.4 Car Loans Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 59. If all other factors are equal, _____will have a lower APR than _______. A) an auto loan; a credit card B) a credit card; an auto loan C) a credit card; a mortgage D) a credit card; a home equity loan Answer: A Solution: A secured loan, such as an auto loan or home loan, gives the lender the right to take the collateral (auto or home) if the loan is not repaid according to its terms. The right to take the collateral reduces the potential risk of default for the lender. Lenders commonly charge much lower rates of interest on secured loans than on unsecured loans, such as credit cards. Format: Multiple Choice Title: Test Bank 5.4 Comparing Consumer Loan Alternatives Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

60. Which consumer loan typically does not offer a variable interest rate? A) Auto loan B) Home equity loan C) Mortgage D) Credit cards Answer: A

Solution: Certain types of loans are more likely than others to have fixed rates. It’s relatively common for rates on automobile loans to be fixed, whereas rates on mortgages and home equity loans can be either fixed or variable. The interest rates on credit cards can be either fixed or variable under the terms of the contract. In practice, revolving credit agreements are more often classified as variable rate, since the issuer generally retains the right to change the rate at any time in the future. Format: Multiple Choice Title: Test Bank 5.4 Variable Interest Rate Consumer Loans Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

61. If all other factors are equal, a(n) ____ will have a lower APR than a(n) ______. A) simple interest loan; add-on loan B) add-on loan; simple interest loan C) discount interest; simple interest loan D) discount interest; add-on loan Answer: A Solution: Add-on interest will always result in a higher APR than simple interest because you’ll always be paying interest on a higher balance than you actually still owe. Like the add-on interest method, the discount interest method results in relatively expensive financing. With this method, which is more commonly used for single-payment loans, such as payday loans, the lender subtracts the interest due from the principal amount before the borrower gets the money. This is the highest cost method of calculating interest on a loan. Format: Multiple Choice Title: Test Bank 5.4 Methods for Calculating Interest on Consumer Loans Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes

62. Variable-rate loans usually carry lower initial interest rates than fixed-rate loans because the A) lender has the option of raising the rate later. B) lender does not have the option of raising the rate.

C) borrower may not receive a lower rate in the future. D) borrower does not have the option of early payment of the loan. Answer: A Solution: A variable-rate loan generally carries a lower initial interest rate than a fixedrate loan because the lender has the option of raising the rate later. Format: Multiple Choice Title: Test Bank 5.4 Fixed or Variable Interest Rates Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

63. With a single-payment loan, A) both interest and principal are repaid at maturity. B) principal is entirely paid at the maturity. C) amortization payments end at a predetermined period, at which time the outstanding principal is due. D) the interest is added to the amount borrowed before the payments are calculated. Answer: A Solution: With a single-payment loan, both interest and principal are repaid at maturity. Format: Multiple Choice Title: Test Bank 5.4 Alternative Methods for Calculating Interest on Consumer Loans Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 64. An installment loan is considered to be in default A) whenever a required payment is overdue. B) when two required payments have been missed. C) when a required payment has been missed. D) when a principal payment has been missed. Answer: A Solution: An installment loan is considered to be in default whenever a required payment is overdue.

Format: Multiple Choice Title: Test Bank 5.4 Payment Arrangements Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 65. A secured loan gives the lender the right to A) take certain assets or property if the loan is not repaid according to its terms in the promissory note. B) take certain assets or property if the loan is not repaid according to state laws. C) any assets or property if the loan is not repaid according to state laws. D) take any assets or property if the loan is not repaid according to its terms in the promissory note. Answer: A Solution: A secured loan gives the lender the right to take certain assets or property if the loan is not repaid according to its terms. The pledged property is the collateral for the loan and can be any valuable asset, such as an automobile or a home. The promissory note for a secured loan will include a description of the collateral pledged for the loan and specify the conditions under which the lender can take possession of the collateral. Format: Multiple Choice Title: Test Bank 5.4 Secured Loans Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 66. Home equity loans are often referred to as a A) first mortgage. B) second mortgage. C) mortgage-backed security. D) reverse mortgage. Answer: B Solution: Like your primary mortgage loan, a home equity loan is secured by your home. However, the lender’s right to the home in the event of nonpayment is secondary to that of the primary mortgage lender, so these loans are also referred to as “second mortgages.” Format: Multiple Choice Title: Test Bank 5.4 Home Equity Loans

Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 67. The maximum amount that can be borrowed with a home equity loan is A) 75 to 90 percent of the current market value of the home less the outstanding primary mortgage. B) 75 to 90 percent of the current market value of the home. C) 75 to 90 percent of the outstanding primary mortgage. D) the original mortgage amount less 75-90 percent of the current market value of the home. Answer: A Solution: In evaluating home equity loan applications, lenders apply a maximum loan-tovalue ratio, commonly from 75 percent to 90 percent. This means that they will not allow total debt on the home, including the first mortgage and any home equity loan, to exceed that percentage of the current market value of the home. Format: Multiple Choice Title: Test Bank 5.4 Home Equity Loans Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 68. What is the income tax advantage of home equity loans? A) Interest on home equity loans (loan amount up to $100,000) is tax-deductible. B) Payments on home equity loans (loan amount up to $100,000) are tax-deductible. C) Interest on home equity loans is tax-deductible only if it is used to improve the home, and the total debt on the home cannot exceed $750,000. D) Payments on home equity loans is tax-deductible only if it is used to improve the home, and the total debt on the home cannot exceed $750,000. Answer: C Solution: Interest on a home equity loan is tax-deductible only if it is used to improve the home, and the total debt on the home cannot exceed $750,000. Format: Multiple Choice Title: Test Bank 5.4 Home Equity Loans Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs.

Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 69. Below-market interest rates on car loans are often A) offset by higher prices and additional fees. B) due to trade-ins. C) offset by longer loan maturities. D) due to manufacturer rebates. Answer: A Solution: Getting a below-market interest rate from an auto dealer doesn’t necessarily mean you’ve come out ahead, as dealers generally make up the difference in higher prices and fees. Format: Multiple Choice Title: Test Bank 5.4 Low Interest Automobile Loans Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 70. In most cases, the ____the term on a consumer loan, the _____ charged. A) longer; higher the interest rate B) shorter; higher the interest rate C) longer; higher the annual fee D) shorter; lower the annual fee Answer: A Solution: The term of the loan affects the rate of interest you pay. Lenders usually charge higher rates of interest on loans with longer terms because risk increases as uncertainty rises with a longer period of time. Format: Multiple Choice Title: Test Bank 5.4 Interest Rates and Maturity Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

71. Most depository institutions use the ______ method to determine finance charges on consumer loans. A) discount interest B) simple interest C) add-on interest D) interest-only Answer: B Solution: Most depository institutions use the simple interest method to determine finance charges on consumer loans. Format: Multiple Choice Title: Test Bank 5.4 Bank Loan Interest Methods Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Knowledge Expected Time to Complete: 1 minute 72. How do you approximate the APR on an add-on interest loan? A) Total annual finance charges as a percentage of half the original loan amount B) Nominal rate multiplied by the face value of the loan C) Nominal rate multiplied by the average outstanding loan balance D) Total annual finance charges as a percentage of the loan amount Answer: A Solution: The approximate APR on an add-on interest loan is the total annual finance charges as a percentage of half the original loan amount. The denominator (original loan amount × 0.5) is an approximation of the average loan balance, based on the idea that, because you’re paying back the principal evenly over time, the average balance owed will be about half of the original amount borrowed. Format: Multiple Choice Title: Test Bank 5.4 Add-on Interest APR Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 73. A balloon loan is a type of _______ that requires full repayment at a date much earlier than the amortization payment maturity. A) installment loan B) revolving credit C) line of credit

D) interest-only loan Answer: A Solution: A balloon loan is a special type of installment loan that is based on a fixed monthly amortization payment like all closed-end loans for a typical maturity, such as 30 years; however, it requires repayment of the outstanding loan balance after a shorter period of time, such as 5 years. Format: Multiple Choice Title: Test Bank 5.4 Balloon Loans Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 74. Car loans typically have short maturities from two to seven years because A) the economic value of the collateral for the loan declines quickly. B) the comparative value to leases is the most competitive within that period. C) it matches the allowable IRS limits on deductible amortization. D) the insurable value diminishes at that point. Answer: A Solution: Because of the relatively short economic life of a car, car loan maturities are typically from two to seven years. Format: Multiple Choice Title: Test Bank 5.4 Automobile Loans Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 75. When the interest owed on a loan is calculated every period on the outstanding balance, this is known as the method. A) discount interest B) add-on interest C) simple interest D) interest-only Answer: C Solution: When the interest owed on a loan is calculated every period on the outstanding balance, this is known as the simple interest method.

Simple Interest = Outstanding balance ×

Nominal rate Payments per year

Format: Multiple Choice Title: Test Bank 5.4 Consumer Loan Interest Methods Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 76. When the interest on a loan is calculated at the beginning of a loan based on the original amount borrowed and the number of years, this is known as the method. A) discount interest B) add-on interest C) simple interest D) amortized interest Answer: B Solution: If a lender uses the add-on interest method, the interest is added to the amount borrowed before the payments are calculated. The total is then divided by the number of payments to determine the payment amount. Payment =

Loan amount + (Loan amount 𝑥 Nominal rate × # of years) Number of payments

Solution: When real property is used as collateral, as in the case of a home mortgage or home equity line of credit, the lender records a lien against the property at the county courthouse, putting the public on notice of its potential right to the property. This ensures that if you sell the home, the loan will be repaid before you can take any of the proceeds from the sale. Format: Multiple Choice Title: Test Bank 5.4 Secured Loans Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 78. The equity in a home is defined as the A) market value of the home. B) market value of the home less the current home loan balances. C) appraised value of the home less the current home loan balances. D) appraised value of the home. Answer: B Solution: Home equity is the difference between the market value of your home and the remaining balances on your mortgage and any home equity line of credit. A home equity loan allows you to borrow against this valuable asset. Format: Multiple Choice Title: Test Bank 5.4 Home Equity Loans Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 79. An installment loan is a loan that requires a borrower to pay A) periodic payments over the repayment period including both principal and interest. B) interest at the beginning of the loan and the principal at the end of the loan period. C) periodic payments over the repayment period equal to the loan amount divided by the number of periods. D) interest-only payments during the repayment period and the principal at the end of the loan period. Answer: A

Solution: An installment loan allows the borrower to repay over time, usually in equal monthly installments that include both principal and interest. Format: Multiple Choice Title: Test Bank 5.4 Installment Loan Payment Arrangement Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 2 minutes 80. An acceleration clause is a loan term that requires immediate repayment of the _______ on a loan that is in default. A) amount overdue B) outstanding balance C) minimum monthly payment D) original borrowed amount Answer: B Solution: Some loan agreements include an acceleration clause that makes the entire balance due and payable if you don’t make payments as promised. Format: Multiple Choice Title: Test Bank 5.4 Acceleration Clause Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 81. A secured loan is a loan that has a(n) A) pledge of collateral. B) cosigner. C) minimum monthly payment. D) acceleration clause. Answer: A Solution: A secured loan is a loan that has a pledge of collateral. Format: Multiple Choice Title: Test Bank 5.4 Secured Loan Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy

Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 82. The current market value of a home is $200,000 with a mortgage balance of $140,000. If the lender requires a 75% loan-to-value ratio , what is the home equity credit limit on this house? A) $10,000 B) $45,000 C) $105,000 D) $150,000 Answer: A Solution: In evaluating home equity loan applications, lenders apply a maximum loan-tovalue ratio, that is, 75% in this scenario. This means that they will not allow total debt on the home, including the first mortgage and the home equity loan, to exceed that percentage of the current market value of the home. Hence, $200,000 (market value of home) multiplied by 0.75 (maximum loan-to-value ratio) less $140,000 (mortgage balance) is $10,000 (home equity credit limit). Format: Multiple Choice Title: Test Bank 5.4 Home Equity Credit Limit Calculation Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes [Note to programmers: Please make this problem algorithmic by varying the home value and the mortgage amount. This is similar to EOC Application Problem #3. Home value range from $100,000 to $200,000 in $20,000 increments. First mortgage amount should be between 60%, and 70% of the home value. Lender loan-to-value ratio should be 75%, 80%, 85%, or 90%. Distractor answers: (Value – mortgage) × lender ratio, (1-lender ratio) × home value, Value – mortgage] 83. Which of the following statements is true concerning home equity loans? A) Home equity loan proceeds are generally restricted as to purpose. B) Home equity loans are generally installment loans with a one- to five-year term. C) Home equity loan interest is tax-deductible if used for home improvements, and the total debt on the home does not exceed $750,000. D) Home equity loans cannot be used to pay for college costs. Answer: C Solution: Home equity loan interest is tax-deductible if used for home improvements, and the total debt on the home does not exceed $750,000. The proceeds can be used for any

purpose if you have no expectation of tax benefits. Home equity loans are usually installment loans payable for over 5 to 15 years. Format: Multiple Choice Title: Test Bank 5.4 Home Equity Loans Section: Common Types of Consumer Loans Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 84. For a $5,000, three-year, 6% loan with monthly payments, how much will you pay in interest over the life of the loan (rounded to the nearest dollar)? A) $476 B) $612 C) $900 D) $476 Answer: A Solution: First, calculate the payment necessary to amortize a $5,000 loan (PV) over 36 months (N) at a 6% APR. Then total all the payments required to amortize this loan. The total interest paid over the life of the loan is the difference between the total payments and the original loan. CALCULATE PAYMENT Financial Calculator: Input PV = 5,000, FV = 0, N = 36, I = 6/12 and solve for PMT => -152.11 Excel Function: =PMT(Rate,Nper,PV,FV,Type) =PMT((0.06/12), 36, 5000, 0, 0) => -152.11 TVM Formula: PMT = PVA ×

𝑖 0.005 𝑛 = $5,000 × 36 = $152.11 1 1 ( ) 1– ) 1– ( (1 + 𝑖) (1 + 0.005)

CALCULATE TOTAL PAYMENTS $152.11 × 36 = $5,475.96 CALCULATE TOTAL INTEREST PAID $5,475.96 total payments - $5,000 loan = $475.96 total interest paid Format: Multiple Choice Title: Test Bank 5.4 Total Interest Paid on a Loan Calculation

Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes [Note to programmers: Please make this problem algorithmic. This question is similar to EOC Application Problem # 13. Vary the interest rate (6% to 10%), the amount of the loan ($3,000 to $6,000) and the number of years (3 to 8). Correct answer: PV = 5000, N = 36, I = 6/12, FV = 0, solve for PMT = -152.11. Total payments = 36 × 152.11 = $5,476 less the original loan of 5000 = $476. Distractor Answers: B) Calculate annual payment × 3 and subtract the loan amount: PV = 5000, N = 3, I = 6, solve for PMT: (1871 × 3) – 5000 = 612 C) rate × loan amount × 3 = 6% × 5000 × 3 =900 D) total of loan payments =PMT × number of months] 85. Kerry borrows $100,000 with a five-year interest-only loan to finance a new business venture. If her interest rate is 5 percent, what is her monthly payment (rounded to the nearest dollar)? A) $417 B) $5,000 C) $1,887 D) $1,925 Answer: A Solution: Interest-only loans charge a stated APR on the balance owed in each period and require repayment within a relatively short period of time, either as a balloon payment or converting to an installment payment for the remaining life of the loan. $100,000 loan × (0.05 APR/12 months) = $416.67 monthly interest payment Format: Multiple Choice Title: Test Bank 5.4 Interest-Only Loan Payment Calculation Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes [Note to programmers: Please make this problem algorithmic by varying the interest rate and the number of years. Keep the amount of the loan the same. Correct answer is loan amount × rate/12 = 100k × 5%/12. Detractor answers: B) Loan amount × rate, C) amortized payment: PV = 100k, N = 5 × 12, I = 5/12, solve for PMT, D) annual amortized payment divided by 12: PV = 100k, N = 5, I = 6, solve for PMT=23,097, /12= 1,925]

86. The legal document that specifies the terms and conditions of a consumer loan is the A) lien. B) judgment. C) promissory note. D) trust agreement. Answer: C Solution: All the important loan terms are spelled out in the promissory note, the legal document that represents your promise to repay the loan amount. Consumer loans vary in the interest rates charged, payment arrangements, and collateral required. Format: Multiple Choice Title: Test Bank 5.4 Terms and Conditions of a Loan Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 87. Samantha has been approved for a $20,000 car loan at 6% interest. The lender is willing to give her a three-year loan or a four-year loan at the same rate. at the same rate. How much difference will it make in her monthly payments? (Round to the nearest $10). A) $90 B) $100 C) $140 D) $1,710 Answer: C Solution: First, calculate the payment necessary to amortize a $20,000 loan (PV) over 36 months (N) at a 6% APR. Then calculate the payment required to amortize this same loan over 48 months. Take the difference between the two payments. CALCULATE MONTHLY PAYMENT Financial Calculator: 36-month PMT: Input PV = 20,000, FV = 0, N = 36, I = 6/12 and Solve for PMT => 608.44 48-month PMT: Input PV = 20,000, FV = 0, N = 48, I = 6/12 and Solve for PMT => 469.70 Excel Function: =PMT(Rate,Nper,PV,FV,Type) 36-month PMT: =PMT((0.06/12), 36, 20000, 0, 0) => -608.44 48-month PMT: =PMT((0.06/12), 48, 20000, 0, 0) => -469.70 TVM Formula:

PMT = PVA ×

36– month PMT = $20,000 ×

48– month PMT = $20,000 ×

𝑖 𝑛 1 ) 1– ( (1 + 𝑖) 0.005 36 1 ) 1– ( (1 + 0.005)

0.005 48 1 ) 1– ( (1 + 0.005)

= $608.44

= $469.70

CALCULATE DIFFERENCE IN PAYMENTS $608.44 (36-month payment) – $469.70 (48-month payment) = $138.74 ~ $140 rounded Format: Multiple Choice Title: Test Bank 5.4 Loan Payment Comparison Calculation Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 4 minutes [Note to programmers: Please make this problem algorithmic. This question is similar to DEMONSTRATION PROBLEM 5.4. Vary the interest rate (6% to 10%), the amount of the loan ($10,000 to $30,000) and the number of years (3 to 7). 36-month payment: PV = 20000, N = 36, I = 6/12, FV = 0, solve for PMT = -608.44. 48-month payment: PV = 20000, N = 48, I = 6/12, FV = 0, solve for PMT = -469.70. ANSWER is 36-month payment – 48-month payment. Distractor Answers: B) 36-month payment: PV = 20000, N = 36, I = 6, FV = 0, solve for PMT = -608.44. 48-month payment: PV = 20000, N = 48, I = 6, FV = 0, solve for PMT = -469.70. Distractor Answer is 36-month payment – 48month payment. C) 36-month payment: PV = 20000, N = 36, I = 5, FV = 0, solve for PMT = -608.44. 48-month payment: PV = 20000, N = 48, I = 5, FV = 0, solve for PMT = -469.70. Distractor Answer is 36-month payment – 48-month payment. D) 36-month payment: PV = 20000, N = 3, I = 6, FV = 0, solve for PMT = -608.44. 48-month payment: PV = 20000, N = 4, I = 6, FV = 0, solve for PMT = -469.70. Distractor Answer is 36-month payment – 48-month payment.] 88. Josef has been approved for a $30,000 car loan at 6% interest. The lender is willing to give him a three-year loan or a four-year loan at the same rate. How much difference will it make in his total monthly interest paid? (Round to nearest $10.) A) $930 B) $960 C) $14,390

D) $18,150 Answer: B Solution: First, calculate the payment necessary to amortize a $30,000 loan (PV) over 36 months and 48 months (N), at a 6% APR. Then total all the payments required to amortize each loan, and respectively subtract the original loan to calculate total interest paid over the life of each loan. Then take the difference between the total interest payments. CALCULATE MONTHLY PAYMENT Financial Calculator: 36-month: Input PV = 30,000, FV = 0, N = 36, I = 6/12 and Solve for PMT => -912.66 48-month: Input PV = 30,000, FV = 0, N = 48, I = 6/12 and Solve for PMT => -704.55 Excel Function: =PMT(Rate,Nper,PV,FV,Type) 36-month: =PMT((0.06/12), 36, 30000, 0, 0) => -912.66 48-month: =PMT((0.06/12), 48, 30000, 0, 0) => -704.55 TVM Formula: PMT = PVA ×

36– month PMT = $30,000 ×

48– month PMT = $30,000 ×

𝑖 𝑛 1 ) 1– ( (1 + 𝑖) 0.005 36 1 ) 1– ( (1 + 0.005)

0.005 48 1 ) 1– ( (1 + 0.005)

= $912.66

= $704.55

CALCULATE TOTAL PAYMENTS $912.66 (36-month payment) × 36 months = $32,855.76 $704.55 (48-month payment) × 48 months = $33,818.40 CALCULATE DIFFERENCE IN TOTAL INTEREST PAID $32,855.76 (36 months) - $30,000 loan = $2,855.76 $33,818.40 (48months) - $30,000 loan = $3,818.40 $3,818.40 - $2,855.76 = $962.64 ~ $960 (rounded) is the difference in total interest paid.

Format: Multiple Choice Title: Test Bank 5.4 Comparing Total Interest Paid Between Two Loans Calculation Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Hard Bloomcode: Evaluation

AACSB: Analytic Expected Time to Complete: 4 minutes [Note to programmers: Please make this problem algorithmic. This question is similar to DEMONSTRATION PROBLEM 5.4. Vary the interest rate (6% to 10%), the amount of the loan ($10,000 to $30,000) and the number of years (3 to 7). 36-month payment: PV = 30000, N = 36, I = 6/12, FV = 0, solve for PMT = -912.66. 48-month payment: PV = 30000, N = 48, I = 6/12, FV = 0, solve for PMT = -704.55. ANSWER is (48-month payment × 48) – (36-month payment × 36). Distractor Answers: B) 36-month payment: PV = 30000, N = 36, I = 6, FV = 0, solve for PMT = -2,051.85. 48-month payment: PV = 30000, N = 48, I = 6, FV = 0, solve for PMT = -1,916.93. Distractor is (48-month payment × 48) – (36-month payment × 36). C) 36-month payment: PV = 30000, N = 36, I = 5, FV = 0, solve for PMT = -1,813.03. 48-month payment: PV = 30000, N = 48, I = 5, FV = 0, solve for PMT = -1,659.55. Distractor is (48-month payment × 48) – (36-month payment × 36). D) 36-month payment: PV = 30000, N = 3, I = 6, FV = 0, solve for PMT = -11,233.29. 48-month payment: PV = 30000, N = 4, I = 6, FV = 0, solve for PMT = 8,657.74. Distractor is (48-month payment × 4) – (36-month payment × 3)] 89. The method most commonly used by financial institutions to determine finance charges on consumer loans is the A) simple interest method. B) add-on interest method. C) annual percentage yield method. D) compound interest method. Answer: A Solution: Most financial institutions use the simple interest method to determine finance charges on consumer loans. Format: Multiple Choice Title: Test Bank 5.4 Finance Charge Method Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 90. Which of the following statements concerning the add-on interest method is true? A) It results in a lower APR than the simple interest method. B) The lender subtracts the interest due from the principal before the borrower receives the loan proceeds. C) Interest is added to the amount borrowed before the payments are calculated. D) It usually results in a higher APR than the discount interest method. Answer: C

Solution: Interest in the add-on method is added to the amount borrowed before the payments are calculated. Format: Multiple Choice Title: Test Bank 5.4 Finance Charge Method Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 2 minutes 91. Saundra graduated from college with $20,000 in student loan debt. The annual rate on her loans is 6% simple interest, and she will make monthly payments for 10 years. What is her monthly payment (rounded to the nearest dollar)? A) $222 B) $2,717 C) $226 D) $176 Answer: A Solution: Calculate the payment necessary to amortize a $20,000 loan (PV) over 120 months (N) at a 6% APR. Financial Calculator: Input PV = 20,000, FV = 0, N = 120, I = 6/12 and Solve for PMT => -222.04 Excel Function: =PMT(Rate,Nper,PV,FV,Type) =PMT((0.06/12), 120, 20000, 0, 0) => -222.04 TVM Formula: PMT = PVA ×

𝑖 0.005 𝑛 = $20,000 × 120 = $222.04 1 1 ) 1– ( ) 1– ( (1 + 𝑖) (1 + 0.005)

Format: Multiple Choice Title: Test Bank 5.4 Student Loan Payment Calculation Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes

[Note to programmers. Please make this problem algorithmic. It is similar to EOC Application Problem 17A. vary the loan interest (5%, 6%, 7%), and the amount ($20,000 to $40,000), but leave the number of months the same (120). Distractor Answers B. PV = loan amount, N = years, rate = annual, solve for PMT, C. divide answer to B by 12, D. loan amount × (1+interest rate)/number of months] 92. The purpose of an amortization table is to A) calculate monthly payments on an installment loan. B) show the interest and principal payments for each period of an installment loan. C) identify when a revolving loan will be paid in full. D) estimate the average monthly balance of a revolving loan. Answer: B Solution: An amortization table shows the interest and principal payments for each period of an installment loan. It displays payments that stay constant, whereas the portion allocated to interest declines and the portion that repays principal increases over the life of the loan. Format: Multiple Choice Title: Test Bank 5.4 Amortization Table Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 93. Karina bought a car three years ago for $20,000 and financed the full purchase price with a four-year (48 months) simple interest car loan at 5% (monthly payment = $460.59). If she has made all of her payments on time and has 12 payments remaining, her current loan balance (rounded to the nearest dollar) is A) $5,380. B) $5,527. C) $3,419. D) $4,419. Answer: A Solution: First calculate the monthly amortization payment necessary to pay off a $20,000 loan (PV) in 48 months (N) at a 5% APR (I/12), and then compute the amortization at the end of 36 months. With the financial calculators, you have to reset “N” prior to solving the amortization after 36 months. Financial Calculator (HP 12-C): Input PV = 20,000, FV = 0, I = 5/12, N = 48; solve for PMT = -460.59 Input N = 0, solve for 36 AMORT = -1,961.30 total interest Press RCL PV to display the loan balance = 5,380.21

Financial Calculator (TI BAII Plus): Input PV = 20,000, I/Y = (5/12), N = 48. Solve for PMT = -460.59 Press 2nd followed by AMORT, P1 = 1, down arrow key and P2 = 36 Press the down arrow again and you will see that balance = 5,380.21 Excel Function “=CUMPRINC(rate,nper,pv,start_period,end_period,type)” =CUMPRINC((0.05/12), 48, 20,000, 1, 36, 0) => -14,619.79 cumulative principal paid $20,000 original loan – 14,619.79 principal paid in 36 months = $5,380.21 loan remaining Format: Multiple Choice Title: Test Bank 5.4 Mid Period Amortization Calculation Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes [Note to programmers: This problem is similar to EOC Application Problem #16. Vary the amount borrowed $15000 to $25000 and the number of years/months 3 years to 6 years and the interest rate 5% to 7%]

94. Ashley saved $5,000 for a down payment on a new car. If she budgets $250 a month for a five-year loan at 4% APR, how much can she spend on a new car? (Round to the nearest whole number.) A) $18,575 B) $13,575 C) $20,000 D) $15,000 Answer: A Solution: Calculate the present value of a loan based on $250 monthly auto loan payments (PMT) for 60 months (N) at 4% APR (I/12). Then add the $5,000 down payment to the loan value. CALCULATION OF LOAN VALUE Financial Calculator: Input PMT = -250, FV = 0, N = 60, I = (4/12), and Solve for PV => 13,574.77 Excel Function: =PV(Rate, Nper, PMT, FV, Type) =PV((0.04/12), 60, -250, 0, 0) => 13,574.77

TVM Formula:

𝑛 1 ) (1 + 𝑖) PVA = PMT × 𝑖 60 1 ( ) 1– (1 + 0.003333) PVA = $250 × = $13,574.90 0.003333

1– (

CALCULATION OF PURCHASE POWER $13,575 loan + $5,000 down payment saved = $18,575 she can spend on a new car. Format: Multiple Choice Title: Test Bank 5.4 Auto Purchase Power Calculation Section: Comparing Consumer Loan Alternatives Learning Objective: 5.4 Evaluate consumer loan choices based on your financial needs, loan terms, and costs. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes [Note to programmers. Please make this problem algorithmic. Vary the loan interest (1% - 6%), the payment amount (175 - 400), and the down-payment (3,000 – 7,000). Leave the number of months the same (60). Distractor B: PMT = payments, N = months, rate = APR/12, solve for PV; Distractor C: (payments × N) + down-payment; Distractor D: payments × N]

Chapter 6 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 125 questions. 123 Multiple Choice | 2 Multiple Select LO 6.1 LO 6.2 LO 6.3 LO 6.4 LO 6.5 Total

33 21 17 32 22 125

26% 17% 14% 26% 18% 100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

24 51 23 18 4 5 125

19% 41% 19% 14% 3% 4% 100%

Easy Medium Hard

24 91 10 125

19.2% 73.6% 7.2% 100%

Calculations Q# 11 19 20 21 22 24 29 51 123 124 60 65 68 70 71 90 91 92 93 96 97 98

Test Bank Question

6.1 Auto Loan Calculation (Compute Loan Value) 6.1 Auto Loan Payment Calculation (with distractor) 6.1 Annual Gasoline Cost Calculation 6.1 Automobile Ownership Calculation 6.1 Annual Gasoline Cost Calculation (Compare 2 Vehicles) 6.1 Fuel Efficient Car Payback Calculation 6.1 Annual Gasoline Cost Calculation 6.2 Lease Versus Buying Calculation 6.2 Cost of Excess Mileage Calculation 6.2 Lease Value Calculation

6.3 Minimum Down Payment to Avoid PMI Calculation 6.3 Maximum Affordability Calculation 6.3 Tax Savings on Annual Housing Costs Calculation 6.4 Mortgage Debt Service Ratio Calculation 6.4 Debt Payment Ratio Calculation 6.4 Evaluate mortgage financing Alternatives 6.4 Total Interest Paid on a Mortgage Calculation 6.4 Mortgage Debt Service Ratio Calculation 6.4 Cumulative Interest Savings Between 2 Loans Calculation 6.4 Points on a Mortgage Calculation 6.4 Break-even Calculation 6.4 ARM Rate Cap Calculation

99 116 117 118 119

6.4 Compare 2 Refinance Alternatives Calculation 6.5 Rate Lock Fee Calculation 6.5 Closing Cost Calculation (itemized) 6.5 Closing Cost Calculation 6.5 Property Area Calculation

1. The first step in making consumer purchase decisions is to A) determine what you can afford. B) research your alternatives. C) determine what you need. D) negotiate the best price. Answer: C Solution: The decision process for consumer purchases is to (1) determine what you need; (2) assess your budget to see what you can afford; (3) do your research, identify alternatives, and compare attributes and price; (4) decide how to finance your purchase (rent/lease vs. buy, cash vs. credit); and (5) negotiate the terms of the rent/lease or purchase contract. Format: Multiple Choice Title: Test Bank 6.1 Decision Process for Consumer Purchases Section: Making Auto Decisions on a Budget Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 2. Whenever you decide to buy something, you’re also deciding not to A) spend the money on something else. B) save those funds. C) invest those funds. D) All of the choices are correct. Answer: D Solution: Whenever you decide to buy something, you’re also deciding not to spend the money on something else and not to save or invest those funds. Format: Multiple Choice Title: Test Bank 6.1 Opportunity Cost Section: Making Smart Purchase Decisions Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 3. Which of the following is not a luxury? A) New convertible B) Home theater system C) Studio apartment D) Spring break trip

Answer: C Solution: Luxuries are things you want to have but can live without, like a new car, a home theater system, or a spring break trip. Basic shelter, such as a studio apartment, is a necessity. Format: Multiple Choice Title: Test Bank 6.1 Luxuries Section: Making Smart Purchase Decisions Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 4. Which of the following is not a necessity? A) Groceries B) Clothing C) Existing car used for commute D) Existing ski cabin Answer: D Solution: Necessities are things you need in order to live, like food and clothing, and requirements for work, like a commuter car. Although, basic shelter is a requirement to live, a second home for vacations, like a ski cabin, is a luxury. Format: Multiple Choice Title: Test Bank 6.1 Necessities Section: Making Smart Purchase Decisions Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 5. Consumer purchase decisions should be directly related to your A) future standard of living. B) financial goals. C) personal feelings. D) aspirational lifestyle. Answer: B Solution: Every purchase decision influences your ability to achieve your shortterm and long-term goals. Therefore, consumer purchase decisions should be directly related to your financial goals. Format: Multiple Choice Title: Test Bank 6.1 Consumer Purchase Decisions Section: Making Smart Purchase Decisions Learning Objective: 6.1 Evaluate your household automobile needs and budget.

Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 6. When analyzing excess spending, it is recommended that you A) ignore the small dollar item purchases. B) ignore the large dollar item purchases. C) look carefully at frequent small purchases that are easy to overlook. D) only focus on the large purchases. Answer: C Solution: When people analyze their excess spending, they often find that the little stuff is to blame, such as clothes, books, food, and other less expensive consumer items that seem inconsequential alone but can add up to thousands of dollars each year. Format: Multiple Choice Title: Test Bank 6.1 Making Smart Purchase Decisions Section: Making Smart Purchase Decisions Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 7. Which of the following is a variable operating expense of an automobile? A) Taxes B) Insurance premiums C) Finance charges D) Gasoline Answer: D Solution: Variable expenses, such as gasoline and maintenance costs, differ from month to month and can therefore be more difficult to estimate; whereas, taxes, insurance, and finance charges are all fixed payments that remain constant month to month. Format: Multiple Choice Title: Test Bank 6.1 Variable Expenses Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

8. What is depreciation? A) The increase in the value of an asset due to wear and tear and other factors B) The proportion of an asset that will not decline in value for any reason C) The result of all expenses incurred while using an asset D) The decline in the value of an asset over time as a result of normal wear and tear Answer: D Solution: Depreciation is the loss in value due to wear and tear. Format: Multiple Choice Title: Test Bank 6.1 Depreciation Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 9. The dealer’s invoice price is the price that the dealer A) uses when selling the car to a buyer. B) pays to purchase a new vehicle from the manufacturer. C) uses as the beginning negotiating price with the buyer. D) puts on a car after purchasing it from the manufacturer. Answer: B Solution: The dealer’s invoice price is the price that the dealer paid to purchase the vehicle from the manufacturer and is an important piece of information to have in the negotiation process. Format: Multiple Choice Title: Test Bank 6.1 Dealer Invoice Price Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 10. When you buy a new car, you can afford to finance the car loan over a _______repayment term to reduce your overall interest expenses if your down payment is _______. A) shorter; greater B) longer; smaller C) shorter; smaller D) longer; greater

Answer: A Solution: The bigger the down payment you make on a car purchase, the shorter the finance term you can choose, which will save you money in interest charges over the course of the loan. Format: Multiple Choice Title: Test Bank 6.1 Calculating the Price You Can Afford Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 11. Sarah has saved $3,000 for a down payment on a car. She has determined that she can afford a monthly payment up to $350 per month for an auto loan. Her credit union has quoted her a 6% rate on a 60-month car loan. What is the maximum amount Sarah can afford to finance? (Round to the nearest $100.) A) $14,900 B) $17,900 C) $18,100 D) $21,100 Answer: C Solution: Calculate the present value of a loan based on monthly payments of $350 and 6% APR over 60 months. Financial Calculator: Enter PMT = -350, N = 60, I = (6/12), FV = 0 and solve for PV = 18,103.95 or $18,100 Excel Spreadsheet: =PV(rate,nper,pmt,fv,type) => =PV((0.06/12), 60, -350, 0, 0) => 18,103.95 or $18,100 TVM Equation:

𝑛 1 ) 1−( (1 + 𝑖) PVA = PMT × 𝑖

1−( PVA = $350 ×

60 1 ) (1 + 0.005) = $18,103.95 or $18,100 0.005

Format: Multiple Choice Title: Test Bank 6.1 Auto Loan Calculation Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 12. Extended warranties are also often called A) unlimited warranties. B) service contracts. C) added services. D) lifetime warranties. Answer: B Solution: In addition to a regular warranty, most manufacturers and dealers offer the opportunity to purchase an extended warranty or service contract. This type of agreement either extends the amount of time that your car is covered by the original limited warranty or adds services or coverage to your existing warranty. Format: Multiple Choice Title: Test Bank 6.1 Warranties Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 13. If a product does not come with an express warranty, A) there is no warranty made by the seller with respect to the qualities of the vehicle being sold. B) there is no warranty made by the seller with respect to the qualities of the vehicle being sold or the seller’s obligation to repair or service the vehicle. C) there is an implied warranty that it will work as intended. D) it was sold “as is.” Answer: C Solution: An express warranty is a promise made orally or in writing. Even without an express warranty, there is an implied warranty that a purchased vehicle is suitable for its intended use, unless it was explicitly sold “as is,” which means that the seller makes no warranties at all. Format: Multiple Choice Title: Test Bank 6.1 Reliability and Warranties Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 14. When estimating the cost of automobile ownership, the only relevant costs are A) the lease or loan payments. B) the lease or loan payments and insurance. C) the lease or loan payments, insurance, taxes, and registration. D) the lease or loan payments, insurance, taxes, registration, fuel, and maintenance. Answer: D Solution: Many people make the mistake of estimating the cost of automobile ownership based on their auto lease or loan payment alone. Many other costs should enter into the decision process and can amount to thousands of additional dollars per year, such as insurance, taxes, registration, fuel, and maintenance. Format: Multiple Choice Title: Test Bank 6.1 Costs of Auto Ownership Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehensive AACSB: Analytic Expected Time to Complete: 1 minute 15. The ______ on an auto loan is an example of a ____ expense of auto ownership. A) loan payment; fixed B) loan payment; variable C) insurance requirement; variable D) APR; variable Answer: A Solution: The loan payment on an auto loan is an example of a fixed expense of auto ownership. Format: Multiple Choice Title: Test Bank 6.1 Costs of Auto Ownership Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

16. Depreciation causes a(n) _____ in the value of an automobile and, therefore, a _____ in one's wealth. A) increase; increase B) decrease; decrease C) decrease; increase D) increase; decrease Answer: B Solution: Depreciation causes a decrease in the value of an automobile and, therefore, a decrease in one's wealth. Format: Multiple Choice Title: Test Bank 6.1 Depreciation Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 17. ______ is a _______ expense of owning a car. A) Gasoline; fixed B) Gasoline; variable C) Insurance; variable D) Maintenance; fixed Answer: B Solution: Gasoline is considered a variable expense of owning a car. Although commuting miles may be fixed, most of an individual’s mileage is personal and discretionary. Format: Multiple Choice Title: Test Bank 6.1 Gasoline Expense Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 18. The total cost per mile of automobile ownership _____ with the _________. A) increases; mileage driven B) decreases; mileage driven C) decreases; rise in fuel prices D) increases; decline in fuel prices Answer: B

Solution: Because a portion of the total cost of automobile ownership is fixed, the cost per mile decreases with mileage driven, as the fixed costs are spread over a larger number of miles. Format: Multiple Choice Title: Test Bank 6.1 Costs of Automobile Ownership Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 19. Jacob purchased a car for $14,000. If the loan amount is $12,000, term is 4 years, and the APR is 8%, what is his monthly loan payment (rounded to the nearest dollar)? A) $293 B) $302 C) $342 D) $352 Answer: A Solution: Calculate the monthly payment based on $12,000 loan for 48 months at 8% APR. Financial Calculator: Enter PV = 12,000, FV = 0, N = 48, I = 8/12, and solve for PMT = -292.96 or $293 Excel Spreadsheet: =PMT(rate,nper,pv,fv,type) => =PMT((0.08/12), 48, 12000, 0, 0) => -292.96 or $293 TVM Equation: PMT = PVA ×

PMT = $12,000 ×

𝑖 𝑛 1 ) 1−( (1 + 𝑖)

0.006667 48 1 ) 1−( (1 + 0.006667)

= $292.96 or $293

Format: Multiple Choice Title: Test Bank 6.1 Car Payment Calculation Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget.

Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes [Answer is PV=12000, N=48, I=8/12, FV=0, Solve PMT; Distractor 1 is PV=14000, N=48, I=8/12, FV=0, Solve PMT; Distractor 3 is PV=12000, N=4, I=8, FV=0, Solve PMT/12; Distractor 4 is PV=14000, N=4, I=8, FV=0, Solve PMT/12] 20. If you drive 10,000 miles per year, your car gets 22 miles per gallon, and the average cost of gasoline is $4 per gallon, how much will you spend on gasoline per year (rounded to the nearest dollar)? A) $455 B) $1,818 C) $2,500 D) $2,955 Answer: B Annual miles driven Solution: Annual gasoline cost = × Price per gallon MPG $10,000

Annual gasoline cost = 22 MPG × $4 per gallon = $1,818.18 or $1,818 Format: Multiple Choice Title: Test Bank 6.1 Annual Gasoline Cost Calculation Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 21. Jacob purchased a car in January for $14,000. Given the following information, what is his total cost of ownership for the first year (rounded to the nearest $100)? • Monthly loan payment: $293 •

Gasoline: $1,818

•

First-year depreciation: $3,000

•

Auto insurance annual cost: $1,200

•

Registration and license: $250

•

Sales tax: 5% of sales price

•

Regular oil changes: $120

A) $7,380 B) $7,600

C) $9,900 D) $10,600 Answer: D Solution: Cost of ownership for the year is as follows: Monthly Loan payment: $293 × 12 = $3,516 Gasoline: $1,818 First-year depreciation: $3,000 Auto insurance annual cost: $1,200 Registration and license: $250 Sales tax: $14,000 × 0.05 sales tax = $700 Regular oil changes: $120 TOTAL COST OF OWNERSHIP $10,604 or $10,600 Format: Multiple Choice Title: Test Bank 6.1 Automobile Ownership Calculation Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 22. You are deciding between a car that gets 40 miles per gallon and one that gets 20 miles per gallon. If gasoline costs $4 per gallon and you typically drive 15,000 miles per year, how much will you save each year by choosing the more fuelefficient vehicle? A) $750 B) $1,500 C) $2,250 D) $3,000 Answer: B Solution: Compare the annual gasoline cost between the 20 MPG and the 40 MPG vehicles: Annual miles driven Annual gasoline cost = × Price per gallon MPG $15,000

Annual gasoline cost40 MPG car: 40 MPG × $4 per gallon = $1,500 $15,000

Annual gasoline cost20 MPG car: 20 MPG × $4 per gallon = $3,000 The 40 MPG car will save $1,500 annually in gasoline cost over the 20 MPG car.

Format: Multiple Choice Title: Test Bank 6.1 Annual Gasoline Cost Calculation Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 23. In evaluating vehicle choices, which of the following factors is least important from a financial perspective? A) Reliability B) Sportiness C) Size D) Fuel efficiency Answer: B Solution: Although price is usually a major factor, practical considerations also may include safety, reliability, size, and fuel efficiency. Qualitative features are comfort, color, and sportiness. Format: Multiple Choice Title: Test Bank 6.1 Evaluating Vehicle Choices Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Easy Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 24. How long will it take to recoup the $1,800 price difference between a hybrid and a regular sedan assuming gas costs $3 per gallon, you drive 12,000 miles per year, and the hybrid gets 45 miles per gallon (MPG) on the highway and the regular sedan gets 30 MPG on the highway? A) 1 year B) 4 years C) 4.5 years D) 6 years Answer: C Solution: Divide the $1,800 price difference by the gasoline savings from the hybrid: Annual miles driven Annual gasoline cost = × Price per gallon MPG $12,000

Annual gasoline costhybrid: 45 MPG × $3 per gallon = $800

$12,000

Annual gasoline costregular car: 30 MPG × $3 per gallon = $1,200 The hybrid car will save $400 annually in gasoline cost ($1,200-$800). $1,800 cost premium Payback = $400 annual fuel savings = 𝟒. 𝟓 𝐲𝐞𝐚𝐫𝐬 Format: Multiple Choice Title: Test Bank 6.1 Fuel Efficient Car Payback Calculation Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 25. An express warranty _________ by the seller in order to be enforceable. A) must be in writing B) must be verbal C) can be verbal D) can be verbal or in writing Answer: D Solution: An express warranty is a promise made orally or in writing. A warranty is a legal promise made by the seller, in this case with respect to the qualities of the vehicle being sold or the seller’s obligation to repair or service the vehicle for a period of time. Format: Multiple Choice Title: Test Bank 6.1 Express Warrantee Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 26. Bumper-to-bumper warranties on new cars cover all A) mechanical problems. B) routine maintenance. C) mechanical problems and most routine maintenance D) mechanical problems, most routine maintenance, and accident damage. Answer: A Solution: This type of warranty covers the costs of most problems you might experience with your vehicle, except for routine maintenance and accident damage.

Format: Multiple Choice Title: Test Bank 6.1 Bumper-to-Bumper Warranties Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 27. The decline in value of an asset over time is known as A) depreciation. B) minimization. C) amortization. D) discounting. Answer: A Solution: The decline in value of an asset over time is known as depreciation. Format: Multiple Choice Title: Test Bank 6.1 Costs of Automobile Ownership Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 28. What is normally referred to as the "sticker price" on a new car is actually the A) dealer's invoice. B) manufacturer's invoice. C) manufacturer's suggested retail price. D) dealer's retail price. Answer: C Solution: Manufacturers provide a printed form for new cars that identifies the manufacturer’s suggested retail price (MSRP) for the car with its accessories and options, often referred to as the sticker price. Format: Multiple Choice Title: Test Bank 6.1 Sticker Price Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

29. Jim owns a truck that gets approximately 18 miles per gallon. If Jim drives 13,000 miles in a year and the average cost of a gallon of gasoline is $2.50, what is Jim's approximate annual gasoline cost? A) $289 B) $1,806 C) $2,137 D) $9,360 Answer: B Annual miles driven Solution: Annual gasoline cost = × Price per gallon MPG Annual gasoline cost =

$13,000 × $2.50 per gallon = $1,805.55 or $𝟏, 𝟖𝟎𝟔 18 MPG

C) They generally are more comprehensive in coverage than original warranties. D) They are not transferable. Answer: A Solution: An extended warranty or service contract is a type of agreement that either extends the amount of time that your car is covered by the original limited warranty or adds services or coverage to your existing warranty. Many extended warranties exclude coverage for the problems you’re most likely to experience. It is also generally the case that the warranty contract price is greater than the expected costs of covered repairs. Format: Multiple Choice Title: Test Bank 6.1 Extended Warrantees Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 32. Which of the following factors is true when considering a 48-month loan at 6% APR and a 36-month loan at 5% APR? A) You will pay less interest for the shorter-term loan. B) The longer-term loan has a higher monthly payment. C) You will pay less in total for the longer-term loan. D) The shorter-term loan has a lower monthly payment. Answer: A Solution: You will pay less interest but a higher payment for the shorter-term loan. Paying off a loan quicker reduces the principal faster, thus lowering finance charges. Paying off a loan quicker will also require larger principal payments. Format: Multiple Choice Title: Test Bank 6.1 Cost of Financing Section: Evaluating Vehicle Choices Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 33. Generally, the __________ costs associated with buying a car are higher than the costs of leasing. A) up-front B) monthly C) back-end

D) up-front and monthly Answer: D Solution: Generally, the up-front and monthly costs associated with buying a car are higher than the costs of leasing. This tends to make leases attractive to consumers who want to limit their monthly expenses. Format: Multiple Choice Title: Test Bank 6.2 Leasing Versus Buying Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 34. A lessee is a person who A) owns property and charges someone money to use that property for a period of time. B) purchases property from another person but sells it back after a period of time. C) sells property to another person with the intention of purchasing it back after a period of time. D) pays money for the privilege of using someone else’s property for a period of time. Answer: D Solution: A lessee agrees to pay money for the right to use someone else’s property, such as a vehicle, for the period of time. Format: Multiple Choice Title: Test Bank 6.2 Lessee Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 35. A closed-end lease is a lease in which the A) lessee takes the risk that the resale value of the car at the end of the term will be less than what was originally assumed. B) lessor takes the risk that the resale value of the car at the end of the term will be less than what was originally assumed.

C) terms of the lease contract are nonnegotiable by the lessee. D) terms of the lease contract are nonnegotiable by the lessor or lessee. Answer: B Solution: A closed-end lease is a lease in which the lessor takes the risk that the resale value of the car at the end of the term will be less than what was originally assumed. Format: Multiple Choice Title: Test Bank 6.2 Closed-End Lease Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 36. Gross capitalized cost in an automobile lease is equivalent to the _______ for a new car. A) down payment B) price you negotiate C) finance charge D) depreciation Answer: B Solution: Gross capitalized cost in an automobile lease is equivalent to the price you negotiate for a new car. Format: Multiple Choice Title: Test Bank 6.2 Gross Capitalized Cost Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 37. Which of the following is a reason why consumers lease cars? A) Ability to get a new car every two or three years B) Lower up-front costs in leasing than in financing a purchase C) Lower monthly costs in leasing than in financing a purchase D) All the choices are correct. Answer: D

Solution: The up-front and monthly costs associated with leasing a car are lower than the costs of buying. This tends to make leases attractive to consumers who want to limit their monthly expenses. Leases also allow consumers to drive a new car every two or three years without the uncertainty of trade-in or resale value. Format: Multiple Choice Title: Test Bank 6.2 Advantages of Leases Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. In a _____ lease, the _____ bears the risk that the resale value of the car at the end of the term is less than originally assumed. A) closed-end; lessee B) closed-end; lessor C) open-end; lessor D) open-end; bank Answer: B Solution: In a closed-end lease, the lessor takes the risk that the resale value of the car at the end of the term is less than originally assumed. Format: Multiple Choice Title: Test Bank 6.2 Closed-End Versus Open-End Leases Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 39. The most common type of auto lease is the _______. A) closed-end lease B) open-end lease C) closed-end credit D) open-end credit Answer: A Solution: The most common type of auto lease is the closed-end lease. Leases are a long-term rental, not a form of credit loan. Format: Multiple Choice Title: Test Bank 6.2 Closed-End Versus Open-End Leases Section: Leasing Versus Buying

Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 40. Up-front fees on an auto lease include (select any two) A) Insurance. B) credit report. C) application processing fee. D) delivery charge. E) sales tax. Answer: B and C Solution: Up-front fees on an auto lease include credit report and/or application processing fees. Format: Multiple Select Title: Test Bank 6.2 Up-Front Fees Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 41. What is the equity in the car? A) The difference between the car’s purchase price and the amount of the loan B) The difference between the car’s purchase price and the remaining amount of the loan C) The difference between the car’s market value and the remaining amount of the loan D) The difference between the car’s market value and the resale value Answer: C Solution: The equity in the car is the difference between the car’s market value and the remaining amount of the loan. Format: Multiple Choice Title: Test Bank 6.2 Equity Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 42. A walk-away lease is a(n) A) closed-end lease. B) open-end lease. C) contingent lease. D) capitalized lease. Answer: A Solution: A closed-end lease is also sometimes called a walk-away lease because you can return the car in good condition and simply walk away from any further responsibilities. Format: Multiple Choice Title: Test Bank 6.2 Walk-Away Lease Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 43. If you must pay a fee at the end of the lease term if you choose not to purchase the vehicle, this is known as a A) capitalized cost reduction. B) purchase fee. C) back-end fee. D) disposition fee. Answer: D Solution: A disposition fee is charged if you choose not to purchase the vehicle at the end of the lease. Format: Multiple Choice Title: Test Bank 6.2 Lease Terminology Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

44. Which is not a component of the total cost of car ownership? A) Dealer profit B) Finance charges C) Fuel efficiency D) Insurance Answer: A Solution: Although the negotiated purchase price of the car makes the most difference in the total ownership cost, fuel efficiency affects the cumulative cost of running the car, finance charges adds to the purchase cost, and insurance is required to drive the car. The dealer’s profit or loss has no bearing on your acquisition cost. Format: Multiple Choice Title: Test Bank 6.2 Cost of Ownership Section: Negotiating the Auto Purchase Price Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 45. Which of the following is not one of the main sources of auto dealer profits? A) Licensing fees B) Profit on vehicles traded in for less than resale value C) Manufacturer incentives D) Service contracts Answer: A Solution: Licensing fees are typically paid to the state motor vehicle department. The sales margin (profit) on a car, manufacturer’s sales incentives (allowances), and service charges are all sources of dealer profits. Format: Multiple Choice Title: Test Bank 6.2 Components of Auto Dealer Profit Section: Negotiating the Auto Purchase Price Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 46. State laws that protect consumers against defective vehicles are known as A) blue laws B) red laws

C) lemon laws D) orange laws Answer: C Solution: State laws that protect consumers against defective vehicles are known as lemon laws. Format: Multiple Choice Title: Test Bank 6.2 Consumer Protection Section: Making Consumer Complaints Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 47. Generally, a person should consider leasing a car under a closed-end lease contract rather than purchasing a new car with a car loan if A) he or she wants to have a lower monthly payment. B) he or she does not want to take the risk of residual value fluctuation. C) he or she does not drive a lot of miles annually. D) All of these are true. Answer: D Solution: Generally, a person should consider leasing a car under a closed-end lease contract rather than purchase a new car, if she wants to lower monthly payments, have low annual mileage, and does not want the uncertainty of resale value. Format: Multiple Choice Title: Test Bank 6.2 Leasing Versus Buying Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 48. Ginny has researched several cars, and she has narrowed down her choices to two cars. The car on the top of her list can be purchased with a bank loan or leased through the manufacturer's program. Ginny had a bad experience with her previous car, which gave her a lot of mechanical trouble and quickly lost its value at the time of trade-in. Ginny does not want to go through a similar experience again. She normally changes her cars every three to four years. Ginny should consider

A) leasing her next car under an open-end lease. B) leasing her next car under a closed-end lease. C) buying her next car with cash. D) buying her next car with a bank loan. Answer: B Solution: Ginny should get a closed-end lease, where the lessor (dealer) takes the risk that the resale value of the car. This type of lease you can return the car in good condition and simply walk away from any further responsibilities. A disadvantage of closed-end leases is that you are committed to the full term of the lease and may be subject to a large penalty for canceling prematurely; however, she keeps the car for the typical lease term. Format: Multiple Choice Title: Test Bank 6.2 Leasing Versus Buying Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 49. Michael is considering getting a closed-end lease on a car for 48 months. The car dealer quotes him a monthly payment of $349. If Michael were to buy the car with the same down payment, his monthly payment would be $465 a month. Michael's lease payment is lower because A) car dealers make a lower profit on leased cars. B) leased cars do not come with a manufacturer's warranty. C) he is not paying for the residual value of the car at the end of the lease. D) he is paying finance charges only on the amount of the car that will be depreciated over four years. Answer: C Solution: Michael's lease payment is lower because he is not paying for the residual value of the car at the end of four years. Format: Multiple Choice Title: Test Bank 6.2 What Determines the Cost of an Auto Lease Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute

50. Janelle is debating whether to buy or lease her favorite car. Under a closed-end lease, Janelle will A) have to purchase the car at lease end. B) not be required to compensate the lessor for fluctuations in the resale value at lease end. C) be required to compensate the lessor for fluctuations in the resale value of the car at lease end. D) be able to walk away from her lease no matter the condition of the car. Answer: B Solution: Under a closed-end lease, Janelle will not be required to compensate the lessor for fluctuations in the resale value at lease end or purchase the car. However, the car must be in good condition commensurate to just normal wear for the lease term. Format: Multiple Choice Title: Test Bank 6.2 Lease Contracts Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 51. Mona needs to determine whether to lease or buy a car for 4 years. The purchase price is $30,000 (including taxes and dealer fees). Her bank is offering the most competitive financing deal: 2% APR for a 4-year loan with 10% down payment. The dealer’s 4-year lease agreement requires a monthly payment of $299 with a capitalized cost reduction of $2,000 and a $500 security deposit. The mileage allowance is well beneath her annual average. The estimated value of the car at the end of 4 years is $12,000. Without consideration for forgone interest, which will cost you more, leasing or buying? A) Lease is $2,889 cheaper. B) Finance purchase is $2,889 cheaper. C) Lease is $2,765 cheaper. D) Finance purchase is $2,765 cheaper. Answer: C Solution: Calculate the car loan payment and determine the cumulative cost of ownership versus the cumulative cost of the lease. Car Purchase Cost Financial Calculator: Enter PV = (30,000*0.90), FV = 0, N = 48, I = (2/12), solve for PMT = 585.77

Excel Spreadsheet: =PMT(rate,nper,pv,fv,type) => =PMT((0.02/12), 48, (30000*0.90), 0, 0) = 585.77 TVM Equation: PMT = PVA ×

𝑖 𝑛 1 ) 1−( (1 + 𝑖)

PMT = ($30,000𝑥0.90) ×

0.001667 48 1 ) 1−( (1 + 0.001667)

= $585.77

Total Up-front Cost = $30,000 × 0.10 down payment Total Loan Payments = $585.77 × 48 LESS: Expected Value in 4 Years TOTAL COST OF OWNERSHIP

$ 3,000 $28,117 ($12,000) $19,117

Lease Cost Total Up-front Cost = $2,000 capitalized cost reduction + $500 deposit = $ 2,500 Cost Lease Payments = $299 × 48 $14,352 LESS: Return of Security Deposit ($500) TOTAL COST OF OWNERSHIP $16,352 $19,117 purchase - $16,352 lease = lease is $2,765 cheaper Format: Multiple Choice Title: Test Bank 6.2 Lease Versus Buying Calculation Section: Leasing Versus Buying Learning Objective: 6.2 Evaluate your housing needs and budget. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 5 minutes 52. By law, housing leases A) have to be in writing. B) can be verbal. C) can be verbal but must be in writing if longer than a year. D) can be verbal but must be in writing if longer than two years. Answer: C Solution: In most states by law, leases don’t have to be in writing unless they’re for a period of more than a year, but it’s a good idea to have a written lease to guard against misunderstandings at a later date. Format: Multiple Choice

Title: Test Bank 6.3 Leases Section: The Rent-Versus-Buy Decision Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 53. Mortgage insurance is required if your loan-to-value ratio is A) more than 70 percent. B) more than 80 percent. C) less than 80 percent. D) less than 70 percent. Answer: B Solution: When you borrow more than 80% of the value of the home (80% loanto-value), lenders charge an extra amount to cover mortgage insurance. Format: Multiple Choice Title: Test Bank 6.3 Mortgage Insurance Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 54. Mortgage insurance premiums are based on A) the value of your home. B) your mortgage loan balance. C) the equity of your home. D) the credit history. Answer: B Solution: Mortgage insurance is required when your loan amount exceeds 80% of the value of your home. It is charged as a percentage of the mortgage balance. Format: Multiple Choice Title: Test Bank 6.3 Mortgage Insurance Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

55. With the exception of the mega-rich, the percentage of income people spend on housing is ________ income brackets. A) relatively consistent across B) greater for people in low C) greater for people in high D) lower for people in middle income brackets Answer: A Solution: With the exception of the mega-rich, the proportion of a household budget that is spent on housing is relatively consistent across income brackets. Format: Multiple Choice Title: Test Bank 6.3 Income Spent on Housing Needs Section: Housing Needs over the Life Cycle Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective thinking Expected Time to Complete: 1 minute 56. Housing needs are a function of A) a household’s position in their life cycle. B) real estate prices. C) household income. D) gender. Answer: A Solution: Over your life cycle and with changing life circumstances, your housing needs will probably change. Young single adults often rent small apartments and share living quarters with friends. Married couples tend to prefer to live on their own, and families with children often need more space. Federal government statistics show that average housing expenditures are greatest for people during their child-rearing years, ages 35–44, averaging more than $20,000 per year. In contrast, retiree households spend about one-third of that amount because they commonly downsize and pay off their mortgages prior to retirement. Format: Multiple Choice Title: Test Bank 6.3 Housing Needs Section: Housing Needs over the Life Cycle Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute

57. When considering spending on housing needs, if a person is heavily immersed in credit card debt, A) housing needs should be an independent decision. B) it would be a good idea to save money by cutting housing expenditures and paying down debt first. C) they should first satisfy housing needs and then focus on paying down credit card debt. D) they should continue to borrow against credit cards to maintain a roof over their head. Answer: B Solution: When considering spending on housing needs, if a person is heavily immersed in credit card debt, it would be a good idea to save money by cutting housing expenditures and paying down debt first. Because you have a wide variety of choices to meet your housing needs, it’s up to you to make this decision in light of your other priorities, such as reducing your credit card debt. Format: Multiple Choice Title: Test Bank 6.3 Housing Needs Section: Housing Needs over the Life Cycle Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 58. Which is an advantage of owning a home? A) Lower monthly payments B) Investment value C) Mobility D) Less responsibility Answer: B Solution: Homeowners benefit from the increase in value of the property over time. Mortgage payments are typically greater than rent payments; selling a home often takes a long time, and homeowners have responsibility for maintenance of lawns and gardens, clearing of snow, or exterior cleaning and painting. Format: Multiple Choice Title: Test Bank 6.3 Home Ownership Section: The Rent-Versus-Buy Decision Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute

59. When lending money in the form of a mortgage on a home, the lender requires a down payment in order to A) make sure only those people who have a commitment to owning are qualified. B) make sure that there is a safety margin in case the value of the house falls and the mortgage exceeds the value of the home. C) hold it as a security deposit, which is returned when the mortgage is paid off in full. D) apply it toward the first year's mortgage payments. Answer: B Solution: When lending money in the form of a mortgage on a home, the lender requires a down payment in order to make sure that there is a safety margin in case the value of the house falls and the mortgage exceeds the value of the home. Format: Multiple Choice Title: Test Bank 6.3 The Down Payment Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 60. Mike is applying for a home loan and wants to buy a house worth $350,000. How much of a minimum down payment will he have to make to avoid mortgage insurance? A) $35,000 B) $52,500 C) $70,000 D) $87,000 Answer: C Solution: A down payment of at least 20 percent is required to avoid mortgage insurance. Mortgage insurance protects the lender against the possibility that you will fail to pay back the mortgage as promised. A home worth of $350,000 will require a $70,000 down payment ($350,000 × 0.20). Format: Multiple Choice Title: Test Bank 6.3 Minimum Down Payment to Avoid PMI Calculation Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective thinking Expected Time to Complete: 1 minute

61. Joe is shopping for a new home. He is trying to decide how large his down payment should be. Joe is earning 2.5 percent APY in his savings account, whereas his mortgage loan will cost him 5 percent APR. If Joe has the money available in his savings account, he should A) reduce the down payment on the house. B) increase his down payment on the house. C) not buy the house right now. D) purchase mortgage insurance. Answer: B Solution: If Joe has excess money available in his savings account, he should increase his down payment on the house because the cost of financing is double the rate he can earn in the savings account. Format: Multiple Choice Title: Test Bank 6.3 Down Payment Decision Section: The Rent-Versus-Buy Decision Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 62. Closing costs on the purchase of a house A) increase the amount of cash available for the down payment. B) increase the mortgage insurance premium. C) reduce the amount of cash available for the down payment. D) are paid by the lender. Answer: C Solution: When you buy a home, you’ll also incur various costs associated with the real estate transaction. These are usually called closing costs, because the meeting where you sign all the required paperwork to finalize your purchase is called the closing. Closing costs can vary widely and can be a substantial drain on your available cash for a down payment. Format: Multiple Choice Title: Test Bank 6.3 Closing Costs Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute

63. Mortgage payments (including principal and interest) depend upon the interest rate, A) down payment, and the length of the mortgage. B) loan amount, and the length of the mortgage. C) down payment, and the loan amount. D) insurance premium, loan amount, and the length of the mortgage. Answer: B Solution: The mortgage payment depends upon the interest rate, loan principal, and the length of the mortgage. In some cases, a lender will also collect additional amounts in an escrow account to fund property tax and homeowner’s insurance payments, but these are separate from the mortgage. Format: Multiple Choice Title: Test Bank 6.3 Mortgage Payment Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 64. Mary Anne is considering buying a home. She is currently renting and does not have to pay for some utilities, landscaping, taxes, repairs, or maintenance. While she is excited about living in her own home, she is worried about being responsible for many more aspects of ownership. In order to determine the true cost of ownership of a home, Mary Anne should consider A) the initial purchase price and future appreciation or depreciation. B) the cost of financing. C) repairs and maintenance costs. D) all of these. Answer: D Solution: Mary Anne should consider the initial purchase price and future appreciation or depreciation of the home, the cost of financing, and future repairs and maintenance costs. Format: Multiple Choice Title: Test Bank 6.3 Costs of Home Ownership Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute

65. The Jones have $72,000 in savings available for up-front costs on a home purchase. They qualified for a 30-year mortgage at 5.5% APR. They also expect closing costs to total $3,000. They have budgeted $2,500 per month to allocate to housing costs, including monthly nonfinancing costs of $150 for homeowner’s insurance, $585 for property taxes, $130 for repairs, and $60 for maintenance. What is the maximum they can afford to pay for a home? A) $346,392 B) $349,392 C) $509,304 D) $672,217 Answer: A Solution: First, calculate the present value of a loan based on the budgeted mortgage payment, at 5.5% APR for 360 payments. Then, add the net value of the up-front money for closing. Budgeted monthly payment available for mortgage $2,500 - $150 homeowners insurance - $585 property taxes - $130 repairs - $60 maintenance = $1,575. Financial Calculator: Enter PMT = -1575, N = 360, I = (5.5/12), FV = 0 and solve for PV = 277,392 Excel Spreadsheet: =PV(rate,nper,pmt,fv,type) => =PV((5.5/12), 360, -1575, 0, 0) => 277,392 TVM Equation: 𝑛 1 ) 1−( (1 + 𝑖) PVA = PMT × 𝑖

1−( PVA = $1,575 ×

360 1 ) (1 + 0.0045833) = $277,393 0.0045833

Maximum they can afford to pay for a home $277,392 mortgage + ($72,000 savings - $3,000 closing costs) = $346,392 Format: Multiple Choice Title: Test Bank 6.3 Maximum Affordability Calculation Section: How Much House Can You Afford? Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic

Expected Time to Complete: 4 minutes 66. Most lenders require that a borrower’s mortgage debt service ratio be no more than 28 percent of their A) equity. B) income. C) overall debt. D) assets. Answer: B Solution: Lenders will also limit your borrowing based on your capacity to repay the loan. They commonly use the mortgage debt payment ratio of no more than 28 percent of your income. Format: Multiple Choice Title: Test Bank 6.3 Minimum Debt Payment Ratio Section: Factors That Affect Mortgage Payments Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 67. The tax advantages of home ownership include all of the following except A) tax-deductible maintenance costs up to $50,000. B) tax-deductible interest on up to $750,000 mortgage. C) tax-deductible property taxes up to $10,000. D) tax-free gain on up to $250,000 in profit from the sale of your primary residence. Answer: A Solution: The tax advantages of home ownership include the tax deductibility of mortgage interest and property taxes, not maintenance of the property. The sale of your primary residence allows for an exemption of up to $250,000 ($500,000 if married) of long-term capital gains from income tax, if lived in the home at least two out of past five years. Format: Multiple Choice Title: Test Bank 6.3 Tax Advantages of Home Ownership Section: The Rent-Versus-Buy Decision Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

68. The Sayeds bought a home in January and borrowed $400,000 to finance it. The mortgage interest and principal payment is $2,147 per month. In the first year, they paid $19,799 in interest, $5,965 in principal, and $10,100 in property taxes. They are in the 24% marginal tax bracket. Approximately, how much will they save in federal income taxes from home ownership the first year, if itemizing deductions? (Round to the nearest whole dollar.) A) $2,424 B) $4,776 C) $7,176 D) $8,607 Answer: B Solution: The $19,799 interest on their mortgage is tax-deductible, and the $10,100 in property tax paid is also tax deductible. Thus, $29,899 in total deductions @ 24% marginal tax is $7,175.76 ($29,899 × 0.24). Format: Multiple Choice Title: Test Bank 6.3 Tax Savings on Annual Housing Costs Calculation Section: The Rent-Versus-Buy Decision Learning Objective: 6.3 Evaluate your housing needs and budget. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 69. The two ratios most commonly used by mortgage lenders to evaluate the ability to pay a mortgage loan are the A) current ratio and mortgage debt service ratio. B) total debt service ratio and total credit utilization ratio. C) mortgage debt service ratio and debt payment ratio. D) current ratio and debt payment ratio. Answer: C Solution: The two ratios most commonly used by mortgage lenders to evaluate the ability to pay a mortgage loan are the mortgage debt service ratio and debt payment ratio. These ratios measure the total debt or total housing costs as a percentage of income. Format: Multiple Choice Title: Test Bank 6.4 Mortgage Evaluation Criteria Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 1 minute

70. Tim's monthly gross income is $2,900. He is buying a house that requires a $660 monthly payment. Property taxes would be $120 per month and insurance premiums of $45 per month. What is Tim's mortgage debt service ratio? A) 28.45% B) 17.07% C) 35.15% D) 58.59% Answer: A Solution: Mortgage debt service ratio =

Principal + Interest + Taxes + Insurance Gross monthly income

Mortgage debt service ratio =

$660 + $120 + $45 = 0.2845 or 28.45% $2,900

Format: Multiple Choice Title: Test Bank 6.4 Mortgage Debt Service Ratio Calculation Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 71. Sam's mortgage payment is $750 per month. He also has other monthly debt payments of $440. If his monthly after-tax income is $3,950, what is Sam's debt payment ratio? A) 30.13% B) 29.14% C) 8.27% D) 33.19% Answer: A Solution:

Debt payment ratio = Debt payment ratio =

Total monthly debt payments After−tax monthly income

$750 + $440 = 0.3013 or 30.13% $3,950

Format: Multiple Choice Title: Test Bank 6.4 Debt Payment Ratio Calculation Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Analysis

AACSB: Analytic Expected Time to Complete: 2 minutes 72. Which of the following is a mortgage loan that has a fixed rate, a fixed term, and fixed payments? A) ARM B) Equity mortgage C) Conventional mortgage D) Reverse annuity mortgage Answer: C Solution: A conventional mortgage is a fixed-rate, fixed-term, and fixed-payment loan. Format: Multiple Choice Title: Test Bank 6.4 Mortgage Types Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 73. Which of the following statements is true of adjustable rate mortgages? A) They generally carry higher initial interest rates than conventional mortgages. B) They usually convert to a fixed-rate loan after a period of time. C) The interest rate changes are subject to limits. D) There is no limit to interest rate changes. Answer: C Solution: An adjustable rate mortgage (ARM) has an interest rate that changes over time with market conditions. Because the lender is less exposed to the risk of rising rates, the initial rates on ARMs are usually lower than those on conventional mortgages. Changes in the rate over time are governed by the terms of the mortgage contract. The amount that the rate on an ARM can change is limited by interest rate increase caps after an initial fixed period, commonly five or seven years. The caps apply to both the change per year and the total change over the life of the loan. Format: Multiple Choice Title: Test Bank 6.4 Features of ARMs Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 74. Which type of mortgage allows homeowners to stay in their homes but receive a stream of cash flow from their homes? A) Insured mortgage B) Reverse annuity mortgage C) Graduated mortgage D) Shared appreciation mortgage Answer: B Solution: If you have a lot of equity in your home and would like to apply the money to something else, you may be able to access it through a reverse annuity mortgage, also known as a home equity conversion mortgage. A financial company will take the equity in your home and convert it to a tax-free stream of cash. Format: Multiple Choice Title: Test Bank 6.4 Types of Mortgages Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 75. A mortgage is a A) long-term amortized loan that is secured by real property. B) long-term amortized loan that is secured by real or financial assets. C) short-term amortized loan that is secured by financial assets. D) revolving credit line that is secured by real property or financial assets. Answer: A Solution: A mortgage is a long-term amortized loan that is secured by real property. Format: Multiple Choice Title: Test Bank 6.4 What is a Mortgage? Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 76. If a financial institution makes a home loan and then sells the loan to another financial institution, this is a type of A) primary mortgage market transaction.

B) secondary mortgage market transaction. C) mortgage origination. D) reverse mortgage. Answer: B Solution: After contracting with you for a mortgage (also called “originating” the mortgage), your lender will most likely sell the loan to another financial institution in the secondary mortgage market. This allows your lender to recoup the cash and lend it out again. Format: Multiple Choice Title: Test Bank 6.4 Resale of Loans Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 77. Under a (n) ____________ mortgage, the loan balance is paid off more quickly than under a conventional mortgage. A) adjustable rate B) fixed-to-adjustable rate C) graduated payment D) growing equity Answer: D Solution: Total annual payments on a growing equity mortgage are greater than those on a conventional loan of the same amount, but the added amounts are applied to the principal, so the loan balance can be paid off more quickly. Format: Multiple Choice Title: Test Bank 6.4 Types of Mortgages Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 78. In a home purchase, what are discount points? A) A reduction in the annual interest rate of the mortgage loan because the buyer made a higher-than-required down payment B) A reduced annual interest rate because of a very high credit score C) Interest paid up front to the lender in return for a reduced annual interest rate D) A reduction in the closing costs due to the fact the buyer put up a large amount of earnest money

Answer: C Solution: Lenders often give you the opportunity to pay discount points to reduce your loan interest rate, commonly referred to as a rate “buy-down.” The points required for a specific rate reduction vary with competition and market conditions. In deciding whether to pay points in return for a lower rate, you need to evaluate the up-front cost against the present value of future payments. Format: Multiple Choice Title: Test Bank 6.4 Points Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 79. One discount point is equal to ___ percent of the loan amount. A) 1 B) 10 C) 0.1 D) 0.01 Answer: A Solution: Lenders often give you the opportunity to pay discount points to reduce your loan interest rate, commonly referred to as a rate “buy-down.” A “point” is one percent of the loan amount. Format: Multiple Choice Title: Test Bank 6.4 Points Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. Refinancing a home incurs ________ mortgage-related finance charges than a mortgage on a new home purchase. A) substantially lower B) substantially higher C) mostly of the same D) no Answer: C Solution: Refinancing a mortgage is exchanging the old rate for the new rate on your mortgage to get a lower payment. The costs of refinancing may sometimes outweigh the benefits of the lower rate. Because a refinance results in a

completely new mortgage, you will incur most of the same mortgage-related finance charges and closing costs as with the original mortgage. Format: Multiple Choice Title: Test Bank 6.4 Refinance Costs Section: When to Refinance Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 81. Which is not a good reason to refinance your mortgage? A) To save money B) To access your home equity C) To reduce the term of your mortgage D) To extend the term of your mortgage Answer: D Solution: Refinance to save money by either lowering the rate or reducing the term of your mortgage is a good reason to refinance. Although you can do this with a second mortgage, it’s often cheaper to do so by refinancing your first mortgage for a larger amount to access your home equity for improvements. Extending a mortgage is a bad idea because you will be paying more interest over the life of the loan. Format: Multiple Choice Title: Test Bank 6.4 Why Refinance? Section: When to Refinance Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 82. Which of the following statements is true of adjustable rate mortgages? A) The interest rate changes on ARMs are limited per year and per lifetime. B) They cannot be converted to fixed-rate loans. C) They generally carry higher initial interest rates than conventional mortgages. D) The interest changes are the same for each year of the loan. Answer: A Solution: The amount that the rate on an ARM can change is limited by interest rate increase caps after an initial fixed period, commonly five or seven years. The caps apply to both the change per year and the total change over the life of the loan. Format: Multiple Choice Title: Test Bank 6.4 ARMs

Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 83. A good reason to refinance your home is to A) lower your monthly payment by increasing the term. B) lower your monthly payment but keep the same maturity. C) increase your line of credit. D) increase your loan-to-value. Answer: B Solution: If you can lower your monthly payment by lowering the interest paid on the loan, and not extend the term, it makes great sense to refinance, provided the savings outweigh the cost of closing. Format: Multiple Choice Title: Test Bank 6.4 When to Refinance Section: When to Refinance Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 84. Refinancing makes sense only if you A) will stay in the house long enough to recoup the refinancing costs. B) can get a significant reduction in the rate. C) can reduce your repayment period. D) All of the these. Answer: A Solution: A simple rule of thumb for deciding whether it’s worthwhile to refinance a mortgage is to divide the estimated costs of refinancing by the monthly payment savings from the refinance. That will tell you how many months it will take to recoup your costs. If you plan to stay in the home for at least that long, you will save money by refinancing. Format: Multiple Choice Title: Test Bank 6.4 Costs of Refinancing Section: When to Refinance Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Application AACSB: Analytic

Expected Time to Complete: 1 minute 85. A balloon mortgage is A) usually amortized over five years. B) a loan that requires a higher down payment. C) usually amortized over 30 years but requires a final payment that is much larger than the earlier regular payments. D) usually paid over its term of 30 years. Answer: C Solution: A balloon mortgage is usually amortized over 30 years but requires a final payment that is much larger than the earlier regular payments. Format: Multiple Choice Title: Test Bank 6.4 Balloon Mortgage Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective thinking Expected Time to Complete: 1 minute 86. An interest rate cap is likely to be associated with a(n) ________ mortgage. A) adjustable rate B) fixed-rate C) balloon D) growing equity Answer: A Solution: An interest rate cap is likely to be associated with an adjustable rate mortgage. Format: Multiple Choice Title: Test Bank 6.4 Interest Rate Cap Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective thinking Expected Time to Complete: 1 minute 87. Risk of negative amortization is associated with ________ mortgages. A) adjustable rate B) fixed-rate C) subprime

D) conventional Answer: A Solution: Negative amortization occurs when the required payment on a loan is insufficient to cover the periodic interest so the lender adds the difference to the loan balance. This can occur with adjustable rate mortgages if they have a payment cap. Format: Multiple Choice Title: Test Bank 6.4 Negative Amortization Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Knowledge AACSB: Reflective thinking Expected Time to Complete: 1 minute 88. Borrowers sometimes pay points to their mortgage lender in order to A) reduce the term of the loan. B) reduce the principal balance of the loan. C) reduce the interest rate. D) cover their closing costs. Answer: C Solution: Borrowers sometimes pay points to their mortgage lender in order to reduce the interest rate. Format: Multiple Choice Title: Test Bank 6.4 Why Pay Points? Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 89. If a borrower wants to lower a person’s monthly mortgage payments, he or she can A) negotiate a lower interest rate. B) extend the term of the loan. C) make a larger down payment. D) do all of these. Answer: D

Solution: If a borrower wants to lower a person’s monthly mortgage payments, he or she can negotiate a lower interest rate, extend the term of the loan, and/or make a larger down payment. Format: Multiple Choice Title: Test Bank 6.4 How to Lower Monthly Payments? Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 90. You are comparing two options for a $125,000 home mortgage. The first option is a 15-year mortgage with a 4% annual rate, and the second option is a 30-year mortgage with a 4.5% interest rate. If you want your monthly payment under the first option to be the same as the monthly payment under the 30-year option, how much additional down payment will you need to put down under the 15-year option? A) $7,664 B) $39,375 C) $42,208 D) $44,909 Answer: B Solution: First, calculate the monthly mortgage payment of the $125,000 30-year mortgage at 4.5% APR. Then, calculate the present value (loan principal) that would result with a 15-year 4% APR mortgage that has the monthly payment calculated for the 30-year loan. Monthly Payment for Loan 1: $125,000 30-year Mortgage at 4.5% APR Financial Calculator: Enter PV = 125,000, FV = 0, N = 360, I = 4.5/12, and solve for PMT = -633.36 Excel Spreadsheet: =PMT(rate,nper,pv,fv,type) => =PMT((0.045/12), 360, 125000, 0, 0) => -633.36 TVM Equation: PMT = PVA ×

𝑖 𝑛 1 ) 1−( (1 + 𝑖)

PMT = $125,000 ×

0.00375 360 1 ) 1−( (1 + 0.00375)

= $633.36

Loan 2 Principal: $633.36 monthly payment, 15-year 4% APR Mortgage Financial Calculator: Enter PMT = -633.36, N = 180, I = 4/12, FV =0 and solve for PV = 85,625.30 Excel Spreadsheet: =PV(rate,nper,pmt,fv,type) => =PV((0.04/12), 180, -633.36, 0, 0) => 85,625.30 TVM Equation:

𝑛 1 ) 1−( (1 + 𝑖) PVA = PMT × 𝑖

180 1 ) 1−( (1 + 0.0033333) PVA = $633.36 × = $85,625.53 0.0033333

Additional Down-payment Required to Match Loan 1 Payment for Loan 2 $125,000 loan 1 principal - $86,625.53 loan 2 principal = $39,374.47 Format: Multiple Choice Title: Test Bank 6.4 Impact of Rate and Maturity of Mortgage Payment Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 4 minutes [Distractor 1: use same Int as Loan 1 for Loan 2; Distractor 2: use same N as Loan 1; for Loan 2 but positive number; Distractor 3: use the difference of Int from Loan 1 and Loan 2 for Int]

91. Damien has just signed a mortgage contract on his new home for $150,000. The mortgage term is 20 years and his monthly payments will be $990. How much lifetime interest will Damien pay to the lender? A) $11,880 B) $19,800 C) $87,600 D) This cannot be determined without the interest rate.

Answer: C Solution: The total payments required for this loan is $990 × 20 years × 12 months = $237,600. The total interest paid on this loan will be $237,600 in total payments - $150,000 loan = $87,600. Format: Multiple Choice Title: Test Bank 6.4 Total Interest Paid on a Mortgage Calculation Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute [Distractor 1; PMT × years; Distractor 2: PMT × 12] 92. The lender requires a borrower's total debt payment ratio to be 36% or less, and the mortgage debt service ratio to be no more than 28% of gross income. If the Gonzales have PITI payments of $475 per month and $75 of additional debt, how much gross income do they need to qualify for the mortgage? A) $1,319 B) $1,528 C) $1,696 D) $1,964 Answer: C Solution: Calculate the gross monthly income by using the mortgage debt service ratio formula: Principal + Interest + Taxes + Insurance Mortgage debt service ratio = Gross monthly income 0.28 =

$475 = $1,696 Gross monthly income

Verify that this amount of income will also ensure that the debt payment ratio is less than 36%: Debt payment ratio =

PITI + Other debt payments $475 + $75 = = 32.4% Gross monthly income $1696

AACSB: Analytic Expected Time to Complete: 1 minute [Distractor 1: (PITI+additional debt)/mortg ratio; Distractor 2: (PITI+add’l debt)/ debt ratio; Distractor 3: (PITI+add’l debt)/debt ratio]] 93. You are considering a $100,000 loan for 30 years. A new bank is currently offering an APR of 6% and your current bank is offering an APR of 6.25%. How much is the difference in total payments over the life of the loan? A) $194 B) $288 C) $5,821 D) $5,862 Answer: C Solution: Calculate the monthly mortgage payments for each loan, and compare the cumulative difference. New Bank Financial Calculator: Enter PV = 100,000, FV = 0, N = 360, I = 6/12, and solve for PMT = -599.55 Excel Spreadsheet: =PMT(rate,nper,pv,fv,type) => =PMT((0.06/12), 360, 100000, 0, 0) => -599.55 TVM Equation: PMT = PVA ×

PMT = $100,000 ×

𝑖 𝑛 1 ) 1−( (1 + 𝑖)

0.005 360 1 ) 1−( (1 + 0.005)

= $599.55

Current Bank Financial Calculator: Enter PV = 100,000, FV = 0, N = 360, I = 6.25/12, and solve for PMT = -615.72 Excel Spreadsheet: =PMT(rate,nper,pv,fv,type) => =PMT((0.0625/12), 360, 100000, 0, 0) => -615.72 TVM Equation:

PMT = PVA ×

PMT = $100,000 ×

𝑖 𝑛 1 ) 1−( (1 + 𝑖)

0.0052083 360 1 ) 1−( (1 + 0.0052083)

= $615.72

Difference in Bank Offers $615.72 payment for current bank - $599.55 payment for new bank = $16.17 $16.17 × 360 payments = $5,821.20 Format: Multiple Choice Title: Test Bank 6.4 Cumulative Interest Savings Between Two Loans Calculation Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 4 minutes 94. Many lenders will offer better rates on loans with A) smaller loan-to-value ratios. B) larger loan-to-value ratios. C) smaller cash-to-loan ratios. D) larger cash-to-loan ratios. Answer: A Solution: Many lenders will offer better rates on loans with smaller loan-to-value ratios. If home values go down in your area, having a lower loan-to-value ratio makes it less likely you’ll end up “under water,” owing more than the value of the home. When that happens, a homeowner may decide to walk away from the loan. Format: Multiple Choice Title: Test Bank 6.4 Determinants of Rates Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 95. Compared with a 15-year mortgage at the same rate of interest, a 30-year mortgage will A) require payment of a mortgage insurance premium. B) result in less interest being paid over the life of the loan. C) result in more principal being repaid over the life of the loan.

D) require a lower monthly payment. Answer: D Solution: All else being equal, the longer the term of the loan, the smaller the monthly mortgage payment and the more interest you will pay over the life of the loan. Format: Multiple Choice Title: Test Bank 6.4 Term of the Loan Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 96. Jim is considering a mortgage loan with two points. If he plans to make a down payment of $40,000 and finance $150,000, how much will two points cost him? A) $800 B) $2,200 C) $3,000 D) $3,800 Answer: C Solution: Lenders often give you the opportunity to pay discount points to reduce your loan interest rate, commonly referred to as a rate “buy-down.” A “point” is 1 percent of the loan amount. Thus, if you’re borrowing $150,000, two points is equal to $3,000 paid at the time you get the loan; $150,000 loan × 0.02 = $3,000. Format: Multiple Choice Title: Test Bank 6.4 Points on a Mortgage Calculation Section: Factors That Affect Mortgage Payments Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 97. Naomi is working with her mortgage lender on the terms of her new $100,000 30-year, fixed-rate mortgage. The lender offers a rate of 4.5% APR with no points (monthly payment $506) and 4.25% with one point (monthly payment $492). If Naomi plans to live in the house for 5 years, does it make sense for her to pay the point? A) No, 7.1 years is breakeven. B) No, 6 years is breakeven. C) Yes, 7 months is breakeven.

D) Yes, 6 months is breakeven. Answer: B Solution: A simple rule of thumb for deciding whether it’s worthwhile to refinance a mortgage is to divide the estimated costs of refinancing by the monthly payment savings from the refinance. That will tell you how many months it will take to recoup your costs: $100,000 × 0.01 point Months required to break even = = 71.4 months $506 − $492 To live in the home to break even on the rate buy-down, 71.4 months, or 5.95 years, is required. Format: Multiple Choice Title: Test Bank 6.4 Break-even Calculation Section: When to Refinance Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 98. If you have an adjustable rate mortgage with an initial rate of 4 percent, an annual interest rate cap of 1 percentage point, and a lifetime cap of 5 percentage points, what is the maximum annual interest rate you could end up paying on the ARM? A) 5 percent B) 6 percent C) 9 percent D) 10 percent Answer: C Solution: The amount that the rate on an ARM can change is limited by interest rate increase caps after an initial fixed period. The caps apply to both the change per year and the total change over the life of the loan. In this example, you have an ARM with an initial rate of 4 percent, an annual rate increase cap of 1 percent, and a lifetime rate increase cap of 5 percent. With this loan, you’ll never see the interest rate increase by more than 1 percentage point per year, and the highest interest you’ll ever pay is 9 percent per year. Format: Multiple Choice Title: Test Bank 6.4 ARM Rate Cap Calculation Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute

99. Cathy and Tom presently have a mortgage rate of 5.25% on their home, with 27 years and $260,000 remaining on their mortgage. Thirty-year mortgage rates have recently dropped to 4.5%. Costs related to refinancing would be $4,000, and they’re planning to stay in their home for at least 10 more years. Does it make sense for them to refinance? A) Yes, because it always makes sense to refinance for a lower rate. B) Yes, because the savings they will realize through lower mortgage payments over the next 10 years are greater than the cost of refinancing. C) No, because it doesn’t make sense to refinance unless the mortgage rate is at least 2% lower a homeowner’s current rate. D) No, because the cost of refinancing is greater than the rate savings over 10 years. Answer: B Solution: Calculate the monthly mortgage payments for each loan, and use the cumulative difference to determine if the refinance makes sense. Current Loan: $260,000 Mortgage at 5.25% over 27 years (324 months) Financial Calculator: Enter PV = 260,000, FV = 0, N = 324, I = 5.25/12, and solve for PMT = -1,502.78 Excel Spreadsheet: =PMT(rate,nper,pv,fv,type) => =PMT((0.0525/12), 324, 260000, 0, 0) = -1,502.78 TVM Equation: PMT = PVA ×

PMT = $260,000 ×

𝑖 𝑛 1 ) 1−( (1 + 𝑖)

0.004375 324 1 ) 1−( (1 + 0.004375)

= $1,502.78

New Loan: $260,000 Mortgage @ 4.5% over 27 years (324 months) Financial Calculator: Enter PV = 260,000, FV = 0, N = 324, I = 4.5/12, and solve for PMT = -1,387.67 Excel Spreadsheet: =PMT(rate,nper,pv,fv,type) => =PMT((0.045/12), 324, 260000, 0, 0) => -1,387.67 TVM Equation:

PMT = PVA ×

PMT = $260,000 ×

𝑖 𝑛 1 ) 1−( (1 + 𝑖)

0.00375 324 1 ) 1−( (1 + 0.00375)

= $1,387.67

Difference in Bank Offers $1,502.78 current payment - $1,387.67 new payment = $115.11 monthly savings $115.11 × 324 months = $37,295.64 total savings $4,000 refinance cost Months required to break even = = 34.8 months $115.11 savings To break even, 34.8 months, or 2.9 years, is required. Format: Multiple Choice Title: Test Bank 6.4 Refinance Calculation Section: When to Refinance Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Hard Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 100. What features would you expect of a mortgage offered at a very low rate of 2 percent? (Select any two) A) It is an ARM (adjustable rate mortgage). B) It has a fixed-rate. C) It has high interest rate caps. D) It has low annual rate caps. Answer: A, C Solution: An adjustable rate mortgage (ARM) has an interest rate that changes over time with market conditions. Because the lender is less exposed to the risk of rising rates, the initial rates on ARMs are usually low, such as 2 percent. The lower the initial rate, the higher the interest rate caps will be to match the average rate on conventional rate mortgages. Format: Multiple Select Title: Test Bank 6.4 ARM Features Section: What is a Mortgage? Learning Objective: 6.4 Evaluate mortgage financing alternatives. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

101. Real estate brokers are paid on a A) flat fee. B) fee based on the listing price. C) percentage of the sale price. D) percentage of the listing price. Answer: C Solution: Real estate agents and brokers are paid a commission by the seller. The commission is typically a percent of the negotiated sale price of the house. Format: Multiple Choice Title: Test Bank 6.5 How a Broker Is Paid Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 102. The commission charged by real estate brokers commonly ranges from A) 2 to 4 percent. B) 4 to 6 percent. C) 5 to 7 percent. D) 8 to 10 percent. Answer: C Solution: Real estate agents and brokers are paid a commission by the seller. The commission is typically 5 to 7 percent of the negotiated sale price of the house. Format: Multiple Choice Title: Test Bank 6.5 Real Estate Broker Fees Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 103. The ______ of a house is the most important determinant to its value. A) age B) square footage C) location D) architecture Answer: C

Solution: The location of a house is the most important determinant to its value. Home prices across the United States vary widely. Two identical houses will have different values depending on their location. A beautiful mansion with all the amenities will be worth practically nothing if it’s located next to a smelly landfill. And a small, run-down bungalow on the Florida beachfront may be worth a million dollars. A home in a good location will appreciate more quickly, and you’ll have an easier time reselling it later. Format: Multiple Choice Title: Test Bank 6.5 Determinants of Real Estate Value Section: Determinants of Real Estate Value Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 104. An account held by the lender used to pay closing costs and prepayments of property taxes and insurance is known as a(n) A) escheatment account. B) escrow account. C) cash management. D) closing account. Answer: B Solution: Closing costs include prepayments of homeowner’s insurance and property taxes to be held in an escrow account from which the lender will make payments on your behalf. Format: Multiple Choice Title: Test Bank 6.5 Closing Costs Section: The Closing Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 105. Actual closing costs are _____ to the buyer ____ the actual date of closing. A) not known; until B) known; before C) not known; until after D) known; at Answer: B

Solution: Prior to the closing date, your lender will give you a detailed accounting of the mortgage-related costs, and you will receive an accounting of the other purchase-related funds that will be collected and disbursed at the closing, such as prepayment of property tax and insurance. Format: Multiple Choice Title: Test Bank 6.5 Closing Costs Section: The Closing Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 106. The purpose of a title search is to A) verify the buyer's legal ownership of the property. B) ensure that there are no other claims on the property that would interfere with the seller's ownership. C) verify the seller's legal ownership of the property and ensure that there are no other claims on the property that would interfere with the buyer's future ownership. D) verify the seller's legal ownership of the property and ensure that there are no other claims on the property that would interfere with the seller's ownership. Answer: C Solution: The purpose of title insurance is to verify the seller's legal ownership of the property and to ensure that there are no other claims on the property that would interfere with the buyer's ownership. Format: Multiple Choice Title: Test Bank 6.5 Title Search Section: The Closing Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 107. An account held by the mortgage lender and used to cover property taxes and homeowner's insurance is known as a(n) A) escrow account. B) guardian account. C) tax account. D) assessed account.

Answer: A Solution: An escrow account is a reserve account where a lender will hold two to six months’ property taxes and homeowner’s insurance on your behalf so the lender can pay these as they come due. Format: Multiple Choice Title: Test Bank 6.5 Property Tax and Insurance Prepayments Section: The Closing Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 108. Among other factors, the price a buyer is willing to pay for a house is a function of A) mortgage interest rates and the condition of real estate market. B) the income of the seller and the family size. C) the family size of the seller and the distance to work. D) the marital status of the buyer and years of employment. Answer: A Solution: Among other factors, the price a buyer is willing to pay for a house is a function of mortgage interest rates and the condition of real estate market. Format: Multiple Choice Title: Test Bank 6.5 Factors in Price Negotiation Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 109. Housing prices are influenced by all of the following factors except A) sales tax. B) maintenance and upgrades. C) location. D) the quality of construction and the structural design. Answer: A Solution: There is no sales tax on a home purchase. Format: Multiple Choice Title: Test Bank 6.5 Real Estate Prices Section: Determinants of Real Estate Value

Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective thinking Expected Time to Complete: 1 minute 110. If a home is well maintained, but the neighbors do not clean their yards, the price of the well-maintained home will A) decline because potential buyers will not like to be surrounded by neglected yards that would be eyesores to passersby. B) be unaffected because every homeowner is only concerned about their own property and neighbors can do as they please without affecting other home values. C) increase as the home will look better compared to other homes in the neighborhood. D) increase because the supply of good homes in the neighborhood will be low. Answer: A Solution: Various aspects of location affect property value, including the desirability of the neighborhood. Format: Multiple Choice Title: Test Bank 6.5 Determinants of Real Estate Value Section: Determinants of Real Estate Value Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 111. A home in a good location will generally A) sell for more. B) appreciate faster in value. C) be easier to sell. D) have all of these benefits. Answer: D Solution: A home in a good location will appreciate more quickly and sell for more, and you’ll have an easier time reselling it later. Format: Multiple Choice Title: Test Bank 6.5 Determinants of Real Estate Value Section: Determinants of Real Estate Value Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium

Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 112. When a buyer selects a broker, it is important that the buyer understands that A) they must pay half the commission. B) the broker is legally required to show them at least three houses before they can make a decision. C) the seller pays the broker’s commission. D) the broker is not allowed to contact the seller. Answer: C Solution: The seller is the one that pays the broker the commission and is therefore the one to whom the broker owes primary legal duty. Format: Multiple Choice Title: Test Bank 6.5 Choosing a Broker Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 113. Elaine is going to hire a listing broker to sell her house, with an estimated price of $200,000. She believes she will be able to negotiate a 5 percent commission. Based on real estate conventions, A) her broker's firm will receive $5,000. B) the cooperating broker's firm will get $10,000. C) her broker's firm will get $10,000. D) her broker will get $5,000. Answer: A Solution: In a standard listing contract, the listing brokerage firm and cooperating brokerage firm will each be entitled to one-half of the full commission, to be split between the actual broker and the broker’s firm. The full commission of 5 percent ($10,000) is split evenly between the listing broker’s firm ($5,000) and the cooperating broker’s firm ($5,000). Format: Multiple Choice Title: Test Bank 6.5 How a Broker Is Paid Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Application

AACSB: Analytic Expected Time to Complete: 1 minute 114. Harry wants to buy a new home but only after he has sold his existing home. He has looked at other properties and likes one that is close to his work and gym. While the asking price seems to be fair, Harry thinks he could negotiate the price down a little. The real estate market is currently picking up steam. In order for the potential seller to accept Harry's conditional offer contingent upon the sale of his own home, Harry A) may have to offer a slightly higher price. B) should offer a lower price and try to negotiate the best price in order to buy some time to sell his house. C) should wait to make an offer on a new home until his old house has been sold. D) should sell his house at a fire sale price to be able to buy the new house quickly. Answer: A Solution: Harry will have to offer a slightly higher price as an incentive for the seller to take the home off the rising market until he can close the sale of his existing home. Any other strategy will risk losing the purchase. Format: Multiple Choice Title: Test Bank 6.5 Negotiating the Contract Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 115. Jennifer is putting in an offer on a home that she likes for many reasons. Some of the things she likes about the house are the kitchen, the large bathrooms, and the state-of-the-art washer and dryer in the laundry room. In order to get the house as she likes it, Jennifer A) needs to do nothing as her agent will verbally tell the seller that she would like the washer and dryer to stay with the house. B) should send a letter to the sellers after the contract stating that she would like the washer and dryer to stay with the house. C) needs to have it in the contract that the washer and dryer stay with the house. D) needs to do nothing as they are required by law to include everything as is in the sale price of the home. Answer: C

Solution: Jennifer needs to have it in the contract that the washer and dryer stay with the house. Format: Multiple Choice Title: Test Bank 6.5 Purchase Contract Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 116. Gary has applied for a mortgage on a house that he is buying for a purchase price of $200,000. He will put 20% down. Gary is concerned that the interest rates may rise by the time the transaction closes in 45 to 60 days. In order to lock in the current low mortgage rate, his lender requires a 0.75% fee. In order to lock in the current interest rate, Gary will have to pay the lender A) $1,500. B) $1,200. C) $750. D) $600. Answer: B Solution: The 0.75 fee to lock in the rate until closing is based on the mortgage principal. $200,000 home - 20% (0.20) down payment = $40,000 down payment $200,000 home - $40,000 down payment = $160,000 loan $160,000 loan × 0.0075 fee = $1,200 fee Format: Multiple Choice Title: Test Bank 6.5 Rate Lock Fee Calculation Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 117. Timothy’s statement of expenses for his new home purchase to be paid at the time of closing is summarized next Mortgage-related costs: $1,250 Home inspection fee: $300 Escrows: $3,500 Title search: $450 Title insurance: $1,300 Real estate commission: $10,500

Attorney’s fee: $450 (seller) and $550 (buyer) Closing charge: $200 (buyer and seller each) What amount will Timothy have to pay at the time of closing? A) $7,550 B) $12,700 C) $12,800 D) $18,050 Answer: A Solution: All the items for the “buyer” are due at closing. He is not responsible for the real estate commission. Mortgage-related costs: $1,250 Home Inspection fee: $300 Escrows: $3,500 Title search: $450 Title insurance: $1,300 Attorney’s fee: (Buyer) $550 Closing charge: $200 Total $7,550 Format: Multiple Choice Title: Test Bank 6.5 Closing Cost Calculation Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 3 minutes 118. Tina and Tony have successfully negotiated a house price and have been approved for a loan at an attractive rate. They are going to pay 20% down on the house and borrow the rest. However, they were shocked to see the good faith estimate of closing costs provided to them by the lender. The house value is $250,000 and the closing cost estimate, excluding escrows, represented approximately 3% of the loan amount. If the escrow for taxes and insurance are $3,800, how much money do Tina and Tony have to come up with at the time of closing (excluding the down payment)? A) $9,800 B) $6,000 C) $3,800 D) $2,200 Answer: A Solution: Loan amount = $250,000 value × (1 – 0.20 down payment) = $200,000

Closing cost estimate (excluding escrow) = $200,000 loan × 0.03 = $6,000 Closing cost = $6,000 estimate based on loan + $3,800 escrow = $9,800 Format: Multiple Choice Title: Test Bank 6.5 Closing Cost Calculation Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Hard Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 119. George is comparing two homes in the same neighborhood. The first is priced at $375,000 for an area of 2,700 sq. ft. and the second is priced at $350,000 for an area of 2,300 sq. ft. Which house is more expensive? A) The first home B) The second home C) no difference between the homes D) Cannot determine with the information provided Answer: B Solution: The second house is more expensive at $152.17 per sq. ft. compared to the first house at $138.89 per sq. ft. $375,000 First house = = $138.89 per sq. ft. 2,700 sq. ft. Second house =

$350,000 = $152.17 per sq. ft. 2,300 sq. ft.

Format: Multiple Choice Title: Test Bank 6.5 Property Value Calculation Section: Determinants of Real Estate Value Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 120. A real estate agent who works exclusively for the buyer and owes no legal duty to the seller is a A) listing broker. B) cooperating broker. C) buyer broker.

D) commission broker. Answer: C Solution: A buyer broker is a real estate agent who works exclusively for the buyer and owes no legal duty to the seller. Format: Multiple Choice Title: Test Bank 6.5 Legal Relationship in Homebuying Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 121. Which of the following is commonly collected at the real estate closing to be placed in an escrow account? A) Prepayment of following month’s mortgage payment B) Prepayment of property tax C) Payment for utilities D) Commission payable to the agent Answer: B Solution: The prepayment of property tax is collected in a real estate closing escrow account. Format: Multiple Choice Title: Test Bank 6.5 Escrow Account Section: The Closing Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 122. Which of the following is generally not included in the sale of property unless specifically stated? A) Lighting fixtures B) Furniture C) Wall-to-wall carpets D) Window treatments Answer: B

Solution: If you don’t specify what is included with the house, certain conventions will apply. Although furniture and personal property of the seller are obviously not included (and must be removed from the premises prior to sale), most appliances (except the washer/dryer and sometimes the refrigerator) are included. Light fixtures, window treatments, wall-to-wall carpeting, and landscaping stay with the house unless otherwise agreed. Format: Multiple Choice Title: Test Bank 6.5 Negotiating the Contract Section: The Home-Buying Process Learning Objective: 6.5 Identify factors that affect home prices, and explain the other costs of completing a real estate transaction. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 123. Jackson is considering a lease with a mileage limitation. The mileage limitation for the lease is 10,000 miles per year with a penalty of 10 cents per excess mile. Calculate his penalty for excess mileage in the first year if he drives 15,000 miles? A) $500 B) $1,000 C) $1,500 D) $2,000 Answer: A Solution: Excess mileage = 15,000 miles – 10,000 miles = 5,000 miles Cost of excess miles = 5,000 excess miles × $0.10 per mile = $500 Format: Multiple Choice Title: Test Bank 6.2 Cost of Excess Mileage Calculation Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 124. If a car is worth $29,000 today and is expected to be worth $15,000 in two years, then the finance charges on a two-year lease will be based on A) $44,000. B) $29,000. C) $15,000. D) $14,000.

Answer: D Solution: $29,000 purchase price - $15,000 residual value = $14,000 is the value that lease is based on. Format: Multiple Choice Title: Test Bank 6.2 Lease Value Calculation Section: Leasing Versus Buying Learning Objective: 6.2 Decide whether to lease or buy a vehicle, and negotiate the terms for purchase and financing. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 125. Which of the following is an example of a fixed cost of automobile ownership? A) Gasoline B) Maintenance C) Loan or lease payment D) Repair Answer: C Solution: Fixed costs are those that remain constant each month, such as loan or lease payments, insurance, and registration. Format: Multiple Choice Title: Test Bank 6.1 Fixed Cost of Vehicle Ownership Section: Assessing Needs and Affordability Learning Objective: 6.1 Evaluate your household automobile needs and budget. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

Chapter 7 Test Bank To accompany Personal Finance, 1st edition, by Vickie Bajtelsmit Summary: 108 questions (all multiple choice). LO 7.1 LO 7.2 LO 7.3 LO 7.4 LO 7.5 Total

28 20 27 22 11 108

26% 19% 25% 20% 10% 100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

25 44 28 5 3 3 108

23.1% 40.7% 25.9% 4.6% 2.8% 2.8% 100%

Easy Medium Hard

25 77 6 108

23% 71% 6% 100%

Calculations Q# 18 19 45 63 64 106 107 108

Test Bank Question

7.1 Expected Loss Calculation 7.1 Expected Severity & Loss Calculation 7.2 Deductible Calculation 7.3 Personal Property Coverage Calculation (with deductible) 7.3 Property Coverage Calculation (with Coinsurance and Deductible) 7.4 Auto Accident Coverage Calculation (with deductible and PAP) 7.4 Auto Accident Coverage Calculation (with deductible and PAP) 7.1 Insurance vs Retention Evaluation Calculation

1. Speculative risk is defined as the A) exposure to a loss. B) possibility of either loss or gain. C) volatility of markets. D) downside possibility of outcomes. Answer: B Solution: Speculative risk is a risk that involves the possibility of either loss or gain, such as gambling or investment. Format: Multiple Choice Title: Test Bank 7.1 Speculative Risk Section: Managing Personal Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 2. A risk that produces only bad outcomes, such as an accident or a fire, is called ____ risk. A) speculative B) marginal C) pure D) negative Answer: C Solution: Pure risk is a risk that produces only bad outcomes, such as car accident or fire. Format: Multiple Choice Title: Test Bank 7.1 Risk Section: Managing Personal Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 3. Pure risk is a type of risk that exposes a person to uncertainty that A) offers the possibility of either losses or gains. B) produces only losses. C) is associated with only controllable events. D) produces only good outcomes.

Answer: B Solution: Pure risk is a type of risk that exposes a person to uncertainty that produces only losses. Format: Multiple Choice Title: Test Bank 7.1 Pure Risk Section: Managing Personal Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 4. What is the first step in the risk management process? A) Evaluating potential losses B) Identifying your risk exposures C) Obtaining insurance quotes D) Choosing the best risk management method Answer: B Solution: The first step to managing a risk is to recognize that it exists. Although it may seem that most risks are obvious, some of the biggest risks are not. In general, people are not very good at recognizing and evaluating their own risk exposures. Format: Multiple Choice Title: Test Bank 7.1 Risk Management Process Section: The Risk Management Process Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 5. As in most financial planning, the last step in developing your insurance plan is to A) reevaluate your needs regularly. B) determine your coverage needs. C) choose the best package available. D) identify top insurers. Answer: A Solution: The last step in developing your insurance plan is to reevaluate your needs regularly. Format: Multiple Choice

Title: Test Bank 7.1 Risk Management Process Section: The Risk Management Process Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 6. Frequency of loss is the A) dollar amount of the loss if a loss occurs. B) amount of loss as a percentage of total finances. C) likelihood that a loss will occur. D) method for avoiding risk. Answer: C Solution: The frequency of loss is the likelihood or probability that a loss will occur. Format: Multiple Choice Title: Test Bank 7.1 Frequency of Loss Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 7. If a loss occurs, the dollar value of that loss is known as A) liability risk. B) pure risk. C) severity of loss. D) frequency of loss. Answer: C Solution: The severity of loss is the dollar value of the loss if it does occur. Format: Multiple Choice Title: Test Bank 7.1 Value of Loss from Risk Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic

Expected Time to Complete: 1 minute 8. Insurance is the risk management method usually most appropriate for __________________ risks. A) high frequency and low severity B) low frequency and high severity C) low frequency and low severity D) high frequency and high severity Answer: B Solution: Insurance is the risk management method usually most appropriate for low frequency and high severity risks. Format: Multiple Choice Title: Test Bank 7.1 Transferring Risk Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Analytic AACSB: Analytic Expected Time to Complete: 1 minute 9. Which is not an appropriate risk management method? A) Avoiding B) Retaining C) Transferring D) Evaluating Answer: D Solution: The most common methods are risk avoidance, risk reduction, risk transfer, and risk retention. Evaluation is not a risk management method. Format: Multiple Choice Title: Test Bank 7.1 Risk Management Methods Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 10. Liability risk is the risk of being held responsible for A) your losses. B) someone else’s losses. C) the actions of others. D) the actions of mother nature.

Answer: B Solution: Liability risk is the risk of being held legally responsible for someone else’s losses. Format: Multiple Choice Title: Test Bank 7.1 Liability Risks Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 11. The severity of loss involves estimating A) the likelihood that loss will occur and applying it to the value of the loss. B) each possible loss scenario and its respective probability and taking the weighted average of the possible scenarios. C) the worst-case value of the loss. D) the probability of the loss and applying that to the replacement value of the loss. Answer: B Solution: The expected severity is the weighted average of the possible loss scenarios, after taking the probability of each outcome into consideration. Multiply the dollar loss for each possible loss amount by the probability that it will occur and add the results. Format: Multiple Choice Title: Test Bank 7.1 Severity of Loss Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 12. To determine the expected loss, multiply the A) expected frequency by the expected severity. B) frequency by the loss history. C) probability of frequency by the value of a total loss. D) probability of frequency by the market value of loss. Answer: A Solution: Expected loss = Expected frequency × Expected severity Format: Multiple Choice

Title: Test Bank 7.1 Expected Loss Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 13. It is impossible to avoid exposure to property and liability risks if you A) don’t own insurance. B) don’t own property. C) go beyond your property limits. D) own property or go beyond your property limits. Answer: D Solution: Although risk avoidance and risk transfer through insurance is effective for some risks, it’s impossible to avoid property and liability risks completely. Format: Multiple Choice Title: Test Bank 7.1 Risk Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 14. Wearing a helmet when riding a bike is an example of risk A) avoidance. B) reduction. C) transfer. D) retention. Answer: B Solution: You can reduce the frequency or severity of your risk exposures by engaging in actions aimed at loss control. Wearing a helmet significantly reduces the severity of injuries sustained in an accident. Format: Multiple Choice Title: Test Bank 7.1 Example of Risk Management Method Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking

Expected Time to Complete: 1 minute 15. Purchasing insurance is a common A) loss control technique. B) risk transfer method. C) risk avoidance method. D) loss avoidance technique. Answer: B Solution: The most common method for dealing with pure risks is to transfer them to someone else, usually an insurance company. By pooling the risks of many policyholders, insurers are able to spread the risk so that no single individual is faced with a catastrophic loss. Format: Multiple Choice Title: Test Bank 7.1 Insurance Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 16. If you choose not to buy collision insurance for your older automobile, this is an example of risk A) avoidance. B) retention. C) transfer. D) reduction. Answer: B Solution: Choosing not to purchase insurance is risk retention or self-insurance. Format: Multiple Choice Title: Test Bank 7.1 Example of Risk Management Method Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 17. In order to evaluate your potential losses, you must A) estimate the dollar cost of potential losses and transfer the risk.

B) estimate the probability the loss will occur and estimate the dollar cost of the loss.identify your risk exposures and estimate the dollar cost of potential losses. C) avoid the risk or reduce the risk. Answer: B Solution: In order to evaluate your potential losses, you must estimate the probability the loss will occur and estimate the dollar cost of the loss. Format: Multiple Choice Title: Test Bank 7.1 Evaluate Risk Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 18. If you have a 30% chance of having your car stolen next year and the average loss of a stolen car is $12,000, then the expected cost of the loss to you would be A) $171. B) $400. $3,600.$8,400.Answer: C Solution: Expected loss = Expected frequency × Expected severity Expected loss = 0.30 × $12,000 = $3,600 Format: Multiple Choice Title: Test Bank 7.1 Expected Loss Calculation Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 19. Jenny owns a home in a heavily wooded area. If there is a 1-in-25 chance of fire in the area, what is her expected loss given the following possible outcomes: • Minor smoke damage: cost = $5,000, probability= 50% • Exterior fire damage: cost = $15,000, probability= 30% • Everything ruined: cost = $150,000, probability = 5% A) $280 B) $580 C) $800

D) $6,800 Answer: B Solution: Expected loss = Expected frequency × Expected severity Expected severity = ($5,000 × 0.50 smoke) + ($15,000 × 0.30 fire) + ($150,000 × 0.05 total loss) = $14,500 Expected loss = (1/25) × $14,500 expected severity = $580 Format: Multiple Choice Title: Test Bank 7.1 Expected Severity and Loss Calculation Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes

20. A person abstaining from smoking is practicing which of the following methods of risk management? A) Risk avoidance B) Risk reduction C) Risk transfer D) Risk retention Answer: A Solution: A person abstaining from smoking is avoiding risk. Format: Multiple Choice Title: Test Bank 7.1 Example of Risk Management Method Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 21. The most common method of transferring risk is A) avoidance. B) buying insurance. C) self-insurance. D) loss control methods. Answer: B Solution: The most common method of transferring risk is buying insurance.

Format: Multiple Choice Title: Test Bank 7.1 Example of Risk Management Method Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute

22. When you purchase homeowner’s insurance, you are A) transferring the risk. B) reducing the risk. C) avoiding the risk. D) retaining the risk. Answer: A Solution: When you purchase homeowner’s insurance, you are transferring the risk. Format: Multiple Choice Title: Test Bank 7.1 Example of Risk Management Method Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 23. Self-insurance is another name for A) risk retention. B) risk reduction. C) risk avoidance. D) risk averseness. Answer: A Solution: Self-insurance is another name for risk retention. Format: Multiple Choice Title: Test Bank 7.1 Example of Risk Management Method Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 24. What is the equation for estimating expected, or average, loss? A) Expected loss = Expected frequency × Expected severity B) Expected loss = Expected frequency + Expected severity C) Expected loss = Expected frequency − Expected severity D) Expected loss = Expected frequency/Expected severity Answer: A Solution: Expected loss = Expected frequency × Expected severity Format: Multiple Choice Title: Test Bank 7.1 Evaluate Property and Liability Risks Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 25. Vickie owns a small grocery store. She knows that inexpensive items, such as gum and candy, are often stolen, so she anticipates the cost into her budget. For Vickie, the risk of shoplifting is considered A) low frequency and low severity. B) low frequency but high severity. C) high frequency but low severity. D) high frequency and high severity. Answer: C Solution: The risk of shoplifting low-cost items is high frequency but low severity. Thus, she can easily accept the risk and just include the costs into her expected profitability of the items. Format: Multiple Choice Title: Test Bank 7.1 Business Risk Management Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

26. All of the following are loss reduction methods except A) wearing old clothes when you do yard work. B) wearing a seat belt when in a motor vehicle. C) constructing your home with fire-resistant materials. D) taking a defensive driving course. Answer: A Solution: Wearing old clothes when you do yard work is retaining risk (damage to clothes), whereas the other choices are forms of risk reduction. Format: Multiple Choice Title: Test Bank 7.1 Example of Risk Management Method Section: Risk Management Methods Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 27. ___________is the risk of being held legally responsible for injuries to another person or their property. A) Liability risk B) Risk retention C) Speculative risk D) Pure risk Answer: A Solution: Liability risk is the risk of being held legally responsible for injuries to another person or their property. Format: Multiple Choice Title: Test Bank 7.1 Identify and Evaluate Risks Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 28. Risk pooling is based on the A) law of averages. B) law of large numbers. C) normal distribution of risk. D) historical averages.

Answer: B Solution: Risk pooling is based on the law of large numbers, which holds that as the size of a pool of identical risks increases, the loss per person becomes more predictable. Format: Multiple Choice Title: Test Bank 7.2 Risk Pooling Section: Risk Pooling and Insurance Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 29. The price an insurer charges a policyholder for insurance protection is called the A) coinsurance. B) premium. C) insurable interest. D) copayment. A) Answer: B Solution: The price an insurer charges a policyholder for insurance protection is called the premium. Format: Multiple Choice Title: Test Bank 7.2 Cost of Insurance Section: Insurance Premiums Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 30. Which is a characteristic of property risk in flood zones? A) Nonrandom B) Unpredictable C) Correlated D) Systematic Answer: C Solution: Correlated risks are risks that affect large numbers of policyholders in the same area, such as flooding on wetlands. Format: Multiple Choice Title: Test Bank 7.2 Correlated Risks

Section: Insurance Premiums Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 31. A suicide would be classified as a A) nonrandom risk. B) correlated risk. C) unpredictable risk. D) idiosyncratic risk. Answer: A Solution: Nonrandom risks are risks that are within the control of the policyholder, that is, intentional acts such as arson and suicide. Format: Multiple Choice Title: Test Bank 7.2 Nonrandom Risks Section: Insurance Premiums Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 32. If your home has a value of $75,000, you cannot insure it for $100,000. This is based on the A) law of reciprocity. B) law of averages. C) principle of indemnity. D) principle of insurability. Answer: C Solution: The principle of indemnity, which underlies insurance law, says that you should never be able to recover more from your insurance than what you’ve lost. Format: Multiple Choice Title: Test Bank 7.2 Value of Insurability Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Application

AACSB: Reflective Thinking Expected Time to Complete: 1 minute 33. The amount of a loss that must be paid by an insured before the insurance company will pay any insurance benefit is known as the A) premium. B) deductible. C) coinsurance.up-front fee. Answer: B Solution: A deductible is an amount that you must pay out of pocket before the insurance company is obligated to pay anything. Format: Multiple Choice Title: Test Bank 7.2 Insurance Claim Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 34. Correlated risks are A) a perfect storm of risks that happen at the same time. B) isolated risks that affect a distinct group of policyholders. C) risks that affect a large number of policyholders in the same area. risks that affect a distinct group of policyholders in different areas. Answer: C Solution: Correlated risks are risks that affect a large number of policyholders in the same area. Format: Multiple Choice Title: Test Bank 7.2 Correlated Risk Section: Insurance Premiums Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 35. The principal of indemnity, which underlies insurance law, says you should A) not be able to recover more from insurance than what you have lost. B) be able to command a premium on what you have lost.

C) be reasonably compensated for pain and suffering through loss. D) not be able to recover up to what you have lost. Answer: A Solution: The principal of indemnity, which underlies insurance law, says you should not be able to recover more from insurance than what you have lost. Format: Multiple Choice Title: Test Bank 7.2 Indemnity Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 36. Jerome insured his home for $120,000. He purchased it for $125,000 and the recent fair market value is $110,000. He recently had a kitchen fire that extended its damage to the foundation. It looks like his home is beyond repair. What is the most he can recover from his insurance policy? A) $110,000 B) $115,000 C) $120,000 D) $125,000 Answer: A Solution: The principle of indemnity, which underlies insurance law, says that you should never be able to recover more from your insurance than what you’ve lost. Thus, even if you insure your $110,000 home for $120,000, the most you can recover from your insurance is $110,000. Format: Multiple Choice Title: Test Bank 7.2 Insured Value Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 37. If an agent added a rider to a policy, the coverage for loss most likely would have A) increased. B) decreased. C) stayed the same.

D) been nullified. Answer: A Solution: For an additional premium amount, most insurers offer supplemental coverage for limited or excluded items in the form of a contract addendum called a rider. Format: Multiple Choice Title: Test Bank 7.2 Rider Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. If there is an exclusion on your policy, it identifies losses that ________ covered under the policy. A) are B) are notwill be C) used to be Answer: B Solution: An exclusion specifically identifies losses that are not covered under the policy at all. Format: Multiple Choice Title: Test Bank 7.2 Exclusion Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 39. A deductible is the A) proportion of the loss the insured must pay after the insurance company pays an initial amount. B) amount of a loss the insurer must reimburse the insured after a loss. C) proportion of the loss the insurer must pay before the insured pays any of the cost. D) amount of a loss the insured must pay before the insurance company will pay any insurance benefits.

Answer: D Solution: A deductible is an amount that you must pay out of pocket before the insurance company is obligated to pay anything. Format: Multiple Choice Title: Test Bank 7.2 Deductible Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 40. The principle of indemnity means that an A) insured can only purchase an insurance policy that covers actual losses. B) insurance company will only pay the policyholder up to the face amount of the policy. C) insurance company will reimburse the insured only for actual losses. D) insured can only purchase insurance to cover his or her own property. Answer: C Solution: The principle of indemnity, which underlies insurance law, says that you should never be able to recover more from your insurance than what you’ve lost. If the value of an insured property depreciates in value, it is important to review your policy every year so that you are not over insured. Format: Multiple Choice Title: Test Bank 7.2 Indemnity Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 41. A deductible requires the policyholder to pay A) a percentage of the year’s claim. B) a fixed dollar amount out of pocket before the insurance company is obligated to pay anything. C) the amount in excess of the insurance company’s negotiated amount for the claim. D) a fixed percentage amount of every claim. Answer: B

Solution: A deductible requires the policyholder to pay a fixed dollar amount out of pocket before the insurance company is obligated to pay anything. Format: Multiple Choice Title: Test Bank 7.2 Deductible Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 42. Insurance policies often include terms and conditions that increase the predictability of the loss to the insurer and _______ premium costs to the insured. A) increase B) reduce C) do not affect D) ignore Answer: B Solution: Insurance policies often include terms and conditions that increase the predictability of the loss to the insurer and reduce premium costs to the insured. Format: Multiple Choice Title: Test Bank 7.2 Premium Cost Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 43. The law of large numbers holds that as the size of a pool of identical risks _______, the loss per person becomes ________ predictable. 44. A) decreases; more B) increases; more C) increases; less D) remains the same; more

Answer: B Solution: The law of large numbers holds that as the size of a pool of identical risks increases, the loss per person becomes more predictable. Format: Multiple Choice

Title: Test Bank 7.2 Law of Large Numbers Section: Risk Pooling and Insurance Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 45. If Sharon Johnson, a 49-year-old experienced driver, and Tia Young, a 16-yearold new driver, were both applying for an auto insurance policy in town, they would be placed in A) the same risk classification. B) the same premium class. C) different risk classifications. D) different correlated risk classes. Answer: C Solution: In determining how much to charge, insurers estimate the expected loss by classifying policyholders according to their risk characteristics and looking at past loss experience for similar risks. Thus, for auto insurance, people with long and experienced driving records will have a different risk classification than those who just received their driving license. Format: Multiple Choice Title: Test Bank 7.2 Insurance Premiums Section: Insurance Premiums Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 46. Maryanne has chosen a homeowner’s insurance policy with a low premium that meets her financial needs. Her home was broken into, and $5,000 worth of possessions were stolen. If her deductible is $3,000 and she did not have an alarm system. How much will her insurance company pay for the loss? A) $0 B) $2,000 C) $3,000 $5,000Answer: B Solution: $5,000 worth of possessions − $3,000 deductible = $2,000 Format: Multiple Choice Title: Test Bank 7.2 Deductible Calculation

Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 47. If you want insurance coverage for your art collection, you will need to purchase which of the following? A) A homeowner’s insurance policy B) A rider on your homeowner’s insurance policy C) A personal property insurance policy D) You cannot insure your art collection because the risk of theft is too great. ’ Answer: B Solution: For an additional premium amount, most insurers offer supplemental coverage for limited or excluded items in the form of a contract addendum called a rider. An art collection in your home can be insured under a rider. Format: Multiple Choice Title: Test Bank 7.2 Supplemental Coverage Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 48. Lucy McCain bought supplemental coverage for an additional premium on her policy. She purchased a(n) A) exclusion. B) rider.deductible. C) addendum. Answer: B Solution: For an additional premium amount, most insurers offer supplemental coverage for limited or excluded items in the form of a contract addendum called a rider. Format: Multiple Choice Title: Test Bank 7.2 Supplemental Coverage Section: Insurance Policy Terminology Learning Objective: 7.2 Explain how risk pooling works, and define common insurance policy terminology. Difficulty: Medium

Bloomcode: Application AACSB: Analysis Expected Time to Complete: 1 minute 49. Christopher’s house is insured for $250,000, and he has been paying premiums for the past 10 years. Chris’s home was wiped out in a hurricane. The face value of the policy is $250,000, the remaining mortgage is $115,000, and the appraised value is $210,000. How much can he recover from his insurance company for the loss? A) $95,000 B) $115,000 C) $210,000 D) $250,000 Answer: C Solution: The principle of indemnity, which underlies insurance law, says that you should never be able to recover more from your insurance than what you’ve lost. Thus, even if you have $250,000 face value policy, the most you can recover from your insurance is the $210,000, the actual value of the home. Format: Multiple Choice Title: Test Bank 7.3 Coverage Purchased Section: Pricing of Homeowner’s Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 50. For homeowners, the risk of being held legally responsible for losses incurred by visitors to their home is called A) liability risk. B) real property risk. C) personal property risk. D) umbrella risk. Answer: A Solution: If a visitor or a visitor’s property is injured on your premises, you may be legally responsible for the loss. Liability risk occurs when the person sues you in a court of law to get you to pay for their injuries or losses. Format: Multiple Choice Title: Test Bank 7.3 Liability Risk

Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 51. For homeowners, the risk that your home will be damaged by fire, rain, wind, hail, or another natural occurrence is called A) liability risk. B) real property risk. C) personal property risk. D) umbrella risk. Answer: B Solution: Real property risk is the risk that the physical building will be damaged by perils such as fire, rain, wind, hail, or other natural occurrences. Format: Multiple Choice Title: Test Bank 7.3 Risks to Your Home Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 52. People who rent homes or apartments can purchase insurance that covers A) all property and liability risks. B) personal property and liability losses but not damage to the building itself. C) personal property losses only. D) liability risk only. Answer: B Solution: People who rent homes or apartments can purchase renter’s insurance that covers personal property and liability losses but not damage to the building itself. Format: Multiple Choice Title: Test Bank 7.3 Renter’s Insurance Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 53. A swimming pool on your property normally invokes a special liability standard known as A) the principle of indemnity. B) contributory negligence. C) strict liability. D) variable liability. Answer: C Solution: Most states have a special standard called strict liability that applies whenever children are injured by an “attractive nuisance” on someone else’s property, defined as a dangerous environment that might be attractive to children, such as a swimming pool. Format: Multiple Choice Title: Test Bank 7.3 Liability Risk Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 54. If a person bears some fault for his or her own injury, this is known as A) contributory indemnity. B) contributory negligence. C) strict liability. D) variable liability. Answer: B Solution: Contributory negligence exists when the injured person actually contributed to his or her own injury. If the person bears some fault for the injury, he or she may not be able to hold you financially responsible. Format: Multiple Choice Title: Test Bank 7.3 Defenses to Liability Claims Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

55. The standard homeowner’s insurance policy pays for the _______ value of your home. A) replacement B) depreciated C) amortized mortgage D) face Answer: B Solution: Unless you have specifically replacement cost coverage, the standard HO insurance will pay you the depreciated value of what you have lost, which is often insufficient to replace your property following a loss. Format: Multiple Choice Title: Test Bank 7.3 Property Coverage Section: Insuring Your Home Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 56. A laptop computer that is stolen from Vanessa’s home while on vacation is covered under her A) homeowner’s insurance policy in full. B) homeowner’s insurance policy, subject to the deductible. C) auto insurance policy, subject to the deductible. D) umbrella liability insurance policy. Answer: B Solution: Personal property, under typical homeowner’s or renter’s insurance policies, is covered regardless of where it is located at the time it is lost, damaged, or stolen. Vanessa’s laptop computer is covered on her homeowner’s insurance policy and would cover her loss, subject to the applicable deductible. If she has comprehensive physical damage coverage under her auto insurance policy, it will cover the theft of personal belongings inside her car. Format: Multiple Choice Title: Test Bank 7.3 Property Coverage Section: Insuring Your Home Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

57. Most homeowner’s insurance policies provide _____ in basic personal liability coverage. A) $10,000 B) $100,000 C) $500,000 D) $1,000,000 Answer: B Solution: Most homeowner’s insurance policies provide $100,000 in basic personal liability coverage. Format: Multiple Choice Title: Test Bank 7.3 Liability Coverage Section: Insuring Your Home Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 58. Homeowner’s insurance premiums are based on the A) replacement amount of coverage you select. B) face value of the policy. C) expected loss and risk characteristics of the insured. D) expected loss average of the insurance pool. Answer: C Solution: In determining how much to charge in premium, insurers estimate the expected loss by classifying policyholders according to their risk characteristics and looking at past loss experience for similar risks. Thus, while the insured amount is important in calculating the expected loss, the risk characteristics as to the probability of loss is just as important. Format: Multiple Choice Title: Test Bank 7.3 Insurance Premiums Section: Pricing of Homeowner’s Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 59. Whenever children are injured by an “attractive nuisance” on your property, the standard of _______ applies. A) large numbers

B) strict liability C) indemnity D) insurability Answer: B Solution: Most states have a special standard called strict liability that applies whenever children are injured by an “attractive nuisance” on someone else’s property, defined as a dangerous environment that might be attractive to children, such as a swimming pool or construction equipment. Format: Multiple Choice Title: Test Bank 7.3 Attractive Nuisance Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 60. If a cable repair technician decides to climb on your roof to check the wiring and jump off, you probably _____ be responsible for his injuries because of the ______. A) will; assumption of risk B) will not; assumption of risk C) will; attractive nuisance D) will not; attractive nuisance A) Answer: B Solution: Contributory negligence exists when the injured person actually contributed to his or her own injury. If the person bears some fault for the injury, he or she may not be able to hold you financially responsible. Similarly, if the injured person knew about the risk and voluntarily exposed himself or herself to it, you will be able to avoid legal liability in using the defense of assumption of risk. Format: Multiple Choice Title: Test Bank 7.3 Defenses to Liability Claims Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute

61. No-fault medical coverage in the liability section of a homeowner’s policy means A) both parties are assumed to be equally at fault and no claims are filed. B) the insurer will pay the loss without requiring the injured party to prove negligence. C) that everyone must file under their own policy. no fault is assumed by the homeowner or the injured. D) no party is assumed to be at fault, unless claims are adjudicated in court. Answer: B Solution: For minor injuries and accidents, policies include no-fault medical coverage in the amount of $1,000, as well as no-fault property coverage of $250. No-fault coverage, in this context, means the insurer will pay the loss without requiring the injured party to prove negligence. Format: Multiple Choice Title: Test Bank 7.3 No-Fault Coverage Section: Insuring Your Home Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 62. When you apply for homeowner’s insurance, the insurance company will normally look up your loss history on a national electronic database called the _____ database. A) Comprehensive Loss Underwriting Exchange B) Comprehensive National Underwriting Association C) National Underwriters’ Exchange Registry D) National Loss Answer: A Solution: When you apply for property or liability insurance, your insurer will commonly look up your loss history on the Comprehensive Loss Underwriting Exchange (CLUE). This is a national electronic database where insurers report insurance claims paid by them on property and liability insurance policies, as well as inquiries regarding losses that did not result in paid claims. Format: Multiple Choice Title: Test Bank 7.3 Your Risk Profile Section: Pricing of Homeowner’s Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Application

AACSB: Analytic Expected Time to Complete: 1 minute 63. ________ is/are the single most valuable asset(s) owned by most families. A) Retirement accounts B) Mutual fund investments C) Home equityVehicles Answer: C Solution: Home equity is the single most valuable asset owned by most families. Home equity is 34.5 percent of total household assets based on the 2014 U.S. census. Format: Multiple Choice Title: Test Bank 7.3 Household Assets Section: Managing Homeowner’s and Renter’s Risk Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 64. Carol lost all her belongings in a burglary. She has a $150,000 face value homeowner’s policy with a $500 deductible. The appraised value of her various insured personal property is $77,000. How much will she receive from insurance? A) $74,500 B) $75,000 C) $76,500 D) $77,000 Answer: A Solution: Personal property coverage is limited to 50% of the amount of insurance on the house; thus, she will receive: 50% personal property limit = $150,000 face value × 0.50 = $75,000 Insurance benefit = $75,000 personal property limit − $500 deductible = $74,500 Format: Multiple Choice Title: Test Bank 7.3 Personal Property Coverage Calculation Section: Insuring Your Home Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes

65. Brenda experienced a fire that caused $60,000 of damage on a home that is appraised at $120,000. She has an $80,000 face value homeowner’s policy. Her policy has a $500 deductible and has an 80% coinsurance requirement. How much will her insurer reimburse her for the repair? A) $39,500 B) $47,500 C) $59,500 D) $23,500 Answer: A Solution: Brenda’s coinsurance requirement is that the face amount, or the amount of insurance coverage purchased, must be at least 80% of the actual value. If not, the insurer will proportionally reduce how much it reimburses for a covered loss. She bought insurance that was two-thirds (0.66667) of the correct amount ($80,000 face value/$120,000 appraised value), and she incurred fire damage of $60,000 during the policy period; the insurer would only consider twothirds of the damage or $60,000 in damages × 0.66667 = $40,000. Her reimbursement would be $40,000 benefit consideration − $500 deductible = $39,500. Format: Multiple Choice Title: Test Bank 7.3 Property Coverage Calculation Section: Insuring Your Home Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 66. Insurance purchased to cover personal property and liability but not damage to the landlord’s building is called ________ insurance. A) umbrella B) renter’s C) homeowner’s D) limited liability Answer: B Solution: Insurance purchased to cover personal property and liability but not damage to the landlord’s building is called renter’s insurance. Format: Multiple Choice Title: Test Bank 7.3 Managing Homeowner’s and Renter’s Risk Section: Managing Homeowner’s and Renter’s Risk Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 67. Which risk is not a category of home risks? A) Personal property risk B) Real property risk C) Contributory negligence risk D) Liability risk Answer: C Solution: The three categories of home risk are personal property risk, real property risk, and liability risk. Format: Multiple Choice Title: Test Bank 7.3 Categories of Home Risk Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 68. A failure to fulfill a legal duty that causes injury to another person or that person’s property is considered A) negligence. B) liability. C) property risk. D) personal risk. Answer: A Solution: A failure to fulfill a legal duty that causes injury to another person or that person’s property is considered negligence. Format: Multiple Choice Title: Test Bank 7.3 Liability Risk Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 69. What legal rule applies when the victim of negligence is found to have had a part in causing his or her own injury?

A) Contributory negligence B) Assumption of risk C) Strict liability D) Causal negligence Answer: A Solution: Contributory negligence exists when the injured person actually contributed to his or her own injury. If the person bears some fault for the injury, he or she may not be able to hold you financially responsible. Format: Multiple Choice Title: Test Bank 7.3 Defenses to Liability Claims Section: What Risks Do Homeowners and Renters Face Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 70. An umbrella policy is a policy purchased to A) provide coverage for rain, snow, and hail damage. B) supplement other liability insurance coverage. C) supplement other property and liability insurance coverage. D) provide excess personal property coverage. Answer: B Solution: Umbrella coverage supplements your standard liability coverage in your homeowner’s, renter’s, and/or auto insurance policies and also includes coverage for personal injury claims against you that wouldn’t be normally covered under your homeowner’s insurance, such as libel, slander, and invasion of privacy. Format: Multiple Choice Title: Test Bank 7.3 Umbrella Liability Insurance Section: Umbrella Liability Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 71. In trying to protect his increasing net worth, Arbuckle Farnsworth is worried about lawsuits stemming from accidents and situations not covered by his modest liability limit on his homeowner’s policy. Which type of insurance should he consider purchasing in addition to his current policy?

A) Scheduled property insurance B) Strict liability insurance C) Umbrella insurance Rider insurance Answer: C Solution: Umbrella coverage supplements your standard liability coverage in your homeowner’s, renter’s, and/or auto insurance policies and also includes coverage for personal injury claims against you that wouldn’t be normally covered under your homeowner’s insurance, such as libel, slander, and invasion of privacy. Format: Multiple Choice Title: Test Bank 7.3 Liability Insurance Section: Umbrella Liability Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 72. Why do insurers use credit history as a factor in rating auto and homeowner’s insurance? A) People with bad credit are likely to make fraudulent claims on their insurance. B) People with bad credit are less likely to pay their insurance premiums. C) There is a statistical correlation between high credit scores and a person being financially responsible and having fewer claims. D) People with good credit histories are likely to live in less risky areas. Answer: C Solution: Your own characteristics can affect your premium. Your credit score will affect an insurance company’s assessment of your risk. A credit score measures how responsibly a person handles certain aspects of his or her finances. Insurers have found that the credit score is also correlated with claims activity; people with low credit scores tend to make more claims. Format: Multiple Choice Title: Test Bank 7.3 Your Risk Profile Section: Pricing of Homeowner’s Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute

72. Peeta owns valuable antique musical instruments that have been in her family for generations. In order to insure these items, her insurance company required her to provide a specific list of the insured property with written appraisals from an expert. The property on such a list is called A) special property. B) excluded property. C) real property. D) scheduled property. Answer: D Solution: Items on a scheduled property list are a specific list of insured property. In some cases, you may need to get an appraisal of the property to verify its value. Format: Multiple Choice Title: Test Bank 7.3 Coverage Purchased Section: Pricing of Homeowner’s Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 73. All else being equal, a ______ deductible will lead to a(n) _____ premium on an insurance policy. A) higher; lower B) lower; lower C) higher; higher D) lower; unchanged

Answer: A Solution: All else being equal, a higher deductible will lead to a lower premium on an insurance policy. Format: Multiple Choice Title: Test Bank 7.3 Deductibles and Discounts Section: Pricing of Homeowner’s Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

74. If you have a(n) ___ credit score, you will probably pay a _____ than average rate for your auto and homeowner’s insurance. A) low; lower B) high; lower C) high; higher D) average; higher Answer: B Solution: If you have a high credit score, you will probably pay a lower rate for your auto and homeowner’s insurance. Format: Multiple Choice Title: Test Bank 7.3 Credit Score and Risk Profile Section: Pricing of Homeowner’s Insurance Learning Objective: 7.3 Describe the loss coverage provided by homeowner’s and renter’s insurance and the factors that affect premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 75. State laws requiring drivers who have been in a traffic accident to show proof of insurance or the ability to pay a claim are known as A) interstate commerce laws. B) financial responsibility laws. C) indemnity laws. D) compulsory automobile insurance laws. Answer: B Solution: Most states have financial responsibility laws that require drivers who have been in a traffic accident to show proof of insurance or the ability to pay a claim. Format: Multiple Choice Title: Test Bank 7.4 State Auto Insurance Laws Section: State Auto Insurance Laws Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 76. States with no-fault automobile insurance laws have seen A) reductions in insurance premiums and litigation costs. B) increases in insurance premiums and litigation costs. C) reductions in premiums but higher litigation costs. D) increases in premiums but lower litigation costs.

Answer: B Solution: States with no-fault automobile insurance laws have seen litigation and claims payments increased, insurance premiums increased, and state legislators eventually gave up on no-fault coverage and reverted to a negligencebased system. Format: Multiple Choice Title: Test Bank 7.4 No-Fault Auto Insurance Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 77. The primary reason that young men pay higher rates for insurance than young women is that A) women are better drivers. B) young women are less likely to use cell phones while driving. C) young women drive fewer miles per year than do young men. D) young women drive safer cars. Answer: C Solution: Young female drivers pay lower auto insurance rates than young males; because, teenage girls drive less than teenage boys, about half as many miles per year on average. Format: Multiple Choice Title: Test Bank 7.4 Auto Insurance Pricing Section: Auto Insurance Pricing Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 78. If you are_____________, you will probably have a lower auto insurance premium than if you were___________. A) single and smoke cigarettes; single and do not smoke B) married and do not smoke cigarettes; single and smoke C) married and smoke cigarettes; married and do not smoke D) single and smoke cigarettes; married and do not smoke E) married and smoke cigarettes; married and do not smoke Answer: B

Solution: Insurers have found that people who act responsibly in other areas of life (healthy habits) are also better drivers. Married couples often get lower rates than singles. Many insurers give better rates to nonsmokers as well. Format: Multiple Choice Title: Test Bank 7.4 Your Risk Characteristics Section: Auto Insurance Pricing Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 79. Which of the following statements regarding state automobile insurance laws is true? A) Some states have compulsory automobile insurance laws but all states have financial responsibility laws. B) All states have both compulsory automobile insurance laws and financial responsibility laws. C) All states have compulsory automobile insurance laws and some states have financial responsibility laws. D) Some states have compulsory automobile insurance laws and some states have financial responsibility laws. Answer: A Solution: Some states have compulsory automobile insurance laws but all states have financial responsibility laws. Format: Multiple Choice Title: Test Bank 7.4 State Auto Insurance Laws Section: State Auto Insurance Laws Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 80. Which is not a component of the bodily injury coverage category of a typical auto insurance policy? A) Bodily injury liability B) Medical expenses C) Comprehensive physical damage D) Uninsured motorists Answer: C

Solution: The components of coverage available under the categories of bodily injury coverage are bodily injury liability, medical expenses, and uninsured motorists. Format: Multiple Choice Title: Test Bank 7.4 Bodily Injury Coverage Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 81. When considering pricing factors associated with the type of vehicle you drive, you may be eligible for a ________, if your car has antitheft devices, airbags, and other safety features. A) discount B) premium C) deductible D) rebate Answer: A Solution: When considering pricing factors around what type of vehicle you drive, you may be eligible for a discount, if your car has antitheft devices, airbags, and other safety features. Format: Multiple Choice Title: Test Bank 7.4 Auto Insurance Pricing Section: Auto Insurance Pricing Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 82. Bodily injury auto insurance coverage includes all of the following except A) living expenses for you and any passengers injured in an auto accident. B) medical costs for you and any passengers injured in an auto accident. C) injuries caused by an uninsured motorist or a hit-and-run driver. D) legal defense costs and judgments against you if you lose in court. Answer: A

Solution: Bodily injury auto insurance coverage includes medical expenses, uninsured motorists, and bodily injury liability costs and judgments, not living expenses. Format: Multiple Choice Title: Test Bank 7.4 Policy Coverage Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 83. If you have purchased auto liability, collision, and comprehensive physical damage coverage, which of the following would not be covered by your insurance policy? A) Liability for damage to property of others B) Costs for you and your family from injuries caused by an uninsured motorist or a hit-and-run driver C) Damage to your own vehicle due to auto accident, regardless of fault D) Damages caused by perils other than collision, including theft, vandalism, fire, wind, hail, tornado, lightning, earthquake, falling objects, and hitting a deer regardless of fault Answer: B Solution: If you have purchased liability, collision, and auto physical damage coverage, your policy will cover liability for damage to property of others, damage to your own vehicle due to auto accident (regardless of fault), and damages caused by perils other than collision—including theft, vandalism, fire, wind, hail, tornado, lightning, earthquake, falling objects, and hitting a deer (regardless of fault). Uninsured motorist coverage is an additional coverage that requires payment of an additional premium. Format: Multiple Choice Title: Test Bank 7.4 Property Damage Coverage Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 84. Collision coverage is insurance that will cover loss or damage to your own vehicle in the event of a(n)

A) auto accident. B) theft. C) natural disaster. D) All of these situations. Answer: A Solution: Collision coverage is insurance that will cover loss or damage in the event of an auto accident. Format: Multiple Choice Title: Test Bank 7.4 Collision Coverage Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 85. If Mike Johnson still owes his credit union $10,000 for his car, he will be required to carry collision coverage and ________ coverage. A) umbrella B) uninsured motorist C) personal injury comprehensive physical damageAnswer: D Solution: If your vehicle is collateral for a loan, your lender will require that you carry collision coverage, which insures against loss or damage to your vehicle in an auto accident, and comprehensive physical damage coverage, which covers loss or damage to your vehicle from any other peril. Format: Multiple Choice Title: Test Bank 7.4 Personal Automobile Policy (PAP) Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 86. States specify minimums for ________ coverage, which covers injuries you cause to other people. A) auto liability B) comprehensive physical damage C) umbrella D) personal property

Answer: A Solution: States specify minimums for auto liability coverage, which covers injuries you cause to other people. It covers only the injuries you cause to other people. For damage to your own person, vehicle, or property, you need additional coverage. Format: Multiple Choice Title: Test Bank 7.4 State Minimum Insurance Section: State Auto Insurance Laws Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 87. If the state of Louisiana has minimum auto liability limits of 25/100/20, what does the 100 represent? A) $100,000 limit on payments to all persons in an accident B) $100,000 limit on payments per person in an accident C) $100,000 limit on payment for damage to the property of others in an accident D) $100,000 limit on payment for damage to personal property in an accident Answer: A Solution: The 100 represents the $100,000 limit on payments to all persons in an accident. Format: Multiple Choice Title: Test Bank 7.4 Personal Automobile Policy (PAP) Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 88. Melvin has auto insurance with the following liability limits: 25/50/10. If Melvin is in an accident where he is at fault, what is the maximum his insurance company will pay to fix the property of the car Melvin hit? A) $0 B) $10,000 C) $25,000 $50,000Answer: B

Solution: Melvin’s auto insurance policy has a $10,000 limit on payments for property damage. Format: Multiple Choice Title: Test Bank 7.4 Interpreting Minimum Auto Liability Limits Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 89. The Garcia family has three autos parked in their garage and two full-time drivers and two part-time drivers in the household. Which standard automobile insurance policy is for different family members driving either car? A) Personal automobile policy B) Family automobile policy C) Comprehensive automobile policy D) No-fault automobile policy Answer: B Solution: A family automobile policy (FAP) covers several people in a family who all drive the same car. Format: Multiple Choice Title: Test Bank 7.4 Policy Coverage Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 90. Consider a family with three drivers each driving their own car. Which standard auto policy should they choose? A) A family automobile policy B) A personal automobile policy C) A comprehensive policy D) A collision policy Answer: B Solution: The family should choose a personal automobile policy (PAP) for individual coverage since each driver drives their respective car. Format: Multiple Choice Title: Test Bank 7.4 Policy Coverage

Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 91. If a shopping cart damages a car parked at the store, which type of auto insurance coverage will pay for the damage? A) Comprehensive B) Collision C) Personal D) Liability Answer: A Solution: Comprehensive covers physical damage caused by perils other than a vehicle collision—including theft, vandalism, fire, wind, hail, tornado, lightning, earthquake, falling objects, and hitting animal or object—regardless of fault. Format: Multiple Choice Title: Test Bank 7.4 Policy Coverage Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 92. Some states have no-fault automobile insurance, which is a type of automobile insurance system in which the A) insurer pays into a fund administered by the state insurance department and the claims of persons in an automobile accident are paid out of that fund regardless of who is at fault. B) insured pays into a fund administered by the state insurance department and the claims of persons in an automobile accident are paid out of that fund regardless of who is at fault. C) insured driver in a car accident files a claim and collects from their own insurance company regardless of who is at fault. D) insurer pays out equal amounts after a claim is made, regardless of who is at fault or what the damage was to each person or vehicle. Answer: C

Solution: Some states have no-fault automobile insurance, which is a type of automobile insurance system in which the insured pays into a fund administered by the state insurance department and the claims of persons in an automobile accident are paid out of that fund regardless of who is at fault. Format: Multiple Choice Title: Test Bank 7.4 No-Fault Auto Insurance Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 93. Which is not a factor that will usually affect your auto insurance premium? A) Your risk characteristics B) How much you drive C) Where you work D) What vehicle you drive Answer: C Solution: As with other types of insurance, auto insurance premiums are intended to cover the insurer’s expected losses and expenses and generate a reasonable amount of profit. Expected losses are determined by the company’s assessment of each policyholder’s risk level. Risk is assessed based on several rating factors, but not all companies weight them the same. Factors that will usually affect your auto insurance premiums include how much you drive, how well you drive, your risk characteristics, where you drive, where you park your car, and what vehicle you drive. Premiums are not affected by employment. Format: Multiple Choice Title: Test Bank 7.4 Factors That Affect Auto Insurance Premiums Section: Auto Insurance Pricing Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 94. Which of the following is not a way that a consumer can reduce his or her auto insurance payments? A) Installing antitheft devices B) Driving only occasionally C) Driving a safer car D) Choosing lower deductibles

Answers: D Solution: A deductible is a form of risk retention. The higher the deductible, the lower the premium, all else being equal. Format: Multiple Choice Title: Test Bank 7.4 Auto Insurance Pricing Section: Auto Insurance Pricing Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 95. An insurance agent who can only sell products for a specific insurer is known as a(n) A) captive agent. B) direct agent. C) independent agent. D) registered agent. Answer: A Solution: An insurance agent who works directly for a specific insurer and sells only that insurer’s products is known as an exclusive or a captive agent. Format: Multiple Choice Title: Test Bank 7.5 Agents and Brokers Section: The Role of Agents and Brokers Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 96. An insurance agent who represents many different insurance companies is known as a(n) A) independent agent. B) exclusive agent. C) captive agent. D) registered agent. Answer: A Solution: An independent agent sells insurance products for a number of different insurers. Format: Multiple Choice Title: Test Bank 7.5 Agents and Brokers

Section: The Role of Agents and Brokers Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 97. Bill Writer was involved in an accident and wants to file a claim with his insurance company. Which of the following is not a step in the claims process? A) Increasing the liability coverage on the policy B) Documenting the progress of the claim C) Documenting losses D) Notifying your insurance agent or insurer Answer: A Solution: To make a claim, you should take the following steps: 1. Notify your insurance agent or insurer. 2. Document losses. 3. Document the progress of the claim. 4. Don’t sign any documents that may limit your ability to receive further from the insurer until you’re satisfied that the entire claim has been paid. Format: Multiple Choice Title: Test Bank 7.5 Steps in Filing a Claim Section: Making a Claim on Your Insurance Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 98. When you have a motor vehicle accident, you should do all of the following, except A) waiting at the scene for an insurance adjuster. B) waiting at the scene for a police officer. C) exchanging insurance information. D) obtaining contact information for witnesses to the accident. Answer: A Solution: At the time of the accident, you should do the following: 1. Wait at the scene of the accident for a police officer. 2. Call 911 to report the accident, and seek medical assistance for anyone who is injured.

3. Exchange names, addresses, phone numbers, and insurance information with the other driver(s). 4. Obtain contact information for any witnesses. Format: Multiple Choice Title: Test Bank 7.5 What to Do if You Have an Auto Accident Section: Making a Claim on Your Insurance Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 99. Larry Walsh and his wife suffered a fire in their home and initialized the claims process a week ago. The adjuster assessed the loss and is prepared to write them a check for $100,000 today. Should Mr. Walsh accept the check? A) No, he should wait for at least a year before settling any claims. B) No, it is best to wait before accepting settlements, as additional items and damage may be uncovered. C) Yes, the amount offered by the adjuster is the maximum allowed under their policy. Yes, it is possible he will not receive any other settlement offers in the future.Answer: B Solution: It’s not uncommon for a claims adjuster to offer to settle a homeowner’s claim promptly following a fire or theft loss by writing a check on the spot. Although it may be tempting to take the money and run, once the excitement of the initial loss event has passed, homeowners often later discover that additional items have been damaged or stolen, so it’s advisable to let some time pass before agreeing to a final settlement amount. Format: Multiple Choice Title: Test Bank 7.5 Filing a Claim Section: Making a Claim on Your Insurance Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 100. Documents you can use when you file a claim for losses include all of the following except A) receipts for the items lost. B) a written description of the occurrence. C) names and addresses of emergency contacts.

photographs of the items lost. Answer: C Solution: Documentation can include photos, receipts for lost or stolen items, a written description of the event, names and addresses of witnesses, and other information that will verify your loss. There is no need to document your emergency contacts to a claim’s adjuster. Format: Multiple Choice Title: Test Bank 7.5 Document Your Losses Section: Making a Claim on Your Insurance Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Medium Bloomcode: Comprehension AACSB: Communication Expected Time to Complete: 1 minute 101. The insurance company professional who assesses whether the loss is covered under your policy and assigns the dollar amount for a claim is called a(n) A) underwriter. B) independent agent. C) claims adjuster.broker. Answer: C Solution: A claims adjuster assesses whether the loss is covered under your policy and assigns a dollar amount to the loss. Format: Multiple Choice Title: Test Bank 7.5 Making a Claim on Your Insurance Section: Making a Claim on Your Insurance Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 102. Becky is looking for some independent information on types of insurance and the insurance-buying process before she starts negotiating prices for products. Where should she start her research? A) The Insurance Information Institute B) Her family’s independent insurance agent C) A leading commercial insurance website D) A national agency’s local sales office

Answer: A Solution: If you need more information about insurance and the insurance-buying process, go to the Insurance Information Institute (www.iii.org), which is a nonprofit organization that maintains a consumer-friendly website. Format: Multiple Choice Title: Test Bank 7.5 Resources to Evaluate Your Insurance Options Section: The Role of Agents and Brokers Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 103. When evaluating insurance companies, you should consider all of the following except the company’s A) discounts you qualify to receive. B) customer service. C) commercials. financial strength. Answer: C Solution: When evaluating insurance companies, you should consider the insurer’s financial strength, customer service, and discounts. Television and radio commercials are for attention and unbiased information. Format: Multiple Choice Title: Test Bank 7.5 Evaluating Insurance Companies Section: Using Online Resources to Evaluate Your Insurance Options Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 104. Where can you check the financial strength and credit ratings of various insurers and learn more about the rating process? A) A.M. Best B) KBB C) Consumers report D) Edmunds Answer: A

Solution: You can check the financial strength and credit ratings of various insurers and learn more about the rating process at A. M. Best Company, one of the three major rating agencies. Format: Multiple Choice Title: Test Bank 7.5 Ratings Section: Using Online Resources to Evaluate Your Insurance Options Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 105. Which type of insurance company professional is responsible for evaluating the risk profile of the policyholder and providing the premium quote? A) Independent agent B) Underwriter C) Adjuster D) Captive agent Answer: B Solution: A company underwriter or an automated underwriting system will evaluate policy information to provide a premium quote. Format: Multiple Choice Title: Test Bank 7.5 Insurance Quotes Section: Comparing Insurance Policies Learning Objective: 7.5 Compare insurers based on quality, service, and price before buying a policy. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 106. Betty has a personal auto policy with coverage limits of 25/50/10, collision coverage with a $500 deductible, and comprehensive with a $250 deductible. She backs into a car in the shopping center parking lot, causing $1,000 damage to her car, $2,000 damage to the other car, and totaling two shopping carts valued at $300. No one was injured. How much will Betty have to pay out of pocket? A) $500 B) $800 C) $1,000

D) $1,050 Answer: A Solution: She is liable for the $2,000 damage to the other car and the $300 in shopping carts. She has $10,000 property liability coverage that will pay for the $2,300 in liabilities. Her collision claim for $1,000 in damages to her car will be split $500 in deductible that she is responsible for and $500 that her insurer will reimburse her for. Format: Multiple Choice Title: Test Bank 7.4 Auto Accident Coverage Calculation Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 107. Zac and his two friends were driving back from a football game in the snow and crashed into an embankment after driving over a mailbox. He had $3,500 damage to his vehicle, $300 for the mailbox, and his rear passenger wasn’t wearing a seatbelt and he suffered a neck injury that resulted in $12,500 in chiropractor expenses. His personal auto policy has coverage limits of 25/50/10, collision coverage with a $500 deductible, and comprehensive with a $250 deductible. What will his insurance company pay? A) $3,000 from collision, $300 property liability, and $12,500 in medical B) $3,250 from comprehensive, $50 property liability, and $12,500 medical C) $3,000 from collision, $50 comprehensive, and $10,000 in medical D) $3,250 from comprehensive, $300 property liability, and $10,000 medical Answer: A Solution: The insurer will pay $3,000 from collision coverage ($3,500 damage less $500 deductible), $300 mailbox reimbursement from property liability coverage of $10,000, and $12,500 in medical expenses for back seat passenger from $25,000 medical per person liability coverage. Format: Multiple Choice Title: Test Bank 7.4 Auto Accident Coverage Calculation Section: Policy Coverage Learning Objective: 7.4 Understand your choices for auto insurance coverage and what factors are likely to increase your premiums. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes

108. Bret purchased a new smartphone for $1,100 and is considering the twoyear accident protection for $180. Based on an industry blog, accidental damage with these laptops have an 80% chance of needing a glass replacement ($150) and 20% chance of internal damage, which would be a complete loss based on the value of a new replacement. Based on his community of friends, only 1 out of 15 had an accident with their phones within two years of purchase. Should he purchase the two-year protection? A) Yes, the expected loss is $220. B) Yes, the expected loss is $340. C) No, the expected loss is $27. D) No, the expected loss is $176. Answer: C Solution: Expected loss = Expected frequency × Expected severity Expected severity = ($150 × 0.80 glass) + ($1,100 × 0.20 total) = $340 Expected loss = (1/15 expected frequency) × $340 expected severity = $26.67 Format: Multiple Choice Title: Test Bank 7.1 Insurance Versus Retention Evaluation Calculation Section: Identify and Evaluate Property and Liability Risks Learning Objective: 7.1 Apply the risk management process to identify risks and decide how to manage them. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes

Chapter 8 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 93 questions (all multiple choice)

LO 8.1 LO 8.2 LO 8.3 LO 8.4

30 28 15 20

32% 30% 16% 22%

Total

100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

18 43 20 4 2 6 93

19% 46% 22% 4% 2% 6% 100%

Easy Medium Hard

18 67 8 93

19% 72% 9% 100%

Calculations Q# 4 26 27 29 30 57 58 92 93

Test Bank Question

8.1 Life Expectancy Calculation 8.1 Income-Multiple Method Calculation 8.1 Income-Multiple Method Calculation (with existing term) 8.1 Financial Needs Method Calculation 8.1 Financial Needs Method Calculation (Married Couple) 8.2 Buy Term Insurance and Invest the Difference Calculation 8.2 When Cash Value Interest Covers Premium Calculation 8.4 LTC Insurance Versus Budgeting for LTC Calculation 8.4 LTC Policy Coverage Calculation

1. Mortality risk is a A) speculative risk. B) pure risk. C) liability risk. D) comprehensive risk. Answer: B Solution: Mortality risk is a pure risk; a risk that produces only a bad outcome. Format: Multiple Choice Title: Test Bank 8.1 Life Insurance Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 2. Life insurance is based on the concept of A) diversification. B) actuarial science. C) risk pooling. D) mortality intermediation. Answer: C Solution: Life insurance is based on the concept of risk pooling. People die with a certain degree of predictability, and each person’s death is, in general, independent of the deaths of others. Therefore, mortality is a type of risk for which the pooling mechanism is particularly well suited. Format: Multiple Choice Title: Test Bank 8.1 Life Insurance Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 3. Compared to property insurance policies, life insurance policies generally have a A) shorter term. B) longer term. C) similar term and risk classifications. D) similar term but different risk classifications. Answer: B Solution: Unlike other types of insurable risks, death occurs with 100 percent certainty. The very certainty of the insured event makes life insurance inherently

different from property, liability, and health insurance. Life insurance policies also tend to be longer term in nature than other policies. Format: Multiple Choice Title: Test Bank 8.1 Life Insurance Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 4. Phil is a 21-year-old male. What is his life expectancy?

A) 56.3 years B) 55.3 years C) 77.2 years D) 77.3 years Answer: D Solution: Life expectancy is the additional years a person will live, on average, based on current age. Using the mortality table, begin at the attained age given in the row, and look for the corresponding life expectancy. At age 21, Phil has a life expectancy of 56.3 more years for a total expected age at death of 21 + 56.3 = 77.3 years.

Format: Multiple Choice Title: Test Bank 8.1 Life Expectancy Calculation Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need.

Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 5. Which of the following factors do not affect life insurance premiums? A) Expenses incurred by the insurer B) Quality of health-care insurance, of the person seeking the insurance C) Risk classification of the person seeking the insurance D) Profitability of the insurance company Answer: B Solution: The premium you’re charged for life insurance depends on expenses incurred by the insurer (for commissions to agents, underwriting, investigation and payment of claims, and management of the firm), profitability of the insurance company, and your risk classification. Format: Multiple Choice Title: Test Bank 8.1 Factors That Affect Premiums Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 6. Life insurers use different tables to estimate the mortality risk for A) cancer patients. B) overweight people. C) smokers. D) athletic people. Answer: C Solution: Life insurers use different tables to estimate the mortality risk for smokers versus nonsmokers. At any age, a smoker’s risk of dying is equivalent to that of a nonsmoker who is 5 to 10 years older. Format: Multiple Choice Title: Test Bank 8.1 Factors That Affect Premiums Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 7. Larger insurers can often provide lower rates than small insurers because they A) are more profitable.

B) earn better returns on their investments. C) provide larger policies to their customers. D) can spread their costs across a bigger group of policyholders. Answer: D Solution: Larger insurers can often provide lower rates than small insurers because they can spread their costs across a bigger group of policyholders. Expenses and profits can be quite different across insurance companies; however, the law of large numbers provides economies of scale advantage to large insurers. Format: Multiple Choice Title: Test Bank 8.1 Factors That Affect Premiums Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 8. Your life insurance ________ is/are based on the insurer’s estimate of the probability that you will die during the policy period. A) longevity risk B) risk classification C) deductible D) beneficiaries Answer: B Solution: Your life insurance risk classification is based on the insurer’s estimate of the probability that you will die during the policy period. Format: Multiple Choice Title: Test Bank 8.1 Factors That Affect Premiums Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 9. The likelihood of an individual dying in the next year is called _____ risk. A) liability B) mortality C) speculative D) systemic Answer: B Solution: The likelihood of an individual dying in the next year is mortality risk.

Format: Multiple Choice Title: Test Bank 8.1 Factors That Affect Premiums Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 10. There are separate standardized mortality tables for women and men, because A) men systemically live longer. B) women systemically live longer. C) insurers want to increase more business with women to balance their risk pool. D) of the Affordable Care Act. Answer: B Solution: There are separate standardized mortality tables for women and men because women systemically live longer. Format: Multiple Choice Title: Test Bank 8.1 Mortality Tables Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 11. Half of all life insurance policies sold today are A) short-term policies that mature well before retirement. B) short-term policies that accumulate cash value over time. C) long-term policies that do not accumulate cash value. D) long-term policies that accumulate cash value over time.

Answer: D Solution: An important difference between life insurers and property insurers is that the average term of a life insurance policy is much longer, and about half of all life insurance policies sold today are long-term policies that accumulate cash value over time. Format: Multiple Choice Title: Test Bank 8.1 The Role of Insurance Company Investments Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension

AACSB: Reflective Thinking Expected Time to Complete: 1 minute 12. Hank Johnson named his three kids and nephew as people to whom his life insurance should be paid out upon his death. This is an example of designating _____________. A) riders B) accidental death benefits C) beneficiaries D) a participating policy Answer: C Solution: Life insurance is intended to benefit someone else you’ve designated as a beneficiary. If you die while the insurance policy is in force, your beneficiary will be paid a sum of money by the insurer. Format: Multiple Choice Title: Test Bank 8.1 Intended Use of Policy Proceeds Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 13. Which of the following is not a benefit of life insurance? A) Protection against business losses due to the death of a key person in the business B) Protection against household losses C) The ability to purchase large amounts of coverage D) Protection from creditors for a spouse Answer: B Solution: Proceeds from your policy can be earmarked for a particular purpose, such as protection from financial losses resulting from your death. Life insurance can be purchased in large amounts and protected from general creditors. Life insurance is based on a loss of life, not loss of property. Format: Multiple Choice Title: Test Bank 8.1 Intended Use of Policy Proceeds Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

14. Insurers estimate a person’s risk of dying by using A) a standardized mortality table. B) the insured’s family history. C) experience in the life insurance business. D) a record of that person’s diet and exercise habits. Answer: A Solution: Insurers estimate a person’s risk of dying by using a standardized mortality table. Format: Multiple Choice Title: Test Bank 8.1 The Role of Insurance Company Investments Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 15. The most important category addressed in a needs analysis is A) household savings. B) the cost of death. C) income replacement. D) using the emergency fund. Answer: C Solution: The most important category addressed in a needs analysis is income replacement of the deceased. Format: Multiple Choice Title: Test Bank 8.1 Financial Needs Method Section: 8.1Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 16. A life insurance needs analysis includes estimating your A) risk tolerance. B) business needs. C) parent’s needs. D) dependents’ financial needs. Answer: D

Solution: The process of determining the potential financial impact of your death on others is called life insurance needs analysis. To decide how much life insurance is necessary, you estimate your dependents’ total financial needs and then compare them with the financial resources you currently have to meet those needs. Format: Multiple Choice Title: Test Bank 8.1 Life Insurance Needs Analysis Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 17. If all other factors are equal, how will your life insurance needs change if you and your spouse adopt a child? A) They will increase. B) They will decrease. C) They will remain unchanged. D) There’s not enough information to know. Answer: A Solution: The more dependents you have and the younger they are, the more life insurance you’ll need. Format: Multiple Choice Title: Test Bank 8.1 Factors Affecting Your Life Insurance Needs Section: 8.1 Factors Affecting Your Life Insurance Needs Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 18. If all other factors are equal, how will your life insurance needs change if your youngest child graduates from college and gets a well-paying job? A) They will increase. B) They will decrease. C) They will remain unchanged. D) There’s not enough information to know. Answer: B Solution: While you’ll need more life insurance during the child-rearing years, particularly if you are the primary breadwinner, the opposite is true when your children are independent. Thus, your life insurance needs will decline.

Format: Multiple Choice Title: Test Bank 8.1 Factors Affecting Your Life Insurance Needs Section: 8.1 Factors Affecting Your Life Insurance Needs Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 19. If all other factors are equal, how will your life insurance needs change after you have paid off your mortgage? A) They will increase. B) They will decrease. C) They will remain unchanged. D) There’s not enough information to know. Answer: B Solution: The lower your wealth and the higher your financial obligations, the more life insurance you’ll need. Thus, as your debt obligations decline, your life insurance needs will correspondingly decline as well. Format: Multiple Choice Title: Test Bank 8.1 Factors Affecting Your Life Insurance Needs Section: 8.1 Factors Affecting Your Life Insurance Needs Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 20. An advantage of the income-multiple method to determining how much life insurance is needed is its A) complexity. B) simplicity. C) accuracy. D) popularity. Answer: B Solution: The simplest approach, and one that is often used as a shortcut in analyzing life insurance needs, is the income-multiple method. With this method, you simply multiply your income by a factor of 5 to 10. Format: Multiple Choice Title: Test Bank 8.1 Income-Multiple Method Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 21. The most effective method for determining how much life insurance is needed is the A) income-multiple method. B) mortality multiplier method. C) percent of debt method. D) financial needs method. Answer: D Solution: The most effective method of determining your life insurance needs is the financial needs method. You first estimate how much money your dependents will need after your death, and then calculate the income replacement required to fund the lost income, services, and long-term capital needs. Some of these needs can be met with existing household savings and income, and the remainder is the amount that you’ll fund with life insurance. Format: Multiple Choice Title: Test Bank 8.1 Life Insurance Determination Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: comprehension AACSB: Analytic Expected Time to Complete: 1 minute 22. A weakness of the income-multiple method used to determine life insurance needs is its assumption that A) everyone with the same income has the same life insurance needs. B) individuals have different life insurance needs. C) existing household resources can be used for support by the surviving family members D) the more insurance you can afford, the better. Answer: A Solution: The idea behind this method is that the life insurance should be sufficient to replace your income for a period of time. A weakness of this method is it assumes that everyone has the same life insurance needs. Some people need far more, and others don’t need any at all. Another problem is that the income-multiple method doesn’t take into consideration the resources you already have to meet your financial needs. Format: Multiple Choice Title: Test Bank 8.1 Income-Multiple Method

Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 23. Which of the following would not be eligible for survivor benefits under Social Security? A) A 59-year-old employed wife with no children under age 18 B) A 40-year-old unemployed wife with a 10-year-old daughter C) A 17-year-old son D) All would receive survivor benefits. Answer: A Solution: In addition to being a retirement program, Social Security pays benefits to the surviving spouse and children of qualified workers. Under current rules, benefits are payable for each child under the age of 18 and for a nonworking surviving spouse who stays at home with children, up to a specified family maximum. Format: Multiple Choice Title: Test Bank 8.1 Social Security Survivor Benefits Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 24. The __________ method allows you to analyze your life insurance needs by simply multiplying your income by a factor of 5 to 10. A) financial needs B) income-multiple C) surviving spouse D) Social Security survivor Answer: B Solution: The income-multiple method allows you to analyze your life insurance needs by simply multiplying your income by a factor of 5 to 10. Format: Multiple Choice Title: Test Bank 8.1 Life Insurance Needs Analysis Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need.

Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 25. The __________method analyzes your life insurance needs by estimating how much money your dependents will need after your death, while taking into account existing household resources. A) financial needs B) income-multiple C) surviving spouse D) duel income, no kids Answer: A Solution: The financial needs method analyzes your life insurance needs by estimating how much money your dependents will need after your death, while taking into account existing household resources. Format: Multiple Choice Title: Test Bank 8.1 Life Insurance Needs Analysis Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 26. Jason earns $50,000 per year. If he uses the income-multiple method to estimate his life insurance needs, he will need approximately what range of life insurance? A) $50,000 to $100,000 B) $100,000 to $200,000 C) $250,000 to $500,000 D) $750,000 to $1,000,000 Answer: C Solution: With the income-multiple method, you simply multiply your income by a factor of 5 to 10. If you have income of $50,000, for example, you need between $250,000 ($50,000 income x 5) and $500,000 ($50,000 income x 10) in life insurance, according to this approach. The idea behind this method is that the life insurance should be sufficient to replace your income for a period of time. Format: Multiple Choice Title: Test Bank 8.1 Income-Multiple Method Calculation Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium

Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 27. Violet earns $160,000 per year and has a family who depends on her financially. Violet has a life insurance policy through her job that will pay benefits of one year’s salary. Based on the income-multiple method, how much more does Violet need in life insurance? A) $640,000 to $1,440,000 B) $640,000 to $1,600,000 C) $800,000 to $1,440,000 D) $800,000 to $1,600,000 Answer: A Solution: With the income-multiple method, you simply multiply your income by a factor of 5 to 10. Violet has an income of $160,000; thus, she will need between $800,000 ($160,000 income x 5) and $1,600,000 ($160,000 income x 10) in life insurance. However, her employer provides $160,000 in life insurance (one-year salary); thus, her additional life insurance needs are reduced by $160,000; $640,000 to $1,440,000. Format: Multiple Choice Title: Test Bank 8.1 Income-Multiple Method Calculation Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 2 minutes 28. If you have no dependents and insufficient assets to cover funeral costs, you A) do not need life insurance. B) should consider comprehensive coverage on your PAP. C) should consider buying long-term care insurance. D) should consider buying life insurance. Answer: D Solution: Funeral costs can easily exceed $10,000. In addition, many people run up extensive medical bills in the last few months of their lives, which can otherwise deplete household resources that are required for funeral costs. Format: Multiple Choice Title: Test Bank 8.1 Intended Use of Policy Proceeds Section: Life Insurance Compared with Auto and Homeowner’s Insurance Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Medium Bloomcode: Application

AACSB: Analytic Expected Time to Complete: 1 minute 29. Nicole is a single parent who earns $60,000 per year after taxes. Her household expenses are $50,000 per year. If she were to die, she estimates that death costs would total $10,000. She wants to provide $50,000 for an education fund for each of her twin children, who are currently 10 years old. She does not qualify for Social Security benefits, so she needs $25,000 per year in addition to household expenses for child care for her twins until they reach 18. She currently has savings of $20,000 but should also have an emergency fund (3 months’ expenses). Using the financial needs approach, how much life insurance would you recommend? A) $652,500 B) $690,000 C) $702,500 D) $722,500 Answer: C

Solution: Sample of Excel Worksheet 8.1: Life Insurance Needs A. Costs of Death Funeral expenses TOTAL COST OF DEATH

$10,000 $10,000

B. Lump Sums 1 Emergency Fund 2 Education fund TOTAL LUMP SUMS

$12,500 $100,000 $112,500

C. Cost of Household Maintenance Household Expenses Childcare expenses Annual Social Security survivor benefits NET INCOME SHORTFALL

$50,000 $25,000 $0 $75,000

Number of years you want to replace income shortfall Total household maintenance fund needs

8 $600,000

TOTAL FUNDS NEEDED

$722,500

D. Available Resources to Meet Needs Total savings Other Life insurance TOTAL RESOURCES TO MEET NEEDS

$20,000 0 $20,000

Total Life Insurance Needs

$702,500

1 2

Emergency Fund is 3 months household expenses Education fund is the $50,000 goal x 2 children = $100,000

Format: Multiple Choice Title: Test Bank 8.1 Financial Needs Method Calculation Section: Life Insurance Needs Analysis Learning Objective: 8.1 Determine how much life insurance you need. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 30. Marc is 32 and married to Estella, who is 30. Estella is a stay-at-home mom to their two children, ages 1 and 4. They currently live on Marc’s salary of $110,000 (after taxes) that just about meets their household expenses. They would like to make sure that if Marc dies, they replace his income for 17 years, which would match their mortgage maturity and their kids would be well off to college; fund the

children’s college education ($300,000); establish a retirement fund for Estella ($250,000) to supplement Marc’s Social Security retirement benefits; cover funeral costs ($10,000); and establish a 3-month emergency fund. If Estella dies, they want to have enough insurance to be able to pay for child care ($36,000 per year) and housekeeping services ($12,000 per year) for 17 years, to establish an emergency fund, and for funeral costs. They have the following financials: Marc’s employer provides a year’s salary life insurance. Family is eligible for Social Security survivor benefits of $55,000 if Marc dies. Household expenses would be 20% lower if either parent dies. Current savings and investments of $23,000. Using the financial needs approach, how much life insurance would you recommend? A) $487,500 on Marc; $340,500 on Estella B) $905,500 on Marc; $778,500 on Estella C) $1,015,500 on Marc; $756,500 on Estella D) $1,063,500 on Marc; $708,500 on Estella Answer: C

Solution: Sample of Excel Worksheet 8.1: Life Insurance Needs Marc

Estella

A. Costs of Death Funeral expenses TOTAL COST OF DEATH

$10,000 $10,000

B. Lump Sums 1 Emergency Fund Retirement Fund Education fund TOTAL LUMP SUMS

$27,500 $250,000 $300,000 $577,500

$27,500

C. Cost of Household Maintenance 2 Household Expenses Additional childcare expenses Housekeeping expenses Annual Social Security survivor benefits NET INCOME SHORTFALL

$88,000

$26,000

17 $561,000

17 $442,000

$1,148,500

$779,500

$23,000 $110,000 $133,000

$23,000

$1,015,500

$756,500

D. Available Resources to Meet Needs Total savings Other Life insurance TOTAL RESOURCES TO MEET NEEDS Total Life Insurance Needs

($22,000) $36,000 $12,000

($55,000) $33,000

Number of years you want to replace income shortfall Total household maintenance fund needs TOTAL FUNDS NEEDED

$300,000 $327,500

$23,000

Emergency Fund is 3 months household expenses 2 Household expenses would be 20% lower if either parent dies

C) identical premium D) comparable Answer: B Solution: Term life insurance allows a particular individual to buy a larger amount of insurance with a smaller premium than whole life insurance. Format: Multiple Choice Title: Test Bank 8.2 Choosing the Type of Policy Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 32. A disadvantage of term life insurance is that as an individual gets older, A) they become uninsurable. B) their premium will go up. C) their premiums will go down. D) the face value declines. Answer: B Solution: There are two primary problems with term insurance: premiums increase with age and term life insurance remains in effect only for a specific period of time. If the policy lapses, you might have to go through the complete application process all over again, including any required medical examinations. Format: Multiple Choice Title: Test Bank 8.2 Term Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 33. Which of the following is the key characteristic of term life insurance? A) Flexible premiums B) Selection of investment options C) No cash value D) Valid for an unlimited amount of time Answer: C

Solution: Term life insurance provides protection for a specific period of time, such as one year or five years. Term life is not an investment product, and there is no buildup of cash value. Format: Multiple Choice Title: Test Bank 8.2 Term Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 34. The major advantage of term life insurance over whole life insurance for young people is that term life A) is available without proof of insurability, whole life is not. B) always has a constant premium, whole life does not. C) tends to have lower premiums than whole life for the same face value. D) has a choice of investments, whole life does not. Answer: C Solution: Term life insurance provides protection for a specific period of time, such as one year or five years. Term life is not an investment product, and there is no buildup of cash value. The annual premium for a given face amount of permanent insurance is much greater than the premium for the same amount of term insurance, especially when the insured is young and healthy. Format: Multiple Choice Title: Test Bank 8.2 Term Versus Whole Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 35. A term life insurance policy that the insured person can extend for another term without taking a medical exam has A) convertibility. B) decreasing protection. C) permanent life protection. D) guaranteed renewability. Answer: D

Solution: Guaranteed renewability is the right to renew the term life insurance policy without additional proof of insurability, such as a medical exam. In renewable policies of this type, the face value usually remains the same over time, but the premium increases periodically. Format: Multiple Choice Title: Test Bank 8.2 Term Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 36. The right to renew a term life insurance policy without additional proof of insurability is known as A) permanent life protection. B) level-premium guarantee. C) guaranteed renewability. D) the extended life rider. Answer: C Solution: Guaranteed renewability is the right to renew the term life insurance policy without additional proof of insurability, such as a medical exam. In renewable policies of this type, the face value usually remains the same over time, but the premium increases periodically. Format: Multiple Choice Title: Test Bank 8.2 Term Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 37. Which life insurance policy will offer the cheapest method to insure your life for $3 million for at least 20 years? A) Universal life B) whole life C) Convertible term life D) Level-premium term life Answer: D Solution: Level-premium term life insurance has a fixed premium rate for a period of years. Essentially, the insurer estimates the future premiums for the specified

period of time, with increases for age-related risk, and then sets a fixed premium rate for the period that will be sufficient to cover those costs. The premiums will be higher than what you would otherwise have paid at the beginning of the period but lower than what you would have paid at the end. This policy will maintain a fixed face value and premium for 20 years. Format: Multiple Choice Title: Test Bank 8.2 Term Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. If a term policy is convertible, the insured has the right to convert to A) permanent life insurance for the same premiums. B) permanent life insurance without additional proof of insurability. C) long-term care insurance for the same premiums. D) long-term care insurance without additional proof of insurability. Answer: B Solution: If a term policy is convertible, the insured has the right to convert to permanent life insurance without additional proof of insurability. Format: Multiple Choice Title: Test Bank 8.2 Convertible Term Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 39. Which value of a life insurance policy does the beneficiary receive upon death of the insured? A) Cash value B) Surrender value C) Face value D) Market value Answer: C Solution: If you die during the contract period, your beneficiary will receive the face value of the policy. For example, if the face value of a life insurance policy is $100,000, the beneficiary receives a $100,000 death benefit.

Format: Multiple Choice Title: Test Bank 8.2 Death Benefit of a Life Insurance Policy Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 40. Nadine is shopping for a ten-year term life insurance policy. She wants her premium to stay the same each year for the entire 10-year term. What type of life insurance should she buy? A) Decreasing-term B) Convertible term C) Level-premium term D) Guaranteed renewable term Answer: C Solution: Level-premium term insurance has a fixed premium rate for a period of years. Essentially, the insurer estimates the future premiums for the specified period of time, with increases for age-related risk, and then sets a fixed premium rate for the period that will be sufficient to cover those costs. The premiums will be higher than what you would otherwise have paid at the beginning of the period but lower than what you would have paid at the end. Format: Multiple Choice Title: Test Bank 8.2 Term Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 41. Premiums for permanent insurance are more expensive than premiums for term insurance when you are younger because A) your risk of dying is higher. B) the policy is shorter term. C) the premiums do not increase with age. D) the investment returns are lower. Answer: C Solution: Permanent insurance allows policyholders to stay insured for their lifetime while paying a guaranteed level premium. Essentially, the insurer estimates the future premiums for the specified period of time, with increases for

age-related risk, and then sets a fixed premium rate for the period that will be sufficient to cover those costs. The premiums will be higher than what you would otherwise have paid at the beginning of the period (when young) but lower than what you would have paid at the end (older years). Format: Multiple Choice Title: Test Bank 8.2 Permanent Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 42. Which of the following statements is true about cash value life insurance? A) The cash value includes all of the premiums the policyholder pays for the policy. B) The extra cash from premiums is invested in the policy and eventually used to offset the increased costs of providing death protection at older ages. C) The cash value is paid out only if the policyholder dies. D) The premium declines over time as the cash value increases. Answer: B Solution: The extra cash invested in the policy, which will eventually be used to offset the increased costs of providing death protection at older ages, is known as the cash value. For this reason, permanent life insurance is also commonly referred to as cash-value life insurance. Format: Multiple Choice Title: Test Bank 8.2 Permanent Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 43. If a whole life insurance policy has premiums paid over the insured's whole life, this is an A) limited-payment life insurance. B) ordinary life insurance policy. C) single-premium whole life insurance. D) multi-premium whole life insurance. Answer: B

Solution: Whole life insurance provides death protection for a person’s entire life. If the premiums are payable over the insured’s whole life, the policy is ordinary life insurance. If the premiums are paid only for a specified period of time, after which the policy is paid up and still in force, the policy is limited-payment life insurance. Format: Multiple Choice Title: Test Bank 8.2 Whole Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 44. Which type of life insurance allows policyholders to direct the investment component of their policies? A) Universal life B) Variable life C) Whole life D) Both universal life and variable life Answer: B Solution: Variable life insurance allow policyholders to decide how to invest the cash value accumulating in their policy. The insurer provides professional management of the accounts, and the policyholder selects from among several investment choices, similar to those in employer retirement plans. Format: Multiple Choice Title: Test Bank 8.2 Types of Permanent Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 45. Which of the following is a criticism of whole life insurance? A) Higher tax rate than on comparable investments. B) Premiums do not increase with age. C) Generally low investment returns. D) Accumulation of cash value. Answer: C Solution: The concept of bundling death protection with an investment component makes sense only if the policy offers you a cost-effective way of

achieving both objectives. Traditional whole life insurance has often been criticized for the low rates of return credited to policyholders, particularly during periods when the stock and bond markets have done well. Format: Multiple Choice Title: Test Bank 8.2 Whole Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 46. Corey has not paid the premium on his universal life, flexible-premium policy for one month. His insurance company has yet to cancel the policy. Why? A) He has not passed the two-month free look period. B) His policy allows him to use accumulated cash value to cover mortality costs for the period. C) His insurance company is too large to notice. D) His insurer is a mutual company rather than a stock company. Answer: B Solution: Universal life insurance also includes a flexible-premium option. A policyholder with sufficient cash reserves can choose not to pay the premiums, using accumulated cash value to meet mortality costs for the period, or to take some of the funds out of the policy entirely. This flexibility is a benefit in that the policy won’t lapse if you run into some financial difficulties. Format: Multiple Choice Title: Test Bank 8.2 Universal Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 47. Which of the following is the key characteristic of variable life insurance? A) Flexible premiums B) Selection of investment options C) No cash value D) Low cost Answer: B Solution: Variable life insurance allows policyholders to decide how to invest the cash value accumulating in their policy. The insurer provides professional

management of the accounts, and the policyholder selects from among several investment choices, similar to those in employer retirement plans. Format: Multiple Choice Title: Test Bank 8.2 Variable Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 48.

Which of the following is not a feature of variable life insurance? A) It allows policyholders to select the type of investments that their premiums will be used for. B) It has tax advantages compared with taxable savings accounts because the buildup of cash value is tax-deferred. C) It does not accumulate a cash value. D) It is riskier than whole life insurance. Answer: C Solution: All permanent life insurance, including variable life, provide an investment component along with its protection component. It’s called permanent because, unlike term insurance, it doesn’t need to be renewed and is intended to be in place for your entire lifetime. The extra cash invested in the policy, which will eventually be used to offset the increased costs of providing death protection at older ages, is known as the cash value. Format: Multiple Choice Title: Test Bank 8.2 Variable Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 49. Which of the following types of life insurance is the riskiest for the insured? A) Variable life insurance B) Whole life insurance C) Universal life insurance D) Term life insurance Answer: A Solution: Variable life insurance allows policyholders to decide how to invest the cash value accumulating in their policy. The insurer provides professional

management of the accounts, and the policyholder selects from among several investment choices, similar to those in employer retirement plans. The ability to invest in at-risk investments makes. variable life the riskiest among cash value life insurance. Format: Multiple Choice Title: Test Bank 8.2 Cash Value Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 50. Which of the following is the key characteristic of universal life insurance? A) Flexible premiums B) Selection of investment options C) No cash value D) Lack of permanence Answer: A Solution: Universal life insurance includes a flexible-premium option, where a policyholder with sufficient cash reserves can choose not to pay the premiums, using accumulated cash value to meet mortality costs for the period, or to take some of the funds out of the policy entirely. This flexibility is a benefit in that the policy won’t lapse if you run into some financial difficulties. Format: Multiple Choice Title: Test Bank 8.2 Universal Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 51. The rate of return on most permanent life policies is _________ rates earned on other investments. A) comparable with B) lower than C) higher than D) not comparable with Answer: B Solution: The primary advantages of permanent insurance are that investment returns are not taxable and provide a mechanism for forced saving. However, it’s

important to carefully consider alternative investment options before deciding to buy permanent life insurance because the rates of return are typically lower and expenses might be higher than for mutual funds of comparable risk. Format: Multiple Choice Title: Test Bank 8.2 Rates of Return on Cash Value Life Insurance Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 52. Consumers considering the purchase of life insurance should research the financial strength rating for the insurance company they plan to purchase from. Which of the following has the highest financial strength?

A) Allstate Life Insurance Company B) First Penn-Pacific Life Insurance Company C) Great-West Life Assurance Company D) Guardian Life Insurance Company of America Answer: D Solution:

Format: Multiple Choice Title: Test Bank 8.2 Financial Strength Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium

Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 53. Life insurance policies issued by a mutual company are called A) participating policies. B) convertible policies. C) shareholder policies. D) partner policies. Answer: A Solution: Policies issued by a mutual company are called participating policies. Owners participate in the good performance of the company by receiving a dividend at the end of the year that can be used to reduce the premium for the next year. Dividends aren’t guaranteed, so the net premium you end up paying each year will vary based on the financial performance of the mutual company Format: Multiple Choice Title: Test Bank 8.2 Mutual Companies Section: Choosing an Insurer Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 54. Stock life insurance companies pay a dividend to A) policyholders. B) beneficiaries. C) the insured. D) shareholders. Answer: D Solution: A stock company is owned by the stockholders, who expect to make a profit on their investment in the firm. Owners participate in the good performance of the company by receiving a discretionary dividend during year. Dividends are paid to the shareholders of the stock company, not policyholders. Mutual companies may pay dividends to the policyholders who collectively own the company. Format: Multiple Choice Title: Test Bank 8.2 Stock Companies Section: Choosing an Insurer Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 55. Which of the following is not one of the characteristics you should consider when choosing a life insurance agent? A) Profitability B) Education C) Reputation D) Responsiveness Answer: A Solution: In selecting an agent, you should consider the following factors: education, experience, reputation, responsiveness, and ethical behavior. Format: Multiple Choice Title: Test Bank 8.2 Choosing an Agent Section: Choosing an Agent Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 56. Which of the following is an ethical life insurance practice? A) Suggesting you convert a term policy into a whole life policy B) Using the highest rates of return in determining expected cash value C) Encouraging replacement of an existing cash-value policy with an identical one D) Suggesting borrowing from a whole life policy to buy a variable annuity Answer: A Solution: An agent is paid a commission for selling you a policy and thus may have incentives that aren’t compatible with your best interests. Using the highest, in lieu of the most conservative, hypothetical rates of return is setting up unrealistic expectations in a policy solicitation. Replacing an identical policy with no added-value is simply selling a product to generate a commission, at the additional expense to the consumer. Borrowing from an existing policy to purchase another policy is potentially placing an unsustainable burden of premiums on a consumer for the purpose of generating a sale. Converting an existing policy to an upgraded benefit eliminates additional fees generated with a new policy sale. Format: Multiple Choice Title: Test Bank 8.2 Ethical behavior Section: Choosing an Agent Learning Objective: 8.2 Select the type of life insurance that best meets your needs.

Difficulty: Hard Bloomcode: Evaluation AACSB: Reflective Thinking Expected Time to Complete: 3 minutes 57. You have been quoted a premium of $1,200 per year for $1,000,000 in term life insurance, with the premium fixed for 20 years, and a premium of $4,175 per year for a permanent life insurance policy with an equivalent face value. If you decided to implement the “buy term insurance and invest the difference” strategy, how much will you accumulate after 20 years at a 6% APY? A) $109,437 B) $116,003 C) $153,580 D) $162,795 Answer: B Solution: You can purchase 20-year term insurance for $1,200 of the $4,175 premium for permanent policy and invest the difference of $2,975. Calculate the future value of an annual $2,975 annuity due over 20 years at 6% APY. Insurance premiums are due at the beginning of the coverage period. Financial Calculator: Set to BGN; enter PMT = -2,975, N = 20, I/Y = 6, PV= 0; and solve for FV = 116,003 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) => =FV(0.06, 20, -2975, 0, 1) => 116,003 Format: Multiple Choice Title: Test Bank 8.2 Buy Term Insurance and Invest the Difference Calculation Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 1 minute [ANSWER IS =FV (I, N, -DIFF IN PMT, 0, 1); Distractor 1 is =FV (I, N, -perm life pmt, 0, 1); Distractor 2 is = FV (I, N, -DIFF IN PMT, 0, 0); Distractor 3 is = FV (I, N, -perm life pmt, 0, 0)] 58. You have been quoted a premium of $1,200 per year for $1,000,000 in levelpremium term life insurance for 20 years and a premium of $5,375 per year for a permanent life insurance policy with an equivalent face value. If the insurer’s rate of return is 5% APY, at what point will the permanent policy generate enough cash value to pay the premiums? A) 13.7 years

B) 14.2 years C) 16.4 years D) 17.0 years Answer: C Solution: The insurer’s annual cost of pure insurance is $1,200, as evidenced by the term policy. The permanent life policy premium is $5,375, so the extra premium that can be invested at 5% APY is $4,175 ($5,375 - $1,200). Now, calculate the cash value required to generate $5,375 in annual premiums: Annual whole life premium $5,375 Cash value = = = $107,500 ′ Insurer s APY 0.05 Then, calculate the number of years required to accumulate $107,500 cash value in the policy through annual premium investments of $4,175 (extra premium applied to cash value) at 5% APY. Remember, life insurance premiums are due at the beginning of the coverage period. Financial Calculator: Set to BGN; enter PMT = -4,175, I/Y = 5, PV = 0, FV = 107,500; and solve for N = 16.4 years Excel Spreadsheet: =NPER(rate,pmt,pv,fv,type) => =FV(0.05, -4175, 0, 107500, 1) => 16.4 years Format: Multiple Choice Title: Test Bank 8.2 When Cash Value Interest Covers Premium Calculation Section: Choosing the Type of Policy Learning Objective: 8.2 Select the type of life insurance that best meets your needs. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 5 minutes [Answer is Nper=(Rate,(perm.premium-term prem),0,(perm.prem/i),1); Distractor 1 is Nper=(Rate,(perm.premium-term prem),0,(perm.prem/i),0); Distractor 2 is Nper=(Rate,perm.premium,0,(perm.prem/i),1); Distractor 3 is Nper=(Rate,perm.premium,0,(perm.prem/i),0)] 59. Adelaide has purchased a new life insurance policy. Her agent sent her a document that states the face amount of the policy, policy issue date, key features of the policy, and the insurer’s promise to pay. This is an example of a(n) A) rider. B) incontestable representation. C) policy declarations page.

D) viatical settlement. Answer: C Solution: All life insurance policies have a policy declarations page, which includes basic information about the policy, such as the following: name of the insurance company, name of the insured and policyholder, face amount of the policy, policy issue date, type of insurance and key features, period of time in which the policyholder can back out of the contract, rescission period, and the insurer’s promise to pay the beneficiaries upon the insured’s death. Format: Multiple Choice Title: Test Bank 8.3 Reading Your Policy Section: Reading Your Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 60. How long is the typical grace period on a fixed-premium policy? A) One week B) One month C) Sixty days D) One year Answer: B Solution: If you don’t pay your premium on time, your policy will lapse on its anniversary date. However, insurers are required to give you a grace period for payment of the premium, usually one month for fixed-premium policies and two months for flexible-premium policies. Format: Multiple Choice Title: Test Bank 8.3 Grace Period Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 61. Which life insurance policy does not allow policyholders to borrow against the accumulated value of the policy? A) Whole life B) Level-term life C) Variable life D) Universal life Answer: B

Solution: If you have a cash-value policy, you’re allowed to borrow from your accumulated funds without terminating the policy. The extra cash invested in the policy (cash value) can eventually be used to offset the increased costs of providing death protection at older ages and is available for loans. For this reason, permanent life insurance is also commonly referred to as cash-value life insurance. Format: Multiple Choice Title: Test Bank 8.3 Policy Loans Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 62. Insurers might be tempted to do very limited investigations before issuing a policy if a life insurance policy did not have a(n) A) convertibility provision. B) guaranteed renewability provision. C) incontestable provision. D) nonforfeiture provision. Answer: C Solution: Under general contract law, a contract is voidable by one of the parties if that party entered into it as a result of misrepresentations made by the other party. Because voiding the policy has the effect of leaving your beneficiaries without protection, insurers are given a limited time during which they can use misrepresentation to contest a claim or refuse payment, often one or two years from the policy issue date. The rationale for the incontestable clause is that, without such a limitation, insurers might be tempted to do very limited underwriting investigations, collect premiums for years, and then use misrepresentation as a reason to refuse to pay when the policyholder dies. Format: Multiple Choice Title: Test Bank 8.3 Key Provisions in a Life Insurance Policy Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 63. Barry’s life insurance company is refusing to pay his beneficiaries because they say he never disclosed the fact that he was a smoker when he purchased his policy 20 years ago. Do Barry’s beneficiaries have grounds to sue the insurance company?

A) Yes, the company has violated the entire contract clause. B) Yes, the company has violated the incontestable clause. C) No, Barry violated the incontestable clause. D) No, Barry violated the nonforfeiture clause. Answer: B Solution: Under general contract law, a contract is voidable by one of the parties if that party entered into it as a result of misrepresentations made by the other party. Because voiding the policy has the effect of leaving your beneficiaries without protection, insurers are given a limited time during which they can use misrepresentation to contest a claim or refuse payment, often one or two years from the policy issue date. The rationale for the incontestable clause is that, without such a limitation, insurers might be tempted to do very limited underwriting investigations, collect premiums for years, and then use misrepresentation as a reason to refuse to pay when the policyholder dies. Format: Multiple Choice Title: Test Bank 8.3 Key Provisions in a Life Insurance Policy Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 64. Nonforfeiture laws require that insurers must ____________ the permanent life insurance policy after a minimum number of years, if the contract lapses. A) reinstate B) allow for term conversion of C) provide a grace period for D) refund a fair amount of the cash value of Answer: D Solution: With permanent insurance, the premiums in the early years build up a cash reserve in addition to covering mortality risk in the current period. Nonforfeiture laws require that, if your contract lapses before maturity but after some minimum amount of time, such as three years, the insurer must refund a fair amount of the cash reserve. Format: Multiple Choice Title: Test Bank 8.3 Nonforfeiture Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

65. Which of the following statements is correct about reinstatement provisions on life insurance policies that have lapsed? A) All life insurance policies allow lapsed policies to be reinstated. B) Reinstatement of a life insurance policy typically requires proof of insurability and payment of any missed premiums with interest. C) Reinstatement requires the forfeiture of the cash value of the policy. D) Reinstatement provisions typically allow for missed premiums to be waived upon reinstatement. Answer: B Solution: Reinstatement of a life insurance policy typically requires proof of insurability and payment of any missed premiums with interest. This is common when policyholders lose employment and can’t afford to make the required premium payment for the coming year. Although you could surrender the policy for its cash value, it might be preferable to allow the policy to lapse and then reinstate it once your financial situation allows it. Format: Multiple Choice Title: Test Bank 8.3 Reinstatement Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 66. Stella is permanently disabled and unable to work. When she bought her life insurance policy, she included a(n) _____________ provision, so that she is allowed to keep the policy in force without further payment of premium. A) entire contract B) reinstatement C) living benefits D) waiver of premium Answer: D Solution: Many insurers offer a relatively inexpensive option called waiver of premium. A policyholder who has purchased this option is allowed under some limited circumstances, usually permanent disability, to keep the policy in force without further payment of premium. Format: Multiple Choice Title: Test Bank 8.3 Key Provision for Disability Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

67. Most life insurance policies ____ pay out on policies if the insured commits suicide. A) never B) always C) partially D) may Answer: D Solution: If an insured person commits suicide, his or her beneficiaries may still be entitled to payment under the policy. This will depend on the terms of the suicide clause, which allows the insurer to deny coverage if the insured commits suicide and the policy has been in force less than a specified period of time, usually two years. Format: Multiple Choice Title: Test Bank 8.3 Suicide Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 68. The suicide clause in a life insurance policy A) does not allow your beneficiary to collect if you commit suicide. B) spells out whether or not your beneficiary can collect if you commit suicide. C) allows you to collect if a beneficiary commits suicide. D) allows the insurer to automatically deny the claim. Answer: B Solution: Whether beneficiaries are entitled to payment for suicide will depend on the terms of the suicide clause, which allow the insurer to deny coverage if the insured commits suicide less than a specified period of time, usually two years, since the policy has been in force. Format: Multiple Choice Title: Test Bank 8.3 Suicide Clause Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 69. Under a(n) ________, you can buy interest in someone else’s life insurance policy.

A) beneficiary clause B) viatical settlement C) convertibility settlement D) entire contract clause Answer: B Solution: Under a viatical settlement agreement, an investor purchases the policy from its owner and becomes the beneficiary of the policy. The investor pays the original owner from 40 to 80 percent of the death benefit, depending on life expectancy and other factors (cash value, quality of the insurer, and premiums necessary to keep the policy in force), and the original owner gives up all rights to the policy. The investor pays the premiums and receives the death benefit when the original owner dies. Format: Multiple Choice Title: Test Bank 8.3 Purchasing Life Insurance Policies Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Comprehension AACSB: Ethics Expected Time to Complete: 1 minute 70. Life insurance policies with an __________ will double the amount of the death benefit if the insured dies as a result of an accident. A) accelerated living benefit B) accidental death benefit C) incontestable clause D) entire contract clause Answer: B Solution: Your life insurance policy may include an accidental death benefit rider or amendment that doubles the face value payable under the policy if your death is a result of an accident instead of natural causes. Since the percentage of deaths that occur from accidents is fairly small, this is an inexpensive benefit to provide. Format: Multiple Choice Title: Test Bank 8.3 Double Indemnity Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 71. Accelerated or living benefits are options that A) double the proceeds of your policy.

B) allow anyone to collect the proceeds of your policy before death. C) allow some terminally ill people to collect part of their policy proceeds before death. D) outline how long you need to live before you can collect on the policy. Answer: C Solution: An accelerated benefits option allows terminally ill policyholders to receive a portion of their life insurance proceeds before their death. More than half the states have adopted a model regulation governing this type of benefit. The regulation lists the conditions that will trigger the benefit, including AIDS, acute heart disease, permanent brain damage from stroke, and kidney failure. This option may be an automatic feature of a policy, or it may require an additional premium. Format: Multiple Choice Title: Test Bank 8.3 Accelerated (or Living) Benefits Section: Key Provisions in a Life Insurance Policy Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 72. Which of the following is not one of the common settlement options for beneficiaries of life insurance policies? A) Lump sum plus interest B) Periodic interest only C) Income for life D) Lump sum Answer: A Solution: Settlement options are choices regarding how the beneficiaries are to receive the proceeds of the policy. Your beneficiary’s choices for receipt of the funds after your death include lump sum, periodic interest only, income for a period of time, income for a specific amount, and income for life. Format: Multiple Choice Title: Test Bank 8.3 Settlement Options Section: Settlement Options Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 73. Chris and Marla are married and have a universal life insurance policy on Chris. He just passed away, and Marla wishes to receive the earnings on the settlement

and leave the face amount to their grown children. Which of the following settlement options should she choose? A) Lump sum B) Periodic interest only C) Income for a period of time D) Income of a specific amount Answer: B Solution: Periodic interest only is the only option that leaves the face value intact. Marla can leave the money with the insurer, who will pay her taxable interest on the accumulated value. Because she will not deplete the principal, it will become part of her estate when she dies. Format: Multiple Choice Title: Test Bank 8.3 Settlement Options Section: Settlement Options Learning Objective: 8.3 Define key terms used in life insurance policies. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 74. Long-term care (LTC) is a term that is broadly used to describe A) all medical care needed by people that extend beyond their medical insurance coverage. B) medical care needed by people that extend beyond one year. C) all supportive medical, personal, and social services needed by people who are unable to meet their basic living needs for an extended period of time. D) all supportive medical, and personal services needed by people who are unable to meet their basic living needs beyond one year Answer: C Solution: Long-term care (LTC) is a term that is broadly used to describe all supportive medical, personal, and social services needed by people who are unable to meet their basic living needs for an extended period of time because of accident, illness, or frailty. Format: Multiple Choice Title: Test Bank 8.4 Long-term Care Section: Planning for Long-Term Care Costs Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 75. Which of the following is true about long-term care costs?

A) As baby boomers are getting older, the cost of long-term care is going down due to greater availability of nursing home facilities. B) The cost of long-term care does not vary much from state to state. C) A financial plan should include a plan for paying for future long-term care costs. D) The demand for long-term care is decreasing. Answer: C Solution: A financial plan should include a plan for paying for future long-term care costs. Planning for the costs that would be incurred by your family in the event of your death is a cornerstone of a long-term financial plan. A related risk that many people fail to plan for is the risk of being incapacitated in old age. Because people are living longer, an increasing proportion of the population will eventually need nursing home care. Format: Multiple Choice Title: Test Bank 8.4 Planning for Long-Term Care Costs Section: Planning for Long-Term Care Costs Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 76. Meals on Wheels serves meals to the elderly who cannot prepare meals. This is an example of what type of long-term care source? A) Medicare B) Medicaid C) Community resources D) Household resources Answer: C Solution: Because the most expensive long-term care is institutional care, it makes sense to try to maximize home health-care options before resorting to nursing home care. Community resources can help an infirm person, particularly one who needs a relatively low level of care, to remain at home or in a relative’s home for a longer time. Services that might be available in your community include Meals on Wheels, which delivers regular meals to elderly people. Format: Multiple Choice Title: Test Bank 8.4 Sources of Funds for Long-Term Care Section: Sources of Funds for Long-Term Care Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

77. Which federally supported program provides long-term care for the elderly that cannot afford institutional services, such as assistance with activities of daily living? A) Community resources B) Medicare C) Medicaid D) Long-term care insurance Answer: C Solution: Medicaid is a federally authorized and state-administered health insurance program for the poor. People who meet low-income guidelines or who have exhausted all or most of their financial assets may be eligible for Medicaid coverage of nursing home expenses. Medicare does not provide coverage for assistance in the activities of daily living and, therefore, is not really a source of coverage for long-term care needs. Format: Multiple Choice Title: Test Bank 8.4 Government Sources for Long-Term Care Section: Sources of Funds for Long-Term Care Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 78. Long-term care insurance is a financial product that pays health-care expenses associated with A) long-term hospital care. B) hospice care. C) incapacity. D) physical and occupational therapy. Answer: C Solution: Long-term care (LTC) insurance is a financial product that pays healthcare expenses associated with incapacity. Format: Multiple Choice Title: Test Bank 8.4 Long-Term Care Insurance Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

79. Most long-term care insurance includes a ______ period, which is the number of days you receive and pay for care out of pocket before the insurance begins to pay for care. A) benefit B) waiting C) services covered D) deductible Answer: B Solution: The waiting period is the number of days you must pay for care before the long-term care insurance begins to pay for it, typically 30, 60, or 100 days. Because Medicare pays for the first 100 days, this is the period most often selected. Format: Multiple Choice Title: Test Bank 8.4 LTC Policy Provisions Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. Long-term care insurance is a relatively ___ product whose costs to insurers have been fairly ____ to predict. A) older; easy B) new; easy C) new; difficult D) older; difficult Answer: C Solution: Long-term care insurance is a relatively new product whose costs to insurers have been fairly difficult to predict. Format: Multiple Choice Title: Test Bank 8.4 Long-Term Care Insurance Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 81. Under the provisions of the Health Insurance Portability and Accountability Act (HIPAA), you A) can get a tax credit for long-term care costs you paid out of pocket. B) can get a tax credit for premiums you paid for long-term care insurance.

can take an itemized deduction both for long-term care costs you paid out of pocket and for premiums you paid for long-term care insurance. C) cannot take any deductions for long-term care insurance or premiums for long-term care insurance. Answer: C Solution: Under the provisions of the Health Insurance Portability and Accountability Act, you can take an itemized deduction both for long-term care costs you pay out of pocket and for premiums you pay for long-term care insurance. Format: Multiple Choice Title: Test Bank 8.4 Tax Considerations for Long-Term Care Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 82. Which of the following is not a typical waiting period for long-term care insurance? A) 30 days B) 60 days C) 100 days D) 120 days Answer: D Solution: The waiting period is the number of days you must pay for care before the LTC insurance begins to pay for it, typically 30, 60, or 100 days. Because Medicare pays for the first 100 days, this is the period most often selected. Format: Multiple Choice Title: Test Bank 8.4 Waiting Period for Long-term Care Insurance Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 83. How long will Medicare Part A provide coverage for skilled care? A) 90 days B) 100 days C) 120 days D) 180 days

Answer: B Solution: If you’re over 65, Medicare Part A will provide benefits for skilled nursing care, home visits by nurses, and related medical expenses for up to 100 days following a hospital stay of at least three days. Format: Multiple Choice Title: Test Bank 8.4 Medicare Section: Sources of Funds for Long-Term Care Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 84. According to the American Health Care Association, the best time to buy longterm care insurance is between the ages of A) 40 and 45. B) 45 and 50. C) 50 and 55. D) 55 and 60. Answer: C Solution: The American Health Care Association, a federation of 50 state health organizations representing assisted living facilities, nursing facilities, long-term care facilities, and other care providers, recommends that you buy LTC insurance between ages 50 and 55 to obtain the optimal price. Format: Multiple Choice Title: Test Bank 8.4 Best Time to But Long-term Care Insurance Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 85. Although George J. Winthrop IV is not as wealthy as his forefathers, he was able to acquire some wealth through his years and has planned on his and his wife’s long-term care to be paid from his retirement savings. Therefore, he has decided NOT to buy long-term care insurance. Is this a sound strategy? A) Yes, because long-term care insurance is extremely expensive and can be hedged with household savings. B) Yes, because long-term care insurance is only for people who have not saved enough household wealth.

C) No, because of the “first to care” concept, one spouse could wipe out the savings before the second spouse could use them. D) No, because long-term care insurance is very inexpensive. Answer: C Solution: If you’re wealthy, you may be able to fund all your long-term care needs from your household resources. One of the problems associated with this strategy is that one spouse may need nursing home care before the other. The nursing home expenses of the spouse who is “first to care” might exhaust household resources, leaving the survivor with inadequate wealth to finance retirement. Some experts believe that the large percentage of elderly widows living at or below the poverty level is at least partially attributable to this problem. Format: Multiple Choice Title: Test Bank 8.4 Household Resources for Long-Term care Section: Sources of Funds for Long-Term Care Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 86. In comparing long-term care insurance policies, you would consider all of the following except A) beneficiary coverage. B) benefit amount. C) services covered. D) benefit period. Answer: A Solution: If you decide to buy long-term care insurance, you’ll want to consider the benefit amount, inflation protection, benefit period, waiting period, and services covered. There are no beneficiaries in a long-term care policy. Format: Multiple Choice Title: Test Bank 8.4 LTC Policy Provisions to Consider Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 87. What is the primary reason one should not buy long-term care insurance too early? A) Inflation may negate the value of the funds you have paid in to your policy. B) You may pay too much for your insurance over the life of the policy.

C) Long-term care insurance policies are only good for 50 years from date of issue. D) The premiums you pay in the future could be significantly lower. Answer: B Solution: Because you’ll pay premiums until you go into long-term care, which might be never, your lifetime cost for the insurance may end up being much higher if you purchase the insurance at too early an age. Format: Multiple Choice Title: Test Bank 8.4 When Is the Best Time to Buy Long-Term Care Insurance Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 88. In a long-term care insurance policy, the amount the insurer will pay per diem in care is called the A) copay. B) coinsurance. C) benefit amount. D) face amount. Answer: C Solution: The benefit amount is usually paid as a dollar amount per day of qualified care or a percentage of actual expenses. You should select a benefit amount that corresponds to the average cost of care in the area where you live less an amount that you can afford to pay out of pocket. Format: Multiple Choice Title: Test Bank 8.4 LTC Policy Provisions Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 89. In a long-term care insurance policy, protection against rising prices of long-term care facilities and medical services is called the A) accelerated benefit. B) protected amount. C) benefit amount. D) inflation protection. Answer: D

Solution: The cost of care will increase over time, so your policy benefits should be inflation-protected. Although inflation protection may be expensive, it’s very important because LTC costs have been rising faster than the prices of other goods. Format: Multiple Choice Title: Test Bank 8.4 LTC Policy Provisions Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 90. The length of stay in a long-term care facility that will be paid for by a long-term care insurance policy is called the A) benefit period. B) waiting period. C) benefit amount. D) incontestable period. Answer: A Solution: The length of stay in a long-term care facility that will be paid for by a long-term care insurance policy, is called the benefit period. Format: Multiple Choice Title: Test Bank 8.4 LTC Policy Provisions Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 91. In a long-term care insurance policy, the amount of time that the policyholder must pay for long-term care, either from household resources or from Medicare, before the insurance will cover any of the cost is called the A) benefit period. B) waiting period. C) benefit amount. D) eligibility period. Answer: B Solution: The waiting period is the number of days you must pay for care before the LTC insurance begins to pay for it, typically 30, 60, or 100 days. Format: Multiple Choice Title: Test Bank 8.4 LTC Policy Provisions Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs.

Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 92. Mai’s mother is currently living in a nursing home, and she is worried about the financial drain of her mother’s long-term care costs. She would like to start planning for her own potential future in assisted living. Her quote for long-term care insurance is $1,900 per year until she is eligible for the maximum benefits of $240 per day (inflation protected) for a 3-year benefit period. She is 55 years old and can earn an APY of 3.5%, and the long-term inflation rate is 1.7%. If she estimates her long-term care needs based on her mother at 85 years old and plans to retire in Arizona, where the current cost of nursing care is $78,000, what should she do? A) Purchase the long-term care policy because it will cover more than the 3 years of nursing care in Arizona. B) Purchase the long-term care policy because it will cover more than the invested value of the annual $1,900 over 30 years but not the full 3 years of nursing care. C) Invest the $1,900 a year instead of purchasing the long-term care policy because it’s worth more than the total benefit amount. D) Invest the $1,900 a year instead of purchasing the long-term care policy because it will cover more than the 3 years of nursing care in Arizona. Answer: A Solution: First, calculate the future value of $1,900 annuity savings for 30 years (until Mai is 85 years old) at a 3.5% APY. Then compare it to the total benefit amount ($240/day x 365 days) of the long-term care insurance policy over the full benefit period (over 3 years). Future Value of $1,900 per year for 30 years @ 3.5% APY Financial Calculator: Enter PMT = -1,900, N = 30, I/Y = 3.5, PV = 0 and solve for FV = 98,083 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) => =FV(0.035, 30, -1900, 0, 0) => 98,083 TVM Equation: (1 + 𝑖)𝑛 -1 FVA = PMT 𝑥 𝑖 FVA = $1,900 𝑥

(1 + 0.035)30 -1 = $98,083 0.035

Value of Long-Term Care Insurance The value of long-term care insurance is $240 benefit amount (inflation protected) x 365 days = $87,600, which is slightly more than the current annual cost of nursing care in Arizona. Hence, the LTC Policy will be enough to cover the inflation adjusted cost of nursing care in Arizona in 30 years. The invested value of $1,900 annual savings over 30 years ($98,083) may not even cover 1 year of care in 30 years. Format: Multiple Choice Title: Test Bank 8.4 LTC Insurance Versus Budgeting for LTC Calculation Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 4 minutes 93. Sam is researching nursing homes for his father who owns a long-term care policy that has a $330 per day (365-day year) benefit amount, 3-year benefit period, and a 100-day waiting period. The Sunshine Home can accommodate his dad for $151,000 a year, for 3.5 years. How much will his out-of-pocket cost be for the first year and the second year? A) $59,832; $30,132 B) $60,250; $30,550 C) $63,132; $30,132 D) $63,550; $30,550 Answer: D Solution: The facility cost per day is $413.70 ($151,000 a year divided by 365 days). The benefit amount is $330 per day. Thus, his out-of-pocket cost is $83.70 ($413.70 cost per day - $330 benefit per day). His First Year Out-of-Pocket Cost 100 days (waiting period) = $413.70 cost per day x 100 days = $41,370.00 265 days (coverage period) = $83.70 per day net cost x 265 days = $22,180.50 Total first year cost = $41,370.00 + $22,180.50 = $63,550 His Second Year Out-of-Pocket Cost 365 days (coverage period) = $83.70 per day net cost x 365 days = $30,550 Format: Multiple Choice Title: Test Bank 8.4 LTC Policy Coverage Calculation Section: Long-Term Care Insurance Learning Objective: 8.4 Explain the choices for funding long-term care needs.

Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 4 minutes

Chapter 9 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 100 multiple-choice questions LO 9.1 LO 9.2 LO 9.3 LO 9.4

22 32 21 25

22% 32% 21% 25%

Total

100

100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

16 49 22 6 2 5 100

16% 49% 22% 6% 2% 5% 100% Calculations

Q# 10 11 19 20 22 41 54 70 72 81 82

Easy Medium Hard

16 77 7 100

16% 77% 7% 100%

Test Bank Question

9.1 Tax Savings from Pretax Employee Benefit Calculation (periodic cost) 9.1 Tax Savings from Pretax Employee Benefit Calculation 9.1 Comparing 2 Jobs by COLI Calculation 9.1 Equivalent Salary COLI Calculation 9.1 Value of Pre-Tax Employer Benefit Calculation 9.2 Insurance Deductible and Coinsurance Calculation 9.2 Total Insurance Out-of-Pocket Cost Calculation 9.3 Disability Income Benefit Calculation (+Social Security Disability) 9.3 Disability Income Protection Calculation 9.4 Growth of Tax-deferred versus Taxable Account Calculation 9.4 Defined-benefit (DB) Plan Retirement Benefit Calculation

1. Education reimbursement offered by your employer is an example of a(n) _______ employee benefit. A) tangible B) intangible C) guaranteed D) contingent Answer: A Solution: Tangible benefits are those that have a financial or dollar value. Education reimbursement is an example of a cash-equivalent tangible benefit. Format: Multiple Choice Title: Test Bank 9.1 Employee Benefits Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 2. Which of the following is not a tangible employee benefit? A) Paid vacation B) Use of a company car C) Flexible work hours D) Wellness programs Answer: C Solution: Tangible benefits are those that have a financial or dollar value. Use of a company car and wellness programs are examples of noncash tangible benefits. Paid vacation is a cash-equivalent, intangible benefit. Flexible work hours are a nonquantifiable non-tangible benefit. Format: Multiple Choice Title: Test Bank 9.1 Employee Benefits Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 3. The working environment on the job is A) a tangible benefit. B) an intangible benefit. C) not a benefit. D) an entitlement, regulated by OSHA.

Answer: B Solution: A pleasant working environment is an intangible benefit that may not be readily quantifiable in money terms but still has an actual cost to your employer and a significant value to you. Format: Multiple Choice Title: Test Bank 9.1 Employee Benefits Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 4. A contributory benefit plan is one for which the A) employer pays for the benefits. B) employee pays some of the costs of the plan. C) employee pays all of the costs of the plan. D) employer reimburses the employee for the costs of the plan. Answer: B Solution: If you’re required to pay some or all of the cost yourself, the benefit plan is called a contributory plan. Format: Multiple Choice Title: Test Bank 9.1 Contributory Benefit Plan Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 5. If an employee benefit is wholly paid by the employer, it is a(n) A) contributory plan. B) noncontributory plan. C) employer-sponsored plan. D) direct payment plan. Answer: B Solution: Benefits are sometimes completely paid for by the employer, in which case they’re said to be noncontributory. If, instead, you’re required to pay some or all of the cost yourself, the benefit plan is called a contributory plan. Format: Multiple Choice

Title: Test Bank 9.1 Employee Benefits Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 6. If you get a sum of money that can be applied to purchase benefits from a menu of employer-selected benefit options, this arrangement is called a A) cafeteria plan. B) direct purchase plan. C) contributory plan. D) noncontributory plan. Answer: A Solution: A cafeteria plan is an employee benefit plan where the employer provides a sum of money that can be applied to purchase benefits from a menu of options that they have selected. Format: Multiple Choice Title: Test Bank 9.1 Employee Benefits Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 7. On average, large firms offer ____ employee benefits than small employers. A) more B) less C) about the same D) exactly the same Answer: A Solution: Some employers are very generous in what they offer their employees, and others are stingy. The types of benefits provided will often depend on the size of the company. Differences in employee benefit offerings across firms are largely due to costs. It’s very expensive for employers to provide and administer benefit plans. It is less cost-effective for small employers because they can’t spread the administrative costs across a large group. Format: Multiple Choice Title: Test Bank 9.1 Employee Benefits at Large Versus Small Companies

Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 8. Group insurance is generally ______ equivalent individually purchased policies. A) more expensive than B) less expensive than C) the same as D) cost comparable to Answer: B Solution: Group insurance is an insurance purchased by an employer for the benefit of a group of employees. In general, managing a group insurance plan is less expensive than managing many individual policies, and these cost savings can be passed on to the employer and employees. The cost savings might result from consolidation of premium collection, claims management, and record keeping. The insurer also might have lower average claims because the group will likely include a balanced mix of healthy and unhealthy, young and old individuals. Format: Multiple ChoiceTitle: Test Bank 9.1 Group Insurance Costs Section: Why Benefits Are Preferable to Cash Compensation Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 9. Group insurance is an insurance purchased on a(n) A) group basis by an employer for the benefit of employees. B) individual basis within a group, such as a company. C) group of employers in the same geographic area for the benefit of their employees. D) individual basis by an employee for a group of other employees. Answer: A Solution: Group insurance is an insurance purchased by an employer for the benefit of a group of employees. Format: Multiple Choice Title: Test Bank 9.1 Group Insurance

Section: Why Benefits Are Preferable to Cash Compensation Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 10. If you were to pay $1,000 in health insurance premiums through your employer as a pretax deduction from your monthly payroll, how much annual savings will you have, assuming a 25% marginal tax rate? A) $250 B) $333 C) $3,000 D) $4,000 Answer: D Solution: For a precise estimate of the tax savings from pretax employee benefits, use the following equation: Tax savings =

Tax savings =

Benefit cost − Benefit cost 1 − Marginal tax rate

$1,000 × 12 months − ($1,000 × 12 months) = $𝟒, 𝟎𝟎𝟎 1 − 0.25

Answer: B Solution: For a precise estimate of the tax savings from pretax employee benefits, use the following equation: Tax savings =

Benefit cost − Benefit cost 1 − Marginal tax rate

Tax savings =

$5,000 − $5,000 = $𝟏, 𝟐𝟓𝟎 1 − 0.20

Format: Multiple Choice Title: Test Bank 9.1 Tax Savings from Pretax Employee Benefit Calculation Section: Why Benefits Are Preferable to Cash Compensation Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 12. Flexible spending accounts can be used to pay for A) medical and educational expenses. B) child-care and educational expenses. C) child-care and medical expenses. D) medical, educational, and child-care expenses. Answer: C Solution: Flexible spending accounts (FSA) are cafeteria benefits that allow you to set aside up to $2,750 of pretax income (2020) for the payment of qualified medical expenses and $6,000 per family for qualified child-care expenses (2020). Format: Multiple Choice Title: Test Bank 9.1 Flexible Spending Accounts Section: Why Benefits Are Preferable to Cash Compensation Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 13. A major difference between a flexible spending account (FSA) and a health savings account (HSA) is that an A. HSA can roll over unused amounts from year to year, whereas FSA cannot . B. FSA can roll over unused amounts from year to year, whereas HSA cannot.

C. FSA contribution is made from pretax dollars, whereas HSA contribution is made from after-tax dollars. D. HSA contribution is made from pretax dollars, whereas FSA contribution is made from after-tax dollars. Answer: A Solution: An HSA is connected with an employer health plan and can be used in the same way as an FSA for current medical expenses. Unlike an FSA, however, the HSA allows you to save for medical expenses that may occur far in the future. It is the only type of savings account that offers triple tax advantages: taxfree contributions and investment earnings, with no tax on withdrawals. Format: Multiple Choice Title: Test Bank 9.1 Health Savings Account (HSA) Section: Why Benefits Are Preferable to Cash Compensation Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 14. Employers who offer employee benefits generally qualify for _______ tax deductions that they would get if they had offered equivalent cash compensation to employees. A) higher B) lower C) no D) about the same Answer: D Solution: Compared with cash compensation, employee benefits offer significant tax advantages to employees. To employers, there’s no real tax difference. Subject to some limitations, employers can deduct both types of compensation as a business expense. Format: Multiple Choice Title: Test Bank 9.1 Employer Tax Savings from Cash-Equivalent Benefits Section: Why Benefits Are Preferable to Cash Compensation Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 15. Noncash benefits received by employees A) must be reported as taxable income by the employee.

B) must be reported as taxable income by the employer. C) must be reported as taxable income by the employee and employer. D) are not reported as taxable income. Answer: D Solution: All cash compensation is reported by your employer as taxable income, as well as the value of cash-equivalent benefits (although not all taxable income). Noncash benefits are not reported. Format: Multiple Choice Title: Test Bank 9.1 The Value of Employee Benefits Section: The Value of Employee Benefits Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 16. Even though the cost of living is higher in urban areas, urban salaries are generally A) high enough to match the increased cost of living. B) low enough to offset the increased cost of living. C) higher than the increased cost of living. D) not high enough to cover the increased cost of living. Answer: D Solution: The prices of food, clothing, housing, child care, and transportation can vary greatly by geographic area. In general, it’s more expensive to live on the East or West Coasts than in the middle of the country, and it’s also more expensive to live in urban areas than in rural areas. Although salaries are higher in expensive areas, you’ll probably find that they’re not sufficiently higher and will likely result in a lower standard of living than a lower salary for the same job in less expensive areas. Format: Multiple Choice Title: Test Bank 9.1 Cost of Living Across the Country Section: Comparing Job Offers Based on Salary and Benefit Packages Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 17. When comparing similar job offers in different geographical areas, it is critical to evaluate __________ differences between the different locations. A) salary

B) cost-of-living C) benefit D) tax Answer: B Solution: While compensation and benefits are important, if the cost of living is higher than what your compensation can support, your standard of living will greatly diminish. The net benefits must be considered to truly compare opportunities across geographies. Format: Multiple Choice Title: Test Bank 9.1 Comparing Job Opportunities Across Country Section: Comparing Job Offers Based on Salary and Benefit Packages Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 18. Which of the following statements is true concerning cost-of-living differences? A) It is generally more expensive to live on the coasts than in the middle of the country. B) It is generally more expensive in rural areas than urban areas due to lower compensation levels. C) There are few sources that allow for comparison of these differences. D) Although housing varies by geographic area, food and clothing costs are relatively constant. Answer: A Solution: It is generally more expensive to live on the coasts than in the middle of the country. If you’ve traveled around the country much, you know that the prices of food, clothing, housing, child care, and transportation can vary greatly by geographic area. In general, it’s more expensive to live on the East or West Coasts than in the middle of the country, and it’s also more expensive to live in urban areas than in rural areas because of higher cost of living. Format: Multiple Choice Title: Test Bank 9.1 Cost of Living Differences Section: Comparing Job Offers Based on Salary and Benefit Packages Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

19. Suppose that you are offered a position in Boston for $36,000 per year and a position in Tallahassee for $36,000 per year. If Tallahassee’s cost of living is 95% of the national average and that Boston’s is 110% of the national average, which is the better job offer financially? A) They are both the same at $36,000 each. B) Boston is better because you can purchase 110% of what you can in Tallahassee. C) Tallahassee is better because it has a lower cost of living. D) There is no sufficient information to make this decision. Answer: C Solution: Urban City will provide more purchasing power. Use Equation 9.2 to compare the salaries: COLI1 Equivalent salary in City 1 = × Salary in City 2 COLI2 110

Equivalent salary in Boston = 95 × $36,000 = $41,684.21 The equivalent salary in Boston is $41,684. This implies that the Boston salary provides $5,684 ($36,000 − $41,684) less purchasing power than the Tallahassee salary. Format: Multiple Choice Title: Test Bank 9.1 Comparing Two Jobs by COLI Calculation Section: Comparing Job Offers Based on Salary and Benefit Packages Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 20. You are comparing a $45,000 job offer in St. Paul to a $57,000 job offer in San Francisco. St. Paul's costs are 92% of the national average, whereas San Francisco's costs are 150% of the national average. What is the equivalent salary in San Francisco? A) $27,600 B) $34,960 C) $73,370 D) $92,935

Answer: C Solution: St. Paul will provide more purchasing power. Use Equation 9.2 to compare the salaries: Equivalent salary in City 1 =

COLI1 × Salary in City 2 COLI2

150

Equivalent salary in San Francisco = 92 × $45,000 = $73,370 The equivalent salary in San Francisco is $73,370. This implies that the San Francisco salary provides $16,370 ($57,000 – $73,370) less purchasing power than the St. Paul salary.

Format: Multiple ChoiceTitle: Test Bank 9.1 Equivalent Salary COLI Calculation Section: Comparing Job Offers Based on Salary and Benefit Packages Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 21. In order to compare fringe benefits of different jobs, you should A) consider the cash-equivalent benefits plus the compensation. B) consider the cash-equivalent value of all intangible benefits. C) compare the cash equivalence of the benefits. D) only consider those benefits that are valuable to you. Answer: D Solution: In comparing employee benefit packages, apply marginal analysis. When there are a lot of things to compare, you should focus only on the differences between two choices. You can also simplify the problem by considering only the benefits that are valuable to you at your current stage in the life cycle. There may be some benefits you really don’t need right now and others that are particularly important to you. Format: Multiple Choice Title: Test Bank 9.1 Comparing Employee Benefit Packages Section: Comparing Job Offers Based on Salary and Benefit Packages Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

22. Charlotte is a graduating finance major and is considering two job offers in the same city. Techtronics LLC pays a salary of $40,000, and the firm will contribute 5% of her salary to a retirement plan. Compusoft LLC pays a salary of $42,000, and the firm doesn’t offer a retirement plan. If all other factors are equal, which job opportunity is better? A) Techtronics by $166 B) Techtronics by $222 C) Compusoft by $1,000 D) Both are even. Answer: A Solution: The $2,000 (5% contribution × $40,000 salary) retirement contribution for Techtronics puts the gross pay of both jobs at parity. However, the $2,000 retirement contribution is pretax. While you can invest the extra $2,000 you make from Compusoft in a traditional IRA and get a tax deduction equal to the tax savings from the employer contribution, you will still have to pay FICA payroll tax (7.65%) on those funds, so you will have less than $166 less available to invest. $2,000 extra earnings from Compusoft = $2,166 gross earning required before FICA tax (1−0.0765 FICA rate) Format: Multiple Choice Title: Test Bank 9.1 Value of Pretax Employer Benefit Calculation Section: Comparing Job Offers Based on Salary and Benefit Packages Learning Objective: 9.1 Explain the value of employee benefits as a component of compensation. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 1 minute 23. In assessing your potential health-care needs, you should consider your A) tax situation. B) savings. C) family health history. D) income. Answer: C Solution: In assessing your potential health-care needs, you should consider your family history, even if you haven’t been diagnosed with a particular condition or illness. Expected health-care costs are higher than average because of a family history of cancer, diabetes, or heart disease. Format: Multiple Choice Title: Test Bank 9.2 Expected Health-Care Costs

Section: Health Insurance Needs Analysis Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 24. National trends in health-care costs shows that A) the share of health insurance premiums paid by employers has remained stable. B) wages have risen at a faster rate than health costs. C) the share of health insurance premiums paid by employers has decreased. D) the rise in health insurance premiums has corresponded closely to the inflation rate. Answer: A Solution: Although health insurance premiums have been rising steadily, the share paid by employers has so far remained relatively stable. Health insurance premiums have increased faster than wages and inflation, mainly due to the increased quality of care and escalating prescription drug prices and medical costs. Format: Multiple Choice Title: Test Bank 9.2 National Trends in Health-Care Costs Section: Health Insurance Needs Analysis Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 25. In March 2010, Congress passed the politically controversial Patient Protection and Affordable Care Act, commonly called “ObamaCare.” Which of the following is not an included provision? A) Expand coverage required by insurers B) Health-care cost controls C) Improvement in the health insurance marketplace through the creation of exchanges D) Nationalized health care Answer: D Solution: The Patient Protection and Affordable Care Act, commonly called “ObamaCare,” included provisions to expand coverage, control health-care costs, and improve the health-care delivery system.

Format: Multiple Choice Title: Test Bank 9.2 Health-Care Reform Section: What Happened to Health-Care Reform Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 26. Under the Affordable Care Act (ACA), A) 70 percent of all premiums collected by insurers must be used to pay for actual claims costs and quality improvements. B) children under age 30 can be covered under parents’ plans even if they don’t live at home. C) insurers cannot use health as a rating factor in pricing individual insurance policies. D) individuals cannot obtain health insurance if they have a preexisting condition. Answer: C Solution: Under the Affordable Care Act (ACA), insurers are only allowed to rate policies based on age, geographic area, and smoking status. Format: Multiple Choice Title: Test Bank 9.2 ACA Mandates Section: What Happened to Health-Care Reform Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 27. Many states have developed electronic clearinghouses for individuals and small businesses to shop for and compare health insurance plans. What provision of the Patient Protection and Affordable Care Act of 2010 was this created under? A) Health insurance exchanges B) Premium credits and subsidies C) Employer mandates D) Medical loss ratios Answer: A Solution: Many states developed electronic health insurance exchanges through which individuals and small businesses can compare shop for health insurance plans with specific coverage options. In most states that do not offer exchanges,

individuals are able to purchase insurance through a federally facilitated exchange. The federal exchange is located at www.healthcare.gov. Although some states are still operating their own exchanges, many have switched to the federal exchange. Format: Multiple Choice Title: Test Bank 9.2 ACA Mandates Section: What Happened to Health-Care Reform Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 28. What provision of the Patient Protection and Affordable Care Act of 2010 required U.S. citizens and legal residents to hold health coverage? A) Individual mandate B) Employer mandate C) Coverage D) Medicaid expansion Answer: A Solution: The individual mandate required all U.S. citizens and legal residents to have qualifying health coverage or be subject to a tax penalty. This provision was later repealed. Format: Multiple Choice Title: Test Bank 9.2 Major Provisions of the Patient Protection and Affordable Care Act of 2010 Section: What Happened to Health-Care Reform Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 29. A fee-for-service plan, also known as an indemnity plan, A) controls your access to medical services in order to control costs. B) pays for medical services within closed networks in order to control costs. C) pays or reimburses for the actual medical costs incurred. D) reimburses only for customary medical costs based on national averages. Answer: C Solution: A fee-for-service plan, sometimes called an indemnity plan, reimburses for the actual medical costs incurred. So, for example, if you have an X-ray or a

blood test, the bill is submitted to the insurer, who either pays the provider or reimburses you if you have paid the cost out of pocket. Format: Multiple Choice Title: Test Bank 9.2 Fee-for-Service Plans Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 30. A managed-care health insurance plan focuses on reducing health-care costs by A. having large deductibles. B. having low maximum dollar limits of protection. C. contracting with health-care providers to give them incentives for low-cost alternatives. D. reimbursing the actual medical costs incurred. Answer: C Solution: A managed-care health insurance plan focuses on reducing health-care costs by contracting with health-care providers to give them incentives for lowcost alternatives. Format: Multiple Choice Title: Test Bank 9.2 Managed-Care Plans Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 31. HMOs and PPOs are both examples of _________ health insurance plans. A) fee-for-service B) managed-care C) major medical D) indemnity Answer: B Solution: The overall objective of managed-care plans is to keep health-care costs down by providing cost-saving incentives to providers and patients. Three common types of managed-care plans are health maintenance organizations (HMOs), preferred provider organizations (PPOs), and point-of-service (POS) plans.

Format: Multiple Choice Title: Test Bank 9.2 HMO and PPO Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 32. The most common type of employer-based health insurance plan today is the A) fee-for-service plan. B) preferred provider organization (PPO). C) health maintenance organization (HMO). D) point-of-service (POS) plan. Answer: B Solution: Nearly all employer-based health insurance plans are managed-care plans. Of these, about half are PPOs. Format: Multiple Choice Title: Test Bank 9.2 Distribution of Health Plan Enrollment for Covered Workers by Plan Type Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 33. A ________ is less restrictive on its members than a ____________. A) preferred provider organization; health maintenance organization B) health maintenance organization; preferred provider organization C) health maintenance organization; point-of-service plan D) preferred provider organization; fee-for-service plan Answer: A Solution: A preferred provider organization is less restrictive on its members than a health maintenance organization. A fee-for-service plan, sometimes called an indemnity plan, which basically reimburses for the actual medical costs incurred, is the least restrictive health insurance plan. The overall objective of managedcare plans is to keep health-care costs down by providing cost-saving incentives to providers and patients by staying in-network. The point-of-service (POS) plan, having elements of fee-for-service, is the least restrictive managed-care plan, in that you must choose a so-called primary physician, but other services will be billed on a fee-for-service basis. The PPO gives you financial incentives to use “preferred” or “participating” providers who have contracted with the insurer to

provide services at a reduced rate. A PPO is similar to a traditional fee-forservice plan because it pays for services provided, but it’s also similar to an HMO due to the limitations on choice of provider. Thus, PPO is less restrictive than an HMO. Format: Multiple Choice Title: Test Bank 9.2 Types of Health Insurance Plans Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 34. Basic health-care insurance benefits include A) hospital, surgical, and pharmaceutical expenses but not physician expenses. B) physician, surgical, and pharmaceutical expenses but not hospital expenses. C) hospital expenses but not physician and surgical expenses. D) hospital, surgical, and physician expenses. Answer: D Solution: Basic health-care insurance covers hospital, surgical, and physician expenses. These plans commonly limit the types of expenses covered and have relatively limited protection. Format: Multiple Choice Title: Test Bank 9.2 Basic Health-Care Insurance Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 35. What fee-for-service plan only includes hospital, surgical, and physician expenses? A) Major medical insurance B) Basic health-care insurance C) Coinsurance D) Premium medical insurance Answer: B Solution: Basic health-care insurance covers hospital, surgical, and physician expenses. These plans commonly limit the types of expenses covered and have relatively limited protection.

Format: Multiple ChoiceTitle: Test Bank 9.2 Basic Health-Care Insurance Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 36. Major medical insurance plans A) often have high maximum limits and no deductible. B) only cover hospital, surgical, and physician expenses. C) add to the protection offered by basic health-care insurance by providing coverage for additional expenses and a wider range of medical services. D) are managed-care plans offered by the state-sponsored insurance exchange. Answer: C Solution: Major medical insurance adds to the protection offered by basic healthcare insurance by providing coverage for additional expenses and a wider range of medical services. Format: Multiple Choice Title: Test Bank 9.2 Major Medical Insurance Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 37. In health insurance plans, coinsurance is a(n) A) initial amount the insured will have to pay before the insurer will pay any of the covered expenses. B) proportional sharing of medical costs by the insurer and the insured. C) maximum amount an insured has to pay out of pocket in a given year. D) maximum amount an insured can be reimbursed by an insurer. Answer: B Solution: Coinsurance is a proportional sharing of medical costs by the insurer and the insured; you pay a percentage of medical costs after the deductible, often 10 to 30 percent, or a fixed fee, such as $10 to $25. This requirement applies until your total covered out-of-pocket costs reach a stated annual dollar amount. After that, the insurer will cover 100 percent of covered charges. Format: Multiple Choice Title: Test Bank 9.2 Coinsurance

Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. If you must pay 20 percent of your medical costs and the insurer pays the other 80 percent, this is an example of A) a deductible. B) coinsurance. C) indemnity. D) a copay. Answer: B Solution: With coinsurance, you pay a percentage (i.e., 20%) of medical costs after the deductible, the amount that you must pay before the insurer pays any of the claim. This requirement applies until your total covered out-of-pocket costs reach a stated annual dollar amount. After that, the insurer will cover 100 percent of covered charges. Your required contribution is sometimes called a copay, but this term is more appropriately used to describe the dollar charge that some managed-care plans require you to pay for specific services, such as a $10 copay each time you visit the doctor or a $30 copay for prescription drugs. Format: Multiple Choice Title: Test Bank 9.2 Deductibles, Coinsurance, and Copay Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 39. Which type of health-care plan provides comprehensive services, encourages preventive medicine, and gives health-care providers financial incentives to control costs? A) Fee for service B) Indemnity C) HMOs D) Medicare Answer: C Solution: A health maintenance organization (HMO) controls health-care costs by providing relatively comprehensive health insurance, encouraging preventive

medicine (checkups, diagnostic tests, and immunizations), and giving health-care providers financial incentives to control costs. Format: Multiple Choice Title: Test Bank 9.2 Types of Health Insurance Plans Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 40. The primary disadvantage of HMOs is that A) they are not widely available in many parts of the United States. B) the patient often has a limited choice of physicians and limited access to specialist care. C) the deductibles are relatively high. D) there isn’t a primary care physician to manage the use of medical specialists. Answer: B Solution: HMOs use a primary care physician to serve as a “gatekeeper” to other medical services. In other words, if you are an HMO member, you must get a referral from your regular HMO physician to see a specialist or to be hospitalized. HMOs normally charge a modest copay but do not require any deductible. The primary disadvantage of the HMO model of health care is that the patient often has a limited choice of physicians and limited access to specialist care. Format: Multiple Choice Title: Test Bank 9.2 Health Maintenance Organizations (HMOs) Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 41. Ethan Johnson is injured in a boating accident and incurs a $1,000 medical bill. If his plan has a $250 deductible and a 70/30-coinsurance provision, how much of the bill will be his responsibility? A) $250 B) $300 C) $475 D) $1,000 Answer: C

Solution: A deductible is the amount of a loss that you must pay before the insurer pays any of the loss. With coinsurance, you pay a percentage of medical costs after the deductible. This requirement applies until your total covered outof-pocket costs reach a stated annual dollar amount. After that, the insurer will cover 100 percent of covered charges. $1,000 bill − $250 deductible = $750 covered expenses $750 covered expenses × 0.30 coinsurance responsibility = $225 coinsurance $250 deductible + $225 coinsurance = $475 patient responsibility Format: Multiple Choice Title: Test Bank 9.2 Insurance Deductible and Coinsurance Calculation Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Analysis Expected Time to Complete: 3 minutes AACSB: Analytic 42. With dental expense insurance, you will normally have to pay A) premiums. B) coinsurance. C) deductibles. D) premiums, coinsurance, and deductibles. Answer: D Solution: Dental expense insurance, which is primarily available as a group benefit, is very similar to health insurance in that you pay a premium in return for being reimbursed for qualified expenses. You’ll normally have to pay deductibles and coinsurance as well, and you will be subject to limits on some procedures, such as root canals and crowns. Format: Multiple Choice Title: Test Bank 9.2 Dental Insurance Plans Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 43. Vision insurance is considered A) inexpensive for the benefit received. B) expensive for the benefit received. C) essential for the benefit received. D) complementary to medical insurance. Answer: B

Solution: Vision care insurance provides reimbursement or discounts on eye examinations, glasses, and contact lenses. Normally, your regular health insurance will cover care related to diseases of the eye, such as glaucoma or macular degeneration, but not well care. This implies that vision care insurance policies essentially cover an annual expense that you can easily estimate and budget for. Although nearly every person over the age of 40 requires eye correction of some sort, vision insurance is often expensive relative to the benefit received. Format: Multiple Choice Title: Test Bank 9.2 Vision Care Insurance Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 44. Medicaid is a A) federally operated health insurance program. B) state-operated health insurance program. C) federally run insurance exchange. D) employer-sponsored, federally subsidized insurance plan. Answer: B Solution: Medicaid is a federally authorized, state-run program that provides health-care coverage and premium subsidies for low-income families. The federal government funds much of the cost of Medicaid through state block grants but allows each state to determine eligibility and benefits beyond some minimum requirements. Format: Multiple Choice Title: Test Bank 9.2 Medicaid Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 45. Which of the following are covered by Medicare? A) People aged 65 and over B) People receiving Social Security disability benefits C) People with end-stage renal disease D) All of these.

Answer: D Solution: Medicare is a federally mandated health insurance program for individuals aged 65 and over, individuals receiving Social Security disability benefits, and individuals with end-stage renal disease. Format: Multiple Choice Title: Test Bank 9.2 Medicare Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 46. Which of the following health programs is funded by a payroll tax? A) Worker’s compensation B) Medicare C) Medicaid D) Affordable Care Act Answer: B Solution: While you’re employed, a portion of your Social Security payroll tax goes to Medicare (2.9%, split between you and your employer). The tax applies to all earned income, such as wages, salaries, and Schedule C business income. Format: Multiple Choice Title: Test Bank 9.2 Payroll Tax Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 47. Which of the following medical costs is/are covered by basic Medicare (Part A)? A) Doctors’ costs B) Hospital costs C) Prescription drug costs D) All of the above. Answer: B Solution: Medicare (Part A) covers hospital room and board, prescription drugs furnished by the hospital, and post-hospitalization extended care services for up to 100 days.

Format: Multiple Choice Title: Test Bank 9.2 Medicare (Part A) Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 48. Medicaid is a government program that is administered by A) the federal government and provides health insurance for the poor. B) each state and provides health-care coverage for low-income households. C) each state and provides health-care coverage for low-income elderly consumers. D) the federal government to provide health insurance for persons of age 65 and older. Answer: B Solution: Medicaid is a federally authorized, state-run program that provides health-care coverage and premium subsidies for low-income families. The federal government funds much of the cost of Medicaid through state block grants but allows each state to determine eligibility and benefits beyond some minimum requirements. Format: Multiple Choice Title: Test Bank 9.2 Medicaid Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 49. Under COBRA, you are eligible to purchase health insurance through a previous employer for A) as long as you remain unemployed. B) as long as you were employed. C) a period of 18 months (extendable under some circumstances to 36 months). D) a period of 24 months (extendable under some circumstances to 48 months). Answer: C Solution: Under the Consolidated Omnibus Reconciliation Act (COBRA) of 1986, if you lose or quit your job, you’re eligible to purchase coverage through your

previous employer’s plan for a period of 18 months (extendable under some circumstances to 36 months). Format: Multiple Choice Title: Test Bank 9.2 COBRA Continuation Coverage Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 50. If you elect to obtain COBRA coverage after losing your job, you will be responsible for paying the A) same portion of the premium cost as you did while employed. B) entire premium and your former employer can add up to 10 percent for administrative costs. C) entire premium and your former employer cannot increase it. D) same premium as you did while employed, with a subsidy paid by the federal government. Answer: B Solution: If you elect to obtain COBRA coverage, you will be responsible for paying the entire premium and your former employer can add up to 10 percent for administrative costs, so your health insurance costs most likely will increase substantially. Format: Multiple Choice Title: Test Bank 9.2 COBRA Continuation Coverage Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 51. COBRA health insurance coverage is available for which of the following previously insured individuals? A) Divorced spouses B) Nondependent children under 26 years old C) Dependent children under 18 years old D) All the choices are correct. Answer: D Solution: If you participated in a spouse’s employment-based health plan before a divorce, you can elect to pay for the COBRA continuation coverage after the

divorce. This rule also applies to widows and widowers who previously were covered under their deceased spouse’s plan. COBRA also allows continuation coverage under a parent’s health insurance plan for a child who is no longer eligible for family coverage. Under provisions of the Affordable Care Act, children can remain on their parents’ plan until age 26, even if they are not dependents for tax purposes. Format: Multiple Choice Title: Test Bank 9.2 COBRA Continuation Coverage Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 52. A health plan that provides financial incentives for the insured to practice preventive care and invest in their own health is called a A) consumer choice plan. B) managed-care plan. C) preventive care plan. D) healthy living plan. Answer: B Solution: The overall objective of managed-care plans is to keep health-care costs down by providing cost-saving incentives to providers and patients. Managed-care plans give you financial incentives to use “preferred” or “participating” providers who have contracted with the insurer to provide services at a reduced rate. If you choose to use other providers, you’ll pay a larger share of the cost. Format: Multiple Choice Title: Test Bank 9.2 Types of Health Insurance Plans Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 53. Insurance policies designed to pay costs not covered by Medicare are called A) Medigap policies. B) Medicare Plus plans. C) Medicaid policies. D) complete coverage policies.

Answer: A Solution: To fill in the gaps in Medicare coverage, many private insurers offer one or more Medicare supplement plans, commonly called Medigap policies, for participants in the Part A and B plans. Most of these plans include prescription drug coverage, so you don’t have to pay an extra premium for Part D. Format: Multiple Choice Title: Test Bank 9.2 Non-Covered Medicare Costs Section: Government-Sponsored Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 54. Chuck’s health insurance requires payment of an annual deductible of $500 per person or $1,000 per family. After meeting the deductible, he must pay 20% of covered charges until he reaches $4,200 out of pocket, after which the insurer will pay 100% of the costs. Chuck has had no other claims during the year. Zoey, his daughter, fell from a playground swing set and requires emergency surgery. The hospital stay costs $20,000. How much will he end up paying out of pocket? A) $3,900 B) $4,000 C) $4,200 D) $4,400 Answer: C Solution: Because all the costs are for one family member, the deductible that applies is the individual deductible of $500. To find the total out-of-pocket cost: Out-of-pocket deductible $ 500 $19,500 costs after the deductible × 0.20 coinsurance $3,900 Total deductible + coinsurance* $4,400 * Total out-of-pocket costs are capped at the $4,200 maximum. Format: Multiple Choice Title: Test Bank 9.2 Total Insurance Out-of-Pocket Cost Calculation Section: Types of Health Insurance Plans Learning Objective: 9.2 Evaluate your health-related costs, and select appropriate health insurance to meet your needs. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes

55. Marnie has recently compiled her required monthly expenses and evaluated all of her sources of nonemployment earnings in the event that she was unable to work for a period of time. She has just completed a(n) A) incomplete financial statement. B) life insurance needs analysis. C) disability income needs analysis. D) emergency fund analysis. Answer: C Solution: The process of disability income needs analysis includes three steps: estimate your income needs, consider existing sources of funds to meet those needs, and determine whether you need any additional disability income protection. Format: Multiple Choice Title: Test Bank 9.3 Planning for Disability Income Section: Planning for Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 56. Which of these is not a source of disability income replacement? A) Life insurance B) Household emergency funds C) Investment portfolio D) Government program benefits Answer: A Solution: Sources of disability income replacement include household emergency fund; employment income from another member of the household; employee paid sick days, personal days, or vacation days; income from investments; group or individual disability insurance; and government program benefits, such as state disability insurance, workers’ compensation, or Social Security. Life insurance is needed for income replacement in case of death. Format: Multiple Choice Title: Test Bank 9.3 Sources of Disability Income Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

57. Which of these is not a disability income insurance source? A) The government B) Employer benefits C) Unemployment insurance D) Private insurance company Answer: C Solution: Disability income insurance replaces lost income during a period of disability and is available from a number of sources including government (Social Security), employer (group benefits), and individual insurance policies sold by insurance companies. Format: Multiple Choice Title: Test Bank 9.3 Disability Insurance Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 58. Jeb McCrown has been injured out on his ranch and will not be able to return to work for a few months. Of the following sources of disability income replacement, which one should be the last source of income he should consider? A) Tax-deferred retirement savings B) Vacation days from his employer C) Investment income D) Household emergency fund Answer: A Solution: Tax-deferred retirement savings should be the last source of income he should consider, because the tax penalties and income taxation will further drain the assets that he will need in retirement. This would essentially be trading a current problem for a future one. Format: Multiple ChoiceTitle: Test Bank 9.3 Sources of Disability Income Replacement Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

59. Short-term disability insurance from employers typically has _______ waiting period and will replace income for _________. A) 7–14 days; 3–6 months B) 7–14 days; 6–12 months C) 15–30 days; 3–6 months D) 15–30 days; 6–12 months Answer: D Solution: Short-term disability (STD) insurance for workers with a qualifying disability pays a portion (commonly 60% or 70%) of your pretax earnings after you’ve exhausted all sick and personal days and you’ve been unable to work for a specified waiting period (commonly 15–30 days). These policies usually replace income for 6–12 months. Format: Multiple Choice Title: Test Bank 9.3 Short-Term Disability Insurance Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 60. The majority of long-term disability insurance plans offered by employers pay benefits A) for 5 years. B) for 5–10 years. C) until 65 years of age. D) for the rest of the policyholder's life. Answer: C Solution: The majority of long-term disability insurance plans offered by employers pay benefits until 65 years of age if the policyholder is permanently disabled. Format: Multiple Choice Title: Test Bank 9.3 Long-Term Disability Insurance Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 61. Long-term disability income insurance is usually a(n) ________ group benefit.

A) optional contributory B) mandatory noncontributory C) optional noncontributory D) mandatory contributory Answer: A Solution: Long-term disability income insurance is usually an optional contributory group benefit. When you purchase disability insurance through your employer, you’re usually given the option of paying for it with either after-tax dollars or pretax dollars. Format: Multiple Choice Title: Test Bank 9.3 Employer-Sponsored Disability Income Protection Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 62. Why is it considered preferable to buy disability insurance on an after-tax basis? A) You are not allowed to purchase disability insurance on a pretax basis. B) If you purchase disability insurance on an after-tax basis and later are disabled, the income benefit you receive while disabled will be tax-free. C) Disability insurance is so inexpensive that a pretax purchase is an administrative burden. D) The tax rate on benefits is less than the tax rate on regular earnings. Answer: B Solution: Although it’s generally preferable to use pretax dollars for other types of benefits, you should buy disability insurance on an after-tax basis. If you pay for the insurance with after-tax income and later are disabled, the income benefit you receive while disabled will be tax-free. In contrast, if you use pretax dollars for the insurance premium, you’ll have to pay tax on the disability income when you receive it. Format: Multiple Choice Title: Test Bank 9.3 Taxation of Disability Insurance Benefits Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Comprehension

AACSB: Reflective Thinking Expected Time to Complete: 1 minute 63. What is a common requirement regarding qualification and waiting periods before one can collect employer-sponsored disability income protection? A) Using all sick days B) Using all personal days C) Using all vacation days D) Using all sick days, personal days, and vacation days Answer: D Solution: Short-term disability insurance pays a portion of your pretax earnings after you’ve exhausted all sick and personal days and you’ve been unable to work for a specified waiting period. Format: Multiple Choice Title: Test Bank 9.3 Qualification and Waiting Periods Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 64. Jeff Jeffers was injured two weeks ago and keeps sending his wife to the mailbox to look for his new disability check. Coming back empty-handed, she finally decided to look through their policy to see where the problem may lie. What feature should she look for and why? A) Benefit duration, which shows how long you have to be disabled before you receive payment B) Waiting period, which shows how long you have to be disabled before you receive payment C) Waiting period, which tells you when the benefits start and stop D) Benefit duration, which tells you when the benefits start and stop Answer: B Solution: Waiting period is how long you have to be disabled before you can begin receiving benefits. This period can be anywhere from 30 days to one year. Format: Multiple Choice Title: Test Bank 9.3 Disability Insurance Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income.

Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 65. Workers’ compensation insurance is a A) federally run health-care program that requires employers to pay workers who incurred an injury or illness as a result of their work. B) state-run program that requires employers to pay lost wages and medical costs associated with job-related illnesses or injuries. C) state-run health-care program that provides health insurance for low-income employees. D) federally run health-care program that provides health insurance for lowincome employees. Answer: B Solution: Workers’ compensation insurance is a state-run program that requires employers to pay lost wages and medical costs associated with job-related illnesses or injuries. Format: Multiple Choice Title: Test Bank 9.3 Workers’ Compensation Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 66. State workers’ compensation laws provide for __________, in addition to payment for medical expenses. A) rehabilitation costs B) lost wages C) lump-sum death benefits D) rehabilitation costs, lost wages, and lump-sum death benefits Answer: D Solution: State workers’ compensation laws provide for rehabilitation costs, lost wages, and lump-sum death benefits, in addition to payment for medical expenses. Format: Multiple Choice Title: Test Bank 9.3 Workers’ Compensation Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income.

Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 67. You will be eligible for workers’ compensation benefits if you are injured A) when employed. B) on the job. C) or fall ill when employed. D) or fall ill on the job. Answer: D Solution: All states have laws that make employers financially responsible for employment-related injuries or illnesses, regardless of fault. If you experience a job-related illness or injury, workers’ compensation insurance will provide for payment of medical expenses, rehabilitation costs, lost wages, and specific lumpsum benefits for death and dismemberment. Format: Multiple Choice Title: Test Bank 9.3 Workers’ Compensation Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 68. Most employers provide workers’ compensation insurance through _________ to cover claims associated with job-related illness or injury. A) private insurance B) state-run programs C) Medicaid D) either private insurers or state-run programs Answer: D Solution: Most employers purchase workers’ compensation insurance, through either private insurers or state-run programs, to cover claims associated with jobrelated illness or injury. Format: Multiple Choice Title: Test Bank 9.3 Workers’ Compensation Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 69. In order to be eligible for Social Security disability coverage, you must be unable to work A) at any job, be out of work at least one year, and expect to remain disabled for at least another year. B) at any job, be out of work at least five months, and expect to remain disabled for at least another year. C) your job, be out of work at least six months, and expect to remain disabled for at least another year. D) your job, be out of work at least one year, and expect to remain disabled for at least another year. Answer: B Solution: To qualify for Social Security disability, you must have been out of work at least five months, expect to remain disabled at least one year, and be unable to work at any job. Format: Multiple Choice Title: Test Bank 9.3 Social Security Disability Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 70. Mateo fell from a chimney while constructing a fireplace. His employer, Fireplaces Unlimited, is fully insured and will provide Mateo $2,900 monthly after five months from his accident. Since he is expected to be immobile for 9 months and another 9 months of physical therapy before he can return to work, he is eligible for Social Security disability for $1,800 a month. How much will Mateo receive in benefits after five months? A) $1,800 B) $2,900 C) $3,700 D) $3,800 Answer: B Solution: Payments from other disability insurance plans are usually reduced by any amounts you receive from Social Security. Hence, Social Security will provide $1,800 a month and his employer’s insurance will provide $1,100 (difference of $2,900 coverage less Social Security disability payment of $1,800). Format: Multiple Choice Title: Test Bank 9.3 Disability Income Benefit Calculation

Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 3 minutes 71. Unlike employer-sponsored disability benefits, Social Security disability benefits stipulate that you must be unable to work A) any job. B) your job. C) part-time. D) full-time. Answer: A Solution: To qualify for Social Security disability, you must have been out of work at least five months, expect to remain disabled at least one year, and be unable to work at any job. Format: Multiple Choice Title: Test Bank 9.3 Social Security Disability Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 72. Justin wants to be sure that his family’s expenses would be covered if he were to become disabled for a period of time. His estimated household expenses for the coming year to be approximately $4,800 per month, and if necessary, he could temporarily cut expenditures for job-related expenses ($50), savings ($725), and other discretionary spending ($700). His wife Monica is a stay-at-home mom, so one alternative would be for her to return to work. However, she might not be able to earn enough to cover the additional child-care expenses. Justin’s salary is $65,000 and his employee benefit plan includes 30 paid leave days, as well as disability insurance that pays 65% of his salary after 90 days. If the family has an emergency fund of $10,000, does he have sufficient disability income protection? A) Yes, $196 surplus after waiting period B) Yes, $2,092 surplus after waiting period C) No, $1,279 deficit after waiting period D) No, $504 deficit after waiting period

Answer: A Solution: Justin and Monica’s minimum monthly household expenses are $3,325 ($4,800 household expenses less $50 job-related expenses, $725 budgeted savings, and $700 discretionary spending). They have a $10,000 emergency fund to cover the 2 months of required expenses in the waiting period of $6,650 ($3,325 × 3 months less 1 month in paid leave). Their disability insurance payments are 65% of $5,416.67 monthly salary: $3,520.83. Their monthly cash flow will be $3,520.83 − $3,325 = $196 surplus. Format: Multiple Choice Title: Test Bank 9.3 Disability Income Protection Calculation Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 73. Bill Patterson was injured at work and needs some money while he is out of work. Which disability income should he be receiving? A) Long-term disability B) Short-term disability C) Workers’ compensation D) Social Security disability Answer: C Solution: Workers’ compensation is responsible for employment-related injuries or illnesses, regardless of fault. Workers’ compensation insurance provides for payment of medical expenses, rehabilitation costs, lost wages, and specific lumpsum benefits for death and dismemberment. Format: Multiple Choice Title: Test Bank 9.3 Sources of Disability Income Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 74. Gertrude broke her hand snowboarding over the weekend with her friends in Aspen. Her boss at 10-Key Accounting said there is no work for her that does not require the use of Gertrude’s broken hand. What type of disability insurance could Gertrude collect?

A) Short-term disability B) Long-term disability C) Workers’ compensation D) Social Security disability Answer: A Solution: Workers’ compensation is responsible for employment-related injuries and Gertrude broke her hand snowboarding. While she may not be able to work at her current employer with a broken hand, she does not qualify for Social Security disability insurance that requires inability to do any work. She will have to claim short-term disability for her inability to do her current work through her employer’s group disability policy. Format: Multiple Choice Title: Test Bank 9.3 Sources of Disability Income Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 75. Under a tax-qualified retirement plan, taxes on _______________ are deferred until withdrawal at retirement. A) contributions B) earnings from plan assets C) benefit accruals D) contributions, earnings from plan assets, and benefit accruals Answer: D Solution: Under a tax-qualified retirement plan, taxes on contributions, earnings from plan assets, and benefit accruals are deferred until withdrawal at retirement. Format: Multiple Choice Title: Test Bank 9.4 Tax Advantages of Qualified Plans Section: Tax Advantages of Qualified Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 76. When a retirement plan is tax-qualified, A) earnings on plan assets are subject to a lower federal income tax rate.

B) federal income taxes on contributions made to the plan and earnings on plan assets are not assessed until withdrawal at retirement. C) contributions made to the plan and earnings on plan assets are exempt from federal income taxation. D) earnings on plan assets are subject to additional federal income taxes, including a higher tax rate. Answer: B Solution: When a retirement plan is tax-qualified, federal income taxes on contributions made to the plan and earnings on plan assets are not assessed until withdrawal at retirement. Format: Multiple Choice Title: Test Bank 9.4 Tax Advantages of Qualified Plans Section: Tax Advantages of Qualified Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 77. If you withdraw money from a tax-qualified plan before age 59½, you will have to pay A) federal income tax on the amount withdrawn. B) state income tax on the amount withdrawn. C) a 10 percent penalty on the amount withdrawn. D) All of the above. Answer: D Solution: If you withdraw money from a tax-qualified plan before age 59½, you will have to pay federal and state income tax on the amount withdrawn and a 10 percent penalty. Tax-qualified accounts can start normal distributions after the account owner turns 59½ years old. Format: Multiple Choice Title: Test Bank 9.4 Tax Advantages of Qualified Plans Section: Tax Advantages of Qualified Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 78. In a defined-benefit retirement plan, the employer promises to

A) pay employees a set retirement benefit when they retire based on how much the employee has contributed. B) pay employees a retirement benefit determined by a formula that is typically based on preretirement income and number of years worked. C) pay a certain amount of money into their retirement account each year based on a percentage of their salary. D) allow employees to contribute money to their retirement account out of their current earnings on a tax-deferred basis. Answer: B Solution: In a defined-benefit (DB) plan, sometimes called a pension plan, the company promises that it will pay you a benefit in retirement determined by a particular formula. DB formulas usually are based on the salary you’re making when you retire and the number of years you’ve worked for the firm (commonly called “years of service”). Format: Multiple Choice Title: Test Bank 9.4 Defined-Benefit (DB) plan Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 79. In a defined-contribution retirement plan, the employer promises to pay A) employees a set retirement benefit when they retire. B) employees a retirement benefit determined by a formula that is typically based on preretirement income and number of years worked. C) a certain amount of money or percentage of an employee’s salary into his or her retirement account each year. D) None of the above. Answer: C Solution: Under a defined-contribution (DC) plan, the employer promises to make periodic contributions to your retirement account but makes no promise about the benefit that might result from these contributions. The contribution made by the employer is determined by a formula, often a percentage of salary, such as 3 percent. Format: Multiple Choice Title: Test Bank 9.4 Defined-Contribution (DC) plan Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. XYZ Corp is looking into providing a retirement plan for their employees. They would prefer a plan wherein they (the employer) make a benefit promise, and the actual benefit depends on the performance of an investment account kept on behalf of the plan participant. Which type of retirement plan should they purchase? A) Cash-balance plan B) Defined-benefit plan C) Defined-contribution plan D) Pension plan Answer: A Solution: In a cash-balance plan, the employer makes a benefit promise (as in a DB plan), but the actual benefit depends, in part, on the performance of an investment account kept on behalf of the plan participant (as in a DC plan). This type of plan places some of the investment risk on the employee. Format: Multiple Choice Title: Test Bank 9.4 Defined-Benefit Versus Defined-Contribution Plans Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 81. Ryan puts $10,000 in pretax income in a tax-deferred retirement savings account earning 8% per year. After 40 years, how much more will the investment have grown as compared to investing $10,000 in a taxable account, assuming his marginal tax rate is 25%? A) $54,311.30 B) $102,857.18 C) $114,388.04 D) $162,933.91 Answer: C Solution: Calculate the future value of $10,000 over 40 years at an 8% APY, and compare it to earning 6% APY (after paying 25% tax). Financial Calculator: Enter PV = −10,000, N = 40, I/Y = 8, and solve for FV = $217,245.22

Enter PV = −10,000, N = 40, I/Y = 6, and solve for FV = $102,857.18 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) =FV(0.08, 40, 0, −10000, 0) => $217,245.21 =FV(0.06, 40, 0, −10000,0) => $102,857.18 TVM Equation: FV = PV × (1 + 𝑖)𝑛 FV = $10,000 × (1 + 0.08)40 = $217,245.22 FV = $10,000 × (1 + 0.06)40 = $102,857.18 DIFFERENCE IN ACCOUNTS: $217,245.22 tax-deferred account − $102,857.18 taxable account = $114,388.04 Format: Multiple Choice Title: Test Bank 9.4 Growth of Tax-Deferred Versus Taxable Account Calculation Section: Tax Advantages of Qualified Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 82. A government agency pays their agents’ retirement at 4% of final salary per year of service. Mr. Smith has worked for the agency for 17 years, with a beginning salary of $100,000 and an ending salary of $200,000. At retirement, how much should Mr. Smith expect to receive from the agency? A) $68,000 B) $102,000 C) $136,000 D) $200,000 Answer: C Solution: Credit per year of service = $200,000 final salary × 0.04 = $8,000 $8,000 credit per year × 17 years of service = $136,000 Format: Multiple Choice Title: Test Bank 9.4 Defined-Benefit (DB) Plan Retirement Benefit Calculation Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Hard Bloomcode: Analysis

AACSB: Analytic Expected Time to Complete: 1 minute 83. A defined-contribution plan is a A) plan where the employer promises a benefit upon retirement. B) plan where there is a specific contribution made regardless of salary. C) plan where the employer makes periodic contributions but makes no promise about what benefit might result from these contributions.bonus plan to be received in retirement. Answer: C Solution: Under a defined-contribution (DC) plan, the employer promises to make periodic contributions to your retirement account but makes no promise about the benefit that might result from these contributions. The contribution made by the employer is determined by a formula, often a percentage of salary, such as 3 percent. Format: Multiple Choice Title: Test Bank 9.4 Defined-Contribution (DC) plan Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 84. The proportion of workers participating in __________ plans has been declining, while the proportion participating in __________ plans has been increasing. A) defined-benefit (DB); defined-contribution (DC) B) defined-contribution (DC); defined-benefit (DB) C) no; defined-benefit (DB) D) defined-contribution (DC); no Answer: A Solution: The proportion of workers participating in defined-benefit (DB) plans has been declining, while the proportion participating in defined-contribution (DC) plans has been increasing. Format: Multiple Choice Title: Test Bank 9.4 Defined-Benefit Versus Defined-Contribution Plans Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Easy Bloomcode: Knowledge

AACSB: Analytic Expected Time to Complete: 1 minute 85. IRS rules for tax-qualified plans set a minimum normal retirement age at A) 50. B) 59½. C) 65. D) 70½. Answer: B Solution: IRS rules for tax-qualified plans set a minimum normal retirement age at 59½. In most cases, if you take a disbursement from a retirement plan before age 59½, you’ll have to pay a 10 percent penalty to the IRS in addition to any income taxes owed. Format: Multiple Choice Title: Test Bank 9.4 Retirement Age Section: Features of Defined-Benefit Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 86. The rules that define the number of years of employment required before employees have legal rights to accrued retirement plan contributions and benefits are known as A) portability rules. B) guaranteed benefits. C) vesting rules. defined-contribution rules. Answer: C Solution: Pension plans have vesting rules that determine the number of years of employment required before an employee will have a legal right to accrued retirement benefits. Employees who are fired or leave their jobs without being vested have no right to contributions already made on their behalf and will not receive any retirement benefit from the employer. Format: Multiple Choice Title: Test Bank 9.4 Features of Defined-Benefit Plans Section: Features of Defined-Benefit Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic

Expected Time to Complete: 1 minute 87. Which of the following types of retirement plans require the employer to contribute a set percentage of salary to the plan regardless of profitability of the company? A) Money-purchase plan B) Cash-balance plan C) Profit-sharing plan D) Cash-or-deferred arrangement Answer: A Solution: In a money-purchase plan, the employer promises to contribute a set percentage of salary. For example, your employer might promise to add 3 percent of your salary to a retirement account each year. In a profit-sharing plan, the employer’s contributions are discretionary but are often a percentage of either profits or salary. In a cash-balance plan, the employer makes a benefit promise (as in a DB plan), but the actual benefit depends, in part, on the performance of an investment account kept on behalf of the plan participant (as in a DC plan). Format: Multiple Choice Title: Test Bank 9.4 Features of Defined-Contribution Plans Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 88. Which plan places the greatest amount of risk on the participant? A) Cash-balance plan B) Defined-benefit plan C) Defined-contribution plan D) Pension plan Answer: C Solution: Defined-contribution plans place the greatest risk on employees compared to cash-balance and defined-benefit plans, because the participant must direct their own investments that include stock funds. Format: Multiple Choice Title: Test Bank 9.4 Who Makes the Investment Decisions Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 89. If Blake Thompson were to take his retirement plan from his old employer and invest it in the plan of his new employer, what feature of a defined-benefit plan is he exercising? A) Portability B) Vesting C) Guaranteed benefit D) Cash-or-deferred arrangement Answer: A Solution: Portability refers to the ability to take plan assets from one employer to another. Format: Multiple Choice Title: Test Bank 9.4 Features of Defined-Benefit Plans Section: Features of Defined-Benefit Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 90. In a profit-sharing retirement plan, the A) employer’s contributions are a fixed percentage of the employee’s salary. B) employee’s and employer’s contributions are a fixed percentage of the employee’s salary. C) employee’s contributions are discretionary and the employer’s contributions are a fixed percentage of the employee’s salary. D) employer’s contributions are discretionary and may depend on the company’s financial performance for the year. Answer: D Solution: In a profit-sharing plan, the employer’s contributions are discretionary but are often a percentage of either profits or salary. The employer may pay 3 percent per year into your account, but if profits are down, management can choose to not make a contribution at all. Format: Multiple Choice Title: Test Bank 9.4 Profit-Sharing Plan Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 91. The most common defined-contribution plan for businesses is the A) 401(k). B) 403(b). C) SEP. D) profit-sharing plan. Answer: A Solution: The 401(k) plan, named for the section in the IRS code that outlines the rules for cash-or-deferred arrangements (CODAs), is by far the best-known type of defined-contribution plan. A 401(k) might be purely a salary deferral plan, with no employer contribution or the employer may provide a matching contribution to encourage employee participation. Format: Multiple Choice Title: Test Bank 9.4 Cash-or-Deferred Arrangement (CODA) Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 92. Plenius Jackson owns an engineering firm with 14 employees, and he is evaluating retirement plans for his professional staff. Which of the following retirement plans should he not be considering? A) 403(b) B) SEP C) SIMPLE D) Keogh Answer: A Solution: A 403(b) plan, another type of cash-or-deferred arrangement (CODA), sometimes called a tax-sheltered annuity (TSA) plan, is similar to a 401(k) plan but is sponsored by a nonprofit organization such as a government entity or religious group. Format: Multiple Choice Title: Test Bank 9.4 Cash-or-Deferred Arrangement (CODA)

Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 93. Which of the following is not an example of a defined-contribution retirement plan? A) Money-purchase plans B) 403(b) plans C) 401(k) plans D) Pension plans Answer: D Solution: Defined-contribution retirement plans include money-purchase plans and profit-sharing plans that only employers can contribute. In a cash-or-deferred arrangement (CODA), in addition to your employer’s money-purchase or profitsharing contribution, you can make tax-deferred contributions to the account out of your pretax income. 401(k) plans are CODAs sponsored by companies, and 403(b) plans are sponsored by nonprofit organizations, such as a government entity or religious group. Format: Multiple Choice Title: Test Bank 9.4 Defined-Contribution Plans Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 94. Which of the following statements is true about the trends in employment-based retirement plans? A) Most employees prefer defined-contribution plans. B) Over the past 20 years, the number of defined-benefit plans has stayed about the same. C) Most people who have retirement plans at work are in defined-contribution plans. D) Employers have been shifting to defined-benefit plans in order to reduce their compensation costs. Answer: C

Solution: The proportion of workers participating in defined-benefit (DB) plans has been declining, while the proportion participating in defined-contribution (DC) plans has been increasing. The types of plans being offered by employers are increasingly of the DC type, and the 401(k) plan is by far the best-known type of DC plan. Format: Multiple Choice Title: Test Bank 9.4 Trends in Employment-Based Retirement Plans Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 95. Which of the following groups of workers is least likely to be getting contributions from their employer toward a retirement plan? A) Unionized workers B) Part-time and low-wage workers C) Full-time workers D) High-income workers Answer: B Solution: Since all employer-sponsored retirement plans, whether defined-benefit or defined-contribution, base the benefit on compensation, part-time and lowwage workers will receive the lowest share of contributions. Format: Multiple Choice Title: Test Bank 9.4 Employer-Sponsored Retirement Plans Section: Employer-Sponsored Retirement Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 96. If you have income from self-employment, you can make tax-deferred contributions to an HR-10 plan, commonly called a A) Keogh plan. B) SEP plan. C) 403(b) plan. D) 401(k) plan. Answer: A

Solution: If you have income from self-employment, you can make tax-deferred contributions to a Keogh plan, also known as an HR-10 plan, even if you’re participating in a qualified plan through your primary employer. Keogh plans can be set up to cover partners and employees as well. Format: Multiple Choice Title: Test Bank 9.4 Retirement Plans for Small Businesses Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 97. __________ combine features of both defined-contribution and defined-benefit plans. A) Simplified Employee Pension (SEP) plans B) Cash-balance plans C) Profit-sharing plans D) Employee stock ownership plans (ESOPs) Answer: B Solution: A cash-balance plan combines the features of both defined-contribution and defined-benefit plans. The employer makes a benefit promise (as in a DB plan), but the actual benefit depends, in part, on the performance of an investment account kept on behalf of the plan participant (as in a DC plan). This type of plan places some of the investment risk on the employee. Format: Multiple Choice Title: Test Bank 9.4 Defined-Benefit Versus Defined-Contribution Plans Section: Defined-Benefit Versus Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 98. Which of the following is not a retirement plan for self-employed individuals and small business owners? A) SEP B) ESOP C) SIMPLE D) Keogh

Answer: B Solution: Retirement plans that are specifically intended to meet the needs of self-employed individuals and small business owners are Simplified Employee Pension (SEP) plan, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE), and the Keogh plan. An employee stock ownership plan (ESOP) is typically used by a public corporation that has stock outstanding. Format: Multiple Choice Title: Test Bank 9.4 Retirement Plans for Small Businesses Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 99. Which retirement plan for small businesses allow for employee salary deferrals? A) SEP plan B) SIMPLE plan C) Keogh plan D) Cash-balance plan Answer: B Solution: SIMPLE plans allow employees at small businesses (up to 100 employees) to contribute to a retirement account through payroll deductions, with or without employer matches. Simplified Employee Pension (SEP) plan and the Keogh plan are employer contributory self-employed retirement plans. Cashbalance plan is also an employer contributory plan. Format: Multiple Choice Title: Test Bank 9.4 Retirement Plans for Small Businesses Section: Features of Defined-Contribution Plans Learning Objective: 9.4 Explain the benefits of participating in employersponsored retirement plans. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic 100. Zane Blackstone, a famous lead guitarist for a rock band, is very worried about the possibility of his new skydiving hobby leaving him unable to perform. Which type of insurance should he consider purchasing? A) Own occupation disability income insurance B) Short-term disability insurance C) Long-term disability insurance D) Workers’ compensation

Answer: A Solution: Although there are many variations on individual disability insurance policies, the best types are those that replace lost income if you’re unable to perform the duties of your particular job, often called own occupation insurance. Zane, a musician who has a hand injury, could receive replacement income even if he or she could still work in another profession. Format: Multiple Choice Title: Test Bank 9.3 Individual Disability Insurance Section: Sources of Disability Income Learning Objective: 9.3 Analyze your disability income needs, and identify sources of disability income. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

Chapter 10 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 98 multiple choice questions

15 Q# 10 15 16 17 18 20 21 23 24 25 34 40 41 65 81

LO 10.1 LO 10.2 LO10.3 LO 10.4

28 27 20 23

29% 28% 20% 23%

Total

100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

21 31 28 13 1 4 98

21% 32% 29% 13% 1% 4% 100%

Easy Medium Hard

22 71 5 98

21% 73% 5% 100%

Calculations Test Bank Question

10.1 Replacement Ratio Method Calculation 10.1 Adjusting for Inflation Calculation 10.1 Retirement Expense Adjusted for Inflation Calculation (Replacement Method) 10.1 Adjusting for Inflation Calculation 10.1 Adjusting for Income Tax Calculation 10.1 Expected Income and Income Shortfall Calculation 10.1 Inflation-adjusted Annuity Calculation 10.1 Inflation-adjusted Annuity Calculation (shortfall) 10.1 Adjusted Expense Method Calculation 10.1 Retirement Income Shortfall Calculation (Adjusted Expense Method) 10.2 Pension Benefit Calculation 10.2 PIA Calculation 10.2 Spousal Benefits Calculation 10.3 Premature Distribution Calculation 10.4 Future Cost of College Calculation

1. Which of the following is the first step of the seven basic steps to estimate how much you need to save to achieve your retirement goals? A) Estimating retirement expenses B) Estimating income from Social Security C) Calculating income shortfall for first year of retirement D) Estimating monthly savings required to meet savings goal Answer: A Solution: Retirement planning process begins with evaluating and estimating retirement expenses and then estimating additional savings needed to achieve those retirement funding goals, which would involve estimating all sources of potential retirement income. Format: Multiple Choice Title: Test Bank 10.1 Retirement and Education Planning Process Section: Developing a Retirement Plan Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 2. As with other types of financial planning, the last step in retirement and education planning is to A) monitor your progress and revise your plan as needed. B) implement your retirement and education plan. C) decide on the best retirement and education plan. D) identify your retirement and education needs. Answer: A Solution: As with other types of financial planning, the last step in retirement and education planning is to monitor your progress and revise your plan as needed. Format: Multiple Choice Title: Test Bank 10.1 Retirement and Education Planning Process Section: Developing a Retirement Plan Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 3. When developing your retirement plan, after you have estimated the additional savings needed to achieve your funding goals, what should you do next?

A) Find tax-efficient strategies for savings. B) Implement the funding and savings plan. C) Evaluate your progress and revise if needed. D) Find any discounts offered by different plans and agencies. Answer: A Solution: When developing your retirement and education plan, after you have estimated the additional savings needed to achieve your funding goals, you should identify the best tax-efficient strategies for retirement and education savings. Format: Multiple Choice Title: Test Bank 10.1 Retirement and Education Planning Process Section: Developing a Retirement Plan Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 4. When developing a plan for retirement and/or education savings and funding, you should always reevaluate your needs A) after every step of the planning process. B) on a regular basis. C) when emergencies develop. D) when you graduate college. Answer: B Solution: When developing a plan for retirement and/or education savings and funding, you should always reevaluate your needs on a regular basis. Format: Multiple Choice Title: Test Bank 10.1 Retirement and Education Planning Process Section: Developing a Retirement Plan Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 5. Retirement needs tend to be A. the same for everyone. B. based on an individual’s Social Security benefits. C. based on age. D. different for everyone.

Answer: DSolution: One person’s ideal retirement isn’t the same as another’s; everyone’s retirement needs are different. If you want to retire young enough (and wealthy enough) to travel to exotic places around the world, you’ll need to sacrifice some current spending to achieve your retirement goals. But if you’ll be content with having a lower standard of living in retirement, you won’t have to save as much to accomplish your retirement goals. Format: Multiple Choice Title: Test Bank 10.1 What Are Your Retirement Goals? Section: What Are Your Retirement Goals? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 6. The younger you retire, the __________ your retirement period and the __________ time you have to accumulate wealth. A) shorter; longer B) longer; shorter C) shorter; shorter D) longer; longer Answer: B Solution: The younger you retire, the longer your retirement period and the shorter time you have to accumulate wealth. Format: Multiple Choice Title: Test Bank 10.1 What Are Your Retirement Goals? Section: What Are Your Retirement Goals? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 7. The most common retirement age is __. A. 59 B. 60 C. 65 D. 67 Answer: C Solution: Although the average age of retirement has declined slightly over time. Particularly for men, the most common retirement age is still 65, the age of eligibility for Medicare.

Format: Multiple Choice Title: Test Bank 10.1 What Are Your Retirement Goals? Section: What Are Your Retirement Goals? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 8. Which is not one of the steps in estimating how much you need to save to achieve your retirement goals? A) Estimating expected inheritance B) Estimating expected income from employer defined-benefit pension plan(s) C) Using time value of money calculations to estimate the total retirement wealth you’ll need to have saved by the time you retire to cover your income shortfall D) Estimating the present value of any current retirement savings you have accumulated Answer: A Solution: Step 6 in the basic steps in estimating how much you’ll need to save for retirement is to estimate the future value of any current retirement savings you have accumulated and subtract that amount from total wealth needed to determine how much additional wealth you need to accumulate. Format: Multiple Choice Title: Test Bank 10.1 How Much Will You Need to Save for Retirement? Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 9. The replacement ratio method for estimating retirement expenses assumes retirement expenses will often be _____ percent of preretirement expenses. A. 50 to 60 B. 60 to 70 C. 70 to 80 D. 80 to 90 Answer: C Solution: The replacement ratio method assumes that your retirement expenses will be some fixed proportion of your preretirement expenses, often 70 to 80 percent.

Format: Multiple Choice Title: Test Bank 10.1Replacement Ratio Method Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 10. Joe’s expenses are about $3,500 per month. Use the replacement ratio method to estimate his annual retirement expenses. A) $10,000 to $12,000 B) $21,000 to $25,200 C) $29,400 to $33,600 D) $42,000 to $46,200 Answer: C Solution: The replacement ratio method assumes that your retirement expenses will be some fixed proportion of your preretirement expenses, often 70–80%. Monthly expenses of $3,500 or $42,000 a year ($3,500 × 12 months) would mean that your expenses after retirement will be $29,400 ($42,000 × 70%) to $33,600 ($42,000 × 80%) in today’s dollars. Format: Multiple Choice Title: Test Bank 10.1 Replacement Ratio Method Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 11. The replacement ratio method is considered ________ method than the adjusted expense method, when estimating retirement income needs. A. a more accurate B. a less accurate C. a more uncommon D. a more complex Answer: B Solution: The replacement ratio method assumes that your retirement expenses will be some fixed proportion of your preretirement expenses, often 70 to 80 percent. Although this simplified method is commonly used, it’s less accurate than the adjusted expense method and your expenses may actually be lower or higher in retirement.

Format: Multiple Choice Title: Test Bank 10.1 Estimating Retirement Expenses Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 12. Of the methods commonly used for estimating retirement expenses, the _________ method takes more time to forecast but results in a more accurate forecast. A) adjusted expense B) replacement ratio C) defined-benefit D) inflation-adjusted Answer: A Solution: The adjusted expense method for estimating retirement expenses will take a little more time but will result in a more accurate forecast. Here, you take your current expenses by category and adjust each one based on your estimates of changes that will occur in retirement. Format: Multiple Choice Title: Test Bank 10.1 Estimating Retirement Expenses Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 13. Which is a common reason that most people retire at age 65? A. Minimum age for Social Security B. Minimum age for Medicare C. Minimum age for Medicaid D. Minimum age for Social Security and Medicaid Answer: B Solution: Although the average age of retirement has declined slightly over time, particularly for men, the most common retirement age is still 65, the age of eligibility for Medicare. The minimum Social Security retirement age is 62. Format: Multiple Choice Title: Test Bank 10.1 What Are Your Retirement Goals?

Section: What Are Your Retirement Goals? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 14. The adjusted expense method is used to estimate A) pretax retirement income needs in future dollars by adjusting current expenses for changes expected in retirement. B) after-tax retirement income needs in future dollars by adjusting current expenses for changes expected in retirement. C) after-tax retirement income needs in current dollars by adjusting current expenses for changes expected in retirement. D) after-tax retirement income needs in current dollars by multiplying current expenses by a factor of 70 to 80 percent. Answer: C Solution: The adjusted expense method is used to estimate after-tax retirement income needs in current dollars by adjusting current expenses for changes expected in retirement. Format: Multiple Choice Title: Test Bank 10.1 Adjusted Expense Method Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 15. If you expect to retire in 25 years and have estimated that you will need $45,000 per year in today’s dollars, how much will you need in the first year of retirement assuming a 5% average inflation rate? A) $152,386 B) $154,670 C) $155,853 D) $156,658 Answer: A Solution: Once you’ve estimated your expenses in current dollars, you need to adjust this amount for expected inflation between now and retirement to

determine your expenses for the first year of retirement. To do this, you’ll use the time value of money formula to calculate the future value of a lump sum: Financial Calculator: Enter PV = −45,000, N = 25, I/Y = 5, and solve for FV = $152,386 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) => =FV(0.05, 25, 0, −45000, 0) => $152,386 TVM Equation: FV = PV × (1+i)n = $45,000 × (1+0.05)25 = $152,386

Format: Multiple Choice Title: Test Bank 10.1 Adjusting for Inflation Calculation Section: Estimating Retirement Expenses Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes

16. If your current expenses are $55,000 a year today, using the replacement ratio method of estimating retirement expenses, what is the minimum income you would need 40 years from now, assuming inflation is 2.5%? A) $103,375 B) $118,143 C) $132,911 D) $147,679 Answer: A Solution: The replacement ratio method assumes that your retirement expenses will be some fixed proportion of your preretirement expenses, 70 to 80 percent. Thus, the minimal expense would be $38,500 ($55,000 × 70%). Then you need to adjust this amount for expected inflation between now and retirement to determine your expenses for the first year of retirement. To do this, you’ll use thetime value of money formula to calculate the future value of a lump sum: Financial Calculator: Enter PV = −38,500, N = 40, I/Y = 2.5, and solve for FV = $103,375 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) => =FV(0.025, 40, 0, −38500, 0) => $103,375

TVM Equation: FV = PV × (1+i)n = $38,500 × (1+0.025)40 = $103,375 Format: Multiple Choice Title: Test Bank 10.1 Retirement Expense Adjusted for Inflation Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 17. Janet Arbuckle has decided that she only needs $30,000 per year to live a comfortable life in today’s dollars. In talking to her financial advisor, she forecasts 3% inflation in the long run. Janet wants to retire 20 years from now, and she has calculated her first-year retirement needs will be about $72,000 in future dollars. Is she correct? Why? A) Yes, adjusting for inflation, $30,000 will be worth approximately $72,000 in 20 years. B) No, adjusting for inflation, $30,000 will be worth approximately $39,000 in 20 years. C) No, adjusting for inflation, $30,000 will be worth approximately $31,800 in 20 years D) No, adjusting for inflation, $30,000 will be worth approximately $54,000 in 20 years. Answer: D Solution: Once you’ve estimated your expenses in current dollars, you need to adjust this amount for expected inflation between now and retirement to determine your expenses for the first year of retirement. To do this, you’ll use the time value of money formula to calculate the future value of a lump sum: Financial Calculator: Enter PV = −30,000, N = 20, I/Y = 3, and solve for FV = $54,183 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) => =FV(0.03, 20, 0, −30000, 0) => $54,183 TVM Equation: FV = PV × (1+i)n = $30,000 × (1+0.03)20 = $54,183

Format: Multiple Choice Title: Test Bank 10.1 Adjusting for Inflation Calculation

Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 18. Carlos has estimated that he will need about $145,650 in the first year of retirement (adjusted for inflation), but his wife is worried about being taxed on this income. Assuming they will pay 28% average tax rate, how much do they need to generate in pretax income for their first year’s expenses? A) $202,292 B) $186,432 C) $104,868 D) $113,789 Answer: A Aftertax income $145,650 Solution: Pretax income = 1−Average tax rate = 1−0.28 = $202,292 Format: Multiple Choice Title: Test Bank 10.1 Adjusting for Income Tax Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 19. In order to estimate your retirement income shortfall in the first year of retirement, you need to subtract your expected employer pension plan income from your before-tax income needs in your first year of retirement and then ________ the expected Social Security benefits. A) subtract B) add C) multiply D) divide Answer: A Solution: Once you have estimated your Social Security and DB plan benefits, you can subtract the total estimated benefits from your before-tax retirement income needed to arrive at the retirement income shortfall, as follows: Before-tax income needed in first year of retirement Minus: Expected income from employer DB plans

Minus: Expected Social Security benefits . Equals: Retirement income shortfall in first year of retirement Format: Multiple Choice Title: Test Bank 10.1 Estimating Expected Income and Income Shortfall Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 20. Gloria has calculated that she needs $50,000 her first year of retirement to maintain her standard of living. She expects to receive $1,000 per month from her employer defined-benefit pension and $1,500 per month from Social Security. What is her annual retirement income shortfall? A) $15,000 B) $20,000 C) $32,000 D) $50,000 Answer: B Solution: Once you have estimated your Social Security and DB plan benefits, you can subtract the total estimated benefits from your before-tax retirement income needed to arrive at the retirement income shortfall, as follows: Before-tax income needed in first year of retirement $50,000 Minus: Expected annual income from employer DB plans ($12,000) Minus: Expected annual Social Security benefits ($18,000) Retirement income shortfall in first year of retirement $20,000 Format: Multiple Choice Title: Test Bank 10.1 Expected Income and Income Shortfall Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 21. You expect your expenses in the first year of retirement to be $70,000. Your return on investment is 7%. Assuming you are willing to spend down both principal and interest, how much retirement wealth will you need to have accumulated by the time you retire to be able to pay for 20 years of retirement

expenses that increase at an average rate of 4%? (Select the closest answer.) A) $500,000 B) $750,000 C) $1,000,000 D) $1,250,000 Answer: C Solution: If you plan to use both the interest earnings and the principal to fund your income needs but will fully deplete your assets by the end of the period, you should calculate the present value of an inflation-adjusted annuity using: First year income 1+𝑖 𝑛 ) ] PV inflation adjusted annuity = × [1 − ( 𝑟−𝑖 1+𝑟 $70,000 1 + 0.04 20 ) ] = $1,012,135 PV inflation adjusted annuity = × [1 − ( 0.07 − 0.04 1 + 0.07 *Rate of return = r and inflation rate = i Format: Multiple Choice Title: Test Bank 10.1 Inflation-adjusted Annuity Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 22. Assume that you have estimated your retirement wealth needed to be $1,000,000, based on a 7 percent investment return, 4 percent inflation during retirement, and 20 years of retirement. If inflation turns out to average less than 4 percent per year during retirement, what will be the effect on your retirement wealth needed? A) You will need less than estimated. B) You will need more than estimated C) You will need the same amount as estimated. D) There is not enough information to answer the question. Answer: A Solution: If inflation turns out to average less than 4 percent per year during retirement, then your real rate of return will be greater than anticipated and you will have more wealth than expected. Thus, you will need less than estimated. Format: Multiple Choice Title: Test Bank 10.1 Estimating Retirement Wealth Needed

Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 23. Assume that your retirement income shortfall is $10,000 per year, increasing at 4% per year. You expect to live 30 years in retirement and earn an average rate of return of 6% on your investments. If you plan to use both principal and interest to fund your income needs, your savings goal would be closest to (select the closest answer) A) $10,000. B) $200,000. C) $500,000. D) $2,000,000. Answer: B Solution: If you plan to use both the interest earnings and the principal to fund your income needs but will fully deplete your assets by the end of the period, you should calculate the present value of an inflation-adjusted annuity using: PV inflation adjusted annuity =

First year income shortfall 1+𝑖 𝑛 ) ] × [1 − ( 𝑟−𝑖 1+𝑟

PV inflation adjusted annuity =

$10,000 1 + 0.04 30 ) ] = $217,646 × [1 − ( 0.06 − 0.04 1 + 0.06

*Rate of return = r, and inflation rate = i Format: Multiple Choice Title: Test Bank 10.1 Inflation-Adjusted Annuity Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 24. Lucas plans to retire in 15 years. His current household expenses are $75,000 per year. He estimates that when he retires, he will no longer have $3,600 in monthly mortgage payments, $5,000 in annual commuting expenses, and $12,000 in annual budgeted 401(k) contributions. However, he does expect that his health-care costs will rise by $3,700 per year and his entertainment expenses

to total $8,000 each year. What will be his estimated retirement expenses, in today’s dollars, if using the adjusted expense method? A. $18,550 B. $26,500 C. $52,500 D. $60,000 Answer: B Solution: The adjusted expense method for estimating retirement expenses Current household expenses

75,000

Decrease at retirement 1 Mortgage payments Commuting costs 401(k) savings

$ $ $

43,200 5,000 12,000

Increase at retirement Health-care expenses Entertainment

$ $

3,700 8,000

TOTAL

26,500

Note: $3,600 mortgage payment × 12 months

Format: Multiple Choice Title: Test Bank 10.1 Adjusted Expense Method Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 25. Carlos plans to retire next year. His current household expenses are $85,000 per year. He estimates that when he retires, he will no longer have $3,600 in monthly mortgage payments, $5,000 in annual commuting expenses, and $12,000 in budgeted 401(k) contributions. However, he does expect that his health-care costs will rise by $12,000 and his entertainment expenses to total $38,000 each year. He expects to receive $65,000 annually from his 401(k) and $28,800 in annual Social Security benefits. If he pays an average tax rate of 24%, what will be his estimated retirement income shortfall, if using the adjusted expense method? A. $3,288 income surplus

B. $19,000 income surplus C. $3,512 income shortfall

D. $3,288 income shortfall Answer: C Solution: The adjusted expense method for estimating retirement expenses Current household expenses Decrease at retirement 1 Mortgage Commuting 401(k)

85,000

$ $ $

43,200 5,000 12,000

Increase at retirement Health care Entertainment Total estimated retirement expenses

$ $ $

12,000 38,000 74,800

Estimated retirement income 2 Net 401(k) income 2 Net Social Security income

$ $

49,400 21,888

1 2

Note: $3,600 mortgage payment × 12 months Note: Income × (1 − 0.24 tax rate)

Estimating expected income and income shortfall Income needed in first year of retirement Minus: Expected annual net income from 401(k) plan Minus: Expected annual net Social Security benefit Retirement income shortfall in first year of retirement

$ $ $

74,800 (49,400) (21,888)

3,512

Format: Multiple Choice Title: Test Bank 10.1 Retirement Income Shortfall Calculation Section: How Much Will You Need to Save for Retirement? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 4 minutes

26. The term used by economists to describe the tendency of people to overemphasize short-term goals and outcomes is called A) myopia. B) short ethos. C) average focus. D) avoidance. Answer: A Solution: Myopia, or nearsightedness, is the term used by economists to describe the tendency of people to overemphasize short-term goals and outcomes. Format: Multiple Choice Title: Test Bank 10.1 Why Do So Many People Avoid Retirement Planning? Section: Why Do So Many People Avoid Retirement Planning? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 27. If Jack Miller were to underestimate the effects of inflation on his retirement income, his standard of living in retirement could consistently__________ as he gets older. A) increase B) decline C) stay the same D) improve Answer: B Solution: Most people don’t understand inflation. As a result, they underestimate how much more savings it will take to generate inflation-adjusted income in retirement. If you only save enough to produce a constant income, your standard of living in retirement will consistently decline as you get older. Format: Multiple Choice Title: Test Bank 10.1 Ignoring Inflation Section: Why Do So Many People Avoid Retirement Planning? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 28. Life expectancy charts suggest that a 50-year-old woman will live to be 83 years old. If a 50-year woman uses this information to plan for her retirement, she is guilty of

A) myopia. B) ignoring inflation. C) focusing on averages. D) being overly optimistic. Answer: C Solution: People tend to focus on averages rather than looking at the full range of possible outcomes. This mistake can create a number of difficulties, particularly in estimating life expectancy and investment returns. Based on average life expectancy, you probably think that you’ll live into your mid-80s. But if you use this age to estimate how much you need to save for retirement, you have a 50 percent chance of saving too little. Format: Multiple Choice Title: Test Bank 10.1 Why Do So Many People Avoid Retirement Planning? Section: Why Do So Many People Avoid Retirement Planning? Learning Objective: 10.1 Estimate your retirement income needs, and develop savings goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 29. The three-legged stool of retirement is a metaphor for retirees suggesting that retirement be funded by three sources: employer-sponsored retirement plans, Social Security, and A) earned income. B) inheritance. C) personal savings. D) investment income. Answer: C Solution: The three-legged stool of retirement is a metaphor for retirees suggesting that retirement be funded by three sources: employee-sponsored retirement plans, Social Security, and personal savings. Format: Multiple Choice Title: Test Bank 10.2 The Three-Legged Stool of Retirement Income Section: Retirement Income from Employer Plans and Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

30. If the three-legged stool of retirement income relies too heavily on only one leg, it will be wobbly and will not provide reliable and stable retirement income. Which leg is currently providing insufficient retirement income for most households? A. Private savings B. Social Security C. Employer retirement plans D. Earnings Answer: A Solution: Based on the Social Security Administration (Fast Facts and Figures About Social Security, 2017) while Social Security (33%) and employer retirement plans (21%) provide support, 32 percent of over-65 households must work, in lieu of savings, to provide 32 percent of household income in retirement. Thus, private savings is nearly nonexistent. Format: Multiple Choice Title: Test Bank 10.2 The Three-Legged Stool of Retirement Income Section: Retirement Income from Employer Plans and Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 31. To achieve the greatest level of retirement security, you should plan on multiple sources of retirement income including A) employer-sponsored retirement plans. B) Social Security. C) personal savings. D) All of these sources. Answer: D Solution: A retirement plan that relies too heavily on only one leg of the threelegged stool of retirement income, such as Social Security, will be wobbly and will not provide reliable and stable retirement income. To achieve the greatest level of retirement security, you should plan on a near equal contribution from employer-sponsored retirement plans, Social Security, and personal savings. Format: Multiple Choice Title: Test Bank 10.2 Three-Legged Stool of Retirement Income Section: Retirement Income from Employer Plans and Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

32. Social Security provides about _____ of all income for households whose members are age 65 and over. A) a quarter B) a third C) half D) two-thirds Answer: B Solution: Social Security makes up about one-third of all income for households whose members are age 65 and over (Source: Social Security Administration, Fast Facts and Figures About Social Security, 2017). Format: Multiple Choice Title: Test Bank 10.2 Aggregate Household Retirement Income, Age 65+ Section: Retirement Income from Employer Plans and Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 33. If your company retirement plan considers how long you have worked for the company and your final salary in determining your retirement benefit from the plan, you have a A) defined-contribution plan. B) defined-benefit plan. C) individual retirement plan. D) independent retirement plan. Answer: B Solution: Your future benefit from a defined-benefit plan is usually based on a formula that takes into account the number of years you’ve worked for the employer and how much you earn. Format: Multiple Choice Title: Test Bank 10.2 Income from Employer-Sponsored Plans Section: Income from Employer-Sponsored Plans Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 34. Brenda has been working for BestMart, Inc. for 35 years. She currently earns $97,000 a year and is fully vested in the pension plan. Her employer uses the following benefit formula: 1.5% of final salary for each year of service up to a

maximum of 70%. If she were to retire today, what will be her annual pension benefit? A) $16,975 B) $50,925 C) $67,900 D) $97,000 Answer: B Solution: She will receive a benefit equal to 52.5% (1.5% × 35 years) of her final salary of $97,000 for retirement: $50,925 ($97,000 × 0.525). Format: Multiple Choice Title: Test Bank 10.2 Pension Benefit Calculation Section: Income from Employer-Sponsored Plans Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 35. A retiree’s future benefit from an employer-sponsored defined-contribution plan is usually based on A) a formula taking into account number of years of service and average earnings. B) a formula taking into account number of years of service and final earnings. C) how much is contributed each year and the rate of return on invested assets for many years into the future. D) how much is contributed each year and the number of years of service. Answer: C Solution: The amount of benefit that a DC plan will provide is fairly uncertain because it depends on how much is contributed each year and the rate of return on invested assets for many years into the future. Format: Multiple Choice Title: Test Bank 10.2 Income from DC Plans Section: Income from Employer-Sponsored Plans Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 36. Social Security is a type of A) defined-contribution plan. B) defined-benefit plan.

C) welfare plan. D) savings plan. Answer: B Solution: Social Security is a public defined-benefit program administered by the U.S. Social Security Administration (SSA). In addition to the health and disability benefits, the program is intended to provide at least subsistence-level retirement income to program participants, who include nearly all workers in the United States. Format: Multiple Choice Title: Test Bank 10.2 Income from Social Security Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 37. Delaying social security benefits is a good strategy for maximizing retirement income. By choosing not to begin receiving benefits at the normal retirement age of 67, a participant’s benefits will increase by ____ percent for each year of delay up to age 70. A) 1 B) 1.45 C) 6.2 D) 8 Answer: D Solution: Participants who delay retirement, choosing not to begin receiving benefits at the normal retirement age of 67, their benefits will increase by 8 percent for each year of delay up to age 70. Format: Multiple Choice Title: Test Bank 10.2 Delayed Retirement Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. Which payroll tax is only charged on income up to a maximum cap? A. Medicaid B. Social Security C. Medicare D. Affordable Care Act

Answer: B Solution: Social Security is funded by part of FICA payroll tax and is shared by employers and employees at 6.2 percent of gross earnings up to $132,900 in 2019 (increases annually with inflation). Format: Multiple Choice Title: Test Bank 10.2 What Is Social Security, and How Is It Funded? Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 39. In the computation of your Social Security benefit, average indexed monthly earnings (AIME) refers to the average of your A) 35 years of highest monthly earnings. B) 35 years of highest monthly earnings, adjusted for wage inflation. C) 35 years of lowest monthly earnings, adjusted for wage inflation. D) monthly earnings throughout your working career, adjusted for wage inflation. Answer: B Solution: Social Security benefits are based on a multistep calculation. The SSA first calculates your AIME, using your top 35 years of earnings (up to the taxable maximum for each year), adjusted for inflation to current-year dollars. The AIME is then used in a formula to calculate your primary insurance amount (PIA), the monthly benefit you’d be entitled to if you retired at the normal retirement age (age 67 for anyone born 1960 or later). Format: Multiple Choice Title: Test Bank 10.2 How Much Will Social Security Pay Me? Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 40. Sandra reached full retirement age in 2016, and her average indexed monthly earnings (AIME) are $3,000. Her Social Security primary insurance amount (PIA) will be _____ of her AIME. A) more than 90 percent B) between 32 percent and 90 percent C) between 15 percent and 32 percent

D) less than 15 percent Answer: B Solution: The PIA formula applies a progressive formula to the AIME that replaces a larger percentage of income for lower income individuals. Very lowincome people will have a benefit that is 90 percent of their AIME, but most people’s benefits are between 32 percent and 90 percent of their AIME. Format: Multiple Choice Title: Test Bank 10.2 PIA Calculation Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 41. Renee and her husband Jason have been married for 25 years and are planning to retire this year. Jason’s PIA is $2,000. Renee’s PIA is $800. Assuming they are both at full retirement age, what is their maximum joint retirement benefit under Social Security? A) $2,000 B) $2,800 C) $3,000 D) $4,000 Answer: C Solution: If you’ve been married at least one year to a fully insured worker and you are at least age 62, you’re eligible to receive a Social Security benefit of up to 50 percent of your spouse’s Social Security benefit or a benefit based on your own earnings history, whichever is greater. Since Renee and Jason are both at full retirement age (67), the lower spouse’s PIA can be exchanged for 50 percent of the higher spouse’s PIA. Thus, Jason will receive $2,000 and Renee $1,000 (50% of Jason’s $2,000 PIA); for a total of $3,000. Format: Multiple Choice Title: Test Bank 10.2 Spousal Benefits Calculation Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 42. To be “fully insured” under the Social Security program,

A) you must have earned at least a specified minimum dollar amount for 40 three-month periods. B) you must be at least age 60. C) you must be a naturalized citizen. D) All of the above. Answer: A Solution: You will be fully insured at retirement if you earned at least a specified minimum dollar amount ($1,360 in 2019) in at least 40 three-month periods (10 years) over your working career and paid FICA payroll taxes on that income. Fully insured participants who retire at the normal retirement age are entitled to benefits as defined by law. Format: Multiple Choice Title: Test Bank 10.2 Fully Insured Status Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 43. A divorced woman can receive Social Security benefits based on her exhusband’s Social Security earnings even if he dies, as long as the marriage lasted at least how many years? A) 1 year B) 3 years C) 10 years D) There is no time limit. Answer: C Solution: Divorcées who haven’t remarried are eligible for retirement benefits equal to 50 percent of their ex-spouse’s benefits as long as the marriage lasted at least 10 years. Format: Multiple Choice Title: Test Bank 10.2 Spousal Benefits Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

44. Social Security benefits are ______ for inflation annually, which ensures that a retiree’s purchasing power will not decline over time. A. adjusted higher B. adjusted higher or lower C. not adjusted D. reduced Answer: A Solution: Social Security benefits are adjusted annually for inflation, a feature that ensures that a retiree’s purchasing power will not decline during retirement. It does not get reduced if inflation declines. Format: Multiple Choice Title: Test Bank 10.2 How Much Will Social Security Pay Me? Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 45. Which of the following is not one the causes of the projected insolvency of Social Security? A) Higher incomes lead to higher benefits. B) People are living longer. C) The baby boom generation is larger than the generation following it. D) All of these options are considered potential causes. Answer: A Solution: Several factors are contributing to Social Security’s problems. One is simply that people are living longer and are therefore receiving retirement benefits for more years. Another, as already suggested, is that the Baby Boom generation is larger than the generations that preceded and followed it. This means that, as members of this generation retire, more and more retirees will be receiving benefits, and there’ll be fewer workers paying taxes to cover those benefits. Higher incomes do not lead to higher benefits, as the contribution is capped and the PIA formula is designed to have a redistributive effect by replacing a larger percentage of preretirement income for low-income retirees than for average- and high-income retirees. Format: Multiple Choice Title: Test Bank 10.2 How Much Will Social Security Pay Me? Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Analysis

AACSB: Analytic Expected Time to Complete: 1 minute 46. When compared to married couple retirement households, single retirees have ________ the household income. A) less than half B) less than one-third C) double D) relatively the same Answer: A Solution: Another disturbing aspect of retirement income is the contrast between married-couple households and single households. Compared with marriedcouple household income of $55,108 in 2015, single retirees had less than half the household income ($20,825) and were more likely to be relying on Social Security as their primary source of income and more likely to be living in poverty. Format: Multiple Choice Title: Test Bank 10.2 Retirement Income from Employer Plans and Social Security Section: Retirement Income from Employer Plans and Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 47. Carla and Ben have been married for 50 years. During that time, Carla stayed home raising their children and maintaining their household while Ben worked for an engineering firm. When they reach retirement age, together Ben and Carla are eligible to receive A) 150 percent of Ben’s Social Security benefits. B) half of Ben’s Social Security benefits. C) only Ben’s Social Security benefits. D) 200 percent of Ben’s Social Security benefits. Answer: A Solution: If you’ve been married at least one year to a fully insured worker and you are at least age 62, you’re eligible to receive a Social Security benefit of up to 50 percent of your spouse’s Social Security benefit or a benefit based on your own earnings history, whichever is greater. Carla at full retirement age (67) is entitled to 50 percent of her spouse’s PIA. Thus, Ben will receive 100 percent of his PIA and Carla will receive 50 percent of Ben’s PIA; for a total of 150 percent of Ben’s PIA. Format: Multiple Choice

Title: Test Bank 10.2 Spousal Benefits Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 48. Social Security benefits are based on the ________, which is the top 35 years of earnings (up to the taxable maximum for each year), adjusted for wage inflation to current-year dollars. A) average indexed monthly earnings (AIME) B) primary insurance amount (PIA) C) three-legged stool of retirement method D) same formula used by DB plans Answer: A Solution: Social Security benefits are based on the average indexed monthly earnings (AIME), which is the top 35 years of earnings (up to the taxable maximum for each year), adjusted for wage inflation to current-year dollars. Format: Multiple Choice Title: Test Bank 10.2 How Much Will Social Security Pay Me? Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 49. The ________ is the monthly benefit you would be entitled to if you retired at the normal retirement age. A) primary insurance amount B) average indexed monthly earning C) three-legged stool of retirement D) SSA wage calendar Answer: A Solution: The primary insurance amount (PIA) is the monthly benefit you would be entitled to if you retired at the normal retirement age. Format: Multiple Choice Title: Test Bank 10.2 How Much Will Social Security Pay Me? Section: Income from Social Security

Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 50. The calculation used by Social Security to calculate retirement benefits is meant to replace a(n) _________ of preretirement income for low-income retirees than for high-income retirees. A) larger percentage B) smaller percentage C) equal amount D) equal percentage Answer: A Solution: The Social Security PIA calculation is designed to have a redistributive effect by replacing a larger percentage of preretirement income for low-income retirees than for average- and high-income retirees. Format: Multiple Choice Title: Test Bank 10.2 How Much Will Social Security Pay Me? Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 51. Social Security is a(n) ________ system. A) pay-as-you-go B) delayed benefits C) accumulated value D) incongruent Answer: A Solution: Social Security is referred to as a pay-as-you-go system because the money received from payroll (FICA) taxes assessed on the wages of current workers is used to pay benefits to qualified recipients. Format: Multiple Choice Title: Test Bank 10.2 What Is Social Security, and How Is It Funded? Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 52. What happens when the total payroll taxes collected for Social Security exceed the total being paid out in benefits to current retirees? A) The SSA invests the excess in special-issue government bonds. B) The SSA distributes the excess to the lowest-earning beneficiaries. C) The SSA returns the excess as tax refunds. D) The SSA uses the funds to invest in U.S. Series EE bonds. Answer: A Solution: When payroll taxes collected exceed the total being paid out in benefits to current retirees, the Social Security Administration invests the extra money in special-issue government bonds. The accumulated value of these bonds is called the Social Security Trust Fund. In the future, when payroll taxes are insufficient to cover benefits being paid out, the trust fund’s assets will be used to cover the shortfall. Format: Multiple Choice Title: Test Bank 10.2 Financing of the System Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 53. Experts agree that some sort of Social Security reform will be necessary in the future as the baby-boom generation continues to age. Which of the following would not help improve the solvency of the program? A) Raising the retirement age B) Limiting benefit increases in the future C) Lowering the retirement age D) Reducing the replacement percentages in the PIA formula Answer: C Solution: Lowering the retirement age would further increase the drain on Social Security. Raising the retirement age, limiting future benefits, and further adjusting the PIA calculation to redistribute benefits would all serve to reduce the drain on Social Security. Format: Multiple Choice Title: Test Bank 10.2 Causes of Projected Insolvency

Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 54. Which future change in the Social Security system is most likely as part of Social Security reform? A) Raising the retirement age B) Increasing benefits for the wealthy C) Eliminating the program D) Lowering taxes on the wealthy Answer: A Solution: Raising the retirement age would all serve to reduce the drain on Social Security and is most likely a part of Social Security reform. Format: Multiple Choice Title: Test Bank 10.2 Prospects for Reform Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 55. John was born in 1985; what is his normal retirement age? A) 62 years B) 65 years C) 67 years D) 70 years Answer: C Solution: The normal retirement age is 67 for anyone born after 1960. Format: Multiple Choice Title: Test Bank 10.2 Normal Retirement Age Section: Income from Social Security Learning Objective: 10.2 Explain how employer-sponsored retirement plans and Social Security can help you meet your retirement goals. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

56. The contribution limit for a Roth IRA is ______ the traditional IRA. A. less than B. more than C. equal to D. different than Answer: C Solution: The contribution limit for a both traditional and Roth IRAs are $6,000 and extra $1,000 catch-up if older than 50 years. Format: Multiple Choice Title: Test Bank 10.3 IRA Contribution and Income Limits Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 57. Contributions to a traditional IRA are tax _______ and withdrawals in retirement are taxed as _______ income. A. free; ordinary B. deductible; ordinary C. free; long-term capital gain D. deductible; long-term capital gain Answer: B Solution: Contributions to a traditional IRA are tax-deductible and withdrawals in retirement are taxed as ordinary income. Format: Multiple Choice Title: Test Bank 10.3 Traditional IRAs Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 58. Which of the following is a difference between traditional IRAs and Roth IRAs? A) Deductibility of contributions B) Age at which you can begin contributing to an account C) Amount you can contribute D) Penalty for early withdrawal of earnings

Answer: A Solution: Contributions to a traditional IRA are tax-deductible, whereas contributions made to a Roth IRA is made with after-tax money. Otherwise, both IRAs share contribution limits, penalty for early withdrawal of earnings, and the age at which you can begin contributing to an account. Format: Multiple Choice Title: Test Bank 10.3 Individual Retirement Accounts Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 59. Roth IRAs A) allow pretax contributions and deferral of taxation on investment earnings. B) allow pretax contributions and early withdrawal for first-time home purchases. C) must be funded with after-tax contributions but contributions can be withdrawn at retirement tax-free. D) have lower income limitations than traditional deductible IRAs. Answer: C Solution: Roth IRAs must be funded with after-tax contributions but contributions can be withdrawn at retirement tax-free. Format: Multiple Choice Title: Test Bank 10.3 Roth IRAs Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 60. Which of the following types of investments do not require you to pay taxes on investment earnings until withdrawal? A) Traditional IRAs B) 401(k) defined-contribution retirement plans C) Annuities D) All of the above. Answer: D

Solution: Traditional IRAs, 401(k) defined-contribution retirement plans, and annuities are all tax-deferred investment accounts and do not require you to pay taxes on investment earnings until withdrawal. Format: Multiple Choice Title: Test Bank 10.3 Individual Retirement Savings Alternatives Section: Individual Retirement Savings Alternatives Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 61. Which retirement account has contribution limits based on participation in an employer’s retirement plan? A. Roth IRA B. Traditional IRA C. Variable annuity D. Joint and survivor annuity Answer: B Solution: A traditional IRA has contribution limits based on participation in an employer’s retirement plan. If single filing individually, the income range over which deductibility is phased out is $64,000−$74,000, and if married filing jointly, the income range over which deductibility is phased out is $103,000–$203,000. Format: Multiple Choice Title: Test Bank 10.3 IRA Contribution and Income Limits Section: Individual Retirement Savings Alternatives Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 62. A ________ annuity pays a married couple a benefit until the second spouse dies. A) joint and survivor B) variable C) deferred D) permanent Answer: A Solution: A joint and survivor annuity pays a married couple a benefit until the second spouse dies. Format: Multiple Choice

Title: Test Bank 10.3 Key Features of Annuities Section: Annuities Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 63. ________ are subject to regulations that resemble those of defined-contribution plans offered by employers. A) Traditional IRAs B) Roth IRAs C) Taxable accounts D) Annuities Answer: A Solution: Traditional IRAs are subject to regulations that resemble those of defined-contribution plans offered by employers. Format: Multiple Choice Title: Test Bank 10.3 Individual Retirement Accounts Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 64. Evan works for an employer that does not provide a retirement plan as a benefit. He earns $175,000 per year. He plans to fund his own retirement account through his local bank. Which of the following would best suit Evan? A) A traditional IRA B) A Roth IRA C) A taxable account D) An annuity Answer: A Solution: Evan can contribute to a traditional IRA and receive full deductibility because his employer does not provide a retirement plan. He cannot contribute to a Roth IRA because his income of $175,000 exceeds the phaseout for the eligibility to make contributions ($122,000−$137,000). Format: Multiple Choice Title: Test Bank 10.3 Individual Retirement Accounts

Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 65. Jeff, a 56-year-old professor, is subject to a 28% marginal tax rate. He has a family emergency and must withdraw $5,000 from his traditional IRA to fund it. How much money will he owe the government for this withdrawal? A) $140 B) $1,400 C) $500 D) $1,900 Answer: D Solution: Jeff is subject to a 10% penalty for the premature distribution, and the distribution is subject to ordinary income tax. Thus, he will owe $1,400 income tax ($5,000 distribution × 0.28 marginal tax rate) plus $500 penalty ($5,000 × 0.10 penalty), for a total of $1,900. Format: Multiple Choice Title: Test Bank 10.3 Premature Distribution Calculation Section: Taxable Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities.Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 66. Bill wishes to take a deduction for a $6,000 contribution to his traditional IRA. When is the deadline to fund his traditional IRA in order to take the income tax deduction for 2019? A. December 31, 2019 B. January 1, 2020 C. January 31, 2020 D. April 15, 2020 Answer: D Solution: Contributions are deductible from income for the tax year in which they are made. Contributions are allowed up to the April 15 tax filing deadline in the following year. Thus, Bill has until April 15, 2020. Format: Multiple Choice Title: Test Bank 10.3 Funding Deadline for Traditional IRA Contributions

Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 67. What is the catch-up contribution limit for individuals age 50 and over for Roth IRAs? A) $500 B) $1,000 C) $1,500 D) $2,000 Answer: B Solution: The catch-up contribution limit for individuals age 50 and over for IRAs is $1,000 (2019–2020). Format: Multiple Choice Title: Test Bank 10.3 IRA Catch-up Contribution Limit Section: Individual Retirement Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 68. Along with an early investment start, ________ make(s) a big difference in your accumulated retirement wealth. A) the rate of return on investments B) the tax rate on investments C) contribution limits on investments D) the present value of investments Answer: A Solution: Along with an early start, the rate of return on your investments makes a big difference in your accumulated wealth. Tax-deferred and tax-free investments provide the extra return on your investments simply by not paying taxes annually on your compounded returns. Format: Multiple Choice Title: Test Bank 10.3 Difference Factors in Accumulated Retirement Wealth Section: Taxable Accounts Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 69. Annuities are a recommended means of retirement income because they can provide A. tax-free income. B. tax-deferred growth and income. C. lifetime income and thus reduce the risk of outliving retirement assets. D. tax-deductibility of contributions and tax-deferred growth. Answer: C Solution: Annuities can be particularly valuable for retirement planning because they can produce lifetime income and thus reduce the risk of outliving retirement assets. Format: Multiple Choice Title: Test Bank 10.3 Key Benefit of Annuities Section: Annuities Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 70. As with life insurance, the pricing on life annuities depends on A) life expectancy. B) current income. C) income replacement and financial obligations. D) individual risk characteristics. Answer: A Solution: They are commonly sold by life insurance companies because, like life insurance, pricing depends on life expectancy. Whereas life insurance provides income to your beneficiaries when you die, annuities pay income to you while you’re living. Format: Multiple Choice Title: Test Bank 10.3 Key Features of Annuities Section: Annuities Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

71. Marnie and John have a joint and survivor annuity. This means that A) the annuity pays a benefit until the second spouse dies. B) the annuity pays a double benefit for their entire lives. C) the annuity pays a benefit until the first spouse dies. D) only the beneficiaries receive a benefit after both Marnie and John die. Answer: A Solution: A joint and survivor annuity pays a married couple a benefit until the second spouse dies. Thus, the income benefit of the annuity will continue to the death of the surviving spouse. Format: Multiple Choice Title: Test Bank 10.3 Joint and Survivor Annuity Section: Annuities Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 72. If you opt for a joint and survivor annuity, you are entitled to receive a series of equal payments to A) you and your spouse until the first one dies. B) you and your spouse until the last one dies. C) you and your spouse during the life of both, with the remainder going to your children. D) you, your spouse, and your children until the last person dies. Answer: B Solution: A joint and survivor annuity pays a married couple a benefit until the second spouse dies. Thus, the income benefit of the annuity will continue to the death of the surviving spouse. Format: Multiple Choice Title: Test Bank 10.3 Joint and Survivor Annuity Section: Annuities Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 73. Travis has purchased an annuity to help offset the cost of retirement and reduce the likelihood that he will outlive his other benefits. He is guaranteed an

immediate income benefit of $2,000 per month, which means he has a ________ annuity. A) fixed B) variable C) deferred D) joint Answer: A Solution: A fixed annuity is constant over time. A variable annuity payment varies with the performance of invested assets. A deferred annuity will begin payments at some point in the future, often at retirement. Format: Multiple Choice Title: Test Bank 10.3 Key Features of Annuities Section: Annuities Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 74. Reverse annuity mortgages work by turning ________ into cash flow. A) home equity B) IRAs C) defined benefits D) deferred annuities Answer: A Solution: A reverse annuity mortgage, you trade your home equity for an income stream. You’re allowed to remain in the home for the period of the annuity, which might be a period of years or for life, after which the lender assumes ownership of the home or you have to pay off the loan. Format: Multiple Choice Title: Test Bank 10.3 Reverse Annuity Mortgages Section: Annuities Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 75. Many people approach what they originally imagined would be their retirement age but discover that they can’t afford to retire yet. Which of the following strategies would make the situation worse?

A) Continuing to work B) Reducing expenses C) Taking out a second mortgage D) Increasing savings rate while still working Answer: C Solution: Reducing expenses by downsizing housing and cars and cutting back on vacations and other expenses will make it possible to live on a more modest income. If your health permits, continue working part-time or delay retirement. This will allow you to continue your retirement savings program and will reduce the number of years of retirement income that your nest egg must support. Taking out a second mortgage will not alleviate your problems, as the added debt burden will only exasperate your situation. Format: Multiple Choice Title: Test Bank 10.3 Not on Track to Retire Section: Not on Track to Retire Learning Objective: 10.3 Explain why individual retirement accounts (IRAs) offer advantages over taxable savings accounts and annuities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 76. In recent years, the rise in college tuition has _______ the rate of inflation. A. been slightly lower than B. been slightly higher than C. greatly outpaced D. nearly matched Answer: C Solution: Higher education costs have risen at a faster rate than inflation over the last few decades. Format: Multiple Choice Title: Test Bank 10.4 How Much Will Future Education Cost? Section: Planning for Education Costs Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 77. Which accounts allow pretax contributions of $2,000 per year and tax-free withdrawals for qualified education expenses? A. Traditional IRAs B. Roth IRAs C. Coverdell Education Savings Accounts

D. Annuities Answer: C Solution: Coverdell Education Savings Accounts, previously called Education IRAs, have tax treatment similar to that of Roth IRAs, where contributions are made with after-tax dollars and interest earnings aren’t taxed. No taxes are due when the funds are withdrawn for qualified education expenses. Subject to income limitations ($110,000 for singles, $220,000 for married couples), you can contribute up to $2,000 per year per child. Format: Multiple Choice Title: Test Bank 10.4 Tax-Preferred Education Savings Plans Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 78. Parents can save for their children’s education with a Coverdell Education Savings Account, a savings arrangement that allows A) after-tax contributions of $2,000 per year per child and tax-free withdrawals. B) after-tax contributions of $5,000 per year per child and tax-free withdrawals. C) pretax contributions of $2,000 per year per child and tax-free withdrawals. D) pretax contributions of $5,000 per year per child and tax-free withdrawals. Answer: A Solution: Coverdell Education Savings Accounts, previously called Education IRAs, have tax treatment similar to that of Roth IRAs, where contributions are made with after-tax dollars and interest earnings aren’t taxed. No taxes are due when the funds are withdrawn for qualified education expenses. Subject to income limitations ($110,000 for singles, $220,000 for married couples), you can contribute up to $2,000 per year per child. Format: Multiple Choice Title: Test Bank 10.4 Coverdell Education Savings Account Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 79. A Section 529 plan is a(n) A. tax-deductible prepaid tuition plan. B. after-tax higher education savings plan.

C. state-sponsored, after-tax prepaid tuition plan or a higher education savings plan. D. federally sponsored after-tax higher education savings plan. Answer: C Solution: Most states sponsor a Section 529 plan for funding college education costs. A Section 529 plan can be either a prepaid tuition plan or a savings plan. Both types of plans require after-tax contributions, and some states allow state residents to deduct the contribution from income in calculating state taxes owed. Format: Multiple Choice Title: Test Bank 10.4 Section 529 Plan Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. The benefit of a Section 529 plan is a A) federal income tax credit. B) federal income tax deduction. C) tax savings on investment earnings. D) reimbursement of tuition costs. Answer: C Solution: A Section 529 plan requires after-tax contributions, tax-deferred growth, and tax-free distributions if used for qualified education expenses. Some states allow state residents to deduct the contribution from income in calculating state income taxes owed. Format: Multiple Choice Title: Test Bank 10.4 Section 529 Plan Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 81. John and Mary have a four-year-old son. Annual public college tuition is $12,000 today. If costs increase at 4% per year, how much will college tuition be when John and Mary's son enters college in 14 years? A) $20,780 B) $20,267

C) $13,170 D) $24,188 Answer: A Solution: To do this, you’ll use the time value of money formula to calculate the future value of a lump sum (tuition): Financial Calculator: Enter PV = −12,000, N = 14, I/Y = 4, and solve for FV = $20,780 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) => =FV(0.04, 14, 0, −12000, 0) => $20,780 TVM Equation: FV = PV × (1+i)n = $12,000 × (1+0.04)14 = $20,780

Format: Multiple Choice Title: Test Bank 10.4 Future Cost of College Calculation Section: How Much Will You Need to Save Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 82. When comparing the Section 529 prepaid tuition plan and the Section 529 savings plan, the Section 529 savings plan is most similar to A. an IRA. B. a DB plan. C. a DC plan. D. money purchase plan. Answer: A Solution: In contrast to Section 529 prepaid tuition plans, Section 529 savings plans are more similar to IRAs and Coverdell Education Savings Accounts. You choose how much to invest, and you might be able to allocate your money to particular investment vehicles. The amount you accumulate in your account will depend on how your investments do over time. As with the tuition plans, you can apply the money to any qualified education expenses. Format: Multiple Choice Title: Test Bank 10.4 Section 529 Plans Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 83. When comparing penalties for nonqualified withdrawals on the Coverdell Education Savings Account and the two types of Section 529 plans, which of the following requires payment of taxes on investment earnings plus a 10 percent penalty? A) Coverdell Education Savings Account B) Section 529 prepaid tuition plan C) Section 529 savings plan D) All of these plans. Answer: D Solution: All three of these plans have the same penalty for nonqualified withdrawals: Earnings are subject to income tax plus 10 percent penalty. Format: Multiple Choice Title: Test Bank 10.4 Withdrawals of Education Savings Plan Programs Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 84. In comparing qualified expenses across the three government programs to help fund education expenses, which of the following can be used to pay education costs for K–12? A) Coverdell Education Savings Account B) Section 529 prepaid tuition plan C) Health savings plan D) Education IRA Answer: A Solution: The Coverdell Education Savings Account can be used for all education costs including K–12: tuition, fees, room, board, and books. The Section 529 prepaid tuition plan can only be used to prepay predominantly state universities. Format: Multiple Choice Title: Test Bank 10.4 Qualified Expenses of Education Savings Plan Programs Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs.

Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 85. Which program allows you to claim up to $2,500 per year of a dependent child’s tuition and fees? A) Coverdell Education Savings Account B) Section 529 plan C) American opportunity tax credit D) Lifetime learning tax credit Answer: C Solution: You can claim the American opportunity tax credit for up to $2,500 per year of a dependent child’s tuition and fees (100% of the first $2,000 of expenses and 25% of the next $2,000). The student must be enrolled at least half-time and be in the first four years of a degree program. Format: Multiple Choice Title: Test Bank 10.4 Tax Benefits for Education Expenses Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 86. Which of the three government college savings programs disburses unused funds when the beneficiary reaches the age of 30? A) Coverdell Education Savings Account B) Section 529 prepaid tuition plan C) Section 529 savings plan D) None of the choices is correct. Answer: A Solution: The Coverdell Education Savings Account has a maximum age to use funds: Any unused funds are disbursed when beneficiary reaches age 30. Format: Multiple Choice Title: Test Bank 10.4 Unused Assets of Education Savings Plan Programs Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 87. Which of these government college savings programs do not tax investment earnings or qualified withdrawals? A) Section 529 prepaid tuition plan B) Section 529 savings plan C) Coverdell Education Savings Account D) All of the choices are correct. Answer: D Solution: All the three government college savings programs do not tax investment earnings or qualified withdrawals. Format: Multiple Choice Title: Test Bank 10.4 Qualified Withdrawals of Education Savings Plan Programs Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 88. What are the income limits for Section 529 plans? A) There are no income limits. B) $110,000 C) $220,000 D) $650,000 Answer: A Solution: There are no income limits for Section 529 plans. Format: Multiple Choice Title: Test Bank 10.4 Income Limits of Education Savings Plan Programs Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 89. Who controls the account for Section 529 plans? A) The contributor B) The parent or guardian C) The student if over 18 years

D) The government Answer: A Solution: The contributor is the typical owner and thus controls the account for Section 529 plans. The owner chooses how much to invest and how to invest in the particular investment vehicles within the plan. The amount you accumulate in the account will depend on how the investments do over time. Format: Multiple Choice Title: Test Bank 10.4 Section 529 Account Control Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Comprehension AACSB: Comprehension Expected Time to Complete: 1 minute 90. Contributions to a Coverdell Education Savings Account are made A. after-tax. B. pretax. C. tax-deferred. D. pretax, subject to income limitations. Answer: A Solution: Contributions to a Coverdell Education Savings Account are made with after-tax contribution. Format: Multiple Choice Title: Test Bank 10.4 Taxation of Contributions to Coverdell Accounts Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Comprehension Expected Time to Complete: 1 minute 91. Tammy has a daughter attending Big State University on a full-time basis. Tammy files her income tax as a head of household and earns a $60,000 salary. Which federal tax credit can she claim? A. American opportunity tax credit B. Lifetime learning tax credit C. Either tax credit for the same dependent if the dependent qualifies for both credits D. Both tax credits for the same dependent if the dependent qualifies for both credits Answer: C

Solution: Tammy can claim either tax credit for her dependent, although you can’t use both at the same time for the same qualifying dependent. She qualifies for either tax credit because her dependent is a full-time college student and her income is under the AGI phaseouts ($80,000–$90,000 for singles claiming the American opportunity credit and $52,000–$62,000 for singles claiming the lifetime learning credit). Format: Multiple Choice Title: Test Bank 10.4 Tax Credits for Education Expenses Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 92. If you have begun paying back your student loans, you can deduct up to ________ in student loan interest paid for yourself, your spouse, or qualified dependent, assuming you are under the income limits. A) $1,500 B) $2,000 C) $2,500 D) $3,000 Answer: C Solution: If you have begun paying back student loans, you might be able to deduct the interest on these loans. You can deduct up to $2,500 in student loan interest paid for yourself, your spouse, or a qualified dependent, although the deduction is phased out for incomes from $65,000 to $80,000 ($130,000– $160,000 for married couples filing jointly, based on 2019 tax year). This pre-AGI deduction is available even if you do not itemize deductions. Format: Multiple Choice Title: Test Bank 10.4 Student Loan Tax Break Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 93. Benjamin earns $150,000 per year and has decided to contribute money to his grandson’s education. Which program should he contribute to? A. Coverdell Education Savings Account B. Section 529 savings plan C. American opportunity program D. Fixed annuity

Answer: B Solution: Benjamin can only contribute to a Section 529 savings plan with his grandson as beneficiary. All the plan assets will be tax-free if used for the beneficiary’s qualified higher education expenses. He earns in excess of the Coverdell Education Savings Account income limit (phase out from $95,000 to $110,000). Format: Multiple Choice Title: Test Bank 10.4 Choosing a Tax-Preferred Education Savings Plan Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 94. Robert Barron’s mother is a wealthy widow who wants to contribute to her grandchildren’s education fund. If she were to choose a college savings program in which she has full control, which should she choose? A) Coverdell Education Savings Account B) Section 529 prepaid tuition plan C) Section 529 savings plan D) All of the choices are correct. Answer: C Solution: Prepaid tuition plans enable you to pay in advance for college costs by either paying a lump sum or making a series of payments, thus there is no account value to manage. In contrast to Section 529 prepaid tuition plans, Section 529 savings plans and Coverdell Education Savings Accounts allow you choose how much to invest and how to allocate your money to particular investment vehicles. Unlike the Coverdell Education Accounts, Section 529 savings accounts allow full account owner discretion of fund withdrawals and beneficiary changes. Also, Section 529 plans do not have income limitation for eligibility, like the Coverdell Education Accounts. Format: Multiple Choice Title: Test Bank 10.4 Choosing a Tax-Preferred Education Savings Plan Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 95. The American opportunity tax credit is a tax credit up to a maximum of

A) $500 for every eligible dependent who has incurred college expenses during the year. B) $2,500 for every eligible dependent who has incurred college expenses during the year. C) $2,000 per year for eligible college expenses incurred during a child’s first two years of college. D) $1,500 per year for eligible expenses incurred during a child’s first two years of college. Answer: B Solution: You can claim the American opportunity tax credit for up to $2,500 per year of a dependent child’s tuition and fees (100% of the first $2,000 of expenses and 25% of the next $2,000). Format: Multiple Choice Title: Test Bank 10.4 American Opportunity Tax Credit Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 96. The lifetime learning tax credit is a credit of A) 30 percent of the first $5,000 of college expenses up to a maximum of $1,500 for every eligible dependent who has incurred these expenses during the year. B) 20 percent of the first $5,000 of college expenses up to a maximum of $1,000 for every eligible dependent who has incurred these expenses during the first two years of college. C) 30 percent of the first $5,000 of college expenses up to a maximum of $1,500 for every eligible dependent who has incurred these expenses during the first two years of college. D) 20 percent of the first $10,000 of tuition and fees up to a maximum of $2,000 for every eligible dependent who has incurred these expenses during the year. Answer: D Solution: The lifetime learning tax credit is 20 percent of the first $10,000 of tuition and fees, including graduate school, up to a maximum of $2,000 for every eligible dependent who has incurred these expenses during the year. Format: Multiple Choice Title: Test Bank 10.4 Lifetime Learning Tax Credit

Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 97. Joseph and his wife Matilda earn $182,000 per year between the two of them and file joint income taxes. Will they be allowed to deduct their student loan interest they paid in the past year? A) No B) Yes C) Yes, but only for one spouse D) Yes, but only a partial amount Answer: A Solution: If you have begun paying back student loans, you might be able to deduct the interest on these loans. You can deduct up to $2,500 in student loan interest paid for yourself, your spouse, or a qualified dependent, although the deduction is phased out for incomes from $130,000 to $160,000 for married couples filing jointly ($65,000–$80,000 for single filers). Their earned income exceeds the income limitation threshold to be eligible to deduct student loan interest. Format: Multiple Choice Title: Test Bank 10.4 Student Loan Tax Breaks Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 98. Steve and Steph feel that they make and have plenty of money to send their two children to the best university available; therefore, they rejected their banker’s suggestion to open college savings plans. Which of the following reasons should persuade them to invest in a college savings plan? A) Steve and Steph may qualify for state tax deductions under Section 529 plans and can definitely shield some of their unearned income from taxes. B) The government subsidizes Section 529 plans, so they might as well take the free money. C) Colleges will offer tuition rebates for students who do use college savings plans.

D) Steve and Steph still qualify for American opportunity tax credits even if they contribute to Coverdell Education Savings Accounts that provide tax-free earnings. Answer: A Solution: Steve and Steph may qualify for state tax deductions under Section 529 plans and can definitely shield some of their unearned income from taxes. Section 529 plans do not have any income limitations, like the Coverdell Education Accounts, and provide tax-free growth and earnings, and withdrawals are tax-free when used for qualified education expenses. The higher the income levels, the greater the tax savings from using the account. Format: Multiple Choice Title: Test Bank 10.4 Tax-Preferred Education Savings Plans Section: Government Programs to Help Fund Education Expenses Learning Objective: 10.4 Develop a plan for funding current or future education costs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

Chapter 11 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 109 Multiple Choice Questions

11 Q# 7 8 22 23 26 34 42 43 58 59 60

LO 10.1 LO 10.2 LO10.3 LO 10.4

26 28 31 24

24% 26% 28% 22%

Total

109

100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

14 48 28 11 3 5 109

13% 44% 26% 10% 3% 5% 100%

Easy Medium Hard

14 80 15 109

13% 73% 14% 100%

Calculations Test Bank Question

11.1 Meeting Investment Goal Calculation (TVM Lump-Sum) 11.1 Meeting Investment Goal Calculation (TVM annual savings) 11.1 Tax on Dividend Calculation 11.1 Investment Income Tax Calculation 11.1 After-tax Investment Return Calculation 11.2 Capital Gain Calculation 11.2 Bond Coupon Interest Calculation 11.2 Bond Principal and Interest Calculation 11.3 Rate of Return Calculation (including current income) 11.3 Comparing Rates of Return Calculation 11.3 Rate of Return Calculation (including current income)

1. Before beginning to invest and build your financial capital, you should make sure you have adequate A. insurance coverage only. B. emergency funds in cash or savings accounts only. C. insurance coverage and emergency funds in cash or savings accounts. D. insurance coverage, real estate, and emergency funds in cash or savings accounts. Answer: C Solution: During the wealth accumulation stage of the life cycle, individuals who have already established their foundations (insurance and emergency funds) tend to be more willing to take risks to accumulate the funds necessary to achieve their future goals. Format: Multiple Choice Title: Test Bank 11.1 Foundation for Wealth Accumulation Section: First Things First: Establishing a Firm Foundation Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 2. Which of the following personal financial plan components should be completed before you begin an investing plan? A. Identifying and prioritizing financial goals B. Developing a budget C. Establishing a liquid emergency fund D. All of the above.

Answer: D Solution: Before you begin to develop an investment plan, you should make sure that you have a secure foundation to build on, such as an emergency fund. Have you established the necessary foundation elements of your plan, prioritized your financial goals, and developed a budget that will allow you to set aside sufficient funds for investing? If so, you can move ahead in the investment planning process. Format: Multiple Choice Title: Test Bank 11.1 Before You Begin an Investment Plan Section: First Things First: Establishing a Firm Foundation Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute

3. If you are investing to meet long-term goals, you can afford to take ______ if you are investing to meet short-term goals. A. less risk than B. greater risk than C. the same risk as D. no risk, like Answer: B Solution: Different types of investments have different average returns over time, so you’ll need to consider the riskiness of different investments relative to your time horizon. If you’re saving for a long-term goal, you might be able to weather some ups and downs in the stock market, but if you need the money relatively soon, you can’t afford to take much risk. So, if you are investing to meet long-term goals, you can afford to take greater risk than if you are investing to meet short-term goals. Format: Multiple Choice Title: Test Bank 11.1 Establishing Investment Goals Section: Establishing Investment Goals Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 4. Investment goals should be all of the following except A. realistic. B. specific. C. measurable. D. broad. Answer: D Solution: Many investment goals require that you save money over time in order to achieve them. To be most successful in this part of your plan, you should try to make sure that your investment goals are realistic, specific, and measurable. Format: Multiple Choice Title: Test Bank 11.1 Investment Goals Section: Establishing Investment Goals Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 5. The first step in the investment planning process is to A. evaluate your risk tolerance.

B. learn about your investment choices. C. identify your investment goals. D. select investments consistent with risk tolerance, time horizon, and investment objectives. Answer: C Solution: The investment planning process starts with (1) identifying your investment goals, then (2) learning about your investment choices, then (3) evaluating your risk tolerance, and then (4) selecting investments consistent with risk tolerance, time horizon, and investment objectives. Format: Multiple Choice Title: Test Bank 11.1 The Investment Planning Process Section: First Things First: Establishing a Firm Foundation Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 6. Which of the following is not one of the steps in the investment planning process? A. Learning about your employer’s flexible spending account (FSA) B. Monitoring your investment plan C. Selecting appropriate investments D. Evaluating your investment choices Answer: A Solution: The investment planning process includes estimating your investment goals, learning about investment choices, evaluating risk tolerance, selecting investments, and monitoring your investment plan. It does not include learning about health-care accounts. Format: Multiple Choice Title: Test Bank 11.1 The Investment Planning Process Section: First Things First: Establishing a Firm Foundation Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 7. You want to have $1,000 accumulated in 3 years and you already have $250 in a savings account earning 6%. If you don’t contribute any additional funds, how much will you be short of your goal in 3 years? A) $702

B) $750 C) $407 D) $634 Answer: A Solution: The future value of $250 in the savings account earning 6% APY over 3 years is $297.75. The $1,000 goal less the $297.75 future value is $702.25. Financial Calculator Enter PV = -250, N = 3, I/Y = 6, and solve for FV = 297.75 Excel Spreadsheet =FV(rate,nper,pmt,pv,type) => =FV(0.06, 3, 0, -250, 0) => 297.75 TVM Equation FV = PV x (1+i)n FV = $250 x (1+0.06)3 = $297.75 Format: Multiple Choice Title: Test Bank 11.1 Meeting Investment Goal Calculation Section: Establishing Investment Goals Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 8. You want to invest equal annual amounts over the next 15 years. If your goal is to have $15,000 at the end of that time and if you can earn 8% on your invested funds, how much do you need to invest annually at the end of each year to reach your goal? A) $315 B) $552 C) $920 D) $1,000 Answer: B Solution: Calculate the annual savings required to meet a $15,000 goal in 15 years while earning an 8% APY. Financial Calculator Enter PV = 0, FV = $15,000, N = 15, I/Y = 8, and solve for PMT = -552.44 Excel Spreadsheet =PMT(rate,nper,pv,fv,type) => =PMT(0.08, 15, 0, 15000, 0) => -552.44

TVM Equation 𝐹𝑉𝐴

PMT = (1+𝑖)𝑛 -1 (

𝑖

)

$15,000 (1+0.08)15 -1 ( ) 0.08

= $552.44

Format: Multiple Choice Title: Test Bank 11.1 Meeting Investment Goal Calculation Section: Establishing Investment Goals Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Hard Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 3 minutes 9. Which is a recommended source to find funds to invest? A. Paying your bills first B. Saving half your raise C. Paying the minimum credit card bills and investing the difference D. Avoiding down payments and investing the difference Answer: B Solution: Save half your raise. Make a deal with yourself that you’ll allocate half of your annual raise to savings. If you don’t let yourself become accustomed to the extra income but instead immediately set it aside for your investment plan, it won’t feel like you’re cutting back on immediate consumption. Format: Multiple Choice Title: Test Bank 11.1 Obtaining the Money to Invest Section: Establishing Investment Goals Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 10. Replacing a car with a more fuel efficient one and investing the annual cash savings is an example of finding money to invest? A. Paying yourself first B. Paying your bills first C. Stopping up a cash leak D. Continuing a payment plan Answer: C

Solution: Stop up a cash leak. Careful evaluation of your budget sometimes reveals regular household expenditures that could be avoided or reduced. Replacing a car with a more fuel efficient one, and invest the annual cash savings is an example of finding money to invest. Format: Multiple Choice Title: Test Bank 11.1 Finding the Money to Invest Section: Establishing Investment Goals Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 11. Which investment strategy involves buying the same dollar amount of securities at regular intervals? A. Dollar compounding B. Dollar cost averaging C. Marginal cost investing D. Compound interval investing Answer: B Solution: Many investment advisors recommend a strategy called dollar cost averaging, which involves investing equal dollar amounts at regular intervals rather than making a large investment at one time. The logic behind dollar cost averaging is that you can’t predict whether market prices today are high or low compared with what they’ll be later. By spreading your investment purchases over time, however, you’ll average out the ups and downs of purchase prices. Format: Multiple Choice Title: Test Bank 11.1 Key Strategies for Investment Success Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 12. In the long run, dollar cost averaging will weight your portfolio with more A. low-cost shares than high-cost shares. B. high-cost shares than low-cost shares. C. low-priced stock than high-priced stock. D. high-priced shares than low-priced stock. Answer: A Solution: Dollar cost averaging involves investing equal dollar amounts at regular intervals rather than making a large investment at one time. The logic behind dollar

cost averaging is that you can’t predict whether market prices today are high or low compared with what they’ll be later. By spreading your investment purchases over time, however, you’ll average out the ups and downs of purchase prices. When prices are rising, your dollars will purchase fewer units of the investment at the higher prices. When prices are falling, you’ll be able to buy more but at lower prices. Over the long term, the average purchase price per unit will be lower than the long-term average price for the investment. Format: Multiple Choice Title: Test Bank 11.1 Dollar Cost averaging Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 13. Long-term capital gains are taxed at ______, and most dividends are taxed at ________ than earned income. A. the same rate; a lower rate B. a lower rate; the same rate. C. a lower rate; a lower rate. D. the same rate; the same rate. Answer: C Solution: If you hold an investment longer than one year, the capital gain on the sale is subject to a special lower tax rate. Dividend income from most U.S. stock investments is also taxed at the lower rate. Format: Multiple Choice Title: Test Bank 11.1 Take Advantage of Favorable Tax Rules Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 14. Interest earned on municipal bonds is generally A. tax-deferred until the bonds are sold. B. federal income tax-free C. tax-deferred until the bonds mature. D. federal income tax-free if held longer than one year. Answer: B

Solution: Interest on municipal bonds (debt issued by state and local governments) is exempt from federal income tax, and your interest earnings on these bonds will also be exempt from state income tax if you’re a resident of the state that issued the bond. Format: Multiple Choice Title: Test Bank 11.1 Take Advantage of Favorable Tax Rules Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 15. _____________ are required to report their financial performance to the owners of the company in an annual report. A. All U.S. companies B. Publicly held companies C. Privately held companies D. All companies doing business in the United States Answer: B Solution: Publicly held (traded) companies are required to report each year on their financial performance for the current year and prior years and to make projections about the company’s future. Format: Multiple Choice Title: Test Bank 11.1 Annual Reports Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 16. An example of a tax-deferred investment is a A) traditional IRA. B) Roth IRA. C) mutual fund. D) municipal bond. Answer: A Solution: When you invest in a tax-deferred account such as a traditional IRA, you’ll be able to defer paying tax on the earnings from income and growth until you withdraw the funds at retirement. At that time, your withdrawals will be taxed at your ordinary income tax rate. In contrast, a tax-exempt investment’s interest is not subject to certain taxes at all. Interest on municipal bonds (debt issued by state and local

governments) is exempt from federal income tax. Roth IRA is an after-tax account that has tax-free qualified distributions. Format: Multiple Choice Title: Test Bank 11.1 Tax-Deferred Investments Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 17. Which of the following statements concerning federal and municipal debt is true? A) Interest on municipal debt is tax exempt from federal income taxes and state income taxes if the investor is a resident of the state that issued the bond. Federal debt interest is exempt from state and local income taxes. B) Municipal debt interest is exempt only from federal income taxes. Interest on federal debt is tax exempt from all federal, state, and local income taxes. C) Interest on federal and municipal debt is tax exempt from all federal, state, and local income taxes. D) Interest on municipal debt is tax exempt from both federal and state income taxes regardless of the state in which the investor lives. Federal debt is tax exempt only from federal income taxes. Answer: A Solution: Interest on municipal debt is tax exempt from federal income taxes and state income taxes if the investor is a resident of the state that issued the bond. Federal debt interest is exempt from state and local income taxes. Format: Multiple Choice Title: Test Bank 11.1 Tax-Exempt Bonds Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 18. Which of the following is not one of the strategies for successful investing? A. Understanding and taking advantage of tax rules B. Keeping accurate records C. Hiring a full-service broker to get access to information D. Starting early and be consistent Answer: C

Solution: Most individual investors buy investments through an intermediary, such as a bank or brokerage firm. Although full-service brokerage firms are available, your cheapest alternative is likely to be a discount broker. These firms now provide much the same level of online account management, investment research, asset allocation tools, and loan availability as their more expensive counterparts. Unless you require sophisticated investment advice, minimizing transaction costs while receiving similar access to information is a strategy for successful investing. Format: Multiple Choice Title: Test Bank 11.1 Key Strategies for Investment Success Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 19. If you purchase $100 of stock every 15th of the month, you are practicing A) dollar cost averaging. B) diversification. C) market timing. D) asset allocation. Answer: A Solution: Dollar cost averaging involves investing equal dollar amounts at regular intervals rather than making a large investment at one time. The logic behind dollar cost averaging is that you can’t predict whether market prices today are high or low compared with what they’ll be later. By spreading your investment purchases over time, however, you’ll average out the ups and downs of purchase prices. When prices are rising, your dollars will purchase fewer units of the investment at the higher prices. When prices are falling, you’ll be able to buy more but at lower prices. Over the long term, the average purchase price per unit will be lower than the long-term average price for the investment. Format: Multiple Choice Title: Test Bank 11.1 Key Strategies for Investment Success Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 20. Dollar cost averaging will result in A) the highest average return of any investment strategy.

B) a greater return than a buy-and-hold strategy if prices are rising. C) a higher average purchase price than the average price over the long term. D) a lower average purchase price than the average price over the long term. Answer: D Solution: Dollar cost averaging involves investing equal dollar amounts at regular intervals rather than making a large investment at one time. The logic behind dollar cost averaging is that you can’t predict whether market prices today are high or low compared with what they’ll be later. By spreading your investment purchases over time, however, you’ll average out the ups and downs of purchase prices. When prices are rising, your dollars will purchase fewer units of the investment at the higher prices. When prices are falling, you’ll be able to buy more but at lower prices. Over the long term, the average purchase price per unit will be lower than the long-term average price for the investment. Format: Multiple Choice Title: Test Bank 11.1 Dollar Cost Averaging Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 21. Municipal bonds bought by residents of the state that issues them are a ___________ investment. A) tax-deferred equity B) tax-exempt equity C) tax-deferred debt D) tax-exempt debt Answer: D Solution: Municipal bonds are debt issued by state and local governments, and its interest is exempt from federal income tax. The interest earnings on these bonds will also be exempt from state income tax if you’re a resident of the state that issued the bond. Format: Multiple Choice Title: Test Bank 11.1 Municipal Bonds Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

22. Mandy is subject to a marginal tax rate of 24%. She earned $400 in dividends from a taxable brokerage account last year. How much of the dividend income will Mandy pay in taxes? A) $96 B) $80 C) $60 D) $0, because dividend income is tax exempt Answer: C Solution: Dividend income from most U.S. stock investments is taxed at the lower tax rate used for long-term capital gains. For tax payers in the highest 37% marginal tax bracket, the special rate is 20%. For tax payers under the 12% marginal tax rate, dividends are exempt from tax. For all other tax payers, the special rate is 15%. Mandy’s dividend tax rate is 15%; thus, she will pay $60 in tax ($400 dividends × 0.15). Format: Multiple Choice Title: Test Bank 11.1 Tax on Dividend Calculation Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 23. The following amounts were earned on Ernesto’s portfolio last year: $250 interest income, $100 dividend income, $500 short-term capital gain, and $1,000 long-term capital gain. If Ernesto is in the 24% tax bracket, what is the total amount he will pay in taxes on his investment earnings? A) $323 B) $345 C) $354 D) $444 Answer: B Solution: Ordinary income from investments held in taxable accounts is taxable at your marginal tax rate. Interest and short-term capital gains are ordinary income. Long-term capital gains and dividend are taxed special long-term capital gain rates. For tax payers in the highest 37% marginal tax bracket, the special rate is 20%. For tax payers under the 12% marginal tax rate, dividends are exempt from tax. For all other tax payers, the special rate is 15%. Income Interest

Amount $250

Tax Rate 0.24

Tax $60

Dividend S.T. capital gain L.T. capital gain Total

$100 $500 $1,000

0.15 0.24 0.15

$15 $120 $150 $345

Format: Multiple Choice Title: Test Bank 11.1 Investment Income Tax Calculation Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 24. When making investment decisions within a portfolio, which of the following is not a factor to be considered? A) Obtaining money to invest B) Risk tolerance C) Time horizon D) Tax laws and tax rates Answer: A Solution: When making investment decisions within a portfolio, select investments consistent with risk tolerance, time horizon, and tax efficiency to your investment objectives. Format: Multiple Choice Title: Test Bank 11.1 Key Strategies for Investment Success Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 25. Which of the following is the best strategy for building sufficient wealth for retirement? A. Starting to save early and taking advantage of compound interest B. Investing at the highest rate possible C. Taking very high risks D. Working with a full-service stockbroker Answer: A

Solution: For your investment plan to be successful, you’ll need to stick to your plan, minimize transaction costs and taxes that can erode your investment earnings, and work hard to be an informed consumer. Start early and be consistent: The time value of money will benefit you the most if you get started investing as soon as possible. Taking high risks, such as always selecting the highest potential returns, will add more volatility and potential losses that will undermine the compounding of your money. Working with a discount broker, as opposed to an expensive full-service broker, will minimize transaction costs, while providing the same level of online account management, investment research, asset allocation tools, and loan availability. Format: Multiple Choice Title: Test Bank 11.1 Key Strategies for Investment Success Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 26. Justin is comparing two investments, A and B. A pays its return in interest, whereas B is a growth investment whose return is in the form of price appreciation. Assume Justin sells Investment B after one year. What is the difference between Investments A and B on an after-tax return basis after one year if Justin’s marginal tax rate is 32% and both investments are expected to earn 10% on an initial investment of $50,000? A) The after-tax return on Investment B is $850 more than A. B) The after-tax return on Investment A is $850 more than B. C) There is no difference between the two. D) The after-tax return on Investment B is $600 more than A. Answer: A Solution: The before-tax return on both investments is 10% x $50,000 = $5,000. Ordinary income from investments held in taxable accounts is taxable at your marginal tax rate. Interest and short-term capital gains are ordinary income. Longterm capital gains and dividend are taxed special long-term capital gain rates. For tax payers in the highest 37% marginal tax bracket, the special rate is 20%. For tax payers under the 12% marginal tax rate, dividends are exempt from tax. For all other tax payers, the special rate is 15%. Income Interest L.T. capital gain Income tax rate Income tax1 After-tax return

Investment A $5,000 0.32 $1,600 $3,400

Investment B $5,000 0.15 $750 $4,250

Investment B is better by $850 ($4,250 − $3,400). Note1: Income tax = Income x Income tax rate

Format: Multiple Choice Title: Test Bank 11.1 After-Tax Investment Return Calculation Section: Key Strategies for Investment Success Learning Objective: 11.1 Develop a realistic investment plan to meet your long-term financial goals, taking into account budgetary constraints, transaction costs, and taxes. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 27. A person can invest by being A) either an owner or a lender. B) an owner but not a lender. C) a lender but not an owner. D) neither an owner nor a lender. Answer: A Solution: A person can invest by being either an owner or a lender. An owner has an equity investment in the enterprise and has expectations of growth in the value of the company and potentially receives dividends. A lender has an investment of interest payments before the return of principal. Format: Multiple Choice Title: Test Bank 11.2 Understanding Your Investment Choices Section: Understanding Your Investment Choices Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 28. Which of the following would be an example of a fixed-income investment? A) Commodities B) Bonds C) Stocks D) Land Answer: B Solution: Debt investments are sometimes called fixed-income investments, because the interest is commonly paid in equal installments over time. The relative certainty of future cash flows is one of the advantages of debt investing. Bonds are debt issued

wholesale to investors and typically pay a fixed semiannual interest payment and the entire principal at maturity. Format: Multiple Choice Title: Test Bank 11.2 Major Asset Classes Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 29. Your accountant has just told you that one of your investments had a capital gain over the year. This would mean that A) the value of the investment appreciated. B) the investment paid a large dividend. C) the investment made a large interest payment. D) you received a tax refund related to the investment. Answer: A Solution: Growth in the value of your investment over time is known as a capital gain. If the investment was sold, then the capital gain is realized; otherwise, it would be considered an unrealized capital gain. Format: Multiple Choice Title: Test Bank 11.2 Capital Gain Section: Investing by Lending and by Owning Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 30. Debt investments generally earn lower returns compared to equity investments such as stocks. This is because debt investments ________ equities. A) have less risk than B) have more risk than C) have as much risk as D) are a subgroup of Answer: A Solution: Debt investments generally earn lower returns compared to equities. This is because debt investments have less risk than equities. The relationship between risk and return is one of the basic principles of finance, in that, generally, the lower the risk, the lower the return. Debt investments offer the security of receiving required contractual interest payments. However, the trade-off for this certainty is that you’ll generally earn a lower investment return on debt investments than on other investment alternatives that do not require any cash flow to the investor, such as equities.

Format: Multiple Choice Title: Test Bank 11.2 Risk and Return Section: Investing by Lending and by Owning Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 31. Which of the following is a disadvantage of debt investments? A) They tend to be less risky than many other types of investments. B) They tend to have lower liquidity than many other types of investments. C) They tend to have lower rates of return than many other types of investments. D) All of the above are disadvantages of debt investments. Answer: C Solution: The relationship between risk and return is one of the basic principles of finance, in that, generally, the lower the risk, the lower the return. Debt investments offer the security of receiving required contractual interest payments. However, the trade-off for this certainty is that you’ll generally earn a lower investment return on debt investments than on other investment alternatives that do not require any cash flow to the investor, such as equities and commodities. Liquidity is a function of the secondary market for the investment and is more correlated to the specific investment, than the broader asset class. Format: Multiple Choice Title: Test Bank 11.2 Disadvantages of Lending Section: Investing by Lending and by Owning Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 32. An investor that has an ownership interest in a business is a(n) A. debt investor. B. equity investor. C. commodity investor. D. money market investor. Answer: B Solution: An investor that has an ownership interest in a business is an equity investor. Format: Multiple Choice Title: Test Bank 11.2 Ownership Investment Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 33. Goodroad Transportation Company has earned a profit of $25 million for the year. In order to reward its shareholders, it intends to pay a total dividend of $8 million. Goodroad will pay the dividend from A) its profits. B) the original capital investment of its shareholders. C) tax refunds it gets from the taxing authority. D) the new sale of equity shares to the public. Answer: A Solution: Stock investors generally expect to make a return on their investment in the form of dividends, which are periodic distributions of profits to their shareholders. Format: Multiple Choice Title: Test Bank 11.2 Dividends Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 34. If you buy a stock at $50, and, a year later, sell the stock for $60, you have a A. $10 capital gain. B. $60 capital gain. C. $10 dividend. D. $10 yield. Answer: A Solution: The appreciation of the stock is $10 ($60 current value less $50 cost). Growth in the value of your investment over time, is also known as a capital gain. Format: Multiple Choice Title: Test Bank 11.2 Capital Gain Calculation Section: Investing by Lending and by Owning Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 35. Companies are obligated to make payments to their _____ investors. A. common stock B. preferred stock C. bond D. bond and preferred stock

Answer: C Solution: The most common long-term debt investment is a bond. A bond generally has a fixed maturity date (often 20 years or more in the future), at which time the borrower is obligated to repay the loan in full. Equity investors (either common or preferred) may receive dividends, which are periodic distributions of profits to equity investors. Dividends can be paid only if the company has funds available after paying all its other obligations. Format: Multiple Choice Title: Test Bank 11.2 Distributions to Investors Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 36. Which of the following are entitled to vote in the election of the board of directors of the company? A. Common shareholders B. Preferred shareholders C. Common and preferred shareholders D. Bondholders Answer: A Solution: Only common shareholders are entitled to vote on major issues, such as election of the board of directors of the company or merger opportunities. Format: Multiple Choice Title: Test Bank 11.2 Company Voting Rights Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 37. Dividends represent current income for _______; interest represents current income for ___________. A. bondholders; shareholders B. shareholders; bondholders C. shareholders; shareholders D. bondholders; bondholders Answer: B Solution: Stockholders receives current income on their investment in the form of dividends, which are periodic distributions of profits to shareholders. Bondholders receive current income from their loan to the company as a fixed payment of interest periodically, usually semiannually. Format: Multiple Choice

Title: Test Bank 11.2 Current Investment Income Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. Most bonds pay current income in the form of fixed A. semi-annual periodic payment of interest. B. quarterly periodic payment of interest. C. quarterly periodic payment of dividends. D. semi-annual periodic payment of dividends. Answer: A Solution: Bondholders receive current income from their loan to the company as a fixed semiannual periodic payment of interest. Format: Multiple Choice Title: Test Bank 11.2 Bond Income Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 39. A bond’s ________ is fixed for the life of the bond. A. payment of interest B. price C. yield D. current value Answer: A Solution: The bondholder is entitled to receive a fixed payment of interest periodically, usually semiannually, for the life of the bond. Because the prevailing interest rate and the perceived credit of the bond issuers can change, the current price, yield, and value of the bond will change potentially every day. Only the interest payment, principal, and maturity are fixed for life on a typical bond. Format: Multiple Choice Title: Test Bank 11.2 Bonds Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 40. Unlike common stock, preferred stock has

A. priority in dividend payment. B. a periodic dividend. C. a maturity. D. both a periodic dividend and fixed maturity date. Answer: A Solution: Similar to common stock, preferred stock represents an ownership share in the firm, pays a discretionary periodic dividend, and has no maturity date. Preferred shareholders do, however, have priority over common shareholders for dividends, which is why they are called “preferred.” Format: Multiple Choice Title: Test Bank 11.2 Common Versus Preferred Shares Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 41. Which of the following is a major difference between stock and bond investments? A) Bonds can be issued by governments but stock cannot. B) Stocks have a fixed maturity but bonds do not. C) It is possible to earn current income on bonds but not on stock. D) All of these choices are correct. Answer: A Solution: Stock investment represents a share of ownership in a business. Governments cannot be purchased and owned. Bonds are a promissory note that represents a loan, for which governments commonly issue to finance their budget deficits and expenditures. Format: Multiple Choice Title: Test Bank 11.2 Stock and Bond Investments Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 42. Melvin owns 10 20-year corporate bonds, each with a face value of $1,000. If the bonds pay an interest rate of 7.5%, how much total interest will Melvin earn before taxes in one year on this investment? A) $75 B) $100 C) $375 D) $750

Answer: D Solution: The annual interest on a bond: $1,000 principal x 0.075 stated interest rate = $75 10 bonds x $75 annual interest = $750 total annual interest Format: Multiple Choice Title: Test Bank 11.2 Bond Coupon Interest Calculation Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 43. Kramer Manufacturing wants to issue $50 million in bonds and pay interest at the rate of 5% semiannually on a face value of $1,000. Kramer will need to issue ________ bonds and pay ________ per bond in interest every six months. A) 100,000; $25 B) 500,000; $50 C) 50,000; $50 D) 50,000; $25 Answer: D Solution: The total bond issue and annual interest payment: Total bonds issued (principal) = $50 million total borrowed/$1,000 par per issue = 50,000 bonds issued Total interest payment due per bond = $1,000 principal x 0.025 semiannual coupon rate = $25 interest per bond Format: Multiple Choice Title: Test Bank 11.2 Bond Principal and Interest Calculation Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 44. Skyjet Airlines has $200 million in existing bond debt, $50 million in preferred stock, and total common stockholders' equity of $400 million. If Skyjet were to file for bankruptcy and liquidate its total assets for $500 million, Skyjet would have to pay A) $200 million to its debt holders, followed by $50 million to its preferred stockholders, and lastly, $250 million to its common stockholders. B) $400 million to its common stockholders, followed by $100 million to its debt holders. C) $50 million to its preferred stockholders, $400 million to its common stockholders, and $50 million to its debt holders.

D) $200 million to its debt holders, followed by $300 million to its common stockholders. Answer: A Solution: In the event of financial difficulties, the company must make its debt payments before paying anything to stockholders. Preferred shareholders do, however, have priority over common shareholders, which is why they are called “preferred.” Thus, after the liquidation of $500 million in company assets, the $200 million in debt will be repaid first. Then, $50 million to preferred shareholders. The remaining $250 million will be prorated to the common shareholders. Format: Multiple Choice Title: Test Bank 11.2 Liquidation of a Company Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 45. Derivative securities derive their value from the A. time value of money. B. statistical value of the underlying asset class. C. price fluctuations of the underlying asset. D. net present value of the underlying asset. Answer: C Solution: Derivative securities derive their value from the price movements of an underlying asset, such as a particular stock, bond, index, or commodity. These assets are considered to be highly speculative investments because they do not represent the actual asset but an expiring contract based on the ability to purchase or sell the underlying asset at a fixed price. Format: Multiple Choice Title: Test Bank 11.2 Derivative Securities Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Hard Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 46. The buyer of a call option has the right to ____ the underlying asset at a set price on _______. A. sell; or before the call's expiration date B. buy; or before the call's expiration date C. buy; the call's expiration date D. sell; the call's expiration date Answer: B

Solution: A buyer of a call option has the right, but not the obligation, to buy the underlying asset at a set price on or before the call’s maturity date. Format: Multiple Choice Title: Test Bank 11.2 Call Options Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 47. Which is a difference between options and futures? A. Futures contracts derive their value from the price movements, where options contracts are based on time value of money. B. Options contracts derive their value from the price movements, where futures contracts are based on time value of money. C. The buyer of an options contract is not obligated to go through with the contract. D. The buyer of a futures contract is not obligated to go through with the contract. Answer: C Solution: An options contract is like a futures contract except that the buyer is not obligated to go through with the contract to buy or sell in the future, the investor simply has the right to do so. Both options and futures contracts derive their value from the price movements of the underlying asset. Format: Multiple Choice Title: Test Bank 11.2 Options and Futures Contracts Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 48. Which of the following statements is true regarding speculative investments, such as derivatives? A) The main return on these investments is typically based on price movement. B) These investments typically require a long-term hold. C) These investments typically have large tangible asset values. D) The size of potential return on these investments is usually limited. Answer: A Solution: These assets are considered to be speculative investments because they are not actual assets. Instead, they represent a short-term expiring contract that allows investors to buy or sell the underlying asset at a fixed price, and speculators hope to make a short-term profit based on changes in the underlying asset’s price

movement during this time. Although it’s possible to make unusually large returns on speculative investments, you run the risk of quickly losing everything you’ve invested. Format: Multiple Choice Title: Test Bank 11.2 Speculative Investments Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Hard Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 49. Which of the following would be considered a commodity? A) Gold B) stock option contract C) Mortgage-backed bond D) Real estate Answer: A Solution: Commodities are raw materials, such as oil and precious metals, and agricultural products, such as corn, wheat, and sugar. Investors trade in these assets using futures and options on the respective commodity. Format: Multiple Choice Title: Test Bank 11.2 Commodities Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 50. Which of the following is the most appropriate investment for emergency funds? A) Money market securities B) Stocks C) Corporate bonds D) A diversified mix of stocks and long-term bonds Answer: A Solution: Money market securities are interest-earning investments that mature less than a year. These investments offer very low interest rates and also have very low risk. They include bank deposits and Treasury bills (T-bills) issued by the federal government. These investments are called “money market” securities because they are similar to cash in that they have very low risk of going down in value. Although stocks, bonds, and even a diversified mix can be sold to cash within a couple of days, they fluctuate in value, unlike typical money market securities, and therefore risk losing value if needed in an emergency. Format: Multiple Choice Title: Test Bank 11.2 Investment for Emergency Fund

Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Hard Bloomcode: Analysis AACSB: Reflective thinking Expected Time to Complete: 1 minute 51. Which of the following is the riskiest asset class? A) Treasury bonds B) Derivative securities C) Large company stocks D) Corporate bonds Answer: B Solution: Derivative securities are considered to be speculative investments because they are not actual investment assets. Instead, they represent a short-term expiring contract that allows investors to buy or sell the underlying asset at a fixed price, and speculators hope to make a short-term profit based on changes in the underlying asset’s price movement during this time. Although it’s possible to make unusually large returns on speculative investments, you run the risk of quickly losing everything you’ve invested. Stocks represent an ownership share in a company, and bonds are loans. Format: Multiple Choice Title: Test Bank 11.2 Riskiest Asset Class Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 52. Which of the following is the least risky asset class? A) Money market securities B) Derivative securities C) Large company stocks D) Corporate bonds Answer: A Solution: Money market securities are the least risky category of interest-earning investments. These investments offer very low interest rates and also have very low risk. They include Treasury bills (T-bills) issued by the federal government and CDs issued by banks. These investments are called “money market” securities because they are similar to cash in that they have very low risk of going down in value over short holding periods. Format: Multiple Choice Title: Test Bank 11.2 Least Risky Asset Class

Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 53. Mutual fund investors are considered A. lenders to the fund and expect to share in the income of the fund but not the growth. B. lenders to the fund and expect to share in the income and growth of the investment pool. C. owners of the fund and entitled to share in the growth of the investment pool but not the income. D. owners of the fund and entitled to share in the income and growth of the investment pool. Answer: D Solution: When you buy shares of a mutual fund, you are buying proportional ownership in all the assets held by that mutual fund. As a mutual fund investor, you’re therefore entitled to share in the income and the growth of the investment pool. Format: Multiple Choice Title: Test Bank 11.2 Mutual Funds Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 54. Which of the following would be considered a pooled investment? A) Mutual funds B) Preferred stock C) Bonds D) Common stock Answer: A Solution: Mutual funds are not actually an asset class, like stock and bonds: they are a vehicle through which investors can invest in portfolios of stocks, bonds, and other assets. When you buy shares of a mutual fund, you are buying proportional ownership in all the assets held by the investment pool. The mutual fund hires investment professionals to select and manage a portfolio of investments on behalf of the fund’s shareholders. Format: Multiple Choice Title: Test Bank 11.2 Pooled Investment

Section: Major Asset Classes Learning Objective: 11.2 Identify and define the major types of investments. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 55. In general, _____ investments provide you with _____ average rates of return over time . A. riskier; higher B. less risky; higher C. riskier; lower D. less risky; about Answer: A Solution: One of the most important concepts in investing is the relationship between return and risk. Almost all investments expose you to some amount of risk. In general, however, riskier investments provide you with higher average rates of return over time. Format: Multiple Choice Title: Test Bank 11.3 Risk Versus Return Section: The Risk-Return Trade-Off Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 56. The sacrifice of today's consumption for consumption at a later date is captured in the A) real risk-free rate. B) inflation rate. C) liquidity premium. D) maturity risk premium. Answer: A Solution: The amount of risk that you’re willing to take depends, in part, on whether you expect to be adequately rewarded for taking that risk. Even if an investment were truly risk-free, you’d still expect to be compensated for investing your money instead of being able to spend it for current consumption. Format: Multiple Choice Title: Test Bank 11.3 Opportunity Cost of Consumption Section: Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking

Expected Time to Complete: 1 minute 57. The rate of return on any investment includes A. current income earned only. B. capital gains earned only. C. both current income and any capital gains earned. D. capital gains less current income earned. Answer: C Solution: Investors expect to make money from current income generated by their investments (such as interest, dividends, or rents) and from the gains in the value of their investments over time. These are referred to collectively as the return on investment, which is usually expressed as a rate of return. The rate of return is the gain or loss on an investment over a particular period expressed as a percentage of the price paid for the investment. Format: Multiple Choice Title: Test Bank 11.3 Rate of Return Section: Rate of Return Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 58. You invest $250 into ABC Corp. stock for a price of $62.50 per share. At the end of one year, you sell your shares for $70.50 per share and you received a $1.10 per share dividend during the year. What is your return on investment for this period? A) 11.04% B) 12.36% C) 13.24% D) 14.56% Answer: D Solution: The rate of return is the gain or loss on an investment over a particular period expressed as a percentage of the price paid for the investment. The rate of return is calculated as follows: Rate of return = Current yield + Capital gain yield Rate of return =

Current income + End price − Beginning price Beginning price

Rate of return =

$1.10 + $70.50 − $62.50 = 0.1456 or 14.56% $62.50

Format: Multiple Choice Title: Test Bank 11.3 Rate of Return Calculation

Section: Rate of Return Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 59. An investment of $1 each in two different securities led to a value of $10 (Security A) and $20 (Security B), respectively, after 15 years. When comparing the rate of return earned by the two securities, it can be said that A) Security B earned a higher average annual rate of return. B) Security A earned a higher average annual rate of return. C) both securities earned the same average annual rate of return. D) it is impossible to calculate the securities rates of return based on this information. Answer: A Solution: Security B earned a higher average annual rate of return (1,900%), than Security A (900%). The rate of return is the gain or loss on an investment over a particular period expressed as a percentage of the price paid for the investment. The rate of return is calculated as: Rate of return = Current yield + Capital gain yield Rate of return =

Current income + End price − Beginning price Beginning price

Rate of return on Security A =

Rate of return on Security B =

$10 − $1 = 9.0 or 900% $1

$20 − $1 = 19.0 or 1,900% $1

Format: Multiple Choice Title: Test Bank 11.3 Comparing Rates of Return Calculation Section: Rate of Return Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Hard Bloomcode: Evaluation AACSB: Reflective thinking Expected Time to Complete: 3 minutes 60. Mindy purchased 100 shares of Fly By Wire Training Academy at $75.50 per share one year ago. She has just received a dividend of $2.50 per share and the share is selling at a price of $89.25. If Mindy sold it at this price, what was her rate of return on Fly By Wire stock over the one-year holding period? A) 21.52%

B) 18.21% C) 15.41% D) 3.31% Answer: A Solution: The rate of return is the gain or loss on an investment over a particular period expressed as a percentage of the price paid for the investment. The rate of return is calculated as follows: Rate of return = Current yield + Capital gain yield Rate of return =

Current income + End price − Beginning price Beginning price

Rate of return =

$2.50 + $89.25 − $75.50 = 0.2152 or 21.52% $75.50

Format: Multiple Choice Title: Test Bank 11.3 Rate of Return Calculation Section: Rate of Return Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 61. Based on historical performance of various investments, which of the following is considered the riskiest on the list and therefore will have the highest expected rate of return over the long-term? A) Long-term U.S. government bonds B) U.S. corporate bonds C) Small U.S. company stocks D) Large U.S. company stocks Answer: C Solution: Because there are two sources of return, current cash flow and capital gains, you need to worry about two kinds of risk that might adversely affect your ability to meet your financial goals: the risk that you won’t receive expected cash flows from the investment and the risk that the value of your investment will decline over time. Depending on the type of investment you make, you may have more or less exposure to these two types of risk. Small stocks are most prone to failure, so the risk of not receiving cash flows is fairly high. In contrast, the federal government has never defaulted on its obligation to pay interest to investors, so the risk of not getting paid is very low for Treasury bills or bonds. Format: Multiple Choice Title: Test Bank 11.3 Risky Investments over the Long-Term

Section: Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 62. A risk-averse investor will A. not invest in any high-risk securities. B. prefer to invest in low-risk securities. C. prefer to invest in an asset that would produce an expected return commensurate to the risk involved. D. not invest in low-return investments. Answer: B Solution: Not everyone is comfortable with taking investment risk. For this reason, a risk-averse investor will make sure their investments are consistent with their risk preference. Investment risk exposure should not be greater than the desire and ability to bear risk. To make this decision, a risk-averse investor will assess the expected returns and risks for each investment alternative so that the expected performance is consistent with the risk taken. Format: Multiple Choice Title: Test Bank 11.3 Risk Aversion Section: How Risk-Averse Are You Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 63. You are more likely to take on riskier investments during the _________ stage than during the ____________ phase. A. early life-cycle; wealth accumulation B. wealth accumulation; early life-cycle C. retirement; wealth accumulation D. early life-cycle; retirement Answer: B Solution: In the early life-cycle stages, you’re working on developing a foundation for the future. During this period, you “invest” in your education and career, building your human capital, an asset that will provide returns to you in the form of increased earning potential. The focus on liquidity and safety during this period of your life means that you’re less inclined to take substantial risks. During the wealth accumulation stage of the life cycle, individuals who have already established their foundations (insurance and emergency funds) tend to be more willing to take risks to accumulate the funds necessary to achieve their future goals. The focus shifts from

building human capital to building financial capital. As individuals approach retirement, their focus shifts to protecting their principal. They tend to gradually revert to being more risk-averse, probably because they realize that they have less time to recover from a loss in their investment portfolio. Format: Multiple Choice Title: Test Bank 11.3 Life-cycle Effects Section: Factors Affecting Risk Attitudes Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Hard Bloomcode: Evaluation AACSB: Reflective Thinking Expected Time to Complete: 1 minute 64. In general, families with children tend to be ______ to take financial risk. A. less willing B. more willing C. agnostic D. encouraged Answer: A Solution: In general, families with children tend to be less willing to take financial risk. This tendency may be due to their greater need for liquid emergency funds and to the high cost of raising children. Format: Multiple Choice Title: Test Bank 11.3 Factors Affecting Risk Attitudes Section: Factors Affecting Risk Attitudes Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 65. Studies have shown that investors with a college education have ________ than those without a college education. A. higher risk tolerance B. lower risk tolerance C. no significant difference in risk tolerance D. a significant difference in risk tolerance Answer: C Solution: The effect of education on risk tolerance is less clear-cut than that of some of the other factors affecting risk attitudes. Studies have not shown a significant difference between the risk-taking behavior of those with and without a college education. Format: Multiple Choice Title: Test Bank 11.3 Factors Affecting Risk Attitudes Section: Factors Affecting Risk Attitudes Learning Objective: 11.3 Compare investment alternatives based on return and risk.

Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 66. Which of the following statements concerning risk tolerance is true? A) There is some evidence that women are less inclined to take risk than men. B) Investors in the early life-cycle stages tend to be the biggest risk-takers. C) College-educated investors are lower risk-takers than investors without a college education. D) As investors approach retirement years, they take on more risk. Answer: A Solution: There is some evidence that women are less inclined to take risk than men, but this difference is less pronounced in younger generations, perhaps because the education and work experience of young men and women are more similar today than was the case in previous generations. Format: Multiple Choice Title: Test Bank 11.3 Gender Effects on Risk Tolerance Section: Factors Affecting Risk Attitudes Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 67. Which type of investor usually demands a risk premium to be willing to invest in risky assets? A. Equity investors only B. Bond investors only C. Mutual fund investors only D. All investors Answer: D Solution: Most of us are risk-averse to some extent, but we might be willing to accept a little more risk to get a little more benefit. Furthermore, all of us have a personal preference for just how much extra benefit we require. Format: Multiple Choice Title: Test Bank 11.3 How Risk-Averse Are You Section: How Risk-Averse Are You Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 68. If the inflation rate ______, your purchasing power _________.

A. increases; decreases B. decreases; decreases C. increases; increases D. decreases; remains the same Answer: A Solution: If the inflation rate increases, your purchasing power decreases. Format: Multiple Choice Title: Test Bank 11.3 Inflation Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 69. The minimum rate of return required by investors is usually called the A) nominal risk-free rate. B) nominal inflation rate. C) expected rate of return. D) expected required return. Answer: A Solution: The minimum rate of return you’d expect from any investment would include compensation for delaying consumption and for bearing inflation risk. This minimum rate of return, which is the sum of the real risk-free rate and the inflation risk premium, is usually called the nominal risk-free rate, a rate that is higher during periods of rising inflation than during periods of low inflation. Format: Multiple Choice Title: Test Bank 11.3 Minimum Rate of Return Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 70. The risk of a company becoming bankrupt is also called its A. market risk. B. default risk. C. liquidity risk D. inflation risk. Answer: B Solution: The risk that you won’t receive expected cash flows from an investment is called default risk. For equity investors, who can’t technically be defaulted on, because the company has not actually promised the investors any particular return,

there’s still the risk of business failure. In a bankruptcy proceeding, the value of an equity investment is likely to be zero. Format: Multiple Choice Title: Test Bank 11.3 Risk of Bankruptcy Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 71. Which of the following statements regarding default risk is true? A) In a bankruptcy proceeding, the value of an equity investment is likely to be zero. B) Default risk is greater for short-term securities than for long-term securities. C) In a bankruptcy proceeding, the value of a debt investment is likely to be zero. D) Default risk is greater for illiquid investments. Answer: A Solution: The risk that you won’t receive expected cash flows from an investment is called default risk. For equity investors, who can’t technically be defaulted on, because the company has not actually promised the investors any particular return, there’s still the risk of business failure. In a bankruptcy proceeding, the value of an equity investment is likely to be zero. Format: Multiple Choice Title: Test Bank 11.3 Types of Investment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 72. A bear market occurs when the market is A) generally rising. B) generally declining. C) very volatile. D) fairly stagnant. Answer: B Solution: In a recession, when businesses are cutting back on spending and unemployment rates are high, investment values tend to decline, resulting in a “bear market.” Format: Multiple Choice Title: Test Bank 11.3 Bear Market Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 73. When investors are worried about a possible "bear market," this is an example of A) default risk. B) interest-rate risk. C) liquidity risk. D) market risk. Answer: D Solution: Market risk is the risk associated with general market movements and economic conditions. In a recession, when businesses are cutting back on spending and unemployment rates are high, investment values tend to decline, resulting in a “bear market.” Format: Multiple Choice Title: Test Bank 11.3 Types of Investment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 74. Which of the following is not one of the risks equity investors normally face? A) Inflation risk B) Reinvestment risk C) Maturity risk D) Market risk Answer: C Solution: All investors face inflation, market, and reinvestment risks because the economy affects everyone. Equity investors own a share of the company and thus have no contractual maturity. Format: Multiple Choice Title: Test Bank 11.3 Types of Investment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 75. Reinvestment risk is greatest for A) short-term debt securities.

B) long-term debt securities. C) bonds. D) common stock. Answer: A Solution: Reinvestment risk is the risk that you’ll have to reinvest cash flows from an investment at a time when the rate of return has fallen. Reinvestment risk is highest for short-term debt investments. This risk is greatest during periods of higher interest rates. Format: Multiple Choice Title: Test Bank 11.3 Reinvestment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 76. The risk of not being able to convert an asset to cash without losing value is A) liquidity risk. B) reinvestment risk. C) default risk. D) market risk. Answer: A Solution: Liquidity risk is the risk that you won’t be able to convert your investment to cash on short notice without losing value. This risk is lowest for securities that have active markets with lots of buyers and sellers, as is the case for publicly traded stocks and bonds. In contrast, real estate is fairly difficult to sell on short notice because there aren’t as many buyers interested in any given property and it takes a while to finalize the transaction. Format: Multiple Choice Title: Test Bank 11.3 Types of Investment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 77. All of the following characteristics tend to increase a person’s risk-taking tendencies except A) old age. B) income. C) wealth. D) education.

Answer: A Solution: People with higher income, wealth, and education all tend to be more risk tolerant. Risk-taking changes over the life cycle. In the early life-cycle stages, you’re working on developing a foundation for the future. The focus on liquidity and safety during this period of your life means that you’re less inclined to take substantial risks. During the wealth accumulation stage of the life cycle, individuals who have already established their foundations (insurance and emergency funds) tend to be more willing to take risks to accumulate the funds necessary to achieve their future goals. The focus shifts from building human capital to building financial capital. As individuals approach retirement, their focus shifts to protecting their principal. They tend to gradually revert to being more risk-averse, probably because they realize that they have less time to recover from a loss in their investment portfolio. Format: Multiple Choice Title: Test Bank 11.3 Factors Affecting Risk Attitudes Section: Factors Affecting Risk Attitudes Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 78. Which of the following is not one of the factors affecting risk tolerance? A) Consumer confidence B) The state the person lives in C) Life-cycle effects D) Education Answer: B Solution: Individuals demonstrate wide variation in the willingness to bear investment risk. Differences in risk tolerance arise from life-cycle effects, wealth and income, family status, gender, education and experience, and consumer confidence. Format: Multiple Choice Title: Test Bank 11.3 Factors Affecting Risk Attitudes Section: Factors Affecting Risk Attitudes Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 79. A risk-averse investor will A) not accept any risk. B) accept any risk. C) only accept the risk of inflation. D) only accept higher risk to gain higher returns.

Answer: D Solution: A risk-averse person is someone who prefers to receive a certain amount of money over a gamble that would, on average, produce the same amount of money. The less you’re willing to pay, the more risk-averse you are. In other words, a riskaverse person is only willing to take a gamble if he or she gets something extra for taking the risk. Format: Multiple Choice Title: Test Bank 11.3 Risk-Averse Investor Section: How Risk-Averse Are You Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. A person is said to be risk-averse if he or she A) prefers to receive an amount of money for certain instead of taking a gamble that would, on average, produce the same amount of money. B) prefers to take a gamble that would produce, on average, a certain amount of money, instead of receiving that same amount of money for certain. C) is very comfortable with taking investment risk. D) does not require an extra risk premium for taking more risk. Answer: A Solution: A risk-averse person as someone who prefers to receive a certain amount of money over a gamble that would, on average, produce the same amount of money. The less you’re willing to pay, the more risk-averse you are. In other words, a risk-averse person is only willing to take a gamble if he or she gets something extra for taking the risk. Format: Multiple Choice Title: Test Bank 11.3 Risk Aversion Section: How Risk-Averse Are You Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Hard Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 81. An investor interested in a short-term horizon will avoid purchasing real estate, art, and collectibles due to ________ risk. A) liquidity B) interest rate C) maturity D) default Answer: A

Solution: Liquidity risk is the risk that you won’t be able to convert your investment to cash on short notice without losing value. This risk is lowest for securities that have active markets with lots of buyers and sellers, as is the case for publicly traded stocks and bonds. In contrast, real estate, art, and collectibles are fairly difficult to sell on short notice because there aren’t as many buyers interested in any given unique asset and it takes a while to finalize the transaction. Format: Multiple Choice Title: Test Bank 11.3 Types of Investment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 82. A 10-year government bond is likely to offer a higher yield than a 5-year government security because of A) interest rate risk. B) default risk. C) the real risk-free rate. D) taxation. Answer: A Solution: The longer the term to maturity, the more the price of the security is affected. This effect is commonly called interest-rate risk. Investors expect to be compensated for this risk with an interest-rate risk premium. Short-term securities have a lower interest-rate risk premium, as they provide a lower return on investment, all else being equal, than longer-term securities. Format: Multiple Choice Title: Test Bank 11.3 Types of Investment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 83. Which of the following statements is incorrect? A) Stocks provide a steady rate of return year after year with minimal fluctuations. B) U.S. government-issued securities are some of the safest securities available. C) Inflation risk is considered by the market when setting securities prices. D) Investors with a high degree of risk aversion will generally invest less in bonds. Answer: A Solution: Stocks have not provided a steady rate of return year after year with minimal fluctuations. Stocks expose investors to much greater uncertainty regarding

cash flows from current income and growth, than real estate, bonds, and money market securities. Format: Multiple Choice Title: Test Bank 11.3 Risk–Return Relationship for Various Asset Choices Section: Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 84. Gary is 60 years old, his children are grown, and is planning to retire at age 67. His retirement portfolio has about $900,000 and other wealth totals $350,000. Which of the following asset allocations would be consistent with factors affecting Gary's risk attitude and time horizon? A) Small stocks: 10 percent, large stocks: 30 percent, high-risk corporate bonds: 0 percent, corporate bonds: 55 percent, and money market funds: 5 percent B) Small stocks: 30 percent, large stocks: 40 percent, high-risk corporate bonds: 20 percent, corporate bonds: 10 percent, and money market funds: 0 percent C) Small stocks: 0 percent, large stocks: 20 percent, high-risk corporate bonds: 0 percent, corporate bonds: 10 percent, and money market funds: 70 percent D) Small stocks: 10 percent, large stocks: 60 percent, high-risk corporate bonds: 5 percent, corporate bonds: 15 percent, and money market funds: 10 percent Answer: A Solution: Gary has seven more years until his planned retirement, so he should not have a large cash reserve but fixed-income investments that may mature near his retirement age. Even if he retires at age 67, he should plan on growing his savings for another 20 years to maintain his purchasing power into his 80s, which means nearly half of his investments should be in stocks. Equities provide the best means to beat inflation and most of his stocks should be in large, less volatile companies. Thirty percent large stocks and 10% small stocks will provide the long-term growth needed to protect his purchasing power, and 55% corporate bonds will provide a targeted return of principal with current income. Format: Multiple Choice Title: Test Bank 11.3 Types of Investment Risk Section: Types of Investment Risk Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 1 minute 85. During the period 2008–2010, when the U.S. stock market went through a severe downturn, many people lost their jobs and/or their home values. The "Great Recession," as it was described by economists, led to an increase in risk aversion of most people due to

A) the aging of the population. B) lower consumer confidence. C) increases in wealth of average Americans. D) the increase of female investors. Answer: B Solution: Consumer confidence is your willingness to take risk is also related to your confidence about the future. Whether you’re worrying about the possibility of a future job loss or downturn in the economy, negative prospects for the future will make you less willing to bear risk. In the recent recession, when consumer confidence plummeted, households pulled out of the stock market in favor of less risky alternatives. Format: Multiple Choice Title: Test Bank 11.3 Effects on Market Downturn on Risk Tolerance Section: Factors Affecting Risk Attitudes Learning Objective: 11.3 Compare investment alternatives based on return and risk. Difficulty: Medium Bloomcode: Application AACSB: Reflective thinking Expected Time to Complete: 1 minute 86. The statement "Don't put all your eggs in one basket" is recommending A) active investing. B) market timing. C) diversification. D) portfolio management. Answer: C Solution: The principle of diversification is based on the same principle as the old proverb “Don’t put all your eggs in one basket.” Format: Multiple Choice Title: Test Bank 11.4 Diversification and Performance Evaluation Section: Diversification and Performance Evaluation Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 87. The principle of diversification is effective when A) a portfolio is invested in different investments and asset classes. B) securities in a portfolio belong to the same asset class. C) securities that move up or down together. D) there is only one security in the portfolio.

Answer: A Solution: The principle of diversification is effective when a portfolio is invested in different investments and asset classes, such as stocks, bonds, real estate, and cash. Format: Multiple Choice Title: Test Bank 11.4 Principle of Diversification Section: How Diversification Works Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 88. Portfolio diversification in the real world can be employed to A) reduce some of the risk of a portfolio. B) eliminate the risk of a portfolio completely. C) primarily increase the return of a portfolio. D) reduce the market risk of a portfolio. Answer: A Solution: Portfolio diversification in the real world can be employed to reduce risk of a portfolio up to a point. As you increase the number of investments in your portfolio, the variability of your overall returns will decline. That’s because many of the things that affect a given firm’s profitability are company-specific, and the ups and downs of individual investments will cancel each other out. However, after many different industries and types of companies are introduced, you’re left with market risk, the risk associated with general market movements and economic conditions. Format: Multiple Choice Title: Test Bank 11.4 How Diversification Works Section: How Diversification Works Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Hard Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 89. Diversification reduces the risk of A. the entire portfolio. B. individual securities in the portfolio. C. the entire portfolio and the individual securities in the portfolio. D. losing money in the portfolio as a whole. Answer: A Solution: Portfolio diversification in the real world can be employed to reduce risk of a portfolio up to a point. As you increase the number of investments in your portfolio,

the variability of your overall returns will decline. That’s because many of the things that affect a given firm’s profitability are company-specific, and the ups and downs of individual investments will cancel each other out. Format: Multiple Choice Title: Test Bank 11.4 How Diversification Works Section: How Diversification Works Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 90. It is ______ to completely diversify away all risk __________. A. possible; if securities are carefully selected B. impossible; because market risk remains C. possible; if inflation remains the same. D. impossible; because default risk remains Answer: B Solution: It is impossible to completely diversify away all risk because market risk remains. All investments expose you to market risk, the risk associated with general market movements and economic conditions. Format: Multiple Choice Title: Test Bank 11.4 How Diversification Works Section: How Diversification Works Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Hard Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 91. Financial advisors recommend that you invest no more than ______ percent of your total portfolio in any single investment. A) 5 B) 10 C) 15 D) 20 Answer: B Solution: As a general guideline, financial advisors recommend that you invest no more than 10 percent of your total portfolio in any single investment. Format: Multiple Choice Title: Test Bank 11.4 How Diversification Works

Section: How Diversification Works Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 92. If your investment portfolio consists of common stock in 20 different companies, you are practicing A) asset allocation. B) diversification. C) indexing. D) active investing. Answer: B Solution: As you increase the number of investments in your portfolio, the variability of your overall returns will decline. That’s because many of the things that affect a given firm’s profitability are company-specific, and the ups and downs of individual investments will cancel each other out. Diversification is to have enough investments so that all the company-specific risks average out, resulting in reduced variability of return for your total portfolio to match that of the overall market. Format: Multiple Choice Title: Test Bank 11.4 How Diversification Works Section: How Diversification Works Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 93. A comparison of two portfolios shows the following: Portfolio A is invested in stocks: 70 percent, bonds: 20 percent, and cash: 10 percent. Portfolio B is invested in stocks: 30 percent, bonds: 40 percent, and cash: 30 percent. What can be concluded about the investors to whom these portfolios belong? A) Portfolio A represents a younger person, probably in their 40s. B) Portfolio B represents a younger person, probably in their 40s. C) Portfolio B represents a very young person, probably in their late 20s. D) Portfolio A represents a retired person, probably in their late 60s. Answer: A Solution: Portfolio A, with a 70 percent dominant position in stocks, is clearly aligned for a person with a long-term investment horizon, such as a younger person. Format: Multiple Choice Title: Test Bank 11.4 Asset Allocation

Section: Asset Allocation Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 94. Active investors typically try to _______ the market, whereas passive investors attempt to _______ the market. A) perform as well as; outperform B) outperform; perform as well as C) outperform; underperform D) perform as well as; underperform Answer: B Solution: The objective of an active investor is to beat the market or to make greater returns than would normally be expected for the level of risk in the portfolio. Passive investors are happy to do as well as the market on average, earning a return that is appropriate for the portfolio risk. Format: Multiple Choice Title: Test Bank 11.4 Active Versus Passive Investing Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 95. Which of the following is not a passive investment strategy? A) Timing B) Buy-and-hold C) Indexing D) Laddering Answer: A Solution: Common passive investing strategies include buy-and-hold, indexing, dividend reinvestment, laddering, and maturity matching. Format: Multiple Choice Title: Test Bank 11.4 Passive Investing Strategies Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 96. Actively managed portfolios, such as those run by professional money managers, tend to A) outperform the market as a whole. B) underperform the market as a whole. C) perform the same as the market as a whole. D) remain uncorrelated to the market at all.

Answer: B Solution: Many studies show that long-run performance of professionally managed funds achieves lower annual returns, on average, than the market as a whole. Format: Multiple Choice Title: Test Bank 11.4 Can Active Investors Beat the Market Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 97. If a market is truly efficient, security prices reflect A) no public or private information on the company. B) all private information available on the company. C) all publicly available information on the company. D) all public and private information on the company. Answer: C Solution: Market efficiency means that, as investors use publicly available information to make buy and sell decisions, market prices adjust very quickly to be accurate reflections of security value. Format: Multiple Choice Title: Test Bank 11.4 Market Efficiency Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 98. A buy-and-hold strategy is considered an example of a(n) A) active investment strategy. B) passive investment strategy. C) market timing strategy.

D) day trading strategy. Answer: B Solution: Most passive investment strategies are types of buy-and-hold strategies. When you use a buy-and-hold strategy, you select an asset allocation appropriate for your life stage and risk tolerance and then choose a diversified set of securities within each asset class. After making your investment selections, you hold them for the long term, making changes only as necessary to maintain your asset allocation and to reflect changes in information about the assets in your portfolio. Format: Multiple Choice Title: Test Bank 11.4 Buy-and-Hold Strategy Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 99. A major advantage of a buy-and-hold strategy is A) greater expected return. B) buying securities at their lowest price. C) lower transaction costs. D) lower default risk. Answer: C Solution: The advantages of a buy-and-hold strategy are that you can capture the long-term gains for each asset class while avoiding most of the transaction costs associated with buying and selling securities. You pay less in brokerage commissions, and you defer the taxes on your gains until you choose to sell. Format: Multiple Choice Title: Test Bank 11.4 Buy-and-Hold Strategy Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 100. DRIPs allow investors to A) receive higher dividends than investors who are not in the program. B) avoid brokerage commissions on small trades. C) receive returns comparable to the index. D) purchase a collection of bonds with different maturities spread out over your investment horizon. Answer: B

Solution: Another way to stick to your plan and, at the same time, avoid brokerage commissions on small trades is to have dividends from current investments automatically invested in new shares of the same fund or company. If you hold stock in a company or mutual fund that pays regular dividends, you can usually choose to reinvest your cash dividends in the stock through a dividend reinvestment plan (DRIP). Format: Multiple Choice Title: Test Bank 11.4 DRIPs Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 101. The major advantage of dividend reinvestment programs is the A) discounted stock price. B) preferred dividend. C) higher dividend. D) avoidance of brokerage commissions. Answer: D Solution: Another way to stick to your plan and, at the same time, avoid brokerage commissions on small trades is to have dividends from current investments automatically invested in new shares of the same fund or company. If you hold stock in a company or mutual fund that pays regular dividends, you can usually choose to reinvest your cash dividends in the stock through a dividend reinvestment plan (DRIP). Format: Multiple Choice Title: Test Bank 11.4 DRIPs Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 102. A program that allows investors to automatically reinvest dividends in additional shares of stock is a A) DRIP. B) DIP. C) ESOP. D) DROP. Answer: A

Solution: A program that allows investors to automatically reinvest dividends in additional shares of stock is a DRIP. Format: Multiple Choice Title: Test Bank 11.4 DRIPs Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Easy Bloomcode: knowledge AACSB: Analytic Expected Time to Complete: 1 minute 103. The problem with timing strategies is that A) small investors are often unable to get in or out of the market when they want to due to institutional control. B) the window of opportunity for capitalizing on any new information on a company is fairly small. C) the window of opportunity for capitalizing on any new information on a company is too large. D) transaction costs will outweigh the profits from day trading. Answer: B Solution: The problem with timing strategies is that markets are efficient and prices react to news instantaneously. Because information is so easily available today and there are so many investors in the marketplace who are all trying to identify undervalued securities, the window of opportunity for capitalizing on any new information is fairly small. Format: Multiple Choice Title: Test Bank 11.4 Market Timing Strategies Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 104. The biggest problem with timing strategies is A) it is difficult to correctly predict highs and lows in the market. B) transaction costs are higher than with other active investing strategies. C) small investors are usually not able to get in and get out during market highs and lows as are institutional investors. D) taxes will be higher on your investment returns. Answer: A Solution: The biggest problem with timing strategies is the difficulty to correctly predict highs and lows in the market. The problem with timing strategies is that

markets are efficient and prices react to news instantaneously. Because information is so easily available today and there are so many investors in the marketplace who are all trying to identify undervalued securities, the window of opportunity for capitalizing on any new information is fairly small. Format: Multiple Choice Title: Test Bank 11.4 Market Timing Strategies Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 105. By increasing the number of securities in a portfolio, the variability of the portfolio A) declines. B) increases. C) remains the same. D) increases at first and then declines . Answer: A Solution: As you increase the number of investments in your portfolio, the variability of your overall returns will decline. That’s because many of the things that affect a given firm’s profitability are company-specific, and the ups and downs of individual investments will cancel each other out. Format: Multiple Choice Title: Test Bank 11.4 How Diversification Works Section: How Diversification Works Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 106. ________ is a type of investing strategy in which you purchase a collection of bonds with different maturities spread out over your investment horizon. A) Laddering B) Buy-and-hold C) Indexing D) DRIP Answer: A Solution: Laddering is a type of buy-and-hold investment strategy in which you purchase a collection of bonds with different maturities spread out over your investment horizon. Format: Multiple Choice

Title: Test Bank 11.4 Passive Investing Strategies Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 107. People who have retired still need to include stocks in their portfolios primarily in order to A) reduce the impact of inflation on their portfolio and income. B) decrease the risk in their portfolio. C) reduce the volatility of their portfolio. D) increase the liquidity of their portfolio. Answer: A Solution: People who have retired still need to include stocks in their portfolios primarily in order to reduce the impact of inflation on their portfolio. Even in retirement, you’ll want to allocate some of your money to stocks. After all, if you retire at 65 and expect to live to be 90, you’ll still have a fairly long investment horizon. Format: Multiple Choice Title: Test Bank 11.4 Asset Allocation over the Life Cycle Section: Asset Allocation Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 108. In order to assess the performance of a diversified mutual fund invested in stocks, one would use the ________ because it is a broad benchmark. A) S&P 500 Index B) Dow Jones Industrial Average (DJIA) C) NADAQ Composite Index D) Lehman Brothers United States Treasury Index Answer: A Solution: The most popular is the S&P 500 Index, which tracks the performance of 500 of the largest US companies, most of them traded on the New York Stock Exchange (NYSE). Because this index represents a broader cross section of American businesses than the DJIA, the S&P 500 is a somewhat better indicator of general stock market performance. For this reason, the S&P 500 is the benchmark most commonly used by mutual funds and money managers to assess performance. Format: Multiple Choice Title: Test Bank 11.4 Evaluating Performance Against a Benchmark

Section: Evaluating Performance Against a Benchmark Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 109. Mark believes that securities markets are efficient. He is seeking to earn returns consistent with the market index. He should A) invest as a passive investor. B) trade his portfolio actively on a daily basis. C) try and time the movements in the broad market indexes. D) buy stock options. Answer: A Solution: Market efficiency means that, as investors use publicly available information to make buy and sell decisions, market prices adjust very quickly to be accurate reflections of security value. Thus, Mark should invest as a passive investor and buyand-hold a broad stock index fund to capture the growth of the stock market. Format: Multiple Choice Title: Test Bank 11.4 Active Versus Passive Investing Section: Active versus Passive Investing Learning Objective: 11.4 Evaluate portfolio performance relative to a similarly diversified benchmark index. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute

Chapter 12 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 128 multiple choice questions

19 Q# 5 12 15 23 29 30 31 32 36 40 64 65 75 92 93 94 95 96 99

LO 12.1 LO 12.2 LO12.3 LO 12.4

38 37 25 28

30% 29% 20% 22%

Total

128

100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

29 50 15 28 3 3 128

23% 38% 12% 22% 2% 2% 100%

Easy Medium Hard

29 93 6 128

23% 72% 5% 100%

Calculations Test Bank Question

12.1 Proportionate Share of Ownership Calculation 12.1 Stock Split Calculation 12.1 Future Value of a Portfolio Calculation 12.1 Market Capitalization Calculation 12.1 Dividend Yield Calculation 12.1 Dividend Yield Calculation (quarterly dividend) 12.1 Capital Gains Yield Calculation 12.1 Capital Gains Yield Calculation (dividend distractor) 12.1 Earnings Per Share Calculation (P/E Ratio) 12.1 Rate of Return Calculation 12.2 Coupon Payment Calculation 12.2 Coupon Payment Calculation (semi-annual) 12.2 Yield to Maturity Calculation 12.3 Preferred Stock Value Calculation (dividend given) 12.3 Preferred Stock Value Calculation (dividend yield given) 12.3 Preferred Stock Evaluation Calculation 12.3 Annual Dividend Payout Calculation 12.3 Quarterly Dividend Calculation 12.3 Dividend Yield Calculation

1. Which is the best strategy for a beginning investor? A) A portfolio of individual stocks B) A portfolio of individual bonds C) A portfolio of individual stocks and bonds D) A portfolio of mutual funds Answer: D Solution: For beginning investors, investing in individual stocks and bonds is not the best strategy for achieving financial goals. There are many factors that influence stock and bond values, and more sophisticated investors may have an informational advantage over you. Diversification of your portfolio reduces your risk, so it is generally more appropriate to invest in well-diversified mutual funds rather than individual stocks and bonds. Format: Multiple Choice Title: Test Bank 12.1 Investing in Stocks and Bonds Section: Investing in Stocks and Bonds Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 2. Which of the following portfolio strategies is the riskiest? A) Investing 100 percent in a small-cap technology company B) Investing 100 percent in a blue-chip manufacturing company C) Investing equally in 20 stocks that are all in different industries D) Investing 50 percent each in a small-cap technology company and a blue-chip manufacturing company Answer: A Solution: Diversification of your portfolio reduces your risk, so it is generally more appropriate to invest in well-diversified selection of securities. The more non-correlated the particular risk of each respective investment, the less volatile the entire portfolio will be. Investing 100 percent in a small-cap technology company will be the riskiest, no diversification at all. Format: Multiple Choice Title: Test Bank 12.1 Investing in Stocks and Bonds Section: Investing in Stocks and Bonds Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective thinking Expected Time to Complete: 1 minute 3. Owners of sole proprietorships generally have ____ personal liability than owners of corporations. A) less B) more C) the same

D) no Answer: B Solution: The corporate form of organization enables the company to have many owners with limited rights and obligations. In contrast, the owners of companies organized as sole proprietorships and partnerships have more extensive rights, such as the ability to directly participate in the management of the business, but they also have greater responsibility, such as personal liability for the debts of the business. Format: Multiple Choice Title: Test Bank 12.1 What Is Common Stock? Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 4. Dell is an American computer company. The founder, Michael Dell, and global technology investment firm, Silver Lake Partners, own all of the shares of Dell. It is not possible to buy shares of Dell stock on the secondary market because Dell is a A) sole proprietorship. B) partnership. C) private corporation. D) public corporation. Answer: C Solution: A corporation is a type of business organization that exists as a legal entity separate from its owners, the shareholders. The corporate form of organization enables the company to have many owners with limited rights and obligations. Corporations can be classified as private or public. Shareholders of private corporations do not buy or sell their shares. Format: Multiple Choice Title: Test Bank 12.1 What Is Common Stock? Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 5. If you buy 100 shares in a corporation that has issued 1,000 shares, your proportionate share of ownership in the company is A) 0.01%. B) 0.1%. C) 1%. D) 10%. Answer: D

Solution: Each share of common stock represents a proportionate share of ownership in a corporation, equal to the number of shares owned divided by the total number of shares owned by all investors in the firm. 100 shares owned Proportionate share of ownership = = 0.10 or 10% 1,000 issued Format: Multiple Choice Title: Test Bank 12.1 Proportionate Share of Ownership Calculation Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 6. A common shareholder’s claim on a company’s assets is residual, meaning the shareholder has a right to share in the assets and income of the corporation only after higher-priority claims from________ are satisfied. A) bondholders B) creditors C) preferred shareholders D) All of the above. Answer: D Solution: A common shareholder’s claim on the firm is said to be a residual claim. That means the shareholder has a right to share in the assets and income of the firm only after higher-priority claims, such as interest payments on bonds, are satisfied. Format: Multiple Choice Title: Test Bank 12.1 Residual Claim Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 7. Common stockholders have A) the right to payment of reasonable dividends. B) the right to vote on all company decisions. C) limited liability. D) All of the above. Answer: C Solution: Investors who buy a company’s stock are hoping to share in the future income and growth of that company. Their investment comes with very few strings attached. Shareholders have limited rights to influence the management of the firm, but they also have limited liability for the firm’s losses. Format: Multiple Choice Title: Test Bank 12.1 What Are the Rights and Obligations of Stock Ownership?

Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 8. A stock dividend provides ___ benefit to a stockholder as a cash dividend. A) as much immediate B) not as much immediate C) the same immediate D) no Answer: B Solution: A stock dividend in place of a cash dividend, you get additional shares of the firm’s stock in proportion to the number of shares you already hold, instead of cash. While a stock dividend doesn’t immediately provide as much benefit as a cash dividend or capital gain, it has the potential to produce benefits in the future. Because all stockholders receive these additional shares, everyone’s percentage of ownership remains the same. Format: Multiple Choice Title: Test Bank 12.1 Types of Dividends Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 9. A written agreement that gives your common stock voting rights to someone else is known as a A) proxy. B) preemptive right. C) forfeit agreement. D) voting assignment. Answer: A Solution: If you own some shares but can’t go to the annual meeting, you’re allowed to pass your voting right to someone else through a written agreement called a proxy. Format: Multiple Choice Title: Test Bank 12.1 Voting Rights Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic

Expected Time to Complete: 1 minute 10. Limited liability for common shareholders means the most one can lose on a share of stock is A) the value of the share itself. B) the prorated value of the company’s debt. C) your proportionate value of the company’s debt. D) your proportionate value of the company less its debt. Answer: A Solution: Each share of common stock represents a proportionate share of ownership in a corporation, equal to the number of shares owned divided by the total number of shares owned by all investors in the firm. A corporation is a type of business organization that exists as a legal entity separate from its owners, the shareholders. The corporate form of organization enables the company to have many owners with limited liability to the extent of their ownership. Format: Multiple Choice Title: Test Bank 12.1 Shareholder Liability Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 11. The reason corporations give the preemptive right to stockholders is to A) allow them to maintain their percentage interest in the firm. B) reduce the dividend payments to the common stockholders. C) entice them into buying more shares of stock. D) keep control of the company within a small number of investors. Answer: A Solution: In some cases, shareholders are entitled to maintain their proportionate interest in a company as the number of shares outstanding increases with new issues. This allows you to have the same proportional ownership after the new stock is issued as you had before. The preemptive right protects your ownership interest in the company, which would otherwise be proportionately smaller. Format: Multiple Choice Title: Test Bank 12.1 Preemptive Rights Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 12. If you own 100 shares of stock currently selling at $50 per share and the company declares a 3 for 1 split, you will have about ______ after the split. A) 33.33 shares at $150.00

B) 50 shares at $100.00 C) 200 shares at $25.00 D) 300 shares at $16.67 Answer: D Solution: In a stock split, each shareholder gets a number of new shares in proportion to the number of shares already held. The price of each share usually adjusts so that the total value remains the same. 100 shares × $50 = $5,000 before split 300 shares × $16.667 = $5,000 after split Format: Multiple Choice Title: Test Bank 12.1 Stock Split Calculation Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 13. Which of the following statements concerning stock splits is true? A) Announcement of a stock split often causes the price to rise. B) The major reason for a stock split is to increase the shares outstanding. C) Stock splits are like stock dividends as both increase the value of the firm. D) After a stock split, the total value of shares increases. Answer: A Solution: Investors tend to view a stock split as favorable information about the company’s prospects for future growth, so the company’s market value often increases a little when a company announces a split. The logic is that management likes to keep the company’s share price below some maximum value perceived as affordable to the company’s investors. Announcement of a split is seen as a signal that management expects the stock price to continue to rise above this maximum value. Investors typically respond to the news by buying the stock and driving up the price. Format: Multiple Choice Title: Test Bank 12.1 Market Reaction to Stock Splits Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 14. When a stock split occurs, A) owners of stock end up with a lower number of shares. B) owners of stock end up with a higher number of shares C) the price of the share increases. D) the price of the share decreases.

Answer: B Solution: Corporations sometimes decide to declare a stock split, which is similar to a stock dividend in that each shareholder gets a number of new shares in proportion to the number of shares already held. The most frequent type of stock split is a two-for-one split, but three-for-one or three-for-two splits are also relatively common. Format: Multiple Choice Title: Test Bank 12.1 Stock Split Section: What Is Common Stock? Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 15. You plan to put $1,500 in an investment account today. What will it be worth in 20 years if you invest half in corporate bonds that pay 4% per year and half in corporate stock that earns 9% per year? Assume annual reinvestment of returns and round to the nearest dollar. A) $3,287 B) $5,285 C) $5,847 D) $8,406 Answer: C Solution: Calculate the future value of half the $1,500 investment ($750) for 20 years at 4% and the other half at 9%. The portfolio value will be the sum of the compound returns. Financial Calculator: Enter PVbonds = -750, N = 20, I/Y = 4, and solve for FV = 1,643.34 Enter PVstocks = -750, N = 20, I/Y = 9, and solve for FV = 4,203.31 Excel Spreadsheet: =FV(rate,nper,pmt,pv,type) FV of bonds: =FV(0.04, 20, 0, -750, 0) => 1,643.34 FV of stocks: =FV(0.09, 20, 0, -750, 0) => 4,203.31 TVM Equation: FV = PV × (1+i )n FVbond = $750 × (1+0.04 )20 = $1,643.34 FVstocks = $750 × (1+0.09 )20 = $4,203.31 PORTFOLIO VALUE WILL BE: $1,643.34 + $4,203.31 = 5,846.65 Format: Multiple Choice Title: Test Bank 12.1 Future Value of a Portfolio Calculation

Section: Advantages of Stock Investing Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 16. Consider the following potential investments, which is the most liquid? A) One-year certificate of deposit B) Checking account C) Common stock D) Corporate bond Answer: B Solution: A liquid asset is one that can be converted to cash quickly without loss of value. Any bad news, such as a product recall that will cost a company millions of dollars, can cause a stock’s value to decline rapidly. While this may be temporary, stocks and bonds cannot be placed in the same category as liquid savings and checking accounts that are agnostic to any news. Format: Multiple Choice Title: Test Bank 12.1 Liquidity Section: Advantages of Stock Investing Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 17. Which of the following is a disadvantage of common stock ownership? A) Relative liquidity B) Low interest-rate sensitivity C) Management control D) High potential long-term returns Answer: C Solution: A stock investor, particularly in a large publicly held corporation, has little power to influence the actions of management. Management can do many things that cause your share value to decline. Top managers can make business decisions that increase the company’s risk or reduce its competitive advantage. Their financial decisions might dilute your ownership interest if they issue more shares or decrease your residual interest if they take on more debt. Format: Multiple Choice Title: Test Bank 12.1 Common Stock Ownership Section: Advantages of Stock Investing Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension

AACSB: Analytic Expected Time to Complete: 1 minute 18. A stock that pays investors a regular dividend is a good example of a(n) A) cyclical stock B) income stock. C) growth stock D) defensive stock Answer: B Solution: An income stock is one that pays investors a regular dividend rather than concentrating on reinvestment of profits. Cyclical and defensive stocks are classified based on sensitivity to economic conditions and not whether they distribute regular dividends. Format: Multiple Choice Title: Test Bank 12.1 Classification of Common Stock Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 19. In the last several years, Monster Beverage Corporation’s stock price has increased substantially. The company has never paid its common shareholders a dividend. Monster Beverage Corporation can be classified as a(n) _______ stock. A) income B) growth C) cyclical D) blue-chip Answer: B Solution: Monster Beverage Corporation is a growth stock because it compensates investors primarily through increases in the value of the shares over time. An income stock is one that pays investors a regular dividend rather than concentrating on reinvestment of profits. Because these stocks pay most of their profits in dividends instead of reinvesting for future growth, there is usually less capital appreciation. Format: Multiple Choice Title: Test Bank 12.1 Classification of Common Stock Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 20. A stock issued by a large, stable, mature company is known as a(n)

A) blue-chip stock. B) growth stock. C) black chip stock. D) income stock. Answer: A Solution: A blue-chip stock is one issued by a large, stable, mature company. The earnings and growth of these multibillion-dollar companies tend to track the overall market. Blue-chip stocks may be growth or income stocks. Format: Multiple Choice Title: Test Bank 12.1 Classification of Common Stock Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 21. Cyclical firms are more likely to produce A) consumer durable goods. B) consumer staples. C) food and beverages. D) health-care products. Answer: A Solution: A cyclical stock exhibits above-average sensitivity to the business cycle, and it tends to perform well during strong economic climates and poorly in downturns. Cyclical companies include firms that produce consumer durable goods. Format: Multiple Choice Title: Test Bank 12.1 Cyclical Stocks Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 22. Which of the following two stocks is least risky, assuming it is held in a diversified portfolio? Use the information below.

Beta One-year return

ABC Corporation 2.2 8%

XYZ Corporation 0.75 8%

Five-year return

12%

A) ABC Corporation

B) XYZ Corporation C) They are equally risky. D) There is insufficient information to determine risk. Answer: B Solution: A measure commonly used to estimate the risk of stock investments held in a diversified portfolio is the beta. A stock’s beta measures its market risk. A beta equal to 1 means that the stock has the same degree of volatility as the overall market and is expected to earn a similar long-term rate of return if held in a diversified portfolio. A beta less than 1 means that the stock is less volatile than the market average and investors should expect a proportionally lower return. A beta greater than 1 means that the stock is more volatile than average and should provide a proportionally higher return. XYZ is least risky because of its low beta. Format: Multiple Choice Title: Test Bank 12.1 Measuring Market Risk Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 2 minutes 23. If a company has 1.5 million shares outstanding at $25 per share, what is its market capitalization? A) $1.5 million B) $25 million C) $37.5 million D) $75 million Answer: C Solution: Market capitalization = Current market price × Number of shares outstanding Market capitalization = $25 per share × 1.5 million shares outstanding = $37.5 million Format: Multiple Choice Title: Test Bank 12.1 Market Capitalization Calculation Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 24. A small-cap company generally has a market capitalization of less than

A) $2 billion. B) $300 million. C) $10 million. D) $2 million.

Answer: A Solution: A small-cap company generally has market capitalization of less than $2 billion. Format: Multiple Choice Title: Test Bank 12.1 Market Capitalization of Small Cap Company Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 25. Which of the following statements is false concerning small-cap firms?

A) They often pay large cash dividends. B) They tend to be more sensitive to market movements. C) They are generally young, growing companies. D) They have historically seen larger investment returns. Answer: A Solution: A small-cap company is small relative to many others and generally are young, growing companies. Although rates of return on small-cap stocks have been greater than the returns on other asset classes over time, their prices tend to be more sensitive to market movement, and the companies usually don’t pay dividends. This means that small-cap investors are subject to a lot more risk. Format: Multiple Choice Title: Test Bank 12.1 Characteristics of Small-Cap Companies Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 26. A company with market capitalization of $2.5 billion is considered a A) micro-cap company. B) small-cap company. C) mid-cap company. D) large-cap company. Answer: C Solution: Mid-cap companies have $2 billion to $10 billion in market capitalization; they’re still large but not giants. Format: Multiple Choice Title: Test Bank 12.1 Market Capitalization of Mid Cap Company Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 27. Large-cap companies have market capitalization greater than or equal to A) $10 billion. B) $1 billion. C) $100 million. D) $10 million. Answer: A Solution: Large-cap companies have market capitalization of $10 billion or more. Format: Multiple Choice Title: Test Bank 12.1 Market Capitalization of Large Cap Company Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 28. A measure of market or non-diversifiable risk is the A) beta. B) variation. C) standard deviation. D) coefficient of variation. Answer: A Solution: A measure commonly used to estimate the risk of stock investments held in a diversified portfolio is the beta. A stock’s beta measures its market risk or how much it tends to move with the overall market. The risk measured by beta is also sometimes called non-diversifiable risk because it’s the risk that remains when you’ve already diversified your portfolio. Format: Multiple Choice Title: Test Bank 12.1 Market Risk Section: Classification of Common Stock Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 29. A stock paying an annual dividend of $1.10 and selling at a price of $27.50 has a dividend yield of A) 1.0%. B) 2.5%.

C) 4.0%. D) 16%. Answer: C Solution: For stock investors, the current yield is usually called the dividend yield, because the current income to a stock investor is the annual dividend payment. Dividend yield =

Annual dividend Beginning stock price

Dividend yield =

$1.10 = 0.04 or 4% $27.50

Format: Multiple Choice Title: Test Bank 12.1 Dividend Yield Calculation Section: Measures of Common Stock Performance Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 30. If a stock is trading at $50 and has a quarterly dividend of $0.55, the dividend yield on the stock is A) 1.1%. B) 4.4%. C) 5.0%. D) 5.5%. Answer: B Solution: For stock investors, the current yield is usually called the dividend yield, because the current income to a stock investor is the annual dividend payment. Dividend yield =

Dividend yield =

Annual dividend Beginning stock price

$0.55 × 4 quarters = 0.044 or 4.4% $50.00

31. If you buy a stock at $46 and sell it one year later for $57, your capital gains yield is A) 19.3%. B) 21.4%. C) 23.9%. D) 41.8%. Answer: C Solution: The capital gain yield is the rate of return for the stock. Capital gains yield =

Annual change in stock price Beginning stock price

Capital gains yield =

$57 − $46 = 0.239 or 23.9% $46

Format: Multiple Choice Title: Test Bank 12.1 Capital Gains Yield Calculation Section: Measures of Common Stock Performance Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 32. Aliyah purchased ABC Corporation stock for $48.90 per share. She sold the stock oneyear later for $54.01 per share and collected $2.20 in dividends. What was her capital gains yield for the year? A) 5.11% B) 9.00% C) 9.46% D) 10.45% Answer: D Solution: The capital gain yield is the rate of return for the stock based on the change in price. Capital gains yield =

Capital gains yield =

Annual change in stock price Beginning stock price

$54.01 − $48.90 = 0.1045 or 10.45% $48.90

Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 33. Which of the following is false regarding earnings per share (EPS)? A) Companies with higher EPS are better investments than those with lower EPS. B) EPS provides a rough measure of a company's profitability. C) Investors commonly use EPS in their analysis of stock investments. D) Better-than-expected EPS will usually cause the stock price to rise. Answer: A Solution: Investors commonly look at financial ratios that have been found to be good indicators of future performance. Perhaps the most closely watched ratio is the company’s EPS. When a company reports better than expected earnings, its stock price tends to go up, because investors see that as a good sign for the future. EPS provides a rough measure of profitability and can be compared over time for a particular firm. However, it’s not very useful as a decision-making tool, because there isn’t a universally accepted “good” or “bad” value (as long as EPS is positive and increasing over time). Format: Multiple Choice Title: Test Bank 12.1 Earnings per Share (EPS) Section: Measures of Common Stock Performance Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 34. The EPS ratio measures the A) market capitalization to its market price . B) relationship between earnings and the market. C) investor’s proportionate share of the firm’s annual after-tax net income. D) investor’s proportionate share of the firm’s annual dividend payout. Answer: C Solution: The EPS ratio measures the proportionate share of the firm’s annual after-tax net income. Stock investors own a proportionate share of the company, so they have an interest in a proportionate share of the firm’s annual after-tax net income, commonly called earnings. Format: Multiple Choice Title: Test Bank 12.1 EPS Ratio Section: Measures of Common Stock Performance Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

35. When comparing similar firms, a high P/E ratio is often viewed as an indication that a stock is ________ . A) overpriced B) underpriced C) fairly priced D) uncorrelated Answer: A Solution: A high P/E ratio, relative to those of other similar firms, can be considered to be an indication that a stock is currently overpriced relative to similar stocks that have lower P/E ratios. If one company’s stock is half as expensive as the other’s, you’d have to conclude that the lower-priced stock was giving you a better relative level of earnings. Format: Multiple Choice Title: Test Bank 12.1 Measures of Common Stock Performance Section: P/E Valuation Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Comprehension AACSB: Reflective Thinking Expected Time to Complete: 1 minute 36. If a firm has a P/E of 12 and a current price of $48, then its EPS is A) $0.25. B) $4.00. C) $576.00. D) impossible to determine. Answer: B Solution: The price-to-earnings (P/E) ratio measures the relation of share price to earnings per share. Price per share Price to earnings ratio = Earnings per share 12 =

$48 Earnings per share

Earnings per share =

$48 = $4.00 12

Format: Multiple Choice Title: Test Bank 12.1 Earnings per Share Calculation Section: Measures of Common Stock Performance Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute

37. See-Saw, Inc., has a P/E ratio of 45, and SloMo Corporation’s P/E ratio is 12. Based on these performance measures, which stock do you expect has the better growth prospects? A) See-Saw Incorporated B) SloMo Corporation C) They have equal growth prospects. D) This cannot be determined without knowing the past price history. Answer: A Solution: The P/E ratio is seen as a measure of potential for future growth in earnings. A high P/E ratio, like See-Saw, Inc., relative to those of other similar firms, is considered a positive indicator of a firm’s potential for future growth. The implication is that investors perceive the firm as being “worth” the extra price given the expectations of growth. Format: Multiple Choice Title: Test Bank 12.1 P/E Ratio Implications Section: Measures of Common Stock Performance Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 38. When you buy bonds issued by a company, you become a(n) _______ of the company. A) owner B) lender C) partner D) shareholder Answer: B Solution: When you buy bonds, you’re a lender. A bond is a type of financial security that represents a long-term loan of money to a company or governmental entity. When you invest in a bond, you have the right to receive interest payments and to have your loan repaid in the future. Format: Multiple Choice Title: Test Bank 12.2 What Is a Bond? Section: What Is a Bond? Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 39. A bond investor is a(n)________. A) lender B) creditor C) owner D) Both A and B are correct. Answer: D

Solution: When you buy bonds, you’re a lender and creditor. A bond is a type of financial security that represents a long-term loan of money to a company or governmental entity. When you invest in a bond, you have the right to receive interest payments and to have your loan repaid in the future. Format: Multiple Choice Title: Test Bank 12.2 What Is a Bond? Section: What Is a Bond? Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 40. Marian bought $3,000 in stock and held it for one year. She paid $50 per share in cash, received no dividends, and sold the shares for $55 per share one year later. Ignoring transaction costs, what was her return on investment? A) 3% B) 5% C) 10% D) 30% Answer: C Solution: Rate of return =

Rate of return =

New price −1 Old price

$55 − 1 = 0.10 or 10% $50

Format: Multiple Choice Title: Test Bank 12.1 Rate of Return Calculation Section: Advantages of Stock Investing Learning Objective: 12.1 Describe the characteristics and classifications of common stock. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 41. Debt financing is typically _______ for a company than equity financing. A) more expensive B) less expensive C) the same cost D) exorbitant Answer: B Solution: Debt financing is usually cheaper than equity financing. Because they bear more risk than bondholders, equity investors expect to earn a higher rate of return. This expectation puts greater pressure on management to generate profits and increase the value of the firm. In contrast, a company can afford to pay its bond interest even if it’s only moderately profitable.

Format: Multiple Choice Title: Test Bank 12.2 Financing Costs Section: What Is a Bond? Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 42. Which of the following are reasons that a company might prefer to sell bonds than issue stock? A) It typically costs less to issue bonds than to issue stock. B) Interest payments on bonds are tax-deductible for the firm, whereas dividend payments are not. C) When a firm issues bonds, the percentage ownership of existing shareholders is not reduced. D) All of the above are reasons that a company might prefer issuing bonds over issuing stock. Answer: D Solution: Bond financing has more favorable cost, tax efficiency, and ownership dilution than stocks. Interest expense is tax-deductible and typically yields much less than preferred stock yield, and common equity issuance is dilutive for current shareholder ownership. Format: Multiple Choice Title: Test Bank 12.2 Bond Versus Stock Issuance Section: What Is a Bond? Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 43. Increasing the amount of debt financing used by a company will usually _______ the return to the stockholders. A) decrease B) increase C) have no effect on D) have a negative effect on Answer: B Solution: Stockholders benefit from increased debt. The effects of financial leverage associated with using borrowed funds improves the returns to existing shareholders. As long as debt is at a low rate and the company can earn a higher rate of return, the profit accrues to the residual owners, the shareholders. Format: Multiple Choice Title: Test Bank 12.2 Financial Leverage Section: What Is a Bond? Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium

Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 44. Favorable leverage occurs when the A) interest rate on debt financing is less than the rate of return earned by the firm. B) dividend rate on a stock is less than the interest rate a on bond. C) interest rate on debt financing is less than the dividend yield on a stock. D) rate of return earned by the firm is less than the interest rate on its debt financing. Answer: A Solution: Favorable leverage occurs when the interest rate on a bond is less than the rate of return earned by the firm. The effects of financial leverage associated with using borrowed funds improves the returns to existing shareholders. As long as debt is at a low rate and the company can earn a higher rate of return, the profit accrues to the residual owners, the shareholders. Format: Multiple Choice Title: Test Bank 12.2 Financial Leverage Section: What Is a Bond? Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 45. Corporate bonds are typically issued in denominations of A) $25. B) $100. C) $1,000. D) $10,000. Answer: C Solution: Corporate bonds are usually issued in denominations of $1,000 and promise semiannual interest payments based on a fixed rate. Format: Multiple Choice Title: Test Bank 12.2 Corporate bonds Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Expected Time to Complete: 1 minute 46. Which of the following types of bonds has the lowest liquidity risk? A) Treasury bonds B) corporate bonds C) municipal bonds D) All have equal liquidity risk.

Answer: A Solution: High-yield bonds, or as commonly referred as junk bonds, are substantially riskier than higher-quality bonds. This is not only because of the difference in default risk but also because of lower liquidity. Junk bonds are less actively traded and tend to be more sensitive to economic conditions. Format: Multiple Choice Title: Test Bank 12.2 Bond Risk Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 47. A U.S. government security that has an original maturity of one year or less is called a A) Treasury bond. B) Treasury note. C) Treasury bill. D) municipal bond. Answer: C Solution: The U.S. government regularly issues debt with various terms to maturity. Treasury bills have maturities of one year or less. Format: Multiple Choice Title: Test Bank 12.2 U.S. Government Debt Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 48. The interest paid on municipal bonds is always exempt from A) federal income tax. B) all state income tax. C) federal and all state income taxes. D) federal and state income tax of residency. Answer: D Solution: One of the most important features of municipal bond investments is that interest payments are exempt from federal income tax. If the investor lives in the state of issuance, the interest is usually exempt from state and local taxation as well. Format: Multiple Choice Title: Test Bank 12.2 Tax Considerations of Municipal Bonds Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

49. A municipal bond that is repaid from normal operating cash flows is a(n) A) general obligation bond. B) secured bond. C) revenue bond. D) operational bond. Answer: A Solution: For a general obligation bond, the interest and principal payments will come from the normal operating cash flows of the issuing entity, and the security for the bond is just the “full faith and credit” of that entity. Normally, general obligation bonds can be issued only by states, cities, and other entities that have taxing authority (the power to assess taxes on property, sales, or income). Format: Multiple Choice Title: Test Bank 12.2 Municipal bonds Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 50. Agency issues are issued in _______ denominations than Treasury issues and are more commonly bought by _______ investors than are Treasury securities. A) larger; individual B) larger; institutional C) smaller; individual D) smaller; institutional Answer: B Solution: Agency bonds are issued by federal agencies and backed by pools of loans, such as mortgages or student loans. Each agency specializes in a specific segment of the market, buying particular types of loans from banks and savings institutions. It finances the cost of buying the loans by borrowing the money from bond investors, such as pension funds and insurance companies, in large denominations (a minimum of $25,000). U.S. Treasuries are typically issued in $1,000 denominations. Format: Multiple Choice Title: Test Bank 12.2 Agency Versus Treasury Issues Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 51. The most common arrangement for bond coupon payments is A) fixed-rate interest paid in semiannual payments. B) floating-rate interest paid in annual payments. C) zero-coupon payments. D) indexed-rate payments. Answer: A

Solution: Most bonds pay a fixed rate of interest in semiannual installments. Format: Multiple Choice Title: Test Bank 12.2 How Interest is Paid on Bonds Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 52. A bond that has its interest payments tied to current market interest rates is called a A) market rate bond. B) floating-rate bond. C) fixed-rate bond. D) zero-coupon bond. Answer: B Solution: Floating-rate bond interest payments are tied to current market interest rates and adjusted periodically, similar to an adjustable-rate mortgage. The issuer of floatingrate bonds gains the advantage of keeping the interest it pays on the bonds close to the market rate of interest. If rates go down, investors will get a lower interest rate, but they will not be subject to large fluctuations in price. Format: Multiple Choice Title: Test Bank 12.2 Bond Coupon Rates Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 53. Which of the following is an advantage of floating-rate bonds? A) No risk of being called B) Greater resale value C) Higher interest rates D) Increased marketability Answer: A Solution: Floating-rate bond interest payments are tied to current market interest rates and adjusted periodically, similar to an adjustable-rate mortgage. The issuer of floatingrate bonds gains the advantage of keeping the interest it pays on the bonds close to the market rate of interest. Hence, there would be no reason to call these bonds for a refinance since the rates fluctuate with the prevailing market. Format: Multiple Choice Title: Test Bank 12.2 Floating Rate Bond Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 54. The annual rate of return on a zero-coupon bond investment comes from the A) interest yield. B) capital gain yield. C) interest yield and the capital gain yield. D) tax savings. Answer: B Solution: A zero-coupon bond makes no interest payments but instead is discounted at the time of sale so that the gain in value over the life of the bond will provide the bondholder with an appropriate rate of return. With this type of bond, your entire yield comes from the increase in value from the purchase date to the maturity date (capital gain yield). The price is the discounted present value of the face value, so the longer the time to maturity, the steeper the discount. Format: Multiple Choice Title: Test Bank 12.2 Zero-Coupon Return Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 55. Which of the following is false regarding zero-coupon bonds?

A) They make regular semiannual coupon payments. B) Both corporations and governments issue them. C) Their entire yield comes from capital gains. D) All of the choices are correct. Answer: A Solution: A zero-coupon bond makes no interest payments but instead is discounted at the time of sale so that the gain in value over the life of the bond will provide the bondholder with an appropriate rate of return. With this type of bond, your entire yield comes from the increase in value from the purchase date to the maturity date (capital gain yield). Zero-coupon bonds are issued by both corporations and governments, with the U.S. Treasury being the largest issuer. Format: Multiple Choice Title: Test Bank 12.2 Zero-Coupon Bonds Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 56. If you own a TIPS bond that promises an inflation-adjusted rate of return of 2.5 percent, and annual inflation is 3 percent in a given year, A) you will be paid a higher rate of interest on the bond the following year.

B) your bond’s face value in the following year will be increased by the inflation rate, resulting in an increase in the amount of interest paid. C) the dollar amount of interest you receive will go down in the following year to compensate for inflation. D) both the bond face value and the coupon rate will be increased by 3 percent the following year. Answer: B Solution: Treasury Inflation-Protected Securities (TIPS) are purchased to protect against inflation by adjusting the face value of the bond each year. If you buy a $100 face value TIPS bond that promises to pay 2.5 percent over inflation, and inflation turns out to be 3 percent the next year, the face value of the bond will increase by 3 percent to $103 and your coupon payment will be 2.5 percent of the adjusted value. Format: Multiple Choice Title: Test Bank 12.2 Inflation-Protected Bonds Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 57. If Standard & Poor's Ratings Services lowers its corporate credit rating on a particular company’s bonds from B+ to BB-, the new rating informs investors that the bonds are A) very high quality. B) high quality. C) speculative. D) in default. Answer: C Solution: Standard & Poor's speculative rating on bonds is BB. Speculative is defined by S&P as low-grade bonds. Capacity to pay interest and repay principal is speculative. Company may have some merits, but there is great uncertainty about its exposure to adverse conditions. Format: Multiple Choice Title: Test Bank 12.2 Bond Ratings and Their Meanings Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 58. Bonds that are rated BBB or better by Standard & Poor's are referred to as A) investment-grade bonds. B) risk-free bonds. C) junk bonds. D) recession-proof bonds. Answer: A

Solution: Bonds rated BBB and above in Standard & Poor’s ratings system are called investment-grade bonds, whereas those with lower ratings are called high-yield bonds or junk bonds. Format: Multiple Choice Title: Test Bank 12.2 Bond Ratings and Their Meanings Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 59. Bond rating agencies grade the lowest risk bonds as A) junk bonds. B) speculative-grade bonds. C) low-yield bonds. D) investment-grade bonds. Answer: D Solution: Bonds rated Baa and above in Moody’s system and BBB and above in Standard & Poor’s are the lowest risk bonds and are classified as investment-grade, whereas those considered speculative are called high-yield bonds or junk bonds. Format: Multiple Choice Title: Test Bank 12.2 Bond Ratings and Their Meanings Section: Types of Bonds Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 60. A trustee of a bond issue is usually A) the investment bank that sold the issue. B) the issuer’s commercial bank. C) the Federal Reserve. D) a bank trust company. Answer: D Solution: A trustee, usually a bank trust company, is hired by the bond issuer to keep an eye on the company, making sure that the bondholders’ rights are protected. The trustee enforces a bond indenture agreement that lists all of the issuing company’s obligations. Format: Multiple Choice Title: Test Bank 12.2 Trustee Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 61. How does the typical bond pay down principal?

A) Amortized monthly over the life of the issue B) Amortized at coupon dates C) Amortized annually D) Payable at maturity Answer: D Solution: The maturity date is the date on which the bond comes due—when the issuer must repay the loan in full. Format: Multiple Choice Title: Test Bank 12.2 Bond Repayment Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 62. The annual rate of interest on a bond is known as the A) face value. B) coupon rate. C) call provision. D) dividend. Answer: B Solution: The coupon rate on a bond is the fixed rate of interest that the issuer will pay the holder each year. It is quoted as a percentage of the face value. Format: Multiple Choice Title: Test Bank 12.2 Annual Rate of Interest on a Bond Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Expected Time to Complete: 1 minute 63. The coupon rate is the fixed interest rate on the bond and is quoted as a percentage of A) face value. B) current value. C) market value D) callable value. Answer: A Solution: The coupon rate on a bond is the fixed rate of interest that the issuer will pay the holder each year. It is quoted as a percentage of the face value. Format: Multiple Choice Title: Test Bank 12.2 Annual Rate of Interest on a Bond Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic

Expected Time to Complete: 1 minute 64. A corporate bond has a 9.4% annual coupon rate. The bond has a $1,000 face value and is currently selling at $900. The annual coupon payment on this bond is A) $84.60. B) $94.00. C) $97.83. D) $108.70. Answer: B Solution: The coupon rate on a bond is the fixed rate of interest that the issuer will pay the holder each year. It is quoted as a percentage of the face value. Coupon payment = Coupon rate × Face value Coupon payment = 0.094 × $1,000 = $94 Format: Multiple Choice Title: Test Bank 12.2 Coupon Payment Calculation Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 65. What amount of interest is paid per year on a 20-year, 7% coupon corporate bond with a $1,000 face value and semiannual interest payments? A) $35 B) $70 C) $1,000 D) $1,070 Answer: B Solution: The coupon rate on a bond is the fixed rate of interest that the issuer will pay the holder each year. It is quoted as a percentage of the face value. Coupon payment = Coupon rate × Face value Coupon payment = 0.07 × $1,000 = $70 Format: Multiple Choice Title: Test Bank 12.2 Coupon Payment Calculation Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 66. Corporate bonds often have a _________, a contractual term that allows the firm to repay the bond before the maturity date. A) convertible provision B) call provision

C) bearer provision D) maturity date provision Answer: B Solution: A company could reduce its interest costs by refinancing, similar to the way a homeowner reduces mortgage payments by refinancing a mortgage at a lower rate. However, a bond issuer can’t require an investor to sell back a bond unless the bond contract includes a call provision, a contractual term that allows early repayment by the issuer, often at a slight premium over the face value. Format: Multiple Choice Title: Test Bank 12.2 Prepayment of Bond Principal Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 67. The price of a convertible bond is more likely to rise when the underlying stock price A) declines. B) rises. C) declares a dividend. D) pays a dividend. Answer: B Solution: Some bond issues include a special provision that allows the bondholders to convert their bonds to shares of common stock in the future. The contract will specify how many shares a bondholder can receive for each bond. When the stock price rises, the market value of the convertible bond will also rise. Format: Multiple Choice Title: Test Bank 12.2 Convertible Bonds Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 68. The value of a bond is the discounted present value of A) the interest to be received. B) the par value of the bond. C) both the interest to be received and the par value of the bond. D) both the interest to be received and the market value of the bond. Answer: C Solution: The value of a bond is determined by the present value of its expected cash flows, which come in two forms: periodic interest payments and repayment of the principal at maturity. In combination, these two components provide bond investors with their expected return on investment or yield to maturity. Format: Multiple Choice

Title: Test Bank 12.2 Bond Valuation Section: Bond Valuation Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 69. Which of the following is not a major risk of investing in bonds? A) Tax risk B) Default risk C) reinvestment risk D) Inflation risk Answer: A Solution: Like all fixed-income debt, the investor will be exposed to credit risk of the borrower (default risk), not be able to make principal or interest payments. Because the cash flows of a bond are fixed until maturity, the investor will be exposed to inflation or risk of loss in purchasing power. Also, at maturity, the investor will be exposed to the risk of a lower reinvestment rate of the principal. Bonds do not expose the investor to any tax risk. Format: Multiple Choice Title: Test Bank 12.2 Risk in Bond Investing Section: Bond Terminology Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 70. Investors who buy bonds often do so because bonds A) have a higher return potential than stocks. B) provide a predictable income stream. C) have a higher risk than stocks. D) are risk-free. Answer: B Solution: Some investors hold bonds because they need or want a steady stream of income. When you retire, for example, you could purchase long-term bonds and live off the interest. The interest payments are usually a fixed amount for the life of the bond, so you’ll know with certainty how much income you’ll be receiving. Format: Multiple Choice Title: Test Bank 12.2 Why Do Investors Buy Bonds? Section: Why Do Investors Buy Bonds? Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute

71. Bond prices go up and down over time in response to changes in A) the consumer price index. B) the stock market. C) market interest rates. D) housing prices. Answer: C Solution: The value of a bond is determined by the present value of its expected cash flows, which come in two forms: periodic interest payments and repayment of the principal at maturity. The present value of any future cash flow will go down when market interest rates go up, and vice versa. Because bond cash flows do not change over time, an increase in market interest rates will cause bond values to decline across the board. Similarly, a decrease in market interest rates will cause an increase in bond values. Format: Multiple Choice Title: Test Bank 12.2 Bond Volatility Section: Bond Valuation Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 72. Which of the following statements regarding bonds and inflation risk is true?

A) Bond investors will require higher yields on bonds if inflation rises. B) Rising inflation will generally cause bond prices to also rise. C) Bonds are less influenced by inflation risk than are common stocks. D) Long-term bonds have less inflation risk than short-term bonds. Answer: A Solution: All loan interest rates incorporate the time value of money and credit risk. Even a risk-free borrower, such as the U.S. federal government, is required to compensate a lender for the opportunity cost of not having use of the money until the maturity of the loan. That compensation for time is the loss of purchasing power during the loan term, or commonly referred to as inflation. Thus, if inflation rises, then the base yield for all loans must rise. Format: Multiple Choice Title: Test Bank 12.2 Bonds and Inflation Section: Bond Valuation Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 73. Which of the following statements regarding bond price and interest rates is true? A) The longer the time to maturity, the greater the percentage decline in bond value for a given rise in interest rates B) The longer the time to maturity, the greater the percentage decline in bond value for a given decline in interest rates

C) The longer the time to maturity, the smaller the percentage decline in bond value for a given rise in interest rates D) The longer the time to maturity, the smaller the percentage rise in bond value for a given rise in interest rates Answer: A Solution: The longer the time to maturity, the greater the percentage decline in bond value for a given rise in interest rates. The present value of any future cash flow will go down when market interest rates go up, and vice versa. Because bond cash flows do not change over time, an increase in market interest rates will cause bond values to decline across the board. Similarly, a decrease in market interest rates will cause an increase in bond values. The longer the maturity, the more extensive this relationship will be, due to the fact that the principal is the largest cash flow to be discounted. Format: Multiple Choice Title: Test Bank 12.2 Bond Valuation Section: Bond Valuation Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 1 minute 74. Yield to maturity is a popular measure because it tells an investor A) the annualized yield they will earn if they hold the bond to maturity. B) the yield they will earn if they sell the bond today. C) how much annual interest they will receive. D) None of the above. Answer: A Solution: Long-term investors commonly evaluate their bond investments using yield to maturity (YTM), which incorporates both the coupon yield and the capital gains yield. The YTM is the annualized return on a bond, assuming that you hold the bond to maturity, receive all promised cash flows from the date of purchase, and reinvest annual payments at the same rate. Format: Multiple Choice Title: Test Bank 12.2 Yield to Maturity Section: Bond Valuation Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 75. A 7.8% coupon bond that pays interest semiannually is selling at $872, has a face value of $1,000, and matures in 12 years. What is the bond's yield to maturity? A) 3.90% B) 4.81% C) 7.80% D) 9.62%

Answer: D Solution: The yield to maturity can be calculated using the time value of money to determine the yield, based on the annuity payments (coupon payments), present value (price of bond), the future value (face value), and the number of periods to maturity. Coupon payment = Coupon rate × Face value Coupon payment = 0.078 × $1,000 face value = $78 Semiannual coupon payment = $78 / 2 = $39 Financial Calculator: Enter PV = -872, FV = 1,000, PMT = 39, N = 12x2, and solve for I = 4.81 semi-annual rate Excel Spreadsheet: =Rate(nper,pmt,pv,fv,type) =Rate(24, 39, -872, 1000, 0) => 0.0481 Multiplying semi-annual rate by 2 gives the annual yield to maturity of 9.62%. Format: Multiple Choice Title: Test Bank 12.2 Yield to Maturity Calculation Section: Bond Valuation Learning Objective: 12.2 Describe the characteristics and classifications of bonds. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 76. Preferred stock usually pays a _______ dividend based on a fixed percentage of its par value. A) monthly B) quarterly C) semiannual D) annual Answer: B Solution: Preferred stock usually pays a quarterly dividend based on a fixed percentage of its par value. Format: Multiple Choice Title: Test Bank 12.3 What Is Preferred Stock? Section: What Is Preferred Stock? Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Reflective Thinking Expected Time to Complete: 1 minute 77. Callable preferred stock generally A) pays a higher dividend than comparable noncallable preferred stock. B) pays a lower dividend than comparable noncallable preferred stock.

C) does not pay a dividend. D) pays the same dividend as a noncallable preferred stock. Answer: A Solution: Similar to call provisions on bonds, callable preferred stock gives the issuer the right to redeem its shares and essentially refinance the issue. Because this is better for the issuer and presents considerable reinvestment risk to the investor, the company will have to pay a higher dividend rate than it would for comparable noncallable preferred stock. Format: Multiple Choice Title: Test Bank 12.3 Callability Section: Contract Terms Affecting Preferred Stock Cash Flows Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 78. Convertible preferred stock allows the stockholder to convert into A) common stock of the company. B) bonds of the company. C) either common stock or bonds of the company. D) bonds and common stock of the company. Answer: A Solution: Similar to convertible bonds, preferred stock can include a feature that allows investors to convert preferred shares to common stock under certain conditions. The number of shares for which each preferred share can be exchanged is determined by contractual agreement. Format: Multiple Choice Title: Test Bank 12.3 Convertibility Section: Contract Terms Affecting Preferred Stock Cash Flows Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 79. You would expect ______ stock to carry a higher dividend rate than comparable ______ stock. A) convertible preferred; nonconvertible preferred B) nonconvertible preferred; convertible preferred C) convertible preferred; common D) common; nonconvertible preferred Answer: B Solution: Similar to convertible bonds, preferred stock can include a feature that allows investors to convert preferred shares to common stock under certain conditions. This feature is beneficial to investors in that it gives them the option of participating in the

future growth of the company like common stock. The associated cost is that the dividend rate for convertible preferred stock, like common stock, is lower than that for conventional preferred stock. Format: Multiple Choice Title: Test Bank 12.3 Yield Difference in Common and Preferred Stock Section: Contract Terms Affecting Preferred Stock Cash Flows Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. Preferred stock values, like ____, generally ________ when interest rates fall. A) bonds; move down B) bonds, move up C) common stock; remain the same D) bonds; remain the same Answer: B Solution: The most important risks faced by preferred stock investors are interest-rate risk, liquidity risk, call risk, and default risk. Like bond values, preferred stock values are sensitive to market rates of interest. The dollar amount of the dividend is constant over time, so the only thing that causes the value of the preferred stock to change is the interest rate used to discount the cash flows. Preferred stock values will move in the opposite direction of interest rates, just as bond values do. Format: Multiple Choice Title: Test Bank 12.3 The Benefits and Risks of Preferred Stock Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 81. The primary reason to invest in preferred stock is the A) potential for large capital gains. B) steady dividend stream. C) guarantee of principal return. D) lack of correlation to interest rates. Answer: B Solution: The primary attraction of preferred stock is its steady dividend stream, which provides a yield that is usually greater than the pretax yield on long-term bonds with similar risk. Format: Multiple Choice Title: Test Bank 12.3 Benefits of Preferred Stock Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 82. For preferred stock investors, the most important risk is the volatility of A) the stock market. B) interest rates. C) the issuer’s earnings. D) the real estate market. Answer: B Solution: The most important risk faced by preferred stock investors is interest-rate risk. Like bond values, preferred stock values are sensitive to market rates of interest. The dollar amount of the dividend is constant over time, so the only thing that causes the value of the preferred stock to change is the interest rate used to discount the cash flows. Preferred stock values will move in the opposite direction of interest rates, just as bond values do. Format: Multiple Choice Title: Test Bank 12.3 Risks of Preferred Stock Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 83. The ________ value is an arbitrary initial value assigned to the preferred stock shares at issuance. A) par B) call C) perpetuity D) coupon Answer: A Solution: Preferred stock par value is the term used for an arbitrary initial value assigned to the preferred stock shares at issuance, usually a round number like $25, $100, or $1,000. Unlike the face value of a bond, the par value of preferred stock is never owed to the investors. The current price of a share of preferred stock might be higher or lower than its par value and will depend on the dividend rate relative to market rates at the time. Format: Multiple Choice Title: Test Bank 12.3 Preferred Stock Values Section: What Is Preferred Stock? Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 84. ________ means that the issuing company must make payments to preferred stock holders for any missed dividends in previous years, before any new dividends can be paid to common shareholders. A) Cumulative preferred stock B) Non-preferred stock valuation C) Preferred stock valuation D) Noncumulative preferred stock Answer: A Solution: For cumulative preferred stock, the company accumulates an obligation to its preferred stock investors that must be paid in subsequent years before any dividends can be paid to common shareholders. For noncumulative preferred stock, the missed dividends are lost and never need to be repaid. Format: Multiple Choice Title: Test Bank 12.3 Preferred Stock Dividends Section: Contract Terms Affecting Preferred Stock Cash Flows Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 85. What feature of preferred stock allows issuers to buy back their shares? A) Callability B) Portability C) Convertibility D) Par value Answer: A Solution: Suppose a company issues preferred stock during a period when interest rates are relatively high, so the dividend rate is also high. Similar to call provisions on bonds, callable preferred stock gives the issuer the right to buy back its shares. Format: Multiple Choice Title: Test Bank 12.3 Contract Terms of Preferred Stock Section: Contract Terms Affecting Preferred Stock Cash Flows Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 86. What feature of preferred stock allows shareholders to change their preferred stock into common stock? A) Convertibility

B) Portability C) Callability D) Par value Answer: A Solution: Similar to convertible bonds, preferred stock can include a feature that allows investors to convert preferred shares to common stock under certain conditions. The number of shares for which each preferred share can be exchanged is determined by contractual agreement. This feature is beneficial to investors in that it gives them the option of participating in the future growth of the company if it becomes favorable to do so. Format: Multiple Choice Title: Test Bank 12.3 Contract Terms of Preferred Stock Section: Contract Terms Affecting Preferred Stock Cash Flows Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 87. Which is the primary reason investors are attracted to preferred stock? A) Steady dividend stream B) Low business risk C) Noncumulative dividends D) Callability Answer: A Solution: The primary attraction of preferred stock is its steady dividend stream, which provides a yield that is usually greater than the pretax yield on long-term bonds with similar risk. Format: Multiple Choice Title: Test Bank 12.3 Benefits of Preferred Stock Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 88. For preferred stock investors, the most important risks to consider are A) Interest-rate risk, liquidity risk, call risk, and default risk. B) stock market risk and interest-rate risk. C) stock market risk, interest-rate risk, and call risk. D) liquidity risk, default risk, and stock market risk. Answer: A Solution: The most important risks faced by preferred stock investors are interest-rate risk, liquidity risk, call risk, and default risk. Like bond values, preferred stock values are

sensitive to market rates of interest. Thus inflation, reinvestment (callable), and interest rates are of main concern. Although the credit and risk of default of the issuer is important, the overall stock market is not. Format: Multiple Choice Title: Test Bank 12.3 Risks of Preferred Stock Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 89. Riskier companies tend to pay _________ preferred stock dividends, compared to less risky companies. A) higher B) lower C) essentially the same D) no Answer: A Solution: Preferred stock dividend rates depend on the return required by investors as compensation for the risk of the investment. Riskier companies are required to compensate the investor for the additional risk, so they tend to pay higher dividends, compared to less risky companies. Format: Multiple Choice Title: Test Bank 12.3 Dividends and Risk Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 90. Who must be paid by an issuing company before preferred stockholders can be paid their dividends? A) Bondholders B) Common stockholders C) convertible preferred stockholders D) Callable preferred stockholders Answer: A Solution: Although preferred shareholders must be paid their dividends before the company can declare a dividend for the common shareholders, bondholders get paid first. Bonds have a contractual obligation to repay interest and principal at defined dates, whereas stock is a form of ownership, not an obligation. Format: Multiple Choice Title: Test Bank 12.3 The Benefits and Risks of Preferred Stock

Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 91. Preferred stock as an investment is less risky than _________ and riskier than ____________. A) bonds; common stock B) common stock; bonds C) money market accounts; common stock D) certificates of deposit; Treasury bonds Answer: B Solution: Although preferred shareholders must be paid their dividends before the company can declare a dividend for the common shareholders, bondholders get paid first. Therefore, preferred stock is generally less risky than common stock and riskier than bonds. Format: Multiple Choice Title: Test Bank 12.3 The Benefits and Risks of Preferred Stock Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 92. John is considering purchasing some preferred stock from BBCC Corp. The company pays a $3 annual dividend per share on its preferred stock, and similar risk companies are earning 7% annual returns. What should be the value of the stock per share? A) $2.10 B) $428.57 C) $21.00 D) $42.86 Answer: D Solution: Preferred stock dividends represent a special type of annuity known as a perpetuity. The series of equal payments for a perpetuity continue into infinity. We can use this equation to estimate the present value of this cash flow: Value of preferred stock =

Annual dividend Required return

Value of preferred stock =

$3 = $42.86 0.07

Format: Multiple Choice

Title: Test Bank 12.3 Preferred Stock Value Calculation Section: Preferred Stock Valuation Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 93. If a preferred stock dividend rate is 8%, the par value is $100, and the required return for similar risk securities is 7%, what is the value of the stock per share (rounded to the nearest dollar)? A) $70 B) $100 C) $114 D) $800 Answer: C Solution: Preferred stock dividends represent a special type of annuity known as a perpetuity. The series of equal payments for a perpetuity continue into infinity. We can use this equation to estimate the present value of this cash flow: Value of preferred stock =

Annual dividend Required return

Value of preferred stock =

$8 = $114.29 0.07

Format: Multiple Choice Title: Test Bank 12.3 Preferred Stock Value Calculation Section: Preferred Stock Valuation Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Hard Bloomcode: Synthesis Expected Time to Complete: 1 minute AACSB: Analytic 94. Aeryn Soon is a potential investor of Hippy Dippy Inc.’s preferred stock, which is currently selling for $475 per share. Hippy Dippy pays an annual dividend of $40, and Aeryn’s required return is 8%. Should she purchase this preferred stock? A) Yes, because the stock is undervalued by $25. B) Yes, because the stock is overvalued by $25. C) No, because the stock is undervalued by $25. D) No, because the stock is overvalued by $25. Answer: A

Solution: Preferred stock dividends represent a special type of annuity known as a perpetuity. The series of equal payments for a perpetuity continue into infinity. We can use this equation to estimate the present value of this cash flow: Value of preferred stock =

Annual dividend Required return

Value of preferred stock =

$40 = $500 0.08

The value of Hippy Dippy preferred stock should be $500 based on the Aeryn’s required rate of return, although the shares are trading at $475. She should buy the stock because its $25 undervalued. Format: Multiple Choice Title: Test Bank 12.3 Preferred Stock Evaluation Calculation Section: Preferred Stock Valuation Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 2 minutes 95. Peacekeeper Corp. is issuing preferred stock at a par value of $250 and a 12 percent dividend, paid quarterly. What is the expected annual dividend payment for this preferred stock?

A) $7.50 B) $15.00 C) $30.00 D) $60.00 Answer: C Solution: Preferred stock usually pays a quarterly dividend based on a fixed percentage of its par value. The rate is quoted as the nominal annual rate, and the amount paid each quarter is that rate divided by 4. Preferred stock par value is the term used for an arbitrary initial value assigned to the preferred stock shares at issuance. Each holder of a share of this stock will receive a dividend equal to $30 (12% of $250), with payments of $30/4 = $7.50 per quarter. Format: Multiple Choice Title: Test Bank 12.3 Annual Dividend Payout Calculation Section: What Is Preferred Stock? Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute

96. Macromicro Inc. initially issued its preferred stock at a par value of $1,000 with a 9 percent dividend rate. What is the quarterly dividend installment for purchasers of the stock? A) $2.25 B) $9.00 C) $22.50 D) $90.00 Answer: C Solution: Preferred stock usually pays a quarterly dividend based on a fixed percentage of its par value. Preferred stock par value is the term used for an arbitrary initial value assigned to the preferred stock shares at issuance. Each holder of a share of this stock will receive a dividend equal to $90 (9% of $1,000) per year, which will be paid out in installments of $22.50 per quarter per share ($90/4 quarters). Format: Multiple Choice Title: Test Bank 12.3 Quarterly Dividend Calculation Section: What Is Preferred Stock? Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 97. A share of noncallable preferred stock has a par value of $100 and pays 7 percent annual interest. Which of the following statements is true? A) The stock will pay $7 per year as long as the company is in existence. B) The stock will pay $7 in the first year, but the amount paid in future years will depend on what happens to interest rates in the future. C) The stock will pay $100 per year for 20 years. D) The stock will pay $7 per year and will pay the investors back the $100 par value at maturity. Answer: A Solution: Preferred stock usually pays a quarterly dividend based on a fixed percentage of its par value. Preferred stock par value is the term used for an arbitrary initial value assigned to the preferred stock shares at issuance. Unlike the face value of a bond, the par value of preferred stock is never owed to the investors. This company issued shares of preferred stock with a $100 par value and a 7 percent dividend rate. Each holder of a share of this stock will receive a dividend equal to $7 (7% of $100) per year. Because the shares have no maturity date, this payment stream is perpetual, continuing for as long as the company is in existence. Format: Multiple Choice Title: Test Bank 12.3 Preferred Stock Cash Flow Section: What Is Preferred Stock? Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Application

AACSB: Analytic Expected Time to Complete: 1 minute 98. Where does the yield for a buy-and-hold stock investor come from?

A) It comes entirely from the dividend cash flows. B) It comes entirely from the market price. C) Half of it comes from the dividend cash flows and half comes from the market price. D) Three-quarters of it comes from the dividend cash flow, and one quarter comes from the market price. Answer: A Solution: Investors usually expect to receive some combination of current cash flow and price appreciation in return for providing capital to a firm. A buy-and-hold stock investor will not trade his investment and, therefore, will not receive any capital gain from the holding. The investor will only have current income from dividends or a dividend yield. Format: Multiple Choice Title: Test Bank 12.3 Total Return for a Buy-and-Hold Investor Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 99. Traci knows that the price of a company’s preferred stock is $150, and she knows that the dividend is $20 per year. What is her dividend yield? A) 1.3% B) 7.5% C) 13.3% D) 30% Answer: C Format: Multiple Choice Solution: For stock investors, the current yield is usually called the dividend yield, because the current income to a stock investor is the annual dividend payment. Dividend yield =

Annual dividend Beginning stock price

Dividend yield =

$20 = 0.133 or 13.3% $150

Format: Multiple Choice Title: Test Bank 12.3 Dividend Yield Calculation Section: Preferred Stock Valuation Difficulty: Medium Bloomcode: Analysis AACSB: Analytic

Expected Time to Complete: 1 minute 100. If you purchase shares of preferred stock and interest rates on similar risk securities later go up, what will happen to the market value of your stock? A) It will increase. B) It will decrease. C) It will stay the same. D) There is insufficient information to determine what will happen. Answer: B Solution: The dollar amount of the preferred stock dividend is constant over time, so the only thing that causes the value of the stock to change is the interest rate used to discount the cash flows. Preferred rates depend on the return required by investors as compensation for the risk of the investment. Increases in the inflation rate or market interest rates can therefore increase the required returns of investors. Preferred stock values will move in the opposite direction of interest rates, just as bond values do. Format: Multiple Choice Title: Test Bank 12.3 Preferred Stock and Interest Rates Section: The Benefits and Risks of Preferred Stock Learning Objective: 12.3 Compare the features of preferred stock with those of common stock and bonds. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 101. An IPO is sold in the A) primary market. B) secondary market. C) third market. D) private placement market. Answer: A Solution: The primary market is where stocks and bonds are sold to the public by the issuers for the first time. Format: Multiple Choice Title: Test Bank 12.4 Securities Markets Section: Securities Markets Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 102. The first time that shares of stock are sold by a corporation is called a(n) A) secondary market. B) initial public offering. C) over-the-counter market. D) prospectus. Answer: B

Solution: When a company issues stock for the first time, we say that the company is “going public,” and the stock issue is called an initial public offering (IPO). Format: Multiple Choice Title: Test Bank 12.4 Initial Issuance of Stock Section: Primary Versus Secondary Market Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 103. A document that gives financial information about a new stock issue and the issuing company to potential investors is called a(n) A) proxy. B) prospectus. C) advertisement. D) public offering. Answer: B Solution: A document that gives financial information about a new stock issue and the issuing company to potential investors is called a prospectus. It is used to advertise the new stock by the investment banker. Format: Multiple Choice Title: Test Bank 12.4 IPO Information Section: Primary Versus Secondary Market Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 104. The IPO process is usually handled, or underwritten, by a(n) A) investment banker. B) commercial banker. C) stock broker. D) venture capitalist. Answer: A Solution: The IPO process is usually handled, or underwritten, by one or more investment banking firms. Format: Multiple Choice Title: Test Bank 12.4 IPO Underwriter Section: Primary Versus Secondary Market Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

105. The _________ is the largest and best-known securities exchange. A) New York Stock Exchange (NYSE) B) National Association of Securities Dealers Automated Quotations (NASDAQ) C) Over-the-counter (OTC) market D) American Stock Exchange (AMEX) Answer: A Solution: The world’s largest and best-known securities exchange is the New York Stock Exchange (NYSE). Format: Multiple Choice Title: Test Bank 12.4 Securities Exchanges Section: Securities Exchanges Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Expected Time to Complete: 1 minute 106. Which of the following is not a listing requirement for the NYSE? A) Have at least 2 million shareholders. B) Have at least $40 million in market capitalization. C) Have at least a share price of at least $4. D) Have at least $100 million in pretax earnings over the last three years. Answer: D Solution: The NYSE requirements for listing a stock is that the firm have at least 1.1 million shares outstanding, $40 million in market capitalization, a share price of at least a $4, and $10 million in pretax earnings over the last three years. Format: Multiple Choice Title: Test Bank 12.4 Listing Requirement for the NYSE Section: Securities Exchanges Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 107. The NYSE is different from the NASDAQ in that it has A) minimum requirements for listing. B) a formal physical location. C) regulation by the SEC. D) electronic trading. Answer: B Solution: Unlike the NYSE, the over-the-counter market, like NASDAQ, is not a formal exchange and doesn’t have a physical location. Otherwise, the NYSE and NASDAQ both have minimum listing requirements, electronic trading, and the largest corporations in the world listed. Format: Multiple Choice Title: Test Bank 12.4 Securities Exchanges Section: Securities Exchanges

Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 108. The bid price represents the price at which a A) seller is willing to sell a security. B) buyer is willing to buy a security. C) security last traded for the day. D) security initially traded for the day. Answer: B Solution: The bid price represents the price at which the buyer with the best price is willing to buy a security. Format: Multiple Choice Title: Test Bank 12.4 Bid Price Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 109. The most frequently traded over-the-counter (OTC) stocks are traded on the A) NYSE. B) NASDAQ. C) S&P 500. D) AMEX. Answer: B Solution: The most frequently traded OTC stocks trade on the NASDAQ, which is the second largest stock market in the world by market capitalization and was the first stock exchange to allow online trading. Format: Multiple Choice Title: Test Bank 12.4 Securities Exchanges Section: Securities Exchanges Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 110. The over-the-counter (OTC) securities market is a(n) A) electronic network used by corporations to sell securities to the general public. B) physical location used by companies to buy back securities from the public. C) electronic securities market where securities are bought and sold. D) physical location for trading securities through securities dealers. Answer: C

Solution: The over-the-counter market is not a formal exchange and doesn’t have a physical location. Instead, it’s a network of securities dealers communicating electronically to quote the prices at which they’re willing to buy or sell securities. Multiple dealers in these stocks post offers on an electronic platform to buy or sell shares at particular prices. Format: Multiple Choice Title: Test Bank 12.4 OTC Securities Market Section: Securities Exchanges Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 111. When an investor asks a broker to place a market order, the investor is offering to buy the stock at A) a predetermined price at the time the order is carried out. B) a minimum price at the time of the trade. C) a maximum price at the time the trade is made. D) the current market price at the time the trade is executed. Answer: D Solution: If you place a market order, the broker will execute your trade at whatever the market price is at the time your trade is actually received. This means it could be higher or lower than the most recent price you saw quoted. Format: Multiple Choice Title: Test Bank 12.4 Market Order Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 112. Which stock order is likely to have the most rapid execution? A) Market order B) Limit order C) Stop order D) Margin order Answer: A Solution: If you place a market order, the broker will execute your trade at whatever the market price is at the time your trade is actually received. This will mean an immediate execution; however, the trade could be higher or lower than the most recent price you saw quoted. Format: Multiple Choice Title: Test Bank 12.4 Types of Orders Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application

AACSB: Analytic Expected Time to Complete: 1 minute 113. Which is an order that is commonly used to minimize losses or protect gains on a particular stock? A) Margin order B) Stop order C) Limit order D) Market order Answer: B Solution: A stop order is commonly used to minimize losses or protect gains on a particular stock. It is essentially a market order that is triggered by the stock reaching a specific price. Format: Multiple Choice Title: Test Bank 12.4 Type of Order Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 114. If you tell your broker, “Buy 100 shares of SBUX stock for me as long as the price is no more than $70,” you are giving a A) stop order. B) limit order. C) market order. D) proxy order. Answer: B Solution: If you don’t want to pay more than $70 per share for SBUX stock, you can give a limit buy order to the broker. It essentially means to buy up to 100 shares of SBUX at $70 or better. Format: Multiple Choice Title: Test Bank 12.4 Types of Orders Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 115. When an investor borrows stock from a broker, sells it, and later buys it at a lower price on the market, this is known as A) selling short. B) insider trading. C) buying on margin. D) day trading. Answer: A

Solution: Selling short happens when you place a sell order but don’t actually have the stock to sell; instead, you borrow it from the broker. They’re betting that the price of the stock will go down so that they can buy the stock later at a lower price and make a profit on the difference. Format: Multiple Choice Title: Test Bank 12.4 Types of Orders Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 116. You would only sell short if you anticipated a A) price rise. B) price decline. C) decline in volatility. D) rise in volatility. Answer: B Solution: Selling short happens when you place a sell order but don’t actually have the stock to sell; instead, you borrow it from the broker. They’re betting that the price of the stock will decline so that they can buy the stock later at a lower price and make a profit on the difference. Format: Multiple Choice Title: Test Bank 12.4 Short Selling Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 117. The major advantage of margin trading is the A) low interest rate on the borrowed funds. B) excess return on the investment. C) better prices you get from the broker. D) lower commissions from higher volume trades. Answer: B Solution: Margin trading allows you to borrow from the brokerage firm to pay for some of your stock purchase. This is called buying on margin. Although margin trading allows you to buy more stock than you could if you used only your own money, it’s also riskier because you have to earn enough on the stock to pay back the loan plus interest. The advantage is that your return on investment is higher than it would have been if you had put up all the money for the stock. Format: Multiple Choice Title: Test Bank 12.4 Margin Trading Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 118. A margin call occurs when a brokerage firm informs a margin customer that additional funds are required A) to execute your limit order. B) to execute your stop order. C) so that you can meet the maintenance margin limit. D) so that you can meet the Federal Reserve minimum margin. Answer: C Solution: The Federal Reserve requires that the margin, the equity in the account divided by the stock value, be at least 50 percent. To guard against the possibility that the value of the stock is less than the loan amount, brokers also set a maintenance margin, such as 30 percent. Thus, if stock prices fall sufficiently, you might get a margin call from your broker requesting that you deposit additional funds into your account so that you can meet the maintenance margin limit. Format: Multiple Choice Title: Test Bank 12.4 Maintenance Margin Limit Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 119. Which securities must be registered with the Securities and Exchange Commission? A) Stocks listed on the NYSE B) Stocks traded over-the-counter C) Stocks and bonds issued by corporations greater than $100 million in sales D) All publicly traded securities Answer: D Solution: All publicly traded securities must be registered with the Securities and Exchange Commission (SEC), an independent agency of the federal government charged with enforcement of the securities laws and broad oversight of the securities market, OTC trading, brokers, and dealers. Format: Multiple Choice Title: Test Bank 12.4 Information Disclosure Requirements Section: Regulation of the Securities Markets Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 120. Which of the following is generally an advantage of a market order over a limit order? A) Faster execution

B) Lower commission charged C) Receiving a better price D) Being able to trade in larger quantities Answer: A Solution: If you place a market order, the broker will execute your trade at whatever the market price is at the time your trade is actually received. This will mean an immediate execution; however, the trade could be higher or lower than the most recent price you saw quoted. Format: Multiple Choice Title: Test Bank 12.4 Types of Orders Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 121. What is a short seller trying to do? A) Buy low and sell high. B) Buy high and sell low. C) Buy on margin and repay with borrowed funds. D) Sell on margin and repay with borrowed funds. Answer: A Solution: A short seller trying to buy low and sell high like everyone else, however, just in reverse order. Selling short happens when you place a sell order but don’t actually have the stock to sell; instead, you borrow it from the broker. They’re betting that the price of the stock will decline so that they can buy the stock later at a lower price and make a profit on the difference. Format: Multiple Choice Title: Test Bank 12.4 Long Versus Short Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 122. Which of the following statements regarding trading on margin is false? A) Margin trading is less risky than trading on a cash basis. B) Margin trading allows you to buy more stock than on a cash account. C) Margin trading can increase your return on investment more than a cash trade. D) Margin trading requires an interest payment on funds borrowed. Answer: A Solution: Margin trading allows you to borrow from the brokerage firm to pay for some of your stock purchase. This is called buying on margin. Although margin trading allows you to buy more stock than you could if you used only your own money, it’s also riskier because you have to earn enough on the stock to pay back the loan plus interest. The

advantage is that your return on investment is higher than it would have been if you had put up all the money for the stock. Margin trading is riskier than trading on a cash basis, because losses are also higher than it would have been if you had put up all the money for the stock. Format: Multiple Choice Title: Test Bank 12.4 Margin Trading Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 123. When brokers engage in excessive trading of customers’ accounts in order to increase their commissions, this is called A) churning. B) discretionary trading. C) insider trading. D) whipsawing. Answer: A Solution: Brokers make more money when they make more trades, so you run the risk that the broker might make lots of trades just to get the commissions. There are ethical restrictions on excessive trading, sometimes called churning. Format: Multiple Choice Title: Test Bank 12.4 Excessive Trading for Commissions Section: Buying and Selling Stocks and Bonds Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 124. State securities laws are referred to as A) blue sky laws. B) cloudy day laws. C) rainy day laws. D) silver lining laws. Answer: A Solution: State have its own securities laws, commonly called blue sky laws in reference to the objective of giving investors a clear view of company finances. Format: Multiple Choice Title: Test Bank 12.4 State Securities Laws Section: Regulation of the Securities Markets Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

125. What is an illegal act in which those who are privy to information about a company that isn’t available to the general public buy or sell company stock based on their information? A) Selling short B) Market loading C) Insider trading D) Margin call trading Answer: C Solution: Insider trading is an illegal act in which company “insiders,” those who are privy to information about a company that isn’t available to the general public, buy or sell company stock based on their inside information. Format: Multiple Choice Title: Test Bank 12.4 Illegal Stock Trading Section: Regulation of the Securities Markets Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 126. It is illegal for corporate insiders to

A) trade on company information not available to the public. B) sell stock in the company as long as they are insiders. C) own stock in the company in which they are insiders. D) All of the choices are correct Answer: A Solution: Although it is illegal to trade stock on insider information, it is common for employees to own and sell company stock. There are regulatory disclosure rules and restrictions on the timing of company stock transactions. Format: Multiple Choice Title: Test Bank 12.4 Illegal Stock Trading Section: Regulation of the Securities Markets Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 127. The securities industry now temporarily halts trading in the event of an unusually large drop in the market using A) circuit breaker rules. B) stop-loss orders. C) specialists' limit order books. D) trading halts. Answer: A

Solution: After the stock market crash in 1987, the securities industry made some changes to its system of self-regulation to protect against extreme market volatility. The stock market now has in place a set of so-called circuit breaker rules that stop trading for a short period of time when the market experiences a large drop. There are also some special rules for price changes on individual stocks during the first and last few minutes of the trading day, when volume is heaviest. Format: Multiple Choice Title: Test Bank 12.4 Rules for Extreme Market Volatility Section: Regulation of the Securities Markets Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 128. Issuers of public securities are required to fully disclose detailed financial reports on their performance to the SEC, in a report commonly referred to as the A) F1040. B) 10-K. C) prospectus. D) blue sky reports. Answer: B Solution: Issuers of public securities are required to fully disclose detailed financial reports on their performance to the SEC, in a report commonly referred to as the 10-K. Information disclosure helps to level the playing field for small investors and makes it easier to compare companies based on financial performance. Format: Multiple Choice Title: Test Bank 12.4 Information Disclosure Requirements Section: Regulation of the Securities Markets Learning Objective: 12.4 Describe the operation and regulation of the securities markets. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute

Chapter 13 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit Summary: 111 Multiple Choice Questions

12 Q# 4 5 43 47 48 49 54 70 76 77 99 107

LO 13.1 LO 13.2 LO13.3 LO 13.4

37 31 23 20

33% 28% 21% 18%

Total

111

100%

Knowledge Comprehension Application Analysis Evaluation Synthesis

26 39 25 11 4 6 111

23% 35% 23% 10% 4% 5% 100%

Easy Medium Hard

26 74 11 111

23% 67% 10% 100%

Calculations Test Bank Question

13.1 Net Asset Value Calculation 13.1 Net Asset Value Calculation 13.2 Sales Load Calculation 13.2 Expense Ratio Calculation 13.2 Back-end Load Calculation 13.2 Contingent Deferred Sales Charge Calculation (sliding charge) 13.2 Expense Ratio Calculation (dividend distractor) 13.3 Annual Deduction for Rental Property Calculation 13.3 Return on Real Estate Investment Calculation (purchase value) 13.3 Return on Real Estate Investment Calculation (investment value) 13.4 Annualized Return on Investment Calculation 13.4 Call Option Rate of Return Calculation

1. An investment company that pools money from many investors and invests those funds in a variety of assets is called a A) common stock. B) preferred stock. C) mutual fund. D) portfolio fund. Answer: C Solution: An investment company that pools money from many investors and invests those funds in a variety of assets is called a mutual fund. Format: Multiple Choice Title: Test Bank 13.1 Investment Company Section: What Is a Mutual Fund Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 2. The net asset value of a mutual fund is calculated as the A) market value of assets less the market value of liabilities divided by the market value of the assets. B) market value of assets less the market value of liabilities divided by the market value of the assets plus the market value of liabilities. C) market value of assets plus the market value of liabilities divided by the number of shares outstanding. D) market value of assets less the market value of liabilities divided by the number of shares outstanding. Answer: D Solution: The net asset value of a mutual fund is calculated as the market value of assets less the market value of liabilities divided by the number of shares outstanding. Format: Multiple Choice Title: Test Bank 13.1 Net Asset Value Section: What Does a Mutual Fund Investor Actually Own Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 3. Assets minus liabilities, per share, is known as

A) net asset value. B) open-end value.

C) unit investment. D) return index. Answer: A Solution: Assets minus liabilities, per share, is known as net asset value. Format: Multiple Choice Title: Test Bank 13.1 Net Asset Value Section: What Does a Mutual Fund Investor Actually Own Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 4. ABC Fund has 9 million shares outstanding. The fund's portfolio is now valued at $300 million and the fund owes $18 million to the fund advisors and $5 million for rent and wages. What is the net asset value of the fund?

A) $30.78 B) $31.33 C) $33.00 D) $34.78 Answer: A Solution: This is calculated as assets minus liabilities, per share: Net asset value =

Market value of assets − Market value of liabilities Number of shares outstanding

Net asset value =

$300 million − ($18 million + $5 million) = $30.78 9 million

A) $100 million. B) $95 million. C) $19 per share. D) $1 per share.

Answer: C Solution: This is calculated as assets minus liabilities, per share: Net asset value =

Market value of assets − Market value of liabilities Number of shares outstanding

Net asset value =

($100 million − $5 million) = $19 5 million

Format: Multiple Choice Title: Test Bank 13.1 Net Asset Value Calculation Section: What Does a Mutual Fund Investor Actually Own Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 6. The increase in ______________ have directly contributed to the growth in mutual funds over the last few decades. A) defined-benefit plans and pensions B) defined-contribution retirement plans and IRAs C) workers paying FICA taxes D) advertising by financial services companies Answer: B Solution: Mutual fund investing by individuals has dramatically increased over the last several decades. In 1980, fewer than 6 percent of households owned mutual fund shares. By 2018, nearly 44 percent were mutual fund investors and in large part due to the growth in defined-contribution retirement plans and IRAs. Format: Multiple Choice Title: Test Bank 13.1 Growth in Mutual Funds Section: Growth in the Market Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 7. What is the best explanation for the recent increase in assets held by mutual funds and other investment companies?

A) Lower tax rate on mutual funds B) Increased flow of funds into employer-sponsored plans and IRAs C) Higher savings rate D) Stock market increases

Answer: B Solution: Mutual fund investing by individuals has dramatically increased over the last several decades. In 1980, fewer than 6 percent of households owned mutual fund shares. By 2018, nearly 44 percent were mutual fund investors and in large part due to dollars flowing into open-end funds from retirement plan investors. Format: Multiple Choice Title: Test Bank 13.1 Open-End Funds Section: Growth in the Market Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 8. Since mutual funds are investment companies, federal regulations A) require less disclosure and reporting than is required of regular corporations. B) does not require financial disclosure and reporting. C) require similar disclosure and reporting that is required of regular corporations. D) does have similar disclosure rules but not require the same reporting information as regular corporations. Answer: C Solution: Investment companies must provide all potential investors with detailed disclosure information, much like the information you’d get for a stock or bond investment. The company also must make regular reports to the Securities and Exchange Commission, which regulates mutual funds. Format: Multiple Choice Title: Test Bank 13.1 Federal Regulations Section: What Is a Mutual Fund Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 9. The _________ of an open-end fund provides the only market for buying or selling the shares of the fund. A) primary market B) secondary market C) investment banker D) issuing company Answer: D Solution: The issuing company of an open-end fund provides the only market for the shares, as they are not traded on any market. The investment company is free to issue new shares at any time to raise additional funds for investment and to meet investor demand for the shares. Format: Multiple Choice

Title: Test Bank 13.1 Open-End Funds Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 10. Which fund structure does not allow for the daily creation and redemption of shares by the issuer or its trustee? A) Open-end fund B) Closed-end fund C) Exchange-traded fund D) Unit investment trust Answer: B Solution: Open-end funds continuously offers new shares for sale to the public and provides the only market for the shares. Exchange-traded funds are technically open-end funds because the company is free to issue new shares or redeem old shares to increase or decrease the number of shares outstanding. Unit investment trust has a small secondary market for shares, and the trustee will usually buy them back on request. Only closed-end funds issue a fixed number of shares that trade on a stock exchange or in the over-the-counter market. Format: Multiple Choice Title: Test Bank 13.1 Trading of Investment Companies Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 11. A closed-end fund is an investment company that

A) sells a variable number of shares based on public demand and buys them back on demand. B) issues a fixed number of shares that are bought back by the company. C) sells a variable number of shares that are traded in the secondary market. D) issues a fixed number of shares that trade on a stock exchange or in the overthe-counter market. Answer: D Solution: Closed-end funds issue a fixed number of shares that trade on a stock exchange or in the over-the-counter market. Format: Multiple Choice Title: Test Bank 13.1 Closed-End Funds

Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 12. Closed-end funds trade primarily A) through the fund company’s custodian. B) through the fund’s issuing company. C) by the fund’s investment banker. D) on major stock exchanges. Answer: D Solution: Closed-end funds trade primarily on major stock exchanges, such as the New York Stock Exchange and the NASDAQ. The market values of shares traded on the secondary market fluctuate with supply and demand and may be greater or less than the net asset value per share. Format: Multiple Choice Title: Test Bank 13.1 Closed-End Funds Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic 13. Which of the following statements is false regarding closed-end funds?

A) Closed-end funds always trade at their net asset value. B) There are far fewer closed-end funds than there are open-end funds. C) Closed-end funds have a fixed number of shares. D) Closed-end funds may trade on organized exchanges or in the over-the-counter market. Answer: A Solution: Closed-end funds trade primarily on major stock exchanges, such as the New York Stock Exchange and the NASDAQ. The market values of shares traded on the secondary market fluctuate with supply and demand and may be greater or less than the net asset value per share. Format: Multiple Choice Title: Test Bank 13.1 Closed-End Funds Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

14. There are more ________ funds today, than there are __________ funds. A) closed-end; open-end B) open-end; closed-end C) closed-end; exchange-traded D) exchange-traded; open-end Answer: B Solution: Mutual funds account for a vast majority of fund investment. In 2018, based on 2019 Factbook data from the Investment Company Institute, open-end funds account for $17.707 trillion within 9,599 funds, exchange-traded funds account for $3.371 trillion within 1,057 funds, and closed-end funds account for $250 billion within 506 funds. Format: Multiple Choice Title: Test Bank 13.1 Market Share of Funds Section: Growth in the Market Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 15. Which of the following is a characteristic of an exchange-traded fund (ETF)?

A) Shares are traded in the secondary market like shares in a closed-end fund. B) Shares trade at the net asset value like shares in an open-end fund. C) The number of shares outstanding is fixed as in a closed-end fund. D) The shares are invested only in common stock of publicly traded corporations. Answer: A Solution: An ETF combines some of the characteristics of open-end and closed-end funds. It is technically an open-end fund because the company is free to issue new shares or redeem old shares to increase or decrease the number of shares outstanding. But like a closed-end fund, an ETF is traded on an organized exchange, and share prices are determined by market forces. Format: Multiple Choice Title: Test Bank 13.1 Types of Investment Companies Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 16. Which of the following statements is false regarding exchange-traded funds? A) Many exchange-traded funds are designed to be index funds. B) Exchange-traded funds are an example of a closed-end fund.

C) Share prices on an exchange-traded fund are determined by market forces. D) All of the choices are true. Answer: B Solution: An exchange-traded fund (ETF) is technically an open-end fund because the company is free to issue new shares or redeem old shares to increase or decrease the number of shares outstanding. But like a closed-end fund, an ETF is traded on an organized exchange, and share prices are determined by market forces. Format: Multiple Choice Title: Test Bank 13.1 Exchange-Traded Funds Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 17. A unit investment trust (UIT) is an unmanaged pool of investments that is often composed of A) common stock. B) preferred stock. C) fixed-income securities. D) real estate investments.

Answer: C Solution: A UIT buys and holds a fixed portfolio of securities for a period of time that’s determined by the life of the investments in the trust, which usually are fixed-maturity debt securities. Because there isn’t any change in the portfolio over the period of investment, this type of fund is essentially unmanaged. Format: Multiple Choice Title: Test Bank 13.1 Unit Investment Trusts Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 18. Which of the following statements regarding unit investment trust is false?

A) A portfolio manager of the trust actively manages the pool of investments. B) Unit investment trust owners are issued redeemable trust certificates. C) Unit investment trusts are essentially unmanaged investments. D) The term of a unit investment trust depends on the maturities of the securities held.

Answer: A Solution: A UIT buys and holds a fixed portfolio of securities for a period of time that’s determined by the life of the investments in the trust, which usually are fixed-maturity debt securities. Because there isn’t any change in the portfolio over the period of investment, this type of fund is essentially unmanaged. The manager of the pool, called the trustee, initially purchases the pool of investments and deposits them in a trust. Owners are issued redeemable trust certificates, which entitle them to proportionate shares of any income and principal payments received by the trust and a distribution of their proportionate share of the proceeds at the termination of the trust. Format: Multiple Choice Title: Test Bank Unit Investment Trusts Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 19. By law, a REIT must have a(n) __________ strategy and have at least _______ stockholders. A) buy-and-hold; 100 B) buy-and-hold; 1,000 C) actively managed; 1,000 D) actively managed; 10,000 Answer: A Solution: A real estate investment trust (REIT) is a special type of closed-end fund that invests in real estate and mortgages. By law, a REIT must have a buy-and-hold investment strategy, a professional manager (the trustee), and at least 100 shareholders. Format: Multiple Choice Title: Test Bank 13.1 Real Estate Investment Trusts Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 20. Which of the following statements regard REITs is false?

A) Unlike UITs, REITs have a limited life span. B) Equity REITs make direct investments in rental and commercial property. C) REITs are a type of closed-end investment company. D) REITs must distribute 90 percent of taxable income to shareholders each year. Answer: A

Solution: A real estate investment trust (REIT) is a special type of closed-end fund that invests directly in rental and commercial real estate and mortgages. The trustee initially issues shares and then uses the investors’ money to buy real estate assets according to the terms of the trust, much like a unit investment trust. The difference is that the REIT doesn’t have a limited life span, because most real estate investments don’t have fixed maturities. An important factor for individual investors is that REITs must distribute 90 percent of their profits to shareholders each year. Format: Multiple Choice Title: Test Bank 13.1 Real Estate Investment Trusts Section: Types of Investment Companies Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 21. The primary objective of a growth fund is A) income. B) tax-exempt income. C) undervalued investments. D) capital appreciation.

Answer: D Solution: The primary objective of a growth fund is capital appreciation. Managers attempt to select assets that will experience above-average growth in value over time. Format: Multiple Choice Title: Test Bank 13.1 Growth Funds Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 22. Growth and income funds are primarily invested in A) defensive stocks. B) high-grade stocks and bonds with stable returns. C) growth-oriented blue-chip stocks D) value-oriented blue-chip stocks. Answer: C Solution: Growth and income funds provide reasonable income to investors while still investing in companies that have good potential for growth in value. Primarily invested in growth-oriented blue-chip stocks, these funds have generated

respectable returns over time and have been more stable than the market as a whole. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 23. A mutual fund that is focused more on reducing investment risk by investing in both stocks and bonds is called a A) value fund. B) income fund. C) balanced fund. D) growth and income fund. Answer: C Solution: A balanced fund, sometimes called a hybrid fund, provides investors with the opportunity to benefit from investments in both stocks and bonds. Because they are better diversified than funds that are entirely invested in stocks and because they tend to focus on high-grade securities, balanced funds tend to have stable returns over time. These funds are similar to income funds but focus more on reducing investment risk, rather than focus on high income. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 24. A mutual fund that invests in a mix of equity and fixed income securities that provide current cash flows is a(n)

A) growth and income fund. B) value fund. C) growth fund. D) income fund. Answer: D Solution: An income fund holds stock and bond investments that provide high current income, either in dividends or in interest. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective

Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 25. Sometimes called a hybrid fund, a ________ fund provides investors the opportunity to benefit from stocks and bonds.

A) balanced B) value C) growth and income D) value and income Answer: A Solution: A balanced fund, sometimes called a hybrid fund, provides investors with the opportunity to benefit from investments in both stocks and bonds. Because they are better diversified than funds that are entirely invested in stocks and because they tend to focus on high-grade securities, balanced funds tend to have stable returns over time. These funds are similar to income funds but focus more on reducing investment risk. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 26. The primary objective of ________ funds is capital appreciation.

A) growth B) life-cycle C) target-date D) value Answer: A Solution: The primary objective of a growth fund is capital appreciation, where a value fund is undervaluation. A life-cycle fund allocates fund assets based on the age of the investor, and a target-date fund adjusts the portfolio allocation to meet a targeted objective, such as retirement or education funding. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 27. A focus on capital appreciation would match which of the following fund classifications?

A) Growth fund B) Income fund C) Balanced fund D) Global fund Answer: A Solution: The primary objective of a growth fund is capital appreciation. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 28. A focus on assets that pay interest and/or dividends would match which of the following fund classifications?

A) Growth fund B) Income fund C) Balanced fund D) Global fund Answer: B Solution: An income fund holds stock and bond investments that provide high current income, either in dividends or in interest. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 29. A focus on a mixed portfolio of both stocks and bonds would match which of the following fund classifications? A. Growth fund B. Value fund

C. Balanced fund D. Global fund Answer: C Solution: A balanced fund, sometimes called a hybrid fund, provides investors with the opportunity to benefit from investments in both stocks and bonds. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 30. A focus on only stocks of Chinese companies would match which of the following fund classifications?

A) Sector fund B) Global fund C) SRI fund D) International fund Answer: D Solution: An international fund invests exclusively in securities from other countries, such as China. In contrast, a global fund attempts to diversify globally, investing in United States as well as foreign securities. A sector fund specializes in a particular industry or business sector, such as technology. An SRI fund selects stocks issued by companies that meet some predefined ethical and moral standard, not geography. Format: Multiple Choice Title: Test Bank 13.1 Classification by Portfolio Composition Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 31. A focus on only stocks of technology companies would match which of the following fund classifications?

A) Sector fund B) Global fund C) SRI fund D) International fund Answer: A

Solution: A sector fund specializes in a particular industry or business sector, such as technology. An SRI fund selects stocks issued by companies that meet some predefined ethical and moral standard, not industry. An international fund invests exclusively in securities from other countries. In contrast, a global fund attempts to diversify globally, investing in United States as well as foreign securities. Format: Multiple Choice Title: Test Bank 13.1 Classification by Portfolio Composition Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 32. A life-cycle fund holds assets designed to meet the needs of individuals who

A) plans to retire in 2050. B) will need funds for college costs in 2030. C) will retire at a particular age. D) believes a recession is eminent. Answer: C Solution: A life-cycle fund allocates fund assets based on the age of the investor. A target-date fund adjusts the portfolio allocation to meet a targeted objective, such as retirement or education funding. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 33. A mutual fund entirely invested in companies in the health-care industry would be considered a(n) A) global fund. B) international fund. C) SRI fund. D) sector fund. Answer: D Solution: A sector fund specializes in a particular industry or business sector, such as health care. An SRI fund selects stocks issued by companies that meet some predefined ethical and moral standard, not industry. An international fund invests exclusively in securities from other countries. In contrast, a global fund attempts to diversify globally, investing in United States as well as foreign securities. Format: Multiple Choice

Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 34. An example of a(n) ________ fund is one that invests exclusively in securities from Europe, Australasia, and Far East. A) global B) international C) target-date D) SRI Answer: B Solution: . An international fund invests exclusively in securities from other countries. In contrast, a global fund attempts to diversify globally, investing in United States as well as foreign securities. An SRI fund selects stocks issued by companies that meet some predefined ethical and moral standard, not geography. A target-date fund adjusts the portfolio allocation to meet objectives related to a particular future need for funds, such as retirement or education. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 35. A mutual fund that avoids securities issued by tobacco, alcohol and firearms related companies are A) target funds. B) life-cycle funds. C) sector funds. D) SRI funds.

Answer: D Solution: An SRI fund selects stocks issued by companies that meet some predefined ethical and moral standards. Thus, SRI funds commonly avoid securities of companies that are involved in “sin industries” such as tobacco-, alcohol-, and firearms-related companies. A sector fund does the opposite; it specializes in a particular industry or business sector, rather than avoiding. A target-date fund adjusts the portfolio allocation to meet objectives related to a particular future need

for funds, such as retirement or education, and a life-cycle funds allocates based on an age group. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 36. A socially responsible fund is a type of mutual fund that will invest only in securities issued by companies that

A) meet certain ethical and moral standards. B) have securities that highly appreciate in value. C) pay high dividends. D) produce a high total return. Answer: A Solution: : An SRI fund selects stocks issued by companies that meet some predefined ethical and moral standards. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 37. Which fund would you expect to produce the greatest returns? A) Income fund B) Balanced fund C) Growth fund D) Growth and income fund Answer: C Solution: The primary objective of a growth fund is capital appreciation. Managers attempt to select assets that will experience above-average growth in value over time. Because growing companies tend to be riskier than stable companies, growth mutual funds are more appropriate for investors who are willing to bear a little more risk to achieve a higher long-run return. Format: Multiple Choice Title: Test Bank 13.1 Classification by Investment Objective Section: Fund Classifications Learning Objective: 13.1 Distinguish different types of investment companies based on key characteristics.

Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 38. Of the following benefits of investing in mutual funds, which pertains to the ability to immediately sell your shares at market price?

A) Liquidity B) Withdrawal option C) Dividend reinvestment D) Diversification Answer: A Solution: Liquidity is the ability to convert an asset to cash without loss of value. If you need access to your money, it’s fairly easy to sell your mutual fund shares if you own a closed-end fund on the listed exchange, at the bid price. If you own shares in an open-end fund, you can always sell them back to the investment company, at the day’s net asset value per share. Format: Multiple Choice Title: Test Bank 13.2 The Advantages of Mutual Fund Investing Section: The Advantages of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 39. Compared with investing on their own, mutual funds provide small investors with

A) lower risk. B) better diversification. C) higher returns. D) all of the above. Answer: B Solution: From the point of view of individual investors, mutual funds have some advantages that make them preferable to investments in stocks, bonds, and other financial assets, such as immediate portfolio diversification. Mutual funds are broadly invested in the financial markets, so it doesn’t necessarily reduce risk or increase returns for like investments. Format: Multiple Choice Title: Test Bank 13.2 The Advantages of Mutual Fund Investing Section: The Advantages of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 40. Mutual funds allow the common investor without much initial capital to be able to ________, a strategy not easily employable among stocks and bonds unless you have large amounts of capital.

A) diversify B) designate a beneficiary C) liquidate holdings D) withdraw with no penalties Answer: A Solution: Mutual funds allow the common investor without much initial capital to be able to diversify, a strategy not easily employable among stocks and bonds unless you have large amounts of capital. Format: Multiple Choice Title: Test Bank 13.2 The Advantages of Mutual Fund Investing Section: The Advantages of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 41. One advantage of mutual funds is that their transactions cost per trade are likely to be __________ than what an individual investor would pay. A) substantially higher B) substantially lower C) incrementally higher D) incrementally lower Answer: B Solution: Because mutual funds make large-volume trades, the cost per trade for mutual funds is substantially lower than for individual investors. Format: Multiple Choice Title: Test Bank 13.2 Transaction Costs Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 42. David Palmer has decided to take control of his financial life and go through his mutual fund statements. He notices his funds pay him a few pennies a month per share, but he has not seen a check for any of that money. He also notices a small fraction of a share

purchased each month as well. What common feature of mutual funds is this scenario exhibiting?

A) Dividend reinvestment B) Withdrawal options C) Beneficiary designations D) Liquidity Answer: A Solution: Most mutual funds allow you to automatically reinvest dividends and capital gain distributions, similar to the dividend reinvestment plans for stocks. Instead of receiving immediate cash flow, you use your dividends and capital gains distributions to buy additional shares in the mutual fund. Format: Multiple Choice Title: Test Bank 13.2 The Advantages of Mutual Fund Investing Section: The Advantages of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 43. Frank Thompson purchased $1,000 of a mutual fund with a front-end load of 5%. How much did he actually invest? A) $900 B) $950 C) $995 D) $1,000 Answer: B Solution: Paying a front-end load has the effect of reducing the amount of your investment. Frank purchased $1,000 of a fund with a load of 5 percent, or $50 ($1,000 × 0.05). Thus, he paid $1,000 but only is investing $950 worth of shares ($1,000 - $50 load). Format: Multiple Choice Title: Test Bank 13.2 Sales Load Calculation Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 44. Fees paid by mutual fund shareholders may include all the following except a(n) A) 10 percent fee on excess returns. B) one-time sales charge assessed at the time of purchase.

C) annual account maintenance fee. D) exchange fee when the investor transfers money from one fund to another. Answer: A Solution: Fees paid directly by shareholders may include a one-time sales charge or commission assessed at the time of purchase, an exchange fee when an investor transfers money from one fund to another, and an annual account maintenance fee charged to cover the costs of providing services to investors who maintain small accounts. Format: Multiple Choice Title: Test Bank 13.2 Shareholder Fees Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 45. A front-end load is a sales charge that is paid A) at time of purchase. B) at the time of sale. C) annually at the anniversary of the purchase. D) quarterly on the calendar year. Answer: A Solution: A front-end load is a one-time sales charge or commission assessed at the time of purchase. Format: Multiple Choice Title: Test Bank 13.2 Front-End Load Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 46. Open-end mutual funds charge an average front-end load of A) 2 percent. B) 3 percent C) 5 percent. D) 8.5 percent. Answer: C Solution: Open-end mutual funds that are not offered through an employer-sponsored retirement plan often assess a front-end load at the time shares are purchased. The load can be as high as 8.5 percent of the purchase price of the shares. However, the average is around 5 percent, and some loads are as low as 2 percent. A fund with a load of 3 percent or less is sometimes called a low-load fund.

Format: Multiple Choice Title: Test Bank 13.2 Front-End Load Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 47. New Age Aggressive Growth fund has $250 million in total assets and paid $1.875 million in total fund expenses. What is its expense ratio? A) 0.75% B) 1.33% C) 7.50% D) 13.33%

Answer: A Solution: A fund’s expense ratio is measured by the expenses per dollar of assets under management: Total expenses Expense ratio = Total assets in fund Expense ratio =

$1.875 million = 0.0075 or 0.75% $250 million

Format: Multiple Choice Title: Test Bank 13.2 Expense Ratio Calculation Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 48. Maryanne invested $1,000 in a mutual fund three years ago and she wants to sell it online for $1,800. Her trade entry screen warns of a contingent deferred sales charge of 2%. What is the sales load? A) $12 B) $16 C) $20 D) $36 Answer: D Solution: If you sell your shares back to the fund within a certain period after the date of purchase, some funds charge a back-end load, officially known as a contingent deferred sales charge, on the proceeds of the sale. Thus, $1,800 proceeds × 0.02 load = $36.

Format: Multiple Choice Title: Test Bank 13.2 Back-End Load Calculation Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 2 minutes 49. Evelyn owns a fund that has a contingent deferred sales charge that starts at 8% if held less than one year and reduces by 1% every year the fund is held. If she purchased the fund for $10,000 and wishes to sell it after 4 years for $20,000, what would the load be? A) $400 B) $500 C) $800 D) $1,000 Answer: C Solution: If you sell your shares back to the fund within a year after purchase, the backend load, officially known as a contingent deferred sales charge, is 8% of the proceeds of the sale. After a one-year hold, the charge is 7%; after two years is 6%; after three years is 5%; and after four years is 4%. Thus, $20,000 proceeds × 0.04 load = $800. Format: Multiple Choice Title: Test Bank 13.2 Contingent Deferred Sales Charge Calculation Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 50. A no-load fund is a mutual fund that

A) does not charge any load or fees. B) does not charge a front-end or back-end load. C) has an expense ratio equal to zero. D) has an expense ratio that is less than 1 percent. Answer: B Solution: A no-load fund charges no commission at the time of purchase or at the time of sale. Instead of charging investors at the time of purchase or sale, no-load funds tend to have higher management fees and may also charge 12-1 fees. Format: Multiple Choice Title: Test Bank 13.2 No-Load Fund Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 51. A mutual fund that does not charge either a front-end or a back-end load at the time of purchase or sale A) is a no-load fund. B) is a unit fund. C) does not charge an annual management fee either. D) always has a higher return than a load fund. Answer: A Solution: A no-load fund charges no commission at the time of purchase or at the time of sale. Format: Multiple Choice Title: Test Bank 13.2 Comparing Costs Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 52. 12b-1 fees are charged to pay for A) operational expenses, such as printing and mailing, of a mutual fund. B) distribution expenses, such as sales, marketing, and advertising, of the fund. C) management fees, such as the fund’s management and transactions. D) taxes and regulatory fees, such as the SEC and FINRA fees and levies. Answer: B Solution: Annual distribution fees, commonly known as 12b-1 fees, are charged to compensate sales professionals for marketing and advertising fund shares and to compensate professional advisors for services provided to fund shareholders at the time of purchase. Format: Multiple Choice Title: Test Bank 13.2 Fund Expenses Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 53. Back-end loads generally decrease over time A) in order to equal the average cost of front-end loads. B) in order to provide an incentive for shareholders to stay in the fund.

C) due to federal regulations. D) due to dollar cost averaging. Answer: B Solution: Back-end loads often become smaller over time and are intended to encourage investors to hold onto their shares. Instead of charging investors at the time of purchase or sale, no-load funds tend to have higher management expenses. Thus, the longer an investor remains in the fund, the more the fund can earn fees in lieu of the load. Format: Multiple Choice Title: Test Bank 13.2 Back-End Load Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 54. Discovery Growth and Income fund has $600 million in total assets; it paid $21 million in dividends and $3.4 million in total fund expenses. What is its expense ratio? A) 0.57% B) 0.59% C) 3.50% D) 4.07% Answer: A Solution: A fund’s expense ratio is measured by the expenses per dollar of assets under management. Dividends are a return of profit to shareholders and not an expense. Expense ratio = Expense ratio =

Total expenses Total assets in fund

$3.4 million = 0.0057 or 0.57% $600 million

C) 8 percent back-end load (reduces 1% per year); 0.45 percent expense ratio D) 1 percent front-end load; 0.30 percent expense ratio Answer: D Solution: If you like a particular mutual fund but aren’t sure which class of shares to purchase, the most important consideration is your time horizon. Front-end loads are a one-time charge, and back-end load is also less important if you plan to hold the shares beyond the point at which it disappears, whereas management fees and 12b-1 fees are incurred on an annual basis forever. Therefore, if you plan to hold the mutual fund shares for a very long time, the relatively lowest annual fee is generally the best option. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Classes by Fee Structure Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes 56. A more actively managed mutual fund will generally have a _____ expense ratio than a fund that is ____ active. A) lower; less B) higher; less C) higher; more D) lower; not Answer: B Solution: A more actively managed mutual fund will generally have a higher expense ratio than a fund that is less active. Because a fund’s operating costs increase with its levels of research and trading, expense ratios for passive funds are usually much lower than for actively managed funds. Format: Multiple Choice Title: Test Bank 13.2 Comparing Costs Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 57. Which ETF would have the lowest expense ratio? A) Diversified Core Bond Fund B) Small-cap equity growth fund C) Money market fund D) Large-cap international equity fund Answer: C

Solution: Because a fund’s operating costs increase with its levels of research and trading expense, the small cap equity growth fund would have the most intensive research and trading expenses, followed by the international equity fund with high foreign transaction costs, then the bonds fund. Money market funds generally have the least expenses due to the low risk nature of the investments and the short time to maturity eliminates the need to trade the securities. Format: Multiple Choice Title: Test Bank 13.2 Comparing Costs Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 58. A fee charged to compensate sales professionals for the marketing and advertising of fund shares is known as a(n)

A) annual management fee. B) annual 12b-1 distribution fee. C) computerized account fee. D) redemption fee. Answer: B Solution: Annual distribution fees, commonly known as 12b-1 fees, are charged to compensate sales professionals for marketing and advertising fund shares. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Fees Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 59. Another term for back-end load is A) distribution load. B) contingent deferred sales charge. C) management load. D) operational load. Answer: B Solution: A back-end load is officially known as a contingent deferred sales charge. Format: Multiple Choice Title: Test Bank 13.2 Fund Expenses

Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 60. Different share classes within a mutual fund differ with regard to A) load type, expense ratio, and dividends paid. B) expense ratio. C) load type. D) load type and expense ratio. Answer: D Solution: Just as a corporation can sell different types of stock (common and preferred), a mutual fund can offer a menu of share classes that differ in load and expenses. For example, Class A shares usually have front-end loads of 4 to 5 percent and minimal 12b-1 fee; Class B shares carry a back-end load and impose a minimal 12b-1 fee; and Class C shares have no front-end load but carry a high 12b-1 fee. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Classes by Fee Structure Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 61. If a mutual fund offers more than one share class, this means A) share classes differ in load and expenses. B) the mutual fund is more diversified. C) each share class invests in different securities. D) this is a fund family. Answer: A Solution: Just as a corporation can sell different types of stock (common and preferred), a mutual fund can offer a menu of share classes that differ in load and expenses. For example, Class A shares usually have front-end loads of 4 to 5 percent and minimal 12b-1 fee; Class B shares carry a back-end load and impose a minimal 12b-1 fee; and Class C shares have no front-end load but carry a high 12b-1 fee. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Classes by Fee Structure Section: The Costs of Mutual Fund Investing Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension

AACSB: Analytic Expected Time to Complete: 1 minute 62. Of the four steps in the mutual fund selection process, which of the following is the first?

A) Buying shares in the selected funds B) Deciding which fund classifications are appropriate for your objective C) Identifying your investment objective D) Comparing funds based on risk and return, costs, and services Answer: C Solution: In selecting which mutual funds to purchase, you need to first identify your investment objective. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Selection Process Section: Selecting and Evaluating Mutual Funds Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 63. When a single company operates several separately managed mutual funds with different investment objectives, this is called a(n) A) asset class. B) share class. C) fund family. D) fund portfolio. Answer: C Solution: A fund family is an arrangement in which a single company, such as Fidelity Investments or Vanguard, operates a number of separately managed mutual funds with different investment objectives. Format: Multiple Choice Title: Test Bank 13.2 Many Funds from a Single Company Section: Selecting and Evaluating Mutual Funds Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 64. Investing in large-cap equity funds from different fund families reduces A) market risk. B) fund expenses. C) transaction costs.

D) default risk of fund sponsor. Answer: D Solution: Holding funds in different fund families can reduce the risk related to investment company failure or wrongdoing, though it may end up costing you a little more. Splitting your money between fund families won’t reduce market risk, though, unless you invest in funds that include different asset classes and different securities within those asset classes. There are some advantages to choosing a fund that is part of a fund family. Firms that offer families of funds often allow you to transfer money between funds within a family at little or no cost. Format: Multiple Choice Title: Test Bank 13.2 Fund Families Section: Selecting and Evaluating Mutual Funds Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 65. Which is an advantage of buying mutual funds through a “financial supermarket”? A) Ability to purchase funds from different fund families B) Easily switch funds from the same family at no cost C) Receive break-point discounts for volume purchases D) Better prices than NAV when selling back to the fund Answer: A Solution: Purchasing funds from different fund families is an advantage of buying mutual funds through a “financial supermarket.” No cost fund switches and break-point discounts only apply to funds within the same fund family. Funds redeem all shares at the NAV each trading day. Format: Multiple Choice Title: Test Bank 13.2 Fund Families Section: Selecting and Evaluating Mutual Funds Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 66. Which of the following is not an advantage of buying fund shares through a financial supermarket?

A) Ability to purchase in larger increments B) Ability to switch money from fund to fund easily C) Consolidated financial report D) Ability to purchase from several fund families

Answer: A Solution: The advantages of buying funds from “financial supermarkets” is that investors can purchase from several fund families, switch money among them easily, and still receive a consolidated financial report from the supermarket company. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Transaction Section: Selecting and Evaluating Mutual Funds Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 67. With hundreds of funds to choose from, you need to screen based on key characteristics. Which is not a key risk and return characteristic? A) Past performance B) Manager tenure C) Reinvestment of dividends D) Income or capital gains Answer: C Solution: With hundreds of funds to choose from, you need to screen based on key characteristics. Risk and return characteristics include past performance, manager tenure, and income or capital gains. Reinvestment of dividends is a service characteristic, not risk and return. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Selection Process Section: Selecting and Evaluating Mutual Funds Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 68. What federal law gave banks and insurance companies the right to create and market mutual funds? A) Financial Services Modernization Act of 1999 B) Investment Company Act of 1940 C) Financial Institutions Reform, Recovery, and Enforcement Act of 1989 D) Securities Acts Amendments of 1975 Answer: A Solution: After Congress passed the Financial Services Modernization Act in 1999, banks and insurance companies obtained the right to create and market mutual funds.

Today, most large financial institutions also have mutual fund holding companies, essentially corporations owned by the parent bank or insurer. Format: Multiple Choice Title: Test Bank 13.2 Mutual Fund Transaction Section: Selecting and Evaluating Mutual Funds Learning Objective: 13.2 Explain the advantages and costs of investing in mutual funds versus individual securities. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 69. Buying a ________ represents a direct real estate investment. A) home B) REIT C) mortgage-backed securities D) limited partnership Answer: A Solution: An investor who has made a direct real estate investment holds title to the actual property. By this definition, your home is a direct investment, but you can also invest directly in a second home, a rental apartment, vacant land, or commercial property. Format: Multiple Choice Title: Test Bank 13.3 Direct Real Estate Investment Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 70. If you purchase a residential rental property for $250,000 that includes a building worth $100,000, how much will you be able to deduct per year from your rental income if the IRS allows you to spread the cost of your initial investment over 27.5 years? A) $3,636 B) $5,455 C) $9,091 D) $12,727 Answer: A Solution: The IRS allows you to spread the cost of your initial investment in the building (not the land) over 27.5 years. Thus, $100,000 building investment divided by 27.5 years is $3,636 deduction per year from your rental income. Format: Multiple Choice Title: Test Bank 13.3 Annual Deduction for Rental Property Calculation Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments

Difficulty: Hard Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 71. Which is a disadvantage of direct real estate investments? A) After-tax cash flows B) Price appreciation C) Liquidity D) Leverage Answer: C Solution: The lack of liquidity is a disadvantage of direct real estate investments. There isn’t an active secondary market like for stocks and bonds, where you can sell your direct real estate investments. In any given area, only a limited number of potential buyers exist, particularly for more expensive properties, and it typically takes three to six months to find a buyer and close the deal. Even if you do find a buyer, it will be difficult to say whether you’ve gotten a fair price for the property. The real estate market isn’t as efficient as the stock and bond markets, where thousands of investors influence the market price of a given security. When only one or two people are interested in your property, you’re likely to get a lower price than you’d like, especially if in a hurry. Format: Multiple Choice Title: Test Bank 13.3 Advantages of Direct Real Estate Investment Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking Expected Time to Complete: 1 minute 72. Which is an advantage of direct real estate investments? A) Large initial investment B) Leverage C) Transaction costs D) Reduced diversification Answer: B Solution: One of the great benefits of real estate investing is that you can often borrow a large proportion of the up-front cost at a fairly low interest rate. In general, if you can borrow at a low rate and invest in assets that earn more than they cost, you’ll end up ahead of the game. The basic idea is that, if you have to put in only a small proportion of your equity investment up-front, your percentage return on investment will be larger than the actual change in value of the real estate. Financial professionals refer to the benefits of using low-cost debt as leverage. Because of leverage, you’ll find that it’s usually beneficial to finance the purchase of investment real estate with a mortgage. Format: Multiple Choice Title: Test Bank 13.3 Advantages of Direct Real Estate Investment

Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 73. Leverage occurs when you use borrowed funds to make an investment that will earn A) more than the cost of the borrowed funds. B) less than the cost of the borrowed funds. C) more than the initial investment. D) less than the initial investment. Answer: A Solution: Leverage occurs when you use borrowed funds to make an investment that will earn more than the cost of the borrowed funds. If you can borrow at a low rate and invest in assets that earn more than they cost, you’ll magnify the return on the investment. The basic idea is that, if you have to put in only a small proportion of your equity investment up-front, your percentage return on investment will be larger than the actual change in value of the real estate. Financial professionals refer to the benefits of using low-cost debt as leverage. Format: Multiple Choice Title: Test Bank 13.3 Leverage Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 1 minute 74. Financing the purchase of investment real estate with a mortgage is using A) price appreciation. B) leverage. C) diversification. D) asset allocation. Answer: B Solution: Financing the purchase of investment real estate with a mortgage is using leverage. Format: Multiple Choice Title: Test Bank 13.3 Advantages of Direct Real Estate Investment Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic

Expected Time to Complete: 1 minute 75. The basic equation for real estate return on investment is the increase in value plus the net rental income minus the interest expense, all of which is divided by which financial component? A) Beginning investment B) Capital appreciation C) Ending outlay D) Market price Answer: A Solution: Return on real estate investment = Increase in value + Net rental income − Interest expense 𝐁𝐞𝐠𝐢𝐧𝐧𝐢𝐧𝐠 𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 Format: Multiple Choice Title: Test Bank 13.3 Return on Real Estate Investment Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 76. What is your annual return on investment for a rental property with the following income and expenses? Rent: Expenses: Mortgage interest: Equity investment: Original mortgage: Market value:

$600 per month $3,000 $7,000 $20,000 $80,000 $110,000

A) 7.2% B) 30% C) 36% D) 136% Answer: C Solution: Rent is $7,200 a year ($600 × 12 months). Original cost of property is $100,000 ($20,000 equity investment + $80,000 original mortgage). Return on real estate investment = Increase in value + Net rental income − Interest expense Beginning investment

($110,000 − $100,000) + ($7,200 − $3,000) − $7,000 = 0.36 or 36% $20,000 Format: Multiple Choice Title: Test Bank 13.3 Return on Real Estate Investment Calculation Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 77. Juanita purchased a rental property for $100,000, put a $20,000 down payment on the home, and borrowed $80,000 to finance the remainder. She rents the home for $1,000 per month and during the first year did not have any maintenance expenses on the home. She paid a total of $7,500 in interest on the loan the first year. The home appreciated 4% the first year. What is Juanita’s total return on investment in the first year? A) 8.5% B) 12.5% C) 26.5% D) 42.5% Answer: D Solution: The increase in value is $4,000 ($100,000 cost × 1.04). Rent was $12,000 a year ($1,000 × 12 months). The interest expense for the year was $7,500. The initial investment in the property was $20,000. Return on real estate investment = Increase in value + Net rental income − Interest expense Beginning investment $4,000 + $12,000 − $7,500 = 0.425 or 42.5% $20,000 Format: Multiple Choice Title: Test Bank 13.3 Return on Real Estate Investment Calculation Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 78. Direct real estate investments lack _______because only a limited number of potential buyers exist and it can take months to find a buyer and close the deal. A) tax benefits B) high returns

C) liquidity D) transaction costs Answer: C Solution: Direct real estate investments lack liquidity because only a limited number of potential buyers exist and it can take months to find a buyer and close the deal. Format: Multiple Choice Title: Test Bank 13.3 Disadvantages of Direct Real Estate Investment Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 79. Which of the following is not a disadvantage of direct real estate investment? A) After-tax cash flows B) High transaction costs C) Reduced diversification D) Lack of liquidity Answer: A Solution: After-tax cash flows are an advantage of direct real estate investments. Cash flows benefit from certain favorable tax rules that apply to rental properties. When you invest in rental property, you’re allowed under tax laws to take a deduction against your net operating income for depreciation. Effectively, the IRS is allowing you to spread the cost of your initial investment in the building. Other allowed deductions include interest expense, property taxes, insurance, utilities, and expenses for repairs and maintenance. Basically, any reasonable expenses that you incur in the management of the property is tax-deductible. The net effect of all this is that many properties generate positive net cash flow to the investors but have negative taxable income. Format: Multiple Choice Title: Test Bank 13.3 Advantages of Direct Real Estate Investment Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. Relative to other types of investments, real estate investments have very A) low transaction costs. B) high transaction costs. C) low tax benefits. D) high liquidity. Answer: B

Solution: Relative to other types of investments, real estate has very high transaction costs. Buyers incur substantial closing costs, and sellers can usually expect to pay a high commission on developed property and vacant land. Format: Multiple Choice Title: Test Bank 13.3 Disadvantages of Direct Real Estate Investment Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 81. If you invest in real estate through a trustee, it is known as a(n) A) indirect real estate investment. B) real estate derivative. C) commercial property. D) blind transaction. Answer: A Solution: An indirect real estate investment is made when you invest through a trustee or company that holds the title to the property. Format: Multiple Choice Title: Test Bank 13.3 Trust Owned Real Estate Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 82. A government agency that is involved in the mortgage-backed security market is the A) Government National Mortgage Association. B) Bank for Cooperatives. C) Federal Land Bank. D) Federal Association of Home Mortgages. Answer: A Solution: The Government National Mortgage Association (GNMA), or “Ginnie Mae,” is a federal agency that issues bonds that are backed by pools of mortgages. Format: Multiple Choice Title: Test Bank 13.3 Mortgage-Backed Securities Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Easy Bloomcode: Knowledge

AACSB: Analytic Expected Time to Complete: 1 minute 83. Bonds that take cash flows from pools of mortgages and passes through to its holders the interest and principal payments are called

A) mortgage-backed securities. B) real estate investment trusts. C) limited partnerships. D) direct real estate investments. Answer: A Solution: Bonds that take cash flows from pools of mortgages and passes through to its holders the interest and principal payments are called mortgage-backed securities. Format: Multiple Choice Title: Test Bank 13.3 Mortgage-Backed Securities Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 84. The performance of mortgage-backed securities is more closely related to the ______ than to the ________ market. A) bond market; real estate B) real estate; bond market C) real estate; stock market D) stock market; bond market Answer: A Solution: Although mortgage-backed securities are more are indirectly related to real estate, their performance is highly dependent on market interest rates, so they are more closely related to the bond market than the real estate market or the stock market. Format: Multiple Choice Title: Test Bank 13.3 Mortgage-Backed Securities Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 85. Investors in real estate generally expect to benefit from A) only the price appreciation of the property. B) only the cash flow from rent. C) the combination of price appreciation and cash flow.

D) the negative income effect of taxes. Answer: C Solution: As with other types of investments, investors in real estate generally expect to benefit from some combination of price appreciation and cash flow. Format: Multiple Choice Title: Test Bank 13.3 Real Estate Investment Expectations Section: Direct Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 86. It’s easiest for the average investor to diversify in their household investment portfolio through a A) second home. B) vacant lot. C) commercial property. D) REIT. Answer: D Solution: A REIT investor buys a share in a trust and the trust manager uses the money to make many direct investments real estate with the pooled funds. Indirect investments like REITs gives you the benefits of real estate investment without incurring the costs and risks of direct investments. These investments provide better liquidity and, because you can make indirect investments in smaller increments, you’ll be able to better diversify your holdings. Format: Multiple Choice Title: Test Bank 13.3 Indirect Real Estate Investment Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 87. Mike Jones has a substantial amount of cash and would like to increase his portfolio with real estate assets. He does not want the hassle of dealing with tenants and the other hands-on aspects of owning real estate. Should he invest in indirect real estate investments or direct real estate investments, and why? A) He should invest in indirect real estate investments because they offer investment choices that do not involve the actual ownership and management of a specific property. B) He should invest in direct real estate investments because he can hire a management company to deal with the tenants.

C) He should invest in indirect real estate investments, because he can hire a management company to deal with the tenants. D) He should invest in direct real estate investments, because they offer investment choices that do not involve the actual ownership and management of a specific property. Answer: A Solution: He should invest in indirect real estate investments because they offer investment choices that do not involve the actual ownership and management of a specific property. Indirect investments give you the benefits of real estate investment without incurring the hassles of management, costs and risks of direct investments. Format: Multiple Choice Title: Test Bank 13.3 Indirect Real Estate Investment Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 88. Sam Drexler is thinking of directly investing in real estate. Which of the following is not a direct investment choice for Sam?

A) Rental property B) limited partnership C) vacant lots D) Commercial property Answer: B Solution: In a limited partnership, several investors (the limited partners) put up the money to buy a property, such as a shopping mall or apartment complex, and a general partner manages the investment. The limited partners are so called because they have no right or obligation to participate in the management of the property and have limited liability. The most they can lose is their original investment, much like a corporate stockholder. Format: Multiple Choice Title: Test Bank 13.3 Indirect Real Estate Investment Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 89. Pug Marbury is looking at some indirect investment choices and notices one of them acts a lot like a mutual fund. Which of the following choices has he likely come across?

A) Real estate investment trust

B) Mortgage-backed security C) Limited partnership D) Commercial property Answer: A Solution: Like closed-end funds, REITs are pooled investments run by a manager, and its outstanding shares are traded on secondary markets. REIT investors buy shares in a trust and the trust manager uses the money to buy many direct investments in real estate. Investors expect to benefit from rising values of their holdings over time, as well as from redistributed cash flows from income producing investments. Format: Multiple Choice Title: Test Bank 13.3 Real Estate Investments That Resemble Funds Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 90. Hiro Watanabe, a successful car dealer in Japan, is looking to invest in and manage shopping malls across California. Which of the following indirect real estate investment choices will Hiro be involved in?

A) Limited partnership B) Mortgage-backed securities C) Real estate investment trusts D) Rental property Answer: A Solution: In a limited partnership, several investors (the limited partners) put up the money to buy a property, such as a shopping mall or apartment complex, and a general partner, such as Hiro, would manage the investments. Format: Multiple Choice Title: Test Bank 13.3 Active Management in Indirect Real Estate Investment Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 91. Mark Forester calculates principal prepayment rates for a portfolio of mortgages with Ginnie Mae. Which indirect real estate investment class does Mark work with?

A) Mortgage-backed securities B) Real estate investment trusts C) Limited partnerships D) Commercial properties

Answer: A Solution: The Government National Mortgage Association (GNMA), or “Ginnie Mae,” is a federal agency that issues bonds that are backed by pools of mortgages. Format: Multiple Choice Title: Test Bank 13.3 Mortgage-Backed Securities Section: Indirect Real Estate Investment Learning Objective: 13.3 Identify the advantages and disadvantages of direct and indirect real estate investments Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 92. Which of the following are considered to be speculative investments? A) BBB- rated corporate bonds B) Platinum C) Blue-chip stocks D) Baa3 rated preferred stock Answer: B Solution: Speculative investments include precious metals, such as platinum, which has high up-front costs and provide no regular cash flow. BBB- and Baa3 are investment grade ratings for corporate bonds and preferred stock. Blue-chip stocks are typically very large, financially strong, and mature companies. Format: Multiple Choice Title: Test Bank 13.4 Speculative Investments Section: Speculative Investments Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 93. Investing in precious metals A) is often marketed as good ways to achieve diversification. B) can only be achieved by a direct investment. C) increases the return of a diversified portfolio in good times. D) must be done through the Treasury Department. Answer: A Solution: Investments in gold and other precious metals are often marketed as good ways to achieve diversification. Gold values tend to increase during times of political uncertainty and inflation and decrease when economic conditions are more stable. In general, however, the average returns on these investments are so low that they drag down overall portfolio returns in good times. If you want to invest directly in gold or other precious metals, you can buy coins or bars from dealers or banks. Alternatively, you can

participate in precious metals by purchasing shares of precious metal mutual funds or stock in mining companies. Format: Multiple Choice Title: Test Bank 13.4 Investing in Precious Metals Section: Precious Metals and Gems Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 94. Gold is considered by many to be a hedge against political uncertainty and inflation. Which would not be a recommended method to hedge a stock portfolio with gold? A) Gold ETF B) Gold futures C) Gold mining stock D) Gold coins Answer: D Solution: Direct investment in gold coins means that you would have to buy or sell from dealers or banks, paying a commission of at least 2 percent. You’ll also need to pay for a safe place to store it, as it’s not a good idea to have gold coins sitting around the house, and your homeowner’s insurance will not cover them if they’re lost or stolen. You can efficiently participate in gold by investing in financial products, such as gold ETFs, gold mutual funds, gold derivatives, or gold mining companies. Format: Multiple Choice Title: Test Bank 13.4 Hedging with Gold Section: Precious Metals and Gems Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 95. Which is not a precious metal? A) Gold B) Silver C) Platinum D) Diamond Answer: D Solution: A diamond is a precious stone. Format: Multiple Choice Title: Test Bank 13.4 Precious Metals and Gems Section: Precious Metals and Gems Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 96. During times of strong economic growth, gold tends to ________ your stock portfolio.

A) drag down B) increase gains in C) equal the growth in D) outpace Answer: A Solution: Gold values tend to increase during times of political uncertainty and inflation and decrease when economic conditions are more stable. In general, however, the average returns on these investments are so low that they drag down overall portfolio returns in good times. Format: Multiple Choice Title: Test Bank 13.4 Gold Versus Stocks Section: Precious Metals and Gems Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 97. Fine jewelry is considered a A) potentially high return market for investors. B) liquid form of investment. C) dependable investment. D) potentially high-risk investment. Answer: D Solution: Although it might seem like your fine jewelry is an investment when you consider how much you paid for each piece, the resale market for jewelry is relatively illiquid; so, in most cases, you probably won’t be able to recoup what you paid. Furthermore, the potential for fraud is fairly high because most buyers can’t tell a diamond from a cubic zirconium or platinum from nickel. For this reason, jewelry is not a dependable investment. Format: Multiple Choice Title: Test Bank 13.4 Personal Jewelry Collection Section: Precious Metals and Gems Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 1 minute 98. The advent of the _____ has greatly increased the resale market for collectibles.

A) mutual fund B) Internet C) Federal Trade Commission (FTC) D) Securities and Exchange Commission (SEC) Answer: B Solution: Although historically the resale market for collectibles was small, making them a fairly risky investment, the Internet has changed the collectible marketplace for the better. It has brought people of similar but unique interests together from geographically far places providing much liquidity for esoteric things. Format: Multiple Choice Title: Test Bank 13.4 Collectibles and Art Section: Collectibles and Art Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 99. If Andre purchased a work of art for $500 in 2005 and sold it for $1,500 in 2015, what is his annualized return on the investment? A) 1.16% B) 11.6% C) 20% D) 200% Answer: B End price

1⁄ 𝑛

Solution: Annualized return on investment = (Purchase price)

− 1

1⁄

$1,500 10 Annualized return on investment = ( − 1 = 0.116 or 11.6% ) $500 Format: Multiple Choice Title: Test Bank 13.4 Annualized Return on Investment Calculation Section: Collectibles and Art Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 100. A put option gives the buyer the right to A) buy a security at a specified price in the future. B) sell a security at a specified price in the future. C) buy a security at today’s price in the future. D) sell a security at today’s price in the future.

Answer: B Solution: A put option gives the buyer the right to sell a security at a specified price in the future. Format: Multiple Choice Title: Test Bank 13.4 Put Option Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 101. The major advantage of investments in derivatives is being able to A) participate in the price movements of the underlying security with less risk than the security itself. B) participate in the price movements of the underlying security without buying the security itself. C) realize a significantly less risk by investing in a derivative security than by investing in the underlying asset itself. D) reduce risk by only trading in the price movements of the asset. Answer: B Solution: The advantage of investments in derivatives is that you can participate in the price movements of the underlying security without buying the security itself. When the price of the underlying asset changes in your favor, you might realize a much greater return by investing in a derivative security than by investing in the underlying asset itself, because the amount you have to spend up-front is low relative to the cost of the underlying asset. However, the risk you take for this extra return is substantial. You actually risk losing your entire investment, compared to a modest holding loss in the underlying assets. Format: Multiple Choice Title: Test Bank 13.4 Risks of Investing in Derivatives Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 2 minutes 102. Due to their relatively low cost, financial derivatives are considered appropriate for A) novice investors. B) Low-income investors. C) speculators. D) long-term investors. Answer: C

Solution: When the price of the underlying asset changes, you realize a much greater return or loss by investing in a derivative security, rather than by investing in the underlying asset, because the amount you have to spend up-front is low relative to the cost of the underlying asset. The risk you take for this extra return is substantial. You actually risk losing your entire investment. Futures and options are financial investments that require in-depth understanding of the markets and of the investments that the derivatives are based on. Speculators who get into this market without the appropriate expertise can lose a lot of money. Format: Multiple Choice Title: Test Bank 13.4 Risks of Investing in Derivatives Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 103. A transaction involving financial derivatives that attempts to offset losses in value of other securities held in a portfolio is known as

A) hedging. B) diversification. C) speculating. D) short selling. Answer: A Solution: If you invest in a derivative contract that will increase in value when something else in your portfolio decreases in value, you are said to be hedging. This is an investment strategy that reduces the overall risk of your portfolio by protecting your assets from big swings in value. Format: Multiple Choice Title: Test Bank 13.4 Using Derivatives to Reduce Risk Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 104. Which of the following is the least speculative investment? A) REIT B) Precious metals C) Art D) Derivatives Answer: A

Solution: A REIT is a diversified pool of real estate investments that pass-through rental income and expects the investments to grow in value over time. Art, precious metals, and derivatives provide no regular cash flow, and their returns are speculative. Format: Multiple Choice Title: Test Bank 13.4 Speculative Investments Section: Speculative Investments Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 105. A(n) ________ contract is a contract in which you promise to buy or sell the underlying asset at a point in the future for a price determined today. A) futures B) indenture C) Treasury D) annuity Answer: A Solution: A futures contract is a contract in which you promise to buy or sell the underlying asset at a point in the future for a price determined today. Format: Multiple Choice Title: Test Bank 13.4 Derivative Contract Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 106. Futures and options are often speculative securities A) and a poor choice to reduce risk in your underlying portfolio. B) but can also be used to reduce risk in your underlying portfolio. C) and a poor choice to leverage your underlying portfolio. D) but can also be used to provide diversification to an underlying portfolio. Answer: B Solution: Although trading in futures and options is often speculative, these securities can also be used to reduce risk in your underlying portfolio. If you invest in a derivative contract that will increase in value when something else in your portfolio decreases in value, you are said to be hedging. This is an investment strategy that reduces the overall risk of your portfolio by protecting your assets from big swings in value. Hedging is not diversification, as it’s a direct opposite investment, rather than a complementary investment. Format: Multiple Choice

Title: Test Bank 13.4 Financial Derivatives Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 107. Rodney purchased a call option on Wildbear Industries stock with a $100 exercise price, for $2 per share, when the actual price of the stock is $97. If the price goes up to $103, what is his rate of return on investment? A) 3 percent B) 6 percent C) 50 percent D) 100 percent Answer: C Solution: For $2 per share, you can buy a call option that gives you the right to buy a particular stock for $100 per share when the actual price of the stock is $97. You’re hoping the stock price will rise as much as possible over $102 (the price of the share plus the cost of the option) before the expiration of the option. If the price goes up to $103, he can then exercise the option to buy at $100 and immediately sell at the market price of $103, making $103 - $100 - $2 = $1 per share. His return on investment is 50 percent, because he made a profit of $1 on an investment of $2, which is what he paid for the option. Format: Multiple Choice Title: Test Bank 13.4 Call Option Rate of Return Calculation Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes 108. Gold values tend to _________ during times of economic growth and stability and __________ during times of economic and political uncertainty. A) increase; decrease B) decrease; increase C) increase; increase D) decrease; decrease Answer: B Solution: Gold values tend to decrease during times of economic growth and stability and increase during times of economic and political uncertainty. Format: Multiple Choice Title: Test Bank 13.4 Gold Prices

Section: Precious Metals and Gems Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 109. Blake Phoenix is a farmer who is concerned about the price of his corn crops that will be harvested in three months. What can he do today to ensure his later profitability? A) Sell corn futures at today’s fixed price for a delivery in 90 days. B) Buy corn futures today for delivery in 90 days. C) Sell corn futures in 90 days for delivery then. D) Buy corn futures in 90 days for delivery then. Answer: A Solution: Many farmers in the United States reduce their risks from uncertain future crop prices by selling futures contracts to lock in the price they will get for their crop at harvest time. For these farmers, the futures contract is not speculative because they are promising to sell something they will actually have. Buying futures would be the opposite. For example, a snack chip producer may buy corn futures for delivery in 90 days, if he wanted to lock into the price of his raw material at today’s prices. Format: Multiple Choice Title: Test Bank 13.4 Using Derivatives to Reduce Risk Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 110. At the age of 55, Linda Banes has decided she will become an investor like her father. As she knows jewelry, she decided to invest in jewelry and collectibles. Her father warned “buyer beware.” What did he mean by this statement?

A) The potential for fraud is high. B) The return on jewelry is very low. C) Buyers tend to lose jewelry before resale. D) The value of jewelry depreciates very quickly. Answer: A Solution: The potential for fraud is high because most buyers can’t tell a precious stone or metal like gold and diamonds from fakes like brass and cubic zirconium. Format: Multiple Choice Title: Test Bank 13.4 Risks in Precious Metals and Gems Section: Precious Metals and Gems Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 111. Andres Fornicelli owns Biosciences Unlimited stock. He is concerned that the results from their new drug trials next week for their cancer treatment may require some additional testing. He still has confidence but is very worried about the stock price. What can he do to hedge a very bad report? A) Buy a call option to buy the stock when the bad news hits the stock price. B) Buy a call option to sell the stock at today’s price for the next two weeks. C) Buy a put option to buy the stock when the bad news hits the stock price. D) Buy a put option to sell the stock at today’s price for the next two weeks. Answer: D Solution: Buy a put option to sell the stock at today’s price for the next 2 weeks. If the stock drops next week, he can exercise his put option and sell his shares at today’s price then. A put option contractually allows the owner to sell the respective shares at the exercise price, at any time before the expiration of the contract. If the stock doesn’t fall, his option purchase will expire worthless. But it is the cost of insurance. Format: Multiple Choice Title: Test Bank 13.4 Using Derivatives to Reduce Risk Section: Financial Derivatives Learning Objective: 13.4 Explain why investments in precious metals, gems, collectibles, cryptocurrencies, and derivatives are speculative Difficulty: Hard Bloomcode: Evaluation AACSB: Reflective Thinking Expected Time to Complete: 2 minutes

Chapter 14 Test Bank To accompany Personal Finance, 2nd edition, by Vickie Bajtelsmit

Summary: 100 Multiple Choice Questions

3 Q# 62 63 64

LO 13.1 LO 13.2 LO13.3 LO 13.4

29 26 25 20

29% 26% 25% 20%

Total

100

100%

Knowledge Comprehensio n Application Analysis Evaluation Synthesis

19%

42 28 7 3 1 100

42% 28% 7% 3% 1% 100%

Easy Medium Hard

19 77 4 100

Calculations Test Bank Question

14.3 Federal Gift Tax Calculation 14.3 Federal Estate Tax Calculation 14.3 Federal Estate Tax Calculation (with expenses)

19% 77% 4% 100%

1. The process of developing a plan for what will happen to your wealth and dependents when you die is known as A) probate planning. B) estate planning. C) retirement planning. D) second to die planning. Answer: B Solution: The process of developing a plan for what will happen to your wealth and dependents when you die is known as estate planning. Format: Multiple Choice Title: Test Bank 14.1 Estate Planning Section: Estate Planning Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 2. Which of these should cause you to revisit your estate plan? A) Birth of a child B) Death of a beneficiary C) Change of state of residence D) All of these choices are correct. Answer: D Solution: Over your life cycle, you should revisit your estate plan whenever you have a major change in circumstances, such as births, deaths, and even change of state of residence. Format: Multiple Choice Title: Test Bank 14.1 When to Revisit Your Estate Plan? Section: Who Needs an Estate Plan? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 3. A person’s net worth at the time of their death is known as their A) estate. B) inheritance. C) probate. D) trust. Answer: A Solution: Your estate is your net worth at death; all your assets less all your debts. Format: Multiple Choice

Title: Test Bank 14.1 Net Worth at Death Section: What Is Estate Planning? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 4. A person’s estate is A) his or her net worth at death. B) his or her net worth during life. C) the value of the assets he or she owned at death. D) the value of the assets he or she owned during life. Answer: A Solution: Your estate is your net worth at death; all your assets less all your debts. Format: Multiple Choice Title: Test Bank 14.1 Estate Section: What Is Estate Planning? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 5. What is the first step in the estate-planning process? A) Developing estate-planning goals B) Deciding whom you want to leave your money to C) Analyzing your current finances D) Evaluating estate-planning strategies Answer: C Solution: Step 1 of the estate-planning process is to analyze your current finances and determine whether you need an estate plan. Format: Multiple Choice Title: Test Bank 14.1 The Estate-Planning Process Section: The Estate-Planning Process Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 6. During the process of estate planning, what should you do after you have developed estate-planning goals? A) Analyze your current finances.

B) Evaluate estate-planning strategies. C) Implement your plan, at least being sure to have a valid will. D) Reevaluate and revise your plan as needed. Answer: B Solution: Following the of estate-planning process, after you have developed estateplanning goals (Step 2), you should evaluate estate-planning strategies (Step 3). Format: Multiple Choice Title: Test Bank 14.1 The Estate-Planning Process Section: The Estate-Planning Process Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 7. Which of the following financial costs may be associated with failure to do estate planning? A) Federal estate tax B) State inheritance tax C) Probate costs D) All of these costs Answer: D Solution: If someone dies without an estate plan or a will, the value of the estate may be unnecessarily eroded by the following costs: federal estate taxes (up to 40% tax on estates above the exemption amount); state inheritance taxes (0%–20%, depending on the state of residence); and probate costs (2%–5%) Format: Multiple Choice Title: Test Bank 14.1 Financial Costs Without Estate Plan Section: Who Needs an Estate Plan? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 8. Which of the following costs will not be impacted by your failure to have an estate plan in place when you die? A) Federal income taxes B) State inheritance taxes C) Probate costs D) Federal estate taxes Answer: A Solution: Probate costs and estate and inheritance taxes are due to death. Income taxes are assessed regardless of death.

Format: Multiple Choice Title: Test Bank 14.1 Financial Costs Without Estate Plan Section: Who Needs an Estate Plan? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 9. The legal process of settling an estate is known as

A) inheritance. B) probate. C) a will. D) liquidation. Answer: B Solution: The legal process of settling your estate, paying your debts and distributing your assets according to your wishes, is called probate. Format: Multiple Choice Title: Test Bank 14.1 Settling an Estate Section: Who Needs an Estate Plan? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 10. Why is it recommended that you make a will and/or an estate plan when you are young? A) You likely do not have dependents yet. B) Your estate is complicated. C) Your death is unpredictable. D) You can accumulate more wealth. Answer: C Solution: In general, estate planning is about taking care of the needs of other people. After all, you’ll be dead before any of your plans takes effect. Most people would prefer that their assets and wealth go to their intended beneficiaries rather than the government. Your death is unpredictable, so an important component of estate planning is taking steps that will transfer your assets according to your wishes and minimize postdeath hassles for your loved ones. Format: Multiple Choice Title: Test Bank 14.1 Estate Planning Section: Estate Planning Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 11. A person designated to receive something from an estate after a person’s death is a A) testator. B) beneficiary. C) escheat. D) probate. Answer: B Solution: A person or entity designated to receive something from your estate after your death is called your beneficiary or heir. Format: Multiple Choice Title: Test Bank 14.1 Heir Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 12. Beneficiaries are those persons or entities who A) will benefit from being the trustee of a trust. B) will benefit from being an agent of a living will. C) receive a distribution under the terms of a will. D) receive the guardianship of minor children via a will. Answer: C Solution: A person or entity designated to receive a distribution under the terms of a will after your death is called a beneficiary. Format: Multiple Choice Title: Test Bank 14.1 Beneficiaries Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 13. Raul just named his daughter as the person to whom his estate will be passed upon his death, making her his A) heir. B) trustee. C) grantor. D) escheat.

Answer: A Solution: A person or entity designated to receive something from your estate after your death is called your beneficiary or heir. Format: Multiple Choice Title: Test Bank 14.1 Estate Transfer upon Death Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 14. If you die without a valid will and have no living relatives, all your assets become the property of the state government through a legal process known as A) probate. B) escheat. C) caveat emptor. D) living will. Answer: B Solution: If you die without a will and have no living relatives, all of your assets will become the property of the state government through a legal rule called escheat. Format: Multiple Choice Title: Test Bank 14.1 Intestate Transfer Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 15. If you die without a valid will, this is known as A) intestate. B) contested. C) escheat. D) interred. Answer: A Solution: Whether you have a will or not, state law requires that your assets be distributed after your death. If you die intestate (without a valid will), every state has legal rules that govern how a resident’s property will be distributed. Format: Multiple Choice Title: Test Bank 14.1 Death Without Will Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one.

Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 16. If you die “intestate,” you have died A) with a valid will. B) without a valid will. C) in a state other than your state of residence. D) with an estate plan. Answer: B Solution: Whether you have a will or not, state law requires that your assets be distributed after your death. If you die intestate (without a valid will), every state has legal rules that govern how a resident’s property will be distributed. Format: Multiple Choice Title: Test Bank 14.1 Intestate Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 17. When you die without a will and your assets become the property of the state government, which legal rule is being acted upon? A) Escheat B) Probate C) Intestate D) Power of attorney Answer: A Solution: If you die without a will and have no living relatives, all of your assets will become the property of the state government through a legal rule called escheat. Format: Multiple Choice Title: Test Bank 14.1 Asset Transfer to State Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 18. A ________ is designed to state a person’s medical preferences if that person is unable to make medical decisions due to illness or disability. A) will

B) living will C) letter of instruction D) letter of last instruction Answer: B Solution: A living will is a document where you specify what kind of medical care you want to receive in the event that you can’t make decisions for yourself due to terminal illness, physical disability, or mental disability. Format: Multiple Choice Title: Test Bank 14.1 Medical Care Directive Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 19. ______________are a relatively new by-product of modern medical care. A) Wills B) Living wills C) Estate trusts D) Living trusts Answer: B Solution: Whereas wills have been around for thousands of years, the living will is a byproduct of modern medical advances. In this document, you specify what kind of medical care you want to receive in the event that you can’t make decisions for yourself due to terminal illness, physical disability, or mental disability. Format: Multiple Choice Title: Test Bank 14.1 Documents Necessitated by Modern Medical Care Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 20. An attorney is not needed to prepare a _________ since it is not a legal document. A) living trust B) do-not-resuscitate order C) letter of last instruction D) letter of intestate Answer: C Solution: Although not a legal document, the letter of last instruction serves the purpose of helping your survivors through the process of your death. You could use this document to communicate your personal wishes regarding funeral arrangements,

identify people who should be notified of your death, and list other wishes regarding the distribution of your minor personal assets (your old football jersey, comic book collection, or family memorabilia) that have sentimental but not financial value. These instructions are nonbinding, in that specific bequests of your assets must be written into your will to be legally enforced. Format: Multiple Choice Title: Test Bank 14.1 Legal Documents Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 21. A long list of minor belongings to be distributed at the time of your death belongs best in a A) living will. B) will. C) letter of last instruction. D) trust. Answer: C Solution: The letter of last instruction serves the purpose of helping your survivors through the process of your death. You could use this document to communicate your personal wishes regarding funeral arrangements, identify people who should be notified of your death, and list other wishes regarding the distribution of your minor personal assets (your old football jersey, comic book collection, or family memorabilia) that have sentimental but not financial value. Format: Multiple Choice Title: Test Bank 14.1 Distribution of Minor Belongings at Death Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 22. The best place to keep wills and powers of attorney is A) in a safe-deposit box. B) at your estate attorney’s office. C) in your home office. D) in your business office. Answer: B Solution: It makes sense to leave a copy of each important document with your estate attorney. Don’t put wills, trust documents, or powers of attorney in a safe-deposit box, because that is often sealed at death. Format: Multiple Choice

Title: Test Bank 14.1 Organizing Financial and Legal Documents Section: Organizing Financial and Legal Documents Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 23. A living will go into effect when

A) you are unable to make medical decisions for yourself. B) you die. C) probate processes begin. D) an heir contests a decision. Answer: A Solution: A living will go into effect when you can’t make decisions for yourself due to terminal illness, physical disability, or mental disability. Format: Multiple Choice Title: Test Bank 14.1 Living Will Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 24. Carrie has been diagnosed with a terminal illness. She decided to obtain a __________ to appoint someone to make specific legal medical decisions for her when she is incapacitated. A) letter of last instruction B) durable power of attorney C) living will D) will Answer: B Solution: Even if you have a living will that outlines your wishes, it doesn’t force your loved ones to abide by them. Therefore, you need a durable power of attorney, a document in which you appoint someone to make the specific medical decisions in accordance with your wishes when you are incapacitated. This document needs to be drafted by an attorney to be sure that it will satisfy legal requirements in your state. Format: Multiple Choice Title: Test Bank 14.1 Document to Provide Legal Medical Decisions Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium

Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute

25. Charles is 23 years old. He recently graduated from college and is making ends meet by working two retail jobs. His only asset is his car. Robin is 35 years old and is working her way up the career ladder at a financial firm. Robin has been married for almost 10 years and has three children. Which of these two people would benefit most from an estate plan, and why? A) Charles and Robin have an equal need for an estate plan. B) Charles, because he has more time to develop an estate plan and shield any future income from estate taxes. C) Robin, because she has a more complex estate and beneficiaries, as well as fewer years until she reaches her estimated life. D) Neither Robin nor Charles, because they are both relatively young and have not had the chance to develop complex estates that would require plans. Answer: C Solution: Because everyone will eventually die, we all should have an estate plan. However, because people’s needs, and their estates differ, some estate plans are very simple, and others are necessarily more complex. Robin would benefit most from an estate plan because she has a more complex estate and beneficiaries, as well as fewer years until she reaches her estimated life. Format: Multiple Choice Title: Test Bank 14.1 Who Needs an Estate Plan? Section: Who Needs an Estate Plan? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Analysis AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 26. Marina is 24 years old and is planning on marrying her fiancé. She already has a will, and it names her older sister as her beneficiary. Marina’s fiancé, Jared, 32, has been divorced once and has a two-year-old son. Jared also has a will, wherein his ex-wife and son are named the beneficiaries. Should they both draft new wills once they are married, and why or why not? A) Yes, because both Marina and Jared will likely wish to have wills that name each other as beneficiaries to prevent Marina’s assets from going to her sister and Jared’s from spending a long time in probate because of legal ambiguity. B) No, only Marina needs to draft a new will because Jared’s ex-wife is no longer his beneficiary because of their divorce, and his son is automatically his beneficiary. C) No, only Jared needs to draft a new will because he needs to explicitly remove his ex-wife as a beneficiary and designate Marina as his son’s guardian in the event of death. D) No, neither Marina nor Jared need to draft new wills because their marriage legally makes the other spouse their beneficiary, and Jared’s son is already provided for.

Answer: A Solution: Yes, because both Marina and Jared will likely wish to have wills that name each other as beneficiaries to prevent Marina’s assets from going to her sister and Jared’s from spending a long time in probate because of legal ambiguity. Estate plans must be reevaluated and revised as your life circumstances change. Format: Multiple Choice Title: Test Bank 14.1 Who Needs an Estate Plan? Section: Who Needs an Estate Plan? Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 27. Grace’s cousin was kept on life support for three years after a car accident left him braindead while his wife and parents argued and fought in court over whether or not to take him off life support. Grace wants to prevent this same thing from happening to her or her husband. Because of this, Grace has created a living will that lays out in very specific language what they would like to happen should either her or her husband suffer brain death. Has Grace made the correct decision?

A) Yes, a living will can legally bind her family and doctors to follow her instructions should she become incapacitated. B) Yes, by drafting a very specific living will, Grace has made sure that she will have her wishes met in the event of brain death. C) No, Grace also needs to draft a durable power of attorney wherein she names a specific member of her family to carry out the wishes she outlined in her living will. D) No, Grace also needs to draft a letter of last instruction or there will be no legal requirement for anyone to follow the instructions in her living will. Answer: C Solution: No, Grace also needs to draft a durable power of attorney wherein she names a specific member of her family to carry out the wishes she outlined in her living will. A living will outline your wishes, but it doesn’t force your loved ones to abide by them. Therefore, you also need a durable power of attorney, a document in which you appoint someone to make the specific medical decisions in accordance with your wishes when you are incapacitated. This document needs to be drafted by an attorney to be sure that it will satisfy legal requirements in your state. Format: Multiple Choice Title: Test Bank 14.1 Document for Medical Incapacity Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Hard Bloomcode: Evaluation AACSB: Reflective Thinking Expected Time to Complete: 1 minute

28. What is the difference between a living will and a letter of last instruction?

A) Living wills are nonlegal documents that describe an individual’s wishes should they ever become incapacitated, while the letter of last instruction is a legal document that instructs survivors on dealing with financial details after an individual’s death. B) Living wills are legal documents that detail exactly how individuals would like their medical decisions handled should they become incapacitated, while a letter of last instruction is a nonlegal document that details how an individual would like his or her finances handled after death. C) Both are legal documents that instruct family members on how an individual would like certain specifics to be handled. However, living wills express persons’ wishes with regard to medical care should they become incapacitated, and a letter of last instruction discusses wishes regarding things such as funeral arrangements and access to personal financial information in the event of an individual’s death. D) Both are nonlegal documents that give instructions for family members or survivors on how an individual would like certain specifics to be handled. However, living wills express people’s wishes with regard to medical care should they become incapacitated, and a letter of last instruction discusses wishes regarding things like funeral arrangements and access to personal financial information in the event of an individual’s death. Answer: D Solution: Both are nonlegal documents that give instructions for family members or survivors on how an individual would like certain specifics to be handled. Even if you have a living will that outlines your wishes, it doesn’t force your loved ones to abide by them. Therefore, you also need a durable power of attorney, a document in which you appoint someone to make the specific medical decisions in accordance with your wishes when you are incapacitated. This document needs to be drafted by an attorney to be sure that it will satisfy legal requirements in your state. The letter of last instruction discusses wishes regarding funeral arrangements, access to personal financial information, and distribution of your minor personal assets, in the event of an individual’s death. However, these instructions are nonbinding, in that specific bequests of your assets must be written into your will to be legally enforced. Format: Multiple Choice Title: Test Bank 14.1 Key Components of an Estate Plan Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Hard Bloomcode: Evaluation AACSB: Reflective Thinking Expected Time to Complete: 2 minutes 29. A legal entity that holds and manages assets on behalf of someone else is known as a A) will. B) living will.

C) trust. D) testator. Answer: C Solution: A trust is a legal entity that holds and manages assets on behalf of someone else. Trusts are commonly used in estate planning for a variety of purposes. Format: Multiple Choice Title: Test Bank 14.1 Legal Arrangements in Estate Planning Section: Key Components of an Estate Plan Learning Objective: 14.1 Identify key components of an estate plan, and determine whether you need one. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 30. The person writing a will is known as the A) grantor. B) heir. C) testator.grantee. Answer: C Solution: The person writing a will is known as the testator. Format: Multiple Choice Title: Test Bank 14.2 Writer of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 31. A testator is a person who A) is the beneficiary of assets distributed under the terms of a will. B) manages a trust. C) writes a will. D) is the beneficiary of assets in a trust. Answer: C Solution: The person writing a will is known as the testator. Format: Multiple Choice Title: Test Bank 14.2 Testator Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic

Expected Time to Complete: 1 minute 32. Cynthia Blair is currently typing up her will so that she can have an attorney look it over to ensure her nieces and nephews receive any inheritance due. What role does Cynthia Blair have in the will preparation process? A) Executor B) Executrix C) Testator Beneficiary Answer: C Solution: The person writing a will is known as the testator. Format: Multiple Choice Title: Test Bank 14.2 Writer of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 33. Which of the following is not required for a valid will? A) The will must be dated. B) The person writing the will must be at least 21 years old. C) You must intend for the document to be your will. D) The will must be signed in the presence of two witnesses who are not named beneficiaries in the will. Answer: B Solution: Wills are governed by state law, and state laws vary. However, in many states, your will must meet the following criteria: The will must be dated, testator must be of legal age (usually 18), you must intend for the document to be your will, and the will must be signed in the presence of two witnesses who are not your relatives or named beneficiaries in the will. Format: Multiple Choice Title: Test Bank 14.2 Preparing a Valid Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 34. Of the following, which is typically the primary purpose of a will? A) Payment of debts B) Appointment of a guardian C) Distribution of assets D) Settling of taxes owed

Answer: C Solution: The primary purpose of a will is to specify how you want your property to be distributed upon your death. Format: Multiple Choice Title: Test Bank 14.2 Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 35. Kangaroo Inc., a very popular kids’ show, just released their top talent from her contract when she turned 16 years old. The star has made $17 million dollars performing over the last seven years and is about to launch her solo career. She, herself, drafted a will naming her parents and siblings as beneficiaries and had it witnessed by two of her employees. Is her will valid? A) Yes, her witnesses were not beneficiaries or family members. B) Yes, her estate is large enough to require the drafting of a will. C) No, a person must be at least 18 years old for his or her will to be valid under the law. D) No, an attorney must write a will for it to be legally valid. Answer: C Solution: Her will is not valid. A person must be at least 18 years old for his or her will to be valid under the law. Format: Multiple Choice Title: Test Bank 14.2 Preparing a Valid Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 36. Which of the following is not a term used to describe a person designated to handle the settlement of an estate? A) Executrix B) Executor C) Personal representative D) Testator Answer: D Solution: In your will, you’ll need to name the person who will handle the settlement of your estate, called the executor (if male), executrix (if female), or, in some cases,

personal representative. This person has the legal and ethical obligation to distribute your assets as you have directed and to pay taxes according to the law. Format: Multiple Choice Title: Test Bank 14.2 Common Elements of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 37. The _______ has the legal and ethical obligation to distribute your assets as you have directed and pay taxes according to the law. A) executor B) testator C) codicil D) beneficiary Answer: A Solution: In your will, you’ll need to name the person who will handle the settlement of your estate, called the executor (if male), executrix (if female), or, in some cases, personal representative. This person has the legal and ethical obligation to distribute your assets as you have directed and to pay taxes according to the law. Format: Multiple Choice Title: Test Bank 14.2 Common Elements of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 38. _________ is a legal term for the process of signing and witnessing a document to make it legally valid. To be properly executed, a will generally must be in writing and signed by the testator in the presence of at least two witnesses. A) Appointment B) Execution C) Escheat D) Probate Answer: B Solution: Execution is a legal term for the process of signing and witnessing a document to make it legally valid. To be properly executed, a will generally must be in writing and signed by the testator in the presence of at least two witnesses. Format: Multiple Choice Title: Test Bank 14.2 Common Elements of a Will

Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 39. ________ of estates receive the assets. A) Executors B) Testators C) Beneficiaries D) Guardians Answer: C Solution: A will enables the person writing it, the testator, to direct the disposition of his or her assets to specific beneficiaries, those who will receive the assets. A guardian takes care of minor children as a trustee, who will manage their inheritance until they reach the age you have designated in your will. Format: Multiple Choice Title: Test Bank 14.2 Preparing a Valid Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 40. In community property states, any property owned by one spouse is assumed to be owned by both spouses, A) regardless of who acquired it or when it was acquired. B) if acquired during the marriage. C) if acquired before the marriage. D) upon the death of a spouse. Answer: B Solution: In community property states, it is assumed that any property acquired during the marriage is owned jointly by both spouses. One spouse’s share of the property, as in a tenancy in common, can be willed to someone other than the surviving spouse. Format: Multiple Choice Title: Test Bank 14.2 Community Property Section: Passing Property Outside a Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

41. If Mark Johnson were to name his two grown children as those who receive the inheritance when he dies, what do his two children represent as a party to the will? A) Testators B) Executors C) Witnesses Beneficiaries Answer: D Solution: A will enables the person writing it, the testator, to direct the disposition of his or her assets to specific beneficiaries, those who will receive the assets. Format: Multiple Choice Title: Test Bank 14.2 Inheritance Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 42. Under requirements for a valid will, what area does “being of sound mind and body” cover? A) Legal age B) Named representative C) Witnesses Capacity Answer: D Solution: Many wills begin with the language “I, [testator name], being of sound mind and body. . . .” In this context, “of sound mind” addresses the requirement of legal capacity. The testator is considered to be of sound mind if he or she understands the nature and content of the document, is mentally capable of making decisions regarding the distribution of his or her assets, and is not acting under threat or coercion from another person. Format: Multiple Choice Title: Test Bank 14.2 Requirements for a Valid Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 43. If your estate is complex, you should consider naming a(n) ________ as executor. A) lawyer B) smart family member C) spouse D) trusted friend

Answer: A Solution: If your estate is complex, your attorney may suggest that you name a lawyer or bank trust department instead of a family member to fill this role. You should also be realistic about the other time commitments of any person you’re considering naming as your executor and should consider whether the person lives close enough to handle the details of financial transactions related to settlement of the estate. Format: Multiple Choice Title: Test Bank 14.2 Requirements for a Valid Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 44. Lucinda Morales has three small children and is preparing a will. In addition to a guardian, who will take care of her children and what other individual should she name to manage their inheritance? A) Trustee B) Testator C) Beneficiary D) Executor Answer: A Solution: If you have minor children, your will should identify a guardian who will take care of them and a trustee who will manage their inheritance until they reach the age you have designated in your will. Format: Multiple Choice Title: Test Bank 14.2 Common Elements of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 45. If a question of mental capacity could arise during a modification of a will, what is the recommended action to maintain the validity of the will? A) Have a family member sign an addendum to the will attesting to the testator’s soundness of mind and body. B) Have beneficiaries sign a notarized statement declaring the intent to receive an inheritance. C) Have witnesses sign a notarized statement declaring the testator is acting in full mental capacity.Have the testator sign a notarized statement declaring the beneficiaries’ validity to receive the inheritance.

Answer: C Solution: To make small changes to your will, you can write a codicil, a short document that reaffirms your original will except for a small provision that is being changed. Because the codicil is a legal document, it should be drawn up, be executed, and have witnesses sign a notarized statement declaring the testator is acting in full mental capacity. Format: Multiple Choice Title: Test Bank 14.2 Making Changes to Your Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 46. Which is not a requirement to show the mental capacity to make a will? A) You must understand the nature and extent of your assets. B) You must understand to whom you intend your assets to be distributed. C) You must understand how the executor will distribute the assets. D) You must understand how you are distributing your assets. Answer: C Solution: To show you have the mental capacity to make a will, you must understand the nature and extent of your assets, to whom you intend your assets to be distributed and how you are distributing your assets. Format: Multiple Choice Title: Test Bank 14.2 Mental Capacity to Make A Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 47. What element of a will discusses funeral expenses? A) Appointment of executor B) Payment of debts and taxes C) Distribution of assets D) Execution of will Answer: B Solution: Payment of debts and taxes is the clause that instructs the estate to pay your debts and expenses, including funeral expenses, medical expenses, and any taxes due. Format: Multiple Choice Title: Test Bank 14.2 Common Elements of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs.

Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 48. The appointment of a(n) ________ identifies who will take care of a person’s children upon death. A) beneficiary B) trustee C) executor D) guardian Answer: D Solution: If you have minor children, your will should identify a guardian who will take care of them and a trustee who will manage their inheritance until they reach the age you have designated in your will. The same person often serves as both guardian and trustee and is commonly the child’s other parent or an adult sibling. Format: Multiple Choice Title: Test Bank 14.2 Common Elements of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 49. Medical expenses are covered under which element of a will? A) Appointment of an executor or executrix B) Distribution of assets C) Execution D) Payment of debts and taxes. Answer: D Solution: Payment of debts and taxes is the clause that instructs the estate to pay your debts and expenses, including funeral expenses, medical expenses, and any taxes due. Format: Multiple Choice Title: Test Bank 14.2 Common Elements of a Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 50. To make small changes to a will, you write a(n) A) tenancy agreement. B) escheat.

C) intestate. D) codicil. Answer: D Solution: To make small changes to your will, you can write a codicil, a short (usually single-page) document that reaffirms your original will except for a small provision that is being changed. Because the codicil is a legal document, it should be drawn up, executed, and witnessed in the same way as a will. Format: Multiple Choice Title: Test Bank 14.2 Making Changes to Your Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 51. Frank Johnson wants to make a small change to his will. He should write a A) codicil. B) distribution modification. C) joint tenancy. D) community addendum. Answer: A Solution: To make small changes to your will, you can write a codicil, a short (usually single-page) document that reaffirms your original will except for a small provision that is being changed. Because the codicil is a legal document, it should be drawn up, executed, and witnessed in the same way as a will. Format: Multiple Choice Title: Test Bank 14.2 Making Changes to Your Will Section: Preparing a Valid Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 52. When two people own property together, one way for them to automatically avoid probate is to A) name each other as executor. B) own the property in joint tenancy with right of survivorship. C) witness each other’s wills. D) serve as each other’s guardians. Answer: B Solution: When two people own property in a joint tenancy with right of survivorship, the ownership of the property automatically passes to the surviving owner upon the death of

the other, without going through probate. The property will also be free of claims from creditors (except for collateralized loans, e.g., mortgages), other heirs, or executors. Joint ownership of this type is not divided; all the owners share ownership of the entire property. Format: Multiple Choice Title: Test Bank 14.2 Ownership of Assets Section: Passing Property Outside a Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 53. One of the disadvantages of ________ with right of survivorship is that you have no say over what happens to the property after you die. A) community property B) sole tenancy C) joint tenancy tenancy in common Answer: C Solution: A disadvantage of joint tenancy with right of survivorship as an estate-planning tool is that you have no say over what happens to the property after you die. If you die first, the property belongs to your joint tenant. If your joint tenant is your spouse and you die first, your spouse can leave the entire property to children from a previous marriage. Format: Multiple Choice Title: Test Bank 14.2 Ownership of Assets Section: Passing Property Outside a Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 54. The type of ownership in which you maintain the right to transfer your ownership of an asset independently of the person with whom you share the asset is known as A) joint tenancy with right of survivorship. B) tenancy in common. C) beneficiary tenancy. D) community tenancy. Answer: B Solution: Tenancy in common retains the right to transfer his or her ownership interest independently. Your portion of the property will be included in your estate and passed by the terms of your will. Format: Multiple Choice Title: Test Bank 14.2 Ownership of Assets

Section: Passing Property Outside a Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 55. How would you own a vacation cottage with your brother and retain the right to transfer your ownership interest to your spouse, upon death? A) Joint tenancy B) Tenancy in common C) Community property D) Right of survivorship Answer: B Solution: Tenancy in common retains the right to transfer his or her ownership interest independently. Your portion of the property will be included in your estate and passed by the terms of your will to your spouse. Format: Multiple Choice Title: Test Bank 14.2 Ownership of Assets Section: Passing Property Outside a Will Learning Objective: 14.2 Explain the importance of having a valid will and arranging in advance for easy transfer of assets to your heirs. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 56. With the passage of the _______________, Congress has reduced the likelihood that you will personally be subject to the estate or gift tax. A) American Tax Relief Act of 2012 B) Tax Cuts and Jobs Act of 2017 C) Patient Protection and Affordable Care Act of 2010 D) Consumer Financial Protection Act of 2010 Answer: B Solution: The Tax Cuts and Jobs Act of 2017 significantly reduced the likelihood that you will personally be subject to the estate or gift tax. Under the current law, individual estates are allowed an exemption of $11.4 million ($22.8 million per married couple) in 2019, less any lifetime gifts in excess of the annual limits. Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Taxes Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic

Expected Time to Complete: 1 minute 57. The federal estate tax rate A) is a progressive tax with the highest marginal rate at 55 percent. B) is a flat tax of 40 percent on the gross estate. C) is assessed only on the amount of an estate that exceeds the exemption amount. D) has increased in the past 20 years. Answer: C Solution: The federal estate tax rate is assessed only on the amount of an estate that exceeds the exemption amount. Under the current law, individual estates are allowed an exemption of $11.4 million ($22.8 million per married couple) in 2019, less any lifetime gifts in excess of the annual limits. Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Tax Rate Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 58. Which of the following is true of the estate tax? A) The unified exemption is gradually being reduced. B) The unified exemption increases annually with inflation. C) The maximum tax rate is the highest it has ever been. D) If your estate owes federal estate taxes, it will also owe state estate taxes. Answer: B Solution: Under the current law, individual estates are allowed an exemption of $11.4 million ($22.8 million per married couple) in 2019, less any lifetime gifts in excess of the annual limits. This exemption is referred to as the federal unified credit for estates and gifts. The amount of your estate that exceeds the allowed exclusion, which will increase with inflation over the years, is subject to the estate tax. Format: Multiple Choice Title: Test Bank 14.3 Unified Credit Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 59. The estate tax in the United States is a(n) A) flat tax. B) regressive tax. C) progressive tax.

D) income tax. Answer: C Solution: The amount of your estate that exceeds the allowed exclusion (which will increase with inflation over the years) is subject to a progressive tax rate schedule with a maximum rate of 40 percent. Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Taxes Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 60. Michael Johnson, an attorney for the estate of Marcus Williamson III, has to file a gift tax return. What paperwork should he file? A) IRS Form 709 B) IRS Schedule 1 C) IRS Form 1040 D) IRS Schedule 4 Answer: A Solution: Under federal law, you may be subject to a tax on gifts you make during your lifetime if they exceed certain limits. You and your spouse can each give up to $15,000 per person in 2019 and 2020 (increasing with inflation) to as many people as you like. If you give more than the allowed annual amount to anyone, you have to file a gift tax return (IRS Form 709), and the excess amount will be applied to reduce the amount of your estate that is exempt from the estate tax. Format: Multiple Choice Title: Test Bank 14.3 Federal Gift Taxes Section: Federal Gift Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 61. Under 2020 tax law, you and your spouse can give up to A) $14,000 per person to as many people as you like each year. B) $14,000 per person as long as it’s not your children. C) $15,000 per person to as many people as you like each year. D) $15,000 per person as long as it’s not your children. Answer: C Solution: You and your spouse can each give up to $15,000 per person in 2019 and 2020 (increasing with inflation) to as many people as you like.

Format: Multiple Choice Title: Test Bank 14.3 Federal Gift Taxes Section: Federal Gift Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 62. In 2020, you gave $15,000 to your brother, $25,000 to your wife, $17,000 to your daughter’s college tuition, and $5,000 to your sister. How much will you owe gift tax on? A) $12,000 B) $10,000 C) $2,000 D) $0 Answer: D Solution: You and your spouse can each give up to $15,000 per person in 2019 and 2020 (increasing with inflation) to as many people as you like. There are two important exceptions to the limits on gifts. First, there is no limit on how much you can give your spouse. Second, there is no limit on gifts for the payment of medical expenses or certain educational costs, provided that you make the payments directly to the service provider or educational institution. This means that the bill for your daughter’s college tuition and the gift to your wife does not exceed gifting limits. Format: Multiple Choice Title: Test Bank 14.3 Federal Gift Tax Calculation Section: Federal Gift Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 2 minutes 63. Patrick O’Riley, a single man with no children, has a taxable estate of $17.47 million. What is the amount the government will levy an estate tax upon? A) $17.47 million B) $11.4 million C) $6.07 million D) $0

million less the Federal unified credit exemption ($11.4 million in 2019) is $6.07 million taxable estate subject to estate tax. Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Tax Calculation Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 64. Lionel’s gross estate is $21 million. Estate expenses and debts total $500,000. His will leaves $6 million to Colorado State University and the remainder of his estate to his son, Lionel Jr. How much of Lionel’s estate will be subject to the federal estate tax in 2019? A) $14.5 million B) $9.1 million C) $3.1 million D) $0

Answer: C Solution: Under the current law, individual estates are allowed an exemption of $11.4 million ($22.8 million per married couple) in 2019, less any lifetime gifts in excess of the annual limits. This exemption is referred to as the federal unified credit for estates and gifts. The amount of your estate that exceeds the allowed exclusion (which will increase with inflation over the years) is subject to estate tax. Lionel’s gross estate of $21 million less estate debt and expenses of $500,000 is $20.5 million adjusted gross estate. Then subtract the $6 million charitable deduction to Colorado State University to get the taxable estate of $14.5 million. Then subtract the federal unified credit exemption ($11.4 million in 2019) to get $3.1 million taxable estate subject to tax. Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Tax Calculation Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Analysis AACSB: Analytic Expected Time to Complete: 1 minute 65. Lionel’s gross estate is $25 million. Estate expenses and debts total $500,000. His will leaves $1 million to Colorado State University and the remainder of his estate to his wife, Marilyn. How much of Lionel’s estate will be subject to estate tax in 2019? A) $23,500,000 B) $12,100,000 C) $700,000 D) $0

Answer: D Solution: An important feature of estate tax law for married couples is that the surviving spouse can inherit the entire estate without paying any tax, regardless of the size of the estate. Therefore, the primary purpose of estate tax planning is actually to minimize the taxes payable by your surviving spouse’s estate (or your estate if you leave your wealth to someone other than your spouse). Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Tax Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 66. There is no federal estate tax due in 2019 for individual estates of less than A) $5.45 million. B) $10 million. C) $11.4 million. D) $22.8 million. Answer: C Solution: Under the current law, individual estates are allowed an individual exemption of $11.4 million ($22.8 million per married couple) in 2019, less any lifetime gifts in excess of the annual limits. This exemption is referred to as the federal unified credit for estates and gifts. The amount of your estate that exceeds the allowed exclusion (which will increase with inflation over the years) is subject to estate tax. Format: Multiple Choice Title: Test Bank 14.3 Federal Unified Credit for Estates and Gifts Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 67. Which of the following statements is false regarding federal gift taxes? A) Monetary gifts of any amount given to children are not taxed. B) There is no gift tax on payments for medical or educational costs if made directly to the provider of the service. C) You can give your spouse an unlimited amount and not pay gift taxes. D) If you and your spouse have one child, he or she can be given $30,000 a year and there will be no gift taxes. Answer: A Solution: Under federal law, you may be subject to a tax on gifts you make during your lifetime if they exceed certain limits. You and your spouse can each give up to $15,000

per person in 2019 and 2020 (increasing with inflation) to a child or to as many people as you like for an annual total of $30,000, without gift tax. Format: Multiple Choice Title: Test Bank 14.3 Federal Gift Taxes Section: Federal Gift Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 68. In 2019, a married couple’s estate is allowed a federal estate tax exemption of A) $10 million. B) $11.4 million. C) $20 million. D) $22.8 million Answer: D Solution: Under the current law, individual estates are allowed an exemption of $11.4 million ($22.8 million per married couple) in 2019. Format: Multiple Choice Title: Test Bank 14.3 Federal Unified Credit for Estates and Gifts Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 69. As the executor of an estate, Blaine Thomas is calculating an estate tax for John and Marsha Williamson, who passed away last year. What can be used to reduce the Williamson’s adjusted gross estate? A) Life insurance B) Estate administration fees C) Charitable gifts D) Federal unified credit exemption Answer: B Solution: Estate administration fees are part of estate expenses that can be used to reduce the adjusted gross estate. Life insurance is an excluded asset and cannot be used to reduce the estate. Charitable gifts and the federal unified credit exemption are used to reduce the taxable estate. Format: Multiple Choice Title: Test Bank 14.3 Adjusted Gross Estate

Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 70. Which gift category has an annual limit on the amount that can be given? A) Gifts for the payment of medical expenses paid directly to the care provider B) Gifts for the payment of educational expenses paid directly to the institution C) Gifts to a spouse D) Gifts to children Answer: D Solution: Gifts to children are subject to annual gifting limits. There are two important exceptions to the limits on gifts. First, there is no limit on how much you can give your spouse. Second, there is no limit on gifts for the payment of medical expenses or certain educational costs, provided that you make the payments directly to the service provider or educational institution. Format: Multiple Choice Title: Test Bank 14.3 Federal Gift Tax Exemptions Section: Federal Gift Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 71. Who can inherit an unlimited estate without being subject to federal estate tax? A) Spouse B) Grandchildren C) Children D) Parents Answer: A Solution: An important feature of estate tax law for married couples is that the surviving spouse can inherit the entire estate without paying any tax, regardless of the size of the estate. Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Tax Exemptions Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

72. Martha Lincoln’s husband passed away unexpectedly last year. His sole estate was bequeathed to her, and in the event of her passing, was to go to his children. Martha has a $25 million taxable estate. If she dies this year, what tax rate will her beneficiaries have to pay under current law? A) 0 percent B) 10 percent C) 20 percent 40 percent Answer: D Solution: The amount of your estate that exceeds the allowed exclusion (which will increase with inflation over the years) is subject to a progressive tax rate schedule with a maximum rate of 40 percent on estates above the exemption amount. Format: Multiple Choice Title: Test Bank 14.3 Federal Estate Maximum Tax Rate Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 73. If you choose to not give away some of your wealth while you are alive, how can you avoid estate tax? A) Make personal gifts in excess of annual exclusion after death. B) Make charitable gifts. C) Make irrevocable trusts. D) Make your grandchildren beneficiaries. Answer: B Solution: There is an unlimited charitable gift adjustment to your taxable estate. Gifts used to fund irrevocable trusts must be gifted when alive, as well as any other gifts that may use the unified credit. Your children and all generations are subject to estate tax prior to receiving assets. Format: Multiple Choice Title: Test Bank 14.3 Reduction to Federal Estate Taxes Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 74. Which asset must be included in your gross estate for federal estate tax calculations? A) Life insurance held in irrevocable trust B) Residence held in irrevocable trust C) Assets transferred through family limited partnerships

D) Ownership interest in a family corporation Answer: D Solution: Life insurance held in irrevocable trust, any other irrevocable trust assets (including residential real estate), and assets transferred through family limited partnerships are excluded assets in the gross estate. Shares in any corporation or business are included in the gross estate. Format: Multiple Choice Title: Test Bank 14.3 Gross Estate Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 75. Which of the following is excluded from your gross estate for federal estate tax calculations? A) Stock held in 401(k) B) Savings accounts held in joint tenant C) Investment held in IRA D) Stocks held in an irrevocable trust Answer: D Solution: All assets held in irrevocable trusts are excluded in your gross estate. Assets held at a custodian, like retirement accounts, are part of your gross estate. Assets held in join tenant are included in the gross estate. Format: Multiple Choice Title: Test Bank 14.3 Gross Estate Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 76. Your gross estate is not reduced by _________ to arrive at your adjusted gross estate. A) funeral costs B) estate administration fees C) charitable bequests D) court fees Answer: C Solution: Estate expenses, such as funeral expenses, executor’s fee, legal fees, court fees, and estate administration fees, reduce the gross estate. Charitable gifts are used to reduce the taxable estate, not adjusted gross estate. Format: Multiple Choice Title: Test Bank 14.3 Gross Estate

Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 77. To arrive at your adjusted gross estate for federal estate tax calculations, reduce the gross estate by the A) estate expenses. B) marital bequests. C) charitable bequests. D) federal unified credit exemption. Answer: A Solution: Adjusted gross estate = Gross estate − Estate expenses Format: Multiple Choice Title: Test Bank 14.3 Adjusted Gross Estate Section: Federal Estate Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 78. Inheritances account for ________ of all wealth in the United States. A) 10 percent B) 25 percent C) 40 percent D) 75 percent Answer: C Solution: Inheritances account for 40 percent of all wealth in the United States. Format: Multiple Choice Title: Test Bank 14.3 Inheritances in the United States Section: Estate and Gift Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 79. States have set their exemption amount A) at the same level as the federal unified credit. B) lower than the federal unified credit. C) higher than the federal unified credit.

D) at various levels. Answer: D Solution: States have set their own estate tax exemption amounts. Several states have repealed their estate tax laws altogether in the last few years. In addition, some states have set their exemption amount at the same level as the federal unified credit, and others are gradually phasing in the increase. Format: Multiple Choice Title: Test Bank 14.3 State Death Taxes Section: State Death Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 80. ____________ states in the United States impose estate or inheritance taxes. A) No B) Only a few C) About half of the D) The majority of the Answer: B Solution: As of 2019, the District of Columbia and 12 states imposed estate or inheritance taxes in the United States. Format: Multiple Choice Title: Test Bank 14.3 State Death Taxes Section: State Death Taxes Learning Objective: 14.3 Explain recent changes to federal estate and gift taxation laws that significantly reduce the number of estates that have to pay these taxes. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 81. Legal entities into which you can move your assets are called A) trusts. B) probates. C) beneficiaries. D) estates. Answer: A Solution: Legal entities into which you can move your assets are called trusts. Format: Multiple Choice Title: Test Bank 14.4 Trusts Section: When Are Trusts Useful? Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 82. Trusts are complicated mechanisms that will not A) get tied up in probate court. B) bypass probate court. C) remove property from the taxable estate. D) ensure that the estate achieves certain purposes after the grantor’s death. Answer: A Solution: Trusts are used in estate planning for several purposes to bypass probate, provide your heirs with immediate access to the property upon your death by removing property from the taxable estate, and ensure that the estate achieves certain purposes after the grantor’s death, such as providing income to surviving dependents. Format: Multiple Choice Title: Test Bank 14.4 When Are Trusts Useful? Section: When Are Trusts Useful? Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 83. A person or entity who sets up a trust and transfers assets to the trust is the A) grantor. B) trustee. C) testator. D) grantee. Answer: A Solution: The grantor, the person putting the assets in a trust, transfers the assets to the trust, which is managed by a trustee for the benefit of the beneficiary of the trust. Format: Multiple Choice Title: Test Bank 14.4 Grantor Section: When Are Trusts Useful? Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 84. Which of the following does not provide trustee services? A) Insurance brokers B) Banks C) Financial institutions

D) Law firms Answer: A Solution: Trustee services are commonly provided by banks, financial institutions, and law firms. Format: Multiple Choice Title: Test Bank 14.4 Trustee Services Section: When Are Trusts Useful? Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic Expected Time to Complete: 1 minute 85. Which of the following is not a characteristic of a revocable trust? A) Grantor can change the terms of the trust. B) It is not subject to federal estate taxes. C) It bypasses probate. D) It takes effect on the death of the person who creates it. Answer: B Solution: A revocable trust will bypass probate, but because you retain the right to change the terms of the trust during your lifetime, the trust assets will still be subject to any applicable state and federal estate taxes. Format: Multiple Choice Title: Test Bank 14.4 Revocable Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 86. Blake Mortinsson’s primary goal is to reduce estate taxes by setting up a trust. Which type of trust should he create? A) Irrevocable B) Revocable C) Living D) Testamentary Answer: A Solution: If your primary purpose is to reduce estate taxes, then you’ll need to set up an irrevocable trust, which means that you can’t change the terms of the trust once it is established. Irrevocable trusts bypass probate and are not subject to federal or state estate taxes. Format: Multiple Choice Title: Test Bank 14.4 Trusts That Reduce Estate Tax

Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 87. Brian Alfredson would like to set up a trust with the power to change the terms of the trust while he’s alive. Which type of trust should he create? A) Irrevocable B) Revocable C) Testamentary D) Charitable remainder Answer: B Solution: If you want to retain the right to change the terms of the trust during your lifetime, you can setup a revocable trust. Testamentary trusts are formed by will at death. Irrevocable trusts, such a charitable remainder trust, do not allow the grantor any authority. Format: Multiple Choice Title: Test Bank 14.4 Types of Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 88. A living trust takes effect A) now. B) upon death. C) upon birth of a beneficiary. D) upon creation of an estate. Answer: A Solution: A living trust that takes effect now and a testamentary trust that is created by your will at the time of your death. Format: Multiple Choice Title: Test Bank 14.4 Types of Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute

89. A testamentary trust is created A) through the provisions of a will. B) by the probate court. C) by the grantor. D) by the power of attorney. Answer: A Solution: A testamentary trust is created by your will at the time of your death. A living trust created by the grantor. Format: Multiple Choice Title: Test Bank 14.4 Types of Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 90. If a charity is already exempt from estate taxes, what is the purpose of setting up a charitable trust? A) It allows a charity to benefit from your assets during your lifetime while allowing you to retain the use of, or the income from, the asset. B) It allows a charity to receive a credit from the government for the charitable institution. C) It allows the trust to generate more income than a charity could generate. D) It provides tax credits to the charitable institution. Answer: A Solution: The objective of a charitable trust is to allow a charity to benefit from your assets during your lifetime while allowing you to retain the use of, or the income from, an asset and to take an income tax deduction for the charitable donation. Format: Multiple Choice Title: Test Bank 14.4 Charitable Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 91. A ________ trust allows you to give away an asset but retains the cash flow generated by that asset during your lifetime. A) charitable remainder B) charitable lead C) charitable income

D) irrevocable Answer: A Solution: A charitable remainder trust allows you to give away an asset but retains the cash flow generated by that asset during your lifetime. It is called “remainder” because the charity gets the remainder of the trust assets after your death. Format: Multiple Choice Title: Test Bank 14.4 Charitable Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 92. What is the difference between a charitable remainder trust and a charitable lead trust? A) A charitable remainder trust allows the grantor to retain the cash flows of the donated asset, while the charitable lead trust provides income to the charity, after which the property goes to a beneficiary of your designation. B) A charitable lead trust allows the grantor to retain the cash flows of the donated asset, while the charitable remainder trust provides income to the charity, after which the property goes to a beneficiary of your designation. C) Both a charitable lead trust and a charitable remainder trust allow the grantor to retain the cash flows of the asset given to the trust and the charity to possess the asset after the grantor’s death. D) Both a charitable lead trust and a charitable remainder trust allow the charity to maintain both the asset and the income generated by the asset. Answer: A Solution: A charitable remainder trust allows you to give away an asset but retains the cash flow generated by that asset during your lifetime. It is called “remainder” because the charity gets the remainder of the trust assets after your death. In contrast, a charitable lead (or income) trust provides income to the charity during your lifetime or for a period of years, after which the property goes to a beneficiary of your designation. It is called an income trust because the charity gets the income, not the assets. If you set up this type of trust, you get an immediate income tax deduction for the present value of the expected future income to be received by the charity. Format: Multiple Choice Title: Test Bank 14.4 Charitable Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Hard Bloomcode: Evaluation AACSB: Analytic Expected Time to Complete: 3 minutes

93. Joe wants to create a trust where he can provide for his pet’s care with the annual income and then receive a tax deduction for a donation to the ASPCA of the balance. Which of the following should he choose? A) Testamentary trust B) Charitable remainder trust C) Charitable lead trust D) Revocable trust Answer: B Solution: A charitable remainder trust allows you to give away an asset, such as a donation to the ASPCA, but retains the cash flow generated by that asset during the lifetime of his pet. It is called “remainder” because the charity gets the remainder of the trust assets after your death. Format: Multiple Choice Title: Test Bank 14.4 Charitable Trusts with Income Use Section: 14.4 Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 2 minutes 94. Quentin wants to reduce his taxable estate by $5 million. He doesn’t care about the income from the assets but wishes his children receive all the assets upon his death. He has a disdain for the government and does not want to pay any estate tax and as little income tax as possible. Which of the following should he choose? A) Charitable lead trust B) Charitable remainder trust C) Testamentary trust D) Revocable trust Answer: B Solution: A charitable lead (or income) trust provides income to the charity during your lifetime or for a period of years, after which the property goes to a beneficiary of your designation. It is called an income trust because the charity gets the income, not the assets. If you set up this type of trust, you get an immediate income tax deduction for the present value of the expected future income to be received by the charity and the exclusion of the trust asset from your gross estate. Format: Multiple Choice Title: Test Bank 14.4 Charitable Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Hard Bloomcode: Synthesis AACSB: Analytic Expected Time to Complete: 3 minutes

95. Taxes payable on tax-deferred retirement plans can be avoided by A) making your spouse the beneficiary. B) making your grandchildren the beneficiary. C) gifting the tax-deferred retirement plan assets to your spouse. D) gifting the tax-deferred retirement plan assets to a charity. Answer: D Solution: Charitable gifts will never be subject to estate taxation. You can also reduce the taxes payable upon your death by gifting your tax-deferred retirement plan assets to a charity. Because the contributions to these accounts are made with pretax dollars, the assets will be subject to income tax when distributed (while you’re alive or after you die). Such taxes can be avoided, however, if you specifically designate in your will that qualified retirement account assets will go to a charity. Although gifting a spouse will avoid estate taxes, it will not avoid income tax on tax-deferred accounts. Format: Multiple Choice Title: Test Bank 14.4 Gifting Alternatives Section: Gifting Alternatives Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 96. Which of the following is not a purpose for using a trust in estate planning? A) To bypass the IRS B) To bypass probate C) To remove property from taxable estates D) To ensure that the estate achieves certain purposes after death Answer: A Solution: For many estate plans, it’s desirable to set up legal arrangements called trusts. A trust is a legal entity that holds and manages assets on behalf of someone else. Trusts are commonly used in estate planning for a variety of purposes but most importantly to use tax avoidance strategies approved by the IRS. Format: Multiple Choice Title: Test Bank 14.4 Trusts in Estate Planning Section: When Are Trusts Useful? Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 97. How does a trust minimize estate taxes owed? A) It removes property from the taxable estate. B) It bypasses probate.

C) It ensures that the estate achieves certain purposes. D) It hides assets. Answer: A Solution: Irrevocable trusts minimize estate taxes by removing property from the gross estate. Irrevocable trusts are not subject to federal or state estate taxes because the trust doesn’t die. Format: Multiple Choice Title: Test Bank 14.4 Types of Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute 98. Margaret wants to set up a charitable trust to minimize her estate taxes. Which of the following should she do first? A) Consult with an experienced estate-planning lawyer. B) Implement her trust plan. C) Decide which assets she wants to gift to the trust. D) Figure out if she is exempt from federal estate taxes already. Answer: A Solution: She should consult with an experienced estate-planning lawyer. Charitable trusts require complex tax planning that encompasses qualified charitable organizations, IRS rules on calculating present value of donations, and rules on gifts to irrevocable trusts. Format: Multiple Choice Title: Test Bank 14.4 Charitable Trusts Section: Types of Trusts Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 99. Fran Schmidt is advising her client on general ways for her to reduce the size of her taxable estate. Which of the following will she likely suggest? A) Gifting assets B) Unloading assets offshore C) Investing in tax-free assets D) Spending all monies until the exemption amount is reached Answer: A

Solution: The most common method in reducing the size of an estate is through gifting. Gifting must be done within the annual limits or using the federal unified credit for estates while alive. Charitable gifts can be made at death or while alive. Format: Multiple Choice Title: Test Bank 14.4 Estate and Gift Taxes Section: Estate and Gift Taxes Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Application AACSB: Analytic Expected Time to Complete: 1 minute 100. How does a trust benefit your heirs with immediate access to assets upon your death? A) Assets in the trust bypass the probate process. B) Assets in the trust are removed from the estate. C) Assets in the trust provide income to surviving family. D) Assets in all trusts are exempt from estate taxes. Answer: A Solution: A trust will bypass probate, which benefits your heirs with immediate access to the assets upon your death. Format: Multiple Choice Title: Test Bank 14.4 When Are Trusts Useful? Section: When Are Trusts Useful Learning Objective: 14.4 Understand how trusts, gifts, and charitable contributions can reduce estate taxes. Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic Expected Time to Complete: 1 minute