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Chapter 27 Study Guide

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Multiple ChoiceEdit

1. Suppose you put $350 into a bank account today. Interest is paid annually at a rate of 6 percent. The future value of the $350 after four years is

  • a. $414.09.
  • b. $434.00.
  • c. $441.87.
  • d. $481.24.
  • e. $371.00.

2. Compounding refers directly to

  • a. finding the present value of a future sum of money.
  • b. finding the future value of a present sum of money.
  • c. changes in the interest rate over time on a bank account or a similar savings vehicle.
  • d. interest being earned on previously earned interest.
  • e. interest being earned on the principle invested.

3. The future value of a deposit in a savings account will be larger

  • a. the more time a person waits to withdraw the funds.
  • b. the lower the interest rate is.
  • c. the larger the initial deposit is.
  • d. the smaller the initial deposit is.
  • e. the less frequent compounding takes place.

4. At an annual interest rate of 10 percent, about how many years will it take $100 to double in value?

  • a. 5
  • b. 7
  • c. 9
  • d. 11
  • e. 12

5. Four people go to the bank to cash in their accounts. Amy had her money in an account for twenty-five years at 4 percent interest. Bill had his money in an account for twenty years at 5 percent interest. Celia had her money in an account for five years at 20 percent interest. Lefty had his money in an account for three years at 25 percent interest. If each of them originally deposited $500 in their accounts, which of them gets the most money when they cash in their accounts?

  • a. Amy
  • b. Bill
  • c. Celia
  • d. Lefty
  • e. They each get the same amount.

6. Suppose the interest rate is 7 percent. Consider five payment options:

  • Option A. $500 today.
  • Option B. $550 one year from today.
  • Option C. $575 two years from today.
  • Option D. $600 three years from today.
  • Option E. $700 ten years from today.

Which of the payments has the highest present value today?

  • a. Option A
  • b. Option B
  • c. Option C
  • d. Option D
  • e. Option E

7. Other things the same, an increase in the interest rate makes the quantity of loanable funds demanded

  • a. rise and investment spending rise.
  • b. rise and investment spending fall.
  • c. fall and investment spending rise.
  • d. fall and investment spending fall.
  • e. fall, but the quantity of investment spending is indeterminate.

8. Using the rule of 70, about how much would $100 be worth after fifty years if the interest rate were 7 percent?

  • a. $400
  • b. $500
  • c. $800
  • d. $1,600
  • e. $3,200

9. Which of the following best illustrates diversification?

  • a. A company that produces many different products decides to produce fewer.
  • b. After selling stock, corporate management spends funds on projects with greater risks than shareholders had anticipated.
  • c. Instead of holding only the stocks of companies engaged in the banking business, a person decides to hold stock in a number of different companies producing different goods and services.
  • d. A person decides to purchase only stocks that have paid high dividends in the past.
  • e. Instead of holding only the stocks of companies engaged in the banking business, a person decides to hold only stocks in the pharmaceutical business.

10. Which of the following actions best illustrates adverse selection?

  • a. A person purposely chooses bonds of corporations with high default risk because of the high returns.
  • b. A person dislikes losing $400 more than he likes winning $400.
  • c. After obtaining automobile insurance, a person drives less carefully than before.
  • d. A person intending to take up dangerous hobbies applies for life insurance.
  • e. A person decides to buy products that are harmful.

11. The problem of moral hazard arises because

  • a. life is full of all sorts of risks.
  • b. after people buy insurance, they have less incentive to be careful about their risky behavior.
  • c. a high-risk person is more likely to apply for insurance than is a low-risk person.
  • d. insurance companies go to great effort to avoid paying claims to their policyholders.
  • e. people make choices in the market for some products that are illegal.

12. In which of the following games is it conceivable that a risk-averse person might be willing to play?

  • a. a game where she has a 50 percent chance of winning $1 and a 50 percent chance of losing $1
  • b. a game where she has a 50 percent chance of winning $100 and a 50 percent chance of losing $100
  • c. a game where she has a 60 percent chance of winning $1 and a 40 percent chance of losing $1
  • d. a game where she has a 40 percent chance of winning $1 and a 60 percent chance of losing $1
  • e. A risk-averse person would find all of these games equally not worth playing.

AnswersEdit

  1. C
  2. D
  3. A
  4. B
  5. A
  6. B
  7. D
  8. E
  9. C
  10. D
  11. B
  12. C
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